TSI Special Edition: Beyond the Palestinian Financial Crisis

Last February, the Palestinian Authority stopped accepting trade tax revenues that Israel collects on their behalf, after Israel deducted an amount equivalent to that paid by the PA to the families of Palestinian prisoners in Israeli jails. Under the Paris Protocol, the economic chapter of the Oslo Accords, Israel collects taxes due on products and services traded with the Palestinian economy in the West Bank and Gaza Strip and clears these dues on a monthly basis with the PA. These payments are around $222 million each month, by which Israel usually deducts payment for electricity, water, sewage and medical treatment service. Israel then transfers the balance to the PA after deducting a 3% administrative fee as agreed upon in the Paris Protocol.

The Israeli move came amid a more than 50% decrease in international aid to the Palestinians. This further aggravated the PA’s chronic financial crisis, pushing it to cut all employees’ salaries to around 60% between March and September, put on hold all payments due to private sector contractors, and borrow hundreds of millions of dollars from private banks to ensure survival.

On the verge of insolvency and facing a growing liquidity crisis, the PA revisited its decision and resumed taking Israeli collected tax money in the beginning of October. Minister of Civil Affairs Hussein Al Sheikh said that following understandings reached with Israeli Finance Minister Moshe Kahlon, both sides agreed to reactivate joint technical committees to resolve all pending financial disputes, and for Israel to transfer a large portion of accumulated PA financial dues.

Hussein Al Sheikh, Head of Palestinian Civil Affairs Commission and Fatah Central Committee Member, announcing agreement with Israel to transfer payment from the PA's financial dues

Beyond the Palestinian Financial Crisis:
The Equation of Economic Disengagement from Israel
Raja Al-Khaldi

a. Background

Despite widespread Palestinian resentment of the Paris Protocol and the overall Oslo arrangements, it is not yet clear whether the Palestinians – on political, economic, and social levels – are ready to pay the price for the dismantling of the Oslo framework, which has become the iron cage of the Palestinian national movement, one that facilitates settlement expansion and exploitation of resources in all of Palestine.

Twenty-five years after the Paris Protocol between Israel and Palestine on economic relations, the failed policy framework governing these relations is at a dead end. This could have been concluded long before now, when Palestinian views, as well as those of many international actors, were already unanimous in seeing the Paris Protocol framework as unsuited to the needs of the Palestinian economy. Even the World Bank and the International Monetary Fund no longer deny that the protocol is being used by Israel as a big stick that undermines the possibility of building a "productive, independent and sovereign" Palestinian economy, as outlined in the PA’s national agenda. In recent years, numerous studies have shown the possibilities of crystallizing a Palestinian trade policy separate from the restrictions of the Protocol, even if gradually, in the absence of sovereignty and statehood.

This has been clearly demonstrated by political and economic developments this year, especially in light of the worsening Palestinian public financial crisis that began in March. The official Palestinian position not to accept any incomplete clearing funds, which received wide popular support, revealed the depth of the Palestinian desire to break the dependence on the Israeli economy, and to attain freedom from Israel's control over Palestinian economic development.

Regardless of the outcome of this confrontation, the extent of the financial crisis, and its effects on all sectors of the economy, it is no longer possible to return to the status of "business as usual." The Palestinian-Israeli economic relationship has, like the political, security and civil relations between both sides, become a crisis that must be subject to a comprehensive review by all categories, classes and institutions of the Palestinian people. While there is unequivocal Palestinian dissatisfaction with the Paris Protocol and the overall Oslo arrangements, it does not seem that Palestinians are prepared to pay the price for the collapse or dismantling of the Oslo framework. The Palestinians have also been unable to articulate a firm vision, and a feasible strategy, to deal with the repercussions of the current financial crisis and its possible economic consequences.

If the recent official statements and resolutions are ratified, the beginning of a new political phase will require unprecedented efforts to significantly disengage from the grip of the economic, political and security occupation that impedes the progress of the Palestinian national liberation project.

The Paris Protocol has failed to achieve its explicit goals of structural change to the Palestinian economy and its external dependence. Meanwhile, the unilateral Israeli implementation of the Protocol has effectively undermined Palestinian aspirations for independence, as well as the PA's mandate and non-sovereign functions.

The five most prominent channels linking the Palestinian economy to the Israeli economy show the relative importance of the issue of clearance revenues among the various aspects of economic dependence. Urgent policies and plans must be put in place if the current confrontation is to truly change the rules of the Paris Protocol/Oslo game. Otherwise, preparation should be made to abandon it altogether.

b. Five axes of the Palestinian economic dependence imposed on the Israeli economy

The relations of economic dependency imposed on Palestine are used to serve Israeli security and colonial policies. They are not limited to the financial aspect, but include a number of axes vital to the Palestinian economy (and, to a lesser extent, to the Israeli economy).

1. Financial leakage to the Israeli treasury

One of the most sensitive and complex financial arrangements involved in the implementation of the Paris Protocol is the mechanism for calculating and transferring Palestinian tax dues (clearance) that Israel collects on Palestinian imports from Israel (value added), and on international direct imports to Palestine (value added, customs, excise and purchase tax on some imports). In addition to opportunities for Israeli financial piracy, the overall aspects of the Palestinian-Israeli trade relationship in the context of the Paris Protocol include arrangements that cause significant losses for the Palestinian treasury. This includes tax revenues that should have been recorded in favor of the PA but which are either levied by the Israeli Treasury (so-called “indirect imports” into Palestine that are imported into Israel prior to their remarketing in Palestine), smuggled goods entering the common market tax-free, and related tax evasion.

In the latest comprehensive study of all forms of financial losses incurred by the Palestinian treasury under the Paris Protocol and the Oslo Accords - soon to be issued by UNCTAD - the 2017 figure was estimated to be more than $1 billion, or about a third of government revenue (7% of GDP). This estimate indicates the magnitude of the occupation’s financial burden. This financial bleeding, attributable to the Protocol, is what can be targeted through Palestinian endeavors to disengage.

2. The flow of Palestinian labor into Israel and its settlements

As part of the tragic legacy of the Paris Protocol, the strongest argument on the Palestinian side for accepting the customs union formula concerned the number of Palestinian workers in the Israeli market from the West Bank and Gaza Strip before 1993, equal to 20-25% of total Palestinian workers. Palestinian workers’ earnings in Israel accounted for 20-30% of Palestinian national income until the early 1990s. Since they could not be absorbed into the local economy in the short term (the original five-year Oslo plan), the “common market” formula, open by default to the flow of goods and labor, was accepted in the hope of building a productive local economy. In theory, this would allow for gradual elimination of dependence on the Israeli market to employ the Palestinian labor force.

Palestinian policies in recent years have not aimed to change this relationship. Despite the removal of all Gazan workers from the equation (and the rise in unemployment in the Strip to 52% in 2018), the number of Palestinian workers in the Israeli market from the West Bank alone is today back to what it was 25 years ago. At roughly 127,000 workers, this number represents 13% of all Palestinian workers today (and 20% of those in the West Bank), contributing 15% of national income - close to that of 25 years ago.

This portends imminent danger to the stability of the Palestinian economy if, for punitive security or political reasons, Israel decides to reduce the number of work or trade permits granted or to combat unauthorized labor, and keeps the Palestinian labor market hostage to the whims of any junior officer in the Israeli military administration.

3. Dependence on imports of goods from Israeli markets or through its ports

Perhaps the greatest bottleneck in the economic relationship with Israel is the latter's control of all borders, ports and trade crossings leading to and from the occupied territories. Of course, this is a major obstacle for Palestinian commodity exports to regional and international markets, one that increases the cost of transport, storage and commercial clearance in both directions (exports and imports). This main focus of the occupation's control of the economy inevitably affects the flow of about $1.2 billion in Palestinian exports (about 82% of which is intended for Israel) and $5.3 billion in imports (about 55% of which comes from Israel and the rest from Europe, Asia and Arab countries).

Here, too, the Paris Protocol is the governing framework for sustaining Israel's commercial dependence, although its economy is not the primary beneficiary of such control. The Palestinian market is of strategic importance to only a few Israeli light industrial, construction and agricultural protectionist lobbies. But Israel's customs, tax and security authorities control all of the actual Palestinian trade flows. It is not easy to loosen this grip as long as the Palestinian Authority is denied a presence at commercial crossings, as long as indirect imports (allowed within the Customs Union) enter the Palestinian markets unconditionally, and as long as Palestinian exporters and importers are denied the access they are enitled to via Israel's international obligations under the World Trade Facilitation Agreement (2013) – all in a long chain of interdependent bottlenecks and tools of control.

4. The Israeli monopoly in the supply of energy to Palestine and the disposal of natural resources

The Palestinian energy market has been dominated by the occupying power since 1967, an arrangement only further entrenched by the Oslo Accords. Since 1994, concessions have been granted to Israeli companies to supply petroleum, diesel and gas to the Palestinian Authority, which in turn distributes them via private companies. Through Israeli improters, the Palestinian economy brings in the equivalent of $800 million annually from oil derivatives, equivalent to about 15% of the total annual import bill. Although the Paris Protocol allows the Palestinian Authority to import energy from Jordan if it wishes, this option has not been seriously explored. The PA has no capacity to generate electricity (except in part of Gaza through the only Palestinian power plant) and relies entirely on the Israeli Electricity Company (the monopoly for power generation) for all its needs, amounting to about $534 million in 2017. Construction of the PA's generating capacity started before 2018, when the Palestine Investment Fund established a gas-fired power plant in Jenin, in the northern West Bank, and a solar power plant near Jericho, both yet to go into operation.

The extent and depth of the organic interdependence between the two economies is also evident in the energy and natural resources sector, with Israel’s control over the West Bank and Gaza’s mineral resources, including offshore natural gas, oil and Dead Sea minerals. This interdependence is also sensitive to the PA's financial crisis. Israel, for example, deducts clearing money from its accumulated debts for Palestinian energy distribution companies. These companies cannot afford to pay the entire bill for their purchases from Israel due to a number of problems, from the loss of electricity due to the deteriorating state of the network, to theft of electricity, to insufficient collection of private and household bills.

Thus, even if Palestine can avoid certain punitive financial measures, there are always alternative channels through which Israel can crack down on the Palestinian people.

5. Palestinian commitment to the Israeli commercial and customs system and denial of monetary sovereignty

According to the Paris Protocol, the economic relationship between the two parties is not only a customs union (which concerns only trade), but reaches the level of a full economic union, distorted and unbalanced. The Protocol stipulates the similarity of indirect tax systems (value added) and Israeli monetary sovereignty, and it does not allow the Palestinians to issue a national currency. The latter prevents the PA from practicing macroeconomic policy by interfering in setting currency exchange rates and interest rates. While the reluctance to issue a Palestinian currency in the absence of political and economic sovereignty is logical both theoretically and politically, this additional constraint shows the limited space available for pursuing any successful economic development policy, and more than any other element, links the Palestinian economic fate to Israel.

c. The road to development: separation, disintegration, decoupling?

This review of the difficult Palestinian financial and economic situation highlights the multiple and interrelated aspects of the matrix of economic domination. Hence, it is clear not only the nature of the dilemma that the Paris Protocol represents for the daily lives of the Palestinian people, for their freedom of self-determination, and for the public treasury resources, but also for the magnitude of the challenge to changing the "harmful path of economic dependency" that began with the occupation of 1967 and was embodied in the Oslo Accords.

Some views – held by international, Israeli and even Palestinian actors – claim that the relationship between the two economies must remain for geographical, security/political reasons, or even for the supposed economic benefits to Palestine through a relationship with one of the most economically advanced countries. From this standpoint, there are voices that have been and still are calling for "pragmatism", claiming that the Paris Protocol can be reformed and not abandoned because its dismantling will cost much more than any potential, alternative benefits.

While no serious economists or business people would argue that economic “separation” could or should be complete, it is difficult to deny that the Oslo arrangements not only deprive Palestine from pursuing its proper development path, but are, in essence, hostile to Palestinian rights, and anthithetical to all the requirements of liberation, independence and sovereignty. If the recent Palestinian political and financial positions regarding “disengagement” are to be taken seriously, this would entail "independence" and decoupling from Israeli domination of energy, manufacturing, trade, employment, finance, and macroeconimic policy as part of an ambitious agenda. In short, what is needed today is to build a formal, private, and popular resistance economy, from the highest to the lowest points of the political, social and economic pyramid, in the farm, factory, bank and ministry, and in every arena of confrontation (West Bank, Gaza, Jerusalem) with all means and resources available. Nothing less will break the stranglehold of the Paris Protocol.

Raja Khalidi is a development economist with over 35 years of experience. He is currently the Research Coordinator at the Palestine Economic Policy Research Institute. Mr. Khalidi has previously worked as UNCTAD Chief of Office for the Director of Globalisation and Development Strategies, and as Coordinator of UNCTAD’s Assistance to the Palestinian people. Mr. Khalidi led the provision of technical assistance to key Palestinian trade, fiscal and economic policy making bodies, such as the Ministry of National Economy, Ministry of Finance and the Palestinian Investment Promotion Agency, as well as private sector institutions. He holds a BA in Politics, Philosophy and Economics from Oxford University and a M.Sc. in Economics from University of London (SOAS).

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