by Orhan Niksic
February 23, 2014 (TSR) – The Palestinian economy is stalling. Growth dropped sharply in 2013, unemployment is on the rise, and tax revenues for the Palestinian authority are falling significantly short of what is needed to finance even recurrent expenditures. That’s the bad news that many are well aware of. There is however a potential source of good news that currently lies dormant, but if tapped could both stimulate growth and transform the Palestinian economy.
For a recent World Bank report, “Area C and the Future of the Palestinian Economy,” my colleagues Massimiliano Cali, Nour Nasser Eddin, and I evaluated the possible impact of enabling Palestinian investments in so called Area C, which comprises around 61 percent of the West Bank and is currently under full Israeli control. Our findings show that it has the potential to grow the Palestinian economy by 35 percent. As numerous analytical works have shown, private sector activity in the Palestinian territories is now severely constrained. Overall political uncertainty combined with a multilayered system of restrictions on access and movement, and internal political divisions make for an unpredictable and risky business environment. Consequently, private investment, in particular in the tradable sector, has been very low. The relative size of Palestinian exports, as a percentage of Gross Domestic Product (GDP), is among the very lowest in the world.
In recent years, economic growth has relied almost exclusively on large amounts of donor aid. Aid has in fact accounted for around one third of the Palestinian Authority’s recurrent budget expenditures of late. With donor fatigue setting in, aid levels have dropped in recent years and are likely to further drop in 2014, and the rate of growth which dropped to 1.5 percent in 2013 is expected to improve only slightly in 2014.
Our report shows that this bleak picture could be turned around by, among other things, enabling Palestinian investments in Area C of the West Bank. Under the peace accords signed between Israelis and Palestinians in 1995, known as the Oslo II accords, the governance of Area C was to be transferred within 18 months to the Palestinian authority, except for issues the status of which was to be decided in the final status agreement. However, the transfer never took place and in the meantime Israel has kept in place a strict regime of restrictions (justified largely on security grounds), which has severely limited any Palestinian investments in Area C. Given that Area C is the only contiguous land in the West Bank (Areas A and B currently governed by the Palestinian Authority are territorial islands) and that it abounds with natural resources, the cost in lost opportunities that these restrictions have imposed on the Palestinian economy is quite sizeable.
To evaluate the economic potential of Area C, we constructed counterfactuals to measure the potential of six different sectors where the effect of the restrictions was thought to be the most significant. These sectors include agriculture, as most fertile land in the West Bank is in Area C, the extraction of Dead Sea mineral deposits, stone mining and quarrying, construction, tourism around the Dead Sea and telecommunications. Forgetting for a moment indirect effects, our analysis showed that investments in these sectors could contribute an additional US$2.2 billion to the Palestinian GDP, representing a 22 percent increase. While not all indirect effects were quantified due to time and other constraints, we estimated that indirect effects related only to the fact that for instance tourism sector’s inputs are transportation sector’s outputs, could contribute another US$1.2 billion. Ultimately, our calculations underestimate the true potential of Area C, as significant indirect effects, such as those associated with the development of public infrastructure, were not measured. In any event, our report shines new light on the importance of Area C for the growth and sustainability of the Palestinian economy and its public finances.
The realization of this potential, as we argue, would require more than access to investments in Area C. Above all, it would need a broad removal of restrictions on economic activity, lower political risk, and regulatory reform. With these conditions in place, a new growth paradigm for the Palestinian economy could be created. Given that 71 percent of Palestinian imports come from Israel, while 86 percent of Palestinian exports are destined for Israel, there is significant scope for joint ventures and other modes of cooperation around some projects in Area C. Both Palestinians and Israelis stand to gain from enabling such investments. As long as Israeli security concerns are addressed, investments in Area C could contribute to the ongoing peace process between Palestinians and Israelis.
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Orhan Niksic is a Senior Economist for World Bank Middle East & Africa.
