print
memri
October 1, 2003 No.
149

Economic Performance in West Bank/Gaza: Highlights from an IMF Report

On the eve of the annual meetings of the International Monetary Fund (IMF) and the World Bank, held in Dubai on September 23 and 24, 2003, the IMF published a comprehensive report on the economy of the West Bank and Gaza (WBG) since the signing of the Oslo agreement in September 1993 and the challenges the Palestinian economy faces under conditions of severe conflict. [1] This report highlights some of the main issues and findings of the report.

Macroeconomic Performance

While the Palestinian economy has retracted, as might have been expected, since the Intifada began in September 2000, the report seems to suggest that the economic situation in WBG is somewhat better than expected. Despite curfews, checkpoints and closures that resulted from the Intifada, "the Palestinian economy has proved to be more resilient than expected." Levels of poverty, while extensive, were cushioned by extended family networks, including a large number of wealthy expatriates who have prevented the situation "from becoming a humanitarian crisis."

The Palestinian economy experienced a major contraction, estimated at 31 percent cumulatively since 1999. The report seems to suggest that under similar circumstances another economy would have contracted at an even steeper rate. The fact that the Palestinian economy has contracted at the rate it has is attributed to its resiliency, which, according to the report, is due to a number of factors:

"On an individual level, Palestinians have resorted to diverse coping mechanisms. This includes reducing consumption, selling assets [i.e. gold jewelry], the sharing of resources within extended families and local communities including credit within local communities and transfers from relatives abroad. On a macroeconomic level, however, the resilience is primarily [due to the] involvement of the international community and to the substantial external assistance provided to WBG [2] … This allowed the PA to continue operations, pay wages, and limit the accumulation of arrears to the private sector." The report also attributes the resiliency to remittances from family members residing abroad and to the work of charitable organizations. Based on local banking figures, net transfers to the private sector as a whole (including family members) grew from $114 million in 1997 to $948 million in 2001. These transfers have provided sufficient alternative sources of income to compensate for the losses experienced in the labor market.

Employment and Unemployment

The Intifada, and counter measures employed by Israel, have had a significant impact on employment in WBG. In the full year prior to the Intifada, 135,000 Palestinians worked in Israel. This figure was even higher in the third quarter of 2000, the months immediately prior to the Intifada. Annual labor income from Israel, amounted to $888 million in 1999, contributed to 16 percent of the Gross National Income. Between 2000 and 2002, labor income from Israel declined nearly two-thirds with a loss of about $530 million per annum. Unemployment in WBG was estimated at 36 percent during the third quarter of 2002 but decreased to 30 percent in the first quarter of 2003. Unemployment in Gaza has traditionally been higher than in the West Bank because the West Bank's porous borders with Israel have permitted non-licensed workers to find employment in Israel. Employment in Israel is significant because money earned generates demands in the WBG and hence more employment in the territories.

The construction of "the separation wall" that is planned to run 225 miles is "[a concern] for the future… Land on either side of the wall, varying from 30 to 100 meters (33.3-111.1 yards) has also been requisitioned from Palestinian farmers for additional barriers, trenches, and fences. The land involved, from which tens of thousands of olive and fruit trees have already been uprooted, is some of the most productive in the West Bank."

Economic Ties with Israel — Advantages and Disadvantages

The IMF report indicates that the close economic ties which exist between WBG and Israel are a mixed blessing. On the one hand, the report states, "the Israeli labor market offered employment opportunities at relatively high wages and thus provided a substantial stream of income to WBG. Israel also represents a large and geographically close market for Palestinians exports. But at the same time, these close economic ties, very beneficial during good times, also make WBG very vulnerable in circumstances of conflict, and the resulting restrictions imposed by the [government of Israel]."

For example, while exports have been hampered by the closures, the report finds anecdotal evidence to suggest that "large companies with good connections [especially with the Israelis] found their way through the various checkpoints and get their goods into Israel and third markets abroad."

The Financial System

Despite the economic downturn, which could have strained the financial system to the limit, the report finds the Palestinian financial system "upright, functioning and liquid."

Revenues and Expenditures

Under the Protocol on Economic Relations signed in 1994 by the PA and Israel, the two sides established a revenue clearance system to apportion an agreed pool of selected tax revenues which arise as a result of the de facto customs union and the unified VAT invoice system. This arrangement accounted for steadily increasing revenues from about eight percent of the Gross Domestic Product in 1994 to around 21 percent by 1999, "bringing the share of revenue to GDP in the [WBG] substantially above the average for other Arab countries in the region."

The impact of the resumption of conflict on fiscal revenues was twofold: First, revenue collection declined in line with the decline in economic activity and income. Second, Israel stopped transferring clearance revenues that it collected on behalf of the PA under the Protocol on Economic Relations after December 2000. The amount of income taxes collected by the PA declined 51 percent because of the lack of enforcement and inability to collect taxes under closure and other military measures.

The declining revenues put a squeeze on expenditures and led to the introduction of an austerityplan. Nevertheless, the wage bill continued to expand and Yasser Arafat resists all attempts to bring it under control. In fact, employment in the PA civil service and the security forces in 2001 increased by some 4,000 and 3,000 employees, respectively, bringing total PA civil service employment to about 122,000 by the end of the year. It is also noteworthy that the office of the Chairman, security agencies, and the media accounted for 45 and 46 percent of budget allocations for 2001 and 2002, respectively. During this same time frame, budget allocation for social services accounted for 35 and 36 percent of the budget, respectively. The figures for the civil service appear particularly high, says the report, given the fact that UNRWA (United National Relief and Works Agency for Palestinian Refugees in the Near East) employs 14,000 to provide services to refugees, which accounts for 42 percent of WBG population.

The report notes that the 2003 budget appropriates $74 million to the Chairman's office, which is eight percent of the total budget. Of this amount, $34 million is dedicated to "transfers." While some of these transfers go to help individuals, such as students or groups which fall below the safety net, other transfers go to organizations that are "part of politically favored networks [which] should not be getting such grants under any criterion."

Tax Administration

The report points out that the high revenue GDP ration achieved by 1999 was mostly driven by indirect taxes, primarily VAT (7.2 percent of the GDP), customs (6.7 percent of the GDP) and excises (3.3 percent of the GDP.) Much of this strong performance "can be attributed to the collection efficiency of the Israeli tax administration." Nevertheless, there was a leakage in the system which pertains to "indirect" Palestinian imports through Israel and Palestinian purchases of local Israel products. This leakage would account for a loss of 3.5 percent of GDP.

The Diversion of Funds

Perhaps the biggest leakage was the diversion of excise tax revenues. It was agreed following the Oslo agreement that VAT and customs revenues were to be transferred to the Palestinian Ministry of Finance (MoF), and that petroleum excises were to be transferred to a special account in an Israeli bank under the control of Chairman Arafat and his financial adviser, Mohammad Rashid. Similarly, tobacco and alcohol excises collected domestically by the PA as well as revenues from PA monopolies and other commercial activities were channeled to accounts outside the MoF.

As a result of this parallel financial management system $591 million of excise tax revenues were diverted from the MoF between 1995 and 2000, except for $119 million which was recovered by the MoF because of the financial crunch. Most of the diverted tax revenue was used for investment in PA "commercial operations." The report points out:

"Together with the lucrative monopolies on cement and petroleum acquired early on, these commercial activities started generating substantial profits which were also being diverted away from the budget. Because of lack of transparency and accountability for these activities [no balance sheets or annual reports were published], it is difficult to estimate the profits which they generated between 1995 and 2000." However, based on conservative estimates, profits generated by the various commercial activities amounted to $300 million bringing the total of "excise tax revenue and profits from commercial activities diverted away from the budget" to an excess of $898 million. "The question immediately arises... as to the wisdom of investing taxpayer money in all these commercial activities and risk ventures. Since there was neither transparency nor accountability surrounding these investments, one may surmise that the only strategy was to build up equity with little regard to risk."

The report also reveals that charges and fees (e.g., automobile licenses) levied by about fifteen PA ministries are retained in the latter's respective bank accounts and spent under their own discretion. No figures for these fees were given.

A Pattern of Monopoly - the Cement Company

The Cement Company, which is wholly owned by a special agency of the PA under Arafat's control, had an exclusive contractual relation and buying agreement with an Israeli producer of cement (the Nesher Company). The market share of the company was 90 percent, but recently reduced to 70 percent as a result of reforms. Because of its monopolistic status, the Cement Company was selling cement in Gaza at 295 shekel per ton (about $65) while the price in the West Bank was at 245 shekel per ton (about $50). The company was able to sell at a higher price in Gaza because a fence around the area makes it difficult to smuggle in less expensive cement. In the West Bank, the price is subject to competitive forces.

Conclusion

Throughout the report a clear picture emerges: at a time of peace and tranquility, macroeconomic performance was quite solid despite the diversion of revenues into questionable commercial activities. At a time of conflict, the opposite inevitably happens. Sometimes even the prospect of peace provides an economic boost. As the IMF report points out, the publication of the r oadmap in April 2003 "served to restore a degree of confidence among Palestinians and in the business community—confidence that had been entirely lacking over the preceding two and a half years."

*Dr. Nimrod Raphaeli is Senior Analyst of MEMRI's Middle East Economic Studies Program.


[1] International Monetary Fund, "West Bank and Gaza: Economic Performance and Reform under Conflict Conditions," Washington, D.C., September 15, 2003.

[2] Budget support by foreign donors amounted to $532 million in 2001 and $467 million in 2002.