1. Introduction

The Paris Protocol (PP) was the agreement that shaped the economic regime in the Palestinian economy after Oslo had been signed in 1994. The PP was supposed to sustain prosperous economic development, an essential ingredient for the success of the peace process. Thus, the PP was devised with the intention of creating the required conditions for such positive performance.

Historical Background

The Palestinian economy is functioning under exceptional circumstances. Following the 1967 war, Israel determined that the Green Line would no longer exist as a full-fledged economic border. A process of “imposed integration” began, where the trade and labor borders between the two very uneven economies tended to disappear. The new arrangement yielded obvious results: The more advanced economy attracted cheap labor from the less developed one. Palestinian employment in the Israeli economy helped to solve some short-term issues, such as high levels of unemployment and low incomes, but it also contributed to the greater dependency of the Palestinian economy.

In early 1990s, and after the First Intifada, Israelis and Palestinians negotiated directly for the first time. In 1993, they reached an interim agreement (Oslo Agreement) that was intended to be valid for five years and was meant to address the economic and political dimensions of the conflict. After six months of negotiations, a new economic agreement (PP) was concluded between Israel and the PLO, with the preamble clearly describing two parties with legitimate interests and equal claims to economic policymaking.  However, the Israeli settlements in the occupied territories created significant obstacles to economic development, among other things, through the use of natural resources (water, the Dead Sea, land, stone, etc.).

 

 

  1. Macroeconomic Imbalances under the Paris Protocol Regime

The Trade Imbalance

One of the primary promises of the Paris Protocol was to grant the newly formed Palestinian National Authority (PNA) policy space in the realm of trade. The PNA tried to utilize this newfound space in signing trade agreements with the EU, EFTA, Turkey and the Arab Free Trade Area.

The PP provided the PNA with tariff lists A-1, A-2 and B, presumed to be the beginnings of a Palestinian tariff book, which would have deviated from the Israeli tariff book. In practice, however, with the Israeli decision to disempower the Joint Economic Committee (JEC), the body in charge of agreeing on Palestinian tariffs, these lists were not realized. Israel has expanded the lists A-1 and A-2 only twice since the signing of the Paris Protocol in 1994. Thus, while the PNA was supposed to be granted (marginal) sovereignty when it came to trade policy- the agreement states that the review of these lists should happen once a year- in practice the “imposed integration” view held its ground.

The “customs union” trade regime set out in the Paris Protocol made the PNA a captive market for Israeli products, which accounted for 70-75 percent of all Palestinian imports over most of the 2000s. Israel was also the sole market for Palestinian exports, absorbing 85-90 percent of Palestinian exports in this period. Furthermore, since the Palestinian economy and the Israeli economy are different in most economic characteristics, the trade policy Israel imposed, which reflected Israeli interests alone, made Palestinian producers less competitive for exporting to countries other than Israel. Such constraints on Palestinian exports to non-Israeli markets had a grave effect on economic development prospects because, as an infant economy, Palestine can generate sustainable long-term growth only through exports. As a result, Palestine developed a huge structural trade deficit that, in turn, greatly increased Palestinian dependency on external sources for financing this deficit. This structural gap in Palestinian trade reflects the severe constraints of the PP-based regime on Palestinian exports and private sector growth: lack of economic sovereignty, high transaction costs associated with movement and access restrictions, and the high cost of clearance of imported goods are a few examples.

 

Mechanisms for Countering the Trade Imbalance: Opportunities on Paper, Limits in Practice

Under the PP regime, the PNA has no economic sovereignty and no tools to deal with the Palestinian economy’s severe dependencies and constraints on sustainable growth. Moreover, the joint customs envelope, resulting from the imposed integration of the Palestinian economy within Israel’s policymaking apparatus, coupled with the increasing transaction costs that Palestinian traders face as a result of the conflict, has led to a situation in which Palestine cannot exploit its comparative advantages – neither with Israel nor with the world. There are several mechanisms that can help close the deficit in the balance of payments: First, increasing the export of labor from Palestine to Israel; second, implementing a trade policy that encourages exports to Israel and the rest of the world; third, granting the PNA sovereignty over its exchange rates – since the PNA does not issue its own currency, it has no functioning exchange rate mechanism.

The Labor Market

While the agreement secured entrance of Palestinian workers to the Israeli economy on paper, in reality the labor flows over the years were heavily restricted. Over the years, labor almost totally stopped flowing from Gaza to Israel, and the West Bank labor flows have heavily declined. The number of Palestinian workers in Israel dropped from 115,600 in 1992 to less than 36,000 in May, 1996.

Despite that, employment in Israel still plays an important role in the West Bank labor market. The total number of Palestinians employed in Israel and the settlements doubled from around 45,000 at the height of the Second Intifada (2002-2004) to almost 90,000 in the second half of 2012. All Palestinian workers in Israel are West Bankers, and their share in total West Bank employment was about 15 percent in 2012. Moreover, since the average daily wage of West Bankers working in Israel is twice as large as the average daily wage of workers inside the West Bank (167 NIS compared to 87 NIS per day), work in Israel still contributes more than one quarter of all wage income in the West Bank.

 

 

  1. Fiscal Imbalances

The economic limits imposed on the PNA as a result of the PP trade regime continue in the form of the so-called “customs envelope.” Israel collects the revenues on imports and transfers them to the PNA (after deducting collection charges). The main result is that the PP regime does not grant the PNA sovereignty over its budget and fiscal policy, since it can neither raise enough revenues due to restrictions on its tax structure nor can it issue debt. Thus, despite impressive progress in its own tax collection performance, the PNA is still dependent on Israel for collection of most of its tax revenues.

The lack of Palestinian sovereignty over fiscal issues makes the stability of the Palestinian economy especially vulnerable to the political whims of the Israeli government, which have manifested themselves time and again over the past decade: In late 2000, after the Second Intifada broke out, Israel indefinitely froze the transfer of tax money to the PNA; in 2006, after Hamas won the parliamentary elections and established a government in Gaza; in October, 2011, as punishment for the Palestinians’ appeal to the UN; and again in November, 2012, after the UN updated the PNA’s status to “non-member state.”

Bilateral Dependencies: Clearances with Israel and Fiscal Leakages

The PP created a revenue-sharing mechanism with the aim of redirecting the benefits resulting from Palestinian trade to the Palestinian National Authority. This clearance mechanism is based on a unified invoice which is used for the exchange of VAT payments between the two sides according to where final consumption of the goods takes place. But if the businesses do not report the unified invoice, the PNA cannot claim the amount. Another problem related to the revenue sharing mechanism is the indirect import; when an Israeli importer imports goods for use in the Israeli market, and then sells the goods to a Palestinian trader while the customs for such goods are not transferred to the PNA. Palestinian sources estimate that the losses incurred from the process of indirect importation is in the range of hundreds of millions of dollars per annum, constituting a major leakage of revenue from the coffers of the PNA.

 

 

  1. Some Implications of the Paris Protocol Regime

The Palestinian economy is riddled with structural weaknesses that are manifested in trade imbalances related to the customs union with Israel, labor shortages, monetary impotence, and extreme fiscal dependencies on Israeli clearances and external aid:

  • Purchasing power and standard of living: Economic integration with Israel under the Paris Protocol is reflected in price levels similar or close to Israeli ones, while Palestinian wages are much lower than in Israel. As a result, the real purchasing power of Palestinian households is much lower than the nominal level shown in national accounts and household income statistics.
  • Palestinian economic fragility. There has been extremely erratic Palestinian economic growth over the last two decades, and a dramatic impact from the overriding influence of Israeli access and movement restrictions on it.
  • Infrastructure development. Two-and-a-half decades of underinvestment in infrastructure, under Israeli rule, has resulted in chronic public underinvestment.

 

  1. Modifications to the Paris Protocol Economic Regime

The following proposed set of amendments to the PP and the present economic regime can serve as a starting point for modifying the Israeli-Palestinian economic regime, instituting the first steps in creating Palestinian economic sovereignty. Such a revised regime will serve two purposes:  First, to enable the Palestinian economy to take a much more viable and immediate course until a permanent status economic agreement replaces it as part of a negotiated political solution; and second, to support Palestinian state-building measures by allowing it increasing sovereignty over economic policy

Create Independent Customs Territory

This can be achieved through a phased change of the present situation, including the following steps:

  1. Expansion of tariff lists A-1, A-2 and B: These lists are severely outdated, having been formulated in 1994 and adjusted only twice within the 19-year period of their implementation. Therefore, we propose expanding the present list and using it as the basic component of a separate Palestinian tariff book, constructed in accordance with Palestinian economic conditions and needs.
  2. Autonomous Palestinian exit/entry points: Israel will give the PNA the responsibility for the management of the economic border-crossings between Palestine and the rest of the world, with an appropriate agreed-upon Israeli security presence and/or arrangements.
  3. Shared control over bilateral Israeli-Palestinian trade passing through all crossing points: It is proposed to have a two-part system for controlling bilateral trade, in addition to the application of the Palestinian separate tariff book to Israeli-Palestinian bilateral trade

It is proposed to achieve this goal through a phased process, which will include:

  • The stationing of Palestinian customs officers at all international exit/entry points (Haifa, Ashdod, Allenby, etc.) to handle Palestinian imports and exports, and at all Israeli–Palestinian crossing points for control of bilateral Israeli-Palestinian trade, alongside the Israeli officers. The Palestinian customs officers’ work will be coordinated with the present system of security and other checks in ways that will not significantly affect the smoothness and speed of movement through the crossing points.
  • Establish a number of Palestinian inland customs clearance houses which will coordinate and oversee the work of the Palestinian customs officers stationed at the international entry/exit points and the Israeli–Palestinian crossing points. This is where shipments that need special customs handling will be sent for clearance, and where the relevant Palestinian institutions will manage, monitor, and control the whole process for clearance. All of these arrangements will be based on modern and integrated customs and security management systems (procedures, standards) and infrastructure (technology, physical infrastructure)

Improving Labor Flows

Considering the strong impact of Palestinian work in Israel on Palestinian incomes, increased access of Palestinian workers to the Israeli labor market could significantly help in easing the high Palestinian unemployment rates and the depressed economic situations in the West Bank and Gaza, especially in the short to medium term. Hence it is recommended  that a program be created for a phased increase in the number of Palestinian workers in Israel, under newly agreed arrangements aimed at gradually replacing foreign workers with Palestinian workers in the Israeli construction, agricultural and industrial sectors. This program should include modifications to the present entry permit system, especially with regard to business people.

Guaranteeing Clearances, Fixing Fiscal Leakages

Israel’s imposed integration in fiscal issues has generated a deeply rooted set of fiscal dependencies and leakages that the paper recommends remedying in the proposed modifications to the Israeli-Palestinian Interim Economic Protocol, as follows:

  • A major component of the reformed regime must be an agreement on the self-collection of Palestinian customs revenues and indirect taxes by the PNA, as manifested in the inland customs clearing houses recommended above. This agreement will replace the present revenue clearance mechanism, thus eliminating Israeli control over Palestinian tax and customs revenue.
  • Customs duties, excise and purchase taxes are all allocated on the basis of final destination for direct imports, but not for indirect imports. It is in the PA’s interest to promote direct imports and to build the capacity of the Palestinian traders to become independent, including formulating ways to import products without the intermediation of an Israeli agent. Increasing direct imports will result in the transfer of more revenues to the PA, given that the final destination principle applies to all taxes on direct imports.
  • Establish mechanisms by which import taxes paid by Israeli importers on specific products intended for sale in the Palestinian market are transferred to the Palestinian coffers.
  • Implement the Paris Protocol articles stipulating that customs clearance at the crossings with Jordan and Egypt be done through Palestinian customs.
  • Create a presence in Israeli ports for Palestinian customs, for the clearance of Palestinian goods through Palestinian customs.
  • Create a system of goods in transit, by which goods imported by Palestinians are cleared at the Palestinian border, after completing their journey through Israeli territory first.
  • Create customs clearance points between Palestine and Israel, at which third party goods are cleared.
  • Create a mechanism through which VAT clearance is done through shared invoices, instead of clearance based on unilateral, unified invoices, to prevent tax evasion by either side’s businesses.
  • Improve the accuracy of revenues from direct and indirect imports transferred to the West Bank and Gaza through an effective customs clearance information system. This will allow an inland customs (Palestinian) control system  to be established for the direct collection of custom duties and all other taxes by the PA.
  • Reconsider the transformation of the PMA into a full-fledged central bank.

The paper recommends that such a set of amendments, addressing the major weaknesses in this sphere, be discussed in the newly activated Joint Economic Committee (JEC). For example, the power to apply autonomous indirect taxation policies will enable the PNA to adapt Palestinian indirect taxes to the conditions of the low-income Palestinian economy, protect infant or key industries, etc. Economic sovereignty in this sphere, in combination with the power to apply trade diversification policies, could enable the PNA to significantly reduce the prices of basic products, such as fuels, electricity, water, etc., and bring the cost of living in Palestine closer to that of neighboring low-income Arab countries, specifically Jordan. Reactivation of the JEC can also help toward removing the complex set of restrictions imposed on Palestinian control over physical resources, such as land, water, roads and other infrastructures, as well as improve the investment horizon, reduce uncertainty, mitigate risks and encourage investments in the private sector.