Palestine on the Brink of Crisis

The swift and effective response by public health authorities across the Palestinian Occupied Territories in confronting the spread of the coronavirus are surely heartening. Although both the Palestinian Authority (PA) in the West Bank and the Hamas-led government in Gaza are non-sovereign and cash strapped, they have each evinced levels of administrative competency and moral clarity over the past few months that put the world’s teetering superpower to shame. In the process, they have delivered their people from a potential health catastrophe.

Regardless of Palestine’s epidemiological successes, however, the fallout from the virus’ paralysis of economic life still promises to be devastating. The magnitude of the macroeconomic contraction is subject to some dispute, but staff at the World Bank have conservatively projected a negative 2.5 percent annual GDP growth rate for 2020.[1] Such a recession will be damaging in its own right. When combined with a number of structural conditions particular to the Palestinian economy (many of which are themselves the product of Israel’s settler colonial project), this recession’s destructive effects are likely to prove even more acutely pronounced and long lasting. The symptoms of these structural conditions are manifest in the pervasiveness of poverty, social vulnerability and household indebtedness; in a labor market ravaged by unemployment, informality, non-participation and declining real wages; in financial markets haunted by risk exposure; and in a government loitering in a state of functional insolvency.

Absent a stimulus package of historic magnitude, it is reasonable to anticipate that the Occupied Territories’ ongoing de-development will accelerate and intensify. In Gaza’s case, international sanctions and Israeli collective punishment, such as the 13-year land, sea and air blockade, ensure that Hamas will be unable to mobilize any such package. For different reasons, the PA also lacks the capacity to spend at the scale needed to pull the West Bank out of the recession that is now consolidating.

 

The PA’s Fragile Fiscal Status

 

To comprehend the economic abyss looming in the West Bank it is crucial to begin with an examination of the PA’s precarious fiscal position. Creative accounting practices—mostly reclassifying certain outstanding debts as arrears, thereby quietly relocating billions in obligations outside the government’s official balance sheet—have obscured that the PA is, for all intents and purposes, bankrupt.

As of 2018, the Ministry of Health alone had accumulated almost $292 million in unpaid bills to hospitals and pharmaceutical firms, while the Ministry of Finance owed public sector workers more than $611 million in back pay. In total, pre-coronavirus estimates of the PA’s outstanding arrears reached over $1.4 billion, with roughly half of that total owed to private sector service providers.[2] An additional $89 million, moreover, was added in February and March alone. Even though official public debt levels are far from excessive (approximately 20 percent of 2019 GDP), the PA has proven itself incapable of honoring its obligations.

Contrary to what might be assumed in some quarters, the PA’s troubles in this regard do not exclusively derive from profligate spending, though current expenditures are relatively high. Servicing the militarized welfarism that underpins the political economy of the governing party Fatah’s rule, these outlays are primarily directed toward sustaining a large public sector wage bill along with the PA’s pension commitments, which expanded significantly due to the early retirement initiatives pushed in 2018–2019.[3] Such expenditures place government final consumption as a percentage of GDP at around 25 percent, near the upper bounds in a global comparison. The consumption to GDP ratio is, however, artificially inflated: The denominator (the GDP) has been reduced by as much as a third due to the costs of the Israeli occupation.[4] Thus, PA expenditures fall within normal ranges when evaluated in both per capita and nominal terms. Although developmentally inefficient, this spending also secures a degree of stability for families otherwise exposed to markets compromised by Israeli design, by the realities of global peripherality and by the character of domestic profit seeking.

Moreover, after then-Finance Minister Salam Fayyad took on the position of prime minister in 2007, the PA more consistently adhered to the principles of fiscal consolidation. To the extent that cuts to current expenditures are liable to precipitate mass unrest and are therefore politically inviolable, this renewed devotion to neoliberal orthodoxy would imply an abdication of responsibility on the part of the PA in relation to capital and development spending. As is the case with social expenditures, outlays across these domains have not only been marginal ever since but are also financed predominantly by volatile donor contributions, which have steadily and significantly declined since 2011.

Instead of spending itself into bankruptcy, the PA reached its current impasse largely due to failures in revenue generation. Such failures derive both from flaws built into the Israeli-Palestinian peace process and from the PA’s choice to hand economic management to Palestinian business elites.

 

The Paris Protocol’s Detrimental Effects on Revenue Generation

 

As part of the wider peace process that included the Oslo Accords of 1993 and 1995, Israeli and PLO negotiating teams met regularly to establish a temporary arrangement for governing economic relations between the emergent Palestinian Authority and the Israeli state. The final agreement, widely known as the Paris Protocol, was signed in 1994 and was meant to last for the duration of the five-year period leading up to Palestinian independence in 1999.

Despite the interim nature and conditional legality of the Protocol, the subsequent stalling of final status negotiations rendered it de facto law for the better part of three decades. Depriving Palestinian officials of meaningful autonomy across the domains of monetary, trade, exchange rate and fiscal policy, the terms set in Paris—in combination with Israel’s discretionary violation of those terms—have been massively detrimental to the PA’s capacity to dependably raise revenues.

One reason the Protocol has been so damaging is because it delegated to Israeli officials the responsibility for collecting—and subsequently transferring—Palestine’s customs duties, excise taxes on fuel purchases, value-added taxes (on economic activity inside Israel and at ports of entry), passenger exit fees and those income taxes that are levied on Palestinian workers laboring inside Israel or Israeli settlements. Unsurprisingly, this outsourcing of sovereign prerogatives has allowed the Israeli state to siphon off significant portions of Palestine’s clearance revenues, as they are referred to, through means both subtle and obvious.

Standing prominently within the latter category, the Israeli state pays itself 3 percent of the aggregate sum collected through the clearance process as compensation for its administrative efforts—a figure five times the charge the World Bank has deemed appropriate. Annually, such service charges cost the PA more than $50-60 million in foregone revenues.[5] In addition, since 2000, Israeli governments have universally ceased transferring taxes and fees levied on Israeli commercial activity in Area C of the West Bank—which constitutes about 60 percent of the West Bank and where Israel has near total civil and military control—setting the PA back an estimated $360 million as of 2017. By also denying Palestinian firms access to Area C throughout the post-Oslo period, Israeli actions have indirectly cost the PA an additional $45 million per year.[6] Israeli tax officials also retain 25 percent of the revenues raised through payroll taxes levied on the 135,000–150,000 Palestinian workers permitted to work in the Israeli labor market. On seven occasions between 1997 and 2015 and again in February 2019, Israeli governments withheld or deducted from Palestine’s clearance transfers in response to either domestic actions (like the PA’s paying of pensions to the families of martyrs or its non-payment of outstanding water bills) or diplomatic actions (such as the PA’s accession to the Rome Statute of the International Criminal Court). As of February 2020, revenues withheld through such actions exceeded $200 million.

Israel’s more subtle predations, meanwhile, have generally been operationalized through customs procedures and the schemes practiced by merchants on both sides. Despite the Protocol’s requirement that all imports ultimately consumed in Palestine be treated as Palestinian imports at the port of entry, customs officials systematically acquiesce to Israeli merchants improperly declaring the final destination of their purchases. Whether a function of incompetence or a desire to enrich the Israeli state coffers, this combination of negligence and criminality has allowed Israeli firms to import goods from the outside world, pay what taxes are owed to their own government and then re-export those same goods into the West Bank tax-free. The prevalence of such practices today—and the costs inflicted upon the PA—are starkly attested to by the fact that Israeli re-exports of this type now constitute 58 percent of all the Israeli goods traded in the Palestinian market. Hoping to avoid arbitrary delays or seizures at the borders, Palestinian merchants also participate in this racket by importing many of their goods through these same Israeli middlemen. Collectively, the mistreatment of Palestinian imports sees $300–350 million in PA revenues rerouted into the accounts of the Israeli state each year. Such sums typically amount to one-fifth the PA’s annual income.[7]

 

Capital’s Capture of the Palestinian Authority

 

As destructive as the legacies of the Paris Protocol have been for the PA’s fiscal health, its current insolvency cannot be reduced to the misdeeds of Israel alone. Another major problem is the PA’s local revenue generation efforts. Most years, the ratio of gross domestic revenues to GDP (which is the ratio of West Bank-raised tax plus non-tax income to GDP) hovers around .08. The domestic tax revenue to GDP ratio, meanwhile, generally sits below .05. Both of these figures are remarkably low.

The PA’s woeful performance in terms of local revenue generation ultimately derives from the class biases, ideological delusion and rampant corruption that have undergirded the Palestinian national project ever since its reterritorialization within the Occupied Territories (if not before). These pillars of the contemporary political economy were laid down at the foundation of the PA, when the political party Fatah’s returning heroes opted to cede development planning and economic management to World Bank technocrats and a narrow coterie of business elites, the majority of whom had accumulated their fortunes while exiled in the petromonarchies of the Gulf. Provided ideological cover by PLO and Fatah leader Yasser Arafat’s axiomatic assertion that social justice could not precede national emancipation, this community of diaspora capitalists were largely free to render public policy into a mechanism for servicing their particular private interests.[8]

The architects of Palestine’s emergent market economy serviced elite interests with growing sophistication (especially following the failed coup of 2007 and Salam Fayyad’s subsequent ascension to prime minister). By leveraging licensing arrangements, land expropriation, public procurement processes, special partnerships with Israeli firms, financial regulations and, at a later date, the economic might of the country’s quasi-sovereign wealth fund (the Palestinian Investment Fund, PIF), they were able to empower a handful of holding companies—principally, Palestine Development and Investment, Ltd. (PADICO) and Arab Palestinian Investment Company (APIC). In order to manage tensions emanating from other power centers, they integrated the post-Oslo caste of political and security leaders into circuits of rent and profit seeking by distributing equity shares and board seats from amongst the many subsidiaries of the PADICO and APIC business empires. Monopolistic and oligopolistic market structures, dominated by the appendages of the two holding companies, were consolidated across each sector of the economy. Calcifying with time, contemporary businessman policymakers such as Muhammad Mustafa (senior economic advisor to Palestinian President Mahmoud Abbas, CEO of Paltel and chairman of the PIF), Khaled el Osaily (minister of the national economy and founder of APIC and Paltel) and Shukri Bishara (minister of finance and former head of the Arab Bank in Palestine) have used their juridical authorities to keep dividends and other returns on investment flowing across these interconnected webs. At the same time, they ensure a semblance of social stability is maintained through state employment and consumer credit markets.

Naturally, the dissolution of any distinction between public goods, developmental goals and elite capital accumulation wound up substantially affecting Palestine’s tax code. While taxes on corporate profits were always fairly low, Fayyad and his allies nevertheless reduced them further until they reached a flat rate of 15 percent in 2016 under his successor Rami Hamdallah. (Regime-backed oligopolists in the telecommunications and financial sectors are required to pay an additional 5 percent premium.) Amendments adopted in 2015 and 2016, meanwhile, also reduced personal income tax obligations by bringing the marginal tax rate for those in Palestine’s highest earnings bracket (approximately $44,000 and above) down to 15 percent. Tax reforms in 2014 rendered all income derived from capital gains wholly tax exempt and decreased taxes on other non-wage forms of income such as dividends, stocks and returns on microfinance investments to a flat rate of 10 percent. The reformulations of the tax code eased the burden on Palestine’s wealthy immensely. As a result, and in combination with the General Directorate of Income Tax’s inability to address various forms of tax evasion and avoidance because of its low audit capacity, the aggregate revenues generated through personal and corporate income tax receipts have typically comprised a mere 7.2–9.4 percent of the PA’s total annual tax revenues.

Given the extent to which real estate speculation has pervaded elite profit seeking throughout the post-Oslo period, the class biases of the PA tax code are also visible in the design and administration of the property tax. Though officially set at 17 percent of a property or building’s annual rental value, 40 percent of property tax obligations can be deducted as an expense and the other 60 percent can be used as a credit against income tax liability. In addition, in most municipalities, property valuations have not been conducted since 1988. Consequently, between 2008 and 2017, a time when inflationary dynamics allowed homeowners and investors in the built environments of Ramallah, Bethlehem and Tireh to amass unprecedented gains in wealth, the public coffers derived only the most marginal benefits from property taxes.[9]

 

Revenue Deficiencies, Private Borrowing and the Specter of Financial Crisis

 

Since local tax receipts are minimal, the PA’s prospects of balancing a budget depends upon inflows of direct budget support from external partners and Israel’s regular transfer of clearance revenues. Together, these two sources typically make up 70–80 percent of the PA’s total income, and largely determine how much the government will be able to spend in a given year. Aid and clearance transfers are both subject to high levels of volatility, however, with the former closely tied to oil prices, especially after the United States severed its financial relationship with the PA in February 2019. Due to these factors, budgeters are frequently (and unexpectedly) left short on cash.

Unable to either issue bonds or borrow from the Palestinian Monetary Authority in large sums, economic policymakers have often been forced to lean on private credit markets in order to fill gaps in the budget. Prior to 2011, this tactic primarily resulted in the accumulation of low-interest, long-term credit arrangements from regional and international institutional lenders. After banking reforms passed under Fayyad’s direction, however, the PA’s borrowing has increasingly been concentrated in locally issued, short term, high-interest loans. As of March, these domestic debts had risen to constitute 55 percent of the PA’s total debt, with the majority owned by the six local commercial banks allowed to operate in the Occupied Territories. In nominal terms, the PA’s aggregate debts to these actors now exceeds $1.5 billion, with $900 million of the short maturity, high-interest variety (4–6.5 percent).

These debts hold significant and multifaceted costs for the PA and the economy writ large. Most immediately, the squeezing of the PA’s fiscal space brought on by repayment and servicing obligations has consistently, if implicitly, contributed to cuts in development and social spending, leading to a harsh upward transfer of wealth. By absorbing the lion’s share of the financial sector’s lending capacity—as of 2016, PA liabilities had come to constitute a remarkable 60 percent of Palestine’s commercial banks’ total assets—these arrangements also crowd out private investment.

The PA’s relationship with Palestine’s commercial banks has also quietly increased the likelihood that fiscal and financial crises might soon intersect. These lending deals have, after all, hitched the financial stability of the entire West Bank to a non-sovereign government with a history of revenue shortages. To make matters worse, due to the same Fayyad-era banking reforms, Palestine’s commercial banks have actually leveraged their risk profiles further by concentrating almost all of their non-government investment and lending in consumer credit, mortgages and real estate—currently subject to high default risk. Consequently, at the very moment that the Palestinian people require that the PA and commercial banks come together for the sake of a stimulus that might stave off an economic depression, neither is capable of acting.

 

A Fiscal Straitjacket in the Time of Coronavirus

 

The coronavirus pandemic arrived during this time of fraught fiscal standing for the PA. Emergency public health expenditures soon combined with revenue losses—from reduced income taxes, customs duties and VAT—to introduce a new $1.4 billion gap into the budget. Fearful that any further deficit spending might risk fiscal or financial calamity, the PA has so far opted to forego any meaningful countercyclical interventions in the economy, restricting itself to a proposed $300 million fund meant to provide soft loans to the country’s small and midsize enterprises. The Palestinian Monetary Authority also enacted a postponement of loan repayments for all borrowers for four months (six months for the tourism and hotel sectors).

Notwithstanding such half measures, losses incurred by the coronavirus shutdown and stay at home orders already exceed $3.8 billion. The Palestine Monetary Authority’s business cycle index—an aggregate measure accounting for production, sales and employment levels—recently fell to the lowest level ever recorded. In human terms, hundreds of thousands of construction, hospitality and retail trade workers—who represent approximately 50 percent of the active labor force according to International Labour Organization estimates and who are almost universally excluded from social insurance systems—now have to deal with lost wages and deeply uncertain futures.

The restraint demonstrated by the PA in these moments is understandable. Debts and deficits in Palestine, as in many parts of the Global South, unfortunately constitute a real and tangible constraint on public action. In Palestine’s case, moreover, the constraints of indebtedness are made even more resolute due to the PA’s unique inability to dependably raise taxes and its lack of monetary powers and basic political sovereignty.

Yet, if the PA’s circumstances indeed render any major spending initiative a risky proposition, to continue on the current course is to risk disaster, both now and for many years to come. A sizable majority of families in the West Bank (and far more in Gaza) were, after all, deeply insecure well before the coronavirus compounded their suffering. In this context, to allow the West Bank’s markets to resolve dueling demand and supply shocks on their own is to ensure profound deprivation and dislocation. In view of a macroeconomic picture long bedeviled by underperformance—in terms of total factor productivity, investment (be it in magnitudes or sectoral allocation), job creation, industrial and agricultural output and trade—relying on markets will also further consolidate Palestine’s de-development.

Tragically, revenue losses incurred by the shutdown are likely to push Abbas and his inner circle into adopting more austerity going forward.[10] The prospects of a foreign assistance-led rescue mission to save Palestine from such a fate, meanwhile, are increasingly bleak after the collapse of oil prices.

It is in moments of upheaval that paradigms can shift. Given the existential peril presented by the Israeli government’s plans to annex the West Bank and the apparent hegemony of the West Bank’s elite networks, it is difficult not to be pessimistic about whatever changes might be coming. Regardless, this is a critical juncture in the lifespan of the PA. How contingent decisions play out in the months to come—whether made by the stewards of high politics or by those who have grown weary waiting on such actors to deliver on their promises—will likely determine the trajectory of Palestine for decades to come.

 

[Colin Powers is a researcher focused on the economies of the Middle East and North Africa. He just finished his PhD at Johns Hopkins School of Advanced International Studies.]

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Endnotes

 

[1]    Projections furnished through the collaboration of the Palestine Economic Policy Research Institute, the Palestinian Central Bureau of Statistics, the Palestine Monetary Authority and the Palestinian Capital Market Authority posit a loss of 1.8–3.8 percent GDP.

[2]    For a detailed breakdown of the PA’s debts and arrears, see Civil Society Team for Enhancing Public Budget Transparency, “2019 Public Budget Performance Report,” AMAN Transparency Palestine (February 2020).

[3]    Ibrahim Shikaki, The Political Economy of Growth and Distribution in Palestine: History, Measurement, and Applications. Doctoral Dissertation, The New School University (2019).

[4]    United Nations Conference on Trade and Development, “A Report Prepared by the Secretariat of the United Nations Conference on Trade and Development on the Economic Costs of the Israeli Occupation to the Palestinian People” (July 2016).

[5]    On the accounting figures regarding fiscal leakage, see The Government of Palestine, “Stopping Fiscal Leakages: The Government of Palestine’s Report to the Ad Hoc Liaison Committee Meeting” (September 2018).

[6]    Orhan Niksic, Nur Nasser Eddin and Missimiliano Cali, “Area C and the Future of the Palestinian Economy,” (World Bank: 2014).

[7]    Mahmoud Elkhafifi, Misyef Misyef and Mutasim Alagraa, “Palestinian Fiscal Revenue Leakage to Israel Under the Paris Protocol on Economic Relations,” United Nations Conference on Trade and Development (2014).

[8]    Tariq Dana, “Crony Capitalism in the Palestinian Authority: A Deal Among Friends,” Third World Quarterly (41:2) 2019.

[9]    Property tax receipts have constituted between 0.5 and 3 percent total tax receipts between 2008–2017, with a majority of years skewed towards the lower bound.

[10]  Estimates project annual revenues in 2020 to be 24.4–32.8 percent below the expected yield. Palestine Economic Policy Research Institute, “Economic Monitory, Special Supplement 2020: Preliminary Assessment of the Possible Impacts of the COVID-19 Health Crisis on the Palestinian Economy.”