PALESTINIAN ECONOMY
THE ECONOMY (part I)

Aggregate performance

The Palestinian economy contracted significantly in the late 1980s and early 1990s in the wake of the intifada and the impact of the Gulf crisis. It revived in 1992, but experienced setbacks in 1996-1997 when there were sharp falls in aggregate and per capita income levels. By 1999, the GDP of the West Bank and Gaza Strip totalled US$4,5 billion and GNP US$5.2 billion, respectively, with a per capita GDP of US$1,614 and US$1,782, respectively, placing the economy within the group of lower middle-income countries. Since 1994, GDP has constituted less than 15 per cent of GNP, compared with historic levels of over 25 per cent. Net factor income from abroad in 1997 was around US$600 million, while net transfers in that year totalled US$407 million, and gross national disposable income was US$4,557 million.

The Palestinian economy grew in real terms by 1 per cent in 1997, and the growth rate for 1998 has been estimated at over 2 per cent. In 1999 and 2000, GDP growth was projected at rates exceeding 6 per cent in current prices. However, these rates are still below historic performance and demonstrated potentials for economic growth, and well below population growth rates. With increasing levels of domestic and foreign investment, and as an outcome of the market-oriented policies being implemented by the PA, the economy had begun by 2000 to demonstrate its potential for even stronger growth rates in the future. Performance in 1999-2000 was reminiscent of performance in 1992-1993 and pre-1988 expansion periods, which were usually followed by a steep decline, highlighting the Palestinian economy's vulnerability to external pressures and shocks.

In 1999 gross fixed capital formation accounted for 39 per cent of GDP. Construction, mainly in housing, accounted for 80 per cent of total private investment, while private productive activities absorbed the balance. The low level of investment in the productive sectors reflects a combination of factors, including uncertainty about regional conditions and insufficient credit facilities, notwithstanding the dramatic expansion of the banking system in recent years. Private consumption expenditure in recent years has been equivalent to around 96 per cent of GDP and government consumption expenditure around 23 per cent of GDP. Imports of goods and services absorbed 83 per cent of GDP, and the Palestinian trade deficit (goods and services) was 65 per cent of GDP in 1997, although this ratio declined somewhat in 1998-1999.

Consumer price increases have moderated in the last few years, increasing by 2.5 per cent on an average monthly basis during 1999. The general inflation rate, which averaged 12 per cent during 1993-1995, declined to 7.6 per cent in 1997 and fell to 5.5 per cent by December 1999. Price trends in the Palestinian economy are highly sensitive to external events and the economy is open to such effects through the Israeli shekel, the Jordanian dinar and the United States dollar, all of which the PA has adopted as currencies in circulation during the interim period.

Economic structure

The Palestinian economy is still predominantly based on traditional activities, with a preponderance of small cottage industries and sole proprietorship undertakings. The economy continues to operate beyond its potential, as indicated by several imbalances during the last two decades. First, there is a resource gap, displaying a large import surplus equivalent to 57 per cent of GDP in 1998. This is evident from another expression of the resource gap - the investment deficit (investment minus saving) - which has steadily increased over the whole period owing to the sustained decline in net factor income which has adversely affected savings.

A second imbalance relates to the labour market. This shows a chronic inability to provide a satisfactory level of employment for a labour force growing at a strong rate. The domestic market provided employment for an average of only 57 per cent of the labour force during the period 1991-1995. The rest of the labour force was either unemployed or employed only partially in Israel.

These two indicators demonstrate the extent to which the Palestinian economy is vulnerable to external shocks, especially those originating in Israel. The performance of government expenditures and revenues reveals the degree of dependence on external financial assistance and is reflected in a large deficit in the PA budget, which reached 37 per cent of the total budget or 7 per cent of GDP in 1995, but has been brought down since. This deficit, amid a host of other political and economic constraints, further complicates the task of the PA, particularly since the deficit is driven mainly by current rather than investment expenditures. The main reason for the deficit is the relatively low level of tax revenue. This amounted in 1995 to 10.5 per cent of GDP, whereas tax revenue is around 19 per cent for countries with a comparable GDP per capita.

Sectoral structure

• Agriculture
  
  Until the 1990s, the agricultural sector's contribution to Palestinian GDP averaged over 30 per cent. During the past decade, however, this share has experienced a dramatic reduction. In 1990 agriculture still represented 35 per cent of GDP, but declined steadily to an average of around 12 per cent in 1994-1996 and fell further to an all-time low of 7 per cent by 2000. Cultivated land in the West Bank covers around 33 per cent of total land, while in the Gaza Strip it covers approximately 50 per cent of the area. The agricultural sector accounted for around 14 per cent of the employed workforce in 2000, although the potentials of Palestinian agriculture have been constrained by restricted access to land and water.
  
  
• Manufacturing and mining
  
  The level of industrialization in the West Bank and Gaza Strip was historically low, under 10 per cent. Since 1994, there has been significant industrial expansion. However, available data have been re-estimated, bringing the annual average share of industry in GDP to around 16 per cent in 2000. In addition to the significant branch of construction-related industries which flourished over the interim period, other principal industrial activities, such as food processing, plastics, soap, pharmaceuticals, clothing and shoes, also witnessed growth during that period. The industrial sector employs 9 per cent of the work force in the West Bank and 14 per cent in the Gaza Strip. About 35 per cent of total industrial employment is in the textile, clothing and leather sectors.
  
  Despite the significant growth in the number of industrial enterprises, from around 4000 in 1991 to 14,849 in 1999, the sector continues to be fragmented and dominated by underdeveloped manufacturing enterprises. In 1999, manufacturing industries accounted for 94 per cent of the total number of enterprises in the industrial sector and 95 per cent of total value added, and absorbed 94 per cent of the labour force engaged in the sector. These industries are mainly family-owned, with less than 2 per cent employing more than 50 workers, as opposed to 77 per cent employing fewer than 5 workers in 1999. They have the same features as cottage industries, suffering from a paucity of managerial skills, as indicated by the low average proportion of administrative employees, and specialize in labour- intensive products. Moreover, the sector is heavily dependent on Israel, as 90 per cent of its inputs are imported, and 70 per cent of its exports transit through Israel.
  
  The stagnating situation in the manufacturing sector is largely attributed to the restrictive environment. Investment in industrial projects is minimal given the high degree of uncertainty generated by the political strife. Another major obstacle to investment in industry has been the lack of effective financial intermediation and risk-sharing institutions. This has led to a situation where the majority of industrial establishments are self-financed, with a low level of working capital. Equally important are the poor market access conditions and lack of support services and infrastructures. The impact of these factors has been further compounded by the lack of both natural resources and an adequate supply of skilled labour.
  
• Services and construction
  
  the Palestinian economy is dominated by services (public and private), which contributed 54 per cent of GDP in 2000. However, the development of the service sector during the last two decades has been uneven. Branches which cater to consumption and imports have grown substantially (retail and wholesale trade), and those more geared to servicing production have stagnated (transport, engineering designs, financial services and others). This is mainly attributed to the minimal contribution of the primary and secondary sectors to the Palestinian economy and to its process of development. This in turn has constrained the development of certain (especially producer) services, while promoting the growth of others (wholesale and retail-trade services). The growth that did occur in services was stimulated by externally generated demand either in the form of international consumers (e.g. tourism) or through the availability of external income and imports, thus increasing personal consumption (e.g. distributive services). 
  
  In 1999, wholesale, retail trade and transport accounted for a substantial portion of service activities (19 per cent of GDP), although the share of public services is high (at 12 per cent of GDP), and real estate services account for a similar share (11 per cent of GDP). Public administration and defence account for less than 10 per cent.
  
  Services represented the main field of employment in 1999 (absorbing 28 per cent of the employed labour force), followed by construction (22 per cent). They were the main field of employment for the female working force, accounting for 46 per cent of this category, followed by agriculture (providing jobs for 32 per cent of females).
  
  There has been a marked growth in the banking industry, and financial intermediation services account for around 3 per cent of GDP. The number of banks increased from 2 in 1993 to 23 in 2000 with a total of 114 branches in the West Bank and Gaza Strip. In addition, assets and deposits have increased substantially. The insurance industry has also expanded over the past several years. It is dominated by automobile insurance, which is not a source of long-term investment. The PA Controller of Insurance at the Ministry of Finance is entrusted with developing the requisite legal and regulatory framework, and supervises the insurance sector and licenses insurers.
  
  The PA has recognized the importance of advanced telecommunications networks and moved promptly to develop its infrastructure. Under arrangements with the PA, the privately owned Palestine Telecommunications Company (PALTEL) is developing this sector on a sound commercial basis, to ensure wide domestic coverage and international connections with modern and diversified facilities.
  
  Given Palestine's abundance of religious and archaeological sites, tourism remains a sector with high growth potential. Growth has been hampered, however, by the prevailing uncertainty in the region and the weak support infrastructure for tourism in the West Bank and Gaza Strip. Nevertheless, there have been some important developments in the hotel, travel agency and tourism-related transport and restaurant sectors as a result of domestic private sector investment and some foreign direct investment.
  
  Construction has traditionally played an important role in the Palestinian economy, contributing over 10 per cent of GDP in previous decades, but has been re-estimated since 1994 at around 10 per cent of GDP.