The Economic Crisis in the Palestinian Authority

Introduction

In recent years, the Palestinian Authority (PA) has enjoyed economic growth in the West Bank. However, this appears to have been only short-term growth based on foreign aid, and not on private sector activity or investment. Reduced foreign aid sparked an economic crisis in the PA, manifested in liquidity problems and difficulty in paying salaries. The crisis undermined statements by Prime Minister Salam Fayyad regarding the PA's readiness to establish a Palestinian state. The delay in the transfer of PA funds that Israel collects for it could exacerbate the crisis, prompting PA leaders to call for replacing the Paris Agreement, which regulates the economic relationship between Israel and the PA, with another agreement that would lessen the Palestinian economy's dependence on Israel.

PA Leaders: The Crisis Is Serious

In the first half of 2011, rumors that the PA was facing an economic crisis were substantiated when the PA was forced to pay its employees only half their salaries. PA President Mahmoud 'Abbas stated, "There is a real economic crisis."[1]

PA employees protest over receiving only half their salaries[2]

The crisis came as no surprise. Signs were seen back in May 2010, when PA Accountant-General Yousef Al-Zumor said: "Arab nations have transferred only $280 million of the $960 million that they committed to give, while the government collects taxes from the West Bank alone to fund the West Bank, Gaza, East Jerusalem, and the Palestinian diaspora."[3]

In a meeting with Palestinian journalists, Prime Minister Salam Fayyad said: "Our financial situation was difficult to begin with, and Israel has stopped the transfer of our funds, which has severely restricted our ability to meet our commitment to pay salaries... The government was forced to borrow money from the banks to solve the problem, but we cannot continue to rely on the banks, whose ability to loan money is limited... The PA's deficit has reached some $535 million. This is a deficit that a government in a country with a budget and resources such as ours... cannot easily deal with. In the past, we have borrowed money to compensate for our shortfall, but we cannot borrow endlessly."[4]

Fayyad took responsibility for the crisis, but he also claimed that he had inherited large debts from the previous government.[5] In an investigative report on the matter in the London daily Al-Hayat, journalist Muhammad Younes wrote: "When Salam Fayyad formed the PA government after Hamas's takeover of Gaza in June 2007, he faced an empty till loaded with debt: $1 billion in salaries for PA employees, which have been withheld; debt to the private sector from the days of the Isma'il Haniyeh government...; $900 million in debt to local banks; and $1.5 billion in debt to Arab funds dating back to the 'Arafat presidency. After a long period of [economic] decline, money from donor countries began flowing to the PA, and to Fayyad, which allowed his government to cover a large portion of these debts and pay proper salaries for four straight years. However, it wasn't long before the influx of money from donor countries was delayed, and some of them stopped contributing at all, which caused another crisis."[6]

PA Prime Minister Salam Fayyad

As a result of the crisis, on August 11, the PA Health Ministry announced budget cuts, but added that this would not affect services to patients or employees. The most obvious effect was a cutback in referrals, to the minimum dictated by professional standards, and the setting in place of a mechanism that would guarantee that this decision was implemented.[7]

In an attempt to overcome the crisis, 'Abbas asked Arab League secretary-general Nabil Al-'Arabi to convene the league to discuss "the grave financial crisis affecting the PA." Before departing to attend the Arab League summit, Prime Minister Fayyad said: "Our Arab brethren, and especially Saudi Arabia, have assisted us in all fields, but we need aid and support now more than ever. The PA urgently needs at least $300 million to meet its commitments. When a government or a regime reaches a point where it cannot meet a basic obligation such as paying a salary, it faces a grave problem. This financial crisis was created by the accumulation [of difficulties] for several years."[8]

The results of the meeting of Arab delegates were disappointing for the PA. The closing statement urged Arab countries that had not met their promises "to hasten to do so, in order for the PA to be able to pay its employees and fulfill its obligations to the people."[9]

On the other hand, the Bank of Palestine mobilized to provide assistance. On August 24, 2011, the bank's management announced that it would transfer funds to the PA so that the latter could pay the second half of its employees' salaries.[10] The salaries were eventually paid thanks to the banks' willingness to assist, and because Israel only delayed the transfer of funds for a relatively short time.

In late November 2011, Salam Fayyad warned that if Israel were to continue delaying the transfer of PA funds, the PA would not be able to pay its employees.[11] It should be noted that shortly thereafter, Israel decided to renew the transfer of PA funds.

The Roots of the Economic Crisis

Reduced Influx of Funds from Donor Countries

The main cause of the crisis is the reduced influx of economic aid from Arab countries. According to Salam Fayyad, "the donor countries have guaranteed our government... the following aid: in 2008, $1.8 billion; in 2009, $1.3 billion; $1.1 billion in 2010; and in 2011, $970 million. However, some of the donor countries have not met their commitments, especially in the past two years [2010 and 2011], causing an increase in the deficit, which has turned into a financial crisis that has prevented the government from paying its employees for the first time in four years."[12]

Realizing that funds from donor countries would not continue indefinitely, Fayyad has worked to gradually reduce the PA's dependence on the donor countries, in an effort to wean it off foreign aid by 2013. This policy has helped to halve its dependence on these countries; in 2008 it dipped to $1.8 billion, and this year, 2011, it decreased still further, to $970 million.[13]

The July 26, 2011 Arab League Summit[14]

Fayyad's efforts to gradually reduce PA dependence on aid were aimed at avoiding liquidity problems: "Our plan determines that we must end the budgetary dependence on foreign aid. We have made strides in that direction, but the cessation of aid transfer from some of the donor countries has caused a crisis."[15]

Fayyad attempted to deal with this new situation by reducing dependence on aid faster than planned. He stated: "The lack of foreign aid that caused this grave crisis requires a reexamination of... the initial estimates regarding fiscal policy in the past two years. We must submit plans and ideas that will hasten the end of dependence on foreign aid to fund ongoing expenses."[16]

On the other hand, economist Dr. Nasser 'Abd Al-Karim noted that the Palestinians could not possibly achieve total economic independence, since their economy is dependent on Israel and on foreign aid: "These two elements control 90% of the Palestinian economy. Eighty percent of income depends on unreliable [foreign elements]; $120 million comes from Israel and $100 million comes from donor countries. In effect, we have no control over $220 million. We only control $50 million."[17]

Fayyad estimated that a Palestinian reconciliation could ease the crisis, saying: "The income situation can improve by at least 25% if we complete and implement the reunification of the homeland, since we currently have no income from Gaza – only expenses."[18]

Waste in Government Institutions

The London daily Al-Hayat cited experts who believe that "the financial crisis in the PA was caused by employing people based on political considerations, [a practice] which began in Arafat's day and gave rise to an overabundance of manpower." According to the daily, "Arafat saw power as a tool to solve unemployment in a poor society under siege and occupation. The number of PA employees has reached 180,000, but over the past four years Fayyad has reduced it to 151,000, by canceling fictitious jobs and forcing a large number of security personnel into retirement."[19]

One of the main problems facing the Palestinian economy is the multitude of employees in apparatuses and bodies that contribute nothing to production. Gaza economist Dr. Farouq Dawwas told the weekly Al-Bayader Al-Siyasi: "In an attempt to improve the economic situation in the early years, the PA decided to forgo the Israeli job market as much as possible, and employed some 25% of [Palestinian] manpower... but not in fields such as industry or agriculture. True, many of them were employed in education, healthcare, and workplace safety, which serve the manufacturing sector, but the majority of them worked in non-manufacturing sectors, especially the many security apparatuses..."[20]

Muhammad Abu 'Alan, columnist for a website close to the PLO, pointed at the need to cut government spending. He called to "reduce the number of ministers to a minimum; stop tens of thousands of dollars in grants and aid to officials and their families, as is indicated by a recent investigative report...; stop official travel by PA employees and junior officials that costs the treasury hundreds of thousands of dollars...; stop benefits for PA officials so that the minister and his deputy and other officials live off their paychecks like junior clerks do; build offices for official Palestinian institutions to end [these institutions' use of] rented [property], which has been widespread since the PA was established; eliminate officials' personal security details and the fleets of vehicles that accompany them...; put an end to corruption, bring the corrupt to justice, and restore everything they stole and the public funds they embezzled."[21]

Workers Union Deputy Chairman Mu'ein 'Insawi called on the PA government not to lease additional cars for ministers who already owned vehicles, and to stop funding haberdashery for ministers, which cost approximately NIS10,000 per month."[22]

Insufficient Tax Revenue and Failure to Pay Taxes

'Ali Al-Khalili, an official in the Palestinian Information Ministry and columnist for the PA daily Al-Ayyam, leveled harsh criticism both at the PA government and at Palestinian residents for not meeting their responsibility to pay taxes, to the detriment of the PA's revenues: "The PA must improve its administrative function, and especially enforce the tax law... The residents must also understand that their right to full residency is dependent on their meeting their obligations in full."[23]

Image Source: Elaphblog.com

The PA's Economic Growth is Illusory

Reports published in recent years by the World Bank and UNRWA created the impression that the Palestinian economy is growing and is prepared for the establishment of a Palestinian state. It has become apparent that this is only part of the picture. Economist Dr. Nasser 'Abd Al-Karim said that the World Bank report disregarded aspects such as unemployment rates and the fact that the growth is fragile. He said: "It is known that various economic sectors have witnessed clear growth in the West Bank since 2007, but this growth is [in fact] an unsustainable semblance [of growth]. The UNRWA report, which focused on unemployment and poverty in the refugee camps, expressed a more reliable picture of this matter." According to Al-Karim, the World Bank reports are overly diplomatic, and are written in a positive tone, like its reports about the Arab world in general, and are unrelated to the actual situation in Palestine.[24]

More explicit statements came from Birzeit University's Faculty of Commerce and Economics dean, Muhammad Nasser: "The growth achieved by the Palestinian economy in the past three years was not sustainable. It was based on government expenditure funded by foreign aid, and not on private sector activity or investment... The [World Bank] reports also indicated a significant slowdown in the economic growth in the PA since the start of the year [2011], due to budget cuts enacted by the government and the lack of foreign aid, especially from regional donors [Arab countries]. This caused a severe liquidity crisis in the PA, which is expressed by the inability to pay full salaries... Only in its most recent report did the World Bank address the close relationship between sustainable growth and building strong institutions, mentioning that the political and economic dangers surrounding the Palestinian economy could cause its achievements over the past two years to collapse... The readiness to establish an independent Palestinian state could erode if it is not bolstered by a sustainable economic force and an independent economic market."[25]

PA Strives to Nullify Paris Agreement

The Palestinians have recently tried to blame the economic crisis on the Paris Agreement, the economic appendix to the Oslo Accords which regulates economic relations with Israel under the interim agreement. PA President Mahmoud 'Abbas called for the PA to be free of this agreement. His economic advisor, Dr. Muhammad Mustafa, claimed that "the Paris Agreement is obsolete, and it must be replaced by an agreement that will ensure the full independence of the PA and its control over its economic and trade policy." According to Mustafa, the PA signed the Paris Agreement in 1994 under terms that were biased against the Palestinians, since they believed it was a temporary arrangement that would end within five years once a permanent arrangement was met. He further said that the agreement hinders economic growth, causes the trade deficit to rise, deepens dependence on the Israeli market, and causes tax losses for the PA.[26]

The Effect of the Economic Crisis on the Establishment of a Palestinian State

The Palestinian appeal to the UN for permanent membership, as well as its acceptance as a member of UNESCO, have not benefited its economic situation, since the US Congress responded to these moves by recommending that the transfer of aid to the PA be delayed. Israel also took punitive measures by temporarily delaying the transfer of funds from PA taxes and customs in response to its unilateral move.

The economic crisis caused PA officials to question Salam Fayyad's statement about finalizing the creation of the institutions necessary for the Palestinian state and the Palestinians' readiness for statehood. Hani Al-Masri, an official in the Palestinian Information Ministry and columnist for the PA daily Al-Ayyam, wrote: "If the [PA] cannot prevail if the aid and the influx of taxes are cut off, how can it declare, citing international [reports], that it is ready to establish a state, that the Palestinian economy is flourishing, and that its growth is on the rise?"[27]

In an article for the Palestinian new agency Ma'an, Suleiman Al-Wa'ri, director-general of the PLO's Department of International Relations, asked: "Have we finished building the [necessary] institutions, and do we have the basic foundations for a state, most important of which is a national economy and sufficient financial resources? It later became clear that we are not prepared [for this], when Dr. Fayyad announced that the Palestinian economy is suffering a severe crisis [and] that [civil sector] salaries would not be paid until Israel transfers the tax payments...

"It is economic stability that establishes and contributes to political stability, and the basic foundations of any country must rely on stable financial resources, in order [to ensure] the continuing function of its institutions. If there are no ongoing resources, it is difficult to continue the enterprise of state[-building], as building the administrative and security structures of the [PA] on scientific and professional foundations is insufficient in the absence of clear and profitable financial resources drawing on investment and production enterprises that benefit every Palestinian and provide numerous job opportunities.

"It is not enough for donations and aid to go to infrastructure alone, as economic reform is a basic condition for and the cornerstone of [any] state-building program."[28]

In response, Fayyad said: "Countries that have existed for several decades have dealt with economic crises. Today, the EU countries face a severe economic crisis. Does this mean that they cannot remain countries, and that their peoples do not deserve their own countries?"[29]

He also said: "The PA has managed to transform its institutions into state institutions, and it can manage the Palestinian people immediately upon the disappearance of the occupation. The occupation is the only remaining obstacle... Israel controls all the border crossings to the PA, and it charges taxes and customs for goods imported to it, and transfers the money to the PA after collecting 3%. Israel also often uses these funds to pressure the PA for political purposes."[30]

Fayyad also rejected any connection between the Palestinian appeal to the UN and the crisis: "The will of the Palestinian leadership is not determined by its need for aid. Aid was never a determining factor in political options and was not important, despite the difficulties we will have to face."[31]

Palestinian columnists pointed an accusing finger at Arab countries. 'Adel 'Abd Al-Rahman, columnist for the PA daily Al-Hayat Al-Jadida, wrote: "The problem does not lie in the lack of coordination with our brothers – the kings and presidents of Arab countries – but rather in the Arab leaders' inability to meet their obligations without a green light from the US administration. This administration wants to twist the arm of the Palestinian leadership by pressuring it and drying up its sources of aid, in order to dissuade it from appealing to the UN for full membership... We must ask Arab countries how they can support the Palestinian appeal to the UN if they can't get past the qualms of the US and Israel. What will become of the Palestinians if Israel's extreme right-wing government stops the transfer of Palestinian tax funds to the PA treasury?"[32]

Another columnist, Dr. 'Abd Al-Majid Swailem, claimed that "in response to the pressure aimed at the Palestinians over the reconciliation and their appeal to the UN, which was expressed by a delay in the transfer of tax funds from Israel to the PA and calls to stop US aid, Arab countries should have doubled their aid to the PA and come out against the stance of the US and Israel... That way, even poor Arab peoples will be able stand up to the extortion employed by the US."[33]

PLO Executive Committee member Saeb 'Ereqat hinted at the possibility of liquidating the PA but without presenting it as a threat: "If the Palestinian appeal to the UN for recognition and acceptance as a member is vetoed, and if tax funds are not transferred, Israel should understand that the moment of truth has arrived, in which it rules from the [Jordan] River to the [Mediterranean] Sea as an occupation regime. Netanyahu must understand the responsibility of the occupation regime."[34]

In response to 'Ereqat's proposal, Ramzi 'Awda, a professor at Bethlehem University, wrote: "The Palestinian people has grown accustomed to the PA managing its life, and it is not easy to turn back... The Palestinian people is very dependent on the PA. PA salaries support more than 35% of the population, including residents of Gaza. The PA provides them with many services in all realms: healthcare, education, and humanitarian matters. The people will not allow the PA to dismantle itself.

"[The people] see the PA as a national achievement that should not be relinquished. There are ambitious Palestinian leaders who would take advantage of the opportunity and take over the leadership if it collapses or threatens liquidation... The Palestinians will lose a lot more if they agree to liquidate the PA... The fundamentally weak Palestinian economy cannot bear a situation in which the world does not trust us and does not invest in the PA... We cannot demand that others support us if we threaten suicide."[35]

Increase in Stipends to Families of Martyrs

The economic crisis did not stop the PA from upping the stipends it pays to families of martyrs. Fayyad said that the PA was ensuring that an issue as sensitive as this stipend was not affected by the crisis.[36] Muhammad Sbihat, secretary-general of the Palestinian Martyr Families, noted that Fayyad had recently increased these stipends – the third such increase since he took office.[37]

* C. Jacob is a research fellow at MEMRI.