The West Bank and Gaza Strip

TRADE AND ECONOMIC LINKS IN THE TRANSITION PHASE: THE WEST BANK AND GAZA STRIP

Avigdor Harekom Mordecai Kun Abraham R. Wagner

soorrrwrdbw Offica of Regional Afbin Bureau of Near Bsmm & %uth.Asian Affairs DEPARTMENT OF STATE Washington, D.C. 20620

Tlu rmmch dwcrbrd In thb npon wos rponrond by tha Awtot lnmnniwl0nr)oprmm - wlr Cbntna No. AIOINEC-lW. Thr virm @*pddo not maamtly dhct the ophrfon . . orgo(lduofthe~olchrnwuch, .. @ ANALmICAL ASSESSMENTS CORPORATION' Post Office Box 9695 Marina del Rey Cxlifarnia 90291 - - - 4640 Admiralty Way, Marina del Rey, California 90291 2131822-2571 * PREFACE

After same three decades of warfare and hostility, two of the major parties to the Arab-Israeli conflict bave taken dramatic steps along the road to an overall Middle East peace. A peace treaty negotiated between Egypt and Israel at the diplomatic level is, of necessity, largely political in nature, with related security questions resolved aa part of the implementation process. Ultimately, however, swh polltical and military coasidera- tiono merely provide the basis and the nmr-term etability in the envirouxno11t during which the conditions for long-teW peace and stabilization cur be rn achieved, In virtually every interrurtiaaal oituatlon, the fundamental basis of .. . long-term stability lies in the economic incentives for the parties to &n- ' tain such a situation, Thus, in the Middle f ast, it is highly litrely that, wet time, the trade, econmdc links, development programe, iu;d other a- tually beneficial aspect. of a settlanent will do more to ensure its ongoing success thaa any other faetor. Crucial in thir regard will be the econamic lintn which develop between tha territories occupied by Israel since June 1967 in the Gaza Strlp and Jordanian West Bank areas, wlth Israel, Egypt, Jordan, and the rest of the world. With ouch a vScw, the present research looks toward the impact of a peace settlement on Tsrael, Egypt, Spa, Jordan, end Lebanon from the atandpoint of the made and acononic links which are kected to develop with the West Bank and Caza in s11pport of PRM 39 study requirements. The analysis here is f acueed on expected deveJ!opments during the five-year traa- - 1 @itionphase and beyond, considering arch potential changes in made linkagea and barriers to trade as wall as the effects of changes in direction and .- r' volme of trade on local production, productivity, employmeat, and income- In campletSng thir research, the authors would like to acknowledge the asdistance of Dr. Carol K. Wagner and Mr. Andrew Terrill of Analytical Asseas- rents Corporation, and Dr. Paul A. Jureidini, B. D. McLaurin, and Jim &ice of Abbott Associates, Inc. In addition, the research hord the benefit of

Pmv!oqg.jl . Page. - Blank .. . A ..

discussions wfth Mr. Henry Engelbrecht, Department of State, and Mr. Robert ',. Xubal, Department of Defense. While each of these individuals has made a u contribution to this study, the authors bear sole responsibility for any errors of fact or judgment. TABLE OF CONTENTS

. LIST OF TABLES AND FIGURES ...... vii '.. I. INTRODUCTION: LINKS IN TBE OCCUPATPON ERA . . m. . 1 1.1 .The Political and Economic Context Since June 1967 .... 1 1.2 Evolution of Economic Links with Israel and the Arab World ...... 4

11. ECONOMIC LINKAGES DURIXG THE TRANSITION PEASE AND BEYOND a 19 2.1 Overview of Fundamental Conditianrr ...... 19 2.2 Evolution of Trade Link# and Institutions ...... 24.:. 2.3 Flow8 o$ Capital and Entrepreneurial Talent ...... 26

2.4 a Labor Flows and Future Labor Force Compositiosr ...... 36 2.5 Banking, Currency and Financial Institutiolne ...... 41 2.6 Development of Links ia Essential Infrastructure ..... 49 2.7 Opt- Policies for Trade and Stabilization ...... 52 111. TRE 106TmCE OF EVOLVING TRADE AND ECONOMIC LINKS ...... 59 3.1 Assumptiom About the Economic Envitonment ...... 59 3.1 The Cooperative Scenari,~:Implicatiaw of Economic Link to tbe West Bank, Gaza ;' ...... 63 3.3 The Status Quo SceaarSo: rplpli~ationu of'EconoaicL~kstothevest Bank, ma...... 76 XV. CON~USIONSm...e..*.*..*....mmm...m.. 85 - ... 89 A. . 4.1 The Liaks with Israel ...... 4.2 The Economic Conlrequences at a Cooperative Scenario ... 85 . 4.3 mlications of a statis QUO ~cenario ...... 86 LZST OF TABLES

Territoriesq Trade with Israel: 1974-1976 ...... 21 Territories' Trade kth Jordan: 1974-1976 ...... '22 Domestic Distribution of Employment in theTerritories by Sector: 1971-193'5 ...... 31 '- Territoriest Output of Selected . . Agricultural Products: 1967-1976 ...... 32 Destination of Agricultd' Output: 197112-1975/6 ...... 33

. , Indices of Industrial Employment in the Territories ...... 34 Population ead Growth Rates in the Tarritor*~ ...... 36 .. Rising Education Level in the Territories: 1968-1976 ...... 37 Composition of Damastic Employmeat in the Territories: 1970-1976 ...... 38 . 2.10 The Rising Employment Link Between Israel and the Territories: 1970-1976 ...... 39 2.11 Real Gross Domestic Product ...... 40

• 2.12 Consumer Prices and Value of the Israeli Pound: 1967-1978 .... 43 2.13 Net Capital Transfers iato the Territories: 1968-1976 ...... 46

.-. . . 3.1 Annual Growth Rate8 of the Populatton in the Territories: 1967-1976 ...... 65 3.2 Population Projections, West Bank. .:. - -. . . . and C6za Strip: 1976 and 1983 ....-.. ;...... 66 . -. - 3.3. Projections of Some Kap . Variables: The Cooperative Scenarlo ...... 95 67 3.4 ~ojectionsof Gross Domestic Product: 1976 and 1983 ...... 68 3.5 Capital Requirements: Cooperative Scenario ...... 69 a 3.6 Project$- of Gross National ~rohct:1976 and 1983 ...... 69 - vii - :I

LIST OF TABLES (Con1t .)

3.7 Pattern of Trade in Territories, Cooperative Scenario: 1983 ...... 74 3.8 Employed Persons by Selected Economic Sectors: Territorial Workers Who Are Employed In Israel (1970-1976) ...' 78 3.9 Projections of Key Economic Variables: Status Quo Scenario (1976 and 1983) ...... 81 . Actual a~dProjected Gruwth Rates: Status Quo Scenario ..... 82 .

LIST OF FIGURES

Earnings of West Bank and Gaza . Rasidents Working in Israel: 1967-1978 ...... 6 ... ~ueof ~xpc;ts from W~etB~UIC and mza to Israel: 1967-1978 .'. 10 - 1.3 Value of Imports from Israel to Wast Bank and Gaza: 1967-1978 . .. 11 l,4 Value of West Bank and Gaza Trade with Jordan: 1967-1978 .... 13 . I . . I . INTRODUCTION : LINKS IX OCCUPATION ERA

1.1 The Political and Economic Context sine0 June 1967 Since the inception of Arab-XsraelA hostilities in May 1448, efforts by the United States and other powers have focused ou achieving an cad to the conflict, and the conclusion of a comprehmsivs settlement. accord. Nego- tiations conducted at various points eince 1948 have led to a series of between Israel and the major.Arab confrontation states, including the 11949 Armistice Accords signed at Rhodes and, most recently, e reries of dir- 1 engagement accords concluded following the 1973 Ocrobar War.

In krge part, theam trucaa, interim y.emantm, and parti8l accmdm . .. - have focused on the immediate problem of tatmiaating hostilities and setting disengagement frontiers. Most of them agreements, negotiated through thitrd-party iztermadiaries, hwa at best looked toward political negotia- " 2 tions vhich would then lead to a comprehrnsiva settlement. While efforts to achieve a political settlemaat have been undar way since the 1973 war, it hs only been eincs the beginning of the Sadat-Be& lnltiat&ve In 1977 that the parties have moved decisively toioard achieving rrhis objective. Although the bulk of the discussions have thus far cm- tered an key political and military isaues, theta is an assumption on the

%her include the 1974 Sinai-I and 1975 Sinai-IX accords between Egypt and Israel, and the 1974 Syrisn-Irsraeli disengagel~~tagreement. - b. . . '' '~h;ra'a~~urs'to haw been at least .'tacit agreemeat 4 the part of the confrontation stater, as well ar the United States, that the priorities in achieving a viable settlement hclude tennfinatian of ongoing hostilities, dSreng.gement of Arab and Israel5 forces on r near-tarm basis, stabilization af the regid military situation to prevent the outbreak of further hos- tiUtiaa, resolution of critical political and military issuer between the parties, and, finally, the implcmantatAoa of s comprehensive rettlcmmt accard which would provide the basis for long-~termregional stability. 4 See R. D. muria, Mohammed Mughisuddin and Abraham R. Wagner, Foreign Policy Ug fn the Middle East (New York: Praeger Publishers, 1977) . . . - part of all concerned that, over the long term, economic incentives dl1 4 the key to any settlement' s ef fectireness. It is useful to note that over the years the nature of the Arab- .Irr - Xsraeli conflict has changed dramatically, largely as a result of the . capture by Israel of the West Bank (including East Jerusalem), Gaza Strip and Colan Heights areas during the June 1967 warm3 Had the major Arab confrontation states been willing to enter into a peace agreement with Israel on the basis of the frontiers then existing, there is'little doubt that such an agreement would have received ovarwhelming support in the 4 Xsraeli Parliament, the Knesset. .. With the exception of areas in East Jerusalem annaed by Israel, the atatus quo has. cmoisted of deferring any Iaraeli decision abdur ehs political future of the West Bank .ad Cat. which is, in eemence, wht the . . . 3. framework emerging from the Camp David Sdtproposes for the transitioa phase of five year. to continue. Israeli government policy (incltding 3 economic and defense policy as well) with respect to these territories ha# * bean based on three essential assumptions: 3

3~sraeliusage contbues to refer to these area* a* "addIristared territories" while common usage in the United States and elsewhere ha.beem to refer to them as the "occupied territoria~.~'As used in the present report, the ten "territories" includes those areas captured by Israel in the . June 1967 War including the. Wemt Bank, areas of bat Jeraulam occupird 3 and annexed by Israel since 1967, and the Gaza Ship. The elan Heights, also occupied since 1967, are not included in the terms of reference for the study and have been excluded. It is also important to note that data - for East Jerusalem has not been included in the aaalysis since published .. 3 figures have excluded it from the West Bank figures md are not readily . . mailable for re-lncluaiad in publZahd figures for the West Bank. , . . ., .

'Theoe fronciera were essentially the 1949 Armi~tice'lbea, although -- agreement could likely have been reached on the basis of the 1947 partsticm plan as well. For a concise review of the political setting, see Larry L. -'a Fabian, "Prologue: The Political Setting," irr Brian Van Arkadie, Benefits and Burdens* A Report on the West Bank and Gaza Strip Economies Since 1967 . (New Pork: Carnegie Endowment for Interaational Peace, 1977). o that Israel would not formally annex the territories (with the excaptPon of East Jerusalem);

o tbt Israel would not withdraw from them, absent an overall Arab- Israeli peace settlement; and

'o Zsraslwould not aUow %hem to become a net econamic burden. The iupllcations of these assumptions are conaidered at swewhat greater length below.

Economic Integration From 1948 through June 1967, Arab-Iaraeli hostilities created a aitua- tian whereby Israel was economically isolated from the rest of the Mddle ~ast.' Prior to June 1957, the economy of the West Bank was linked to the - Arab world through Jordan, and that of the Gats Strip, admbistered by but not treated as part of'Egypt, through the Egypt%- economy. EKlitarp occupation by the Israeli Defense Forcer (IDF) following the w 1967 Six-Day War provided the opportunity for Iurael to "break the seal" on the economic boycott and implement a new type of economic coexistsnce oath the West Bade, Gaza, Jordan, and Egypt. The aconamic implicatiow of thir occupation weire fairly clear. Ffrat, Israel could not treat the terrltorias, as an integral part of the Israeli economy. S-~nd, as the adnixtistaring authority, Israel was forced to deal with the economic requirements of the territories in some frshik and could not be indiff .rant to the wmlfue of their inhabitants. Third,. the revenues provllded by tb. territorSer (either directly or indirectly) would necessarily limit tha scope of Israeli economic actioity in these areas. - . . On balance, it was there conalderatioru, rather' than any war- or matter economic phfor the territories, vbZch deteminqd the lwal of . '~otincluded in thSs analysis is unreported mggUng, vhkh bas beea an esscatial part of the Gaza economy at least since the time of the Cntsades. Additional "unreported" lhks between Israel and the Arab world, largely - through Lebanon, have existed since May 1948 and were considerably expanded following the Israeli "Li tanf Operation" .in March 1978. Israeli public investment in them as we11 as their econamic development and . the development of trade and economic links during the 1967-1978 period. The developments which did take place were characterized by economic hpro- visation. While this fell short of the "maximum integration" sought by some in the Israeli leadership, it did provide for the creation of highly significant economic connections within a remarkably short time. As a practical matter, the territories required markets for their agricultural produce, the foundation of the economies in both the West Bank and ~hza. A net agricultural exporter itself, Israel pedtted the West Bade to continue serving its traditioxx~l'markets in Jordan through an "open- bridges" policy across the Jordan RPver. Caza produce, never a major factor in Egyptian markets, was transferred to Israel and sold through Israeli markec3 gg chnels. . A rapidly expanding Israeli economy provided employment opportunitiss for a considerable number of West Bank and Gaza workers in unskilled and semi- skilled occupations. Here Israeli policies and the short distances involved permitted Gaza and West Bank inhabitants to commute to jobs in Israel on a daily basis, providing an essential and growing econdc link. 1.2 Evolution of Economic Linka with Israel and the Arab World . The close of the June 1967 Six-Day War and Israel's decision not to withdraw from territories occupied during the course of hostilitfes, as it had folloving the 1956 Sinai Campaign, forced Israel to coma to grips with a number of practical problems concerning the territories. Differing points of view within the ruling Labor Alignment as to what should be done with these areas soon arose. The debate included both the issues of administerin8 the newly occupied cueas in the West Bank, Gala Strip, and Golan Heights as uell.as the broader questions of using these territories as bargaining leverage withathe Arab confrontation states fn the search for a comprehensive . settlement, and a partial annexation of land, particularly in the West Bank, to Israel itself. Despite a failure on the part of the 1sr;ell governing authorities to achieve a final resolution ef the broader problem, the implementation of . military rule brought a number of operational decisions which greatly facilitated the development of economic links in a decade of considerable political uncertainty.

Public and Municipal Servlces

Within a matter of days following the cessation of hostilities in June . 1969, the Israeli military administration took its first measures to restore vital links with the West Bank end Gaza areas, cut since the Israeli War of Independence ixi May 1948. These included interconnection of water, electric, telephone, telegraph, postal, and other municipal aervicsr. Transportation, largely provided by the bus cooperative (EM),was extended into the newly occupied territories, while parallel services continued to be provided by

the West Bank bus services. . ,. . .'' Barriers between East and West Jerus3lem. erected in the 1948 war, . r I , .. ( - sealing Israel from the West Bank, were removed by the Israeli military administration shortly after the cease-fire. Within hours, Israeli shoppers L were gurchasing West Bank.agricu1tura.l products in East Jerusalem, while the first Arab and Palestinian workers took up positions on Israeli construction projects. Israeli-funded road works and other construction projects within the West Bank and Gaza proPided employment for an increasing number of the territories' residents, whih an economic boom in Israel itself provided yet additional employment opportunities, illustrated %xi Fagtare 1.1 below. Opening of traditional links with Jordan, via the Allenby and Abdullah bridges wer the Jordan River by the Israeli dUtary authorities in tacit cooperation vith Jordan, permitted the transfer of West Bank produce and articles manufactured in the West Bank (such as handicraft items and - cigarettes) .6 J

'Many of these items were labelled "Made on the West Bank" and re- exported to other Arab states despite the economic boycott of IsraeX. . .. \ PICURE 1.1 EARNINGS OF WEST BANK AND GAZA RESIDENTS WORKING IN ISRAEL: 1967-1978 (milUons of IstaeU pounds)a

I b w i 1- im 1m inr ins im tm ten-im ran . .

"~owetsionof current IL to real IL has been made on the Israeli Consumer Price Indar with a base of 196869- 100.

- Source: Central Bureau of Statistics (Israel), Statistic21 Abstract A- - of Israel (U) , No, 26 (1975), Tables XXVI1/12,22,23. -- Despite the fact that Israel's Labor leadership first viewed the territories as "bargaining chips" from the outset of the occupation era, it is clear that "security arrangements became inextricably mixed with religious and cconumic rnoti~es."~Israel placed ~astJerusalem under the auspice; of Ieraeli law by special legislation passed at the end of 1.967 in deference to popular pressure based on religious grounds. This act had the net effect of annexing Jerusalem's Old City to Ierasl. Following the de facto change in the legal status of Jerusalem, Israel authorized the establishent of a.limited number of settlements on the West Bank and other occupied areas such a. the Wfah salient in northern Sinai, and on the Syrian Golan Beights, and fustifiad on religious, ecouomic, and security grwnda. From 1967 to 1977, succeeding Israeli governments have .. implemented what came to be knm as "Oral Law," a non-written agreement between key Zsraeli leaders on Israeli presence in the administered territories, baaed on the so-celled Allon Plan and containing the following key poines: 8

l o "permanent Israeli presence on the Golan Heightrr";

o "holding a line from el-Arksh on the Mediterranean to Rae 'hbed on the Red Sea"; o "holding Sham el-Sheikh and a laad link to Eilat";

o "a security zone around Jerusalem, in the Latrun Bridge and south of Bethlehem"; and

'Ann Leach, llIsraeli Settlements Zn the 0ctkpied ~c*itor~@s,"Jouraal of PcTeJeine Studies, 111, No. 1 (Autumn 19?7), p. 26.

8Pormulated by f-r Ieraell Foreign Minister Yigal Allon, this plan wcrs never implemented as such but was proposed some two months following the June 1967 War and provided the basis for Israeli discussions for a decade. ' o "a security border at the Jordan River cutting the populous heart- land of the West Bank off from military support from the ~ast."~

Israeli land acquisition has been criticized in part as being accomplished through extra-legal means, with significant areas acquired by Israel formerly belonging to the Hashemite kingdom of Jordan, including urban, agricultural, and forested areas as well as 300,000 duaams of desert. State- owned land acquired by the Israeli administration through 1972 amounted to 1,030,214 dunams, with title being vested in the.Israe1 Lands Authority (IU) .lo An additiorral 328,789 dunams of absentees1 and abanioned properties were acquired in the same perrlod, while in Gaza 119,244 dunams, out of a ll total of 362,923 dunams, were acquired.

'~ohn Ruedy, ''Israeli Land Acquisition in Occupied Territory, 1967- 1977," Israeli Settlements in Occupied Terrffoties, bearings before the Sub- committees on International Organizations and Europe and the Middle East, L Committee on International Relations, House of Representatives, 95th Congress, First Session (Washington: U.S. Government Printing Office, 1977). p. 178.

''The acquisition of public laad is generally recognized i. a laid , act by an occupying power. This does not, however, always mean that the public land in question is unproductive, unused, or unhhabited. With regard to land formerly belonging to the public domain on the West Bank, Paul Quering, program director of the Hennilrite Central Committee in Jeru- salem, testified before three House of Representatives subcammitteee, stating: "It is granted that a large portion of the land which was taken wet by the settlement authority, in the establishment of any of the number of settlements, was used in the public domain before. That should not imply that the land was unused or that it was vacant, or that it was a wasteland .. . in many cases,,that land was actively farmed or was used as grazing - area by adjacent villagers . . . it had been used for generations by villagers, and this continues to be the case with many Palestinian villages today." Israeli Settlements in tbe Occupied Terrdtorfes, p. 70. .. . '/* u~bsentee land has been defined as property belonging to parsons not present in the West Bank at the time of a post-11967 war Israeli census. In a number of cases, owners had fled the area prior to the smtbreak of hostill- ties. Land belonging to persons fleeing the West Bank as a result of the . 1967 war is classified as abandoned. Land acquisition has not been limited to state-owned, absentee, and abandoned property, with same efforts being made to acquire privately-owned land as well. !'Palestinian (continued)

\ For the most part, Israel, a signatory of the Geneva ~mventions,ha allowrd the West Bank and Gaz: to be administered according to the systems in force prior to accupatioa. Thus the West Bank I~trscontinued to be adminin- trred under Jordanian law since 1367 except where such law conflicts with important Israeli pollcie.. Jordanian law regarding the sale of land is on. important case in point. Any Arab West Bank resident who sells land to an IsraeU is subject to military trial for a capital offense. Although significant amounts of the privately-owned Arab land acquired by Ieraelhavebeen through confiscation, thousands of dunams have been bought by the Jewish National Fund area Xaymet ~iyisrael)with the apprwal of the military gwernment, and by Israeli companies and individuals using a variety of legal procedures to avoid the Jordanian law. Purchaser are carried out by mans of granting the pur- . . chaser an irrevocable power of attorney, and by postponing the registration of transfer until such a time as the land is annexed to Israel, (or until) a permit can be 0bt.in.d from the military gwernment, or (until) acquisition of land by private Andividualr is legalized.* Since the purchalee is only recognized upon registration, the original land-. owner rdsu holder of record title.unti1 the land-acquisition restrictions

are lifted by Jordaa. Iir addition, the ' Iaraeli gwernment has frequently utilized hteramdiariw irr the course of purchasas, with such tranaactianr not being publicly recorded. Figures on such transactions are not currently mailable from the Israel Lands Authority nor the military g~nment.

Trade Despite the post-1967 war problm with military rule, land dealings, - und various political and security matters, the volume of trade between Iaraeland the administered territories-on the West Bank and Gaza h.8 been

Emigration and Israeli Land Expropriation in the 0cctf.pied Territories," . Journal of Palestine Studi as, 111, No. 1 (Autumn 1973), p . 112. -. rZZ#raeli Settl-ts in the Occupied Territaries, pp. 44-45. FIGURE 1.2 VALUE OF EXPORTS FROM WEST BANK AND GAZA TO ISRAEL: 1967-1978 (million. of Iisraeli pounds)

'~onveraion of currant IL to real IL has been made on the Israeli Consmar Price Index witb a base 1968-69 - 100. Source: Statfstical Abstract af fsrael, Tables aPtVTI/11,12. FIGURE 1.3 VALUE OF IMPORTS FROM XSRAEL TO WEST BANK AND CAW: 1967-1978 (udllioos of Israeli pounds)

C ~onverrianof current IL to real IL has been made on the Ieraeli Corrrtrmsr Price Index wlth a base 1968-69-100.

. I Source: statfstical Abstract of ~srael,Tables XXPIIIll.12. increasing dramatically, as illustrated in Figures 1.2 and 1.3. While the > Israeli presence in the West Bank and Gaza in the aftermath of the 1967 - Six-Day War served to "break the sealf' between Israel and the Arab Middle ,- East, at least on a de facto basis in economic terns, a number of practical, Y if not political, constraints were now placed on the links between the administered territories and the rest of the Arab world. With the excepeicm '9 transport and communications of the open bridges across the Jordan River, .a between the territories and the Arab stateswerelargely impossible. J- The Ieraeli military gwernment has permitted the export .of agricultural produce and manufactured items out of the West Bank through Jordan, - and on to other Arab markets via Jordan, The growth in this trade, as illustrated in Figure 1.4, has been substantial in currekt terms but has not increased sfgnibicantly in real terms of this trade. Growth has largely . .I been in the export sector, consistins of citrus, vegetables and manufactured - food products. Imports from Jordan to the territories, consisting large1y - of manufactured goods, has increrrseC inarginslly in current terms and de- ehed in both current and real tam ainca 1975. - Reliable data on trade vdth other nations cannot be obtained. Although eome limited caravan traffic has continued between the Gaza and Egypt across the Sinai, as it has for centuries, the actual trade volume is not economically significant . Whlle these figures and the associated statistical tabulations portray the nature of this trade growth in the aggregate, there is considerable difficulty irr presenting the disaggregate composition of this trade, the precise institutions by which such trade takes place, and the exact nature - 13 . .- . of the evolut~cmthat can be anticipated in the transition phase. . . . .

U~nmost cases, diaaggregata data are not published or are not available. Many of the institutions and arrangements are, necessarily, ad hoe and can only be defined by conjecture or inference. While a detailed a@ thorough analysis may, in fact, be possible, it could only be success- fully completed within the scope of a far' more extensive effort. * . - \ -FIGURE 1.4 VALUE OF WEST BANK AND GAZA TRADE WITS SORDAN: 1967-1978 d (millions of Israeli pounds) 600

b#)'

460

400

.. a00

6 280

a00

.ISO

100

FROM JORDAN '150' (CURRENT IU *-- --- *&-I - ..- *-*em --* ------e -/ 1961 1 1- 1870 19tl 1- 1873 1974 1 1876 1877 lets

'~onversion of current IL to real IL bas bean made on'the IauU Consumer Price Index dth r base of 1968-69 = 100. . r 9 Source: Statistical Abstract of Israel, Table fOtPfI/11. - . , * . Historically, the composition of the trade from the West Bank and Caza . '1.'I . I to Israel has consisted of agricultural products, principally vegetables - I and citrus fruit, which have been used in Israel or re-exported through Israel to markets in Weutarn Europe. Increasingly, semi-finished manufactured goods have become a part of the exports to Israel, with raw materials supplied to West Bank and Gsza workshops and the semi-finished goods re-

turned to Israel for finishing, labelling and distribution. .Indeed, much . .--

of this trade has developed along the lines of piecework in Taiwan and - Hong Kong. 1 Trade between the West Baak'and, to a lesser extent, Caza with Jordan . has also centered on the same types of agricultural products exported to - i and through Israel, although there is less evidence of trade in the area of '. manufactured goods of the type des'cribed abwa. So- finished goods are . exported to and through Jordan to the rest of the Arab world, generally in the area of wood handicraft items (particularly olivewood carvings and . soweairs) which are labelled "Made in the West Bank.'' Reliable eotimstes on the extent of such exports are unavailable. For Israel, exports to the territories have consisted increasingly of manufactured and other consumer goods as well am some raw materialo for collstruction. In large part a function of the economic fact that workers in the territories earn substantial wages in Israel, in Israeli pounds, it is inevitable that these Israeli pounds ultimately be used in Israel to purchase goods and services, eithar by the original wage-earners or succss- rive transferees. - While it is fairly evident that these purchaees run the full gamut of - . goods available in Ibrael, both manufact&ed in Israel idd imported from on . Europe, the United States, Japan and other nationc, figures the distri- .. . bution of such goods are unavailable as well. /* 1 Mentioned above was the fact that Israel has also been exporting raw - matarials to workshops in the West Bank and Caza, particularly in the tu- .a tile area, which are th~nre-imported frm the territories to Israel for final -. an fini*hing. In addition, there is increasing patrem of subcontract repair 1- of durabie goods by workshops in the territories, including such items as . - \ motor vehicles, refrigerators and others. When rebuilt, these items are re-exported to Israel, either to .their original shippers or Xsraeli dis- tributors. Precisely why these trade and investment patterns, as detailed in far greater length in Part I1 below, have developed is a difficult and complex topic, requiring an extensive research and analytical effort. For present purposes, however, it is sufficient to understand that, on balance, the territories have, at least economically, tended to act as districts within Israel since their capture, and economic forces have permitted trade to develop where these territories held ;comparative advantage; that is, low wage rates, labor surplus, and availability of arable land. How such patterns can be expected to develop in the transition phase depends on soma major economic assumptions, and is considered in detail in part' IV below...... Trade MecWsms . .. Unfortunately, even though a considerable amount of trade is taking place with the territories and some reasonable &repate data are available oxi the extent of this trade, the amount of authoritative or definitive in- . formation on how this trade is conducted is highly limtted. Here it is essential to bear in mind that these mecharrimus have evolved to avoid or evade legal restrictions and taxes Imposed by Israel and Jordan, and thus Uttle formal information is available which is of use. Indeed, most of the mechaaicrms are informal ones, with the paperwork being limlted or entirely ad hoc. In some areas, the types of arrangemeats are "common knowledge" or conjecture, with little or no official authentication. For example, in . . - the trucking industry it is known that deals are frequently made between trucktng f lrms in the territories axid 'ia,rael for the mansport*. and ,sale of cargos, with the cammissions being split by the firms. Presumably, these are most often cash transfers, with no bPlls of lading, and the parties are seeking to avoid income taxation as much aa anything else. ?fore generally, it is clear that this trade is, to some major extent, - conducted on a cash bahs utilizing ~sraeli'pounds,Jordanian dinar, gold, U.S. dollars, and a variety of other "hard" currencies. In other cases, actual bills of lading and bank transfers are utilized, although, even in such cases, the banks involved have been reluctant to report the nature and -

scope of these trades. - In addition to the incentive to avoid income taxation, a value-added - tax (VAT) imposed by the military governor prwides yet another incentive 11 to keep such trade on a cash basis and unreported to the authorities. Thus,

to a major extent, taxation as much as anything else has pushed a good deal 1 14 '1- of the territories into the "gray" market.

Cornpetitfan and Alternate Sources

With respect to imports by the territories, 'the aggregate data reveal - !i L that some 25 percent of the imports to the territories cQme from Israel, vlth -

the balance .coming from the Arb world, the United States, Europe, and other ' - , . nations. In general, 'such importa consiet of consumer goods, durable6 and 'I - noa4urables, raw materials, and agricultural products not grown locally. While precise data are lacktug, it is estimated that the competition is among alternate sources primarily in Western Europe and secondarily among thd U.S. and Japan, and other nations a distant third. There is much less difficulty with respect to exports from the terri- . - tories since these are fairly well specialized and concentrated in the areas - of agricultural produce and eemi-finished manufactured goods. As detailed in Table 2.i0 (page 39), the two principal export markets for fruit and vegetables grown in the territories are Ierael and Jordan, with an undefined portion of the produce exports to Israel re-exported to markets in Western - Europe. To a considerable extent, Israeli exports of fruit (principally . . citrur) to European markets have varied, depending on seasonal and market

14~urranciesin use in Wsin the West Bank and Gau include the Israeli pound, at least 55 million Jordanian dinar (mostly on the West Bank), Egpptian pounds (in limited amounts, mostly in Gaza), U.S. dollars, gold, and a variety of "hard" Western currencies in limited amounts. The Bank of Ierael, Israeli commercial banks, and their branches in the territories vill clear all of these currencies. factors in Europe. Were the territories to achieve an independent status, . they would likely be able to compete in European markets with Israel to 15 same extent, possibly increasing their market share. The extent to which fruit and vegetables exported to Jordan may be re-exported, either to the Arab world or Europe, is largely unknown, but is estimated to be a relatively ineignif,tcant factor. Further, it is unlikely that this would become a significant factor in either of the two scenario8 considered for the transition phase and beyond. Aa indicated above, the balance of exports from the territories con- 8ists of semi-f inished manufactured , goods returned to 1srael for final finishing aid distribution. Specific figures of any reliability are not currently .. . available on the lwel and scope of this industry. The final category of exports consists of finished goods, largely handicraft and souvkir it-, . .. . which are exported to Jordan for further distribution. Because of the boycott of Israel by the Arab world, such export activities have kept a low profile,andhence data which might othervisa be available cannot readfly be obtained.

I Prospects for Change '

What changes can be anticipated in the composStion, nature, and extent of trade with the territories depends heavily on the type of scenario which evolves during the transition phase and the economic assumptions which .to associated with each of the alternatives. These scenarios, the ecanornic assumptions, and their implications for trade in the transition phase and - beyond are considered in detail in Part- 111 below. The most significant finding of the analysis, however, is that while, - . under current conditions, Israel supplies wet 90 percent of goods ,md arr- vices imported by tho territories, this figure could drop dramatically in the trurslltion period. Jordan and the rest of the world, which now eupply some a

150ffsettinz this effect in the current situation is the advantage which the territories-now have by utilizing Israeli marketing and. distribution networks; and any premium which the llJaffa'l labels give in these markets. 10 percent of these imports, could supply up to 25 percent by 1983, which is a dramatic change in the pattera of trade. While Israel clearly dominates 4 the trade pattern with the territoritee now, they will be "opened up" to a r significant extent under anything approaching a cooperative scenario. 11. ECONOMIC LINKAGES DURING THE TRANSITION PHASE AND BEYOND

2.1 Overview of Fundamental Conditions 4 ' Had an Arab-Israeli conflict not existed, and -.;rider conditions of peace and open boundaries, Israel, the West Bank, the Gaza Strip, Jordan, Lebanon, and perhaps other countrdes in the addle East region could 6rm constituted an integrated economic entity functioning in a way simllar to the Co-n Harket in Europe. The fa& that this is not the case suggests that, before any prediction regarding future trade and economic links can be nnade, it is essential to understand the nature of the links today and what consti- tute the major barriers to achieving a mcre integrated and linked system of . , . ... , , ...... , . , ...... , . .. , , . . economies. . .

It is clear that, as for the period extending from May 1948 to'Jrtlra ' 1967, the noh-eristence of links between Israel, the West Bank, and the Gaza ...... Strip was a simple outcome of the state of belligerence which prwailed in the region following the declaration of Israeli independence.' Thus the 1 interesting period to study is the period of Israeli military occupation, 1967 to 1978, which would suggest what are the vital factors operating ia the region today and will, no doubt, operate there during the transition period as well. The most notable facts regarding the links befween Israel, the West Bank, the Gaza Strip, and Jordan can be sunmrizad as follm: o During the occupation period, a large number of Arab residents of - the West Bank and Gaza found employment in Israel. In many cases, jobs awly were not available in the-territories, and wages in

I 'see Brian Van Arkadia, Benefits and Burdens: A Report on the West Bank adCIza Strf p Economfes Since 1967 (New Pork: Carnegie Endowment for Inter-national Peace, 1977). Israel were some three rimee as high as those prevailing in the territories, increasing at a 13-percent annual rate. o Associated with this employment in Israel, a growing level of 2 imports from Israel to the territories was recorded. o Very minor Israeli economic activity took place in the administered territories and, apart from the settlements, no significant actAvity can be recorded. o Significant economic ties were maintained betweea the West Bank and Jordan and extensive official trade hats been rintaiaed. . . These trends are illustrated in Tables 2.1 and 2.2. Thus the trade with Jordan is modest, where imports from Jordan ara negligible while export8 . to Jordan are rising rapidly. 1t is clear that uten~iveamounts of goods and services move acrosu the frontiers of the territorter and 8 large number of workers cross from the territories into.Israe1; A neg13.gible amount of joint busina~ractivi- b ties does, however, take place, with little private Israeli capital in- . va~ted.in the territorieu and no Arab capital invested in 1&d. Fur- thermore, the growth process ia the territories 'involve. very little direct economic activity of out~idaresources, entrapraneFs, or venture capital, The growth process itself does not seem to be influenced by a clear economic plan aad supported by any specific public actions. 4 This economic picture is a uaique outconte of the special circumstazrces of the Middle East and any future developments must take into account the factor8 which shrpad the abwe developmeato. Before proceeding with the -- . . L ~yssof tha natka of linkages, it is important to review the legal $.sir of econdc activity a8 it relatesnto the potential for future.develop-

%ere both the ~yn~entof wages to territories' residents $n Israel. lower prices in Israel, and the availability of many goods in Israel contri- . buted ta .th%sflaw. Aa an accounting matter, payment of these wages in 0. Ilraeli pounds ultimately led to their being spent in Israel for export items. TABLE 2.1 TERRITORIESf TRADE WITH ISRAEL:

Sxparta Frm mrrl tori 8a lhporu Of Wrrftori 8n ro Iarrel FZQ) Iarael

Current Real Current Real Currant R..l -- rt -ft -I& -tl -ft -IL 372.0 145;O 199.8 68.8 1DSo9 442.8 664.0 180.7 353.2 6006 2000.0 544.4 961.1 227.7 473.4 9307 2649.4 627.7 ...... ,, ...... , ...... , a . . Conversion of current IL to real IL has been made on the Israeli Consumer Price Index rlth a base 1968-69=100. . . . :. . .

Source: AAC computations, based on data frau Statistical Abstract of Israel (1977). Tables M[\III/10,11,l2.

Following the June 1967 War, the area of East Jerusalem was aaaaccd tb qataal and all economic activity ia Jerwalea! has been takiag place subject to the laws of Israel. This mano that any resident of these areas cur establish property rights anywhere in Jerusolan. !Chis is nol: the case in the other terxitories. In holding the legal position that the territories are admidatered - and not annexed, Israel agreed to allow the.JorddLan law to apply in the , west Lkand ~Wtiau~.r to apply in the ~.uStrO. a both territories, Jordan sod Egypt promptly enacted legidation establishing the death penalty to u~ybodywho sold land to an Israeli citizen. Similarly, the Israeli law

*- " does not permit acquisitioa of land by Israeli citizeas without' -a special ' permit by the milim governor. There are some very exceptional cases where the lnilitary governor permitted private land sales for special pur- poser, and in these cases an official registration of these private transfers . - \ TABLE 2.2 TERRITORIES ' TRADE WITH JORDAN: 1974-1976 b (millions of IeraeU pounds)

Exports From Territorfe8 Omports Of Terrf tori es To Jordan From ~ordan

- -- Agrf cultural Industria1 Agrf oul tval Induotrial Products Product8 product8 Product8

- Current Real Current Real Current Real ~urrent-Real ZL IE n IL -n -n --R; -XL. 2.4 .8 18.6 7.3

D b&verdon of current IL to real IL has been plde on the Irruli 8 Consu~rarPrice Index with r Base 196849 = 100.

I . Source: AM: computations, haad on data from Sfatisticrl Abstract of Israel (1977), Tables XXVII/lO, 11,l2. . Y

of titla did take place but are regarded as illegal by the Jordanian or Egyptian lmm. These abaomalities ham generally bean avoided, .ad whan-

cr.r H)I. land was needed by tha udUtary authorities for whatever public purpose, the land was publicly expropriated and msrket duewas paid to . - . .. the mmers as compenration. Most of the land that was expropriated for the purpose of military bases or settlements was public land, wlth the technical 9. owner8 being the Jotdadan or Egyptian govannneat. *C These legal facts of life reflect both the opposition of the citizens -- of the terri,toriao and the governments of Israel to massive purchases of - (60 land by IsraeU citizens is the territories. . It elso reflects a rather - bomt~eeconpnic ~W~T-BD~, not only to ~.ndpurchases by Israeli cttizan. a but to my economic activity involving Israeli 'interests which would require '\ ,.(-- the astabliehment of any property rights and legal protection of these rights. Thir means that even if soma method like renting or leasing of real eetate could have been found to warcome the issue of owning real estate, the general economic climate set much too high a risk premium on direct private Israeli invastmentn in the territories. Thuo, with the impossibility of acquiring real estate and faced with a vary riaky domestic environment, little Israeli prtvate capital had the incantiva to wva into the territories. We may note that if the profit rate were high enough, Israeli finns would have used indirect methods of invest- -. went (if posrible) and would have taken the risks which these would have en- tailed. Thia process did not take place and two factors prevented it frau occurring: First, there is Arab capital, both from local sources and also from tha rert of the Arab world, that hag been invaeted and thereby pre- . vantr the rater of return from being so high as to attract IsraeU investment. For Israeli invastor~r,rates of return in the territories can be approxinutad at 2!i percent for the 1967-78 period, compared with rateo on tho order of SO percent in Israel for risk capital, in current Israeli pound~.~In addition, investments by Inr?alis in the territories lack thn protection sf either the military gwernor or the Stat& of Israel, adding ' considerably to thrr risk factor. Second, the Jordaa%aa, Egyptian, and Is- -raeli l.we do not penult tha acquisition af any property rights by Israelis in the addairtared territories, and this precludes the formation of any putaarship, corporate entities, and any other orgaaizat5an that would irr- volve Iwaeli capital indirectly. The rituation is completely symma&ricwith respect to investments of .- citizens of the territories in Israel, thus precluding the establishment of , my significant ecoaoraic ventures that would croes tha territorial boundaries

It rhwld be abeolutely clear that any prediction of future links beman the territories .ad Israel or the rest of the Arab world depends, to a crucial degree, upon the maintenance or modification of legal structure dircur~adhere. In the scenarios discussed in Part 111, we take up this irnre explicitly. 2.2 Evolution of Trade Links and Institutions The evolution of trade and economic links between the West Bank, Gaza Strip, and othar parts of the Fiddle East following the June 1967 Six-Day War provides the basis for an asst2ssment of the types of further developmenf which are likely to take place in the five-year transition phase and beyond. Eere it is essential to understand that thls development will, to a major extent, be governed by both the fonual in~titutions,such as custonne'unions and restrictions, as well as the infalnnal agreement8 and arrangeinents among the pax ties.

Trade fn the Poat-1967 Bra -. b Since the trade links which evolved in the 1967-78 period betwears the West Bank, Gau, and Israelwere based on Israeli military admin&otratlon . and a desire on the put of many in the Israeli leadership to see econondc Udcs develop, few, .if any, formal restraints on trade were imposed. The territories were vlewed as part of Israel for aama economic purposes, so no customs dutf es, surcharges or othar rertirictions wera imposed on the import of goods from the territories to Israel or from Israel to the territories. To some extent, this made the territories subject to the same international boycott restrictions which Israhl itself faced aver the decade, although the limited scope of trade between the territories and states other than Iaael and Jordan h;s made this a generally insignificant problem thum far. Even during the period of IsraeLt military admin&stratian, Jordan has attempted to maintain the concept that the West Bank was still an integral part of that nation. Consequently, Jordan has not imposed duties or other - restraints on the trade betmen the West Bank and ~ordaa'on the east bank of the river. --\ 4 Thia has had the net impact of creating an ad hcc*kuatau union or free trade zone betwen Xstael, the West: Bank, and Cam Much of the analysis in the present report Is based on the implicit assumption of free trade within the region during the transitionmphaae and beyond. Middle East Free Trade Azea One of the most innovative proposals offered for the post-settlement economic development of Israel, the occupied territories, and the Arab confrontation states has been the formal establishment of a Middle East Free Trade ~rea.~Under sucha plan, a MEM Zone would be established and super- vised by an international authority and operated under United Natioae aus- pices. A free trade area would, presumably, facilitate the development of trade and economic links as well as flows of dtkelopment capital to the West Bank and Gaza areas from a brpad range of potential investors. Such investments are considered at greater length in Section 2.5. Thie would have the additional effect of prwiding employment for ~alestinikrefugees in the areas of constructio~~,tourism, manufacturing, and agriculture. A free trade area would enable such workers to live comfortably under rela- , . tively moderate wage scales, purchaing their requirements dutty-f re.. As- suming that the self-governing authority in the West Bank and Gaza does not maintain a military and, consequently, bear the related defenm costs, &ea on local residents should be minimal.. Under the MEmA firoposal, international free trade buffer zone Zone) on both rides of the intekti-1 i:gypt-Israel border, with an cutention in a strip along the Gulf of Aqaba, would b~1established. . If suc- ~s~fblrIsrael'would be obligated to apply the HEETA principles to a settlemeat of the Palestinian and Golan issues, including the eatabliahment of an independent, non-militarized Palestinian state (like Coeta Rica) on the West Bank and in the Caza Strip. - be The Israeli West Bank settlements would remain, but they would beca91~' free trade, agricultiaral, tourist, commercial, and manufacturing sites of .the international trade sector wer which the Palestinian state would have no

indicated above, the West Bank has experienced considerable success by labelling manufactured products "Made in the West Bank" and re-exporting them through Jordan. See S. C. Yuter, "Bridging the Egypt-Israel Negotiating Gap," Ripon Forum# Vole XIV, NO. 6 (July/A~g~st1978). jurisdiction. The Sinai settlements in the MEFTA Zme would also ram1a u . . part of the free trade sites allocated to IrraeZ. Znternatiorul police would have exclusive jurisdiction over the MEFTA Zone and the international trade are88 in the Palestinian state,

Tho northern end of the MEF!FA Zone adjacent to the Oaza region would I - include a deepwater port, an intarnational airport, and an electric powar- -- desalination plant to provide ample electric power and fresh'mter. Tbu plant wdbe located on the coastline between Yamit and th. 8. interrutianol border, It would be powerad by Saudi gas rold at production , cost, .od deUrerad to the ~ord.ni;n border ac Aqaba-Ekth via a Saudi- constructed pipeline; and from there to the plant via 8 U.S.-cm8truct.d undargrouad pipelha in the ME= Zom. The 0.8. would also chutruct a parallel pipelins to supply desalinated water, not only for' industry ad . . agriculture but to the 'citiar of Blrth and Aqaba (in equal amounts irr ratran far the transit rights) and to the ME- Aqaba Strip to maad tauriw; also, an underground pow.r liru parall- tha water pipeline, The production cost of the fresh water would be' low enougB to 8sarre it8 profitable ore for irrigation, The 1l;rraelir would pruvide as unzertricted tranrit earmsrst from tho . We8t Bank region to the northern PSPIX'2one for 8 li.lted accer8 tbmmy to connect the Wert Bank md Carn regianr, This would giva Jothasare- rtxicted acces8 to the 8eaport in the MeFTA Zoae via tha West Bank region. Tha Zone would be supexvised by an intemm~arrcrlME= Super- visory Authority (MSA) consioting of Egypt, Irrael, .ad the Inter-Govamm~lrtal Maritime Consultative Organizatfon (IMCO), 8 DON. specialiced agency, bared -- in London, having t&iobjectiva of r&ng hindrance~td tr*. . 2.3 Flow of Capit.1 and Entre~reneurialTalent /

r- We have noted previously th; th. legal restrictions on real eatate -- purchases could bme been marcome by a cornplea system of lang-term lcasing. Although not totally oimilar, there are examples of situations where son- / muidant laadowners have granted such leases for various c0mmcrcSal purpouea, \ - including Hawaii, where major commercial tracts are on 99-year leases, and Palm Springs, California, where wer half of the commercial and residential . development has been on land leared from local Indian tribes for long terms. The essential point is that, in the caoe of the territories, the real estate restrictions, either de facto or do juror wera rupplemented by a legal system thut makes it virtually imposeible to develop business enterprises across the territorial frontiers. More specifically,

o in order to make 8 contract, register a corporation, or operate 8 partnership, an Israeli individual or colirporatim must appeal to a Jordanian or Egyptian court, and this .is forbidden by both coutte. The state registrars of corporatiour are in ,Amman and Cairo, where Israeli firms cannot even reach these authorities.

. I o no citizen of the occupied territories can by hflwelf or jointly ' . ,. with an Israeli firm establish a partnership or a corporate , eatiky to be registered in Israel and be protected by'18raeli law.' . . . .. , Thus, both in the territories and in Israel, there is no legal basir for any . intrestmnt and econordc activity of territorial enterpr%aes in Iarul or 3rraeli en'terprises in tha territorfes. & noted earlier, the .mwrrt of trade between the territories and Israel is great, but this is accomplished -. because of the following reasons: o Movement of workerr; into Israel ir not illegal under the abwe arrangaments, and when territori.1 residanrs work in Iurael they are even partly protected by local union rights. 4

o There are special joint venturea between terrftorial mb nos- .- . .- . territorial residents and there are the commercial- vantures moving

4~1thoughthe ddenca is somewhat confllcthg on the extent of thew rights, it io clear that Arab workers are the subject of collective bargoin- %ng agreements negotiated on their behalf by the Bistradrut (Iliraeli General Federation of Labor). Whether Histradrut dues are collected in all cases or . full rights of Bistradrut membership afforded to residents of the territories remains open to dispute vlthirr Israel. the extensive trade between the territories, Israel, and Jordan and Egypt. On the Jordanian and Egyptian sides, there are no prob- ' lems of setting up the legalities of trade. On the Israeli side, the traders on both sides work out their payments via the branches of the Israeli banks which operate in tht territories. Thes: branches are mostly operated by territorial rcsidentr, and they are needed since all three currencies circulate in the territories: principally the Israeli pound and, to a lesser extent, the Jordanian dinar and the Egyptian pound. There are many joint ventures of Israeli residents and territorial residents that do not o land values in Israel have bean increasing rapidly and are mch higher than in the territories; o wage rates in the territories are lower than in Isracl, and Israeli business enterprises do not locate where the wages are low but, rather, the workers travel to Israel to peek gainful employment; o lack of Arab investments in Israel and of Israeli investments in the territories. Leaving aside the political aspecte of the Israeli settlements in the territories, these settlements do have the economic property of inducing further links among the various economies in the region. Thia followe from the basic links bemeen Israel and the settlements; and the potential growth ' of econornic interdependence between the settlements in the territories is not likely to remain agricultural in nature, mostly because of the limited amoun't' of fertile hdavailable in the territories and the inability of the settlers . to maintain adequate standards of living, baaed on thie limitad amouut of land. Thus an extensive 1sraeU settlement program ia ultimately bound to decou industrial in rcope. Such industrial development could take p3ace either within k rural set of colmtnitiea or within a completely urban context. Aa . industrial society will need capital, skilled labor, efffcient transportation and communication, and efficient supply of materials. Thur, if the Israeli settlement program continues, we are likely to see, during the transitIan period and beyond, a growing interaction between the territories and Israel &en if no changes are made in the legal climate discussed abwe and no reduction in the economic risks of investments occur. Sections 2.1 and 2.3 above are intended to show what are the most - important limiting factors in the development of further econ&c lhk between the territorfes and the neighboring areas. In Part 111 of thir report we attempt to indicate the kind of economic developments which may take place in the transition period and beyond. We strongly assert that the kind of economic links which will occur depend upon change8 of the political and legal constraints discussed so far. The two scenarios which - we develop differ essentially in the degree by which these restrictions are, in fact, changed. If some of these restrictions are removed, then the development of economic links will depend upon the nature of the economies at hand, their resources, their investment opportunitiea, their financial institutions, and their political organization. These we must evaluate now.

Investment opportunf ti es and Capd tal Reqttirenwnts In spite of the severe economic, political, and military constraints, the acoaomies of the West Bank ad Caza territories have become more and more , linked to the economies of Israel and, to a lesaar extent, Jordan in the period since 1967. The analysis Ns, however, baea largely limited to lid in the form of increased speeiaUzatioa of the labor force: an increasing number of West Bank and Gaza residents employed in Israel, using their income to purchase goods and servicer imported from Israel. . We have already seen some of the initial effects this has had on employment in the agrlculbre and industry sectors of the territories. The prermt section examines in greater detail two additionalaapoctr of the . ' wotrlng econdc linlrr between thr West Bank and Gau econadu and those . of Xrrasl and Jordan: o due to the rising wag0 rater and competition of hportr, the traditional sectors of agriculture and Ught indurtries have baea concentrating on those actiyities in whkh they have relative advantage and increasing their output by capital deepening ale decreasing the laborloutput ratios; sad

r, a growing fraction of local output becomes rensitive to market conditians in Israel, Jordan, and other axport amrketr. - .. .-...... To examine these two point., recall first our 6bmrvation that the ..'

' grouing smplogment of territorial residents in Ierael hap been aoaoci.ted wltb an actual decline of anplog~lentin agriculture and a nearly constant ratr of employment in industry. A mots precise dcture is illustrated in / Table 2.3, where the decline in agricultural tmplopnent occurs both in the West Bank and Gat.. . . . \ TABLE 2.3 DOMESTIC DISTRIBUTION OF E?lPLOYMENT IN l?lE TERRITORIES BY SECTOR:

We&nk 0.- Strip -----1971 1972 1973 1974 1975 ----- 1971 1972 1973 1974 1975 A&riculture 50.2% 38.m 34.2% 37.9% 34.6% 31.1% 24.8% 25.7% 24.8% 26.S

Serricar and ocher8 39.0 40.2 41.8 40b0 41.2 2 58.5 57.7 58.9 56.6

Toout 100.02 fOO.OX 100.0% 100.02 10a.OX 100.0% 100.0% 100.02 100.0% '100.0%

Total dolnmtic eagloyant t t hourndr 91.22 90.3% 87.82 95.0% 91.9% 51.5% 46.0% 45.62 46.72 46.m '

Source: AAC calculations based on data in Statfstfcal Rbstt'act of . .. . . Israel......

What is unusual in the econaerias of the territories is the fact that the rapid decline in agriculture employment is associated with a slow rise in all other aectors: some rises in manufacturing, services and construction. ThAr remarkable "balmce" in the development can only be explained by the exis- tence of Israel as a large source of supply which then allows all the domestic industriem in the territories to grow in accord with their relatsve advantage. This same conclusion can be drawn from an exadnation of the' specific - crops produced by th6 agricultural sector of the territories, as indicated . in Table 2.4. It is clear fran Table 2.4 that the most rapid growth occurred J in field crops, ;agetables, citrus, and other fait because. , of the growing markets for these products in Jordan, Israel, and overseas. Looking at the destination of agriculture output of the West Bank and ~.zagiven in Table 2.5, it is clear that Jordan buys a large fraction of the output of fruit (particularly citrus) produced by the West Bank and TABLE 2.4 . TERRITORIES' OUTPUT OF SELECTED AGRICULTURAL PRODUCTS: B

(thousands of tons)

RIest Bank Gaza Strfp ----.----1967/8 1973/4 1974/5 1975/6 1967/8 1973/4 '1974/5 1975/6 Field crops 23.5 63.9 38.3 34.9 - u - n Vegetables 60.0 138.5 139.9 147,3 31.8 37.9 46.0 48.0 ll

Halwa ' 36.0 4.2 3.6 4.5 12.5 " 6.1 4.7 3.0 Oliver 28.0 110.0 10.0 50.0 u - - Citrus 30.0 61.5 63.8 74.1 91.0 207.0 201.4 243.7 . . I: Other fruitC 47;9 71.0 78.1 76.6 19.0 26.5 25.2 20.9 Meat 10.3 22.0 20.3 22.4 1.7 3.4 3.7 4.4 b Wilfr 30.3 44.7 46.0 415 2.8 11.7 12.9 12.8 ' Eggs (millions) 23.6 38.0 38.0 38.0 10.0 30.0 32.0 32.4

C1l~therfruit1' fn C.za includes Olives.

- Source: SutiNcrt abstract of &el (1977). Tabla XXVII/26. ..

Gaza, but .1PK)mt no vegetables. Iarael and uversaao markets buy both fruit urd vegetables in the territories, with th. vegetables going to Israel rod the fruit (particularly citrut~)going to werssaa market?, prirP.rfiy -

. # Europe. Note the gr'eat specialization of the Gaza agricultural economy in + , '

The general eonclusioa hare is the greconcentration of 'the agticulture sector on cash crops and 'fruit, all of which depend upon outaide markets and are heavily capital-intensive. The growing links betwaen the -- . territories and outside markets, particularly in Israel, can be seen from the pattern of industrial development. Table 2.6 demonstrakes the growth patterns of key sectors in recent years. v TABLE 2.5 DESTINATION OF AGRICULTURAL OUTPUT: 1971/2-197516 (percent of total vol~)

orf gin -- -- 0.u. Strip

------Wrt Bulk c.u strip Jordan Irnal and mamu

! Source: MCcomputations, based on data from statistical bstract of . .: Israel' (1973), Tables XXVI/28,29, and (1977), Tables lDNI1/27,28. . , . . .

I Without, for the moment, entering into detailed analysis of Table 2.6, it is important to note the striking imbalance of the growth of different sectors. This imbalance stands in sharp contrast to the appearance of balance in the aggregate data. The facts are that industries which have hport competitors or insufficient relative domestic advantage have grown slowly. These include, for example, the food and beverage industries as wall as wood products in Gaza or basic metals and equipment in the West Bank. - The really rapidly growing indwtries are the light industries and tmctiles. ~hesehave orcallat domestic markets and a growing potentt.l of markets in Israel. This arises from the fact chat'rpost of thase industries are based on rremi-skilled workers whose relative availability is greater in the West Bank and Gaza. Furthermore, the products produesd are simple in nature and require unsophisticated technology. The reader who is familiar with the development of Xora and Taiwan will note some similarity of conditions in these far-eastern economies and the economic structure of the administered. \ TABLE 2.6 INDICES OF INDUSTRIAL EMPLOYMENT IN THE TERRITORIES

(index numbers, 1969 1 100)

Weat Bank &za Strip ------1969 1973 1974 1975 1976 1969 1973 1974 1975 1976 Food and beverages Textiles and ~lot~g Wood products Light industries (paper, rubber, plastics, chemi- cals, oil product., rmisc.) Uric metals and equipment

Source: Statfstfcch Rbstract of Israel (1977), Tabla XIIX.

territoriea of the Middle East. The essential characteristics of the Muatrial potential of the territories can ba sumarized as follows:

o The agricultural base of the economiee provides the potential for further capital inveatmente and concentration on speciaUzed - products. The bills of the West Bank are suitable for the .. production of fruit ad the Jordan Valley has some potential for agricultkl development, particularly for winter c;gpa. The

. '1h. rocky corridor to Jerusalem, for example, is being utilized for - . intense agricultural production. See, for example, the increase in production in Table 2.4. . - \ I Eaza Strip has some additional potential for developing citrus crops, Any of theae developments will require irrigation projects, capital inveetments, and major development of outside markets. It then followe that future economic development of these areas vill require further links with outside sources.

o The relatively low wages coupled with rising skill and education levels suggest that future industrial developments are likely to occur in those industries which are sensitive to such conditions: textilee, clothing, light manufacturing, crafts based on leather or plastic, various electrical instruments which require simple assembly lines, etc. Such industrial development will require deeper ties of the territories with sources of finance and marketing. This means that, in considering the transition period and , beyond, the rising ties of the territories with Israel or other . veas dedend upon the arrangements which will enable the utiliza- tion of the above conditions.

o An especially interesting industry is tourism. Obviously, Jerusalem ' is a major tourist attraction, but there are many parts of the territories (e. g., Bethlehem and Hebron) which are very attractive to tourists, both local and werseas. Coasider the "Hotel Bed- Nights" and "Rooms Available" in the West Bank during the recent period. fie reader may note that, up unt$l 1973, tourism was de-, veloping fairly rapidly and in=luded both local and marsus tour-

ists. Yet, after 1973, when the terrorist activities began to ' dse, tourism in the West Bank began falling although it continued - . to develop rather rapidly in Israel. This example demonstrates . the potential evolu'tion of joint economic activity in the terri- . tsries, Israel, Jordan, and other regional centers fike Egypt. Such potential could materialize during the transition period and beyofld only ifcooperative actions are taken and if the political and military environments permit. ZJ 0 2.4 Labor Flows and Future Labor Force Compoeitian - D The population of the West Bank and Cazs territories has one of the highest natural growth rataa in the world. Table 2.7 provides a general view, demonstrating that the net growth rate of the population (net of . death and immigration) has been war 2 percent except for 1975-1976. On the other haad, three otbar basic economic forces are operating in the territories which will become highly significant during the transition period and beyond. The first of these factors, illu8trated.in Table 2.8, ff is the rapidly rising level of education in these tenitarie8. Thm implication of thir riaiag educational Xeval ir that thm stcill8 level of the manpower base in the territories will alro be rising dramatically, which could lead to economic deirelopohent in the territories thmaelvcrr or . a Crab of skilled workers into labor marketa outaide the territories. A rjor factor is determining whether: or not them worker. can be retained

POPULATION AND GROWTE RATES M TEE TERRITORIES - , .

Net Pureeat Natural . .Growth Rate Population Increase - -Year (thou~d8)- (tlsouand8).- Weat- &ak -Cam

Source: Statfsffcal Abstract of Israel (1977), Table ][XPII/l. \ TABLE 2.8 RISING EDUCATION LeVn IN TBE TERRITORIES:

lbtal Wtal Popul. ti am Populr tian Aged 0-14 In ScW orc cent I thouunda) (thouunda) fn School ..

Source: Statfatical Ab#eracf of I-1 (1977), Table8 lPILVII/2,40. . - .. 'will be tb. milability of davmlopmmt capital, comider8d in Section 2.5 - balow. - Th. rwond factor is of oagoiag hportcmca: tha relatively elm tat@ of dmmtis indurtrSaliution ia tb. t8rritea8 coupled Mth a rapid de- cum in a$tic\rlturul employment, sumariaad Sn Tabla 2.9. Tbir table @born -.. .. tht, in mito of the rapid growth of the pogulatSon, total domartic amploy- wnt ir fallitq .od the nlrtive rbra of amplo-t in a@culturm ir .3&0 f Than two phmor#lu crrr ba axpflined by the incruriag percantagr of t8rritori.l teridmtr who have found employmmt in Iarad, and the tram- formadm of agricultttze in th. tarritoriea from a lab-btrrraive form to one more advanced and capital-intatrive. Thir can be reen aa well from a carspariron ef a~icu1tur.l production, which bar been sharply increasing at

-- -l i . '. \ - .\I 4'

I a COMPOSITION OF DOMESTIC EMPLOYNT IN THE TERRITORIES:

ZRanm8tia Per cent Empl oymnt mp1 oyed In -Yew (thousandsJ Agri cul tun

, Source: Statistical Ahmtracf of Isrrel (1977), Tab18 X%VII/23, 3-

'I the ram tima agricultural auploymat has been failing off. Clomdy arm- . - cut& wlth the kttor br bean a rapid mrrctwrizattoo of agriculture io tbr territories, due largely to Arab imrertmQat anC concentration fa otber

* capital-htmsive rubsector8 of tb8 territorial econder. At tha osmr - - Oinra, umufacturiag cnplqamt bar been driug, but only slowly due to

tho ralativoly rlov'growth of thir mctor. Again, chis growth ia Unked '. I

to capital invam(wnC by am-roridaag Arab., which barn been lidtld. ' Them' ' + - noa-resident Arabr includo investors from the OAPEC countrier a8 well 88

rum traditional Lebnnese and Syriorr inoartors who htn made inveetmentr &n \ - - tbb t8rrSteries both for political rearonr and aa a speculation which would - - piald Ugh returns under settlemeat conditisas. 1

0: - - The third and most dietinct factor involved is the rapid rate by which the workers of the territories are becoming linked to the economy of Israel. Table 2.10 shows that the fraction of the territoriesv labor force employed in Israel has risen from 11.9 percant in 1970 to 31.5 p¢ in 1976. This extreme development ie a unique outcome of the realrzicting forces, dircursad above in Section6 2.1and 2.3, which ware imposed by the political forces operating in the region. Had these restrictions not been enforced, undoubtedly the links between Israel and the territories would have led to axtenrive capital investments in the economy of the territories, and this would have established the demaad'for domestic employment in the territories. With these restrictions in force, the rapidly rising wage rates In Israel have been attracting a rising.number of workers from t'he territories. Note

that this process is associa:ed with a very intensive process of capital ... - deepening economic specialization in the territories, leading to a very

TBE RISING EMPLOYMENT LINK BETWEEN ISRAEL 0, I AND THE TERRITORIES: 1970-1976

8 Tsrritori es ' Twritori en ' Workdlps W0rbZ8 ~pl0y.d en0,Jo~d Percent ~sffcally In Israel Ea~ployeti (fhowaadrr) (thouMnd8) In Israel 20.6 11.9X

Source: Statdstfcal Abstract of Israel (1977). Table XXVI1/22. iarprerrive growth of Crosr Domestic Product in the economy, ae ehown in Table 2.11. Tha table indicates thrt, from 1968 to 1976, Groas Domestic Product (CDP) increaud by 127.9 p.rcmt in the west Bank and by 90.1 percent in thm Cam Strip, and all thir when total employmaat in the domea$ic ec0114~fldwlf nod by about 11 percent! When attempting to draw concluslone from all these factors to the my economic Uakrr are going to operate in the future, it is clear that one rhould be very aware of how any of these predictions are sensitive to the

TABU 2011' . REAL GROSS DOMESTIC PRODUCT (milUo~of 1968 1rraeli poundr)

Annu81 krnttal - I We* Growth Gau Growth -reas -mak -at. -Strfp -Rat.

* Source: St.dstical Abstract caf Israel (1977), Table Q[VI[I/6. . , . . \ restrictions discussed in SectAone 2.1 and 2.3. Yet there are a few :&I- portant conclueione to be drawn: o The vary rapid grcmh rate of the population will continue and the size of the population will teach, by 1983, the range 03 1.3 d,lUon. o The rapid growth of the wage rate will continue to take place due to the real growth in Israel, leading to a decline in the rate of employment in the traditional induetries of the tetrftories and generating a large, excess supply of labor in these sections. o The rising supply of labor is likely to be more educated and more dlled than the current labor force. o In order to abrorb thin growing labor force, either a marrive rate of d-atic capital investment'will need to take phce 07: the continuation of the trsad of employment in Israel will occur. . . o Since the domestic industry ir highly epecializad, a growing iadustrSalization of the territories will aecess-ftate a rapid growth of export8 aad foreign trade. Thur, uadar either of the two rcen8rios explored in Part 111 below, the tertitorSas will need to increase thetr liatr and level of trade with the outside ~0?1d. 2.5 Banking, Currency and F!laaacial Institution8

- . ,, .- - ...... Prior to 1967, comncrc&rl banks operating in the West Bank and the Gaza Strip were .ither Arab b'auka or branches of the British Bank of the - . PUddle Wst. In the West Bank, tke Jordanian dinar the chief currency; is 6.~8,the Egyptian pound. Tba Istoall military g&erament closed all commercial bade at' the outmt of the occupation, although aeveralmonthr later the banks were given padrsioa to reopen. None did, howaver, due to the failure of negotiations betwe& Israel and the banking authorities to establish principles of opera- 0 tion. Two of the majar issues have been the control of branches in the West . 0. . \ . .I

:'I Bank by headquarters $a Ammu, and the reopening of branches in Ease Jaru- . 6 dam. Iaraal finds both of ~:fieeepoints unacceptable. Rom 1967 to the praosnt, the only bank8 operating in the West Bank have beon brancheo of the Bank of Israel, which has replaced only olightly the role of the prewar banking institutions. Tb. Bank of Iorael itself osthtes that, it0 West Bank d.epo~it8account for only 4 percent of the Weat Bank'o national product, 88 oppoeed to the 29 percent held by ther Britioh and Arab banke in 1966,' Weat Bank resideinto are reluct,mat to place deposits in Israeli banku for three general reasons: . (t) traditional und political feelings; (2) the rtrengtb of the J0rdrrai.n d%narrelative to t2,~Zsraeli pound; (3) the rrluctrmca of the Irraeli brntcr LO make lorn,& to the occupied

territorior, due to iavestors' reluctance to f.aveot in an area , with an uncertain political futura. The Isr.eli pound and thr Jozdanim dirur citcultnte alongside each other in the Wart Bank, 8Ithough the ZsraaUr bad cuarsidrred olbhaeirrg the dinar frw~tha territory. The conrinund c$rcu?7iation of the dinar "$a- cAUtated both the recwery of businoar actioity wtE:hin tbe Wart Bank and --- - - the re8tor8cion of mad. ruora tb Wvar 3or&?inew8From 1967 to th. pmr.rrt, Wast Baakerr have ohom a rtrong prafrrenca for the JordnaiM dimr: mar the XsxaaU pound. Since thr Jordrmian dinur ir ar stabla, hard currency (i~io a mmbor of the oterliag Kr: ef currencier\) and the XrraeU

.%rim ~.lrAztudie, ~urefitiw Baxd-r A -port' an ~b.~e.t i)urk ' and Girlr Strip Ecandes Since 1967 (New York: Caraegie Endowment for Inter-

'- ' rutio,arl Pace, 1977), p. 102, Mr. 'tm Arkadia aloo otatas that "detailed accmmts of the nagatiatiom and thrr precire tams of the dissg,refdl~~ntare not publicly avai&bl.." . . pound has a continuing record of depreciation, illustrated in Table 2*12, the preference for dinars is sound on a pureXy economic basis.

TABLE 2. 12 CONSUMER PRICES AND VALUE OF THE ISRAELI POUND:

. Exchanga Rate Of The I Cansumor Israeli Pound Price Index (I2 per U.S. $1 L (% Change Framl rear Prior YOU) Officia1 Rate Black Market F *- - - - .-*[ 1967 + 1.6 3-00 3.50 I

" b dh,a of 1Popemb~r1978. . s JW '~fficial st1~f1sticson black market rates prohibited. Estimated at 20.00 for Nwanber 1978.

Source: Cfintral Bureau of Statistics (Israel), Statistfcal Absfzact of Xzfimel (US, No. 26 (1975). Table X/1. Also, The Econamic Intelligence 'flail: (London), Quarterly Ecmdc Revfew of Israel, No. 1 (1976). Nos. 1 8ud 2 (1977'). The popularity of the Jordanian dinar and the small deposits placed 1

in the Baak of Israel suggest that most Palestinians in the territories keep ' 8 '- their savings ia the form of cash or bank it outside Israel and the territoriea. "Transactions are facilitated by the moneychangers who operate on u a narch larger scale thau would be likely if the banking eystlzm were fualy ~~erativa."~The moneychangers are usually indigenous West Bankers whose operatio;ls have "involved some serious costs for the Israeli monetary authorities. "lo In fact, there have been recent officil efforts to con- . trol the morrreychangers. Currency iu probably the largest malrns of payment, most of which b in the form of dinars. West Bank residents tend to hold only as many Israeli pounds ae necessary to meet inmediate needs for transactions with Israelis. 11 The Israeli Government does, howaver, offer a favorable exchange rate for dinars to axporters to Israel, to gain access to the rtrongar Jordanian din&. ! - Despite the fact that the West Bank and Gaza economias have become ia- creasiagly interrelated with the Isradi economy, the tefritories, particu- -I larly the Wwt Bank, have not becoma assimilated into the Israeli monrtary 1 system. West Bank residents hrvo benefitted from continued access to the 0 I ~ordaa% dinar due to its strength in relation to IsraePi currency; rod have enjoyed monetary autonomy due to the limited penetration of Israeli 1: banks, the continued circulation of the dinar, and the fact that financial tiolu ramin. with a.l2

'~ioiur A. B~U, he west a:~s it ~ia~o?-gton: ~exhgton .. C Boofa, 1975), pa 60. Vivian Bull startea that during archaelogical exy:~edi- tions iir 1968 and 1970, she had to offer a bonus to workers to accept Israeli I,_. umay. The 1sra.eli currency oriu, thm taken to moneychangers and converted - ontheepot. . . .

'%an khdie, m fits and Burdens, pa 104. -... ----. -.----..a-- .. '. "Bull, The We* Baak, pp. 60-61. Risk Capital Turning to the s2ecific issues of the transition phase and beyond, no mador economic development can take place without satisfactory financial institutions. . through which risk capital and credit can be made available. We have already seen in Sections 2.1 and 2.3 that the legal fowadations of the territories make it impossible for Israeli risk capital to be invested in the West Bank. Moreover, the law does not provide protection for any joint venturea between citizens of Israel and residents of the territories. Thus, as it stands, the only source of riak capital are the territories themselves and the rest of the Arab world. There are uoow indications of individual and family transfers from the rest ofsthe Arab world to the.tarritories. Bowever, the possible movement of risk capital from and into the territories appears to be more difficult to establish. The evidence ia . . .. Table 2.13 seams to suggest that in the early 19708 risk capital was leaving the territories to the rest of the Arab world at a ti~irlyeensive rate. Soma evidence exists that West Bank capital was used to purchase land in AlImmn. l3 . It appears that this process may have been reversed after 1973. Thus, as the econolnic climate in .the tarritories hs fmpzwed, soma Uted a1- though not insignificant amounts of outside capftal have mwed into their economies and Pdght be Piawed ar a reflection of the trend to increare the economic link8 of the territories with the rest of the Arab world. . It auy ba epeculated that part of the rise in cap$tal~mvementinto the territories my be a manifeatation of the general, porg-197'3 econodc climate in the &8b world, reflecting the availability of a great deal of riak capiul due - to oil income. It can only be speculated what the sources of this capital ' ' uybe, and nd reliable info-tion is presently available to ckrlfy thfs utter. .. ..

evfdence ccasists largely of press aecoltnt. in the Jordanian medi. of Palestiaians Uving in the West Bank and Gaza speculating in real estate in APmran, driving up land prices there. TABLE 2.13 NET CAPITAL TRANSFERS INTO THE TERRITORIES: 1968-1976 (millions of current Israeli powds)

west Bank Gaza Strip 1968 (combined) 1960 (combined) 1970 1971 1972 1973 1974 1975 1976

Source: Statistical Abstract of .Isract (1977). Table WIII/lO.

Given the prof itability of investment opportunities in *the West Bank and Wu and the srrilabuity of risk capital both Zn 1rra& and In the Axab world, we expect that during the transition period further movements -.. . of much capital into the territories will aontirrue. This flow could drama- 1 tically increase if any of the legal restrictions discussed in Sections 2.1 - and 2.3 were relaxed. For example, the extension of Israeli legal protec- , i tion (kod regbtration, etcij to such 1n9astnmts will naturally reduce thi 'indididual risk ro that, even if the territories revert to -Arab owner- I ehip, the individual capital ir given protection. Thd position of the Israeli meramtent is that a condition for a settlement of the status of the terri- B tories is to allow Israeli citizens to buy land and establish business en-) terprisea irr the West Bank and Gaza. Given the conditions analyzed here, we conclude that if the position of the Israeli Government is upheld during the transition period and beyond, the flow of risk capital and entrepreneurial activities into the territories will rise by a very significant propor tim.

Credit and Banking Banking in the territories is in a most peculiar and unsatisfactory state. As indicated above, the pre-1967 Arab and British bank8 that operated in the territories were closed after 1967 and never reopened. The reasons for their closure are not completely known, but it is clear that two of their. conditions for the continuation of service were not acceptable to Israel. The first insisted that the branches in the territories would continue tosreport to their central offices in Aman and Cairo. The second mr their demand for continued operations in East Jerusalem under the same legal status as in the territories. Following the closure of the banks, Israel allowed its own commarical banks to open branches in the territories, but the*. have not tha podti* of the previous bsnlu. The banks have enabled the payment mechanism for labor ~ervicesand commodity trades with Israel, but play no part in the trade with Jordan. It appears that these banks contribute little to domestic trade and most of it is carried out in cash; also, a great deal of the personal liquid assets are held in cash. Due to the failure of the commercial banks to develop 8 reliable finmcial Watem, the monep-exchurge dealers have played an important part in the financral operations of the territories. It is rather peculiar that the situation with credit is different than the legal condition of ownership of land or busfners enterprises. The law does not prohibit an Israeli citizen from receiving credit in an Arab bank in the hat Bank or Gou, and a resident of the territories uyobtain credii in 8 private bank in Te1 Avitt.' No reliable information is available for us to nuke an evaluation of the extent of such activities. although we think th.y are neglibile at the present.moment. None of the banks currently con- ducting business in the territories Psme the type of fiscal or economic reportsag conmum to the Bank of Israel, Israeli commercfal hanks, and many Arab banks as well. Again, this may, in part, be due to a desire an the part of such banks to maintain a low profile with respect to trade activi-

ties. We do,*however, know that it is posaible for territorial residents I to obtain credit at Israeli compwrciaf, banks, particularly w%th the authorization of the military governor, although most such transactions are 0 closely guardlad and not reported. Our main conclusion here is that the financial machinery for expansion 4 of financial liaka between the territorias.and the rest of the world is virtually noneadstest and wfll require 8 complete reconstruction if such financial sewices are needed in thtm pe;iod ahead. -r- As noted earlier, the legal state of affairs in the territories ia . rather unique since all three currencies -- Saraeli, Jordanian, and . Egyptian -- circulate there to some degree dth .a active market to establish

' the axchan~erace among them.14 ~rkto Iovemher 1977. when Israel abolished 1 .. foreign currency controla, the eacchrrrge rate@among the three cutrrrncies -re established in rather thin markets. Sirrce the opaniag of markets in foresgn curraacy in Irra81, the markets for all three currencies in U.S.

..., ,, .-.. dollrra..arc4xtansive so that the uchange rates are more rtable. Tbe fact tht the territories accept three currencies does not seem, by itself, to came any veat difficulty. Moreover, given that the trrri- tori- trade vith all three countries, the presence of three currencies doer not represent any limiting factor on irrcrsuring the ocoa~cliPlrs vitb my om of the three countrias. Wa shall see in the next section that tho lack of a separats territoiial currency airply me- that the - .- torritorhs cannot follow m independent ' econorpic policy; To maka this i poht a bit clearer, the reader amp note, for utample, that'the territories . 8 \

141n Oaza, the Israeli pound circulate^ gen=rrlly, trfth U.S. dollar., old, and various "hard" European currencies also used to some UPlited ex- ,. tent. Smlimited numbers of Egyptian pounds are also in use and are

.) clured by Israeli banks. In the West Bank, both the Xsraeli pound arid Jordanian dinar circulate widely, wtth U.S. dollars and other "hard" cur- Z~CI- accepted ~81.1. . f cannot determine the money rupply or the inflation ratr in their rconomias: , Th. oroaey suppllrr are determined in Jerusalem, Anonan, and Cairo, resulting in territorial raeidents experiencing three different inflation rater. 3ivan the institutional arrangements that exist, there ir littlr that can be done without a major change :xi tho statue of the territories. 2.6 Devalopment of Wnkr in Essential Infrastructure To fwther link the Wert Bank and Gaza to their neighboring countries, f t is necessary that the baric infrastructure for such linke be in place. Let us briefly review the smtr of affairs wfth the intenr of evaluating whether any major: limitations radst iri thia area. Pranapattation System

The basic highway rrystan of the West Bank rwro in the north-south ,. .. direction ad oily thr,ee secondary roads go in the eart-uest direction. Tha nuin aamt-vest highway is the one co-cting Jerusalem and Trl AvZV, and

this highway is, indeed, a major route for the movement of c~itiestraded . . batween tb West Bank and Irrul. Zrr the direction of Jordan, the main highway cwhecting Jenurlem and hmis 8 good roadway. Other roadways and bridges cannacting the Wert Batik to Jordan d Syrio are not operative, but could open f.f an agreement ware rmchad. Thus, in principke, tha system at' 'this tiow is not gearad for MI utmsive pattern of made and C-dity radrtements in an ust-.mst direczPon. If additional econodc links evolve, then a more intricate system of highways from the West Bank to Israel wlll nead to be constructed and more highways rad btidger over the Jordan River w3ll need to be opened aad devrloped. - a. Ydthar a11 nor air transports are ablealteruativu for the region, of the Wemt Bank. s&ce it is moatly 8 mountainous regha and. if needed, raddentr could use the Israeli rail rarpice which runs in a north-south direction very close to the Green Line (the old, pre-1967 bord&). Tlm Galw'Strip is so clore to the Zrraeli network of highways, rail mystem, and air transport that, frm the economic view~oint, the Gaza Strip ha no transportation problems with Israel. Furthermore, tiaa Gaza Strip is very clore to Arhdod, the southern Mediterranena port of Irrael, and thus all export ehipmentu can travel via Israel without my difficulty. A more complicated problem eximts when considering the transportation network between the Caza Strip and the West Bank, Jordan and Egypt. In relation to Egypt. the distance is vary great since the center* of population are west of the Suez Canal. In relation to Jordan and the West Bank, there is no open, direct road from Caza to the West Bank; goods need to travel via the transportation network of Israel. Thus, if future links between the 0.u 8thand the West Bank upand, a more efficient traispurt system linking them will need to be constructad.

The problem of establishing portal and cdcation links h the .. Wddla East would be the easiest one to solve. We fe~lthat, apart from the capital investments nreded to acquire and install additional camnrcmnicatiolos equipment, tePephone exchanges, atc., the present situation repre8ents.a minor limitatt~non future lialu. Israel. and the Arab stater are a11 siptories to the Udvdtsal Poetal Union Convention (1868). and them is little to inbibit th. delivery of mil' to and frum the territories. Mail saiPice to the territories has been Wled ~5thcarrriderrbla efficiency by Israel and Jordan in the 1967-78 period, and mail from the territories to Israel, the Arab world, and beyond has hen upedited a8 well, using turd parties where necestmry. As a peace agreement tabs effact and fwther-transport links develop, it can b@ expected that postal service dl1 continue and possibly improve in speed - of delivery, at a lower cost. . . -. Soon after the capture of the territories by Israel in June 1967, col~rmrcialtelephone service -8 extended from Israal to the terr$tories " urd subsequently upgraded to 8 "direct dial" basis where aquipment permitted. This was, in part, due to the dlitarp utiUzatfon of commercSa1 telephone .patema, but also due, in part, to a desire on the part of Israel to integrate these ueaa into the Israeli economy to the fullest eutent poseible. Tale- &me and telex semicc between the territories and the rest of the Arab . \ world, particularly Jordan and Egypt, har bran poosible from time to time, politic81 factors and aquipment permittinge Indeed, in the aka of the No- vdar 1977 Sadat-Br~ininitiative, talac~nicationrbetwarn Ioraal and Bwpe Pi. BOIL8 war8 opmod up for the Sirrt ti-. A8 ndrs of tha international t8lecommuniccrticrnr conventionr, it ir anticipated that ae1CP0ce will improve dursns; the trazarition pture, dependent larsely on tho availability of modern nritchiag equipment and the inrtalla- tlon of long distanca links, vi. microwava or satellite. The trrziteriar are part of the international dlrast dialing ryrtam, where aquipmcat perdtr, and it rtr qoctod that mch aquEpmont vill become wra wldeapred during thr cdng docado, par&cuhrly as th8 cortb of mhequipment decreaae due to tho incrowing ura of computerixad rwitcbing oquiporat.

At th oaornt, each municipality in tba Wart Bank md C.u h.8 it. own pouu: 878tom. In Jeruf~8h,th. Jorduriur Powr cempany has not beon integr8ted into tb Xoraeli IX8ctrie Campay and fs operating rather indo-

Iaraol,' vbich hs a vow modem and fully integr.tod powrt grid. Israel has extouaivo plam to ddop nuclur~ructorrtbt will join tho grid urly ia th 19808. fitlo, it 8ppur8 t&t tb p-8 to trmwOrt W8t.r f~mtho *Meditorrr9.rrr Su to tb. Dud Sudl1 entail very largo powrr rutions and pornr liner, which wifl probably crorr the Wart Ikntc. Hotaove'~~,the plaa to rafu tb. I.nP of tho Dud So8 dl1 oat.il floodihv rop. area8 in Jardm ut$ thr Wart hak, aud this is lika1.j to lead to some ragid dir- ctusioru on tbu ismma. Thora is Utfl. dmbt in oar pind that th. -

. , futura ocoaoric dmlopprat of tbWest &nk aad tho C.za Strip will raise . . t- dea8ad for pewer .ad thw would, 8oon.r or latar, rase the porribil2ty of fntegr~ttagch. entire panr grid of Irrael and the 'tarri eerier. Although tbio all not rare grast 6rcWcal dUlicultier, it map rai~some pclitical difficolties. TUr ir ro rhe, as rt~tedabove, the local pmr mi~rcesare coaeolhd by the aanicipalitios of tha West Bank d hza. Now, depending f . -.poo tkir depee of political autohoay during the tranrit$o. period, thoy larp not virh to dopand upon eourcar of power in Irraal. Thur the linkage of pmr gridr may turn, during the eranoition period, into a political irrua which may by. important rymbolic value, It ir thur coaceivabla that durias the transition period, aad perhaps beyond ar wall, the procars of faduetrializatim and economic development in the Wert Bank and Ceta may induce major invertmants in powar-~enerating etatione which may ultia~aeely put each tarritory on a complataly integrated and iadapandmt power grid but with no connection to aitkar Jordan or Irrael. 2.7 OPeieul Policiaa for Trade and Stabilizatfon .

In evaluating the future wolutrton of economic linlu of the tarritorias witb Irxaal .ad tha Arab world, lt is necostmry to take into account tha effect8 of any fircal or monetary polfcirr follomd in the territorier. Wa , . note first thf, f~zthe momant, it appmrs naive to zaire this quertion riace the territoriao clurly ha9. no currency of their own, no central bmk, no gwernmental taxing ability, and no power to rertrict foreiga trade. Tat it ir importoat to hap ia aiad tht Ioraalhr agreod to Held the ddlirn Governmant to localauthotitier md, during the trurrition period .nB kpd, local residents may uain more indrpandence or furthar political Udcs wfth ~ordlh. Thim dght ablr tb tezzltorier to Zollw independent oconodc policl), resultbg in eather rlowf,ug down or accelerating theit link. uith &a couxitry or another. Tlmr orur dlrurrion hare ia purely

Local authoritier bva, today, Uted tadag ability which is carrirui-. out vi. the military gme~or. The office of tb military goweraor h.8 a280 ba.n. . 8nforcSng tuc,lawe thusly, colPacting incfmm taxer, property taxer, uns, and tha recently introduced rulue-added tax ki~).Wber~ the rdli- ganmmat ir dthdrawn, it ir ltke!Ly tht a local authority to .rrfotce thr tu law dlXbe ert8bUrh.d. If tax revenuer all be re-# channeled back- to the municipalftfes, than the change of gwermnt opera- a-8 will not ctunge the neutrality of the current policy Mth re8prhct to expanding economic links. This ia reinforced by the fact that, under the plewnt arrangements, there is no locally indapandunt currency or central bank; thus the governing body will have little 'rf any effect on the money rupply and the rate of expansion of the economy. This means that any stabilization (or deatabiliution) policies fdloued in Israel, Jordan or I!gypt will warflow into the territories to the extent of their links with that country.

If New Governmental Body Gadns Taxing Power Differant tax lawe will have profound hplications to future linke with one country or mother. For example, if the tarritories impose a heavy tax oa labor incow ummd in laraal, then the incentive to work in Israel will b. reduced. But 8 more oubtle tur could have differential effect. For

example, jli heavy hport dutier are imposed on import. of induotrial goods,. '

(. tbca such taxes will differentiate aminst imports from Israel, which sends moutly industri.1 goods to the ta.ritori8s.' Taxing A -. authority nay able tha.tarritoriea to impose taxer against foreign ratarprinr and thus reduea their 1- vith tho rest of the world. a Aa L.8 the uu with my other sornr.ifn endty, tbr ability & inpore duties, tadfu, and other conutraintr on tbs economic activities of foreigners pro- ddea a c~tldduabledegrea of 1rrr.rrga. In the case of tha territories,

thi# POWeZ Could be W8d to wt foreign ~VO~V-t .md COUUO~-~PO%V~~, trade links, 'thuu cmtrolliq tha nature of economic darelopment. Ae indicated elmewbare, the nan-imPpooitim of ruch ms could be uved to promote tb oppoaite affect, encouraging th. developmaat of trade lint6 and foreign 8conooic involvamrpt . -

We briw tkre -1er to indicate that, in our opinion, ' such .issuer . all appear in tho nagotiat?lons during the transition petiod and it is lqorullt to keap'in mid the duper and long-rua irpliutions of &ch porribla 8cooomic mw8. / If a Central Bank and an Independent Currency Are Esta2il lt shed

We have already indicated that, without control wet the money supply, the territories cannot control the rate of their economic growth and thus the utent ead nature of their interdependence wighatheir neighbors. Thus the act of establishing a eeparata central bank and currency can have deep implicationr for the nature of economic links in the Middle East beyond the period of transition, A govenunant in the territories that may elect for limiting or raduc- ing trada and economic links may courequently elect to impose tuea on Pin- ported comoditier. It may also slow tfre growth rate of the economy by controlling the mpply and thus engaging irr a deflationary policy with Wgh interest rates. Altenudvalp, a-emernment that may not fur increaring the economic ties vith tha rest of the region auy httempt to ~intaina policy of me- tained growth wlth m axpawion of the my-ply in accordurea arith a oapwuh.t full aaployl~antpolicy.' Obwtously, these two possible policies or eouAea' of action would,have -mw dittereat comsequanees tor tb evolution of the rcmm of the territoriu.

l'k LfR.19 Dstn10-t The present adyris suggests that the territories, Jordan, 8nd Israel hve already estabU8h.d a sat of such int2mrte link* that they all stand to ou8t.Ln large rhort-term losrs from bseak3ng down these ads. Given the natw. of the political farces at bad, we believe that wbatsvar the pofiti- - . . . .- cal paw~and taxing abiUty given to the local authorities in the terri-

, . tori.9, the basic principle8 tb.f all be used during tha &ansition persod *. e are: .\

o No independent currency and central bank ~$11be established.,

o No taxer will be imposed which 611 have dArect or indirect discriminatory force with respect to economic lixh wLth any country in the region.

\ o Tax revenurr will be usad to imprwe rocial sonticas and bbric infraotructure in the territorisr. There will tend to imprwe capital productivity and further attract private capital.

The evolution of economic links as presented here has been a subject of a rrgid controversy ,war the meanjing and deoirability of the development procesr. Xrrael haw been pointing, out the extremely high, and rus- toined, rater of growth of both the a?and experienced by the territories since 1967. This view 8uggerts tbat, Virh only limited Xrraeli inter- vantion, economic forcrs of cipecial1z;ntion and trade developed links. have been beneficial to the territories and Israel. The opposite view, haXd by many Palestinis;as, holds that economic

growth and an improved standard of ?Living are not. the issue. They maintain . , , .. that by exposing the territ:ories to competition of Israeli products, without protection of th'doute8tic indnstry in tha territories, the development . . of the territories was IiaPited, cmti made the territorias into an XsraeU . . "colony" specializing ouly in some products in which they can compete with Israel At the same tima, the ttr.~itorieswere muding a growing fraction of the able-bodied labor force to work for low wages in Israel. According to this viav, the proceros is ons benefitting only Israel since it prevents the deveiopment of a balanced, viabla, national economy in the territories. Sbca our objectj~vetn tha present analysis is not to evaluate the desirability of any giveu process and its contfibution to the national arpllration of one group dr mother, the iaaue is Smportant only to the atrat that It Is related to the ucplanatian of the forces operating in - the .e?aies wider conaideration. With this Za mind, d may note that . the oblretvsd ecoirsmtc factr were a natural consequence of the conditions . . which ware analyzed earliar. I In economic forms, opening the borders betwaen Israel and the terri- torlea ahply ret free competitive, economic factors which tended to make the territarkecl develop as regions. vlthin a larger economic system. In the 8ama way that the north of Isrlel concentrated on d~elopingalong the liner of itr relatgve advantage, 80 d4id the Weet Bank and the Caza Strip. Thr peculiar araar of opecialization and thr specific direction of movement of labor and cormmodit.les ware determined. by the apecial polit- i-1-legal rertrictionr placad mi this regional development. Thrr outcoma of ouch a procrsr with theoa restrictions ia exactly what oar would expect: a marsivtr opovesrcmt of labor to arwr of higher wagas, eelectiva development of the d~owrsticeconomy in the territories, and marrive trade in commoditire. Israel hcam the largest market for oxparted goods from the territories, and the West Benk and Gaza bec- the recmd largart (aftar the U.S.) market for Israeli exports. The deficit ikl the balance of payments betwean 'the territories and Israel is simply an outcme of +he income earned by the reddento of the territorier who vork in Irrael. It would be in error to thW of the grot4ing axports of - Israel into the terrieorier u a form of market daination by Israel. Rather, it iu a rinple 'outccou of the aarnines of the turitories from labor reroicas wld to Israel wblch generated the income used to bring the imports frm Israal. To what ustent this procara will continue throughout the tranaitioa plum urd beyond r&us 0ubJect' to two major polgtical uncertaintier. If, on the La band, any rettlamaat accozd perdtr Trrael to effectively -ex the territories, it $8 clear that the procesrer deacribed above will con- thue largely unabated. On the other hmd, if ntcb a settlement provides for tha ratablirhrwnt of a rovereign Palestin5.a state, St is unlikely that tbua trends will continue 88 hfore. a , Rather than rpeculate about the political enxCronment wblch vlll parameterr in tarnu of t~)scoaarioa representing the alternative limits .. . of the erroiromnent vhich ia expected to merge wer the f ive-year "trans1tion phaae.15 Tha scenario;, the aasrmption. behind them, and the alternative economic implications for trade $atterns and developments of the territories

' ue coasidered in Part I11 below.

ISpor an analpsi. of the political context and uncertainties, sea Avigdor Hauelkorn, Ihrcertaintfes of Political Cooperation and the Durability - of Economic Links in the Transition Phase TR-9902/78 (rHarina del Rey: - . . hlytical Assesswnts Corp., November 1978). t& t& - -. 111. THE NATURE OF EVOLVING TRADE AND ECONOMIC LINKS

P 3.1 Assumptions About the Economic Environment The most Important observation which we have atreseed throughout this research is the fact that any future evolution of the patterns of trade, investments, and output depends crucially upon political and, indirectly, legal developmanta during the same period. During the past ane years, the governments of Israel and the resideats of the territories sought to avoid direct Israeli imreetments in the West Bank and Caza. As a result, the pattern of output, investnunt, ad frade favored the movement of workera from the territories into Iaraeli lv;bor markets. Associated with this trend lua hen a reduction in the domrsttc rate of employment in the territories .' . and a rapid rise of fmports from Xsrael into tha territories. At the same time, the territories proceeded to develop those dopleatic crops and industrial products 9n which they b~drolatlve advantage. This entire pattern resulted tn a very rapid ri~ein per capita incoma irr the territories but a relatively slower rate of domestic product. Bad the parties elected a diffetent. . political and legal arrangement, the resulting structuva of linku would have been different, indeed. To analyze the pattara of trade and economic linkages anticipated for the five-year transition phase ad beyond, we have analyzed two altarnativa .m.rurios: a cooperative^' vu. contLnuation of the "Status Quo" scenario. The two crcsnarlos represent somewhat polar sets of political and economir forecasts. As a matter of arbjactive Judgment, we believe that the political .nd legal developments~othichwill, in fact, take place as a reoult of the . - srttlament process are probably in between the two hypothetical scenarios ' dapeloped here. Considering two sets of political aesumptims, however, .C provides 8 form of intrinsic sensitivity adyeis rinc'e .it ~110~a clearat: puapective of how the polittcal assumptione change the economic forecaets.

Revious Page Blank The Coogera tive Scenario The first major scenario represents the outcome of agreements concluded among the parties, to move the entire region toward an integrated economic system like the Common Market in Europe. The main parties to this coop-era- tion will be Israel, Jordan, and the territories. Such cooperation would not necessarily imply a resolution of all the open political problems, and 1 it would not necessarily be achieved during the transition period itself. Under such a scenario, the following political-economic circumstances can be expected: o. Removal of limitations in purchases of land and establishment of economic enterprises in Israel, Jordan, and the territories by the parties involved: Israelis, Jordanians, territorial residents, . and foreign investors. o Discontlnuatioa of support by Egypt, Jordan, Saudi Arabia, and local -residents for any act of terror against economic enterprises and movement of workers and/or commodities across the regional ' boundaries.

o Special legal protection and encouragement of foreign investors who will be offered essentially a politically safe economic end-

o Customs agreements that may include a few additional Middle Eastern

o Cooperative attitude toward taxation; rapid development of social - . ... . eenrices and public iafrastructure......

\t Is, of course, unlikely that a Middle Eastern c-on market could be achieved within the five-year transition period. A realistic view of the optidstic poasibility looks something like Western Europe after the Kennedy round of trade negotiations and prior to the establishment of the Common Market. o Israeli agreement to the expansion of trade and sconondc ties between the territories and the rest of the Arab world.

-. TJm Status Q1;o Scenario

The recond alternative represents a continuation and perhaps an i'n- tansification of the tension between Israel, the residents of the territories in ths West Bank and Gaza, the PU), Jordan, and Syria. The addi- tionrlautorromy galnad by the territories under the Camp Davict accords may be exploited by the extreme element8 in the territories to intensify thsir struggle againat Arab work in Iarael and against the devulopiag trade between Iaraal and the territories, such as pressure on traders not, to proceed wlth transactions, etc. Thua we can describe the scenario at bad in the ' following my: o Continuation of the preeent legal system preventing the aetablish- 0aat of property right6 by Israeli citizens in the territories and by territorial residents in Israel. o Contimution of PLO terrorist activities against workers employed

I i.n Israel and against isrdividuals involved with the growing trade with Iarael. 8 o Dm to the political climate involved, the econaralc .mxLronment vdll ba rlsky for imr~stors(forelm urd domestic alike), as- . c&ragiq foreign imertments, thus limiting the flow of capital and new technology from the Arab world and overmeas hto the tarri tories.

o Lidted 8bility of local authorities to tax #ad drjvelop o Pita1 - b. ' fiscal rystcm. This will result ia a slow {growth of social rer- . . vices and public infrastructure. o The condltionu of Status Quo will intensify the securlty problems of Iaraeland thus It, is to be expected that countermeasures will bk taken to prevent the PLO and Jordanian influences from developing beyond their prarmt levelr. Thir will probably antail further rattlmnts in th. territorieu.

The Likely Middle Ground Between these rather atreme alternativar, used to define the end's of tho porsible political and aconomic rpectrum, lie# the less wall-defined middle ground wbera futura trade and economic links dl1 develop. Am indicated above, it is probably too much to expect a formal, Counnon-MQrket- type arraugamant in the firat five years of the transition, although tha I tnforpp.1 and tacit begim5ngs of ouch an arrangement ara likely to emergo. As more of the polftical problarm are removed, and "normalization" of ra- latione prograssas, ouch a formal trade union vlll become,incr.~qlfnelyPOI- ribla. Similarly, it cannot be expected that tha affects of regional terror-. im, ac011omic bopcoits, and other antagontams wlll suboidv %mumdi.t.ly. At * I , brt it can be expatad that, otnr th. caurra of the traaait2on pbara, thre effects will diminish a8 plans for Palestinian autonomy are iOlplm~ented. - Whather or not atch rutonorqp will provide the baois for increased axtradrw, . .. a# indicated in the sacond acmario, ranulna opaa to quertiorr. Here asu wauld expect that nodarata el.p1.rrtr in tha Arab world h.v. a canaiderabla I iacrotiva to reatrain extrust alamants. 'It i8 also unUfc8ly that tax and firccrl rpstem~will avoltn in any I rapbirticated fashion ln the mu term. Over tho fiva purr, it is possibla tbat ouch syrtame, as well, as rocfal rervicpr and publgc infrastructure, could reach lmlr currurtly being uparienced fa Wastern Europe. Even Wa - uttnmta, h-r, tend. toward th. optidat%c rid. and hplicitly as.llrs . t . I tha availabiUty of nrbrtantirl funds from tha OAPEC stater to finance such - develapaarrrts. , .* . 1 ' Shce the uncert.iOtiar about what middle grourvd may prevdl ara ro I meat, the umlysir balm cantinws along the polar lines suggested in the ko aftern8tSva acanarior and developr a rat of q~ntitativeestimatrr for uch. Pre~bly,what rituatiw actually develops will l%ebetween these m - tw6 ratr of astimatar. ' 3.2 The Cooperative Scenario: Implications of Economic Links to the West Bank, Caza

Conera1 Charaoteri za ti on of the Procara Although closar to the textbook davelopment tnodal, the Cooparative Scenario $8 difficult to describe quantitatively since little or no bare- liar data for this rcenario axiats for an analyris to procrrd upon. Any projection which might be made is likaly to be aubjrct to rubrtantial rrror, .nd for thio reason it is difficult to uuke a precire avaluation of the rcenario at hand. Yet the difference between the outcomes of the Statur Quo and the Cooperative scenarios could be so great tht there iu no difficulty es- tablirhhg the key quantitative forcer at work. Bared ou the analyris in Part 11, above, the fwrdamental economic . forces that would operate under the Cooperative Scenario are: (1) The territorier have a relatively large rerervoir OF unskilled and semi-skilled workers and 1rra.l has a great ehortage of such , workers. Horewer, the high cost of labor and the difficult l.bor-~uugam.at relations in Israel will create an inceative i

for some Israeli enterprises to locate rome of their plants in I tha territories. Thua we could visualize 8 gradual but rureaiaed movement of capital from Israel to thi territories, employin8 the

rurplus labor in the territories themselves rather than in Israal. :I The rising education urd skill lpl of workers in the territories irr the future will not slat dmthis incentive rince the wage -- rates in the territories are likely to stay lower tban in IrraQl . -. b for years .. I some to come. ..I ! (2) A peaceful envlro-nt wtI.1 reduce the risk f@ctorof domestic iavmtments all around and will make extensive quantities of I capital available for investmmtn. The sources of this capital vill include both the domestic income of residents and resources I from the rest of the Arab world. In addition, inver-ents from the oil-producing countries are likely to be attracted to the area. It in clear that the dramatic nature of the economic boom which may result is difficult to eutimato. (3) The discrepancy of rates of return to capital, land prices, and hma valuas between Israel and the territoriar ir very extenrive. A unit of land on the Israali aide of the Green Line costs r&ta 10 to 20 timer what it may coot on the side of thm tarritories. Furthermore, it is likely that a significant number of Xuraeli citizens wlll either wish to buy real estate or live in some parts of tha torrrtorlre. This "private" movement might be associated wfth a public policy aiding Israeli settlements in the territories. A11 ruch acts will further add to the economic momentun which might build up in the domestic economy of the territories. (4) The reduction in the risk factor md tha availability of capital . will attract entrepreneurial talent from the territories, the Qab world, 'and I8ra.l. thus providing the final veNcle for the gradual transformation of the domestic economies of the two territories. Turning now to some specific projections, it is Important to bear in mind that these axr highly speculative projections based mostly upon our judgment ad not on any complete, formal model. Our objective in presenting athero projections is only to prwide tha reader vith the quantitative baris

1. Population, &bor Force and Employment Under the Cooperative Scenarf o - The natural growth rate of thd population in the adminietered terri- tori88 is among the highest in the world, but the actual growth rate includes kgration, and this is influenced by economic factors. ~on;idar the annual growth rater of the population in the territories as reported in Table 3.1. The years of lowest giowth rate were 1967-1968, following the 1967 Six- Day War, and the years 1975-1976, when the Israeli economy slowed down to ersentirlly zero growth., The year 1972 was also a recession year in Israel TABLE 3. 1 ANNUAL GROWTH RATES OF TRE POPULATION IN TRE TERRITORIES: 1947-1976 (percent)

Nest- Bank -1.7% - a7

Source: Statfstical Ubstract of Iurul (1977), Table QCBLVII/l.

urd it reflectr itself in r lower growth rate of the territorial population. The point which wa doh to rtrear fa that the growth rate of the popuhdan in the territorhs is sensitive to the economic conditions of the' tarritoriae, .ab thane have depended upon th. econaaric conditions in Israel, The Iara8li aconoarp, on the other hand, wr,ll continue to axperfence rather slow growth - for the next year or two, gradually resuming growth in the urly 1980s with . the tart of the Western c8conomier. . Thua, under the Statur Quo Scenario, the economic conditions of the territories all axhibit relatively slow growth rates which will improve rlowly 8s we move into the 1980s. Under thm Cooperative Scenario we would axpect 8 rapid rate of investmaat in the tarritories, thus enabling them to - . ucperltmce rapid growth wen when Iarael is experiencing rather elow growth ratar. Thir will ba conridarad at greater langtb below. For the meat, we oota that tha rvaraga annual growth rate of tha population in the tarritorier batwaan 1970 urd 1976 wrrr 1.7 petcant irP tha Wart Bank md 2.4 parcmt in tha Cars Strip, bringing the total growth rate to 2.0 parcent. 13 Uadar the Statw Quo Scrauio we prcjact tkr avaraga tnaual growth rat.' vmtll 1983 ut about 1.6 percent, arrb under tha Cooparatitre Scenario it will 0 k 2.2 parcant. Thur our population a8amptionr are ar rhwn Zn Tabla 3.2. Clrrrly, in such a rhort par$od tha diffaranca batwean 1229.2 and 1280.1 ir not wry larga: Such 8 diffaranc. in tha growth rata rill& a rignificant 0 -act ia tha lon$ar run. Tha detrrdning factor ir to be found in tha ability of tha Irraali rcmq ro abrorb Arab workarr. h wa rar from 0 Tabla 2.6, tha n*&arc of tarritorfrl warlurr in Irrnr increamed from 20,600 ia 1970 to 61,3QO irr 1973, but thm ~mtto 68,700 irr 1974, 46,300 iir . . B . 1975, and 64,800 Irr 1976. Wa tW that tha erarant rlow tratth rat. of tha Irraoli economy is trmporav p+mommou vhich ir fadllar i\rr may Wertam El .. cmatrior, Wa b8li.v. that a rqid growth rat8 wi%l rmeaft= 1980, when sort Buropun rcoaorir. are' axpecSed to .d;p.irca. - Tueaaw to the rart of our pro~.ctionr, lat tu nom fitrt the u- I rutrpttom on wZlich thy ua bud: I o Th. growth rata of the population, aa indicattd earlier, is likely to ba appwrirutaly 2.2 percent pu yuitr. E

TABU 3.2 POPtlLbTIrn PmJmTxam, . . I BAlOI lllQb eAZA STRIP: 1976 AND 1983 \ , b (a tboud8) -* o Total number of remidento working in Irrael will be held, by 1983, down to about 50,000 per year in rpite of the growth of the labor force. * o %"here will be adequate capital and entrepreneurfio.1 raaourcer to enable the domartic economy to grow at a rat. which, will onsura errential domestic full auployment during the traasktion period. Table 3.3 prerentr our best estimate of how the structure of the labor force will evolve under the Cooparativa Scenario. Given the arrum~dgruwth rate of the p~$2lrtioaand the availability of capitol, the high rate of inttertsmt in the domestic economy ir rrtimatd to generat. rufficiant jobs to enable a rapid increara in itr emplopment. We think that:

PBQfECTIONS OF SOME KE!t ECObS~CVARIABLES: TBE COOPERATIVE SCENARIe

Ch8ng. 8.tmon -1978 -2083~ 1976- and 1983 Population (thou(lundr) 1099 9 P28Q.1 16* 4%

Total employmmnt (tkourmdr) 204.9 2!l6 0 24,9 irr 1.r.81 (tho11unds) 64.8 50.0 X mloyed in Israoj, 31. 5 19.5 Domartic amploymmt (thott~mdr) 140.9 206.0

X amployed in domer&c agricultura - , 31.4 27.0

X qloyed in domestic induotry 14.4 20.0 ' X employed in construction 8.2 12.0 X aaployed in remicar and others -- 46.0 41.0

8Actual 1976 data. h Analytical. Asres~ntsCorporatiorn computstians. o Domertic agriculture will expand itr employmant modsrataly, thur the psrcantcge employed in the arctor will continue to decline.

o Tha two expanding roctors will be industry and construction, ab- rorbing together come 19,350 new workerr during the perkod through 1983

2. Capf -1 Rqufrsmsnts and CNP We aroume that the Wart Bank sconomy will grow under the present scenario at a 10-percent avoraga annual rate adthe C.za Strip at 11 per- ceat. Thir will yield the following CDP projectitma of Table 3.4. For tho 1971-1976 period, we have amtintatad the averarm incrmmtal capital/output ratio to ba 3.3. Oa that barir, we arrive at the capital requirements im- plied by tb projection# in Table 3.5. Thur wo calcul~tea total rum of . . . 2,897 million poundr (equivalent to. 1,346 million 1977 dollur) at invert- mntr. Includ~ngthe ertipp.td income from labor rmp1oy.d in Irraal, wr .- emtimate tho QQP of the territories to grow as rhowrr in Tabla 3.6. 'Ilhur th. prcporad invertmant program will raquae a rate of grore inmrtmontm . mr tb five-pert pariod which ia about 1.23 timar tha tarmfaal year GNP. Maia a rapid rate of invastmat and, if'th. Cooper8tiva Scenario taker placo, the appr0pri.t. capital inmrtmmtr will ba forthcopling met likely ' .from Irrael, the Arab world &ad owrrur. .,

TMLE 3.4 - . PROJECTIONS OF CROSS DOMESTIC PRODUCT: 1976 AND 1983 . 1

CaP in wart nlntc GDP in Cam Strip Total TABLE 3.5 CAPITAL REQUIREMXNTS: COOPERATIVE SCENARIO (~15lllonrof 1968 IrrraU pouado)

West Bank O.za Strip Total U - - 324 124 448 391 U7 528 430 150 580

5-ylar total 2,139 758 2,897 (in I977 doll.+r)

0 Source: A~lytiylAararuoroatr Corporation caprputatiooo.

. -PROJECTIONS OF CROSS NATIONAL PRODUCT: 1976 AND 1983

Q9P in Wart Bank 949 ' , 1,668 11.9% CNP irr &to Strip 365 687 UoSX ... C .' . - - - b. Po314 2,355 12.4%

It ir difficult to auk8 a relfable aaeeesmcmt af the pattern of acooomic m - trada in 1983, hcking any reliable information or! potential sources of risk capital which will be inverted in the territorier during the transition phaee. We can eetimate the amount of capital neadad to be invarrted, r,l- I though wo cannot predict where precisely it will came from. Due to these facts, we rhll evaluate the pattern of trade in two rtapr. Fixrt, wa rhall rwiw the qualitative forces at work and provide eoPP. baeic raaron- 4 ing for there, Sec~~td,we rhall propore a certain rot of quantitative i arsumptions and, on that basia, develop a numerical exercise which will 0 illustrate the pattern of trade which might result, Such esthetes provide a general order of magnitude of the flows involved, I i 1. QualitatLve Evalwtiolrs 8. Wage Rateo. ~u annual growth rate of CNP by i2 to 13 percent. 1. I while population is rising at eoum 2.2 percent mean@ that the per capita arowth rata of incam will risa by about 10 par- 8 * ', cant. Due to the exteariva discrrpancy in the wage ratar between Irsul and the torritoriar, St PI likely that terri- P =m torial workers in Irraeluill experienca 8 rata of increare of thoir wage ratar which will uceed 10 pazcent. Wewill be amplified by tbr fact that, under the scenario at 'hand, 1 th. IrraeU economy will need to compete for terrStbri.1 wrkar dua t~ thr riming deaund for labor ira the danortic acaaaoiar. For this ruron, wa 8r-d in our QlSP calcula- .ti-. that the annual rat. of incrum of the wage 'rat. ra- caived by the territorial workma will b. 11 to 12 percmt. .- - - . - - . -- -- b.- .Fareign Trade. Ih -1976 tha pattern ,of foreign trade of a~Pcultura1.\ld hduatrial in the terr1tori.s vu u follawrt . - - -rfr Exparts "i . . ?ra 1rr.al 90.3% To Irrael '- 63 3% From Jordan .9% To Jordan 29,6X Zkaa th. rut of To the rest of tha votld 8.8% the world 7.U t with the excess of imports over exports in current 1976 Israeli pounds: Excese from Israel +1977.2 Excess from Jordan - 905.3 . Exceos from the rest of the world + 175.0 Z646.9 The high rate of imports from Lsrael result8 partly from the mount of labor income earned in Israel, which amounted to 929.3 milliao pounds. Thus the essential factors operating bre consist both of labor income in Israel and the surplus with Jordan together financing most of the deficit. The rest was financed by transfer payments (801.7 lnillion in 1976) whi*, . capital movement was nif (see Tabla 2.12). The Coaperativ~Scenario is likely to change the above -. . -;b - - pscture. Zmport8 from Israel all continue to be la&e, partly due to labor income earned h Israel which & ar-a to ba

. a gemrated by the 90,000 workers in Iarael. Their income will rim from 929.3 million in 1976 to 1,544.2 million in 1983 (in 1976 prices) in spite of tha decline in the total number of - workerr. However, wa wuld expact that the change in enviroa-

' maat all encourage lmportr from Jordan and the rest of the world. The pattern of trrda ir likely to become very complex .. -- a8 iadwtrialization proceadp, due to the rgsing import~of raw amterhl and expanding voluma of exports of finished adseml- finirhed products. On the baeim of the above, we would -act imports ftom Jordaa and the rest of.the world to rise drasti- . cayin importrnca while export8 to the rest of..the world may -. -- .. --- . . . . rime only moderately. The structure of export will probably chmge little. c. Chance. Tha investanent ddand the associated deficit in tha balance of payment will be financed by three sources: . . labor income in Israel, transfer payments, and foreign investments. Some of the extensive amount& of capital required will need to be supplied fro^ abroad, and we expect some of it to came from Israel and the West and some of it from the Arab world. d. Otber Industri etr. We expect agricultural production and 'foreign trade to maintain its current pattern, with slow improvements in productivity and reduction in the fraction of the labor force employed in it. A major improvement in tourism should make an additional contribution i*o the balanca of payment, e Tia Keeping in mind the nature of economic link8 in 1978, it ohould ba clear that even if major changes occur under the Cooperative Sca~lrrio,they will take more than five years to make their way through the rystam. The estimates provided here are based on a five-yoar period with the full expectat%ons of further devdopunt~bayoud., Wa retura to this point later. f. Wade Ils~urqptfon. The estimates ia this chapter are based on the idea of ertablAohing a "free tradetq arrangement around the territories.

Soma Quantitat$ve b.ul9lpeiou8 In order to obtain r clear picture of the balance of trade Sn 1983, let-ur make tha following assumptions which will. be the basis for our numerical axarcire to follow:

0 Tha composition of total mrts and exports in mlatdon to GNP will rem8in the ram8 as in 1976. - o The distribution of cdityexport deathatloas remains the .u ar in 1976. while it mover toward highei export. of Bar- vices to the rest of the world. (Tourimi'and other exported remices rise to about 15 percent of all non-labor export o Imports of commodities and services fro4 Israel fall from 90.3 percent to about 70 gercent, while Jordan and the rest of the world rise to 5 percent rind 25 percent, respectively.

On the basis of the above, we can now carry out the computation of our pattern-of-trade exercise. We repeat that this exercise is presented so that tne order of magnitude of the various variables can be perca5ved. Obviously, we have selected the mest likely para- meters, in our estimation, but a more detailed analysis can be provided. The results appear tn Table 3.7. The main conclusioas one can draw from the pattern presented above are a8 follows: (a) Given the assumptions above, Israel will still be a large source of commodity imports but will have a growing excess purchase of setvices in the territories. - - ibi Tine main 5harrga between 1976 and 1983 is the rising importance of the "rest of the woqld" in the trade of the territories.

-4- urrr Lao& LL- .- ""LU CIUS "rest er' e"n hab worli'' and the econdeu I of tEa West. (c) After taking iato account tfra earnings from labor sewices exported to Israel, the texLtories or131be running an annual deficit of 1.8 billsm Israel$ pods (a'wut $193. rniiiion in 1976 pricar). This will need to be f inancad by transfer payments and net capital %&low.

The picture presented above Wdeu the deep change in the com~)oeif&enOQ imports and exports. This dl1 move toward increased fxactSon gfi inparted -* raw materics and capital gooda wniYe, at: the earn time, lawrl~gthe frac- ' tion of agricuPtu~a1experts and rfsi- fraction of exports oE' iinished anti rmd-finished manufactured goods.

The Errandc &i~sand tosses

The analysis should have made it clear that the Cooperative Sceuario . ~ntailssama gradual changes fn the economic gains of trade wtth the TABLE 3.7 PATTERN OF TRADE IN TERRli'(j;:IiES, COOPERATIVE SCENARIO: 1983 (millions of 1976 Israeli pounds)

Commodity Trade : Net Imports ~xports Iiqportr- From Israel S3483 70% To Israel 2,583 63% 2,900 From Jordan 392 5% To Jordan 1, 230 30% - 838 Rom the reet of To the rest of the world -1, 958 -25% the world -287 -7% -1,671 7,833 100% 4,100 100% 3,733

- Services Traded (including labor rarpicas) : .- . Net -rfs asrpotts . rrspor-- . From Irrd 1,24Q 70% To1ara.l 2,701 74% -1,461

*om the rast of To tha rest of the world 443 2% the world 313 9% 130 L - - - - 3,772 100% 3,631 100% -1,859

.. . . Net aggregate uceaa .of faports over axports

Source: Aadytic~Asreasmeat s Corpora tioa computations . .

territoties. Morewar, thoae gains or Xossas will continue to evolve ia the long nm b.poad the fAve-year transition 'period. It is difficult to evaluate the long-run affects, but it is important to keep them in mind. Irraelt Compared to itr current porition, Israel all loea, under thu Cooperative Scenario, some of its advantages in tarritorier. It wlll certainly loaa sow of itr potential export marketr. Also, dua to the rising competition,, tha profit marginn from orportr to the territorler will be reduced whifa at the ram tiwa the cost of purchased labor will continue EG rise fartar than it is tieing today, It is important to keep in mind that these are "short-term" losses and, .ultimately, the long-run ben@fitoof cooperation my be more important. It ir difficult to eveluate the long-run or. the short-run effectr of the Cooparative Scenario, Howsver, since the short- vs, long-term effects should be considered relativeato the Statur Quo Scenario, we rI1P11 return to this isme in . tho relevant later oection. For the moment, we concentrate rhort-term costa during tha trawiti~nperiod. .' . In addition to thatre ecoadc lorras, one may add the following conrid- rrationr: .- o In order to maintain a strong position in the territories, Iarael - wlll need to fiarnce a.naod portion of th. 1.8- to 2.0-bilPion-pound I deficit of the territorias. Thb will moatly take thm form of pri- mte invertm~~~t.

o The higher rate of aconoPlic axpanoion will ancourage a higher rat8 of population growth in the tar+itorier.

o The present rcexuriu shows that 1rraelirp.trufacturers W.11 be fac- growing competition of products manufactured in the territories. ' . This ~y have ur influrace on the profit margins of some domestic industries in Israal. - . . . . Jduaz It is char that Jordan ir the big gainer from the Cooperati\te 8 Scumrio. The territories will becoma a market for Jordanian products where oo ouch market existed befo~ta. The large deficit in the balance of payments will represent the net annual inwrtmentr of Jordan in the territories.

Thnst af rmr1dr Zn absolute terms, the trade with the rest of ' .r - the world is the moot dramatic clk.rrrge in the trade picture of the territoriea, It $8 difficult to oay which spocific counttiam will ba involved in thir trade, but we hve little doubt 'fht a good portion of thir wlll be the rert of the Arab world. Without further elaborating on the gains md loroer, it to clear that the 0 Cooperative Scenario ropreoaw,tr an oconomic ahort-term lor8 to Irrael. Zf tht r~anariowver becam+o t~rnalie, the anotivatioa for it murt entail 1B important poli'tical conridsratimr. We nu7 add that our uulyrir 80 far ha8 focusad on thfb first five yaarr of the tranmition period. The procirss at hand will cor~tinueinto the period beyond 1983 and that repreraatm further B potmtial economic loar to Irrul. We conclude that rigdficaat factors are operating to perpetuata the B political and econaaic atatur quo in thim territorisr, and for this reacsn wa turn now to thir altenrrrtive rcmmrio. .. A I . 3.3 Tha Status QUQ Scoarrio: Xmplicattonr ef 'Edotromic Links to the, ' west m,(*a

.- Ounra2 Cbaraaterizatfon of tba Precmaa

The ringlei moat importrurt economic force that dl1 be operating under ataturn quo coad!Ltionr fr tha rapidly rihg wage rat. in Lrrael ccnnbiaed with a 'dmpace of dorrt%cirmrmmtr Zn the tarritcrier. The political P aiviroument ~8umedik, tEI. Smtur QUO Scenario will induce 8 very riatry . . echdc eallironmmt, makirag it legally impomrible for I~raelleatarprisam to I fnvert in tha teMtorlles he, at thr uma tba, keoping Arab and other foreign ipmask.mts ao a vary wrodest 1.11.11 In rpita of tM8, the procar. doar 3 artafla vev raptd rate of increase $a tb staadard of lfv%aof the tcrrri- ... tom1 reridmnts, aarociatad with rir- interdependmce of the territories IsTbse ties dl1 have three dirtinct features: I .. . o -'-Aririns fraction of the labor force dlba working in Irrael. o Tha domestic territorial economy will be growing relatively rlowly. o Th. domestic territorial economy will deepen its upecializafion rand 1 further concentrate on the a8ricult'ural crop. and industrial products in which the economy can compete with other regional importa. Thie kind of development is a natural outcome of the fact that, given the conditionr specified, ~conomicforcer will be at work which will make it optimal for the trrritories to concentrate on their rrletive advantage and purchare from other regienr the productr and services which are cheaper to lmport. This type of regional development maximizes the well being of tha reridentr while intrneifying thair interdependence with other regions of the Israeli economy. We thus arrive at what may be viewed as a paradoxical con- clurion: The high rate of political tension between Israel, the territorier, the PLO, and othar actore in the region all produce a risky economic anviron- meat which will only deepen the prerant links between Israel and the territories. This will tend both to increase the flow of labor and goodu between the territories and Israel and to relatively slow down the rate of growth of ' the domestic economy of the territories.

The tong vs. Short Rm

It is clear that during the put nine years both the territoriae and Israel have enjoyed dramatic economic gaina from the economic linka between them. It is our opinion that the potential galas from further links betwean them arb still very great. This means that it is likely that if the Status Quo Scenario is'played out during the transit;ion period and beyond, major 8 econonic gains will accrue to both the West Bank and Caza. Yat it is Important to kaap in mind uane long-term forces which will ba operating and may demonstrate that, as tiue goes by, soma important changes wtll need to taka place. To understand this, note first that those among the reridents of the territories who are a~ployedin Israel tend to hold unskilled and rani-skilled jobr. On the other 'hand, as demonatrated earlier, the adu- carional level of the labor force iu rapidly rising, thus making 8 growing fraction of the labor forc~seek s.?rilled jobs whsch may not be available in th. aconoq of the territories either. This process will be associated with daep changes in the industrial comporition of the Arab labor force working in Israel, as Table 3.8 demon.8trat Table 3.8 ahowr that about half of the territorial labor force in Israel is employed in conutruction. But the table also shows a gradual rise TABLE 3.8 EMPLOYED PERSONS BY SELECTED ECONOMIC 9ECTOR3r TERRITORIAL WORKERS WNO ARE EMPLOYED IN ISRAEL (1970-1976) (percontagas)

a s Source: statfstfca1 -tract ai I.r.01 (1977), Table X%VII/22.

in the lml of empl&nmt fa iadurtry and ~rrices,cmbfned with a rapid doclina in agricultural employmaaf;. What should be kept in dnd ia that aglgnrnt in industry and rarpSceu tend@, bn the whole, t~ bo wra atable tban tht %nconrtruction ad agriculture. With stability cows familiarity

1 ., with other workers, unicraiutiorr, and concern ath rtatur, fringe benaf ito, ,and ulary. Sbce th. labor force at bad dl1 tend to becane more educated, thdr employmaat in Xsraal f r likely to be isrociated vith greater fruntration .nd ranre of soci.ldeprivation. Morewer, som of these employees will p?ob.bly demand imprwad conditionr and fringe benefits, and intensify the d.awd for more parmaneace in employment and the right to Uve in Israel . . ratbr tbm to cammute to it on a daly or weekly basis. All these . \ drvelopmantr will be taking place while the domartic economy in the territories all be creating send-skilled and skilled jobr at a relatively slow pacr, forcing thu educated lebor force to choooe batmen immigration or unskilled ad ralatively low-paying job#. It ie important to keep in mind that the dirctapancy in Living reandardr betwren Irrael md the territories ir hiah md tk rapid induetrializatian of Irrasl eouser the real wager in Irrael to rise rapidly. In fact, the economic banefitr which will accrue to the territorial rroidents arr so great that the five-year tranrition phare ir too rnort for tha fundamental forcer mentionad above to work theRr way out.. It ir porsible that if the procers wa arm discussing intenrifiar, rome axtram elements in the territories may reizs upon the pro wing frustration and anger and ruccead in,organizing, ray, a "genaral strike" of roam regamut of the territorial workerr employed . in 18rroel. Although ruch an act may not achieve a great dad by itrelf and, from th. economic viewpoint, may evan harm the tenitorier more than Irrael, it ir likely to raisc iqorturt questions about the direction of economic developments undo- the etatur quo. Two Israeli options in the face of ouch potential developmnts are iPlportust to keep in and since they may, In fact, ba ueed during tha tranritioa period. 1. Alloorlrrg Skilled Workers from tha Territories to Move to Israel Thir vllP man that the demands of? the vowing number of industrial workers from the territorier will be mat with ur offer of residence in Israel, equal working condltioru, fringe benefits, and industrial status. 2. Indurtrialization in the Territories - In essence) part of the problem will arfse fro; innrfficient job craation in the territoriea. .Israel can encourage investments in the I. . . territories, offering potential investors the legal protectdin of Ioraeli law. Keeping in mind that the amount of available fertile land in the territorier ie limited, any major mwement of Israelis into the territories will have to be urban and industrial in nature; other- wire, they will not provide an adequate standard of living to the wttlmrr. But such an urban-indurtr'La1 procerr wfll certainly have I important rpillovar effects on the economy of the territorier, gmer- ating the capital i~~e~tmo~~swl the rkilled jabs which wlll reduce tho rupply of labor to I~raelproprr. ff Ye ropsrrt our earlie?: rubjective maluat~onthat, ducr to the $reat bm- efgts of tho liar betwen Israel and the totritorier, wrr do aot thiafr that 1 mJor problemo will rurface during the rhort-term transition period. Further, us are not rure if the cumulative, long-run procrrr is operating agaSrut ti Xaraoli iaterarto, but this is a rubject far boy014 tho rcope of thir study. We ww turn to ro~arrpecific quoatitat&ve projectionr under tho Status Quo Scanarb. 1

2 PopllatAon, Ubor Force ad Llaplogamnt PM.r f2m Status Quo Scanatlo

' Aa iadicatod ia Sectim 3.2, w rhll arrusl., andas tho Stat- Quo Sc-20, a population growth rat. at 1.6 porcmt por yur. Coabfning thir with tha rert of tho arnmptioar we rrda in th. StaftPo Quo Scmatio, n prorat, in Tablo 3.9, an 8rrrrrra.at of haw roa. of the koy aariabler.under conrideratfm are blyto d.orlop. A. Tabla 3.9 indimtar, w, mticipatr tht tho population rill paw at an avaraga anuu8l rate of 1.6 pucent, dth ' tha participralion ?.to risSng rlarly to 28 percent of the population rrul moat dir-t C-• ir rtill tha numbor af wtkur employad in Inarl, PrBich n eathate to riro by up eo 30 pwcmt ath doeartic amploymaat to rire by only 4.7 percent. RocrrU tht, until recently, doorrtic employmaat - in the surritorios ftrlliag due tcr th. rapid ri~sh. &ploymeat in Irrael.. We tUnk that under the proeat scenario thir procerr trill be +eversod, and .. . tbdamtic eiploymeat a1r$rs h tho next five yaarr. ~n tbd ram mamu, wo think amcultural tmploymant will coat3nuo to fall moderately raplo-t in M~tv aad ~unufacturbg)-11 riro moderatelyn 'throughout thir procarr we shlf have a significant rise in the domestic monomy and 8 rctpPdly rising elemeat in the national accounts will be the was. paymanto from Ieraal.. TABLE 3.9 PROJECTIQNS OF KEY ECONOMIC VARUBLESr STATUS QUO SCENARIO (1976 AND 1983)

CJaango Betwon 1976 and 1983

Population (thousands) X of population employad

Total employlrmt (thouundo)

Employed in Israel (thousmdr) X ampleyed in Israql X employed in domestic agrfculture . - X amployad in doarrrtie idurtry

Tha arrurti.1 charactuirtic of tha proamrr at hrnd is best 18- from the fact that, during the 1968-1976 period, tow Gross D-ctic Product tmlP) in the Weat Bank graw at ur approxinrite annual rate of 10.8 pcrcent while the Gross National Product (019) grk at 4 approximate amwl rate of 13.3 percent. The dif fuence betwean the CLW and the CDP is "factot paymmts from abroad" which, in th. care at hand, are martly wage payments to rsridentr uorking in Icra.l, and twr factor grew durina the rcmr period at the atmu& rate of 34 percant. By 1975, the fraction of GNP eased abroad wrs 22.5 percant! This ratio eased a bit in 1976, but we think that uadu thr prrrent 8cmarfo it will continue to rise in the future. The wortant fact that must be kept in mind is that the growing lieka bahnaa the territories an16 Inrael will be arrocfated arith a rapidly rtsing rtmdard of living, although the Cross Domert,ic Product will be riring xrlatively alowly. Our projectionr of the growth factors ia.volvrd are pre- rented in Tabla 3.10. The artixmted growth ratrr represent an average war the early period of slow growth and over the later period where wo expect the growth ratrr to pick up. Thur wa rxpact both the CNP and the CDp to rise mora alowly than in the 1971-1976 period and wages earned in Israel to continue to rise rapidly but, perhaps, to slow dmsotnewhat in the Caza Strip. To prwidr a rumury, our Status Quo Scenario euggeats the following pattern:

Lowar growth rates of population and output relative to the 1970s.

o Continued rise in incorn. earned in Israel but a relatively rlower growth rate of Crosr Domestic Produce (GDP). . . o Continua3 rim in domestic wage rater, inducing increased specialization of both agriculture and indurtry in the territorier. This

ACTUAL AND PROJECTED CROWTB RATES: STATUS QUO SCENARIO (per cantagas)

. Pr0jeCt.d 1976-1983 -- llhrf G.u west FA at &nk Strip -Buzk -Strip

; 8 8 Aatrur;l'~rowthof CDP 10.0% 5.7% 8 OX *- 5 ox hu.1 CrowtI :;ate of Wager

Paid in Israal (Real) ' . 8.6% , 29.4% hurl Growth Rate of GNP 10.0% 11 .OX

Annual Growth Rate of . .. Population will cauna modost decline in the fraction employed in agricultura ad modert risa in tho fraction arnploynd in industry. o Riaing dapandunca of tha tarritorier on importr from Irrarl and warsaar and axpart aarningr from Jordan, Iaraol, and ovarrear. o Tho tarritoriar will not provids an adequate ravironmant for high- quality rklllad labor and cntrapranaurial talaat. A good fraction of there talents ir likely to mova eo other countries of tho Arab world. Thir drain will be aesociatad with rising domaetic tmrion. IVe CONCLUSIONS

The prerant research reviaws both the economic forces likely to operate in the Middle Eaat during tk transition pime a* well as their impact on the development of trade and economic linh with the Waat Bank and Cars. Tha main conclusions can now be auamurized. 4.1 The Linka with Israel

The economier of the territorier have already developed rtrong linlllr to tho Irraeli economy war the past decade, and these 1-e wU1 be difficult to change. Approximately o.a.-third of the labor force of the West Bank .ad Car8 ir op1oy.d in Irrrael, and vome 90 percent of all export8 of .. there territorieu go to Israel. Similarly, the territories hPvc become the eecond largest trading partner of Icraal. The economic forc6.5 at work are utpectrd to be effective and, ualerr strong economic and political 2 - -. .. . barriers ua imposed, the procesr ir likely to continue throughout the five- yur transition phare urd beyond, -- * 1. 4.2 The Economic Co.arequrncer of a Cooperative Scanario It is clear that a cooperative rcearrrio will call for r more inde- pardeat damlopmeat of the turitorier rurd grariag rcodc lints of the turitories with Jordan, the rut of the Arab world, urd ovarreaa econ&es, 80PI of there d.tt.lopmentr will occur at the upanre of Irraeli interests. - Tiirtli*rmore, add- the eort of aettlin~the rafugees, tbe ecor.omSc cost to Israel would be vary actenrim and the ec~~lomicgainr to Jordan equally' .- . 'aigaif~cant. Although Jordan uyexperience economtc benefit#, it may not . ba - able to doin cbp.ratir. puc~effort dru to conflicting internal foseea, Putting these together, us arrive at the conclusion that economic

' coarider8tioru alone do not favor a cooperative puce procers between Iarrel, Jordan, md the West Bakers. If economic cooperatSon doer take place, tha following could be expected: Prevflous Page Blink o Tho economier of tha territorier will develop rapidly, with a pro wing rate of investmonte in manufacturing, construction, and rervicas. Thir more balanced development will provide a high lwal of demand for dapurtic labor, competing with Iaraeli de- ~ndrfor territorial labor. Thir will result in a gradual reduction in territorial workers employed in I1raa1. l i o Doppeetic development will raquira rignificant capital imestmeatr ,rolounting to rome $1.5 bill;Con, moat of which era to be financed u by dome8tic ravings and Arab capital. o lexpaurion of srde with Jordan and werseas nurkats will reduce the relativa importance of Irraal ar a tradiq partner, but as of 1983 Iarael will rtill remain the biggert partner. of the terri- torha. . o Tha rtandard'of living in the territorlrr will continua to rir~ at a rapid rate. , 4.3 Tha Implication8 of Staturn Quo Scmario n I . If a coopuative puce procear doar not take place, the basic economiv: forcer currmtly at work are likaly to irrtcwaiiy in the truuition phne I and beyond. Thir will -tail the follow in^ coaridaraticms: (1) The fraction of t8rritqri.l labor force worktag in Israel vil'l I trow-to roma 40 perceit, hcrearing the integration of the Arab labor force with thr 1rraU.i economy. Thir may raprerent a potrntial long-NO problem for 18r8U, but auch long-- cornid- eratiom are to p1q a mi. rithin th. period under - ...... , . . , ...... , ..... ; . coruidrratkan. . . I (2) Zbe economie~of thr territofies will continue to evolve l+e . , / ragid ec01~oaPieadthh a larger integrated econamy, concea- I trat4ng on their indurtriar of relative advantage and with a relatively rlw rate of domartic invertmentr. I (3) Although experiencing a slow rate of domeatic investment, the m -' CDP, @W; and wan11 rt.ad.rd of U-ng in the terrftories will rise rapidly due to the large demand for territorial workers and . exports in Iarael and the significantly higher wage rates in Israal.

(4) The pattern of trade will continue to be based on intimate linka batween Israel and the territories; the territories being the second biggest partner of Israel and Israel being, by far, the largest partner of the territories. Exports of specialty agricultural products from the territories to Jordan and everseas will expand, but will maintain a stable relative position. V. BIBLIOGRAPHY

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1 Backer, Abraham, Israel urd the PalestMan Occupied Territ mi48 r Killtary a Polftfcal Zssues in the Debate, R-882-ISA. Santa Monica: The BAND . . Corporation, (Decdar, 1971). "Begb Iuterv$aw on Relations with 0.8.-Vast Bank." Jerusalem Domutic - Television Servica. Reported in Fordgn Broadwt Infc,vwfion Senrice. 23 by 1977, p. #-5.

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