United Nations Trade and Development Board Enlarging the

United Nations Trade and Development Board Enlarging the Palestinian economic policy space to promote sustainable development and competitiveness, and breaking the cycle of aid dependency in the OPT Presented by Mutasim Elagraa First Economic Affairs Officer Assistance to the Palestinian People 02 July 2014

The Palestinian economy today • 1. 5 per cent GDP growth, down from an average of 10 -11 per cent in 20112012; • Trade deficit at 4. 4 billion dollars – 40 per cent of GDP; • Budget deficit 12% of GDP; • Unemployment at 27%; • However, unemployment rate understates the severity of the socioeconomic conditions for reasons such as declining real wages, low productivity, long duration of unemployment spells, and the low participation rate -44%;

The Palestinian economy today • Poverty and food insecurity have deepened in the OPT; • 34 per cent of households are food insecure ; • 26 and 16 per cent of households are marginally food secure and vulnerable to food insecurity. only 1 in 4 households in the OPT are classified as food secure.

Constraints on the Palestinian economy • Expansion of settlements. More than 150 settlements in the West Bank and some 100 “outposts”. • Loss of land natural resources and destruction of the productive base; • The blockade on Gaza; • Between 2004 and 2012 Gaza’s share in the economy of the OPT fell from 33% to 25% ; • Had Gaza maintained its 2004 share in the Palestinian economy, its 2012 GDP would have been 40 % higher;

Constraints on the Palestinian economy • The construction of the separation Barrier; • isolation from international markets; • Mobility and access restrictions; • 540 internal checkpoints, roadblocks and other physical obstacles impede Palestinian movement within the West Bank.

Constraints on the Palestinian economy • For instance, travel time between Bethlehem and Ramallah has more than doubled as a result of the Israeli prohibition of Palestinian commuters to take the short road that passes through East Jerusalem; • Movement barriers aggravate unemployment by lowering the profitability of firms via the inflated transaction cost, heightened uncertainty, small-scale production inefficiency, and lack of access to imported technology and inputs; • Inflated production costs that cripple competitiveness;

Weakened competiveness undermines the tradable goods sector • the tradable goods (manufacturing and agriculture) sectors has been shrinking because it is disproportionately impacted by the closure policy, inflated cost of doing business and the dearth of imported inputs and technology; • Agriculture has been disproportionately impacted by the loss of land water resources and the expansion of settlements. Between 1995 -2012, agriculture contribution to GDP decreased from 12 to 5 %; • The decline in the tradable goods sectors has cultivated aid dependence;

The mirage of Palestinian fiscal sustainability • The restrictions imposed by occupation reinforce the fiscal crisis from both the revenue and expenditure sides by : – reducing the tax base; – restricting the PA's capacity to raise revenue; – increasing spending on social services and transfers and – forcing the PA to act as an employer of last resort.

The mirage of Palestinian fiscal sustainability • Clearance revenue accounts for 70% of total revenue, it covers roughly 84% of the wage bill and 45 % of current expenditure; • The PA's fiscally vulnerability can be seen from Israel’s repeated withholding of clearance revenue; • Following the successful bid for the recognition of the State of Palestine as a non-member observer state by the UN in November 2012 Israel withheld clearance revenue (about $120 million a month). As a result, the PA was able to pay public employees only half of their November salaries by resorting to foreign aid and borrowing from banks;

Revenue leakage from direct and indirect imports • Fiscal leakage refers to Palestinian fiscal revenues that were supposed to be destined to the PA, but instead are retained by the Israeli Treasury; • According to the Paris Protocol, any product that enters the Palestinian market that was produced in Israel is exempted from Palestinian customs duties, but not exempted from the VAT or purchase tax; • 39% of official Palestinian imports from Israel are actually produced in a third country, cleared as Israeli imports before being re-exported to the OPT as if they had been produced in Israel;

elements of Revenue leakage from direct and indirect imports The Palestinian treasury does not receive from Israel • Customs revenue from “indirect imports” which is collected by the Israeli authorities; • “Purchase taxes” on all imports from Israel; UNCTAD estimates that, in 2010 and 2011, about $115 million per year of revenue from direct and indirect imports from Israel have not been transferred to the PA.

There is also revenue leakage from smuggling • Smuggling is source of significant fiscal revenue loss. Where the smuggled goods are produced in Israel, the PA loses VAT and purchase tax revenue. However, in the case of goods produced in a third country, tariff revenue is also leaked; • The smuggled goods are in the range of 25 -35% of imports owing to the uncontrolled borders and the lack of PA control over area B and C; Based on the data for 2010 and 2011, leaked revenue from smuggling is estimated at about $190 million per year. This is on the conservative side, because it assumes that all the smuggled goods are Israeli products, and therefore are not subject to customs duty.

Total leakage from direct and indirect imports + smuggling from Israel is estimated at more than $300 million per year. Had these revenues been transferred to the PA, tax revenue would have increased by 17%; covering 18% of the public wage bill. 2010 2011 506. 0 197. 3 516. 1 201. 3 511. 0 199. 3 3 - Purchase tax revenue from taxable imports from Israel 43. 0 47. 1 45. 0 4 - Customs duties on indirect imports from Israel (average 23% of row 2) 44. 0 47. 8 45. 9 5 - VAT revenue on leaked purchase tax and customs duties 23. 3 25. 4 24. 4 110. 2 120. 3 115. 3 Leakage from direct and indirect imports from Israel 1 - Value of taxable imports from Israel 2 - of which indirect imports from Israel (39% of total - row 1) Revenue Leakage from direct and indirect imports from Israel (3+4+5) Leakage from smuggling 1 - Value of total imports of goods from Israel Avg. 2, 873. 3 2, 938. 5 2, 905. 9 718. 3 734. 6 726. 5 63. 2 64. 6 63. 9 125. 0 127. 9 126. 5 Revenue leakage from smuggling (3+4) 188. 3 192. 5 190. 4 Total leakage (direct and indirect imports and smuggling) 298. 5 312. 8 305. 6 2 - Value of smuggled goods (25% of row 1) 3 - Leaked revenue from trade tax on smuggled goods (average 8. 8% of row 2) 4 - Leaked VAT revenue from smuggling (16% of sum of rows 2 and 3)

Employment and output cost of fiscal leakage • There additional outputs and employment costs which the economy would have been able to generate had the lost financial resources been available to expand the fiscal space; • UNCTAD estimation suggest that capturing the leaked revenue would expand the fiscal policy space and the ability of the PA to provide fiscal stimulus to: – raise annual real GDP by 4%; and – Allow the economy to expand its employment generation capacity by more than 9, 000 jobs per year.

Recommendations for stemming the fiscal leakage • The Paris Protocol needs to be replaced with a balanced framework consistent with the needs for Palestinian fiscal independence. • Israel’s cooperation is required to allow the PA: – Full access to all data related to Palestinian imports from or via Israel; – Due tax revenue should be transferred to the PA ; – Abolish the time limit which prevents the PA from claiming due revenue from imports with transaction date of more than six months; – Removing barriers to trade with countries other than Israel to give Palestinian shippers access to cheaper sources; – Access for Palestinian customs brokers to Israeli ports and borders to clear goods destined to the OPT.

Limited policy options • The PA's ability to revive the economy is constrained by the limited policy space available to it under the terms of the Paris Protocol, which is less than the policy space available to local governments in many countries; • • No currency; No monetary policy tools; No exchange rate policy tools; No independent trade policy; • What PA has from a typical sovereign state policy toolkit is a limited, volatile and vulnerable fiscal policy space. The PA can do little more than allocate public expenditure, which leaves the Palestinian economy vulnerable and exposed;

Expanding Palestinian policy options • Rehabilitating and setting the Palestinian economy on a path of sustained development is not possible without empowering the PA with the full range of policy tools; • UNCTAD's projection of the Palestinian economy shows that if the full range of monetary, exchange rate, fiscal trade and labour policies are introduced, it will be possible to achieve substantial improvements in major economic indicators.

Impact of policy space on GDP (millions of 1997 $) ü Empowering the PA with typical policy tools could be used to raise GDP by 24% above the baseline scenario by 2015.

Impact of policy space on unemployment rate (%) ü A movement towards full employment by 2012 is possible with the introduction of the full range of policy tools.

Expanded policy space critical for reversing Palestinian economic regression and achieving sustained growth • There is a critical need to empower Palestinian policy makers with the full range of fiscal, monetary (national currency), trade and labour policy instruments available to other countries.