Washington Report on Middle East Affairs, December 2000, Pages 22-23

Trade and Finance

What If...? The Economic Consequences of Israel’s Threat of Separation

By Colin MacKinnon

At the end of October Israeli authorities were threatening that if Prime Minister Ehud Barak decides he cannot reach a peace agreement with Yasser Arafat, Israel had plans for the Palestinian territories which would not be of benefit to the Palestinians living there.

According to one plan—there are a number—described to the London daily Financial Times, Israel would isolate, both from Israel and from the outside world, the 40 percent or so of the West Bank that the Palestinian Authority controls; would curtail movement among the major West Bank enclaves inhabited by Palestinians as well as sever the connection between the West Bank and Gaza; and, after withdrawing some 30 percent of the 200,000 Jewish settlers living in the West Bank and Gaza, would annex to Israel three large areas now inhabited by settlers. Israel would also annex the Jordan Valley.

The other plans are minor variations on these themes (if Ariel Sharon got his way, for example, there would be no withdrawal of settlers), but the basic picture is the same.

Such talk may well be an Israeli bluff designed to pressure Arafat. Certainly it is difficult to imagine the international community, even a supine American administration, countenancing these measures. But such plans do exist, and under some circumstances the Israeli authorities, if we take them at their word, might be tempted to put them into effect.

What might happen to the Palestinian economy if they did? Plenty, unfortunately, and all of it bad. It is a grimly instructive subject to contemplate.

Start with trade. The Palestinian Territory—let’s call it Palestine—does little business with the outside world. Eighty percent of Palestine’s imports come from Israel; 95 percent of its exports go to the Israeli market. Palestine is dependent on Israel for the necessities of life—food, medicine, energy—as well as for inputs into what small-scale industrial production goes on in Palestine. (Much of Palestine’s exports are agricultural products, by the way, and will rot if allowed to sit around, which they’ve been doing in recent weeks.) Under separation, trade would presumably go on, but probably under conditions less favorable than under the current customs union Palestine has with Israel. Israel might throw new tariffs and quotas on Palestinian products and would always be in a position to cut trade completely.

Complete separation of Palestine from Israel would amount to economic warfare.

Even more important is the problem of labor movement. Under ordinary circumstances, some 125,000 Palestinian workers earn their wages in Israel, legally or otherwise, producing about 25 percent of Palestine’s labor income. A complete and formal border closure—even a fairly well-policed incomplete one, if it meant no Palestinian labor in Israel—would deal a severe blow to an already feeble Palestinian economy. (If the Israelis cut Palestinian access to Israel generally, Palestinians who need services such as medical care in Israel would be hard hit, but this, strictly speaking, is not an economic issue.)

Beyond trade relations and labor movement, separation would leave Palestine vulnerable to Israeli monopolies and various kinds of pressure.

Think of utilities. Israel supplies Palestinian electricity and controls Palestinian water. Supply of both might continue under separation, but would be subject to Israeli whim, and at quantities and prices decided in large part by the Israelis. Israel also controls the only telecommunications and postal links Palestine has with the outside world. These, too, presumably would still be available to Palestinians but, like electricity and water, subject to monopolist rates and to cut-off.

Travel? Israel controls all access by land from Palestine to the outside world—from Gaza into Egypt, from the West Bank into Jordan, and, through Israel itself, to international air and sea carriers. Such routes could be cut, and have been in the past.

Israel controls Palestinian airspace. Nothing flies over Palestine without Israeli approval. All traffic through Gaza Airport is under Israeli supervision and, again, can be and has been stopped when the Israeli authorities so decree.

Getting to Israel and the great world beyond aren’t the only travel problems Palestinians would face. Because Palestinian areas on the West Bank are broken into isolated enclaves by Israeli settlements and military roads, Israeli security forces can and do curtail movement between them. Such “internal closure” has been the rule during the current Al-Aqsa intifada, when Palestinians living in, say, Ramallah and working in Nablus found themselves having more holidays than they wanted. The threat of internal closure and its economic disruption would always be present.

Israeli Discretion

Consider, too, the matter of taxes and other revenues due the Palestinian Authority. Customs duties on goods destined for Palestine are collected at Israeli ports. But it’s the Israelis who do the collecting and who send on the revenues. Remittance, therefore, is at the discretion of the Israelis. Israel has been known in the past to slow revenue payments to the PA for political purposes. It can do so again—or simply stop them altogether.

Furthermore, all the above problems, together, would eliminate the flow of investment into Palestine, never high to begin with, because nobody in his right mind would put money in such a place.

Quite a list. Palestine is exquisitely vulnerable. Complete separation of Palestine from Israel would devastate the former and would amount to economic warfare.

How would Israel fare under separation? Theoretically, not so badly.

Before the latest intifada broke out, Israel’s economy had never been stronger. Israel’s gross domestic product these days is in the range of $100 billion (compared to Palestine’s $5 billion). Per capita GDP in Israel is around $17,000 (in Palestine it is $1,600 or so).

Israel has suffered somewhat—but only somewhat—in the current crisis. At the end of October, the Tel Aviv stock exchange was down 16 percent from pre-intifada levels and the shekel had declined 3 percent against the dollar. Tourism, 3 percent of the Israeli economy, is off. Construction and agriculture, which depend on many of those 125,000 Palestinian workers, are suffering now as well.

Banking relations between Israel and Palestine have been severed, with banks on each side refusing to honor checks drawn on accounts on the other side. Creditors, mostly Israeli, cannot collect from debtors, mostly Palestinian.

Nevertheless, despite the intifada, international credit rating agencies like Standard and Poor’s and Moody’s have seen no reason to change Israel’s rating. Moody’s, in fact, just upgraded Israel’s rating, though it did so before the intifada broke out, declaring the Israeli economy little affected by security problems. Foreign direct investment continues (Marvell Technology of California just paid $2.7 billion for the Israeli high tech firm Galileo Technology). Inflation seems under control.

With separation, Israel’s chief immediate problem would be loss of Palestinian labor, but the loss likely would be manageable: Israel’s labor force is 2 million-plus, with unemployment now at 9 percent. There currently are some 100,000 non-Palestinian foreign laborers in Israel. Despite the social problems they cause, more probably could be tolerated.

There would be some other immediate, but largely manageable, problems as well. Moving settlers out of Palestine, if any Israeli government dared do so, would cost hundreds of millions of dollars. Building an iron curtain along the Green Line would run into the billions. Increased military expenditure to police this new fence and also to police the newly annexed areas would cost indefinite sums and run into the indefinite future.

Still, Israel might be able to handle all this.

But the risks to Israel of actually trying to pull off separation would be very, very high. If Israel really did attempt such a policy, what on earth would happen in Palestine? The current conflict would surely be mild compared to the unrest separation would provoke. How would the Israelis deal with such turmoil? What effect would it have on investment in Israel, and on other aspects of Israel’s economy, such as inflation, GDP growth, and capital deposits in Israel?

And what about the international reaction? Tunisia, Oman, and Morocco already have broken off relations. Would Jordan and Egypt follow? How would the European Union and the United Nations react?

Imponderables all. And surely the risks involved in such unpredictability would deter Israeli authorities from attempting separation. But they are talking about it. What if?

Colin MacKinnon is a country analyst with the Syracuse, New York-based PRS Group.