Law & Development Program
COMMERICIAL LAW REPORT SERIES



Guidelines for Final Status Economic Negotiations Between Israel and Palestine

By Samir Huleileh and Dr. Gil Feiler
With Dr. Gershon Baskin and Dr. Zakaria al Qaq

Supported by
The Center for International Private Enterprise (CIPE)
and Swedish International Development Cooperation Agency (SIDA)

November 1998


Table of Contents

Guidelines for Final Status Economic Negotiations
Introduction

Types of Agreement

The Discussion

The Economic Benefits of the Paris Protocol

The Economic Shortcomings of the Paris Protocol

The Goals of Final Status Economic Agreements

What Type of an Agreement?
A Customs Union? A Free Trade Agreement?
Future Economic Relations
Recommendations
Areas for Further Study

About the Authors




Introduction

In April 1994 in Paris, Israeli and Palestinian negotiators signed the "Protocol on Economic Relations" (commonly called the "Paris Protocol") which was subsequently attached as an annex to the Interim Agreement. The Paris Protocol created a form of a customs union linking Israel and the Palestinian Autonomous Areas. According to the Paris Protocol, the two sides were to enjoy free trade with one another in all manufactured and agricultural goods with the exception of five types of agricultural produce for which quotas were imposed on a five-year plan of gradual phasing out. The Paris Protocol further provided that import policies and tariff schedules applied in the Palestinian Autonomous Areas are to conform to those applied in Israel, except for limited classes of goods appearing on three lists attached to the Agreement. In essence, the Paris Protocol was expected to bring about a transformation of the Palestinian economy from primarily a labor-exporting economy to a goods-exporting economy, increasing prosperity through trade with Israel and third markets. However, the failure to implement the Paris Agreement in its main aspects has left these expectations entirely unrealized and has contributed significantly to economic hardship in the West Bank and Gaza that have been generally negatively effected by the lack of political stability and progress towards real peace that did not emerge following the signing of the Oslo Agreements.

The failure of the Paris Agreement to fully achieve its stated goals has several reasons. First, Israeli security closures have limited the flow of Palestinian goods into Israel, essentially rendering moot the free trade provisions of the Paris Agreement. Second, Israeli security procedures at the external borders have also limited Palestinian exporters from accessing foreign markets. Third, being tied to the customs union with Israel, the Palestinian Authority has been unable to defend Palestinian economic interests as regards foreign trade with third countries. Fourth, different arrangements have been concluded by the Palestinian Authority with certain Israeli and foreign companies closing the Palestinian market to Israeli goods under certain pretexts such as the "Agency Law", monopolies and preventing Israeli companies from being registered thereby not being allowed to operate. Fifth, insecurity regarding the trade issues described above have discouraged investment in the Palestinian economy.

 

The IPCRI Research Project on Trade

The aim of this project was to examine and suggest principles that should guide Israel and the Palestinian Authority with regard to the future negotiations of economic agreements within the framework of the final status arrangements. The principles for this document were drafted by a small group of Palestinians and Israelis during the course of several months.

The working group concentrated mainly on the following issues:

What are the advantages and disadvantages of the Paris Protocol for both parties?
Aims of Palestinian-Israeli Economic Agreements
Help to develop the Palestinian economy
Assure free flow of trade in both directions under fair terms
Assure the collection of revenues for the authorities
Protect consumers from inferior or unhealthy goods and products
Frameworks: What types of an agreements?
Means for guaranteeing implementation
Free movement of people (labor, businessmen, third parties, tourists)
Trade agreements with third parties, mechanisms for consultations and tri-lateral agreements (not imposing agreements on each other)
Cooperation between Standards Institutes
Agricultural trade ­ inputs and outputs
Technical issues (Standards for transportation, crossings, etc.)
Free trade areas, joint processing/industrial zones
Capital markets and banking


Cooperation

In depth discussions took place between the team members regarding the advantages and the disadvantages of the Paris Protocol for both sides focusing mainly on the analysis of what has transpired after more than four years of the agreement. In this paper we are not merely considering only the theoretical aspects of what type of agreement would be most preferable for both sides. After evaluating the implementation and non-implementation of the agreement we have on the basis of this analysis, offered advice for creating better agreements and ways to insure the implementation of the procedures and principles set forth within the agreement.

The IPCRI working group discussed mutual possible agreements including trade relations with third parties, and regional and international contexts. The IPCRI working group has also identified a number of issues that demand in-depth research and analysis in order to allow for the two sides to make more intelligent decisions regarding the future agreements.

The IPCRI working group concentrated mainly on the possibilities and preferences for developing a Free Trade Agreement (FTA) or continuing with some form of a Customs Union (CU) as well creating some kind of a hybrid model of trade including aspects of FTA and CU.



Types of Agreements

In order to provide the reader with a quick understanding of the various possible types of agreements we have provided a brief description of them.

The extent of actual economic cooperation and transactions between the economies depends of course on the formal arrangements made between them. Economic relations range from minimum exchanges of goods and services to a wide spectrum of formal agreements on economic cooperation and preferential treatment. These agreements, in ascending order of economic integration, are(1):

a. Protocol trade: Agreement is reached on lists of goods to be permitted entry to each country, with quantitative limits, and possibly also on the relevant tariffs. (here assumed that the tariffs are no lower than those applying to other countries.)

b. Most favored nations treatment: Trade between the partner countries is permitted subject to the regulations and tariffs which apply to other countries, excluding the special arrangements applying to countries receiving trade preferences. (Membership in GATT is first and foremost the application of the MFN principle to members of that agreement.)

c. Preferential protocol trade: Tariff or QR reductions on lists of goods.

d. Free trade area: All tariffs and other restrictions on trade between the partner countries are eliminated, perhaps gradually in accordance with an agreed upon timetable, but each of the partners retains the right to impose an independent trade policy vis-?-vis non-partner countries. A free trade area agreement may also limit the sectors to which it applies; e.g., excluding agricultural goods.

While this type of arrangement implies the relinquishing of policy options to protect domestic production from competitive imports coming from partner countries, it does allow protective measures against other imports, and also by-passes the need to agree on a common external trade policy, something which may be difficult for countries at different levels of development.

A major drawback of the free trade area is the need to inspect goods passing from one region of the area to another, in order to determine whether the good in question originates in the partner country, and is therefor to be allowed in free of duty, or of external origin, and thus to be charged the appropriate duty. Agreement is needed on what percentage of value added qualifies a good to be originating in the partner country, and checking value added is an expensive inspection process. Most basic and problematic in some cases is the necessity of establishing customs borders between the member countries.

e. Customs union: This is an extension of the free trade area agreement to include a common external trade policy for all members. The relinquishing of independence in external trade policy is compensated for by not having to impose customs borders, because no inspection of intra-regional trade is necessary.

f. Common market: Whereas the above types of integration were restricted to trade arrangements, this form goes considerably beyond that: in addition to free trade in goods and services, the common market provides for free movement of factors of production, labor and capital. Integration can be extended from a common market to include various degrees of common economic policy: fiscal, monetary, and social provisions. As these additional integration measures of joint policy are adopted the name "economic union" becomes appropriate.

The Discussions

The Paris Protocol opened with a general statement of purpose that clearly outlined the hopes of both sides for economic growth and cooperation. It stated:

The two parties view the economic domain as one of the cornerstones in their mutual relations with a view to enhance their interest in the achievement of a just, lasting and comprehensive peace. Both parties shall cooperate in this field in order to establish a sound economic base for these relations, which will be governed in various economic spheres by the principles of mutual respect for each other's economic interests, reciprocity, equity and fairness.

 

This protocol lays the groundwork for strengthening the economic base of the Palestinian side and for exercising its rights of economic decision making in accordance with its own development plan and priorities. The two parties recognize each other's economic ties with other markets and the need to create a better economic environment for their peoples and individuals.

The IPCRI working group believes that the goals stated in the preamble of the Paris Protocol have been largely unfulfilled. Most of the problems encountered over the past four years have been as a result of failure to implement the main aspects of the Protocol. The assessment of the Paris Protocol, in this paper, is directly related to what actually happened on the ground, and less so with regard to the actual original text. We believe that the conditions that created the problems of implementation have not changed. Therefore, any new agreements must take these conditions into account and not only the principles of trade agreements. The authors of the Paris Protocol did not envisage the problems of implementation that were encountered on the ground. The loss of "good will" and trust must today be countered by effective guarantees and mechanisms to insure the implementation of whatever new agreements are negotiated.

The striking problem of implementation was the closures on goods and laborers and the unilateral security arrangements imposed by Israel. Furthermore, Palestinians have asserted that Israel has frequently exploited the security issue to achieve political and economic ends. Today, it is clear to Palestinians that the Paris Protocol reflected an asymmetric balance of power between the two sides, where one side held sovereignty and power and the other side had little or no power and no sovereignty. This was reflected primarily by the fact that the Palestinians accepted the Israeli customs book with little room to maneuver. The Palestinians had the right to import according to their own standards, tariffs and import policies only within the framework of specific lists of goods, i.e., lists A1, A2, and B. Any additions to these lists were to be addressed by the Joint Economic Committee in which consent of both parties was required.

In evaluating the implementation of the Paris Protocol until now, the study team members agree that the economic ministries of relevance to the agreement implemented, to a great extent, the various clauses of importance. Where violation of the Paris Protocol took place, however, was at the political and security decision makers level based on political and security grounds. The political and security pretenses of decision makers in Israel caused a situation leading to significant limitations in the full implementation of the agreement. The imposition of closures that prevented the free movement of goods and people is believed to have been in violation of the spirit of the agreement if not the letter of the agreement. In August 1995, the Palestinian Authority requested to consider renegotiating the agreement in light of the fact that closure had become a regular fixture of Israeli policy. The Israelis understood the problem but were not willing to "open up" the agreement to be renegotiated for fear of similar demands regarding other agreements.

The Economic Benefits of the Paris Protocol

Even with the shortcomings of the Paris Protocol, it has in its four years brought about a full tariff free export possibility in agricultural and industrial goods. Revenue collection directed to the Palestinian Authority was implemented throughout the period except with some exceptions. Public expenditures in the Palestinian side increased from $280 million in 1993 to $818 million in the Palestinian budget of 1997. About 50% of this was collected by Israel. The agreement has increased direct trade between the PA and other parties which has highlighted by the signing of trade agreements between the PA and USA, EU, EFTA, Jordan and Egypt which enhances the possibilities for a more balanced trade between the Palestinian territories and third parties. The Paris Protocol enabled the Palestinians to create a banking a sector and to attract billions of dollars as deposits that can be used for future investments. However, the issue of purchase taxes has not been resolved despite that its being continuously raised at meetings of the Joint Economic Committee.

Israel also benefited from the Paris Protocol in that its trade relations with the Palestinians was regulated and increased throughout the period. This is in addition to the huge benefits that the Israeli economy generated from the beginning of the peace process with the Madrid conference and especially after the signing of the Oslo agreement. In fact, thecoof Israel following the launching of the Peace Process grew by an average of 6% per annum, in addition to a rapid growth in foreign and local investments. The per capita income increased from $12,500 in 1993 to $17,000 in 1997. The agreements with the Palestinians also led to a direct easing of the Arab boycott as well as enabling Israel to development diplomatic and economic relations with several Arab and Muslim countries.

The Economic Shortcomings of the Paris Protocol

The shortcomings of the agreement became increasingly apparent with the lack of full implementation. The agreement should have assured the continuation of the status quo with regard to Palestinian laborers working in Israel, which at that time numbered 120,000. After the agreement, there was a sharp decrease in the number of Palestinians allowed to work in Israel. There was also a significant decrease in the number of working hours allowed in total. This led to a sharp decrease in income to the Palestinian economy and created high rates of unemployment. Both the World Bank and the IMF documented a decrease of more than 20% in the Palestinian GDP over the first four years of the Paris Protocol.

The policy of closures changed the spirit of the agreement and of the Declaration of Principles that envisioned peace developing based on cooperation between the sides. The deterioration of the security situation and the policy of closures brought about a change in direction for the peace process from one of integration and cooperation to one of separation and greater suspicion. The sharp decrease in employment reflected an imposed policy of forced separation between the two economies. The movement of goods and businessmen became heavily regulated by security policies, including back-to-back arrangements and the convoy system that didn't exist prior to the agreement. Many people comment that prior to any Israeli-Palestinian agreement, there was virtually no border between Israel and the territories with regard to the movement of people, goods, and vehicles. Following the agreement, vehicles, both for private use and for trans-shipment of goods were limited and even prevented. The new situation also led to other aspects of separation such as the Palestinian decision to not purchase certain Israeli goods because they could not collect the purchase tax revenues from them, as well as Palestinian policies aimed at preventing or discouraging joint Israeli-Palestinian business ventures.

In Gaza for example, a border was established that completely limited the movement of goods and people. In the West Bank security crossing points were also created. Several Israeli ministries began to develop plans to regulate crossing points (such as physical barricades, fences and walls) that would concretize the separation of the two economies. The Paris Protocol aimed at regulating integration between the two economies, yet today there is institutionalized separation in many aspects, mainly concerning movement of goods and people.

Another outcome of the agreement has been strict limitations on the movement of third parties as well, bringing about a decrease in the numbers of tourists and Israelis entering the Palestinian areas, for tourism as well as for commerce.

The Palestinian Authority put into force in 1997 an old Jordanian law aimed primarily at regulating and limiting the work of Israeli companies in the Palestinian areas. The "Palestinian Agency Law" created tremendous loss of income and business for many Israeli businessmen who had been conducting business there for many years.

Some Israelis exports to the Palestinians were replaced by goods from other parties, even though the total exports of Israel to the Palestinian territories increased. (Some economists claim that the increase in purchases by Palestinians from Israel based on VAT invoices really reflects an increase in the purchasing of goods that are imported by Israel and redirected to the Palestinian areas and not a significant increase in the purchase of Israeli manufactured goods. This issue must be properly studied by both sides in order to make rational decisions based on real data.) In some sectors, the Israeli economy suffered seriously, such as stone aggregates that are disappearing from the Israeli production sector. Another major side effect from the development of separation has been the replacing of Palestinian laborers by foreigners which has created new social ills and problems unknown of before in Israel together with increased burdens on the Israeli infrastructure.

The Goals of Final Status Economic Agreements

Trade between both sides is very important and quite significant with a large potential for increase on both sides. There is a need for lasting and comprehensive economic agreements that will maximize the mutual economic benefits for both parties. Any new economic agreements must provide for the minimization of external factors on the economic life of both parties, such as political developments and security concerns. The movement of the labor force is essential in that it provides substantial income for the Palestinian economy and low cost labor for Israel. The issue of labor must be regulated and guaranteed as an integral part of the new agreements.

The existence of a long, shared border between the two sides demands that economic agreements be comprehensive in confronting the potential problems and possibilities concerning the economic life of both communities. The IPCRI working group believes that there is a need to increase the economic interaction between the two sides under any type of agreement. Attempts should be made to remove all barriers to trade in all areas, including goods, services, and labor. Investments by each party in the areas of the other should be actively encouraged as well as joint venture in both countries. Increased economic interaction will lead to greater prosperity as well as cement the relations between the sides in the development of mutual interests that will make real peace sustainable. Policies should be adopted by both sides to encourage these investments and possible joint ventures. First and foremost amongst these policies must be free movement for businessmen and investors.

Due to the experience of the past years with regard to implementation problems of the Paris Protocol, a third party, such as WTO or other specialized bodies must be included in order to resolve unresolved disputes and to arbitrate between the sides.

What Type of an Agreement?

The working group discussed in detail the issue of various types of possible agreements. Bearing in mind that as an interim agreement, the Paris Protocol did not provide a comprehensive framework answering the needs and interests of both parties, the working group examined the advantages and disadvantages of various kinds of agreements. Both sides seek to see the highest level of free movement of goods, labor and capital, therefore, the main forms of agreement most fully examined were FTA, CU and Common Market. When evaluating these options issues of concern raised were:

Tariffs ­ should they be common?

Standards - could there be mutual recognition of standards, or should we accept a third party's standards

Import policies from third parties including the Rules of origin

Another consideration is how would any preference effect the economies of the two parties, the trade between them and the trade between other parties.

A Custom Union?

In any trade agreement the concept of full reciprocity, mutuality and fairness must be kept for both parties. In a CU adhering orthodoxly to these principles is a sine qua non. A CU agreement between the two parties must tackle the question of joint decision making and provide mechanisms that are more cooperative than those provided for in the Paris Protocol. This mechanism must meet the needs, as much as possible, of both sides. A complete review of tariffs and non-tariff barriers (NTB's) would have to be conducted and a new customs books together with agreements on NTB's would have to be agreed upon.

Standards need to bcommoand agreed upon, and not unilaterally decided by one of the parties. Another example of an NTB limiting Palestinian ability to import freely are the kosher restrictions on imported meat. If Palestinians wish to import non-kosher meat, it should not be a problem, despite the possibility of that meat ending up in the Israeli market.

Reciprocity should be a guiding principle for the economic agreement. Both parties must ensure that the agreement contains measures preventing unilateral decision making. The agreement must build in mechanisms to insure full implementation or there will be constant counter actions from the other side as demonstrated by the past four years of the Paris Protocol. The issue of various forms of guarantees and/or penalties must be examined, evaluated and agreed upon.

The main problem demonstrated through the partial implementation of the Paris Protocol has been in the realm of "security" policies. In response, Palestinians state that if Israel cannot find alternatives to the current policies of closure, then there is no chance that they will once again accept a Customs Union agreement. The Palestinian say this knowing well that the economic consequences of such a decision might lead to a direct reduction in Israeli-Palestinian trade. The precondition for a Palestinian agreement to a Customs Union would be full-fledged guarantees among other things, that the movement of goods, people and capital will not be stopped under any condition. If this cannot be provided, then Palestinian policy makers believe that the best alternative for them is a Free Trade Agreement under which the Palestinians would have their own independent trade policies vis-a-vis third parties.

If a Customs Union is the end result of negotiations, then there must be guarantees for full reciprocity including solving various technical issues and all kinds of difficulties relating to closures. The details of agreements on these technical issues must be part of the agreement and should include a mechanism involving a third party such as the WTO to verify complying as well as arbitration, should disputes be unresolvable in a bilateral framework. Under the current situation, this is not the Palestinian first choice.

A Free Trade Agreement?

The Guiding Principles

Taking the present situation in consideration, and in particular noting the strong Palestinian dissatisfaction with the present Customs Union agreement, the IPCRI working group believes that the best option for both sides to consider is a FTA with elements of custom union and common market agreements added to it, such as movement of labor, movement of capital, etc. We are talking about developing a hybrid model of a Free Trade Agreement that strives to be a Customs Union in the future.

Some of the guiding principles for the new trade agreement are the following:

1. Movement of Goods

In order to reach an agreement that facilitates movement of goods to a high degree, existing FTA's experiences should be studied, both in their faults and their successes. In doing so the differences in the comparative regions should of course be accounted for. For example, there could be an examination of how goods move through EU countries and how the bureaucracy has been cut to move goods rapidly. The EU, however, has a long period of cooperation prior to the EU and does not face the same security issues which makes it difficult to compare. Nonetheless, some lessons could be learned.

All things considered, there must be a guarantee with regard to smooth movement of goods and transportation in general. Any new agreement must be based on existing technology - not projects on the engineer table. In other words: a discussion of concepts, not only future possible technologies must guide the discussions and decision making.

2. The Costs of FTA must be reduced

Costs for handling must be reduced to a minimum. The FTA will create a paper bureaucracy at customs stations at what were only security check points. Great efforts must taken to minimize the bureaucracy, the guarantee that it will be efficient, making use of modern existing technology, and keeping to agreed rules and procedures. A mechanism for the training of customs personnel jointly run should be established thereby helping to encourage positive working relations from the outset.

3. Build Customs Union and Common Market packages or elements into the FTA.

As stated above, the goal of the new economic agreements should be to encourage cooperation and economic links through free trade and investment. While recognizing that the FTA will create customs borders, other areas of economic cooperation should be examined and encouraged within the framework of agreements.

4. Create mutual standards and policies with regard to a long list of goods.

There are many Israeli standards that are acceptable to the Palestinians. There are also other standards that are thought to be too "high" to meet the needs of the Palestinian economy that would like to import lower priced goods. In the framework of the FTA, Palestinians would also be allowed to import goods with different standards than Israel as well. Cooperation between the Israeli and Palestinian standards institutes should be encouraged through training, mutual recognition of laboratory testing, and agreed upon mutual standards where applicable.

5. Concrete arrangements for the guaranteed movement of people, laborers and investors must be part of the agreement.

The issue of labor has already been mentioned several times. In order to create economic stability based on some amount of predictability, it is essential that the policies that have begun to be developed in Israel during 1998 regarding "closure free permits" and Palestinian organized labor be increased and widened. The Palestinian labor market cannot be taken hostage to external factors that do not concern economic developments. The Palestinian labor market must be able to freely compete for jobs in Israel and even be granted certain advantages over foreign imported labor to Israel from outside of the region. There must be a clear recognition by both parties that labor is too important a factor in the development of the Palestinian economy to be reduced as has happened during the past four years. Furthermore, if it is not possible to guarantee the constant and stable flow of labor, there must be mechanisms for compensation for those employees losing their primary source of income.

There must also be a policy of mutuality for investors, including Israeli investors in Palestine and Palestinian investors in Israel, so they can move around freely in both countries.

The free movement of labor will probably be problematic for a long time due to security considerations. These obstructions while not acceptable with regard to labor also must not effect the movement of investors and businessmen who are vital in the building of the Palestinian economy. Investors must be attracted from all over - including Palestinians and Israelis. A special status for investors, that grants them totally free movement and residency rights, must be a part of the agreements. This could be reached in various ways. Some transparent criteria like a minimum amount of investment and a certain number of jobs created within a specific period must be established and kept to.

6. Taxes should be imposed (in Israel) on the employers of foreign laborers not from the West Bank and Gaza.

In reference to advantages that should be provided to encourage the use of Palestinian labor in Israel, a VAT surcharge should be added to the cost of labor from foreign countries outside of the region that would be paid by the employer.

7. Special arrangements should be created on the bulk of major goods being traded between the two sides in order to limit bureaucracy and costs.

There are many goods that are shipped on a regular basis and in relatively large quantities. Special arrangements should be established to facilitate the shipping and transport of those goods with less than normal bureaucracy.

8. There must be transit arrangements for goods imported from the otside wicustoms paid only at the borders between Israel and Palestine. Thus goods going to Gaza do not pay custom in Haifa port and opposite.

9. The existing arrangements on sub-contracting and out-sourcing must continue and special arrangements should be outlined.

10. Both Israel and Palestine desire to reach FTA with Jordan in the future. It is important to consider a Israeli/Palestinian/Jordanian tri-lateral FTA in the future.

11. There must be agreements on transport, insurance and tourism. Tourism is a big and growing industry and the potentials for pilgrimage tourism in Palestine/Israel are significant. There must be arrangements for group visas to be issued as a "shingle visa" for both Israel and Palestine (from agreed upon countries). Insurance policies should cover vehicles and third parties in both Israel and Palestine without having to add additional riders with additional costs.

How to promote and attract regional tourism is an important area to include in the final agreement.

a. Visas have to be issued that are valid in both countries.

b. There should be given advanced approval for group tourists that are traveling in groups and following an already set itinerary.

c. Computer terminals should be linked on both sides.

d. Shared rights to grant visa is preferable. Various arrangements should be investigated.

e. There must be a fair system of revenue sharing for visa and other fees.

f. Islamic tourism should be encouraged. First of all, it will be an important income. Secondly, it will ease fundamentalism in the sense that religious Muslims who see and relate to Israelis are less susceptible to propaganda. Pilgrimage tourism connecting Mecca and Jerusalem must be planned and promoted.

12. An agreement on transit shipments between and through the areas of both parties has to be concluded as an integral part of these economic agreements to guarantee that trade with third parties through their territories will be smooth.

In the FTA hybrid (FTA-CU elements) arrangement, the three main areas to consider with regard to integrating elements of CU into the FTA are:

I. Tariffs, custom and purchase taxes that can be agreed upon. Today, tariffs and customs are not defined by the Palestinians; they follow the Israeli set levels. Since there is no Palestinian concept of a customs book, Palestinians must define their own policy on analysis of what is most beneficial to the Palestinian economy. These custom concepts can be worked out in accordance and with the help of WTO and IMF.

II. Common standards should be developed as much as possible. A fast-track for reaching mutually recognized standards between the Israeli and Palestinian standards institutes should be evaluated.

Since some of the Israeli standards are NTB's, there has to be a research committee to investigate in details the issue of standards.

It should also be taken into account that a low standard of living on one side might desire by design to have certain lower standards in order to allow for the production and importation of less costly goods.

III. Common external trade policies vis a vis some third countries. When Israel negotiates a Free Trade Agreement with a third country, for example with Turkey, it carries many consequences and concerns for the Palestinians. It is Israel's right to enter into these agreements, but the effects on the Palestinian economy of such agreements must be researched and understood. Doing this can also prepare for future agreements that may include a Customs Union.

It is not realistic to expect change in the Israeli policy regarding specific Arab and Muslim countries like Syria and Iran. Furthermore it is questionable whether any conclusion could be reached in a joint committee, but at least the effects of agreements on Palestine must be recognized, analyzed and discussed. The Palestinians, under a Free Trade Agreement would be allowed to enter into trade agreements with countries that do not have diplomatic or economic relations with Israel. This would clearly not be possible under a Customs Union agreement between the two parties.

Future Economic Relations

The FTA might be seen as a building block towards a closer trade relationship. It is desirable to reach a Customs Union or even Common Market arrangements after Israel resolves its security problems and after arriving at a common vision of trade and standards, including agreements on the free movement of people.

The Customs Union would be favorable if the Israeli answer to security concerns was temporary ­ but that is not the case. Israel is also not ready to reconsider from an economic point of view, its standards and tariffs, in order to reach a common ground with Palestinians. Therefore, the FTA is a better framework. Technical arrangements, logistics and administrative issues to counter adverse effects on trade because of this agreement must be further researched and suggested.

Financial areas

Currency, banking, insurance issues (insurance for vehicles, tourists etc.) must also be agreed upon. A common exchange rate for tourist is desirable.

Potential Consequences of an FTA

An evaluation of the economic effect of the various agreements must be done. The main export items from Palestine to Israel are shoes and leather, textiles, stones and building materials. These export items should be analyzed in the study. The main Israeli concerns are agricultural inputs, food products, and agencies. It is important to analyze what will happen to these main export items in an FTA, to evaluate the effects that rules of origin will have and which export/imports will be substituted. Some initial thoughts on these issues follows:

Palestinian exports to Israel:

There is no serious problem regarding stone exports. It will not be affected in a substantial degree by either agreement, since there is sufficient proof that it is of Palestinian origin. Based on existing practices and WTO rules, the 40-50% of local input in the processing is enough to ascertain the source of origin, meaning that stones will continue to come into Israel tariff free.

Concerning textiles, there will be many problems in determining the source of origin. If the raw material comes from Israel or is imported through Israel there will be less problems. However, in most cases the raw materials come from the Far East and sewing amounts to only about 5-6% of local input. If the raw materials come from the EU, the US, or other countries that Israel and Palestine have agreements with, it would be considered tariff free and will keep costs and fees down.

Leather and shoes: there are some wholly produced leather products today, but most of the products are produced with imports of raw material from Egypt and would face tariffs unless they are for export markets.

Israeli exports to Palestine:

For Israel, the key question is what Israeli export items (to the Palestinian areas) will be replaced from countries that Israel does not have trade with? Because trade with the Palestinian Authority areas is significant, there are many goods that might be replaced from sources that are currently not accessible to the Palestinians.

Rules of Origin and Cumulation

There need to reach an agreement on cumulation of origin. Agreements on cumulation of origin with EU, EFTA and NAFTA will resolve many of the problems with and Israeli-Palestinian FTA.

A study on the issues of rules of origin with regard to a number of selected goods should be conducted in order to preempt foreseeable problems that might emerge in an Israeli-Palestinian FTA.

The IPCRI working group recognizes that there may be a reduction of mutual trade between Israel and Palestine as a result of a Free Trade Agreement instead of a customs union, however, it is believed that the relative advantages of the FTA, particularly for the Palestinians, outweigh the disadvantages. This point, however, should be further studied with additional empirical micro-level data analyzed in a comparative forecasting study looking at both a customs union and a free trade agreement.

Disadvantages of FTA

1. There is likely to be a significant reductin trade bePalestine and Israel due to the creation of customs borders and more potential non tariff barriers.

Many customs points with lots of paper bureaucracy.

However, there are already borders for security checks and the customs inspections should not add a lot of time to the security checks. The creation of a paper bureaucracy is recognized as being problematic, however, there are possibilities to streamline procedures and to reduce fees and expenses.

3. Smuggling might increase when there is a large gap in the fiscal and financial policies of both parties. If there will be significant coordination on taxes, customs, purchase taxes and other fiscal policies, problems of smuggling could be better addressed.

4. Settlements. The most problematic aspect of a FTA is the issue of settlements. If these remain Israeli territory, it will be almost impossible to determine clear borders and will require innumerable crossing points and customs stations. Likewise if in the final status agreement the Palestinians will gain some kind of sovereignty or jurisdiction in East Jerusalem, solutions will have to be found which do not lead to the strangulation of the city, its roads and its commercial life.

5. In an FTA there are more opportunities for using trade as a political hostage and damaging the economy.

6. Higher trade cost (handling fees, traffic jams at check points, etc.)

7. There may be a loss of customs revenue on imports to the Palestinians due to a possible lack of immediate efficiency in controlling the customs points or borders.

8. Increased possible limitations on Palestinian goods to Israel.

Advantages of FTA

The main advantage of an FTA is the fact that Palestine can conduct an independent external trade policy. The main implications are the following:

1. Both parties keep its own rules and standards vis-a-via third parties.

2. Palestine will attain new trading partners:

PA can trade with countries that Israel does not have trade with.

3. A possibility of imports with lower standards for Palestine, means cheaper goods.

4. Cheaper raw materials means improving Palestinian competitive advantage.

5. Israeli closure of border cause less damage to the Palestinian economy. Palestine can have access to outside markets, even during closures (even the mechanisms for this are part of the agreements as tey should be).

6. Relations to Arab and Muslim countries (and access to their markets). If the Palestinians and Israel had a customs union between them, some Arab and Muslim countries might continue to boycott Palestine.

7. Possible reduced tension between Israel and Palestine because closures will become less of a crucial issue.

8. There will not be a need for VAT clearance system.

9. Indirect taxes will increase to Palestinians (estimated at $200-300 million).

The new export markets, cheaper prices, competitive advantage mean that the Palestinians get a better strategic position vis-a-vis Israel regarding other markets

Recommendations

Both parties are likely to be members of the WTO and in order to avoid future trade disputes, both sides must take into account that any new agreement must meet WTO guidelines regarding trade agreements.

The economic negotiations should produce a package of economic agreements dealing with trade, agriculture, labor, the movement of people, tax issues, tourism, and banking.

Investments by each party in the areas of the other should be actively encouraged as well as joint venture in both countries..

A third party, such as WTO or other specialized bodies must be included in order to resolve unresolved disputes and to arbitrate between the sides.

The agreement must build in mechanisms to insure full implementation or there will be constant counter actions from the other side as demonstrated by the past four years of the Paris Protocol. The issue of various forms of guarantees and/or penalties must be examined, evaluated and agreed upon.

Areas for further study

Mechanisms for facilitating the movement of goods with minimal costs and bureaucracy.

An evaluation of the economic effect of the various agreements must be done.

A study on the issues of rules of origin with regard to a number of selected goods should be conducted with regard to foreseeable problems that might emerge in an Israeli-Palestinian FTA.

Some economists claim that the increase in purchases by Palestinians from Israel based on VAT invoices really reflects an increase in the purchasing of goods that are imported by Israel and redirected to the Palestinian areas and not a significant increase in the purchase of Israeli manufactured goods. This issue must be properly studied by both sides in order to make rational decisions based on real data.

About the Authors

Samir Huleileh

Samir O. Huleileh was born in Kuwait in 1957. He attended and graduated from the Friends Boys high school in Ramallah. Later he started his studies at the Medical School at Cairo University until his deportation from Egypt after a period of three years. He later began his studies in sociology at Bir Zeit University. He graduated with a Master's degree from the American University of Beirut. He began his career as a lecturer at Bir Zeit University, during the same time he was Dean of Student Affairs. He later joined the Arab Thought Forum in Jerusalem as the head of the research department. In 1989 he became a consultant for the Welfare Association. In 1992, he was appointed as the CEO of the EDG, a credit agency financed by the European Union. Also in 1992, he joined the negotiations in the multi-lateral talks and later in 1992, the Bilateral Economic Talks in Paris. After signing the Oslo Agreements, Mr. Huleileh was appointed as one of the directors of PECDAR (The Palestinian Council for Development and Reconstruction). From July 1993 until May 1997, he held the position of Assistant Undersecretary for the Ministry of Economy and Trade in the Palestinian Authority. Since June 1997, Mr. Huleileh is working as a consultant to Nassar Investment Company based in Bethlehem, and specializing in processing and exporting stone and marble to international markets.

Dr. Gil Feiler

Dr Gil Feiler is the executive director and co-owner of Info-Prod Research (Middle East). He is also the director of the Middle East Business and Economic Research Institute at the Interdisciplinary Center (Herzlia). Having studied in Israel, Egypt and Germany, he wrote his doctoral thesis on economic relations in the Middle East. Dr. Feiler has published extensively on labor migration, economic cooperation, business opportunities and the Palestinian economy. His most recent book includes: Rethinking Business Strategy for the Middle East and North Africa (London: The Economist, 1997); and From Boycott to Economic Cooperation: An Analysis of the Arab Boycott of Israel (London: Frank Cass: 1988). Dr. Feiler is also a director of the Dikla mutual fund for the First International Bank of Israel.

Info-Prod Research (Middle East) is a consultancy specializing in research and economic analysis at the country, sector, and product levels in the Middle East and North Africa. IPR also provides investment consultancy and was instrumental in setting up most of the existing joint ventures in Jordan. Additional services are based on IPR's unique database of Middle East business information, which are constantly updated for on-line vendors including Reuters, Lexis-Nexis, The Dialog Corporation and the Financial Times.

Dr. Gershon Baskin

Dr. Baskin is the Israeli Director and founder of the Israel/Palestine Center for Research and Information. Prior to founding IPCRI, Dr. Baskin was the founder and director of the Institute for Education for Jewish-Arab Coexistence. Dr. Baskin holds a Ph.D. in International Relations. His doctoral thesis was on Sovereignty and Territory in the future of Jerusalem. Dr. Baskin has written extensively on the Israeli-Palestinian peace process including books on water, Jerusalem, settlements, and economic issues.

Dr. Zakaria al Qaq

Dr. al Qaq is the Palestinian Director of the Israel/Palestine Center for Reseaand Information. As a former journalist, Dr. al Qaq was the editor of Kuwait Times and covered the Iraq-Iran war from the Iraqi front. Dr. al Qaq holds a Ph.D. in International Affairs from Aberdeen University. Dr. al Qaq specializes in strategic and security affairs. He has served as a consultant for various local and international organizations on security and strategic matters. Dr. al Qaq has also served as a business consultant for local and international financial concerns interested in investing in the region.

1. 0 This section is taken from Prof. Nadav Halevi in IPCRI's book "Israeli-Palestinian-Jordanian Trade Relations" (September 1997) and provides a brief description of the various types of trade regimes.


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