Breaking down the economic implications of Israeli-Palestinian peace

Will a peace deal bring a huge economic dividend, will the only boom be that of rockets bringing down the economy?

February 1, 2014 17:28
A McDonald's restaurant in Israel.

A McDonald's restaurant in Israel.. (photo credit: REUTERS/Ronen Zvulun)


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A rift has emerged between the two ministers most responsible for shaping Israel’s economy, Finance Minister Yair Lapid and Economy Minister Naftali Bennett.

Though normally allies, even “brothers” on economic issues, politics pulled them apart in the past two weeks over the economic implications of peace talks with the Palestinians.

Bennett fired the first salvo. At a Bayit Yehudi faction meeting on January 20, he declared George H.W. Bush-style: “Read my lips: A Palestinian state will destroy Israel’s economy.”

Giving Palestinians sovereignty over the West Bank, he said, would bring a wave of rockets to Israel’s economic center, a “copy/paste” of what’s happening in Sderot and Ashdod to hi-tech-rich Herzliya Pituah.

On January 29, Lapid responded with estimates from a Finance Ministry analysis, arguing that inking a peace deal could save the government NIS 20 billion in annual spending and boost service exports by NIS 16b.

Who is right? The problem, of course, is that nobody knows what a peace deal would look like, or how it would play out. Would there be constant terror? An occasional rocket? Would there be calm and increased regional trade? There are also several scenarios that could play out if a deal fails to materialize. Would things continue as they have? Would a massive European boycott take hold? Nobody can say for certain, and people are likely to draw their conclusions based on their political outlooks more than anything else. That said, there are some numbers attached to each possible scenario worth considering.

Rockets galore

Bennett’s argument centered around a vision of a newly formed Palestine becoming a terrorist haven and disrupting Israel’s daily life.

“I know exactly what it is to lose a bid because you’re Israeli, and the cities of Israel, Tel Aviv, Jerusalem are exploding. I know what it is when your clients in the US, Canada and London are afraid to come to Israel so [they] don’t buy your products,” he said. “This is exactly what will happen if, heaven forbid, they establish a Palestinian state.”

Bennett pointed to the 1990s as a time of Israeli growth, interrupted by the second intifada, but put back on track following Operation Defensive Shield in 2002, in which the military took control of large swaths of the West Bank that had been turned over to the Palestinians.

It is clear that all else being equal, terrorism is bad for business – but how much? The perpetual low-grade rocket fire on areas around the Gaza Strip have been hard on their economies, but high-intensity rocket campaigns were even worse. The Federation of Israeli Chambers of Commerce estimates that during Operation Pillar of Defense in November 2012, that region lost NIS 90 million-100m. a day.

With the onset of the second intifada, Israel went from growing 8.7 percent in 2000 to shrinking by 0.2% and 0.6% the following two years. Then-prime minister Ariel Sharon asked the US for $10b. in assistance to help get through it.

But Bennett ignored the fact that there was, in fact, a brutal Hamas suicide bombing campaign in the 1990s as well. During those years, Israel was growing at a rate of 4%-7% each year (more on that later).

It’s not that the terrorism didn’t have an effect; one study by Tel Aviv University’s Dotan Persitz estimates that the terror wave from 1994 to 2003 pulled 8.6% off the size of Israel’s economy. Another TAU study by Zvi Eckstein and Daniel Tsiddon found that, although terrorism “changed the death toll by about the same size as due to car accidents,” its effects on annual consumption per capita was about a 3% decrease.

In other words, terrorism has historically had serious effects on the economy.

But it did not cause the economy to completely crumble.

Boycott central

According to Lapid and the yet-unreleased Finance Ministry study, failure of peace talks could lead to a European boycott that would prove burdensome. If exports to the EU fell by just a fifth and Israel lost investment, he said, Israel would lose NIS 11b. in GDP and 9,800 people would lose their jobs.

While that is certainly not a good scenario, NIS 11b. is about 1.1% of Israel’s GDP. In that reading, Bennett’s assertion that rockets are costlier than boycotts seems accurate.

But assuming that a peace deal does not turn Israel into a terrorist battleground, there are also massive economic upsides to inking a deal.

Although Bennett said, “I don’t remember an agreement” around the era of 1990s growth he points to as a model, a significant chunk of that growth came from new markets opening up to Israel as it pursued peace, first by participating in the Madrid conference and then by embarking on the Oslo Accords.

It’s hard to remember that before the 1990s, Israel was closed off from a lot of global commerce. Take cars for example.

Toyota, Honda, Nissan, Mitsubishi, and Mazda refused to sell to Israel, which cost car buyers $2,343 per purchase, according to a study by TAU’s Chaim Fershtman and Neil Gandal. Pepsi did not sell to Israel until 1992, and McDonald’s only graced the Holy Land with its golden arches in late 1993.

Even though the Oslo peace process ultimately failed, just participating in it and making a goodwill effort helped obliterate the once formidable Arab boycott.

A Congressional Research Service study released in December found that today, “since intra-regional trade is small, and that the secondary and tertiary boycotts are not aggressively enforced, the boycott may not currently have an extensive effect on the Israeli economy.”

A Middle East trading hub

Just as the peace process in the 1990s eased the Arab boycott and led to a period of phenomenal growth in the 1990s, those arguing for a peace deal see potential going forward.

Air Canada CEO Calin Rovinescu told The Jerusalem Post in a recent interview that the political situation was the only thing blocking Israel from becoming a major travel hub, which could connect the US and Europe to Asia.

“Everybody is envisioning massive Israeli exports to the wealthy Middle East with the Palestinian state as a gateway, and that’s all definitely out there,” said Tal Keinan, CEO of KCPS Clarity, an investment firm. “The king of Saudi Arabia is saying, ‘This is a regional deal,’ and frankly, we’re taking advantage of the massive Sunni-Shi’ite divide, which in many parts of the Middle East has far surpassed the Israeli-Arab conflict.”

Opening up Israel’s markets to millions of Arabs world not just be good for business, he argues, but would solve some of the pressing socioeconomic issues at home.

“If we do cut a deal, and it is a regional deal, there are some very powerful forces at play in the Israeli economy that really hurt the middle class that could be relieved in a big way. Those come from Israel being an island economy,” he said.

With a population of only 8 million people, enemies to the north and Jordan and Egypt stuck in cold peace over the Palestinian issue, Keinan argued, certain markets in Israel remain cut off from competition. While it’s easy to export technology, shipping costs wipe out the profits for low-margin goods like paint and cement, he said. It’s harder to export perishable products by sea or air.

As a result, only a few companies can survive to service the small Israeli market, and they become monopolies, gouging both workers and consumers. It’s no coincidence the social protests started with cottage cheese.

“You simply cannot get economies of scale in a country of 8 million people without becoming a de facto monopoly or an oligopoly,” he said. “If we could turn this into the regional sector, we will unlock the regional economy. Instead of selling to 5 million, we could sell to 50 million people or more. This has to be a key objective for us.”

The Palestinians, he argues, have every interest to defend that arrangement, as they would likely serve as conduits and benefit tremendously themselves.

A recent World Bank report found that the Palestinian economy would grow 35% if all the restrictions were lifted. As its closest and most logical trade partner, Keinan said, Israel would also benefit tremendously from that growth.

The status quo ante If nothing happens, it’s also possible that Israel will simply slog along as usual; no boycotts, no terror, just foot-dragging.

That solution may be simplest, but far from ideal.

Former Bank of Israel governor Stanley Fischer noted that Israel pays about double the OECD average on its interest due to risk premiums. The difference is equivalent to about a third of the defense budget.

“In the long run this economy will have to make peace with its neighbors, when everyone is ready for that, which I hope will be sooner rather than later,” he said last summer.

In the short run, who can say?

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