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Michael C. Hudson (ed.)
1999
14. Prospects for Arab Economic Integration
After Oslo
Atif A. Kubursi
In a comparative assessment of the global economy and the capacities of states and societies to adjust to its endemic changes, the American historian Paul Kennedy observes that more than any other developing region the countries of the Middle East and North Africa are afflicted by the debilitating issues of wars and internal disorders as "[v]icious one–man dictatorships glare threateningly at arch–conservative, antidemocratic, feudal sheikdoms" (Kennedy 1994, 209). In Kennedy’s assessment, the Arab world remains the least prepared of any region to meet the challenges of the next century.
Equally pessimistic and critical of Arab chances in the next century is a 1995 World Bank study titled Global Economic Prospects and Developing Countries, which offers a bleak outlook for economic growth and development in the Middle East and North Africa. During the 1980s, according to this study, the region’s economic growth averaged less than 1 percent compared with the world average of over 3 percent. A combination of population growth around 3 percent, falling real oil revenues, dismal export performance, the terrible cost of two Gulf wars, Israel’s challenge to the Arab East, civil wars, and an unending wasteful expenditure on military procurement have coalesced to undermine any meaningful future economic prospects for the region.
If indeed the 1980s represented a lost decade for the Arabs and the early 1990s did not augur much improvement, the real question is why has development remained so illusive in the Arab World? What are the basic explanatory factors for this abysmally slow growth? Why have Southeast Asia and other developing regions outperformed the Arabs? What is needed to reverse the negative economic trends? Can a collective Arab development strategy contribute to a brighter economic future for the Arabs? Will peace with Israel bring prosperity or economic domination? Is the Euro–Mediterranean project a viable alternative? Why has Arab economic cooperation been so limited and disappointing? Where should the the Arabs begin? It is perhaps an understatement to suggest that Arab countries today are wrestling with some of the greatest economic challenges they have ever faced. The future of Arab economies will depend on the choices made today. These choices, however, are being made and will continue to be made under duress with little or no regard for their implications for the future. While there is a critical need to establish broad–based agreements among Arab states on what it takes to succeed in the global economy, there are centrifugal forces throwing them apart and tearing at the fundamental linkages that tie them together.
Each Arab country is taking independent initiatives to deal with its future, and while individual state action is necessary, it is not sufficient in today’s globalized economy. This is all the more important in view of Western and Israeli designs for shaping the region’s future. These designs are predicated on attracting each Arab country separately into their spheres. The Arabs can no longer escape or postpone choosing their future economic course from among the current alternatives before them. The choices are real and limited. The competition is basically among three contenders: the American–Israeli project, the European (primarily French) Mediterranean project, and a new and invigorated independent Arab collective action. The past record of Arab economic cooperation is dismal, so the question is: Will the severity of the challenges and the new regional projects bring a new life and shape to old Arab aspirations? Or will it add to Arab fragmentation, dependency, and instability? This chapter begins with a brief examination of old Arab cooperation/integration projects and why they have failed. It considers lessons from other regional cooperation efforts before evaluating the new projects and what they might bode for the Arabs with special emphasis on the Palestinian and Israeli economic agreements as a case study of what other Arab countries can expect from the new Middle East project. The final section ends with some suggestions for an alternative Arab strategy after Oslo.
Lessons from the Past
There is overwhelming international evidence that countries that opted for export promotion and open trade with their partners have achieved higher economic growth rates than those that protected their domestic markets and emphasized import substitution policies. But there is little evidence as to why some countries were successful in exporting in the first place and why others failed to penetrate the world markets despite serious efforts and dogged determination to do so.
Most Arab economies are simply too small to be self–sufficient or self–sustaining. Individually, few of them are of sufficient economic size for rapid industrialization or diversified growth. It follows that Arab regional trade arrangements would be a natural response to these limitations. With cooperation and freer trade would come mutual gains that result from the internal and external economies of larger markets, from augmented bargaining strengths, from the pooling of resources, from inter– and intraindustry specialization, and from freer mobility of resources.
Indeed, the recent history of the Arab world is rife with examples of attempts at Arab economic and/or political cooperation or integration. Unfortunately, most of these attempts were short lived, harvested limited results and were, in general, disappointments. Syria and Lebanon had a full–fledged customs union that operated smoothly throughout the French mandate, but was dissolved in 1950. The British had in effect a less extensive customs union over their mandatory area, which included Palestine, Jordan, and Iraq, that elapsed with the end of British rule in Palestine in 1948. The United Arab Republic (UAR) unified Egypt and Syria for less than three years and was the first such attempt by two independent Arab governments. But it collapsed under the weight of a hostile coup d’état in Syria. The UAR opened the way, however, to many more such attempts. Among them are: the frequent efforts of Muammar al–Qadhafi to unite Libya with Egypt, cooperation efforts with the Sudan and the Maghrib countries; the 1980 formation of the Gulf Cooperation Council; the 1989 Maghrib Cooperation Council, and the 1989 Arab Cooperation Council that included Egypt, Iraq, Jordan, and Yemen. Qadhafi’s attempts have failed, the Maghrib Cooperation Council is dormant, and the Arab Cooperation Council is practically dead. Only the Gulf Cooperation Council is still alive, albeit with serious problems and challenges.
More serious and enduring but no more successful perhaps was the project that began in 1953 with the promulgation of the Arab Joint Defense and Economic Cooperation Treaty that gave rise to the Agreement on Arab Economic Unity. It was signed in 1957, came into effect in 1960, and gave birth to the Arab Common Market in 1964. The Agreement, which led to the creation of some sixty pan–Arab or inter–Arab organizations, had otherwise only limited real economic results. Far–reaching economic cooperation or integration remained principally more declaratory than real. Arab leaders and important segments in the Arab state system paid lip–service to the virtues of integration but blocked any real steps toward its realization, preferring instead to shelter their domestic economies and power spheres from any real or perceived "encroachments" by neighbours.
The absence of genuine democracy in most countries of the Arab world has proven to have a real dampening effect on meaningful Arab cooperation. The lack of democratic principles and institutions militated against the ability of those segments of society that believed in and demanded cooperation from being able to exert sufficient pressure on their rulers for accommodating their aspirations. It also meant that whatever agreements were reached remained simply agreements among leaders because they did not involve the direct participation or approval of the people.
With Israel separating physically the Arabs of Africa from those in Western Asia, the effort to link and expand the Arab economic space has suffered yet another setback. But Israel’s real negative impact on Arab cooperation came with the 1979 signing of the Camp David Accords which dissociated Egypt from the rest of the Arab cooperative efforts until 1990. The Camp David Accords in turn gave birth to the Oslo Agreements in 1993 and 1995, the Israel–PLO Protocol on Economic Relations signed in Paris in April 1994, and the Peace Treaty between Jordan and Israel in 1994. The Camp David Accords (CDA) created a serious and crucial precedent in the region—an Arab country (a leading one) concluded a separate and secret peace accord with Israel outside all the existing joint Arab treaties and cooperation agreements that precluded this possibility. In this way the CDA paved the way for all the other separate agreements that the Palestinians and Jordanians concluded with Israel. Separately or in combination, these treaties are tearing the Arab World apart, reorienting the Palestinians and Jordanians away from their traditional trading partners and blocking the chances of wider Arab cooperative efforts.
There are, to be sure, also basic economic reasons why Arab economic cooperation efforts have not born the fruits expected. First, many Arab economies are characterized by similar patterns of specialization. This reduced opportunities for avoiding competition among them. Second, most of the projects for wider Arab cooperation were premised on maximizing the effects of "trade diversion" (the shifting of exports and imports away from traditional trade partners to new partners) from the rest of the world with little or no concern for "trade creation." Once the beneficial effects of trade diversion were realized, the benefits from cooperation were exhausted. Not surprisingly, most of these efforts did not last long. Furthermore, Arab efforts toward cooperation were marred by an implicit state agenda for broadening its planning sphere in the economy and for extending the boundaries of production for import substitution. In these circumstances politics inevitably intervened. Partners sometimes avoided the costs of adjustments that these agreements often entailed (Lawrence 1994). They were typically unwilling to risk losing domestic industries and activities to other members of the agreement even if there were supposed to be offsetting gains elsewhere. Allocation and deployment decisions became political decisions that were far removed from market realities and dictates (Langhammer 1992). When one country was given the right to a particular industry or activity, other members demanded compensation, with the result that short–term distributional considerations dominated medium– and long–term efficiency considerations.
Despite many disappointments and failures, a large Arab intellectual constituency remains wedded to the project of wider Arab economic cooperation and collective action . A sample of this literature would include the works of Al–Dajani (1966), Al–Ghandur (1970), Nawfal (1971), and Awwad (1977). The failures of Arab attempts at cooperation or integration are matched only by a flood of literature on the advisability and necessity of Arab collective action. The old emotional appeals are giving in to a more somber literature analyzing failures and pointing to the dangers of individual action in the face of the new challenges posed by new schemes and projects designed for dismantling the region’s collective will to work together. One common theme runs across most of the new contributions: the Arabs are better advised to work together and solidify their common interests before they join any new arrangements (see Al–Imam 1994, Al–Khawli 1994, Abd Al–Fadil 1995, and Kubursi 1995).
The dialectics of failures on the ground and high expectations for, and strong emotional commitments to, Arab cooperation are raising doubts about alternative projects that include Israel or wider Mediterranean involvement. This is taking place at precisely the same time that one agreement after another on the ground is being promulgated that set the Arabs away from one another: e.g., the Paris Protocol between Israel and the Palestinians, and North Africa and the European Market. These contradictions are also spawning some highly critical evaluations of old indigenous options and wider realization that the old ways have not worked and that there are some serious economic and political issues that the Arabs need to address at a nonemotional level. The general feeling among Arab economists is that contending alternatives must be evaluated thoroughly and critically against the lessons learned from the experiences and achievements of other regional cooperation projects in the rest of the world, and that regional Arab economic groupings must be retried before investing in Western projects.
Lessons On Regional Cooperation
Preferential trading arrangements (PTAs) do not have a good economic track record (Lawrence 1994). They are typically greeted with justifiable criticisms in developing countries in particular where they failed in the 1950s and 1960s to spur growth and equitable sharing of benefits as it was hoped they would. On the other hand, they have worked very well for the Europeans both in the EEC and in the European Free Trade Area (EFTA). The lesson drawn from this is that these trading arrangements are suitable only for developed countries at the same stage of development and with similar endowments and access to technology. Developing countries, however, are typically at different stages of development, have varying resource endowments and technical skills, and are, therefore, not in a position to benefit much from PTAs (Yamazawa 1992).
There are other opinions, however, as to why these arrangements have failed in developing countries. Lawrence (1994) attributes their failure to the motivation of the participants rather than to differences in resources or stages of development. He argues that the failures arose out of the pursuit of protectionist blocs and from the extension of import substitution policies to the bloc, while success was based on reinforced internal and external liberalization. Lawrence advances the proposition that unless participating countries are willing to allow their economies to be heavily influenced by market forces the arrangements would fail. Amsden (1989), Yamazawa (1992) and others feel that the issue here is not about subordinating the economy to market forces as much as the ability to expand the market, overcome barriers to development, and wider and richer markets. Liberalization seems to work best when an external market exists that allows the exporting country to expand and take advantage of the new economies of scale and scope.
While it is true that developing countries emphasized trade diversion and failed to promote trade creation, whether their failure to create new trade among themselves reflects some developmental barriers rather than resulting from market failures is the subject of controversy. There are many regions within the most advanced economies of the world that rely heavily on market forces and where free mobility of factors of production is assured but where growth remains a problem (e.g., southern Italy, Appalachia, or the Canadian maritime provinces). If subordination to market forces is sufficient, these areas should have no problem.
Equally important is whether the benefits in question are in terms of static or dynamic efficiency. The heart of the problem here is the ability to innovate, to access and adapt new technologies and attract foreign investment. PTAs by themselves cannot spur the entrepreneurial spirit, but neither can liberalization. The issues are more complex. There are new economic models (e.g., Endogenous Growth Theory, Chaos Theory) that emphasize different factors from those invoked by free traders and import substitutionists. The EEC countries and Mercosur (involving Argentina, Brazil, Paraguay, and Uruguay) instituted liberalized trade policies among members, but they had achieved a level of efficiency, maturity, and specialization before liberalization which allowed them to capitalize on that liberalization. When and at what level of development does one start a liberalization process? When and at what stage of development will the dynamic processes governing a country’s growth kick in? And at what stage would self–reinforcing forces count more in shaping development, growth, benefits from trade, etc., than static efficiency conditions? There are no clear cut answers to these questions, but, increasingly, economists are skeptical about the undue emphasis some put on static market conditions and their neglect of the importance of dynamic forces in determining success in world markets.
One of the most distinctive features of the EEC has been the dynamic gains from internal trade liberalization. With it came rapid and extensive intra–industry trade where industries specialized in well–defined niches and increased trade within the same industry. Thus, European economic integration was built on specialization within industries rather than on movement of resources from import competing to export industries. (Sapir 1992). The key to their success was trade creation that superseded trade diversion (although this was itself important and substantial) and the freeing of the mobility of resources. What started as a simple sectoral agreement in coal and steel was expanded into a free trade area with a common tariff against the rest of the world, then a common market where factors of production moved freely from one country to the other. They are steadily but slowly moving into full economic integration and harmonization of currencies, and fiscal and monetary policies.
There are many lessons to learn from their experience. First, they began with sectoral agreements among a small subset of countries. Second, they moved very quickly to liberalize trade among themselves and to free resource mobility. Third, they gradually expanded the geographical and industrial scope of the agreement. Fourth, they erected an elaborate institutional structure to promote and cushion the adjustment processes of harmonization. Fifth, the initial interest of the United States in the success of the common market was instrumental in protecting the fledgling organization through its formative years. Sixth, the intersection of the political interests of the two principal members—Germany and France—in the success of the project coupled economic interest with a strong political will to succeed.
The North American Free Trade Agreement (NAFTA) is a less ambitious project than the EEC. The United States aimed at enhancing its competitive position in world trade by extending its resource base to include resource–rich Canada and energy–rich Mexico and by associating its high cost industries with low–cost supplies from Mexico (Brown, Deardorff and Stern, 1992a and b). Mounting U.S. concerns about many illegal Mexicans in the U.S. Southwest played a major role in prompting the U.S. to woo Mexico into its free trade area (FTA) with Canada. There are many problems, however, with NAFTA. It does not have any compensation mechanism to smooth the adjustment process which is borne unevenly by Mexico and Canada. It proceeded quickly with little preparation time, especially for Mexico. Canada had an Auto Pact with the U.S. for fifteen years before the FTA between them came about. The jury is still out on NAFTA’s success. There are many complications that are difficult to untangle in order to assess the impacts of NAFTA in isolation of the other forces. Ironically, it is the experience of NAFTA that is most relevant to the evaluation of the proposed regional arrangements for the Middle East. This follows from the fact that a developing country like Mexico joined two more economically advanced countries. The Asia–Pacific arrangements have also some strong relevance to this issue as they involve clear sharing and patterns of industrial deployment among the constituent members.
The Association of Southeast Asian Nations (ASEAN) and other Asia–Pacific regional economic projects are far less formal than either EEC or even NAFTA. Yamazawa (1992) argued that East Asia has not been particularly enthusiastic about formal economic integration of the EEC type. There is nothing like a Rome Treaty or a free trade area. The main mechanism underlying their cooperation is the deliberate transfer of manufacturing industry from early starters to late comers, from Japan to the newly industrialized countries (NICs) of Asia and from the Asian NICs to ASEAN countries. This pattern has been dubbed as the "flying geese pattern" in industrial development.
In summary, the lessons drawn from the experiences of several regional economic cooperation projects world wide are clear. PTAs work best when they proceed slowly and cumulatively, preferably with sectoral arrangements preceding overall agreements and among a symmetrical grouping of countries that can expand its membership. They work when trade creation objectives go hand in hand with trade diversion, when they establish compensation mechanisms to smooth the adjustment processes in the weaker economies, and when they arise out of a free democratic process and with wide participation of the population. PTAs function best when efficiency considerations do not subordinate equity considerations since membership is likely to expand and solidify when member countries feel that they are treated fairly; when investment liberalization forms an important plank of trade liberalization; when there are chances for redeployment of industry and wide–range intra–industry trade and specialization; when external forces are accommodating, and when a principal member(s) has a strong political commitment for its success.
The New Middle East
Suppose you are in Europe in 1940 imagining the Europe of 1970, or a Japanese in 1940 imagining the Japan of 1970. How far would you dare imagine? In 1970, the Israeli Association of Peace asked why the people of the Middle East could not resolve their conflicts in the same way the Europeans and Japanese did; why the frontiers of the national states of the area could not be open for trade and why cooperation should not replace conflict. Why should the problems and conflicts in the Middle East today be assumed to be more intransigent than the conflicts among Europeans a few decades ago? Peres’s "New Middle East" (1993) raises the same questions. Put in this framework, the Middle East conflict is reduced to a conflict over frontiers and a simple power struggle among neighbors. Israel is assumed to be as Middle Eastern as Germany is European. Peace is touted as holding benefits for the Palestinians in particular and for the Arabs in general. The Arab "peace dividends" envisioned are presumed to derive from an increase in external aid, from the rebuilding of indigenous institutional capacities to guide economic and reconstruction efforts, from greater and more guaranteed access to the Israeli and possibly other Western markets, from an increased Palestinian command over domestic natural resources, from expected tourism increases, from the decrease in military spending, and from the reduction in political instability and general uncertainty that has worked against foreign investment in the region. The Israeli benefits are less discussed, but these, I fear, are far larger and more certain than Arab benefits. Under peace, Israel appears to be guaranteed all the benefits it derived from the Palestinians under occupation, the opening of new trade vistas with countries that never before traded with it, the possibility of reducing its defense expenditures, the dismantling of the costly Arab Boycott, the increased likelihood of attracting foreign investment and the ability to attract large flows of international tourists.
The alleged peace benefits for Arabs and Palestinians rest on some strong claims that must be examined against the experience of the Palestinians under occupation and traditional economic analysis of evaluating opportunity costs and alternatives. What is unfolding in the Occupied Territories is seen as a test case and as a precedent of what is likely to await the Arab economy at large. The more realistic, credible, and visible the benefits of peace are, the less skeptical neighbors will be.
The economic conditions and problems the Palestinians endured under occupation should provide a background and a yardstick for judging the promises and achievements of peace and the new regional plans. Israeli occupation of the West Bank and Gaza was very costly for the Palestinians and other Arabs. These costs manifested themselves in a loss of control over water, loss of prime agricultural land, severance from traditional markets, constrained industrial growth, disarticulated and precarious education, inadequate and insufficient investment in physical infrastructure, loss of the indigenous public sector that can protect and guide the process of development, subjugation of the Palestinian population to the occupiers’ tax and import regimes, transfer of Palestinian social surplus to Israel, the export of the local producers to either Israel or the Gulf, and political disruption and violence as people rebelled against the humiliating tyranny of repression.
While the occupation has not been a zero–sum game, Israel has derived enormous gains from it. These gains included Palestinian water, a captive export market, a cheap labor pool, prime agricultural land and skimming all the free rents derived from it, tax revenues far in excess of occupation costs, and the large foreign exchange flows from Palestinian remittances from the Gulf and elsewhere. It is natural to expect that under peace most of these factors will be eliminated, some gains will be realized, and the Palestinians will be compensated for their losses and suffering.
Under occupation the West Bank and Gaza were forced into an economic union with Israel, not much different from the vision of the New Middle East. A small, fragmented, disarticulated, poor, and labor–intensive economy was confronted with a relatively rich, advanced, capital–intensive, strategic, and highly centralized economy. This confrontation took place at a time when the Palestinians were denied their most vital resource (water), when access to the Israeli markets was blocked, and ties to traditional Arab markets were severed. It is small wonder that agriculture, the pre–occupation economic mainstay, faltered.
Displaced from agriculture with no alternative employment in industry, labor from the territories moved to work in Israel at generally higher pay than in the territories but at the bottom of the Israeli wage scale. Although Palestinian workers represented no more than eight percent of total employment in Israel, they constituted the majority of workers in construction and a large share of agricultural labor. On the other hand, they represented more than one–third of all employed residents in the Occupied Territories. Their earnings were about one–quarter of the GNP of the West Bank and 40 percent of Gaza’s. This export of labor and the rise in labor costs in the Occupied Territories destroyed any possibility of developing domestic manufacturing. Earnings in Israeli shekels went ultimately to buy Israeli goods. Israeli net exports to the territories were more than $500 million per year before the intifada (Kleiman 1995).
Israeli manufacturing could have taken advantage of cheap, unemployed and uprooted labor by locating in the territories. This did not happen. Some limited subcontracting of clothing and textile subactivities occurred, but their magnitude was limited and restricted to minor assembly generally performed by women. Some have even argued that the security situation in the Occupied Territories and the general uncertainty about the future of the areas scared investment away (Kleiman 1995). The insecurity during the intifada and the uncertainty about the future fate of the Territories may explain the lack of investment in the late 1980s, but what about the lack of investment between 1967 and 1987? The collective pauperization of the Palestinians cannot be dismissed as a pure accident of history nor as an unintended and incidental effect of the occupation. Rather, it is part of a long–standing Israeli denial of the existence of the Palestinians as a people and a community capable of leading an independent national existence. Improvement in Palestinian economic prospects then requires their reconstitution as an independent national community. No amount of international aid can make up for the loss of land and water. In a primarily agrarian economy, water is the most critical economic factor upon which the Palestinian economy can be reconstructed, at least in the initial stages.
The financial requirements for development and reconstruction of the Palestinian economy are finite but massive. The list of urgent needs for sewers, roads, schools, hospitals, ports, airports, etc., is long. But finance without real resources will perpetuate the state of dependency on outside help and on the Israeli economy. Any large investments made now will go through the Israeli economy and would most likely not be sustainable. All current Palestinian trade goes through Israel. The Palestinians do not have control over their borders and do not have an independent port or airport.
This pessimistic view is based on a review of the Arab economy in the 1980s where its GDP rate of growth fell far below other regions, including sub–Saharan Africa. Collectively the Middle East and North Africa grew at less than .5 percent per year between 1980 and 1990, whereas the Third World grew at an average rate of 3.4 percent per year during the same period.
Many underlying structural weaknesses in the Arab economy hamper its ability to adjust to global change and meet the challenges of "peace" while protecting itself from adverse changes in the international economic environment. Throughout the 1970s and 1980s Arab economic success masked many structural problems that are now becoming more critical to future economic performance. The Arabs will have to deal with these structural difficulties before contemplating regional associations with more advanced and vibrant economies.
The most fundamental problem afflicting the Arab economy is its heavy (if not exclusive) direct and indirect dependence on rent from natural resources—namely, oil, which has propagated the "Arab Disease." This disease has raised the exchange values of most currencies in the region to the detriment of effective manufacturing exports, inflated the costs of production and undermined local industry and agriculture, flooded domestic markets with cheap imports that ultimately compromised the balance of payments of even the richest states, and engendered unsustainably high consumption patterns that are divorced from high production costs. It has encouraged investments in large projects that were often unnecessary and unproductive and ultimately saddled the economy with large maintenance costs, bloated domestic bureaucracies with overlapping rings of rent seekers, divorced income from production, and exposed domestic economies to the wide fluctuations of the world oil market over which the Arabs had little control.
It may be convenient to argue that the Arab economic difficulties in the 1980s can be explained totally by falling oil prices, but the truth is more complex. The fact that oil prices so adversely affect all economic indicators of performance is itself revealing. In this respect the heavy dependence on oil rents is symptomatic of general economic failure.
The Arab economy today remains almost as undiversified as it was in the 1970s: oil exports are still the exclusive economic engine of the region. Rentierism is a widespread phenomenon and is not restricted to the oil–rich countries. There is now a "secondary dependence" on oil revenues throughout the region. Exports of manufactured renewable commodities and services contribute only modestly to the external sources of finance of all Arab countries.
Non–oil producing Arab countries have exported labor to the Gulf and have enjoyed the convenience of remittances while neglecting the development of domestic exports. Manufacturing activity outside oil is limited, disarticulated, traditional, inward–looking, and technologically dependent on outside sources. Little or no technological capabilities have been developed within the region. There is strong preference for turnkey projects. Expenditures on research and development have been modest if not totally inconspicuous. Regional cooperation is a political slogan without any real economic transactions (until today, exclusive of oil, Arab regional trade is only 4 percent of their total international trade). Most Arab countries are linking to non–Arab economic centers with little or no concern for their Arab neighbors. External indebtedness is massive and is beginning to sap the energies of the region. The Arab region is still gambling on "sunset" industries and old Fordist and smokestack manufacturing activities. There is little evidence of the new economy in the industrial structures of most Arab economies. Domestic savings are inadequate; they rarely finance investment. High and unproductive consumption habits have been staunchly ingrained in the operating systems of most Arab societies. Illiteracy is still excessively high. Mean years of schooling have increased but remain far below other successful developing countries. Industrial policies are often too stringent or absent and there is a tendency to adopt IMF–peddled "policy fads" that are inappropriate for Arab development and values.
In short, dependency on the rent from oil has reduced Arab incentives to diversify their economies, develop alternative manufacturing capacities, promote export–oriented industries, encourage domestic savings, and anchor income on solid productivity grounds. Traditional economic activities and structures are maintained. Dependence on external sources of finance has deepened and economic performance has slipped. Although large oil revenues brought about significant improvements in health, education, and infrastructure throughout the Arab world, they diminished the incentive to capitalize on these achievements. Arab economic performance in the 1980s is symptomatic of the "Arab Disease" that is more fundamentally damaging than the "Dutch Disease" that afflicted Holland in the 1940s following the discovery and commercialization of natural gas. But Holland had fertile land, abundant water, a highly skilled labor force, and a European infrastructure and market.
For the Palestinians, the need for external sources of finance is urgent, but must be balanced against the negative and disastrous dependency on precarious international charity. They should avoid repeating the Arab experience in the 1970s and 1980s.
While water issues are still to be negotiated, all the agreements with Israel concluded so far do not augur for reasonable Palestinian control over this vital resource. There is a lot of discussion about "unitizing" the management of this "common" resource. Indeed, there are efficiencies in jointly managing this resource, but before any procedures are put in place it is critical that "property rights" be established. Agreement (Oslo I) after agreement (Paris Protocol and Oslo II) still treat Palestinian water as Israeli charity to the Palestinians.1 Israel raises the share of the Palestinian allotment by a modest amount, presupposing Israeli exclusive control and management of the water. Peace will be credible and visible to the extent the Palestinians are able to reclaim their lost land and water. Even under Oslo II and in the last phase of the Agreement, the Palestinians will have authority over only one–third of their land and less than one–fifth of their water.
Dismantling the occupation should allow the Palestinians to manage their economic affairs as they choose and to protect and guide their economy in the manner they see as best serving their interests. The Paris Protocol makes sure that this shall not be the case. The Palestinian economy is put under the Israeli import and tax regimes. Fearing that the Palestinian economy may be used to smuggle duty–free goods into Israel or may act as a tax haven, Israel moved very quickly to impose its own tariff regime (the same tariffs on all foreign goods in both Palestine Authority territory and Israel). Few exceptions are allowed as an afterthought to provide some latitude for the Palestinians over goods imported from countries that do not trade with Israel. The rule is the Palestinians must impose the same tariffs on imports as the Israelis. These tariffs have evolved to protect and promote the Israeli economy, and are not consistent with the interest of a fledgling economy with limited productive capacity. The Palestinians received promises for smoother access to the Israeli market. But for now, quotas are imposed on Palestinian poultry, eggs, potatoes, cucumbers, tomatoes, and melons entering the Israeli market. Although the quotas in principle apply to exports from either side to the other, with the exception of melons these restrictions apply only to the Palestinians.
The price of these Protocols is even greater integration with the Israeli economy. What the Palestinians have worked out is a sort of a mix between a Customs Union and a Common Market with the Israelis. Any such arrangement generally involves "trade creation" and "trade diversion." One wonders whether giving the Israelis full and unimpeded access to the Palestinian market is good for their long–term prospects in building a diversified and productive economy. For all practical purposes, this agreement perpetuates and legitimates the economic structures that emerged under occupation. Accepting the "trade diversion" implications of the Agreement simply means that Palestinian Authority has preferred to tie its economic fortune to Israel rather than the Arabs. Did the Palestinian negotiators concluding this Agreement carefully think through all of its implications? I suspect not. It does not appear to be consistent with their interest in accessing the wider and less competitive Arab markets.
Defenders of the agreements often quote the many advantages that economic theory generally predicts will follow from freer trade. The general belief is that smaller and poorer countries are supposed to gain most from access to the market of richer partners. Missing from this argument are many factors and conditions upon which the theory is built that are present in the Palestinian reality. Economists tend to exaggerate the spread effects of free trade and underrepresent its "backwash effects" and adjustment costs (Kubursi 1997).
Actually, bargaining theory is perhaps more clear and more realistic about the outcomes of negotiations among unequal partners. It predicts that the party with most options is likely to dictate its interests on the party with little or no options. It does not stretch the imagination much to suggest that all the agreements concluded so far between the Israelis and Palestinians have been concluded between grossly unequal partners.
We are told that Palestinian gains will be from the dynamics of foreign investment, large tourism flows, and higher productivity that springs from competing with more advanced competitors. But it is precisely in these areas that the Arabs will lose most. There is the expectation that foreign investment will be attracted to the region and that peace will encourage a larger flow and a more certain attraction. That indeed is likely to be the case. But much, if not all, of this investment will likely go to the Israelis. Much of the foreign investment that is taking place today is of the tariff–jumping kind. The more custom unions the Israelis succeed in drawing in the region and the more clauses they eliminate from the Arab Boycott, the more foreign investment will be attracted to Israel.
The Arab Boycott was very costly for the Israelis. Some estimates put the cost at $40 billion over the past four decades. I believe it may have been even higher if one were to include the amount of foreign investment that Israel could have attracted and if one were to adopt a real present value approach.
The Israelis have increasingly become concerned about the nature of their dependence on foreign aid from the United States. As pressures mount to balance the monumental U.S. federal budget, foreign aid will most likely be on the chopping block, and Israel currently claims the lion’s share of foreign aid. Peace will give Israel some breathing space; it will postpone the cutting but not the cut. Foreign investment of the order of $3 to $4 billion will be the only reliable alternative. Israel has not been very successful in attracting foreign investment in the past ($200 million per year on average). An end to the Arab Boycott and a few customs unions ensuring unimpeded access to Arab markets will change Israel’s picture dramatically. It is already changing. In 1996 Israel was successful in raising more than $1.7 billion in foreign investment. Motorola, Volkswagen, Cable and Wireless, Intel, and many other high–tech firms have plans to locate in Israel. And Israel’s gain here could easily be the Arabs’ loss (see, e.g., The New York Times, August 19, 1995).
Foreign investment in the Arab region has drastically declined from the high levels of the 1950s. The share of the region in total world foreign investment is now less than 3 percent (Page 1995). Access to world markets, new technology, advanced management systems, and large investments are almost the exclusive preserve of the multinational corporations. The Palestinians will be ill advised not to take advantage of the current favorable international climate to host and attract foreign investment. There are abundant examples, however, of multinationals that exploit the local market, wrestle concessions that far outweigh their positive contributions, and provide little or no transfer of technology. It is invariably the case that positive net benefits from foreign investment were derived by enlightened governments that obstinately negotiated favorable terms from multinationals that included product mandates, home base operations, and systematic technology transfer. In the absence of a representative national government and wider Arab cooperation, the Palestinians are in a weak position to negotiate favorable terms. Besides, their chances of getting a respectable share of foreign investment could depend critically on their guaranteed access to the wider Arab market. The more the Palestinians tie their economic fortunes to the Israelis, the less likely that they will be able to derive concessions from their Arab brethren in this regard.
Greece, which is an hour’s flying time from Palestine, attracts 12 million international tourists a year. Israel attracts no more than 2 million. With peace, international tourism is likely to increase rapidly. The Arab region is not well prepared for this influx. Tourism infrastructure in the Arab world is limited and international linkages are almost absent. Lebanon used to have a competitive tourism infrastructure but that was destroyed in the civil war. Today it is not even sufficient to meet the demand of returning Lebanese visitors. Egypt is the only Arab country with the capacity to benefit from the increased flow, but its share of the total is not certain.
The bottom line in tourism is length of stay. The longer tourists stay in a country the more they spend and the larger the benefits from tourism to the host country. Under the prevailing circumstances, even under peace, without sufficient planning and preparation, the rewards of this tourism bonanza will be lost by the Arabs who may even lose existing tourism as Israel may succeed in diverting tourists away from traditional Arab tourist centers (e.g., tourists from Gulf states may visit Israel instead of Lebanon or Egypt.) The potential rewards from increased tourism are there and would be more certain with proactive preparation and planning. A concerted Arab tourism strategy is required to mount joint marketing and advertising campaigns and to connect tourism flows. In the absence of proactive planning, Israel will be the only beneficiary of increased numbers of tourists and will determine how long they stay, how much they spend, and where they spend their dollars. The Arabs will get at most daytrippers or safari–like visits where foreign tourists will simply pass by Arab areas. The Jordanians are already experiencing some of these negative effects.
For every dollar spent on education in the Arab world $166 is spent on defense. If peace were to be just and enduring, there could be substantial savings in wasteful military expenditures. The Middle East has the dubious distinction of having the highest military expenditures shares to GDP than any other region in the world. Of the ten largest military spenders, seven countries are in the Middle East. Israel has already reduced defense expenditures from 22 percent of GNP before the Camp David Agreement to the current 10 percent. Israel will benefit far more than the Arabs from the reallocation of resources away from the military given the high differential average productivity of the resources in the military in Israel and in the Arab world (Kubursi 1981).
Israeli exports correspond very closely to Arab imports. My own calculation of the concordance indices (indices of structural similarity of trade composition by commodity) shows that the degree of Israeli concordance with Saudi, Iraqi, Syrian, etc., trade is twice as large as the corresponding indices with Europe or the U.S. My estimates suggest a doubling of Israeli exports under peace.
In the past two years Israel has experienced trade surpluses due to increased trade with China, India, and Japan—countries that would not have dared to do business with Israel before the new arrangements with the Palestinians were in place.
Conclusion
Israel’s "peace dividend potential" is massive while Palestinian and Arab gains are conditional, precarious, and highly illusive. The peace agreements concluded so far not only guarantee Israel all the economic benefits it derived under occupation, but also open new trade vistas, allow for reduced defense expenditures, dismantle the Arab boycott, and attract new foreign investment and increased international tourism.
There is no level playing field between the Palestinians or the Arabs and the Israelis. The agreements reflect the vertical organization of power in existence. What is concluded under duress cannot last. The interest of peace calls for immediate and unconditional independence of the Palestinians and an Arab cooperation strategy. It is only then that the Palestinians can be expected to conclude meaningful, symmetrical, and lasting agreements. Arabs who are watching both the Israelis and the Palestinians are not encouraged. Israel is using its superior bargaining power to wrestle enormous concessions from the Palestinians and now from the Jordanians. This is to be expected from disjointed Arab bargaining. Unfortunately, the only way to correct the situation will be to start over. This is admittedly difficult. But the Arabs must make the painful economic adjustments and true reforms (stemming from the ingrained rentierism from the operating systems of their economy and society by balancing production and consumption, increasing the share of the new economy, improving productivity and efficiency of enterprises, relying on market determined exchange rates, harmonizing tariffs and fiscal/monetary policies with their neighbors and opening their economies to international trade) that their dependence on oil have allowed them to postpone before they contemplate joining any regional arrangement with more advanced economies.
First among the pressing needs is the formation of more meaningful regional economic groupings among the Arabs (Fertile Crescent countries, Maghrib countries, etc.) that can create true dynamic gains in productivity and export performance. Drawing on the many lessons of regional economic cooperation programs around the world, Arab economic integration programs will work.
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