Pathway towards a two-state solution

The roadmap for peace supported by the Middle East Quartet (US, EU, Russia and the UN) provides for three phases that would ultimately lead to a final solution to the conflict. Phase I (December 2002 to May 2003) includes the end of violence by both sides, the cessation of settlement activities by Israel and a comprehensive security reform by the Palestinian Authority. In Phase II (June to December 2003), a Palestinian state with provisional borders and a new constitution should be established. Finally, phase III (2004 – 2005), should foresee the conclusion of a permanent status agreement and the creation of a sovereign Palestinian state with final borders. However, the roadmap reached a deadlock early in the process as neither Palestinians nor Israelis fulfilled the requirements of Phase I.

70 According to a group of scholars and observers, the failure of the roadmap is partly attributed to its definition solely in political terms, while a clear vision of the economic arrangements in a final status associated with Phase III could provide momentum for the implementation of the content of Phases I and II (Aix Group, 2004). As most officials in both Israel and Palestine are still committed to the two-state solution, and as the international community has reaffirmed its commitment to the two-state solution, in the UN Security Council’s Resolution 2334 of December 2016, research-based evidence is needed to provide a clear vision to the economic arrangements in the final status.

Among scholars and observers, there is a wide consensus that the final status needs to entail the creation of economic borders and to grant the Palestinians full control over their trade and monetary policies (Malul et al., 2008). While promoting independence in economic policy-making, the final arrangements should acknowledge the economic interdependence (Aix Group, 2004). With respect to labour markets, the Palestinian employment in Israel is likely to remain sizeable, at least in the short-term. In the long-term, i.e. in a final status perspective, a group of Israeli and Palestinian academics and experts elaborated the “Economic Roadmap” where they call for a restored flow of Palestinian workers into Israel that is stable, predictable, and coordinated with the PNA, with security restrictions kept at the minimum necessary (Aix Group, 2004). With respect to trade, independence of policy- making means for Palestine an exit from the customs union with Israel. Subsequently, the Palestinian authorities could choose among several trade options including: a free trade area with Israel, a non-discriminatory liberal trade regime, or treating Israel the same way countries with no preferential trade agreement with Palestine are currently treated.

4.7. Conclusion

The Palestinian economy is asymmetrically linked to that of Israel. The two economies coexist within a customs union that was formalised by the Paris protocol. This customs union is largely based on the Israeli rules and, due to structural differences between the two economies, those rules are not favourable to the Palestinian economy. Moreover, the work permit policy and closures introduced by Israel – as security measures – have altered the flow of the Palestinian workers and the goods to and through Israel with substantial negative consequences on both the employment and economic development in Palestine.

Several Palestinian and Israeli experts argue that for a permanent solution to the conflict, the establishment of a sovereign Palestinian state, which would eventually have full control over trade and monetary policies, as well as a restored flow of Palestinian workers to the Israeli economy are needed. However, few studies were designed to quantify the effects of the required changes in trade and labour market policies on the Palestinian economy. This

71 thesis aims at filling that gap by presenting four CGE applications with policy simulations, which are focusing on West Bank trade and labour markets, in order to identify political and administrative options for the Palestinian National Authority.

In the first application, Chapter 6, the effect of a return of Palestinian employment in Israel to its pre-intifada level of 1999 is investigated under different model specifications. This application aims at identifying which model specification fits the West Bank labour markets and under which conditions.

In the second application, Chapter 7, the short-term effects of changes in the employment of Palestinians in Israel are investigated, assuming segmented factor markets and the existence of a surplus labour. Four counterfactual scenarios are simulated. The first scenario considers a return of Palestinian employment in Israel to its pre-intifada level of 1999 while keeping its composition as in the base year of 2011. This corresponds to an increase in Palestinian employment in Israel by 36%. The second scenario contemplates a return of Palestinian employment in Israel to its 1999 levels with the additional labour being only sourced from males who are eligible for a work permit in Israel. The third scenario increases Palestinian employment in Israel to its 1999 levels while increasing the supply of the labour force assuming labour previously outside the labour force would have incentives to participate the labour force. The last scenario reduces the number of Palestinian workers in Israel by 36%, which corresponds to the assumption that Israel tightens further the access to its market for Palestinian workers.

The third application, Chapter 8, investigates the long-term effects of a return of Palestinian employment in Israel to its 1999 levels. To this end, a mobility function is included in the model and the labour-leisure trade-off specification is used to model the labour market conditions.

Finally, the fourth application, Chapter 9, assesses the effects of changes in the trade regime. Two trade options are simulated, assuming an exit from the customs union with Israel and trade policy in the West Bank being solely determined by the Palestinian authorities. The first scenario is the elimination of tariffs on imports from all trade partners, and the second scenario simulates the imposition of high tariffs on imports from Israel, assuming that Israel is treated the same as countries with no preferential trade agreements with Palestine. Moreover, the performance of three exchange rate regimes is compared in order to inform the choice of a monetary policy that a sovereign Palestinian state with its own currency may want to pursue.

For all four applications, a unique and comprehensive social accounting matrix for the West Bank described in the next chapter is used.

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5

A SOCIAL ACCOUNTING MATRIX FOR THE WEST

BANK

6 _{Parts of this chapter have been published as a working paper: Agbahey, J., Siddig, K., Grethe, H., 2016. A 2011} Social Accounting Matrix for the West Bank with detailed representation of households and labour accounts. Berlin: Humboldt University of Berlin, Department of Agricultural Economics, Working Paper No. 93/2016, p.69.

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