With the flurry of diplomatic maneuvering over the Palestinian Authority's plan to seek recognition at the UN next week, it's worth remembering the financial obstacles that will face those living in the Palestinian territories, whatever does or does not happen at the UN.

A new World Bank report out this week puts the Palestinian economy – and the PA's near-total dependence on aid – front and center. Palestinian economic problems won't be addressed at all by what happens at the UN, where Palestinians say they will press for full membership as a sovereign state.

That's unlikely to happen since the US has vowed to wield its veto on the Security Council, which controls the membership process. But even if Palestinians succeeded, or got a lesser upgrade to their current status, any prospects for major improvements will remain firmly in Israel's hands.

The World Bank says that recent economic growth in Gaza and the West Bank has been almost entirely thanks to foreign aid, that a slowing of foreign aid delivery has presented the PA with a possible fiscal crisis, and that Israeli policies continue to stand in the way of sustainable economic improvement in the territories.

The report says that the Palestinian private sector "remains stifled by Israeli restrictions on access to natural resources and markets. Under these conditions, lower-than-expected aid flows in the first half of 2011 had an immediate impact on the Palestinian economy. Real GDP growth, steadily increasing in 2009-10 and previously projected to reach 9 percent in 2011, is now expected to be 7 percent. The shortfall in external financial support in the first half of 2011 has also contributed to the current fiscal crisis facing the Palestinian Authority."

The World Bank review comes at the end of a two-year program of institution building that Palestinian leaders hoped would set the stage for an independent state. It gives Palestinian bureaucrats high marks: "In areas where government effectiveness matters most – security and justice; revenue and expenditure management; economic development; and service delivery – Palestinian public institutions compare favorably to other countries in the region and beyond." But it says there's little within the PA's own power that they can do to produce sustainable economic growth.

Why? "Ultimately, in order for the Palestinian Authority to sustain the reform momentum and its achievements in institution-building, remaining Israeli restrictions must be lifted," the World Bank says. "The resulting revival of the private sector can be expected to grow the tax base and gradually reduce dependence on external assistance. Until then, however, West Bank and Gaza will remain vulnerable to reductions in aid flow, and these will need to be managed carefully."

The economies in the West Bank and Gaza have of course grown at relatively high rates in recent years, and unemployment has declined. (The World Bank says overall Palestinian unemployment is now 19 percent, though that's out of the only 40 percent of the population still seeking work.)

But it seems to imply a dramatic reversal in fortunes is possible if the aid taps are turned down, or off. It says growth was from a low base and that while Israel eased restrictions on Palestinian trade in 2009, "there has been little further easing since."

US could withhold aid

The US is going all out to stop the recognition bid, and has threatened to withhold the roughly $550 million in annual aid that it gives the Palestinians.

Speaking at a Monitor breakfast this week, US Ambassador to the UN Susan Rice flatly said that it would work against Palestinian interests.

But the reasons for Palestinian frustration aren't hard to find. Settlements have expanded in the West Bank since the Oslo Accords, freedom of movement and trade remain severely restricted there by Israel, and Gaza continues to confront a crippling economic blockade.

If the Security Council blocks the Palestinians' bid for full membership, the UN General Assembly, which convenes Sept. 20 in New York, could upgrade the Palestinian mission to nonvoting observing status. But even that would do little to change things quickly. It amounts to an attempt by its supporters to redefine the terms of discussion from a peace process that seems no closer now to ending with a Palestinian state than it did a decade ago, to one in which in Israeli – and perhaps close allies like the US – are framed as the obstructionist party.

Maen Rashid Areikat, the Palestinian ambassador to Washington, told the Monitor yesterday that UN recognition is "an issue of national pride for a people who want to be independent and free.... I don’t think it’s the natural role for the US to block the admission of a state... (it's) not compatible with US principles.”

Israeli restrictions

While Israel has relaxed some security measures in the West Bank that have allowed for greater economic activity, other restrictions have increased, particularly in Gaza. The World Bank report says that since 2002, Israel "has progressively added materials, machinery, and equipment (including telecommunications equipment) to the list of items considered 'dual-use' ” in Gaza. Dual-use refers to materials that Israel deems a potential military threat. Israel "now allows most consumer goods and many intermediate inputs to enter Gaza. However, it restricts the entry of most construction materials. In addition, [Israel] still prevents all exports from Gaza except for a limited amount of agricultural goods."

The West Bank has severe restrictions of its own. Israel "still does not allow any Palestinian development in the 60 percent of the West Bank comprising Area C. In addition, [Israel] maintains strict controls on the passage of goods and people between Israel and East Jerusalem and the rest of the West Bank." (Area C is a term introduced by the Oslo Accords that refers to West Bank areas under Israeli control, including the major Israeli settlements.)

The whole report is worth a read. The takeaway is a simple one. A lasting peace between two real states side by side will rely, at least in part, on a much stronger Palestinian economic base. For the moment, the chances of real economic improvement remain slim.

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