Mideast economies after the Israel-PLO handshake.

• Author: Clawson, Patrick
• Position: Contemporary Issues in World Trade

The Israel-Palestine Liberation Organization Declaration of Principles has created enthusiasm about the prospects for economic cooperation between Arabs and Israelis. Arab-Israeli economic cooperation is exciting because of its political benefits, not to mention its economic effects. Thus, proposals for economic cooperation should be judged primarily by their promotion of peace, rather than simply by their direct economic effect. In particular, economic cooperation can ease the Israeli sense of regional isolation and promote its acceptance by its neighbors. Furthermore, as each side reaps measurable economic benefits, future agreements may be more feasible in less politically sensitive areas than Palestinian sovereignty.

The strategy of achieving peace through incremental cooperation in areas of mutual advantage, such as trade, is problematic. The strategy itself has long been controversial among Arabs and continues to be rejected by many Arab radicals. For many years, the majority in the Palestine Liberation Organization (PLO) preferred to hold off on any form of cooperation, no matter how profitable, as a means to increase the pressure for a comprehensive political settlement. Today, Arab radicals complain that economic cooperation is Israel's latest strategy in its ongoing campaign to dominate the region. As Aqba Ali Saleh wrote in the leading Saudi daily Asharq al-Awsat, "The merging of technologically backward economies with a high-tech economy necessarily entails domination by the latter and restriction of the former's scope for development."(1)

Despite objections from such radicals, most in the region view economic cooperation as a step towards peace. Unfortunately, some also have the unrealistic expectation that Arab-Israeli economic cooperation is the key to a nation's prosperity. No one is more optimistic than Israeli Foreign Minister Shimon Peres, a longtime advocate of economic cooperation. As he argued, "There are only two alternatives [for the Levant]: Benelux or Yugoslavia." That is, prosperity and peace through cooperation or poverty and war.(2) In his latest book, written with Arye Naor, Peres outlines his vision of a Middle East common market.(3) Crown Prince Hasan of Jordan shares Peres' vision. At an important recent conference on the economic implications of Middle East peace, Hasan spoke of the long-term possibility of Palestinians, Jordanians and Israelis establishing "an arrangement similar to that which exists between Belgium, the Netherlands and Luxembourg." As Hasan has noted:

A free-trade zone across the Middle East would be the ultimate goal. Arrangements for a Middle East Free Trade Agreement -- a MEFTA along the lines of NAFTA [North American Free Trade Agreement] -- would allow the region to play a more creative role in the world economy ... Such a development would provide an impetus for a new relationship of hope in the Middle East.(4)

Peres' and Hasan's vision of the Middle East developing along lines similar to NAFTA is not realistic. The Middle East is just not in the same economic league as either NAFTA or the European Union (E.U.). The 1991 gross domestic product (GDP) of Israel and the Arab states was less than $500 billion, as compared to over $6,000 billion for NAFTA and the E.U. [Table 1]. The merchandise trade of Israel and the Arab states in 1992 was less than $300 billion, as compared to four times that amount within NAFTA and seven times as much within the E.U. The total GDP of the Arab League members is less than the GDP of Belgium and the Netherlands. Even if Israel were to develop as close relations with the Arab states as it now has with those two, the market opportunities would still be limited when compared to the greater possibilities in the larger E.U. market -- the natural market for Israeli, Jordanian, and Palestinian producers. While there are some excellent opportunities for profit from Arab-Israeli economic cooperation, the regional markets are just too small for such an endeavor to have much of a macroeconomic effect on the region.

Furthermore, the Middle East is a region in which states have not yet developed close economic relations with each other. Examples abound of political restrictions on economic ties between Arab states: Jordan has been effecfively shut out of the Saudi market in retaliation for King Hussein's stand on the Iraqi invasion of Kuwait; Libya and Egypt each has slammed shut its common border in response to one or another episode; and Syria cut off the flow of the oil pipeline from Iraq when the latter invaded Iran. For the most part, Arab states do not trade very much with each other. In 1992, for instance, Jordan had $54 million in trade flows with its neighbor Syria and $64 million with Egypt - 1.2 percent and 1.4 percent of its total trade, respectively.[5]

Even if governments were not to interfere with economic ties, consumer resistance based on traditional enmities could still jeopardize Israeli-Arab economic cooperation. Such resistance could continue for decades after a comprehensive peace treaty. Look at Greece and Turkey for example. They have been at peace for 70 years; their troops serve under common North Atlantic Treaty Organization (NATO) command. The two neighbors have economies that should be complementary, as Turkish textiles could be traded for Greek industrial goods. Yet their trade flow in 1992 was a paltry $250 million, less than 0.7 percent of either country's total trade flows.

Economic cooperation is not the central economic issue for Israel, Jordan, the West Bank and Gaza; rather, job creation is everyone's top economic priority. All three economies face the same fundamental problem: double-digit rates of unemployment combined with an exploding labor force looking for work locally. In Jordan, this explosion is due to returnees from Kuwait; in the West Bank and Gaza, to the fewer opportunities for employment in Israel; and in Israel, to immigrants from the former Soviet Union and Ethiopia. The real impetus for job creation is going to come from economic reform: easing government regulations, building new infrastructure, providing ready access to bank credit and enacting policies to promote exports to the larger European markets. In summary, the needed economic reforms themselves have little to do with cooperation; they depend much more on internal reforms in each area.

COOPERATION ON TRADE

Trade cooperation is blocked by the illiberal trading regimes common in the region. The Egyptian, Syrian and Israeli governments each have long traditions of paternalistic etatisme, rooted respectively in Nasserism, Ba'athism and Labor Zionism. Breaking free from the outdated statist models of the past would do more than any other step to make economic cooperation among private sector firms possible. Trade is not likely to grow as long as the state protects local firms against foreign competition.

As an example of how artificial barriers can restrict trade, consider the small volume of Egyptian-Israeli trade: $13.3 million in 1992, amounting to 0.04 percent of Israel's trade and 0.07 percent of Egypt's.(6) Much could be done to simplify trade procedures. Israelis justifiably protest the administrative barriers to exporting to Egypt, but Egyptians could also complain about the low share of Gaza's imports that come through Egypt or the impossibility of marketing cheap Egyptian agricultural produce in Israel.

The Arab-Israeli trade that does occur usually violates the rules of at least one of the governments. For example, Israeli rules have until recently firmly forbidden the import of Palestinian eggs except in a few special circumstances, yet West Bank producers provide about 120 million eggs a year for the 1.8 billion-egg Israeli market. The practical effect of the Israeli rules is to increase the income of Israeli middlemen who find ways to smuggle the eggs, while reducing the income of Palestinian farmers who do not receive the price they otherwise could for their produce. Every attempt to crack down on the smuggling ends up increasing the margins demanded by the smugglers, reducing the income of the Palestinian producers and raising the prices paid by Israeli consumers.

Israel is not the worst offender with regard to trade-inhibiting rules -- quite the contrary. The Arab League maintains several layers of boycott against Israel, observed by all its members except Egypt. The primary or direct boycott on Israeli products is enforced well enough that Israeli exports have to use subterfuge to find their way into Arab markets, reducing the trade volume to a trickle. The direct boycott boasts strong political support and is unlikely to end soon, except in Jordan. On the other hand, the secondary boycott on companies doing business with Israel, and the tertiary boycott, on companies doing business with companies on the boycott blacklist, are increasingly less enforced.(7)

The paradox of the boycott is that its primary victims are Palestinian businessmen who cannot ship their goods to Arab markets because they use inputs and equipment imported via Israeli ports. Ending the boycott of these Palestinian products could significantly increase Palestinian sales in the Arab world. On the other hand, dropping the boycott on Israeli-made products would not necessarily create great market opportunities for Israeli businessmen, since the regional market is small (Israel's Arab neighbors have a GDP less than Israel's) and Arab consumers may resist Israeli products even if there are no official barriers.

The official barriers to trade are being reduced in most of the Middle East. Many governments have announced plans to ease back the heavy hand of regulation and liberalize the economy. In recent years, Israel and Jordan in particular have issued bold statements about their commitment to structural reforms to open up their economies. Not surprisingly, each has proceeded at a slow pace, because they face challenges from...