1. May 2005Economic Policy Programme1 ECONOMIC POLICY PROGRAMME TOWARDS AN ECONOMICALLY-VIABLE PALESTINIAN STATE: The Regulation of External Trade Monday May 23, 2005 Grand Park Hotel, Ramallah

2. May 2005Economic Policy Programme2 Future Trade Policy Options: NDTP and Keeping Options Open for an FTA with Israel Options for Tariff Policy for Palestine Jaime de Melo, Jean-Marie Grether, L Alan Winters Professor Jaime de Melo

3. May 2005Economic Policy Programme3 Palestines Current Trade Policy Background on Palestinian economy International Experience Quantifying Low and Uniform Tariffs Governance of Trade Policy Free-Trade & Two-track trade regime (EPZ) Key Recommendations

4. May 2005Economic Policy Programme4 Palestines Current Trade Policy Paris Protocol (PP) formalised q-CU with Israel Tariffs set by Israel with few exceptions (Lists A1, A2, B) Israel transfers customs duties, VAT and purchase tax on goods destined for WBG, to PA (subject to administration fee a-nd for long withheld) Very limited autonomy to set own trade policy though agreements with EU, EFTA and many others

5. May 2005Economic Policy Programme5 Current Palestinian Tariff Structure

6. May 2005Economic Policy Programme6 PP: Agreements vs. Reality Revenue loss through indirect imports –Approx 1/3 of imports from Israel are indirect = loss of 3% of GDP Closures and Restrictions –Goods & People transaction costs –…and relative profitability of exports (=60% tax on exports in illustrative example below!!!) +Destruction of Infrastructure & equipment

7. May 2005Economic Policy Programme7 PP: Reality Implications Israeli border measures –Generate uncertainty –Often captured by interest groups for protection –Impede free flow of goods –Raise costs and discourage investment Palestine currently impeded from drawing benefit from economic relationship with Israel …but economic considerations suggest that Palestine should pursue close integration with Israel in the future in order to maximise gains from trade.

8. May 2005Economic Policy Programme8 Designing Palestines Tariff policy Tariffs (and exchange rate policy) TRANSMIT PROFITABILTY SIGNALS TO THE ECONOMY 3 Reasons for a low and uniform tariff policy Widely accepted gains from trade (no sustained growth by countries with bad trade policies) Characteristics of the Palestinian economy Other countries have done it (international experience)!

9. May 2005Economic Policy Programme9 Gains from Trade: What we know Big for small economies For small economy, gains do not depend on (reciprocal) preferential market access Channels by which trade raises income Specialization (marble or T&A instead of cars) exploitation of economies of scale expands variety of inputs and consumer products helps achieve a more competitive market structure (FT= substitute for competition policy in a small economy, e.g. HK) greater access to knowledge and know-how

10. May 2005Economic Policy Programme10 Characteristics of Palestinian Economy High & variable transaction costs ( not suitable for active industrial policy = pick winners) –Difficult to predict pattern of trade –Difficult to compete on world markets –Protection would tax exports further Financial transfers from RoW large ( 20% of GDP) –Non-tradables expensive for consumers, profitable for producers ( tradables activities less profitable) Trade taxes not key to raise govt revenue

11. May 2005Economic Policy Programme11 International Experience Liberal trade policy contributes to better policies in general less potential for corruption less volatile macro policies Openness aids flexibility better signals from world markets more rapid adjustment to external shocks reduces overall adjustment costs Links between openness and performance Causality & relative strength of links hard to establish …but no post WW2 evidence that openness hurts growth

12. May 2005Economic Policy Programme12 Effects of tariffs on income: (-) = loss (+) = gain Costs of protection = Sum of: Average tariff level (-) Variance in tariffs (-) Terms of trade gain (+) / loss (-) Market access to FTA partner (+) Market access by FTA partner (-) Quantification: 260 products (98) for EU, Israel, US, RoW

13. May 2005Economic Policy Programme13 All scenarios start from current tariff structure (6.4% average): –And Maintain FTAs with EU and US Scenario 1: uniform 5% tariff Scenario 2: Go to a uniform 10% tariff Scenario 3: Go to free trade (0% tariff) Scenario 4: Go to a uniform 5% tariff with an FTA with Israel. Ranking (quite robust) of scenarios (of which 2% recovery of tax leakage: (3)=[2.9%] > (4)=[2.5%] >(1)=[0.9%]>(2)=[0.2%]

14. May 2005Economic Policy Programme14 Caveats on simulations (Effects not captured in quantification but important ) Additional gains from removal of NTBs (not modelled) Cost of implementing duty drawback scheme Loss to specific producers (e.g. agriculture)= Important: needs compensation. Adverse implications of multiple FTA (costs of Rules of origin)

15. May 2005Economic Policy Programme15 Governance of Trade Policy Correct bias towards interests of producers and away from interests of consumers Need for contestability (remove rents) Dangers of anti-dumping duties –Safeguard law better Dangers of variances in tariffs (lobbying, etc…) …In sum: Trade policy : business friendly but not business owned

16. May 2005Economic Policy Programme16 Free Trade (0% Tariff) Regime? Additional advantages of free trade regime –Signalling –Avoidance of Trade diversion –Remove incentives for Rent-seeking activity –No need for Duty-drawbacks and RoO Objections to free trade regime –Loss of bargaining power (not applicable here…) –Real exchange rate adjustment (how to bring about real depreciation) –Adjustments in agriculture (substantial as t>10%) –Effects of possible adverse Israeli reaction

17. May 2005Economic Policy Programme17 Two-Track Regime (=EPZ for Gaza and low & uniform elsewhere) Successful strategy elsewhere (e.g. Mauritius) Policy likely to get more support (business can reinvest profits from protected sector) + less need for adjustment A signal and incentive to attract FDI Spillovers (technological acquisition) from RoW

18. May 2005Economic Policy Programme18 Key recommendations Low and uniform tariff best for Palestinian economic growth and future prosperity WTO binding at prevailing rate (not above!) Palestines unique opportunity: take advantage and implement this policy from outset upon statehood, (now to Gaza?) …. But beware of short term costs (especially on the poor in agriculture). To address through donor funded adjustment and expenditure-led compensation (not tariffs)

19. May 2005Economic Policy Programme19 ECONOMIC POLICY PROGRAMME TOWARDS AN ECONOMICALLY-VIABLE PALESTINIAN STATE: The Regulation of External Trade Monday May 23, 2005 Grand Park Hotel, Ramallah