ECONOMIC POLICY PROGRAMME

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

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

3. Palestine’s 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” Economic Policy Programme

4. Palestine’s 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 Economic Policy Programme

5. Current Palestinian Tariff Structure Economic Policy Programme

6. 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 Economic Policy Programme

7. 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. Economic Policy Programme

8. Designing Palestine’s 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)! Economic Policy Programme

9. ►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 Economic Policy Programme

10. ►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 Economic Policy Programme

11. ►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 Economic Policy Programme

12. Quantification: 260 products (98) for EU, Israel, US, RoW • 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 (-) Economic Policy Programme

13. 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%] Economic Policy Programme

14. 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) Economic Policy Programme

15. 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” Economic Policy Programme

16. ►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 Economic Policy Programme

17. ►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 Economic Policy Programme

18. Key “recommendations” • Low and uniform tariff best for Palestinian economic growth and future prosperity • WTO binding at prevailing rate (not above!) • Palestine’s 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) Economic Policy Programme

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