Palestinians living in the Gaza Strip received a rare piece of good news on 17 June, as Tel Aviv announced the easing of restrictions on the territory’s land borders. The move, explained Prime Minister Binyamin Netanhayu, was designed to “liberalise the system by which civilian goods enter Gaza [and] expand the inflow of materials for civilian projects”.

It also represents the first evidence in many months that Israel is feeling the heat over its prolonged siege of Hamas-controlled Gaza.

Israel’s decision, which followed the controversial deaths of nine Turkish activists on board a Gaza-bound aid convoy in late May, is intended to ease growing international pressure on Netanyahu’s embattled government, which has for three years failed to address the humanitarian consequences of the blockade. 

Temporary relief

The move to allow imports of ‘dual-use’ goods, such as cement, steel and other construction materials should help speed up the reconstruction process after the December 2008 bombardment of the territory by Israel. But for local businesses, any relief from the opening is likely to be short-lived.  

The decline in economic activity has left the Gaza authority deprived of income sources

Besides falling short of demands for a complete lifting of the embargo, it fails to address the critical issue for Gaza’s private sector: the inability to export. The stifling of trade, the lifeblood of an economy that has traditionally served as a source of exports to the large Egyptian and Israeli economies, has had the most impact on Gazan economy.

“No easing of the blockade will be effective if it does not result in an opening or a clear opportunity to create sustainable jobs in the Gaza Strip,” says Sami Abdel Shafi, senior partner at Emerge Consulting Group in Gaza City. “Any blockade, which results in anything other than allowing us our right to create jobs for people, who want to earn their own living, isn’t worth the name.”

Gaza’s economy has almost ground to a halt in the past three years, since Israel tightened its blockade following the Hamas takeover of government in June 2007. The December 2008 air attacks added a humanitarian crisis to the mix, besides damaging more than 1,100 private sector firms at an estimated cost of $400m.

Yet the consequences of the month-long attack pales in comparison to the long-term impact of the ban on imports of raw materials and on exports. A report from the Israeli human rights group B’Tselem released in April, says the blockade has led to the closing of 95 per cent of Gaza’s factories and workshops. Prior to the siege, there were more than 4,000 factories and workshops in the territory, but the latest estimates suggest only 500-600 are still functioning.

Unemployment now exceeds 40 per cent, and more than 70 per cent of the population depends on food aid from international organisations. Restrictions on capital inputs and building materials have impeded the post-war private sector recovery, as well as the reconstruction effort, the IMF says in its report on the West Bank and Gaza economies, also published in April.

The blockade on border crossings has cut the quantity of goods that Israel allows into Gaza is less than one quarter of what entered before the siege. The range of goods that Israel allows is limited: some 150 products compared with 4,000 before the siege, according to B’Tselem.

It is estimated that more than 60 per cent of establishments have closed down in the construction sector due to their inability to access materials.

Disparity grows

As result, there is a growing disparity between the economies of West Bank and Gaza. While real gross domestic product (GDP) in the West Bank in 2009 was estimated to have grown by 8.5 per cent, the equivalent figure for Gaza was just 1 per cent, according to the IMF. And while clearance revenues – Israeli repayments of taxes collected from Palestinian commercial activities – in the West Bank reached NIS4bn ($1.05bn) in 2009, Gaza yielded just NIS352m that year, a decline of 13 per cent.

The restrictions on economic activity has left the Hamas-controlled administrative authority of Gaza deprived of income sources. Barely $36m of the authority’s $428m 2010 budget was sourced from local revenues.

Liquidity has also contracted. In the year to December 2009, private credit declined by about 17 per cent, and lending activity has all but dried up, to the extent that Arab Bank this year closed two of its three Gaza branches.

“Banks aren’t working as banks anymore – they are just dispensers of money,” says Abdel Shafi. “There isn’t any extension of loans or credit management, which ironically turned out to be an advantage as one of few places not impacted by financial crises was Gaza. Our economy was zeroed out, so we haven’t felt anything.” 

The recent easing of the blockade cannot redress the impact of more than 10 years of economic isolation, which have lost Gazan exporters valuable market share in Israel.

The textile industry is a case in point. “Before, around 90 per cent of our garments were exported to Israel. But you can’t expect Israeli merchants to wait three or four years for borders to reopen and import garments from Gaza again – they’ll look to other countries, such as Egypt, Jordan and Morocco. So we’ve lost most of our quota in the Israeli market,” says Amr Hamad, a Gaza-based executive manager of the Palestinian Federation of Industries.

Tunnel economy

The siege has distorted the economy in other ways. Most businesses started using underground tunnels to import raw materials, equipment and other production inputs. The smuggling of resources through tunnels from Egypt remains the main means by which the territory’s 1.5 million inhabitants have defied the blockade.

The tunnels have served to sustain economic activity while the Israeli blockade – reinforced by Egypt’s closure of the Rafah crossing – has starved the economy of vital commodities.

At their peak in 2009, the number of commercial tunnels was estimated at more than 1,000, employing between 20,000-25,000 workers. Around 400-600 tunnels into Gaza are still manned, sustaining supplies across a range of products. Much of Gaza’s fuel is funneled through the subterranean links, at a reported rate of 100,000 litres a day each of diesel and petrol.

The problem is that the tunnels have created a black market that threatens to swallow the formal economy, permanently damaging the Gazan private sector, which now must compete with the new breed of ‘illegitimate’ tunnel entrepreneur.

The tunnels have also flooded the market with imported goods – many of poor quality – slashing prices and resulting in smaller margins for official businesses. Many Gazan companies have been importing raw materials through tunnels at a higher cost in order to re-start production lines.

Businessmen say the tunnels are effectively thwarting investment. “If a legitimate entrepreneur makes a surplus around $100,000, he either puts it into the bank as a deposit or buys a piece of land and uses it as collateral for a new loan from the bank, and with new loan he invests in a new production line – that adds much to the economy,” says Hamad.

“But the illegitimate tunnel businessman doesn’t deposit the surplus with the bank, instead he buys a piece of unregistered land or buys up commodities, which do not add to the economy.”

Tunnel activity is cyclical. The first quarter of this year saw a halt in the construction of new tunnels as the reported construction of an underground steel wall along the Egyptian border suggested a bleak future for tunnel entrepreneurs. Yet, few envisage the speedy demise of the tunnel economy.

The Hamas government, in want of revenues, has attempted to take a bigger slice of the smuggling business with new taxes on imports, including luxury cars smuggled from Egypt. 

The effect of all this, says Abdel Shafi, is a bad deal for the Gazan consumer, leaving no price controls and no regulations with respect to quality and all other aspects of regular commerce. “The underground economy is a sloppy exchange. If you buy any piece of equipment, say a refrigerator, which came through the tunnels, there is no recourse if it’s defective. Notions such as maintenance and warranty are not applicable,” he says.

The partial opening of the border may stem some of the flow through the tunnels, as will Egypt’s decision to reopen the Rafah crossing, but Gazan businesses face an uphill battle in competing with the smugglers.

The siege has created additional burdens on the private sector, beyond the black market. The growing dependence on donor aid is one such example. “The international community should take a serious look at minimising so-called humanitarian aid, which in the ends constitutes a sunk cost,” says Abdel Shafi, who urges donors to apply positive pressure on Israel to direct their financial assistance to development and employment generation.

If the international donor community applies pressure politically, it could reduce the level of humanitarian assistance in favour of a more developmental budget that could transform passive recipients of donor assistance into productive, motivated employees who earn their own living.

Reaching out

Such is the sorry state of the peace process that the current best-case scenario for the Gaza economy following the easing of the blockade is for a reversal to the situation before the June 2007 Hamas takeover. 

“Objectively, this would not be the best scenario, as even before the June 2007 events activity at border crossing with Israel was heavily restricted. But relatively speaking, it would be great if we get back to how things were,” says Abdel Shafi.

“It just shows we are a constant case of lowered ceilings and that goes for our economy, as well as for our politics.”

The Hamas government has opportunities to build bridges with the international community, as well as with the West Bank-based Palestinian Authority leadership. In doing so, it could lessen Gaza’s isolation and help the international community positively influence Israeli actions.

The international community for its part remains wary of engaging with Hamas. And this may have to change, if real progress is to be made. “There are times when to advance politics you have to start with economics, and there are times when you really want to advance economies you have to start with politics. This is one,” says Abdel Shafi.