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Economic Miracle

A Middle East peace strategy that could actually work.

Benjamin Netanyahu’s visit to Washington is a good opportunity for the prime minister and President Obama to ponder why decades of strenuous diplomatic efforts and hundreds of billions in aid have done so little to advance peace or improve the lot of Palestinians, who still languish in refugee camps or in chronic penury under the oppressive rule of the Palestinian Authority (PA) and Hamas. For decades, diplomats have been seeking formal peace based on the political separation of Jews and Arabs. But these efforts have achieved nothing, and it could be argued that they have actually made things worse. With the recent announcement of an alliance between Fatah and Hamas, they are likely to continue to fail.

That does not mean, however, that all is lost. Because would-be peacemakers have mainly concentrated on the political aspects of the conflict, they have missed a crucial element that could help mitigate, if not resolve it: the economic one. And that neglected force, in contrast to the innately flawed political peace process, gives us reason for hope.


For the first 20 years of its occupation of the West Bank and Gaza—from the 1967 war to the 1987 intifada—Israel generally followed a laissez-faire economic policy in the territories. It kept open bridges with Jordan and did not interfere in Palestinians’ internal affairs. Israel’s maintenance of law and order facilitated rapid economic growth, and its introduction of technical innovations revolutionized Palestinian farming. Crowds of Israelis ate and shopped in Arab towns and markets. During this time, the real income of Palestinians nearly quadrupled. Enhanced wealth created social mobility, loosening the grip of clan and family. Education levels rose, and so did health levels. Palestinian women were the greatest beneficiaries of these changes.

There were remarkably few terrorist attacks during this period. The few that happened were mostly perpetrated by Palestine Liberation Organization (PLO) hirelings. Not that the Palestinians were enamored of Israeli occupation: No one likes an occupation. But, realizing the economic benefits it had brought them, many Palestinians found the occupation a lesser evil than oppressive Jordanian and Egyptian rule.

Then, in the mid-1980s, a deep recession in Israel and the Gulf states—where many Palestinians were employed—brought this prosperity to a halt. Concurrently, Israeli bureaucracy, which routinely makes economic life miserable for Israelis, tightened its stranglehold over Palestinian commerce, levying high taxes and imposing complex administrative strictures designed mostly to protect Israeli monopolies.

The 1987 intifada started, according to its perpetrators, as an economic protest. Of course, there were plenty of other factors involved, as well. But one can see the role that economics played by looking at what happened, or rather didn’t happen, in Jerusalem. During the intifada, the city remained mostly calm despite strenuous efforts by the PLO to ignite it, in part because its Palestinian residents benefited from the high income that the tourist economy had brought.

Despite the impressive earlier success of the economic peace process, the Israeli peace camp kept clamoring for a political solution. So Rabin and Peres made a Faustian pact with Arafat. They invited the PLO, a terrorist organization committed to the destruction of Israel, to return from Tunisia and become their partner in peace. The moment that Arafat and his minions took over the territories, they began undermining the power of the merchant class by extorting money from businesses.

Under Arafat, unemployment climbed to nearly 60 percent. This created fertile ground for the incessant anti-Semitic propaganda the PA pushed into its media, schools, and mosques. The propaganda engendered such deep hatred that it is surprising only dozens and not hundreds of Palestinians were ready to become suicide bombers. (Just consider what five years of intensive pre-World War II propaganda combined with economic misery did to Germany’s population.)

Not that Israel was guiltless. The notorious Israeli bureaucracy made a dependent Arab population miserable with its oppressive, arbitrary misbehavior. Moreover, because of pressure from Europe, the United States, and its own leftists, Israel refrained from fighting terrorism the only way terrorism can be successfully fought: by eliminating its leadership and logistical infrastructure. Instead, Israel tried to fight terrorism through ineffective half-measures, such as closures and roadblocks, which punished innocent Palestinians and harmed their economy.


Yet the situation today is not hopeless. True, the recent Fatah-Hamas agreement has blocked any chance for a political solution. But the prospects for economic development are promising. Improved law and order, and the efforts of the Palestinian Authority’s prime minister, Salam Fayyad, have resulted in a resurrection of commercial life in the West Bank and in an urban renewal of sorts. After a long hiatus, Palestinians (including young women) are frequenting coffee shops again, and talking openly about their disenchantment with the endless struggle against Israel and about the benefits of normalcy. The good life seems to be partly counteracting the culture of hatred that has been promoted for years by the Palestinian Authority.

The other reason for optimism is that even as Israel was pursuing a fruitless peace process with Fatah, it was shedding some of the monopolistic practices and bureaucracy that had held back not only Israel’s economy but its economic relations with the Palestinians. Significant changes took place between 2003 and 2005, when Netanyahu—who was then serving as finance minister in the government of Ariel Sharon—began to reform Israel’s statist economy. He slashed public spending, cut exorbitant social benefits and taxes, curtailed the stifling bureaucracy, and—his greatest achievement—broke up a bank duopoly that was gravely misallocating credit. The result was impressive: Over the past five years, Israel has seen spectacular economic expansion.

Of course, Israel still faces great challenges if it is going to liberate its economy from the old model. The major impediment to vigorous growth is an excessive concentration of economic power in the hands of a few oligarchs: In 2009, the Bank of Israel reported that “some twenty business groups, nearly all of family nature and structured in a pronounced pyramid form, continue to control a large proportion of public firms (some 25 percent of firms listed for trading) and about half of market share.” This badly inhibits competition, and leads to poor efficiency and low wages (the average Israeli worker’s salary is significantly lower than the salary of the average American worker). What’s more, the country suffers from an excessively close relationship between a handful of oligarchs and politicians.

Still, Israel now has a far more successful, open economy than it did just a decade ago. This means it is in a much better position to serve as an engine of growth for the Palestinian economy-especially if it opens its markets to Palestinian enterprises, and if the PA allows Arab firms to cooperate with Israeli ones.

Meanwhile, the Fatah-Hamas alliance may, in an odd way, provide an economic opening. International donors will now have a reason to shift funds away from an irredentist Fatah-Hamas regime and redirect them toward private initiatives. Where housing is needed for ex-refugees, cheap loans could be offered to families to build their own homes, rather than channeling funds through the corrupt Palestinian system and its favored European contractors. Development tenders should be opened to small Arab contractors. This will revitalize the Palestinian private sector and create a civil society with a stake in peace.

It is not reasonable, of course, to suppose that economic growth can solve all problems. But given that the prospects for political peace look terrible, it is now time to give the economic path to peace the serious hearing it has rarely received. In 2008, Netanyahu unveiled a plan for peace through economic growth, calling for the massive construction of desperately needed housing and infrastructure, as well as the creation of thousands of Palestinian jobs. But his plan fell on deaf ears among the political-solution addicts at Foggy Bottom, whose misguided faith in the PA mirrored their support for other dictatorial regimes across the region.

An economic initiative for peace is still possible today; but time is running out. If Hamas ends up in control of the West Bank, as now seems possible, and if it uses the area as a base from which to shower missiles on central Israel, then Israel will likely decide to retake the territory and a bloody war will ensue. Before this happens, would it not be more productive and less painful to give economic peace a chance to succeed where political peace has clearly failed?

Daniel Doron is president of the Israel Center for Social and Economic Progress, an economic policy think tank. This article originally ran in the June 9, 2011, issue of the magazine. 

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