Israel holds key to Palestinian state's prosperity: In the first of two articles, Christopher Huhne considers the economic and trade implications of a peace accord in the Middle East

THE Palestine Liberation Organisation's inheritance is not the biblical land of plenty. Jericho is a small and dusty market town whose principal export since the peace agreement with Israel appears to be Palestinian flags and Yasser Arafat T-shirts. Around Jericho, the land is so arid that it is a surprise the Bedouin succeed in grazing their sheep.

The Palestinian area - Jericho and the Gaza Strip, and soon maybe the rest of the West Bank - desperately needs to meet the aspirations raised after 25 years as a Third World enclave within a far richer society. The occupied territories have an annual income per head of dollars 1,350 (pounds 906) - similar to Jordan or Tunisia. By contrast, Israel's dollars 10,878 a year is akin to Portugal, Greece and Spain.

Although a recent opinion poll found that 65 per cent of the Palestinians in the occupied territories favoured Mr Arafat's deal with Israel, they also want rapid progress in improving economic conditions. The poll also gave an indication of what might happen if those expectations are not met: even now, 28 per cent of the population in the radicalised Gaza Strip believe the rejectionists must use violence if necessary.

This poses a central dilemma for the Palestinian leadership. If it wants to improve living standards rapidly, it has little option but close co-operation with Israel. It needs Israeli markets, employment opportunities and administrative expertise. But if the PLO co-operates too closely with Israel, it risks being outflanked by its rejectionist critics.

Eventually, the ties of the West Bank and Gaza with Israel will weaken, because they have been artificially intense thanks to the obstacles to trade with Arab states. But if Palestinian politics decrees a cold rather than warm peace with Israel, the gradual disengagement could become sharp.

By losing the income of those who work in Israel - worth in normal years 24 per cent of all occupied territory incomes - prosperity would be far more difficult to achieve. The Israeli market is also crucial. In 1968, a year after the Six-day war, the occupied territories sent 45 per cent of exports to Jordan. Today, Israel is virtually their sole trading partner.

This dependence on Israel has done nothing to lessen the gulf of Arab fear and misunderstanding. A repeated refrain, in conversations with Jordanian and Palestinian policy-makers and business people, is that Israel will exercise imperial powers in the region by virtue of its industrial prowess rather than its military might. Israel's economy is more than eight times the size of the Jordanian and Palestinian economies combined.

These fears are acute because of Israel's proposal that it should share a customs union with the West Bank and Gaza (as it effectively does now). This goes beyond free trade, when countries agree to give free access to each others' markets but retain border posts to stop goods from outside the free-trade area entering without paying the due tariff. In a free-trade area, each country can have different tariffs against countries outside the area.

The Israeli proposal has fundamental political implications. A customs union between Israel and the Palestinian entity would imply border posts between the West Bank and Jordan; but free trade alone implies border posts between the Palestinian entity and Israel. Otherwise, European and US goods that enter Israel tariff-free could also enter the West Bank and Gaza.

This issue has not been settled by the PLO. Yusif Sayigh, the senior PLO economist charged by Mr Arafat with preparing an economic programme, has recommended free trade, but has not ruled out a customs union. But there is clearly a desire to set tariffs to protect infant industries, which may not be possible in a customs union. Israel itself had high tariffs for some industries in the early Fifties.

The PLO also suffers from having no economist among its leadership, so that many statements have been ill-informed about the realities of the West Bank and Gaza. Some exiled leaders seem to remain implacably hostile to Israel. For example, Yasser Abed-Rabbo, a PLO executive member, recently said that Israel's aim is to 'make (Palestinian) independence superficial and to transform the Palestinian entity into an entity in orbit around Israel, cut off from its surroundings'.

However, there is a Palestinian group, particularly among business people, more optimistic and open to opportunities. With the reduction in aid from the Gulf states in the wake of the PLO's support for Saddam Hussein in the Gulf war, these rich Palestinians have increasing influence.

'If the Jews have proved to be the masters of business, then the Palestinians are the Jews of the Arab world,' says Asad Abdul-Rahman, a member of the Palestine National Council who has Mr Arafat's ear. 'Arabs are well educated, and the business community has lots of credibility in building an economy. We can compete with the Israelis.'

Leading Palestinian business families are said to be planning investments in the West Bank, and a banking official in Amman reports that there have been large cash flows into West Bank property: land prices in Ramallah and Nablus have more than doubled in six months. Commercial property prices are also rising strongly.

The flow of private money will be supported by Western aid for public projects. The draft World Bank report on the West Bank and Gaza proposes nearly dollars 300m a year on projects over 10 years, mainly in water, electricity, sewerage, telecommunications and roads.

Water consumption in the occupied territories is just 60 litres a day, half the level of Tunisia or Jordan. More than a quarter of villages have no permanent electricity supply, and the World Bank says there are serious health concerns about the lack of modern sanitary landfills and poor waste- water collection systems.

The World Bank's proposal is not enough for the Palestinians. Mr Sayigh told bankers in Washington last week that the Palestinian entity needed dollars 11.6bn over six years, a figure greeted with incredulity. Much of the difference is explained by adding private sector investment needs in industry, agriculture and tourism to the need for public sector infrastructure.

In reality, the Palestinians are pushing at an open door. Mr Sayigh has already persuaded the World Bank to raise its estimate of financing from dollars 300m a year to dollars 475m. Much to the annoyance of the Jordanians, who feel themselves shut out by developments, governments have been falling over themselves to promise aid. The European Community has promised 500m ecu over five years, half of it through European Investment Bank loans.

But the Palestinians may need to swallow their pride here, too, as the chances of implementing many projects quickly depend on continuity with the Israeli civil administration. Daniel Rothschild, who runs the civil administration, says the top 1,500 policy- making civil servants in a bureaucracy of 24,000 are Israeli.

The specifications for some dollars 800m of projects - such as a desalination plant for seawater in Gaza - have been prepared, he says. These could go to tender and start within a year. Even if spread over a longer period, such spending would boost an economy with an output of just dollars 2.2bn a year and a population of 1.7 million.

But if the PLO insists on new assessments and specifications, there could be serious delays. The situation will have eerie parallels for students of British decolonisation in the Fifties. Although the Palestinian diaspora is well educated, and has substantial commercial acumen, it has little experience of public administration.

On the World Bank's central case, which assumes an outward- looking and free-trading economic policy, real living standards in the Palestinian entity could increase by 3 per cent a year. This is rapid by Middle Eastern standards, but would allow only a modest catch- up compared with the dynamic Israeli economy. Even that, though, depends on the Palestinians swallowing a lot of pride.

Tomorrow: Israel's future

(Photograph omitted)