A Structuralist Model of the Palestinian Economy: Who Bears the Economic Burden of the Israeli Occupation?

By Ibrahim Shikaki

This article formally examines the economic impact of Israeli movement restrictions on the Palestinian economy, taking into account the distribution of economic burden among Palestinian workers and capitalists. It utilizes a model that postulates restrictions as an external third claimant on income (together with wages and profits). It highlights the importance of a political economy lens that takes social classes into consideration, both in the presented stylized facts and in the formal model. Formally, instead of assuming that capitalists passively bear the full burden of the restrictions on their profitability, the new model assumes that capitalists channel the burden to workers via the nominal wage. It also adjusts the assumption that the savings rate is homogeneous between Palestinian workers and capitalists. The article derives the new specifications for the profit rate, capacity utilization and capital accumulation, and finds that shifting the distributional impact of movement restrictions has a clear impact on the short-run equilibrium levels of capacity utilization and capital accumulation.

1. Introduction

In recent years, the impact of the Israeli occupation on the Palestinian economy has been well-documented by international organizations. In 2016, the United Nations Conference on Trade and Development reported on the ‘staggering’ economic cost to the Palestinian economy, stating that the ‘[o]ccupation imposes a heavy cost on the economy of the Occupied Palestinian Territory, which might otherwise reach twice its current size’ (UNCTAD Citation2016, p. 1).

Since then, UNCTAD has released reports on the fiscal ‘leakage’ due to the occupation during the 2000–17 period, estimated to be $48 billion, or three times the Palestinian GDP in 2017 (UNCTAD Citation2019a), and on the costs of unrealized oil and natural gas potential (UNCTAD Citation2019b). Similarly, the World Bank concluded that Israeli-imposed movement restrictions ‘have been the main constraint to Palestinian economic competitiveness and have pushed private investment levels to amongst the lowest in the world’ (World Bank Citation2016, p. 5, emphasis added).

Whilst these recent reports and others document the empirical ramifications, very few have incorporated the economic impact from a theoretical or modeling perspective. The report on the forgone revenue of oil and natural gas (UNCTAD Citation2019b) attempts to conceptualize the economic costs using elements of New Institutional Economics and the Kaldor–Hicks potential compensation principle of welfare analysis. However, both theories are bound by the marginalist, neoclassical utility theory, and lack a political economy perspective. In contrast, the work of Botta and Vaggi (Citation2012) provides a sensible start for an alternative by utilizing a heterodox, post-Keynesian model.

Heterodox models, namely, post-Keynesian growth models, in the neo-Kaleckian tradition share common features that better suit stylized facts of contemporary economies. First, unemployment is a persistent feature in both the short and long runs; as such, labor supply is not a constraint on growth. Second, firms operate in a monopolistic competition framework where they have certain price-setting powers, and the mark-up pricing above costs determines the functional distribution of income between workers and capitalists. Third, firms operate with excess capacity in both short and long runs. Fourth, and finally, investment determines savings via income, capacity utilization and growth effects.

The article by Botta and Vaggi encapsulates the economic impact of the occupation via the higher transaction costs (and market fragmentation) that accompany Israeli restrictions on movement. The model incorporates transaction costs as a variable (θ)(�) that estimates the percentage loss of output through its effect on the mark-up and profitability of firms and capitalists. This article argues that, because of the weak bargaining power of Palestinian labor, it is more likely that capitalists channel the impact to workers via the nominal wage rather than passively bear the burden, and modifies the formal model as such.

This introductory section is followed by Section Two that profiles the key structural features of the Palestinian economy and its class transformation process. Section Three discusses the suitability of post-Keynesian, structuralist models for the Palestinian economy. Section Four briefly presents the key components of the original model presented in Botta and Vaggi (Citation2012). Section Five delves into modifying the model by shifting the burden of Israeli restrictions from capitalists (profits) to workers (wages), and adjusting assumptions regarding the savings rates of workers and capitalists. Section Six concludes.

2. A Political Economy Profile of the Palestinian Economy

2.1. 1967: Occupation and Dependency

After the military occupation of 1967, Israel issued hundreds of military orders that would become the law of the land in the West Bank and Gaza Strip (WBG). Some of the very first military orders would capitulate the economy of WBG to the Israeli military commander and stifle economic activity. For example, military orders 10, 11 and 12 outlawed all import–export activities (Samara Citation1989), while orders 7, 18, 26 and 30 effectively shut down all 30 bank branches in the WBG (UNCTAD Citation1989). These and other orders were coupled with an abrupt increase in prices (and costs) from opening up the economy of the WBG to the Israeli economy, which rendered small employers, the self-employed and unpaid family workers out of work.

Furthermore, restricted access to agriculture lands and the relatively higher wage in the Israeli economy eventually lead to an influx of Palestinian workers from the WBG to the Israeli economy, in a phenomenon that would entrench dependency on the Israeli labor market and would define the shape of the Palestinian economy until the current time. The resulting movement of Palestinian labor into the Israeli economy was massive. Israel was facing a shortage of unskilled labor, particularly in the construction sector, which would eventually employ at least 50 percent of Palestinian workers in Israel. In the first 20 years after 1967, the percentage of the Palestinian labor force working in Israel jumped from virtually 0 percent to a whopping 39 percent in 1987.

Figures from the period (1970–85) illustrate the scale of this dependency. The number of workers in the domestic economy was virtually stagnant during this 15-year period. In 1970 the domestic economy employed 152,677 workers compared to 152,881 workers in 1985. During the same period, the number of Palestinian workers in the Israeli economy increased from 20,500 to 89,200 in 1985, a 335 percent increase (Shikaki Citation2021a). Furthermore, while those in the domestic economy were not working in the Israeli economy per se, subcontracting became a leading feature in which Palestinians assembled and finished semi-processed Israeli material. The phenomenon would do little to enhance local productive capacity as ‘subcontracting shifted from one branch to another in line with the changing trade dynamism of a liberalizing Israeli economy, while technology transfer was minimal’ (Khalidi and Taghdisi-Rad Citation2009, p. 4). The domestic economy was never able to rid itself of this dependency or absorb its growing labor force internally. Figure 1 shows the visual correlation between the availability of work in Israel and the level of unemployment in the domestic economy.

Figure 1. Work in Israel vs Palestinian unemployment rate. Source: Calculated by author from CBS (Citation1993a) and PCBS (Citation1995–2019).

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But it would not only be the Palestinian labor force that would forcefully morph to suit the needs of the Israeli economy. In parallel, structural shifts in domestic economic sectors would follow. Prior to 1967, agriculture had been the backbone of the Palestinian economy, both in terms of employment and contribution to GDP. Agricultural products satisfied domestic needs and surplus was exported to neighboring Arab countries. After 1967, the contribution of agriculture to economic activity and employment gradually declined, making place for the ever-growing service sector that would serve to satisfy the demand from the Israeli economy, particularly trade and transportation services. Figure 2 traces the evolution of employment in agriculture and services for the domestic economy, excluding employment in Israel. Manufacturing would remain around 10 percent, albeit almost solely focused on subcontracting in light manufacturing such as textiles and footwear.

Figure 2. Contribution of agriculture and services to employment in the domestic economy. Source: Calculated by author from Farsakh (Citation2005, Table A5).

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As a result, the productive sectors were weakened and local production severely held back (Shikaki Citation2021b). At the same time, Palestinians were not short on purchasing power due to the remittance-like transfers from workers in Israel. The logical conclusion of work in Israel and a dwindling productive base was an increasing trade deficit that jumped 18-fold in the first 20 years after 1967 (UNCTAD Citation1993). Although Israel eventually allowed Palestinians to export part of their limited production to Jordan, the challenges of customs, transportation and infrastructure, as well as the skewed incentives Israel promoted through its ‘open bridges’ policy, would keep the Palestinian economy completely dominated by trade with Israel (Hilal Citation1975; Shikaki Citation2021a), and would drive Palestinian manufacturing towards ‘low value-added, uncompetitive, labour-intensive production processes’ (Khalidi and Taghdisi-Rad Citation2009, p. 3).

To summarize, in the first 20 years of the occupation, the Palestinian economy had gradually become dependent on the Israeli labor and goods market. Half of the labor force worked in or for the Israeli economy, which had become the undisputed trade partner for the WBG. Both the substantial level of remittances and the trade deficit with Israel will be used to justify the assumptions of the formal model.

2.2. 1993: Old and New Dependencies

The dependency on the Israeli labor and goods markets persisted following the signing of the Oslo accords and the establishment of the Palestinian Authority (PA) in 1993. In fact, several of these dependencies were formalized by economic agreements, most notably the semi-custom union that existed. This was ‘disastrous’ for the Palestinians because it meant the Palestinian economy was forced to ‘remain under the high Israeli cost structure, even though income and per capita levels were completely on different scales’ (Samhouri Citation2017). In terms of job creation, neither the newly-formed public sector nor the availability of jobs in the NGO sector and other professional services were able to compensate for the structural distortions, the lack of investment and the sheer physical destruction caused by the second Intifada in 2000.

As a result, employment still seemed to rely on external factors, namely, Israel issuing work permits for Palestinians. As Figure 1 showed, in the last 20 years, the minimum unemployment rate in the WBG was 20 percent. In the meanwhile, the Israeli economy was becoming more diversified, and replaced the dependency on low-skilled Palestinian labor with workers from Romania, Thailand and the Philippines. Non-Palestinian foreign workers increased from less than 20,000 in 1993 to 60,000 in 1994 and more than 100,000 in 1996 (Diwan and Shaban Citation1999). Israel would also diversify its trade partners. The WBG had been one of Israel’s main trading partners in the 1970s, second only to the US. As recently as 2018, the share of Israeli exports absorbed by the Palestinian goods market was around 5 percent, which is not insignificant but much less than it absorbed earlier. On the other hand, Israel is still the main trading partner of the WBG, accounting for 80 percent of Palestinian exports and 58 percent of imports (UNCTAD Citation2019c).

It is no surprise that, after 50 years of occupation and forced open trade with the Israeli economy, trade dominates economic activity in the WBG. In 2018, wholesale and retail trade accounted for 22 percent of GDP, followed by manufacturing (12 percent), public administration and defense (8.5 percent) and agriculture (7 percent) (PCBS Citation2019).Footnote¹ Recent data from the 2017 establishment census provides another angle: out of 166,486 economic establishments operating in the WBG, more than half (51 percent) operated in trade. The all-encompassing service sector provided 35 percent and another 13 percent operated in manufacturing. Going deeper in the ISIC classification, the predominant establishment in the WBG operated in ‘retail sales in non-specialized stores, with food, beverages or tobacco predominating’ (12 percent), followed by retail sales of food (7 percent) and clothing (7 percent). Maintenance and repair of motor vehicles is also prevalent (5 percent), while hairdressers accounted for 6 percent of economic establishments. As the reader can imagine, many of these economic units are very small; 89 percent of establishments employed 1–4 workers, while only 1.5 percent employed 20 or more. The majority are legally registered as sole proprietorship (88 percent), and only 677 (0.5 percent) are public shareholding companies (PCBS Citation2018).

This period would also witness new forms of dependence on international aid and private debt; the former will feature critically in the external sector of the formal model. In its early days, the PA would face a fiscal gap to finance both its developmental and recurrent expenditures, i.e., the public wage bill. While responsibility for the Palestinian population in WGB transferred from Israel to the PA (at least de facto), the Israeli government did not transfer control of natural resources, borders or monetary policy to the PA. International donors stepped in and committed $2.9 billion for the period 1994–98, but that amount was clearly insufficient. By 1996, as a quarter of the labor force was unemployed and a quarter of the population poor, donors committed an additional $845 million. The additional aid, expansion of the public sector and easing restrictions on movement imposed by Israel alleviated the overall macroeconomic situation until the eruption of the second Intifada in 2000. The largest spike in international aid ever since the inception of the PA, however, was that under Prime Minister Salam Fayyad (2007–13), a character widely accepted to have brought to the WBG a new wave of neoliberal policies and practices (Khalidi and Samour Citation2011). In the Paris donor meeting in 2007, donors pledged an estimated $7.4 billion for the PA under Fayyad. Figure 3 traces the overall development assistance per capita, together with GDP per capita for the period (1994–2018). Despite billions of dollars in aid, it proved to offer only a temporary boost and, not surprisingly, could not resolve the underlying structural distortions of dependency on the Israeli economy. Data on gross fixed capital formation in the last 25 years is evidence that the political process and international aid were not able to entice the animal spirits of investors. The form of investment in the WBG has remained mostly constant: the overwhelming portion of gross fixed capital formation is in the non-tradable, buildings sector (see Figure 5, later in this article).

Figure 3. Official Development Assistance and GDP per capita. Source: World Bank (Citation2020b) and PMA (Citation2020a).

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On average, from 1994–2018 the ratio of final household consumption to GDP was more than 90 percent, one of the highest levels on a global scale.Footnote² One way in which Palestinians were able to fuel that consumption, particularly after the second Intifada, was the abrupt availability of credit. After 2008, many of the strict requirements applied to private credit were removed, and a new law required banks operating in the WBG to extend 40 percent of their credit locally. Banks started promoting credit on a large scale and total credit facilities skyrocketed from $1.3 billion in 2008 to $7.1 billion in 2018, a 450 percent increase (PMA Citation2020b). More significantly, very little credit is directed to productive sectors. In 2018, only 1 percent and 6 percent of credit was allocated to agriculture and manufacturing, respectively. Real estate financing and trade financing accounted for approximately 22 percent of credit facilities each, while cars, credit cards and consumption goods totaled 33 percent (calculated by author from PMA Citation2020b; see Figure 4).

Figure 4. Percentage of gross fixed capital formation. Source: Calculated by author from PMA (Citation2020a).

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To summarize, most structural distortions persisted in the 1994–2020 period after the establishment of the PA, and would become worse with the eruption of the second Intifada in 2000. The dependency relationship continued in one direction, as Israel minimized its reliance on Palestinian labor and goods markets. Furthermore, new types of dependency on international aid and private credit emerged, in parallel with a neoliberal turn in PA policies.

2.3. Class Transformation

The final section of this profile involves a summary of class transformation since 1967. This section is necessary not only to justify using a two-class model, but also to explain why it is sensible to adjust the formal model presented in the work of Botta and Vaggi. Some of the very first signals of agrarian and class transformation in the Palestinian society date back to the mid-nineteenth century. The debt crisis of the Ottoman Empire forced it to change certain land laws, allowing for gradual land concentration. New immigration laws followed that allowed immigrants, including Jews fleeing antisemitism in Europe and Tsarist Russia, to resettle. In their efforts to buy land and property, Zionist organizations, including the Jewish Colonization Association (established in 1891) and the Jewish National Fund (established in 1901), distorted land prices by paying above-market prices and effectively removing them from the market (Naqib Citation2001). Later on, in the early twentieth century, the excessive taxes imposed by the colonial British mandate and its one-sided economic policies exacerbated these tendencies, forcing more farmers to sell their smaller plots of land (Farsoun and Aruri Citation2006). Finally, the 750,000 Palestinians who were forcibly removed from their land after the establishment of the state of Israel in 1948 lost their means of production and would later become either unemployed or wage workers.

More recently however, the occupation of 1967 would play the primary role in the completion of the proletarianization process. To assume that the shift to wage work in Israel after 1967 was a ‘rational’ decision, in other words, that the Palestinian peasant choosing wage work in Israel was a purely economic phenomenon due to higher wages, is hollowed out from the political and social context. Rather, to understand this political economy development, one must understand the demise of the prevalent, self-employed petty bourgeoisie and their transformation to wage workers in Israel. The petty bourgeoisie class was divided into three groups: the agriculture component of this class bore the most severe impact. Instead of Marx’s (Citation1976) ‘primitive accumulation’ or Harvey’s (Citation2004) ‘accumulation by dispossession’, Palestinians faced more direct dispossession through land confiscation, leaving them with only their labor to sell. Land confiscation for Israeli settlements in the WBG was at its highest levels between the mid-1970s and mid-1980s. The number of Palestinians working in Israel jumped from 66,000 to 89,000 in the 1975–85 period, a 35 percent increase. Many of those who shifted to work in Israel used to be employed in agriculture: during that same period, the number of Palestinians working in agriculture within the domestic economy decreased from 45,000 to 37,000 workers (Farsakh Citation2005, Table A5).

The industrial component of the petty bourgeoisie class faced a similar fate. Israel controlled all borders and the entry of machinery, intermediate goods and raw materials. Moreover, Israeli producers used capital-intensive production and benefited from state subsidies and hence were able to dump their goods in the Palestinian market at low prices with which Palestinian small producers could not compete. Finally, smaller-scale industrial producers were unable to compete with the higher wages paid by Israeli capitalists or Palestinian large producers who were paid hefty incentives to sell their products outside the local market and open the market to Israeli products. As a result, many wage workers, self-employed and unpaid family members in these small enterprises were forced to seek wage labor in Israel. The third and final component of the petty bourgeoisie class is the trade component. Smaller merchants, traders and craftsmen had to turn to wage labor as well. They were unable to cope with Israeli taxes and the ever-increasing cost of living that accompanied the opening up to the Israel economy. In sum, the prevalent petty bourgeoisie class was unable to cope with increasing costs and occupation policies, and was forced to seek wage labor in the Israeli market, intensifying the proletarianization process. As one indicator of the demise of the petty bourgeoisie, self-employment fell from 45 percent in 1969 to a mere 25 percent in 1987 and remain around 20 percent today. Figure 5 compares work in Israel and the shift from self-employment to wage work during the first 20 years of the occupation.

Figure 5. Wage workers vs work in Israel. Source: Calculated by author from Farsakh (Citation2005) and CBS (Citation1993b).

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As the section above showed, the post-1994 era did not exhibit any structural break in terms of economic activity or the dependency relationship. However, developments in the institutional framework would have an impact on the dynamism of class formation. This era would witness the rise of a new ‘professional’ middle class fueled by the creation of the PA public sector, the establishment of local and international NGOs and the availability of professional private sector employment opportunities made possible through the arrival of a segment of Palestinian capital from the Gulf countries. Following Hilal’s (Citation2006) method, we identify the new professional middle class as those who occupy the following two types of occupation: ‘legislators, senior officials & managers’ and ‘professionals, technicians, associates & clerks’. During the last 20 years, the size of this new middle class grew from 20.6 percent in 1997 to 36.9 percent in 2017. In comparison, before the political process and the establishment of the PA, the professional class was significantly smaller (10.8 percent of the labor force in 1989).Footnote³ For a detailed breakdown of the years covered by the population census, see Table 1.

Table 1. Distribution of labor force according to type of occupation.

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The other important class development after 1994 was within the capitalist class. As early as 1948, the capitalist class had already begun to flee and move their capital to neighboring Arab and Gulf countries. The remaining capitalists accounted for a small segment of society: as a proxy, the category of ‘employers’ in labor force surveys fluctuated around 2 percent during the 1967–91 period, and grew after the establishment of the PA to around 7 percent. Part of what explains this development, is that, after 1994, a number of Palestinian capitalists and businessmen would return and ‘dominate’ the Palestinian economy, despite the fact that their main source of capital accumulation would remain predominantly in the Gulf states. The holding companies controlled by them invested in a wide array of sectors, including financial institutions, to the extent that it was ‘almost impossible to find a large or medium-sized company in which they do not own a significant stake’ (Hanieh Citation2011, p. 95). Part of this dominance was facilitated by the public and private monopolies that came about through ‘crony capitalism’ relationships between these capitalists, the PA and Israeli political and security officials (Dana Citation2020). As early as the mid-1990s, a few years after the establishment of the PA, US officials had identified that five members of the upper echelons of the PA had already secured control of 13 of those monopolies (Samara Citation2000).

In sum, the post-Oslo era would see the rise of a new ‘professional’ middle class fueled by the creation of the PA public sector, the establishment of local and international NGOs, and the availability of professional private sector employment opportunities made possible through the arrival of a segment of Palestinian capital from the Gulf countries. As a result of the latter, a new form of capitalist class would arise.

3. A Kaleckian, Post-Keynesian Growth Model of the Palestinian Economy?

In his introduction to a special volume on Kaleckian modeling, Amitava Dutt (Citation2012) remarks that Kalecki’s work has been an inspiration ‘for those who take the view that the unemployment of resources, such as labor and capital, can persist in the economy over long periods of time and who seek to develop models that take into account important behavioral and institutional features of real economies, rather than relying on the optimizing agent as a basis for analysis’ (p. 1).

The economic, political and class context of the Palestinian economy detailed in the previous section requires a more nuanced approach than is possible with the neoclassical one currently adopted by international institutions (Astrup and Dessus Citation2005; World Bank Citation2017) or presented in earlier development models such as those of Lewis (Citation1954) and Harris and Todaro (Citation1970). The development models are subject to the same line of criticism as other neoclassical models; they equate savings with investment, assuming away any problems with inducing investment, and explain the economic context of developing countries as an instance of optimizing decision-making (Chakravarty Citation1987).

Instead, heterodox growth modeling that presents stylized facts akin to Kaldor (Citation1957) and respects the structural and institutional peculiarities of developing countries a la Taylor (Citation1983, Citation1990) is better suited to the task. In the spirit of the quote from Dutt (Citation2012) above, Foley and Taylor (Citation2006) note that heterodox models in general, including post-Keynesian variants, share several core insights. Unlike neoclassical models, heterodox models focus on the functional distribution of income, avoid model closures that imply full employment; present differential modeling of consumption and saving decisions for workers and capitalists; and adopt an investment demand function independent of saving decisions.

In particular, neo-Kaleckian variants of post-Keynesian growth models posit a steady-state rate of accumulation simultaneously with a steady-state degree of capacity utilization differing from its normal rate, and suggest that investment decisions of firms are captured by a separate investment function, which normally entails a variable representing animal spirits.Footnote⁴ Some of the earliest contributions to this strand were provided by Asimakopulos (Citation1975) and Harris (Citation1975). However, the first model to present an endogenous investment function was by Rowthorn (Citation1981), followed by contributions from Amadeo (Citation1986), Dutt (Citation1984) and Taylor (Citation1985), among others.Footnote⁵ Similar to Steindl (Citation1952), Botta and Vaggi present a ‘stagnationist’, wage-led growth model in which higher mark-up of firms, i.e., larger profit shares, decrease overall capacity utilization, general profit rate and accumulation rates, and lead to stagnation in the economy. The works of Blecker (Citation1989) and Bhaduri and Marglin (Citation1990) propose a specification for the investment function that includes the profit share rather than the profit rate. This alteration allows for results that are not necessarily wage-led but can also be profit-led or ‘exhilarationist’. Further clarifications of and additions to the simple closed economy were introduced by Hein (Citation2006), Lavoie (Citation1992) and Lima and Setterfield (Citation2010), among others.

The model below follows the aforementioned literature. Utilizing different variants of post-Keynesian, two-class, one-sector growth models is popular with scholars interested in the impact of distribution on growth. Furthermore, many economists in developing countries, especially in Latin America, have adopted a ‘structuralist’ approach described as ‘a combination of abstract descriptions of the structures that Third World scholars have always emphasized with analytical models largely developed by Keynes, Michal Kalecki, and their followers of the Cambridge School’ (Taylor Citation1983, p. 4). An industrial, one-sector model is employed in many structuralist models for developing countries. While it is understood that manufacturing accounts for only a small percentage of total value added and employment in developing countries, including the Palestinian economy, the manufacturing sector and related activities play a central macroeconomic role (Taylor Citation1983): the industrial sector often grows faster than the rest of the system and is more responsive to policy tools. Moreover, it is normally characterized by excess capacity, and as such its adjustments take place on the quantity side, following Keynesian reasoning. Finally, prices in the industrial sector are likely to be fixed in the short run by relatively stable markups over variable cost, similar to the Kaleckian cost-plus approach. As noted above, after the early 1990s a significant amount of new capital coming from the Gulf countries was directed towards trade and services, not manufacturing. Still, while large-scale industrial enterprises did not materialize, the highly adaptive manufacturing private sector managed to survive. According to the 2017 establishment census, 12.5 percent of economic enterprises in the WBG worked in manufacturing (food processing and light manufacturing), second only to wholesale and retail trade (51 percent).

A two-class model is not a foreign concept to the current Palestinian economy. On the one hand, as we detailed in the above section, Palestinian society experienced an intense process of proletarianization after 1967. In the current state of the economy, 71 percent of the labor force are wage workers. It is true that a portion of that figure are part of the ‘new’ middle class, but more than half of the labor force occupies jobs that are classified as elementary occupations, trade and market workers, and assemblers (PCBS Citation2018). On the other hand, after the establishment of the PA in 1994, Palestinian capitalists, especially those with closer ties to the political ruling class, became a more differentiated and prevalent class. The total number of Palestinian ‘employers’ increased from 5748 (2 percent labor force) in 1991 to 32,970 (6 percent) in 1995, and 65,845 (6.5 percent) in 2019. The recovery is chiefly attributed to heightened ‘animal spirits’ and expectations following a series of developments. Licensing for businesses in areas under control of the PA became considerably easier after 1994. The Palestinian Investment Promotion Agency (PIPA) was created and an investment promotion law was enacted to encourage domestic investment and foreign direct investment (FDI). Banking and other credit institutions became more widespread. Moreover, international aid was channeled to various economic sectors and loan guarantee programs from international institutions such as the World Bank’s Multilateral Investment Guarantee Agency (MIGA) became available. This enthusiasm, however, was short-lived, and capital formation remained extremely low compared to expectations. This was partly because of the continuation of Israeli control over natural resources, borders and policies, and partly due to the corruption, nepotism and lack of transparency on the part of the PA.

Aside from the previous criteria for utilizing a one-sector, two-class type of model, many of the long-standing economic issues facing the (WBG) are Keynesian in nature. Botta and Vaggi (Citation2012) argue that ‘the depressed domestic investment climate is, by far, the main problem Palestine has to tackle in order to unleash its growth potential’ and that ‘low levels of investment in Palestine do not seem to be the result of lack of savings’ (p. 204). Instead, they stipulate that chronic Palestinian unemployment is strongly connected to a problem of effective demand in which case ‘neo-classical-type relative price adjustments are unlikely to be useful for restoring full employment  …  the Palestinian price system only partially responds to macroeconomic imbalances. As a consequence, quantity-driven adjustments, instead of price-driven adjustments, may take place inside the economy’ (pp. 207–208).

4. The Botta–Vaggi Model

The model describes the Palestinian economy as ‘demand-driven’ and attempts to understand how the Israeli occupation impacts profitability, capacity utilization and investment, and ultimately how growth is affected. The model incorporates transaction costs due to movement restrictions as a variable (θ�) that estimates the ‘percentage loss of output’ through its impact on the mark-up and as such on profitability. This variable is meant to be an overarching variable that incorporates restrictions on movement of both goods and labor, internally and externally, simultaneously. As such the loss in output could be a result of restrictions on movement of goods on external borders, inefficient trucking systems enforced by Israel (the so-called back-to-back system), and import/export administrative delays. It could also be a result of restrictions on Palestinian workers entering the Israeli market to work. The income from the latter is significant, which is why the model accounts for it as (Ω)(Ω) in equation (7) below.Footnote⁶

In the last 20 years, movement restrictions have been identified as one of the key impediments to investment and growth. The occupation-imposed restrictions were scaled up after the early 1990s, and re-envisioned completely after the second Intifada into a sophisticated web of geographical control.Footnote⁷ The impact of these long-lasting restrictions is far more than temporary. Rather, they have affected the structure of investment and growth as they create ‘a high risk of disruption in projects or trade and have kept investment levels low, resulting in a bias towards non-traded services which have less potential for productivity growth’ (World Bank Citation2020a, p. 5).

In the West Bank alone, there were more than 700 obstacles to movement in 2018 (UNOCHA Citation2018). These range from large-scale checkpoints, to road ditches, road gates and the system attached to the illegal Separation Wall.Footnote⁸ Moreover, Israel imposes an inefficient ‘back-to-back’ system in order to move Palestinian goods across trade borders, increasing transportation costs significantly. In the Gaza Strip, a siege that has been in place since 2007 suffocates most economic activity, and has lead to the capacity utilization of Gaza’s economic units to contract to an all-time low of 20 percent. In a special report on the impact of Israeli movement restrictions, the Applied Research Institute of Jerusalem, (ARIJ) employed 70 vehicles and installed tracking devices in them for a period of 6 months, collecting 18 million records during 2018. The impact of restrictions (delays and closure) on labor force hours only was an estimated 60 million labor force hours, or approximately $274 million annually (ARIJ Citation2019).

This section presents the basic components of the model, the results of the model’s short-run equilibrium, together with brief notes of clarification on their choice of variables.

4.1. Model Components

Assuming a small, open economy that produces a single tradable good, Botta and Vaggi present income distribution in a manner that depicts the transaction costs from movement restriction as an external claimant on income, together with wages and profits. More precisely, they introduce a variable that accounts for the loss in output/income:P¯¯¯(1−θ)X=wL+rPIK�¯(1−�)�=��+����(1)where (P¯¯¯)(�¯) is the price of total output and is considered exogenous, (θ)(�) is introduced as the percentage loss of output resulting from transactions costs, (X)(�) is total output, (w)(�) is the nominal money wage (in the domestic economy), (L)(�) is total labor, (r)(�) is the profit rate, (PI)(��) is the price of capital stock and (K)(�) is the total capital stock.Footnote⁹

Pricing decisions follow a Kaleckian mark-up or cost-plus function. As in equation (1), the domestic price (P¯¯¯)(�¯) is considered exogenous according to the ‘small economy’ assumption. In other words, since Palestinian firms are exposed to strong competition from foreign firms, they become price takers:P¯¯¯=(1+τ)wb(1−θ)�¯=(1+�)��(1−�)(2)orτ=P¯¯¯(1−θ)wb−1�=�¯(1−�)��−1where (τ)(�) is the mark-up, (b)(�) is the labor output coefficient (b=L/X)(�=�/�) such that (1/b)(1/�) represents labor productivity. Introducing the variable (θ)(�) allows us to consider two related outcomes: first, as the level of (θ)(�) increases, the mark-up, and hence profitability, will decrease; second, that the ‘ex-post’ effective value added per worker can be represented as (1−θ)/b(1−�)/�, such that (1−θ)/b<1/b(1−�)/�<1/� when θ>0�>0.

The profit rate as well as the mark-up are considered residual variables. This is because the authors assume that the domestic money wage (w)(�) is fixed ‘according to a Lewis-type argument, i.e. due to the existence of both open and disguised unemployment’ (Botta and Vaggi Citation2012, p. 210). The profit rate is denoted as follows:r=[p(1−θ)−ωpb]u�=[�(1−�)−���]�(3)where (ω)(�) is the real wage (ω=w/P¯¯¯�=�/�¯), p is the price index of capital goods(p=P¯¯¯/PI)(�=�¯/��), and (u)(�) is a measure of capacity utilization (u=X/K)(�=�/�).Footnote¹⁰

Unlike the tradition in neo-Kaleckian models, which either assume that workers do not save or that they save less than capitalists, Botta and Vaggi assume a homogeneous saving propensity for both wage and profit earners.Footnote¹¹ The savings equation is presented below:S=Sπ+Sw�=��+��(4)S=s(rPIK)+s(wL)=s(rPIK+wL)=s(1−θ)P¯¯¯X�=�(����)+�(��)=�(����+��)=�(1−�)�¯�where (S)(�) is total savings and (s)(�) is the savings rate that is assumed to be homogeneous between capitalists and workers.

By dividing both sides of the last equation by (PIK)(���), we get the equation for the growth rate gs�� when S=I�=�.gs=SPIK=s(1−θ)pu��=����=�(1−�)��(5)The specification of the investment function is an ‘ad hoc’ one that describes investment decisions ‘in an open economy characterized by a high degree of uncertainty and social and political instability’ (Botta and Vaggi Citation2012, p. 212).gi=ρ+α(u−un)+γrn��=�+�(�−��)+���(6)Here, (ρ)(�) represents the animal spirit of Palestinian entrepreneurs, which is linked to average growth sales and a function of population (n)(�), expected market sales vis-à-vis foreign products (she)(�ℎ�), and potential markets effectively reached (λ)(�). The ‘normal’ measure of capacity utilization and the expected profit rate are denoted by (un)(��) and (rn)(��), respectively.

Finally, the external account reflects the high levels of remittances and current transfers that help offset the large trade deficit, as well as international loans and foreign aid:(EX−M)+Ω=−Sf(��−�)+Ω=−��(7)where (EX)(��) is exports, M is imports and (Ω)(Ω) is the sizable foreign remittances and current transfers that help offset the large trade deficit. (Sf)(��) is foreign savings, which mostly includes loans and foreign aid.

4.2. Short-run Equilibrium

The model follows Taylor (Citation1983), and as such Botta and Vaggi take three steps: first, they normalize equation (7) by the capital stock; second, they define (Δ)(Δ) as (CA/KPI)(��/���) whereCA=(EX−M)+Ω��=(��−�)+Ω; and third, given that in an open economy domestic investment is equal to domestic saving minus the current account balance, present equation (8) as the equilibrium condition:gi=gs−Δ��=��−Δ(8)The equilibrium levels of (u)(�) and (g)(�) are found by substituting equations (3), (5) and (6) in equation (8) and rearranging:u∗=ρ+[γ(p(1−θ)−ωpb)−α]un+Δ[sp(1−θ)−α]�∗=�+[�(�(1−�)−���)−�]��+Δ[��(1−�)−�](9)andg∗=sp(1−θ)u∗−Δ�∗=��(1−�)�∗−Δ(10)If we keep in mind that the term [p(1−θ)−ωpb]un[�(1−�)−���]�� reflects the expected profitability from equation (3), then the numerator in equation (9) explains that the measure of capacity utilization is positively influenced by animal spirits (ρ)(�), the response of desired investment to the domestic excepted rate of profit (γ)(�), and expected profitability. On the other hand, capacity utilization is negatively affected by the high current account deficit (assuming Δ<0Δ<0). Finally, normal capacity utilization has an ambiguous effect.Footnote¹²

Analytically the short-run effects of (θ)(�), i.e., du∗/dθ��∗/�� are ambiguous (see Section 5.4 for details). In a previous version of this paper (Botta and Vaggi Citation2011), the authors formally set the necessary conditions to demonstrate that an increase in (θ)(�) leads to a sufficiently large contraction in desired investment such that the final sign of du∗/dθ��∗/�� is negative. As such, Botta and Vaggi choose to show the effects graphically (Figure 6) while stating that, without the necessary conditions, the final outcome would not be clear. A rising value of θ� rotates the savings supply function downwards and simultaneously also shifts the investment demand function downwards. If desired investment sufficiently contracts, the economy would move from point 1 to point 2.

Figure 6. The short-run effects of increasing transaction costs. Source Botta and Vaggi (Citation2012, p. 216).

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5. Adjusting the Model: A Political Economy Lens

What this model misses is a political economy lens. This is understood not only as an intersection of politics and economics but also as one that takes into account class and power in the surplus-generating relationship. Two shortcomings in the Botta and Vaggi model arise. First, unlike the literature and based on the tenet of post-Keynesian modeling, Botta and Vaggi assume a homogeneous savings rate, claiming that in Palestinian society one cannot distinguish between different social classes in terms of savings and consumption. Second, the way (θ)(�) is presented conveys only part of the story, particularly the impact on Palestinian capitalists. It does not take into consideration that transaction costs might be channeled to Palestinian workers through wages. I will start with the second shortcoming.

Before adjusting, it is useful to imagine total income before and after the impact of the Israeli measures analytically. Equation (11) represents total income without the restrictions:P¯¯¯X=W+Π�¯�=�+Π(11)where (P¯¯¯X)(�¯�) is the value of total income, (W)(�). is total wages or the wage bill and (Π)(Π) is total profits. If we now take into account the impact of Israeli movement restrictions on output and income, we can represent the new effective income as:P¯¯¯X(1−θ)=W+Π−θP¯¯¯X�¯�(1−�)=�+Π−��¯�(12)where P¯¯¯X(1−0)�¯�(1−0) is the effective income after the restrictions and (θP¯¯¯X)(��¯�) is the portion of output (and corresponding income) that is forgone due to the restrictions. In treating profit as a residual, the original model assumes the mark-up firms desire is not the realized mark-up; rather, firms passively accept the cost consequences of the restrictions. Hence, capitalists bear the burden and face diminished total profits relayed through the mark-up and the profit rate. Rearranging equation (12) makes it clearer, analytically:P¯¯¯X=W+ΠN+θP¯¯¯X�¯�=�+Π�+��¯�(13)where (ΠN=Π−θP¯¯¯X)(Π�=Π−��¯�) is the ‘new’ total profits after the impact of the Israeli measures is relayed from the mark-up to the profit rate and then to total profits, as a result ΠN<ΠΠ�<Π.

Botta and Vaggi argue that, while the original model presents one case, it is one extreme where all the burden is borne by capitalists’ profits. The other (extreme) case to be explored is one where, rather than passively accepting this hit to profits, capitalists will channel the whole burden to workers via the nominal wage.

In reality, of course, it is expected that both wages and profits will be impacted via some sort of weighted impact according to institutional and historical variables that tilt the bargaining power of each side. Still, I argue for theoretically exploring the impact of workers bearing the full burden on capacity and accumulation. Section 5.1 advances the argument that, during heightened movement restrictions, it is much more likely that workers, not capitalists, will bear the brunt of those restrictions.

5.1. Downward Wage Flexibility in the Domestic Economy

It is important to justify the theoretical assumption above, i.e., that at times of high movement restrictions, wage workers in the domestic Palestinian economy ultimately bear the burden of Israeli policies via their wages. Arguments to the contrary exist, and should be entertained, despite their neoclassical origin that pays little attention to class or the bargaining power of labor. The arguments are normally centered around wage rigidity within the domestic Palestinian economy; namely, that domestic wages remain artificially high because of the large segment of Palestinian labor working in the Israeli economy, and earning higher wages. In fact, many supporting such view would argue that the results are those of a textbook neoclassical labor market in which the high level of unemployment is caused by an equilibrium real wage that is higher than the market clearing wage.

Again, this argument is hollowed out by a political economy lens that touches on the bargaining power of labor. First, after the relatively low unemployment rates witnessed until the late 1980s (Figure 1), unemployment averaged (20–30 percent) in the last 20 years, greatly affecting bargaining power. Second, Palestinian workers face extremely low legal and other protections because they are engaged in widespread informal work even within the industrial sector. Figures from labor force surveys indicate that only 32 percent of wage workers have a written contract, 29 percent receive employer contributions to their pension funds, and 16 percent receive contribution to private health insurance (PCBS Citation2020).

More importantly, empirical evidence from the last 20 years strongly suggests that the notion of an artificially high domestic wage does not hold. Instead, there is evidence that real wages have declined in the face of heightened movement restrictions and the weak bargaining power of Palestinian labor.Footnote¹³ Naqib and Hamed (Citation2006) use a basic growth accounting exercise for the period 1996–2004 to study the wage–productivity gap that ‘was thought to be the result of an upward pressure on wages created by the employment of almost one third of the Palestinian labor force in Israel’ (Naqib & Hamed Citation2006, p. 1). They conclude that ‘the gap which existed in the 1970s and the 1980s no longer exists. In fact, it is found to be negative during the period 1996–2004, reflecting a negative growth rate of wages’ (Naqib & Hamed Citation2006, p. 1, emphasis added).

Indeed, data from the Palestinian Central Bureau of Statistics (PCBS) and collected in times-series by the Palestinian Monetary Authority (PMA) show that real wages decreased by more than 2 percent during heightened restrictions (PMA Citation2020c). The more recent work of Calì and Miaari (Citation2018) on Israeli restrictions estimates that such restrictions translate into costs of between $153 and 166 million or between 4 and 4.4 percent of West Bank GDP (in 2007). According to the authors, ‘most of these costs are due to lower wages’ (p. 150). In the same vein, Flaig et al. (Citation2013) find that liberalization of Israeli labor policy, i.e., easing of restrictions, leads to a rise in labor income and vice versa.

Aside from wages, the evolution of the wage share, understood as the portion of national income that is earned by wage workers, is another sign of the bargaining power of labor. The work of Larudee (Citation2012) on functional distribution of income, questions who earns the fruit of international aid and the resulting growth in the period following 2006.Footnote¹⁴ The author shows that ‘the real average daily wage fell sharply in the whole Palestinian economy’ and that the gains for labor from economic growth ‘were almost entirely limited to employment benefits’ (p. x). She concludes that the ‘inescapable conclusion is that for the whole Palestinian economy the disproportionate beneficiaries of growth from 2006 to 2010 were the recipients of non-labor incomes such as profit, interest, and rent’ (Larudee, Citation2012, p. x, emphasis added). While no official wage share series on the Palestinian economy is published by PCBS, one proxy can be calculated from the Economic Survey Series that includes the compensation of employees and gross value added for economic establishments in selected economic sectors. Calculating the wage share as the ratio of compensation over value added shows that the wage share falls significantly, from 35 percent to 26 percent during the years of heightened Israeli movement restrictions (2002–06) (PCBS Citation2008).

5.2. The New Structure

The above section provides sufficient evidence to entertain the notion that workers’ wages are negatively impacted during heightened movement restrictions. To present our model analytically, it is prudent to imagine how income distribution would change. While total income (P¯¯¯X)(�¯�) and the value lost (θP¯¯¯X)(��¯�) do not change, the new distribution of income can now be presented as:P¯¯¯X=WN+Π+θP¯¯¯X�¯�=��+Π+��¯�(14)where (WN=W−θP¯¯¯X)(��=�−��¯�) is the ‘new’ total wages after the impact of the Israeli restrictions is channeled to workers via the nominal wage to total wages, as a result WN<W��<�.

After setting the new income distribution, the next step in the structure of the model is to define the profit rate. The new profit rate (rN)(��) is derived from (14), as follows:Π=P¯¯¯X−θP¯¯¯X−WN=P¯¯¯X(1−θ)−W+θP¯¯¯XΠ=�¯�−��¯�−��=�¯�(1−�)−�+��¯�dividing both sides by PIK���rN=ΠPIK=P¯¯¯PIXK(1−θ)−wP¯¯¯P¯¯¯PILXXK+θP¯¯¯PIXK=pu(1−θ)−ωpbu+θpurN=p(1−ωb)u��=Π���=�¯����(1−�)−��¯�¯������+��¯����=��(1−�)−����+�����=�(1−��)�(15)This modification, however, is incomplete, and equation (15) does not accurately represent the new profit rate. The original model assumes the mark-up shrinks while workers are paid normally (nominal and real wages are fixed). As a result, in the second line of equation (2), the nominal wage is constant and the mark-up adjusts. In our version, this will completely flip. We assume that capitalists see the impact of (θ)(�) coming and exercise their bargaining power vis-à-vis labor to recover the value from the wage bill appropriated by Israeli restrictions. Analytically, we assume that it is the mark-up that will remain fixed, and the nominal (and real) wage will bear the full burden and hence will change. Consequently, the real wage (ω)(�) in equation (15) must reflect this assumption, as captured by equation (2).Footnote¹⁵ By simple rearrangement of equation (2), we can now represent real wages as:ω=wP¯¯¯=(1−θ)(1+τ)b�=��¯=(1−�)(1+�)�(16)by substituting (16) in (15)rN=p(1−ωb)urN=p(1−(1−θ)1−τ)urN=p(τ+θ1+τ)u��=�(1−��)���=�(1−(1−�)1−�)���=�(�+�1+�)�(17)The next step is to specify the savings equation and, unsurprisingly, the savings equations (4) and (5) representing the growth rate at S=I�=� will not change. This is due to the fact that (i) the total effective income has not changed compared to the original model and, more importantly, (ii) the assumption in the original model of a homogeneous savings rate implies that, while the share of income that flows to workers and capitalists has changed, total savings (S)(�) and hence (gs)(��) have not.Footnote¹⁶ We can show this analytically as follows:S=Sπ+Sw=s[Π+WN]�=��+��=�[Π+��](4)substituting (Π)(Π) with the term from equation (14)=s[(P¯¯¯X−θP¯¯¯X−WN)+WN]=s(P¯¯¯X−θP¯¯¯X)S=s(1−θ)P¯¯¯X=�[(�¯�−��¯�−��)+��]=�(�¯�−��¯�)�=�(1−�)�¯�identical to the original model we divide by PIK���gs=SPIK=s(1−θ)P¯¯¯PIXKgs=s(1−θ)pu��=����=�(1−�)�¯������=�(1−�)��(5)The investment function changes insofar as it reflects the new specification of the profit rate (rN)(��). As such, equation (6) is rewritten as:gi’=ρ+α(u−un)+γrNn��′=�+�(�−��)+����(18)The external account specifications do not change and so we use the same equation (7):(EX−M)+Ω=−Sf(��−�)+Ω=−��(7)

5.3. Short-run Equilibrium and Comparative Statics

Following the original model, in an open economy domestic investment is equal to domestic saving minus the current account balance. Equation (8) is rewritten as:gi’=gs−Δ��′=��−Δ(19)(gi’)(��′)is found by substituting (17) into (18)gi’=ρ+α(u−un)+γ[p(τ+θ1+τ)un]��′=�+�(�−��)+�[�(�+�1+�)��](20)By substituting equations (20) and (5) into (19), we are able to find the equilibrium levels of (u∗),(�∗), (r∗)(�∗) and (g∗)(�∗):gi’=gs−Δ��′=��−Δρ+α(u−un)+γ[p(τ+θ1+τ)un]=s(1−θ)pu−Δ�+�(�−��)+�[�(�+�1+�)��]=�(1−�)��−Δρ+[γp(τ+θ1+τ)−α]un=s(1−θ)pu−Δ−αu�+[��(�+�1+�)−�]��=�(1−�)��−Δ−��u∗=ρ+[γp((τ+θ)(1+τ))−α]un+Δ[s(1−θ)p−α]�∗=�+[��((�+�)(1+�))−�]��+Δ[�(1−�)�−�](21)r∗=p(τ+θ1+τ)u∗�∗=�(�+�1+�)�∗g∗=s(1−θ)pu∗�∗=�(1−�)��∗g∗=s⎛⎝⎜⎜⎜1−θ⎞⎠⎟⎟⎟p⎛⎝⎜⎜⎜ρ+[γp((τ+θ)(1+τ))−α]un+Δ[s(1−θ)p−α]⎞⎠⎟⎟⎟−Δ�∗=�(1−�)�(�+[��((�+�)(1+�))−�]��+Δ[�(1−�)�−�])−Δ(22)In order to study the impact of (θ)(�) on the short-run equilibrium levels of capacity utilization, and understand how the result is different (or not) from the original model, we attempt to find the sign of du∗/dθ��∗/��:u∗=ρ+[γp((θ+τ)(1+τ))−α]un+Δ[s(1−θ)p−α]�∗=�+[��((�+�)(1+�))−�]��+Δ[�(1−�)�−�]du∗dθ={ρ+[γp((θ+τ)(1+τ))−α]un+Δ}'[s(1−θ)p−α][s(1−θ)p−α]2−[s(1−θ)p−α]'{ρ+[γp((θ+τ)(1+τ))−α]un+Δ}[s(1−θ)p−α]2��∗��={�+[��((�+�)(1+�))−�]��+Δ}′[�(1−�)�−�][�(1−�)�−�]2−[�(1−�)�−�]′{�+[��((�+�)(1+�))−�]��+Δ}[�(1−�)�−�]2du∗dθ={unγp1+τ}[s(1−θ)p−α][s(1−θ)p−α]2−[−sp]{ρ+[γp((θ+τ)(1+τ))−α]un+Δ}[s(1−θ)p−α]2��∗��={����1+�}[�(1−�)�−�][�(1−�)�−�]2−[−��]{�+[��((�+�)(1+�))−�]��+Δ}[�(1−�)�−�]2We can infer from the sign of the derivative without needing to simplify further.

• The term (unγp/1+τ)(����/1+�) is positive by definition since (un,γ,p,τ)>0(��,�,�,�)>0.
• The term [s(1−θ)p−α][�(1−�)�−�] is positive because it represents the Keynesian stability condition: the sensitivity of savings to capacity utilization, represented by the slope of gs�� or s(1−θ)p�(1−�)�, is larger than the sensitivity of investment to capacity utilization, represented by the slope of gi�� or (α)(�).
• The term (−∗−sp=sp)(−∗−��=��) is positive by definition.
• The term {ρ+[γp((θ+τ)/(1+τ))−α]un+Δ}{�+[��((�+�)/(1+�))−�]��+Δ} is positive because it represents the numerator of the equilibrium level of capacity utilization in our model.

As such, we can conclude that du/dθ>0��/��>0. We can also observe the results graphically. If we assume our original equilibrium levels of u∗1�1∗ and g∗1�1∗, then an increase in the movement restrictions (θ)(�) will have two impacts graphically. First, the slope of gs��, which is s(1−θ)p�(1−�)�, will decrease and rotate the curve downwards; second, the new specification of rN�� in equation (17) indicates that the intercept of gi�� will increase as(θ)(�) increases, shifting the curve upwards. The unambiguous result is an increase in the short-run equilibrium level of capacity utilization and capital accumulation (Figure 7).

Figure 7. The short-run effects of increasing transaction costs in the new model.

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Intuitively, what the analytical and graphical results show are the results of the two channels (savings and investment) in which higher transaction costs impact the model. In terms of savings, the higher level (θ)(�) will decrease total income and, as a result, domestic savings (see second line of equation [4]). Ceteris paribus, this would increase capacity utilization that would operate to ‘fill the savings gap between savings supply and the investment demand’ (Botta and Vaggi Citation2011, p. 15). As for investment, the new expected profitability (equation 17), which features in the new investment demand function (equation 18), explains that, if the full burden of the transaction costs can be channeled to the workers via nominal and real wages, expected profitability and hence investment demand would increase. Both of these channels result in an increase in short-run equilibrium levels of capacity utilization and capital accumulation.

5.4. Comparing with the Original Model

It is clear that the short-run results of the model contrast with the results of Botta and Vaggi (Citation2012). The graphical representations of the short-run impact in the original model are shown in Figure 6. Their paper, however, does not include the algebraic work that determines the sign of (du/dθ),(��/��),and so we attempt to show how they reach their result analytically. We start with the equilibrium level of (u∗)(�∗), as stated on p. 215:u∗={ρ+[γ(p(1−θ)−ωpb)−α]un+Δ}(sp(1−θ)−α)�∗={�+[�(�(1−�)−���)−�]��+Δ}(��(1−�)−�)du∗dθ={ρ+[γ(p(1−θ)−ωpb)−α]un+Δ}'[sp(1−θ)−α][sp(1−θ)−α]2−[sp(1−θ)−α]{ρ+[γ(p(1−θ)−ωpb)−α]un+Δ}−[sp(1−θ)−α]2��∗��={�+[�(�(1−�)−���)−�]��+Δ}′[��(1−�)−�][��(1−�)−�]2−[��(1−�)−�]{�+[�(�(1−�)−���)−�]��+Δ}−[��(1−�)−�]2du∗dθ={−unγp}[sp(1−θ)−α][sp(1−θ)−α]2−[−sp]{ρ+[γ(p(1−θ)−ωpb)−α]un+Δ}[sp(1−θ)−α]2��∗��={−����}[��(1−�)−�][��(1−�)−�]2−[−��]{�+[�(�(1−�)−���)−�]��+Δ}[��(1−�)−�]2The term {−unγp}{−����} in the original model is what leads to an ambiguous sign for the derivative. Even after simplifying further, the sign is still ambiguous:du∗dθ=unγpα+spΔ+spρ−sp2unγωb−spunα[sp(1−θ)−α]2��∗��=�����+��Δ+���−��2�����−�����[��(1−�)−�]2As previously mentioned, this ambiguous result is recognized by Botta and Vaggi, who state that the outcome is in fact ‘not clear’. While analysis of the impact on savings is identical to our analysis above, in the original model expected profitability and investment demand contract. They state that, ‘if the contraction of desired investment (gi)(��) is sufficiently large, the increase in transaction costs will negatively affect both the short-run equilibrium values of current capacity use and capital formation’ (Botta and Vaggi Citation2012, p. 216, emphasis added). In an earlier version of the paper in which the authors explain part of the mathematical passages used, they make it clear that to reach their results they ‘define a sufficient but not necessary condition for higher transaction costs to curtail current capacity use and capital formation’ (Botta and Vaggi Citation2011, p. 16). The results of the modified model provide evidence that which class bears the burden of this external claimant can have a direct impact on the equilibrium levels of capacity utilization and growth.

The new result does not suggest a positive impact of restrictions; rather, it shows that the interplay is in fact between three players (workers, capitalists and the external claimant on income). As such, there are two possible tasks to clarify the results. The first task, implemented in the current article, is to explore the deficiencies in the assumptions of the original model. Section 2.3 provides a historical evolution of class differentiation and suggests that the assumption of a homogeneous savings rate between capitalists and workers is erroneous. As Section 5.5 below shows, it transpires that changing that assumption impacts the sign of (du/dθ)(��/��) and resolves the confusion of the initial result. Having said that, a second task worth exploring in future research, is a theoretical and empirical investigation of the weight of economic burden borne by each class, rather than the assumptions of either class fully bearing the burden. Exploring that possibility theoretically through a weighted impact of (θ)(�), and empirically through an investigation of the impact on profits and wages, can shed further light on the dynamics of short-run growth using this model.

In sum, ultimately the final outcome will rely on the weight that is borne by each class, whether the Palestinian economy can be described as wage-led or profit-led, and finally the savings rate assumptions. Section 5.5 discusses the latter.

5.5. Adjusting the Savings Rate Assumptions

The canonical Kaleckian model, as is the case with most heterodox models, starts with the assumption that the marginal propensity to save out of wages is zero, and that savings originate from non-wage income. When this assumption is relaxed it is normally replaced with positive savings of wages, which are still less than savings out of profits. Botta and Vaggi claim that, since most Palestinian enterprises are small in size, ‘it is often hard to distinguish between different social classes — workers and capitalists, in particular — as far as consumption and saving decisions are concerned’ (Botta and Vaggi Citation2012, p. 211). Section 2.3 above provides a historical and empirical argument that ignoring class differentiation in the formal model does not reflect a ‘stylized facts’ approach.Footnote¹⁷

In the various neo-Kaleckian models, any positive rate of savings out of wages makes that model susceptible to profit-led results, in which a comparative increase in the profit share would increase levels of capacity utilization and even capital accumulation (Blecker Citation2002). When the savings rate is identical, adjustments in income shares will only impact one channel (investment) while the other (consumption) will remain idle. To investigate this further, this section entertains the ‘original’ Kaleckian assumption of zero savings out of wages. This assumption ensures that our model is stock-flow consistent and not susceptible to the infamous Pasinetti (Citation1962) critique: if workers are saving and the only asset in the model is capital, then workers should be earning part of their income as profits too.

In this final modification, workers bear the full burden of movement restrictions and there is zero savings out of wages. To represent the latter analytically, we assume (Sw=0)(��=0) and as a result the savings equation and (gs)(��) will change as follows:S=Sπ=s(rNPIK)�=��=�(�����)We divide by (PIK)(���)gs’=SPIK=srN��′=����=���We use the rN�� from the new adjusted model (equation 17) where workers bear the burden:gs’=sp(τ+θ1+τ)u��′=��(�+�1+�)�(23)Given the new equation gs’��′, we can represent the steady state and the equilibrium rate of capacity utilization as shown below. To make the algebraic manipulation easier, we use the term (ω)(�) as a constant until the final step; in other words we use:gi’=gs’−Δ��′=��′−Δ(24)ρ+αu−αun+γ[p(1−ωb)un]=sp(1−ωb)u−Δ�+��−���+�[�(1−��)��]=��(1−��)�−Δρ+[γp(1−ωb)−α]un=thesp(1−ωb)u−Δ−αu�+[��(1−��)−�]��=�ℎ���(1−��)�−Δ−��u∗=ρ+[γp(1−ωb)−α]un+Δ[sp(1−ωb)−α]�∗=�+[��(1−��)−�]��+Δ[��(1−��)−�]u∗=ρ+[γp((τ+θ)(1+τ))−α]un+Δ[sp((τ+θ)(1+τ))−α]�∗=�+[��((�+�)(1+�))−�]��+Δ[��((�+�)(1+�))−�](25)After mathematical manipulation the sign of (du∗/dθ)(��∗/��) remains ambiguousdu∗dθ=sp(1+τ)(−unγαs−ρ+αun−Δ)[sp((τ+θ)(1+τ))−α]2��∗��=��(1+�)(−�����−�+���−Δ)[��((�+�)(1+�))−�]2Graphically, it is easy to understand the reason for the ambiguous sign. Increasing (θ)(�) will rotate the savings function upward (unlike the original model and the first modification), and the investment demand function will shift upward. Figure 8 shows the case in which the burden is fully absorbed by workers and the short-run equilibrium values of current capacity use and capital formation are negatively impacted. While this is not necessarily the only possible outcome, the larger the upward rotation in the slope of the savings supply function and the smaller the upward shift in the investment demand function, the more likely this result will be the final outcome.

Figure 8. The short-run effects of increasing transaction costs in the new model with zero savings out of wages.

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6. Conclusion

This article examined the model by Botta and Vaggi (Citation2012), which postulates that Israeli movement restrictions are an external third claimant on Palestinian income (after wages and profit). This article makes two crucial adjustments. In the first adjustment, unlike the authors who assume that capitalists passively accept the full burden of the restrictions on their profitability, it suggests that capitalists channel the burden to workers. This assumption tackles a missing angle in economic research in Palestine, which rarely discusses internal distribution as it pertains to the economic impact of the Israeli occupation. This article supports this new assumption in a twofold manner: first, by presenting stylized facts regarding the bargaining power of Palestinian labor, namely, data on unemployment rates, the large informal sector and the lack of certain workers’ rights, including contracts and health insurance; second, it supports the assumption using empirical evidence from data on wages and the wage share, as well as the literature.

The second adjustment relates to a key tenet of post-Keynesian and structuralist modeling, which differentiates savings and consumption behavior of social classes. Unlike the canonical post-Keynesian assumption, Botta and Vaggi assume a homogeneous savings rate between workers and capitalists. This article provides a historical presentation of 50 years of class differentiation within the West Bank and Gaza Strip, including the more recent developments following the institutional shift provided by the establishment of the Palestinian Authority in 1993. As such, it articulates a fundamental political economy, distributional lens that is missing in the original model. This article uses data and historical evidence to argue that using the traditional assumption of zero-savings out of wages is more representative of class dynamics in general, and of stylized facts in Palestinian society.

It also worth noting that merely making the first adjustment yields results contradictory to empirical evidence, and hence it becomes even more obvious that there is a need to also modify the savings assumption. Ultimately, adjusting both the distributional impact of movement restrictions on Palestinian workers and assuming zero savings out of wages results in short-run equilibrium levels of capacity utilization, profit rate and capital accumulation that are different from those in the original model. Furthermore, the comparative statics results, particularly the sign of (du∗/dθ)(��∗/��), are initially different from those in the original model (prior to adjusting the savings assumption), clearly showing that the extent to which (and how much) this external claimant will impact short-run dynamics is dependent on which class bears the income burden, and on the savings assumptions of the two classes.

Aside from the above, this article opens the door for more empirical and econometric work on the profit-led versus wage-led question in the Palestinian economy. Finally, while the article addressed the impact of movement restrictions as an external claimant on income, the applications of this method can include any economic or political measure that hinders workers and capitalists from claiming their full level of wages and profits, respectively.

Acknowledgments

The author wishes to thank Mark Setterfield and two anonymous referees for their comments on earlier drafts of this article. Any remaining errors are my own. I would like to use this opportunity to acknowledge and thank the reviewers who reviewed this article and aided in its publication. This article is available as open access thanks to partial funding from a completion grant provided by the Faculty Research Committee at Trinity College.

Disclosure Statement

No potential conflict of interest was reported by the author.

Notes

1 Although services as a whole contributed to 20 percent of output, the largest sub-sector was education (5.9 percent) followed by real estate activities (4.6 percent) and health and social work (3.4 percent).

2 This is accompanied by a large trade deficit averaging 35 percent of GDP, 25 percent for government spending, and modest levels of investment (gross fixed capital formation) of around 20 percent, only a quarter of which is non-building investment. The reasons for such low levels of investment in the analytical model below boil down to animal spirits, which are linked to expected sales vis-à-vis foreign products and potential markets reached. See equation (6) for more.

3 Calculated by author from Israeli CBS Quarterly Statistics of Judea Samaria and the Gaza Area, volume XXI, March 1993. There are three corresponding categories named slightly differently: ‘scientific and academic workers’; ‘other professional, technical and related workers’; ‘administrators and managers, clerical and related workers’.

4 In contrast with earlier neo-Keynesian work (Kaldor Citation1966; Robinson Citation1956, Citation1962), Kalecki’s work (Citation1954, Citation1971) argued that: (i) firms operate with excess capacity even in the long run; (ii) the appropriate framework is one of monopolistic competition in which prices are set by firms’ mark-up above costs, and functional distribution of income is derived from these mark-up decisions.

5 Del Monte (Citation1975) presented an endogenous investment function before the above-mentioned authors, albeit he was writing in Italian.

6 A separate, related variable (λ)(�) is defined as the level of market fragmentation. Analytically, equation (7) postulates that animal spirits are a function of three variables, including (λ)(�). However, there is no further discussion of (λ)(�) in the short run.

7 The recent maps published by the UN can be accessed at: https://www.ochaopt.org/content/west-bank-access-restrictions-june-2020.

8 In 2004, the International Court of Justice (ICJ) ruled by a 14–1 majority that the wall violated international law and is ‘illegal’. The ruling stated that construction must stop immediately and Israel should make reparations for any damage caused; see https://news.un.org/en/story/2004/07/108912-international-court-justice-finds-israeli-barrier-palestinian-territory-illegal#.WItesTLMzfY.

9 Given that the majority of capital goods are imported, the model, correctly so, assumes that the price of capital stock, PI. is an average of domestic price P¯¯¯�¯ with weight ββ and foreign price PF�� with a larger weight (1−β)(1−β) representing the share of capital stock imported. Analytically, it assumes that P1=βP¯¯¯+(1−β)PF�1=β�¯+(1−β)��.

10 In the original model, Botta and Vaggi substitute the term p(1−θ)�(1−�) with xp�� and define it as ‘the value of effective output in terms of price of capital goods’ (Citation2012, p. 210). The intuition is not clear (aside from notation simplicity). In this article I keep the fleshed-out term, which will be useful later in the algebraic manipulation and finding of partial derivatives.

11 They claim that the small average size of enterprises makes it ‘hard to distinguish between different social classes, workers and capitalists in particular, as far as consumption and saving decisions are concerned’ (Botta and Vaggi, Citation2012, p. 211). This claim has been critically challenged in Sections 2.3 and 3 above.

12 On the one hand, the higher isun��, the higher is expected profitably and investment demand. On the other hand, equation (6) shows that a larger gap between (un)(��) and (u)(�) will depress investment and economic activity via (α)(�).

13 Part of this decline might be attributed to the smaller percentage of the labor force being able to access the Israeli economy, but the data below is consistent for a long period of time, despite the fluctuation in Palestinians working in Israel.

14 This work is not only relevant for its focus on wage vs non-wage income but also because some might argue that an increase in international aid could also result in wage rigidity.

15 We do not assume that the impact is immediately borne by workers, and hence there is no definition of a new nominal wage per se. Rather, the point is to assume that once capitalists realize their mark-up is not fulfilled, they then channel this impact to workers. As such, one part of the model remains the same and the other changes. In other words, the mark-up equation remains the same but, once capitalists expect these restrictions, it is crucial that the real wage equation becomes variable and bears the impact of (θ)(�). The succession of equations (15–17) shows the latter adjustment.

16 We modify these assumptions in Section 5.3.

17 Another anecdotal piece of information published recently shows that in 2019, 52 percent of wage workers in the private sector received less than the government-set minimum wage (PCBS Citation2020). The minimum monthly wage was set in 2012 at the dismal level of $420. The average monthly salary of those earning less than the minimum wage was $215 (PCBS Citation2020). At these levels of wage income, one would expect at least some level of differentiation between the working and capitalist classes in terms of consumption and saving.

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