Eliyahu Kanovsky is professor of economics at Bar Ilan University in Israel, senior research associate at the BESA Center for Strategic Studies, and Ludwig Jesselson Visiting Professor of Economics at Yeshiva University in New York.

WILL ARAB-ISRAELI PEACE BRING PROSPERITY?

Israeli officials have high economic hopes for their current negotiations with the Palestine Liberation Organization (PLO) and the Arab states. In a mood of at least mild euphoria, they see not only the Middle East’s becoming newly prosperous but assert that the ensuing prosperity will go far to make the peace agreements endure. For example, Minister of Construction and Housing Benjamin Eliezer envisions “peace roads,” along which “motels, gas stations, shopping malls, and restaurants will spring up, bringing an economic boom and prosperity to all the towns along them.”¹ The officials justify this optimism on the grounds that the Arab parties will have an abiding interest in adhering to the agreements, since any serious violations would jeopardize not only peace but their economic welfare and newly gained prosperity.

But a close look at six commonly held propositions raises doubts as to the long-term durability of the proposed peace agreements as well as the likelihood that they will bring economic prosperity to the Middle East.

I. RIYADH TO THE RESCUE

Proposition. Saudi Arabia, joined by other Arab oil-rich states, will underwrite much of the cost of establishing the economy of the proposed Palestinian autonomous entity, thereby giving it a firm foundation.

Comment. Those making this suggestion must be completely oblivious to the parlous state of Saudi state finances. (The private accounts of the royal family, wealthy Saudis, and Saudi corporations are entirely another story, and a much happier one; Business Week estimates that their off-shore wealth comes to $250 billion.)² For eleven consecutive years, the Saudis have run large budgetary and balance of payments (current account) deficits, with no end in sight. The government has eaten up the bulk of its financial reserves to cover those deficits, borrowing heavily since 1988, first internally and then, in more recent years, from foreign commercial sources. Its foreign debt of over twenty billion dollars is large and rising rapidly.³ A mission of the International Monetary Fund visited Saudi Arabia in mid-1993, and predicted even higher deficits over the next five years, and increasing debt to cover those deficits. Saudi state penury has many manifestations. The most important with regard to prospective aid to the Palestinians is that Riyadh gave away over $7 billion annually in the early 1980s, but just $1 billion in 1993.

Kuwait had also once, in the heyday of the oil boom, been a large foreign aid donor to the poor Arab states. But it too cut back sharply on foreign aid during the 1980s, as oil prices and revenues declined. Not surprisingly, the Iraqi invasion decimated Kuwaiti finances through lost oil sales, large payments to the allies, and huge costs of reconstruction. The Kuwaiti authorities have eaten up most of their once huge stockpile of foreign assets and are considering such radical measures as reducing the lavish subsidies on consumer items, education, and much else. In this environment, there is not much money for foreign aid.

In addition to the economic factor, both the Saudi and Kuwaiti governments have not forgiven the PLO for siding with Saddam Husayn during the Kuwait crisis; indeed, their anger remains raw. Under these circumstances, the Palestinians are not likely to receive more than token financial aid from the rich Arab states.

II. FOREIGN PRIVATE INVESTMENT WILL FLOW

Proposition. Peace between Israel and the Arabs will bring forth a large increase in foreign private investment, which will stimulate the Middle Eastern economies, create jobs, and raise income levels and living standards. According to Arye Mizrahi, director general of the Israeli housing ministry, “Once the agreement between Israel and the PLO is signed, a development and construction boom can be expected in the region, financed by foreign states and entrepreneurs.”⁴

Comment. Hostilities, or the threat of hostilities, certainly constitutes a deterrent to private investment, foreign or domestic. Likewise, political instability gets in the way. At the same time, peace and political stability alone are not a sufficient condition to attract private investment, especially from foreign sources. Private investors, regardless of nationality, seek a maximum rate of return consistent with a minimum risk for their capital, conditions that obtain far less in the Middle East than in the advanced industrialized countries or those countries of East Asia or Latin America that have adopted and implemented wise economic policies.

Thus, the dearth of foreign private investment in Saudi Arabia outside of oil refineries and petrochemicals has very little to do with the Arab-Israeli conflict. Rather, it results from the fact that foreign investors find few profitable areas for investment in Saudi industry. The same applies to Saudis and other Arabs who invest much or most of their funds in the West. Israel and Jordan, for example, have enjoyed a de facto peace for over twenty years, but Jordanian efforts at attracting foreign private investment have had minuscule results. The high-level growth that Jordan did enjoy between the mid-1970s and mid-1980s was an indirect consequence of the regional oil boom. Relatedly, the subsequent oil crash since the mid-l980s has had a very powerful negative impact on Jordan. Peace agreements, therefore, will contribute little to the solution of Jordan’s basic economic problems.

Egypt and Israel signed a formal peace agreement in 1979, but it won Egypt little foreign private investment, especially in manufacturing. To the contrary, Egypt’s economy has stagnated, at least on a per capita basis, since the end of the oil boom almost ten years ago. Peace between Israel and the other Arab states will have no perceptible impact on Egypt’s economy and on its attractiveness for foreign private investors. Its fundamental problems are internal, not external. Incomes and living standards have fallen while unemployment has risen to dangerous levels. Today, terrorism by Islamic radical groups in Egypt is an additional deterrent to foreign private investment. It has hit particularly hard the tourist trade, an economic mainstay in recent years.

Israel is in a different category from the Arab states, for its economy is far more developed. It has in recent years been more successful than previously at attracting foreign private investment, particularly in its rapidly growing high-technology industries. The buyers of shares in the over fifty Israeli companies listed in American stock exchanges are motivated not by philanthropy but by profit. Foreigners have also invested in banks and some other profitable sectors of the economy. As privatization proceeds--and most Israeli economists agree that the pace is too slow--private investment will probably continue to expand. It’s hard to see how Arab-Israeli peace agreements will induce a much greater influx of foreign private investment into Israel. Foreign investors have refrained from investing in certain Israeli industries, such as those that are labor intensive, while increasing their investments in others, purely for economic reasons.

The major economic problems of the Arab countries stem from internal policies, not the conflict with Israel. So formal Arab-Israeli peace agreements will have at best a marginal effect on foreign private investment in the Middle East.

III. REGIONAL TRADE, TOURISM, AND JOINT PROJECTS WILL INCREASE

Proposition. The signing of peace agreements between the Arab states and Israel will encourage, to the benefit of all parties, large-scale regional trade, tourism, joint projects, and other economic relations. Top Israeli officials even speak of a Middle East Common Market encompassing Israel and many Arab states. Former prime minister Shimon Peres, for example, has called the September 1993 agreement “a historic commitment with an economic lining.” “Ultimately,” he states, “the Middle East will unite in a common market--after we achieve peace.”⁵

Comment. It is noteworthy that Arab officials do not speak in favor of a Middle East Common Market. On the contrary: they freely and openly express a fear of Israeli economic domination. In Al-Qadisiyah, Sami Mahdi argues that under the planned market, Israel would gain everything while “the Arab nation” would have to “give up its unity, sacrifice its cultural identity, forget its usurped rights, and submit to a fait accompli.”⁶ He concludes that the Middle East market would “serve the Zionist entity alone” and “enable it to systematically plunder Arab resources.”⁷ Whether justified or not, this fear will strongly affect Arab policies with respect to economic relations with Israel.

In addition, it’s worth remembering that back in 1964, the Arab League decided to form an Arab Common Market modeled on the European prototype established not many years earlier. But while the European Common Market flourished, the Arab effort never got off the ground. In addition to political conflicts, formidable economic problems impeded its progress. While an industrially more advanced Egypt sought to develop its own industries, other Arab states resisted allowing Egypt free access to their markets for fear of impeding the development of their own industries. Today, Israel has a role similar to that of Egypt thirty years ago, prompting the Arab states to fear that their industries will be overwhelmed by Israel’s.

What about Arab-Israeli agreements that call not for a Middle East Common Market but for nondiscriminatory trade? In other words, both Arabs and Israel would provide equal access to each other’s goods on the same terms as imports from other countries. Even should Israel gain from this arrangement, the extent of its gain will not be great, and this for four reasons.

First, many Israeli goods already find their way to Arab markets through third parties. In other words, where Israel’s goods are competitive, traders find ways to profit from its comparative advantage. Unofficial estimates of Israeli goods sold range from tens of millions of dollars to a few hundred million dollars annually--this out of total commodity exports of $13.3 billion in 1992.⁸

Secondly, the Arab economies are small. In total, they amount to no more than a tiny fraction of the European Community or United States, with each of whom Israel has a free trade agreement. For example, the GDP of all the Arab states combined (based sometimes on overvalued official exchange rates) is estimated around $380 billion, or roughly that of Holland.⁹

Thirdly, many Arab economies are stagnant. If, as is anticipated, oil prices remain depressed or decline (in real dollars), Saudi Arabia and the other oil states will be in even more serious trouble than they are today. During the past few years, the American and other foreign firms in Saudi Arabia have been suffering from lengthy delays in payment, and Israeli firms will fare no better--and probably worse--even if they get a foothold in this market.

Fourthly, the advanced industrialized countries are battling to increase their exports in Arab markets (as elsewhere) by offering financial aid or cheap credits and tying these to the purchase of their goods. Israel will be hard put to match these offers.

For all these reasons, it is unlikely that peace agreements will lead to a quantum leap in total Israeli exports to the Arab states.

From a purely economic point of view, free trade is desirable for all parties. But the Arab fear of Israeli domination will not be erased by a peace treaty. Moreover, obstacles to the free market in Arab countries have nothing to do with Israel, and so are not likely to be much diminished by peace with Israel.

The experience since the conclusion of the Egypt-Israel peace treaty of 1979 supports this conclusion. Despite much talk at that time of significant bilateral trade, Egypt in reality has hardly anything to sell to Israel other than oil--which Israel can readily purchase on the world market--and Egyptians have bought insignificant amounts of Israeli goods. This low amount of imports surely stems from both economic and political reasons, and the two can be difficult to separate. As noted above, aid and easy credit terms from the industrialized countries, for example, are predicated on purchases of their goods, giving them a distinct advantage over Israeli competition.

Tourism is particularly sensitive to political trouble. Fifteen years ago, there was much talk of large-scale tourism between Israel and Egypt, but this too has been disappointing. Israelis flocked to Egypt following the conclusion of the 1979 peace treaty but only a handful of Egyptians visited Israel. More recently, Israeli tourism to Egypt has declined owing to fundamentalist Muslim terrorism.

In short, peaceful conditions--not necessarily a peace treaty--are a necessary condition for a prosperous tourist industry. Both Israel and Egypt--the latter until the recent wave of terrorism--enjoyed a steady significant growth in tourism. In both countries, the number of tourists had been growing even prior to the Camp David agreements of 1979. Whether the peace agreements brought about a significantly greater number of visitors to Israel and to Egypt than there would have been in the absence of those agreements, however, is an open question.

Nineteen seventy-nine also witnessed much talk of joint Egyptian-Israeli projects. Hardly anything came of them. The few small successes, such as a tomato project in Egypt, made an insignificant impact on Egyptian agriculture as a whole. Now again we hear talk of ambitious joint projects, this time on a regional level--a transportation system, a power grid, water supplies, natural gas pipelines, and the like. Assuming for the moment that these are economically feasible plans, obtaining external funding will prove to be a major obstacle. Such international projects would require international financial backing from official sources--private funding would hardly suffice. Government pressure on private companies has hardly been effective in persuading companies to invest. Private companies might be the contractors, but the financing for infrastructure would have to come largely from official national and international sources. Yet, for various political and economic reasons, the prime aid donors--the United States, Western Europe, and Japan--are in no mood to increase foreign aid significantly. At the same time, the number of aid supplicants--the former Soviet Union, Eastern Europe, and others--has grown enormously.

Israel faces an additional problem. Huge infrastructure investments are, by nature, very long term. Yet Middle Eastern states remain unstable and prone to radical changes, such as takeovers by Islamic extremists, raising the prospect that Israel could not really count on the supplies of gas, electricity, and water to be furnished by the proposed regional projects. In that case, the projects don’t do Israel much good: having to invest in back-up systems renders the economic feasibility of these projects suspect.

IV. ISRAEL WILL EXPERIENCE AN ECONOMIC BOOMLET

Proposition. The Arab economic boycott has caused great harm to Israel’s economy. Its abolition will be followed by large-scale foreign private investment in Israel, funds that had been deterred by fear of an Arab ban on the offending company.

Comment. The many estimates about the damage that the boycott inflicts on the Israeli economy are but guesses; in truth, no one knows what might have been. In general, companies that saw a comparative advantage in Israel did invest there, while those that saw no advantage did not. Thus, Intel, Motorola, and other high-tech companies have factories in Israel, while General Motors has no reason to set up facilities in Israel. Neither of these decisions is related to the boycott, because Israel does not have the same comparative advantage as, say, Lebanon in terms of serving as a base of operations in the Middle East. True, the decision by major international oil companies not to invest in Israel may have been influenced by fear of the boycott; but neither did they invest in neighboring Jordan or Lebanon. Perhaps they concluded that these countries have poorer prospects of significant oil discoveries than do locations elsewhere.

Further, Israel enjoyed very high rates of economic growth between the early 1950s and 1973, averaging about 10 percent per annum excepting only a recession in 1966-67. It seems doubtful that Israel would have achieved much higher rates of growth in the absence of the Arab boycott. Conversely, the long-term recession that began in Israel with the Yom Kippur War stemmed from several factors--a sharp escalation in oil prices, Israel’s withdrawal from the Sinai Peninsula with its oil fields, a far more burdensome defense load (even taking U.S. aid into account), and a recession in the West (which reduced Israel’s exports)--and not from the continued boycott.

None of this implies that the boycott had no effect at all; or that limited impact makes it any less repugnant. But it does mean that the impact of the boycott has been greatly exaggerated, and so have the consequences of its abolition.

V. SWORDS INTO PLOWSHARES

Proposition. Peace between Israel and the Arabs will permit all parties significantly to reduce their unusually large military expenditures and reallocate these resources to foster economic growth and prosperity.

Comment. While reductions in expenses would probably benefit the economies in question, it is not clear how much the end of the Arab-Israeli conflict will reduce military spending in the Arab countries. While this conflict receives the widest global attention, it is by no means the only source of dispute in the Middle East, and in many cases is hardly relevant to the size of the armed forces. Moreover, like most authoritarian rulers, the Arab leaders see the armed forces as the bulwark of their regimes against internal enemies, as well as defenders of the country against foreign aggression; and they worry what to do about soldiers rendered unemployed by virtue of cutbacks.

The exact situation varies from country to country. Will the Syrian regime of Hafiz al-Asad, for example, significantly reduce its armed forces and military outlays in the wake of an agreement with Israel? According to estimates of the U.S. Arms Control and Disarmament Agency, the Syrian armed forces almost doubled during the 1970s, then doubled again in the first half of the 1980s, to 400,000. Syria too will still need protection from would-be revolutionaries. In 1982, Asad quelled a major revolt by the Muslim Brotherhood by calling in the army and killing tens of thousands. The problems that led to that bloodletting--in particular, the fact that Asad belongs to a small, despised religious community, the `Alawis--remain in place. Asad also has other needs for a strong military, for he maintains some thirty to forty thousand troops in Lebanon and has antagonistic relations with both Saddam Husayn of Iraq and the Turkish government. These security considerations cast doubt on the prospect that Asad would significantly reduce the size of his armed forces upon signing a peace agreement with Israel.

As for the Saudi monarchy, it hosts in effect two armies, one called the army and the other called the National Guard. A different prince heads each force. It is generally, if unofficially, understood that if one force revolts, the regime would look to the other for its defense. There is also a Frontier Force and Coast Guard under the direction of the Ministry of the Interior, as well as other paramilitary units under the jurisdiction of the General Civil Service Administration. The rulers maintain a large force because they fear both Iran and Iraq, and with good reason. Would an Arab-Israeli peace agreement significantly reduce Saudi Arabia’s huge defense budget?¹⁰ Not likely. Despite much verbiage denouncing Israel, the Saudi regime does not really fear Israeli aggression nearly as much as it worries about internal unrest and Iranian or Iraqi bellicosity.

Jordan has had a de facto peace with Israel since the Black September crisis of 1970, yet its military expenditures remain large. Why would the peace agreement with Israel significantly reduce the size of Jordan’s armed forces and its outlays on arms? Here, too, the leadership has other problems on its mind. With an estimated 60 percent of the population in Jordan considering itself Palestinian, and with the memories of the bloody 1970-71 civil war still vivid, King al-Husayn has a compelling reason to keep his armed forces strong. Looking to the future, the establishment of a PaIestinian entity neighboring with Jordan might also inspire Jordanians to want an enhanced defense capability. Other neighbors also cause worries in Amman. Syrian forces entered Jordan during the 1970-71 civil war and could do so again. The king presently maintains good relations with Iraq, but that fragile bond could any day revert back to the old enmity. In Jordan, too, it is by no means certain that a formal Israel-Jordan peace agreement would prompt a significant cutback in the size of Jordan’s armed forces or the level of its armaments.

Egypt offers the most convincing proof of this assertion. Despite the signing of a peace agreement with Israel in 1979, Egypt’s armed forces have remained at the level they were at that time, or 450,000 (according to the U.S. Arms Control and Disarmament Agency). Here, the purpose of the armed forces is basically internal. On the one hand, the army is needed to exercise a police function (to quell the growing revolt of the Islamic extremists); on the other, where are the jobs for demobilized soldiers in a country where unemployment and underemployment have already reached dangerous dimensions? Unemployed ex-servicemen have been known to vent their anger in violent ways.

As for Israel, it’s not been widely noted that it has already significantly reduced the burden of reserve duty and cut back on the size of its armed forces and defense budget. Moreover, because its economy has grown, the ratio of defense expenditures to GNP has declined precipitously from 29 percent in 1980-81 to 13 percent in 1988-89, and 11 percent in 1992-93.¹¹ Will the proposed Arab-Israeli peace agreements permit Israel to implement additional significant cutbacks in its military preparedness? Not likely. The Palestinian autonomous entity will require a redeployment of Israel’s armed forces, which will raise its defense expenditures, at least in short run. The same applies to an agreement with Syria, because the Israelis will have to compensate for Syria’s gaining the strategic advantage offered by control over the Golan Heights.

In view of the growth in the military of the Arab states, further significant cutbacks in Israeli defense spending would be potentially hazardous. Looking to the longer run, Israel can only lower its defense spending if its potential enemies do so too. And this, we have seen, does not appear to be in the cards. Syrian and Jordanian military spending will likely remain high. Nor can Israel ignore the escalation in arms acquisitions by Saudi Arabia and the possibility that some of these weapons might be transferred to Israel’s enemies in a future conflict. Lurking in the background is the rapid rebuilding of Iraq’s armed forces and its drive to develop unconventional weapons.

Should fundamentalist Muslim groups succeed in taking power, as is a possibility in countries such as Algeria and Egypt, bent on violently overthrowing the existing regimes. The economic deterioration in these countries--rising unemployment, lower living standards for the large majority, widespread corruption, and a yawning gap between the few rich and the many poor--add fuel to the fires of discontent and revolt. For many reasons, including, but not only, depressed oil prices, the economic prospects are poor. (Footnote: For greater detail see my study “The Forgotten Dimension: Economic Development in the Arab Countries and Their Possible Impact on Peace Agreement” BESA Center for Strategic Studies, Bar Ilan University, Ramat Gan, Israel, December 1982). If either of these countries, especially Egypt, is taken over by the extremists, there is little doubt that this forces violently opposed to Israel’s very existence might again become dominant in the Arab countries. The growing strength of Muslim extremism may well undermine the political stability of some of the current Arab regimes and the longer-term durability of the proposed peace agreements. This would not only jeopardize future peace agreements between the Arabs and Israel but it might even undermine or erode the existing treaty with Egypt.

The possible dangers ahead would make any government in Israel wary of lowering its guard in the foreseeable future. Israel will need to resist the temptation to further cut its defense expenditures.

VI. CREATING VESTED INTERESTS IN PEACE

Proposition. The economic benefits of peace to the Arab regimes will be so great that they will have a vested interest in seeing the agreements fulfilled. Israeli officials, such as Shimon Peres, have made such claims: “Cooperation between countries for their mutual benefit and for the good of their residents will also characterize the Middle East’s economic transformation from confrontation to peace.”¹²

Comment. Long-term economic success depends mainly on the adoption and implementation of wise economic and social policies. The economic problems of the Arab states run the gamut from serious to severe, and peace agreements with Israel will contribute little to basic solutions. In 1979, there was much talk in Israel of technical “cooperation” (a diplomatic term for technical aid) with Egypt in such areas as agriculture, where Israel has been eminently successful. Very little, if anything, came of this, however. Israeli officials deluded themselves into thinking their country’s experts and advice would be welcome in Egypt; or that this technical aid would make a tangible difference in Egypt’s economy.

The U.S. government has given billions and billions of dollars to Egypt and has powerful leverage over the government, but even aid from Washington has not succeeded in bringing about a revival of Egypt’s economy, for the main obstacles are internal, not external.

Suppose that rising prosperity did come to the Arab states following the peace agreements, and that this prosperity was attributable to the agreements: would that deter future aggression? Economic ties did not deter armed conflicts in Europe, nor the Japanese attack on Pearl Harbor, nor the current bloody conflict in the former Yugoslavia. Israel had extensive economic relations with Iran, under the shah, presumably of benefit both to Iran and Israel, but when the Muslim radicals took over in 1979, these relations came to an abrupt end. There is almost no reason to think that prosperity would pacify the Arab states vis-à-vis Israel.

CONCLUSIONS

The cessation of hostilities and bloodshed is a supreme benefit in its own right, with or without economic benefit. Looking strictly at the economic dimension, however, the peace agreements are likely to bring only limited economic benefits. The promise of peace leading to prosperity made by Anwar as-Sadat in the 1970s raised expectations that were not fulfilled; and, if one believes the hype, there is a distinct danger that this scenario may be repeated in the Middle East. That disappointment may well become a major obstacle to the durability of peace accords.

¹ Ha’aretz, Sept. 8, 1993.
² Business Week, Apr. 4, 1994.
³ See Eliyahu Kanovsky, The Economic Consequences of the Persian Gulf War: Accelerating OPEC’s Demise (Washington, D.C.: Washington Institute for Near East Policy, 1992).
⁴ Ha’aretz, Oct. 9, 1993.
⁵ Shimon Peres, The New Middle East (New York: Henry Holt and Co., 1993), pp. 98-99.
⁶ Al-Qadisiyah, Mar. 10, 1994, in Foreign Broadcast Information Service, Daily Report: Near East and South Asia, Mar. 30, 1994.
⁷ Ibid.
⁸ Bank of Israel, Annual Report (Jerusalem, 1993).
⁹ International Monetary Fund, International Financial Statistics, (Washington, D.C., 1994).
¹⁰ Saudi Arabia’s defense budget of $16.5 billion for 1993 (according to the International Institute for Strategic Studies) far exceeded that of any other Middle Eastern state. In contrast, Israel’s was a mere $6.⁸ billion (of which the U.S. taxpayer financed $1.8 billion). Since the Kuwait War, Riyadh has placed $25 billion in orders for advanced U.S. military equipment, and further large orders from the U.K.
¹¹ These estimates derive from the U.S. Arms Control and Disarmament Agency and the International Institute for Strategic Studies.
¹² Peres, The New Middle East, p. 98.