1

.usip.org 

Dollars and Diplomacy: 

 Foreign Aid and the Palestinian Question 

By Scott Lasensky and Robert Grace 

The worsening crisis in Arab-Israeli relations has brought into sharp focus the question 

of how foreign aid can be used as an instrument of peacemaking. The fighting in Gaza 

and Lebanon is creating pressure for major new international relief and reconstruction 

assistance. But can foreign aid help the parties return to a political process? Or will 

international economic assistance reinforce the status quo ante? Over the coming 

months, the United States Institute of Peace will examine the use and effectiveness of 

foreign aid in the Middle East. As part of this effort, a recent seminar was held on aid 

dependency and the future of international assistance to Palestinians. Upcoming 

programs will examine international reconstruction assistance to Lebanon, and Arab, 

European and American aid initiatives for Palestinians and Israel. 

For more than thirty years, the United States has relied on foreign aid as a principal 

diplomatic tool in the quest for Arab-Israeli peace. During this period, the U.S. has 

disbursed tens of billions of dollars to implement Arab-Israeli peace accords, to build 

public support in the region, and to facilitate ongoing negotiations. By the early 1990s, 

other donors joined the U.S. in a multilateral process to underwrite Arab-Israeli peace. 

But since the collapse of Israeli-Palestinian negotiations more than five years ago, the 

linkage between foreign aid and political progress has become increasingly strained. 

International aid flows to the Palestinians came to a quick halt with Hamas’ victory in the 

January 2006 legislative elections and the party’s subsequent refusal to meet conditions 

laid down by the Quartet.1

 For its part, Israel is withholding $50 million to $70 million a 

month in Palestinian revenues. Given the Palestinian economy’s heavy reliance on 

international aid and on trade with and through Israel, the result of these sanctions is an 

economic crisis of growing and unprecedented severity. The World Bank’s dim economic 

forecast last spring – which predicted a 40 percent loss in GDP by year’s end, 

accompanied by a rise in unemployment to 45 percent and in poverty levels to 70 percent 

– now appears optimistic, particularly in Gaza, where fighting has raged for months. 

 

1

 Earlier this year, the “Quartet” (the United States, the EU, Russia, and the UN) 

demanded that the Hamas government (a) recognize Israel's right to exist; (b) forswear 

violence; and (c) accept previous Israeli-Palestinian agreements. 

U NITED S TATES I NSTITUTE OF P EACE

1200 17th Street, NW, Suite 200 Washington D.C. 20036-3011 202.457.1700 Fax 202.429.6063 Web Site www.usip.org 

USIPeace Briefing 

August 2006 For more information: 

info@usip.org 
2

Lessons Learned 

During the Oslo years, donors learned some harsh lessons. The Oslo process marked the 

first great experiment in the Israeli-Palestinian context with large-scale aid, making 

Palestinians the largest per capita recipients of international development assistance in 

the world. Initially designed to fuel Palestinian economic growth and to build public 

support for negotiations with Israel, the aid program was quickly redesigned to provide 

life support for a Palestinian economy in decline and a negotiating process that was 

constantly under attack.2

 A rash of Hamas bombings in the mid-1990s resulted in the first 

systematic Israeli “closure” policies – restrictions on Palestinian movement in the 

territories. The donor community’s reaction to these closures was to preserve jobs and to 

give Palestinians a lifeline as they faced economic instability. At the time, the Palestinian 

Authority (PA) was seen as critical to the continuation of the peace process and essential 

for employment in the West Bank and Gaza. Donors operated on the theory that rising 

Palestinian unemployment eroded support for the peace process and damaged Israeli 

security. 

After several years of economic downturns, the situation for Palestinians began to 

improve. Rising employment followed a steady rise in international aid. From 1998 to 

2000 Palestinians enjoyed 90% employment, as close to full employment as one can 

reasonably expect in such a setting. Palestinians were finally enjoying some of the 

economic fruits of peace. But Oslo soon collapsed and large-scale violence erupted in late 

2000. Despite good intentions, it was apparent that donor efforts had few lasting positive 

impacts. Corruption in the PA was rife and often overlooked by international donors. In 

some cases, as with the so-called “monopoly accounts,” corruption was encouraged by 

Israel. In retrospect, more donor conditionality was needed. Continued Israeli settlement 

activity damaged Palestinian security and faith in the negotiations, just as Palestinian 

violence threatened Israeli security and trust. Designed as an instrument to facilitate 

ongoing peace negotiations, foreign aid was suddenly expected to compensate for serious 

pitfalls in the process. 

With the outbreak of the second Intifada, aid to Palestinians was reengineered to address 

growing humanitarian concerns, and also to prevent the collapse of the PA, thus 

preserving a potential negotiating partner for Israel. Faced with a 40 percent loss in 

Palestinian personal incomes in the first two years of the Intifada, the donor community 

responded with a two-fold approach. First, consistent with the thrust of assistance during 

the Oslo years, they sought to strengthen and preserve existing governmental structures to 

ensure that the PA did not fall apart. This was done through direct budget support (from 

Arab states and the E.U., but without American aid). Second, donors sought to sustain the 

general welfare of the Palestinian population through stepped-up health, food, and other 

welfare programs on the ground. Giving lie to the idea of donor fatigue, international 

disbursements in this period doubled to $1 billion per year. Stricter conditionality on 

 

2 See Rex Brynen, A Very Political Economy: Peacebuilding and Foreign Aid in the West 

Bank and Gaza (Washington, DC: USIP Press Books, 2000), and Scott Lasensky, 

"Chequebook Diplomacy: The US, the Oslo Process and the Role of Foreign Aid," in 

Keating et al, eds., Aid, Diplomacy and Facts on the Ground: The Case of Palestine 

(London: Chatham House, 2005). 
3

governance led to notable improvements in areas like public finance, but the overall 

picture was of increasing aid and diminishing prospects for peace. 

The donor approach was reactive. Increased pledges and donations risked becoming a 

substitute for meaningful diplomatic intervention. When opportunities did arise, as with 

the death of Yasser Arafat, the election of Abu Mazen and Israeli “disengagement” from 

Gaza, increased economic assistance was not used in concert with effective political and 

diplomatic strategies, thus becoming simply another feature in an increasingly 

unattractive status quo. 

Uncertain Outcomes 

Born of a desire to pressure Hamas to recognize Israel, renounce violence, and consent to 

the terms of previous Israeli-Palestinian agreements, the Quartet’s strategy of aid 

sanctions may produce side effects even less desirable than the status quo. Three such 

possible outcomes were outlined by the World Bank in a policy paper addressed to the 

donors in early May of this year3: 

The sudden onset of humanitarian crisis. Humanitarian crises, the Bank noted, 

are defined by both suffering and perception; in other words, public perception 

can precipitate and exacerbate a crisis. Moreover, humanitarian crises tend to 

happen all at once, without warning, and the suddenness of their onset can 

overwhelm already insufficient food stocks and mechanisms of distribution. 

Given that the PA is by far the largest employer of Palestinians – more than one 

third of Palestinians depend on PA salaries – the cutoff of Israeli revenue transfers 

and the international aid sanctions have obvious and potentially devastating 

consequences for the population as a whole. Suffering could be especially acute in 

Gaza, where PA employees constitute 40 percent of the working population and 

earn twice as much as private-sector employees. 

A collapse of governance. As with any structure of government, should the PA 

break down it will be extraordinarily difficult to put back together. For example, 

should the PA education infrastructure disintegrate, Palestinian students (the vast 

majority of whom are enrolled in PA schools) will scatter in all directions—

including to Hamas-dominated madrasas. Reincorporating students, teachers, and 

administrators into a public school system will be no small task. More generally, 

the PA was designed as an agent to provide services to Palestinians. Should it 

collapse, a huge vacuum could emerge, and the ensuing instability would persist 

even if the aid spigot was turned back on. 

A breakdown in the security services. Nonpayment of salaries is likely to lead 

to the attrition of government workers, including security personnel. More 

ominous, perhaps, is the prospect of the mutation of the security apparatus: an 

unpredictable realignment of security personnel around new centers of political 

power. These cells could turn into sources of new violence against both Israelis 

 

3

 “The Impending Palestinian Fiscal Crisis, Potential Remedies,” May 7, 2006, World 

Bank, Washington, DC. 
4

and Palestinians. There are signs that this has already begun to occur in Gaza and 

parts of the West Bank.

Aid Sanctions and Hamas 

The Quartet’s policy of aid sanctions has contributed to the weakening of the Hamas-led 

government. But it is not yet clear that the Quartet’s strategy is having the intended effect 

with respect to Hamas’ image in the eyes of Palestinian society. Indeed, rather than 

decreasing the party’s popularity, the suffering caused by the crippled economy appears 

to be engendering public solidarity with Hamas and strengthening its base of support. 

Hamas does not appear to be any closer to the negotiating table than it was before aid 

sanctions were put in place. 

If, alternatively, the Quartet’s strategy is meant to drive Hamas out of the government 

entirely, then it is still too early to judge the impact of aid sanctions. However, should 

Hamas be driven from the government due to outside intervention, it would most likely 

erode the legitimacy of the PA and consequently strengthen Hamas’ well-developed 

network of social and religious institutions. (There is even talk among Palestinians of 

dissolving the PA.) Furthermore, much has been made of the role of corruption in Fatah’s 

downfall and in damaging Palestinian public support for the PA and negotiations with 

Israel. Ultimately, it was the Palestinian electorate who addressed corruption by ousting 

the incumbents. Quartet efforts to discredit Hamas need to be considered with this recent 

past in mind. 

The Role of Israel 

The relationship between the international donor community and the Palestinians is 

unique in that a third party (Israel) is always involved in aid considerations. Donors 

should view Israel as a legitimate and needed participant in the process, not simply as an 

impediment. Israel has genuine and pressing security concerns, given its long history of 

vulnerability to attacks by its neighbors. Furthermore, Israelis and Palestinians have had 

mutually beneficial trade arrangements in the past, when the security situation has 

allowed. Greater understanding and closer cooperation with Israel can be more 

productive than the traditional polemics and recriminations when it comes to finding 

solutions to questions of aid delivery, economic development, and Palestinian access and 

movement. There is growing support within the Israeli national security establishment for 

improving cooperation with the international community, particularly in terms of 

delivering aid. This trend was in evidence during the extensive World Bank-Israel 

dialogue in 2004-2005. Deeper understandings could be reached through more dialogue. 

But Israel is often of two minds when it comes to the Palestinian economy. Some 

members of the national security establishment acknowledge the correlation between 

radicalization and restrictions on access and movement. They view Palestinian economic 

stability as an imperative, and express a willingness to relax Israeli control as much as 

security will allow. But others believe that the economy can be used punitively, as an 

instrument of coercion. International aid is necessary, according to this view, so that 
5

Israel itself will not have to shoulder the financial burden, but can still exercise exclusive 

control over access and movement. 

In times of crisis, the traditional Israeli security perspective takes over and the impulse is 

to exercise as much control as possible, regardless of the price. Short-term security 

considerations present the temptation to tighten the grip on the Palestinian economy, but 

longer-term security imperatives suggest that Israel’s security is inextricably tied to 

Palestinian economic growth. Moreover, Israel’s posture toward the Palestinian economy 

is not unrelated to the settlement question. The intensification and formalization of the 

closure system offered all too many opportunities for Israel to expand settlements and 

preserve privileged access to them. 

Potential Solutions 

There can be no resolution of the current political impasse without an end to the 

Palestinian fiscal crisis. Resuming Israeli revenue transfers is a necessary part of any 

solution, since the continuous flow of tax and customs revenue is a sine qua non of PA 

fiscal stability. But restarting these transfers will not be sufficient. Increased foreign 

assistance is essential to get the Palestinian economy to a level of stability sufficient to 

generate growth. This may also require an increased international presence, perhaps at 

trade crossing points (such as Karni in Gaza). Only when the fiscal situation is stabilized 

can the groundwork be laid for a full economic recovery, since the prospect of a robust 

and sustainable Palestinian economy depends on (largely foreign) investment—and 

investment depends on fiscal stability. 

Still, all the foreign aid in the world will have little impact if the parties cannot agree on a 

way to end violence and renew the political process. Foreign aid can be a powerful and 

effective instrument to facilitate peacemaking and sustain peace settlements. But it is a 

limited tool, especially when aimed at trying to end an active conflict. 

About the Authors: 

This USIPeace Briefing was written by Scott Lasensky, senior research associate, and 

Robert Grace, program assistant, at the Center for Conflict Analysis and Prevention at the 

United States Institute of Peace. The views expressed here are not those of USIP, which 

does not advocate specific policies. 

About the United States Institute of Peace: 

The United States Institute of Peace is an independent nonpartisan national institution 

established and funded by Congress. Our mission is to help prevent, manage, and resolve 

international conflicts by empowering others with knowledge, skills, and resources, as 

well as by our direct involvement in peacebuilding efforts around the world.