Multinationals likely to take Israeli bait: In the second of two articles on the economic implications of a peace accord in the Middle East, Christopher Huhne argues that the future bodes well for Israel

PROSPERITY is not a zero-sum game where one person wins only if another loses, but the Israelis are likely to gain more than most from a Middle East peace. Paradoxically, Israel's new prosperity will not be won in Arab markets that have been closed to it. Its gains will eventually come from deals with European, Japanese and American companies once the Arab boycott lifts.

Europeans who fondly imagine that their own model of a common market could underpin peace across the Middle East - rather as the Community ended a century of Franco-German rivalry - simply misunderstand the nature of the region's economies. The European economies are at a similar level of development and trade a lot. More than half of all their exports goes to their EC partners.

By contrast most Middle Eastern trade involves exports of oil to the developed world and imports of manufactures from it. Even if oil is excluded, just 6 per cent of total Middle Eastern non-oil trade takes place within the region.

Arab fears that Israel could dominate the region economically are therefore misplaced. Israel has a population of 4.7 million and is too small an economy to produce the range of goods that the Arab countries import from the developed world. Nor is the Israeli business community likely to target neighbouring markets.

After all, the Middle East countries are not rich in world terms. The combined national output of the 15 countries and 187 million people that the International Monetary Fund classifies as the Middle East - from Iran in the east to Libya in the west and from Yemen in the south to Syria in the north - is worth just 2.5 per cent of world output, rather less than the share of Canada and two-thirds of Britain's.

Nor is the market easy. Israeli business has already had experience of trying to trade with an Arab country: Egypt has been at peace with Israel since 1979. Israel imports more than a quarter of all her oil needs from Egypt. But the rest of Israeli-Egyptian trade last year accounted for precisely dollars 8m ( pounds 5.3m) or just 0.02 per cent of Israeli trade.

The real gains to Israel will come outside the region. Some Muslim countries, such as Indonesia, Malaysia and Pakistan, will eventually open up to Israeli exports in areas such as agricultural machinery. But the big gains will come from more joint ventures and inward investment from multinationals that had previously surrendered to the Arab boycott of Israel. That potential for Israel is why the Arab countries are reluctant to move quickly: the boycott is a powerful card for further Israeli concessions.

'Now that the political uncertainty is ending,' says Dov Lautman, the entrepreneur who built up Delta Galil Industries as one of Israel's largest textiles companies (and a big supplier to Marks & Spencer), 'Israel will increasingly be a place where people will want to do business. It has a good labour force with a record of research and development. It is the only country that has a free-trade agreement with both the European Community and the United States and it is a miniature Europe because we have business people who speak all the European languages.'

This is not wishful thinking. Stanley Fischer, the former World Bank chief economist, notes that Israel receives only about dollars 200m a year, or less than half a per cent of national income. The more successful reforming developing countries, such as Mexico, Chile and Argentina, attract sustained capital inflows of about 3 per cent of national income, a difference that would be worth dollars 1.3bn a year to Israel and could offset much of any decline in US military assistance.

Israel's potential gains in world markets and joint ventures do not mean that either its policy-makers or its business people are indifferent to the fate of the Palestinians. Jacob Frenkel, the Governor of the Bank of Israel, says that political stability is crucial to Israel, and that there must be a 'significant uplift' in the economies of the occupied territories. Leading Israeli business people want to help but are sensitive to Arab concerns about Israeli influence. Benjamin Gaon, chief executive of Koor enterprises, which accounts for nearly one-in-10 of Israeli industrial production, began his own imaginative peace project over a year ago, convinced by his friendship with Yitzhak Rabin and Shimon Peres that peace would come.

To allay Palestinian fears he has put together a holding company with a subscribed first tranche of capital of dollars 60m; a quarter put in by leading Palestinian industrialists, a quarter by a Spanish bank, a quarter from a Moroccan company and a quarter from Koor. The second tranche will take the capital to dollars 100m. This is not large but the idea is to multiply the impact of the company by taking minority stakes in companies run by the Palestinian community. Each of these would raise further capital.

The structure of the company ensures Arab control but also provides a channel whereby the tiny Palestinian industrial sector can have access to Israeli management and expertise. The holding company plans to invest in agriculture and agro-chemicals, telecommunications, tourism, construction and building materials. Koor's trading network could also help market its products around the world.

In the short term, some of the greatest potential for growth is in tourism. Mr Gaon is even enthused by the idea of a biblical theme park. 'Tourism requires minimal investment and it is highly labour intensive', says Ehud Kaufman, the international director of the Ministry of Finance.

There are, though, some harder tests of Israel's commitment to prosperity on the West Bank and Gaza. The first is its generosity in allowing commuter workers into the Israeli labour market. A report for the Government recommended there should be a limit of 100,000, but this has been scaled down to 60,000. The trade unions are already worried by the impact of the recent immigration of Russian Jews, who swelled the labour force by 7 per cent in 1991 alone.

Israeli policy-makers are aware that they need to provide access to their home market if the Palestinian economy is to thrive. With a comparatively stunted industrial sector, the West Bank and Gaza have considerable potential to sub- contract to Israeli businesses.

In the short term the key is farming, which provides more than a fifth of all output in the West Bank and Gaza. But the occupied territories' agriculture does not have free access to the Israeli market, in part because of the political strength of Israel's farmers. One possibility is the negotiation of a more open European off-season market, which could benefit Israeli and Palestinian farmers.

Surprisingly, one area where neither the Jordanians nor the Israelis expect much of a peace dividend is defence. In Jordan the army employs many indigenous East Bank Jordanians, a political constituency the king cannot afford to alienate when resentments against the Palestinians are increasing.

Israel's defence cuts may also be modest. The peace does not yet encompass all Israel's direct neighbours, or more importantly Iraq. The threat of Scud missiles may lead to investment in anti-ballistic missile systems. At best defence spending may stay constant in real terms, shrinking slowly from its present 11 per cent of national income as the economy grows.

A further worry is whether US military assistance and other aid, which provides nearly 3 per cent of national income, will be phased out slowly enough for foreign investment to fill the hole. Overall, though, Israel's gains from peace should enable its economy to grow at the recent 5 to 6 per cent annual real rate, comfortably outstripping population growth of 2.8 per cent a year until 2000. After winning the war, Israel now looks set to win the peace.

(Photograph omitted)

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