This paper presents a macroeconomic framework of the Palestinian economy and analyzes the main economic processes that began after the 1967 war. The driving force behind these processes was the interaction between two very different economies which met at the market place. The rapid rise in standards of living until 1987 was led by high employment in Israel, while domestic growth of output was more limited. In an economic environment free of controls, it is not obvious that income gaps between such different economies should have been narrowed mainly through labor flows. Part of the adjustment could have taken place through capital movements and trade in goods. However much of the adjustment occurred through labor movements to Israel, reflecting an unbalanced economic interdependence with Israel. In spite of growing standards of living and high saving rates, only a small share of savings was channelled into productive investment and as a result industry hardly contributed. to economic growth. Instead, small scale residential investment constituted an important instrument of saving partly due to the absence of a well functioning banking system. The outbreak of the Intifada halted the growth process in the Westbank. Output and especially incomes fell sharply, compared to their potential, as approximated by the model's forecast. The effect on the Gazan economy has been left for future research. The present framework also helps in analyzing alternative strategies of the economy at the outset of the new political situation of self-government.

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