Service sector dynamics in Palestine: two distinct periods

9The dynamics of the service sector in Palestine can be split into two distinct periods. The first of these is that of the Israeli occupation of the Palestinian territories (from 1970 to 1993). The second began in the mid-1990s after the Oslo Accords were signed between Israel and the Palestinian Authorities.

10Figure 1 shows that during the first period (between 1970 and 1993), the contribution of the service sector to GDP fluctuated around 50%, and its contribution to employment between 45 and 50%. In 1993, the contribution of the industrial sector to GDP was only 12%, while agriculture and construction respectively accounted for 12% and 14%. This confirms the service nature of the Palestinian economy during that period.

Figure 1

The contribution of the service sector to GDP and employment in West Bank and Gaza strip between 1970 and 1993

The contribution of the service sector to GDP and employment in West Bank and Gaza strip between 1970 and 1993

11During the first period, Palestinian service sectors were focused on activities which facilitated Israeli domination of the Palestinian economy. This was true of retail and wholesale trade, which facilitated the flow of Israeli products into the Palestinian market, as well as of the land transport developed in order to freight Israeli products and transport the Palestinian labor force from Palestinian areas to Israel (Jafari et al. 2003; Naser, 2003). Other service sectors (such as the financial sector, tourism and telecommunications) grew very slowly due to occupation restrictions. Moreover, the strict restrictions imposed on international trade between Palestine and the rest of the world led to weakness in the support services for international trade, including international transport, marketing, insurance, refrigeration and storage (Jafari et al. 2003; Naser, 2003).

12Some of these distortions in the service sector continued even during the second period, following the Oslo Accords and the establishment of the Palestinian Authority. If we exclude public services, then retail trade and repair of motor vehicles and motorcycles are still the most prominent services in Palestine, comprising around 72% of the firms and employing more than 60% of the private sector labor force.

13A large proportion of workers who were deprived of their jobs in Israel because of the political situation after the second Intifada in 2000 were employed either in public services (mainly security forces) or in the retail trade, where most jobs are unskilled. For example, based on PCBS data, the number of employees in retail trade grew by around 7% in 2001 and 5% in 2002, which corresponds to 62,000 new employees in 2001 and 70,000 in 2002.

14In some services (such as knowledge-intensive services), the employment rate decreased because of the second Intifada. For example, in the first year of Intifada (2001), employment in real estate activities decreased by around 21%, and it decreased by 31% in R&D and 6% in ICT services.

15The second period saw changes in the structure of the service sector, such as the rising of new service activities like computer and related activities (average growth of 28% yearly), Research and Development (average growth 24% yearly), postal services and telecommunications (average growth of 370% yearly) (see Table 1). The period of peace which followed the end of the first Intifada, and the signature of the Oslo Accords in 1993, prompted the flow of Foreign Direct Investment – mainly in the financial and telecommunications sectors. Furthermore, local investors invested in sectors such as hotels, restaurants, and business services.

Table 1

The growth rate of service sub-sectors between 1995 and 2009 measured in terms of number of firms

Year Sale and repair of motor vehicles Wholesale trade Retail trade, repair of personal goods Hotels and restaurant Land transport Supporting & auxiliary transport Postal services and telecommunication Real estate activities Renting of machinery without operator Computer and related activities R&D Other business activity 1996 –1% 3% 2% –6% –3% 8% 0% 16% 2% 0% 20% 1% 1997 10% 5% 22% 23% –3% 79% 4967% 28% –11% 32% 117% 10% 1998 66% 387% –32% 15% 44% –2% –17% 49% –1% 152% 162% 14% 1999 –32% –76% 73% 6% 1% 2% 10% –37% 5% 37% –59% 6% 2000 3% –4% 10% 6% 11% 8% –17% 33% 10% 40% –14% 4% 2001 2% –4% 5% 5% 1% 2% –3% 0% 5% 18% –21% 2% 2002 4% –15% 5% 5% 4% 3% –8% 106% 7% 19% 5% –2% 2003 2% –9% 3% 5% 179% 3% –4% –35% –25% 17% –15% 7% 2004 –2% –22% –2% 7% –60% 4% –38% 4% 53% 17% 112% 0% 2005 12% 25% 12% 9% 25% 20% 249% 46% 7% 28% 8% 6% 2006 0% –1% 0% 2% 0% –3% 14% –9% 2% –1% 3% 2% 2007 1% –5% –2% 1% 2% –2% 36% 35% 5% 31% 38% –8% 2008 4% 26% 6% 8% 18% 12% –2% –1% –6% 5% –9% 11% 2009 5% –18% 7% 6% 3% 1% 3% –8% 5% 1% –12% 4% Average 5% 21% 8% 7% 16% 10% 371% 16% 4% 28% 24% 4%

The growth rate of service sub-sectors between 1995 and 2009 measured in terms of number of firms

16Nevertheless, the share of these activities in the value added, the production, the employment, and the productivity of the whole service sector remain very weak. Furthermore, these activities face tough competitive pressure from Israel and other countries in the region. For example, in 2009, only 3.1% of the labor force worked in postal services and telecommunications, 0.66% in computer and related activities and 0.26% in the R&D sector. The ratio of value added to overall value in the service sector is less than 1% in computer and relative activities, R&D and real estate activities. There are many reasons for this: I) the lack of corresponding competences under occupation, II) Israel’s persistent control over the movements of goods and people across the frontiers of the Palestinian territories, even after the Oslo Accords, III) uncertainty in the sustainability of the peace period, which discourages foreign investors, IV) manufacturing sector weakness.

17These structural weaknesses in the Palestinian service sector are not corrected by relevant public policy. This policy gap, which was evident during the occupation period, remains after the Oslo Accords. In contrast with other developing or emerging countries such as India, Malaysia or the Gulf countries, the Palestinian Authority does not establish any public policy to support the development of the service sectors in general or strategic capital and knowledge services where ICTs can play a prominent role in prompting growth in productivity. Most of the workshops, conferences and round tables held in Palestine over the past two decades have focused on which policies should be adopted in order to develop the manufacturing sector – considered the only one likely to furnish growth and competitiveness.

18The transportation sector is limited to land transport. Neither air nor water transport exists. Israel still does not allow Palestine to build an airport in the West Bank, and it destroyed the only airport in Gaza at the beginning of the second Intifada. It still bans the construction of a seaport in Gaza – the only Palestinian channel to the Mediterranean Sea. Of course, all these limitations have a strong negative influence on certain service sectors like international trade, tourism, education, and hotels and restaurants.

19The public sector in Palestine grew sharply after the institution of the Palestinian Authority, which employed thousands of employees in the ministries and public departments and in the security forces, in order to perform the functions transferred to it by the occupation authority. Therefore, between 1995 and 2000, the absorptive capacity of employment for the service sector (mainly in the public sector) grew by 5% annually, reaching 61% of the total labor force in 2000. This evolution mainly led to the rise of disguised unemployment, mainly in public services, and put huge pressure on the fiscal budget.

20By the beginning of the second Intifada in 2000, public sector employment increased at a fast pace because – as we mentioned earlier – many of the employees who lost their jobs in Israel because of the second Intifada in 2000 were employed in public services. For example, the proportion of workers in the public sector in the West Bank increased from 19% in 2000 to 23% in 2002 and from 31.5% in 2000 to 41.4% in 2002, in the Gaza strip. It should also be noted that the employment rate of Palestinians in Israel decreased from 18.8% in 2000 to 9.3% in 2002.

21There was no economic justification for increased public sector employment; this was just an unstudied strategy implemented by the Palestinian government in order to solve the severe unemployment caused by the second Intifada. Obviously, the productivity of labor in the public sector heavily declined, given that the increase in labor was not offset by equivalent increases in value-added or production.

22While the wages of employees in the public sector were increasing, average weekly hours worked – and therefore production – was declining. For example, the average weekly hours worked in the public sector fell from 41.86 in 1999, 39.1 in 2001 to 24.41 in 2010. In contrast, the hourly wage increased from 7.69 NIS (New Israeli Shekel) in 1999, 7.89 NIS in 2001 to 11.93 NIS in 2010 (Daoud and Shanti, 2012).

The economic performance of the service sector in Palestine

23In this section we describe the economic performance of services for the period 1995-2010, using indicators such as international trade, number of employees, number of firms, value added, etc. We begin with a general comparison of the service and manufacturing sectors, before addressing the service sector by its various subsectors, and finally we consider foreign trade in services.

Service Sector vs. Industrial Sector

24As illustrated by several indicators in Figure 2, with the exception of productivity, service sector performance was better than industrial sector performance over the past two decades.

Figure 2

Growth in value added, productivity, employment, number of firms, and intermediate consumption between 1995 and 2010 in the service and industrial sectors

Growth in value added, productivity, employment, number of firms, and intermediate consumption between 1995 and 2010 in the service and industrial sectors

25The service sector employment growth rate was 3 times higher than that of the industrial sector. This is mainly due to the occurrence of the second Intifada in 2001, which led to the closing of many industrial firms because of Israeli restrictions on the import of raw materials and the long siege against Palestinian cities (especially Nablus, the main industrial city in West Bank). Furthermore, as mentioned above, many of the employees who lost their jobs in Israel were absorbed by the service sector – mainly into public defense and the retail trade. According to PCBS data, for example, in 2001 the employment rate increased by 6.6% in the service sector – whereas in the industrial sector, it decreased by 15%.

26The increase in number of firms, value added and intermediate consumption was also higher in services than in manufacturing. In 2010, 66.9% of employees in Palestine were employed in the service sector, and the service sector contributed to around 66% of value added (see Table 2). This confirms our previous statement that Palestinian economy is a service economy.

Table 2

Distribution of value added, production, employment, number of firms, and intermediate consumption between Palestinian economic sectors in 2010

Value added Intermediate consumption Production Employment Service sector 66.2% 31.6% 54.3% 66.9% Industrial sector 25.2% 52.1% 34.3% 19.5% Construction sector 3.4% 7.6% 4.7% 1.67% Agriculture sector 5.2% 8.7% 6.6% 11.8%

Distribution of value added, production, employment, number of firms, and intermediate consumption between Palestinian economic sectors in 2010

27The lag of the service sector behind the industrial sector in terms of productivity requires a deep analysis of the main determinants of service sectors productivity growth.

Service Sector Structure in Palestine

28Table 3 shows that there is a high level of heterogeneity between service sub-sectors in terms of major economic indicators such as employment rate, number of firms, output and value added, etc. This heterogeneity is however not specific to the Palestinian economy, since it holds true for all service economies.

Table 3

Intermediate consumption and value added in service sector in 2009

Service sub-sectors Value added (%) Intermediate consumption (%) Output (%) Compensation of employees (%) # Of employees (%) # Of firms or institutions (%) Sale and repair of motor vehicles 9.20 10.38 9.41 6.76 9.20 8.98 Wholesale trade 9.50 5.61 8.72 4.53 3.65 2.36 Retail trade, repair of personal goods 28.8 31.1 29.31 16.05 43.89 59.45 Hotels and restaurant 4.20 11.16 5.64 4.92 6.39 0.562 Land transport 1.60 4.08 2.13 2.90 1.57 0.52 Supporting & auxiliary transport 1 0.85 0.96 0.66 0.55 0.44 Postal services and telecommunication 23.6 8.72 20.67 11.20 2.22 0.38 Real estate activities 0.27 0.39 0.29 0.27 0.17 0.21 Renting of machinery without operator 0.32 0.29 0.31 0.18 0.40 0.43 Computer and related activities 0.34 0.51 0.38 0.47 0.48 0.62 R&D 0.36 0.19 0.32 0.93 0.19 0.05 Other business activity 2.59 4.32 2.94 4.31 3.61 3.59 Education 6.52 5.94 6.40 24.14 8.75 2.57 Health and social work 6.01 7.88 6.39 10.58 6.62 4.66 Sewage and refuse disposal 0.01 0.02 0.01 0.02 0.01 00 Membership organization activities 2.43 3.56 2.66 8.83 5.54 2.00 Recreational culture and sporting activities 1.31 1.63 1.37 1.63 2.50 2.08 Other service activity 1,78 3.37 2.10 1.63 4.25 6.02

Intermediate consumption and value added in service sector in 2009

29In 2009, distribution and social services represented the largest service sub-sectors in terms of employment. Retail trade accounted for nearly 44% of employees and 59.5% of firms, and social services accounted for around 28% of employees and 17% of firms in the service sector. Other personal services such as the sale and repair of motor vehicles accounted for around 9% of employees and 9% of firms in the service sector. This result confirms that the distortions introduced by more than 30 years of occupation are still alive and kicking after the Oslo Accords.

30Percentage of firms, employees, compensation of employees, output, Knowledge-intensive and capital-intensive services such as postal services and telecommunications, R&D, computer and related activities and business activities still accounted for just a small share of employees and firms in the service sector. For example, the computer and related services and R&D sectors respectively accounted for around 0.4% and 0.1% of employment in the service sector. This result illustrates the weak interest in knowledge and R&D services in Palestine, which will negatively affect the ability of the economy to innovate and develop.

31Except for postal services and telecommunications, the value added and output of these sectors represent only a small share of the value added and the output of the whole service sector. For example, the value added for computer and R&D activities accounts for less than 1% of the total, indicating weak performance of these sectors in Palestine.

32The relatively high proportion of value added and output of the postal services and telecommunications sector (around 20% for output and 24% for value added) illustrates the prominent role that this sector is playing, and appeals for more investment in it, as well as its inclusion in the core interest of public policy.

33The public sector contribution to value added and output is relatively low. For example, value added was around 6% in both education and the health sector, 2% in membership organization activities and 1% in recreational culture and sporting activities. Taking into account the high level of employment in these sectors, the productivity level will be negatively impacted.

34Table 4 below shows that the wholesale and retail trade is the largest contributor in GDP among service sub-sectors in Palestine in 2009 with 15.1%, followed by public administration and defense with 11.3%. The contribution in GDP of Knowledge intensive services like financial intermediation (4%), real estate and business services (6.5%) is still low, which confirms the traditional nature of service sector in Palestine.

Table 4

The contribution of service activities in GDP in 2009

Service activity Contribution in GDP (%) Wholesale and retail trade 15.1 Transport, Storage and Communication 9.2 Financial intermediation 4.0 Real estate, Renting and Business Services 6.5 Community, Social and Personal Services 2.0 Hotels and Restaurants 1.0 Education 7.7 Health and Social Works 3.3 Public Administration and Defense 11.3 Households with employed persons 0.1 Public owned enterprises 3.2

The contribution of service activities in GDP in 2009

Measuring productivity in the service sector

36The measurement of productivity in manufacturing raises several problems and issues which have been addressed at length in the literature (Schreyer, 1996; Gullickson, Harper, 1999; Nordhaus, 2000). In services, the problems are more severe (Djellal, Gallouj, 2008; Maroto, Rubalcalba 2008; Wölfl, 2004; Bosworth, Triplett, 2000; Griliches, 1992) and given that world economies are now mainly service economies, the mismeasurement and underestimation of service productivity is likely to lead to an incorrect evaluation of overall economic performance. The productivity gap between the manufacturing and service sectors is also related to measurement issues.

37The main difficulty in measuring service productivity lies not in the definition and measurement of inputs (labor and capital) but in the identification and definition of output. These difficulties are related to the fluid nature of the service process, the intangibility and invisibility of service production and the co-production or co-creation of many services.

38For example, Maclean (1997) states that production in the service sector is underestimated mainly in financial services, real estate, business and personal services, because of their intangible nature and because their quality depends on the inputs provided by users of the services in question.

39Recent measurement experiments consider complementarity between productivity and quality (Johnston, Jones, 2004; Van Ark, 2006). In other words, in order to measure productivity, they use such indicators as utility, quality, availability, etc. This has changed the value of productivity in many countries, to reflect the service sector’s actual role in the economy (Triplett, Bosworth, 2007).

40In the empirical literature, Zheng et al. (2003), Castellacci and Zheng (2008) used total factor productivity (TFP) to measure productivity in the service sector. Bloch and Graversen (2008) used sales ratio, while Cainelli et al. (2006) used labor productivity (sales/number of employees). In this study, we use the growth in labor productivity (value added/number of employees) between two years, because it offers a dynamic measure for productivity.

The relationship between service sector development and growth in productivity

41The relationship between service sector development and growth in productivity is more apparent in developed countries. Growth in productivity comes mainly from productive services (ICT services, R&D, KIBS, telecommunications, transportation, etc.) and the intensive use of ICTs in most service sectors.

42Several reasons push developed countries towards introducing drastic changes in their strategies with regard to development of the service sector and stimulation of service productivity. Firstly, most developed countries are now service economies in which the service sector accounts for the largest proportion of both GDP and employment. Secondly, the proportion of service products in international trade is steadily increasing in most of these countries. It is therefore important to adopt new policies, intertwined with globalization and open market operations. Thirdly, many service activities which had been protected by monopoly power have become open to competition and require new policies aimed at encouraging investment and increasing competition.

43Productivity is affected by numerous factors: at human level (skills, experience, training, education, etc.), firm level (organization structure, innovation, technology, etc.), and national level (economic growth, regulation, public policy, globalization, openness, etc.).

44In the case of South Korea, Jones (2009) explains the fact that labor productivity growth in the service sector has been weak (relative to manufacturing) due to weak competition in services resulting from strict product market regulation, a low level of import penetration and inflows of Foreign Direct Investment (FDI). This demands eliminating domestic entry barriers, reducing barriers to trade and FDI inflows, reforming regulations and laws, and upgrading competition. Another challenge aimed at accelerating growth in service productivity in South Korea is the restructuring of small SMEs (which account for more than 90% of employment in the service sector) focusing on high-growth potential service sectors such as financial services and telecommunications.

45Many works consider labor productivity in the service sector to be affected by globalization and trade liberalization (Sjoholom, 1997; Javantha Kumaran, 1999; Chin Chen and Yir-Hueih, 2000; Mei Hsu & Been-Lon Chen, 2000; Phan, 2004). Sjoholom (1997) found that the openness strategy in Indonesia led to increased service trade as well as improved service productivity. The same result has been established for Thailand (Javantha Kumaran, 1999), Australia (Phan, 2004) and South Korea (Kwak, 1994).

46Foreign Direct Investment (FDI) is one of the most important outputs of globalization. It leads to the inflow of knowledge and technology (technology spillover), skills and experiences of developed economies. The positive relationship between FDI in the service sector and labor productivity has been experienced in many countries. In Taiwan, Mei Hsu & Been-Lon Chen (2000) found that FDI in the service sector (mainly in SMEs) led to increased service exports and labor productivity. Chin Chen and Yir-Hueih (2000) studied the relationship between FDI and service productivity in 10 Asian countries, finding a positive relationship based on the ability of these countries to absorb foreign knowledge and technologies. Koirala and Koshal (1999) established that FDI in Nepal led to increased productivity in foreign firms, in comparison with local firms. This was mainly due to greater use of capital-intensive technology. Similar results were reported in the case of South Africa by Robert and Thoburn (2004), who found that FDI in the textile sector led to a major increase in labor productivity, due to the intensive use by foreign firms of capital technology.

47Lack of experience, skills and knowledge in the service sector limits local economies’ ability to take advantage of FDI. Local employees might not be able to deal with modern technology or absorb skills and experiences originating in foreign countries (Ismail et al., 2010). The literature also addresses the relationship between immigration and the economic performance of home country, leading to ambivalent conclusions.

48Some studies underline the positive impact of immigration on the economic performance of sending countries. This is mainly due to increasing income from remittances, access to finance for starting new businesses, increasing ability to smooth consumption, and tapping into the knowledge and resources provided by the international community (Azam, Gubert, 2006). According to Ratha et al. (2010) migrants from developing countries sent over $315 billion to their origin countries in 2009.

49Other studies underline the negative impact of immigration. For example, Bhagwati, Hamada (1974) and Stark, Wang (2002) disagree on whether immigration is good for sending countries. Immigration of high skilled labor or the so-called “brain drain” can cause a loss of public resources invested in education, reduce the productive capacity, and worsen the business environment mainly in the sectors which need for high skilled labor like knowledge intensive business services, ICT services, health and education.

50It is difficult to understand the economic performance of Middle East economies (Palestine, Lebanon, Syria, Jordan, etc.), only relying on economic factors as explanatory variables. Political variables in countries experiencing (civil, political or armed) conflicts play an important role. The literature provides many references that establish a negative relationship between political instability and economic performance (Evia et al., 2008; Polachek, Sevastianova, 2010; Alesina et al., 1996). Political instability can distract resources away from production. It tends to reduce investment and is therefore likely to reduce economic growth and productivity.

Strategies to enhance service productivity in developing countries

51Developing countries have adopted a set of strategies to prompt the growth of the service sector and to enhance the overall economic performance. In particular, during the last two decades, many developing countries have introduced regulation reforms in order to attract local and foreign investments and facilitate trade in services. Therefore, service exports in developing countries have been steadily growing over the last two decades, even more than in most of developed countries.

52In the Middle East, the service sector experienced significant changes in policies and regulations, with the aim to enhance the contribution of service sector in economic growth and productivity. For example, according to Dubai Chamber of Commerce Statistics, the United Arab Emirates’ investments in the service sector increased from 40% in 1985 to 72% of total investments in 2003, which led to increasing the share of the service sector in GDP from 38% in 1985 to 71% in 2003.

53In Jordan, which economy is similar to the Palestinian economy in terms of structure and scarcity of natural resources, the government adopted a set of policies to develop the service sector and to prompt its overall productivity. First, in 2000 the government offered tariff and tax reduction for investment projects in many service sectors like hotels and restaurants, hospitals, shipping, railways, tourism, distribution of water. Second, it launched the Jordan Services Modernization Program “JSMP” in cooperation with private sector and NGOs. This program supports SMEs in the service sector in order to increase their competitiveness in local and international markets and enhance the share of service products in Jordanian exports.

54In Egypt, despite the high contribution of the service sector in GDP (more than 55%), the potentials of this sector are not efficiently exploited, and therefore its productivity is still low (Ghoneim, Helmey, 2007). Many of the service sub-sectors are not exploited enough either for local or for international demand. The contribution of the service sector in GDP mainly involves tourism and transportation (Suez Canal). Ghoneim and Helmey state that both public and private policies should be directed towards the adoption of an overall reforming plan where capital and knowledge intensive services should play a prominent role in order to enhance the productivity in the service sector.

Methodology and Empirical Approach

58The difficulty of accessing data about certain economic indicators in Palestine has hampered the construction of a comprehensive model which includes all variables likely to impact productivity growth. For example, the literature considers laws and regulations, use of technology, and innovation to play a significant role in improving productivity growth in the service sector – yet there is no available data about such variables in Palestine.

59Furthermore, the Palestinian Central Bureau of Statistics (PCBS) only provides sectoral-level data (as opposed to firm-level); we are therefore limited, here, to sectoral-level analysis.

60In this section, we develop an econometric approach to analyzing the determinants of growth in labor productivity in the service sector, using panel data for the period between 1995 and 2009. A sample size of 234 is used; this was obtained by multiplying the number of service sub-sectors (18) by the number of years between 1997 and 2009 (13). The data about both the dependent and independent variables are obtained from the PCBS which provides them starting from 1995.

61We conclude that a fixed effects approach will be preferable in scenarios. Using the Lagrange multiplier test, we found the data structure to be consistent with panel data; pooled OLS regression is therefore not the appropriate method for estimating our relationship. Secondly, using the Hausman test, we found a correlation between the individual characteristics of service subsectors, and other independent variables.

62In the fixed effects model, 17 dummy variables are defined for each of the service sectors, while sewage and refuse disposal sector is used as a reference sector for building the dummy variable.

63Given the methodological issues outlined above, our empirical approach is based on the following equation:

64

65Productivity represents the dependent variable which is measured using labor productivity (value added/# of employees). We use the growth in labor productivity between two years because it offers a dynamic measure for productivity. Ci/firm is the growth ratio of intermediate consumption to number of firms in each sector, which measures the impact on labor productivity of firms’ use of intermediate consumption. Nb_firm accounts for the growth rate in number of firms in each service sub-sector. Data shows that the service sub-sectors having a high growth rate in the number of firms are characterized by the highest labor productivity growth rate. FDI represents the share of Foreign Direct Investment in each service sector. FDI has increased sharply in the last two decades. It increased from $595.5 million in 1997 to $1378.3 million in 2010, which confirms the prominent role played by FDI in the Palestinian economy. Exp/output represents the growth of ratio of export to output. This variable measures the degree of service sector globalization and openness, which, in many countries, plays a significant role in pushing productivity growth. Sectors which seek to enhance exports should improve competitiveness and therefore production efficiency. K is growth in capital input employed by the service sector. Firm-level data usually shows a positive relationship between large firms and labor productivity. D1 is a dummy variable for capital intensity sectors (D1=1 if the service sector is capital intensive). If K/L is above average value then the service sector uses capital-intensive technology. Many studies found a significant relationship between intensity of labor and productivity growth. D2 is a dummy variable denoting the political instability, which equals one if the conflict between Palestine and Israel is active, and zero if not. In this view, the period between 1995 and 2009 is divided into three phases. The first from 1995 to 2000 after the signing of Oslo Agreement experienced a state of stability and relative prosperity and growth in investments in most of the economic sectors. The second is the period of 2^nd Intifada between 2000 and 2005. It negatively impacts most of the economic sectors because of the destruction by Israel of the infrastructure, the invasion of Palestinian areas, the closure of Palestinian areas by hundreds of checkpoints which highly impeded the trade between different areas inside Palestine and between Palestine and other countries. The third period between 2006 and 2009 experienced a high decrease in violence between, although 2008 has experienced an Israeli war against Gaza. The variable “Migrant” represents the number of international migrants from Palestine. This variable measures the effect of immigration on the productivity of the service sector. It is expected to have low impact on it. Based on PCBS data, the number of emigrants from Palestine is considered low in comparison with countries that experience political instability. This is attributed to the bad 1948 experience of Palestinian people regarding displacement and emigration. For example, based on PCB data, the number of emigrants in 2009 was only 7,122 persons, and 35% of them were students, while the number of returnees to Palestine was 6,426.

Results and Discussion

66Table 5 summarizes the main results of the regression equation estimation. Durbin Watson test of autocorrelation shows no existence of autocorrelation, and Wald test denotes no trace of heteroscedasticity. The level of determination of the independent variables gives R² around 0.96, which means that they explain around 96% of the change in the growth of productivity. The degree of tolerance for the independent variables gives values less than 10, which means no multicollinearity in the model.

Table 5

Results of growth determinants in service productivity estimation^*,**,***

Variable Coefficient T-test g_)Ci/firm(–0.122 0.304 g_nb_firm 0.481 0.003*** g_FDI 0.073 0.003*** g_(export/output) 1.676 0.88 g_(K(0.213 0.02** D1 0.598 0.001*** D2 0.195 0.049 Migrants 0.913 0.77 Service sector Sale and repair of motor vehicles 0.167 0.51 Wholesale trade 0.875 0.001*** Retail trade, repair of personal goods –0.10 0.74 Hotels and restaurants 0.489 0.075* Land transport 0.640 0.15 Supporting & auxiliary transport 0.632 0.02** Postal services and telecommunications 1.08 0.00002*** Real estate activities 0.91 0.001*** Renting of machinery without operator 0.39 0.188 Computer and related activities 0.65 0.19*** R&D 0.75 0.006*** Other business activity 0.3 0.329 Education 0.53 0.0005*** Health and social work 0.23 0.665 Sewage and refuse disposal 2.1 0.412 Activities of membership organization 0.88 0.32 Recreational culture and sporting activities 0.54 0.22 Other service activity 0.99 0.103 N 234 Lagrangian Multiplier Test (chisq = 24.7621, p-value = 6.486e-07) Hausman Test (chisq = 10.674, p-value = 0.00898) R2 = 0.96 Durbin Watson test = 2.02 Wald test for heteroscedasticity P-value = 0.65

Results of growth determinants in service productivity estimation^*,**,***

* Significant at 0.10 level of significance
** Significant at 0.05 level of significance
*** Significant at 0.01 level of significance

67We found that the ratio of intermediate consumption to number of firms has no significant impact on labor productivity. This means that sectors with strong growth in intermediate consumption do not necessarily have strong growth of production. For example, intermediate consumption in the retail trade grew by 12% between 1995 and 2009, whereas productivity grew by only around 7%. A similar result holds for hotels, restaurants, and computer activities. This result contradicts the findings of Rao et al. (2004) who concluded that intermediate input intensity is the most important contributor to labor productivity in the USA service sector. This contribution might be explained by the nature of the intermediate inputs. Indeed ICTs and knowledge account for a high proportion of intermediate consumption in developed countries – which is not the case in developing countries.

68Strong growth in the number of service firms has a positive impact on labor productivity. This is illustrated by postal services, telecommunications and R&D. For example, postal services and telecommunications have strong growth in both number of firms (around 370%) and productivity (around 30%) between 1995 and 2009. Public policy should thus be oriented toward prompting investment in knowledge-intensive services such as R&D, real estate services, and capital-intensive services such as postal services and telecommunications.

69In our analysis, FDI (which is mostly in postal services and telecommunications and financial services) has limited influence on the growth of service productivity. This result is not consistent with Jones (2009) or Mei Hsu, Been-Lon Chen (2000), who establishe that higher FDI inflow leads to higher labor productivity in the service sector. The low impact of FDI on productivity growth (around 0.07) is explained by the fact that FDI is still weak in Palestine because of the political situation and Israel’s control over more than 85% of Palestinian lands.

70Export growth has no significant impact on growth of labor productivity, which is mainly related to fluctuation in trade in services, due to the political situation and the second Intifada. Furthermore, the trade liberalization policies implemented in Palestine were mostly not beneficial to the Palestinian economy. They led to a rise in the trade deficit, especially given the restrictions on the movements of goods and services imposed by Israel. For example, Israel’s control of the borders between Palestine and the rest of the world, as well as its checkpoints between cities, restrict the flow of tourists into Palestine. This is limited to holy cities such as Jerusalem and Bethlehem, and causes significant harm to the tourism, hotel and restaurant sectors.

71Capital growth has a positive impact on labor productivity, which is consistent with the results provided by the literature.

72In line with the literature (Rao et al., 2004; Uppenberg and Strauss, 2010), we note that capital-intensive business services have more impact on labor productivity than labor-intensive services. This is also consistent with the fact that capital-intensive services are characterized by a strong productivity growth. For example, PCBS data indicate that postal services and telecommunications productivity grew by 30% between 1995 and 2010.

73This result provides an explanation for the weak productivity growth of the Palestinian service sector. Indeed most service sectors in Palestine are labor-intensive (trade, sales and repair of motor vehicles, and hotels and restaurants). Furthermore, they mainly employ unskilled workers.

74More than 12,000 students graduate from Palestinian universities every year, yet in 2010 around 45% of them remained unemployed (PCBS, 2010). Skilled labor is thus not appropriately exploited in the service sector. Furthermore, even those graduates who are employed lack the relevant skills and trainings needed in their jobs. This results in the creation of a gap between the service sector growth and productivity growth within the service sector.

75To increase the labor productivity in the service sector, the government should adopt a national program for the rehabilitation of the thousands of workers who lost their jobs in Israel after 2001, upgrading their abilities and merging them into the Palestinian economy in a rational way. Universities and private organizations should implement innovative programs in order to enhance the abilities and know-how of graduates. This will enable service activities to employ them appropriately and enhance their productivity. Furthermore, to meet international standards, most service sectors – and especially distribution services – should invest much more heavily in knowledge and ICTs within their supply chain.

76The impact of the political instability and the increase of violence between Israel and Palestine will weaken the growth of productivity in the service sector. During the period of the second Intifada between 2000 and 2005, Israel laid siege to the Palestinian areas with hundreds of checkpoints between cities and villages, as well as daily invasions of the Palestinian areas, which seriously affected all the economic activities in Palestine. Negative influence on service sectors was apparent mainly in retail trade, wholesale trade, transportation, tourism and real estate because of checkpoints and Israeli destructions of infrastructure (mainly roads).

77The regression analysis doesn’t show any significant impact of migration on the growth of productivity. This result is normal given that the period of study didn’t experience a remarkable migration from Palestine, even the period of second Intifada when the socio-economic situation in Palestine was very miserable. Palestinian people had a bad experience with migration in 1948 (when the State of Israel was created); they left their houses for a short period to protect their life and then became refugees in all over the world until present.

78With the exception of the education sector, public services have no significant impact on productivity growth in the service sector. This confirms weak productivity among workers in public services. With regard to the education sector, Palestine has the lowest illiteracy rate in the Arabic countries. According to the Palestinian Central Bureau of Statistics, illiteracy was 6% in 2009, and the rate of enrolment in basic education (grades one to ten) has steadily grown over the past two decades. The Ministry of Higher Education has taken into account relevant policies and documents developed nationally and internationally in order to improve the performance of the education sector, including (a) The Palestinian Reform and Development Plan 2008-2012; (b) The Education for All Plan and its Terms of Reference; and (c) The Millennium Development Goals.

79Postal services and telecommunications have the highest impact on the growth of productivity. This sector combines high use of capital-intensive services, a large share of FDI, high employment of skilled labor (engineers, IT experts, accountants, and consultants), and high growth of value added. It is also considered the most innovative sector, thanks to the diversity of services it offers, its processes and marketing approaches.

80The real estate sector has also a very positive impact on productivity growth. This is related to the high growth in the construction sector following the Oslo Accords and the construction of the Palestinian institutions. Furthermore, the construction sector attracts most investors due to the high demand for housing.

81The R&D sector also has a strong effect on the growth of labor productivity. This is related to the outstanding efficiency of workers in this sector, who are mostly well-educated and highly skilled workers. Demand for R&D services is also rising in other sectors such as telecommunication, financial services, drugs manufacture, etc. In developed countries, R&D is one of the most productive sectors in the economy, leading to spillover effects on all other economic sectors and enhancing overall economic productivity. However, in Palestine, this sector suffers from a lack of interest from both public and private sectors. For example, R&D accounts for less than 0.1% of employment and less than 0.05% of number of firms in the service sector in 2009. Neither the Ministry for Higher Education, nor most Palestinian universities allocate a budget to R&D.

82The hotels and restaurants sector is characterized by low impact on productivity growth, despite its strong growth following the Oslo Accords. This may be consistent with the restrictions imposed by Israel on the tourism sector. Many foreigners who come to visit the holy sites in Jerusalem and Bethlehem have to travel via Israeli airports, and these visitors are used to book hotels inside Israel. Moreover, Arabs from most Arabic countries are not allowed to enter Palestine. The Palestinian ministry of tourism should also adopt a plan to encourage tourism in the Palestinian area, encouraging the use of ICTs (Internet, Facebook, etc.) in particular. The private sector should also invest more heavily in restaurants and hotels, using ICTs to connect them.

83Traditional service sectors such as retail trade, or the sale and repair of motor vehicles and land transport, have no significant impact on productivity growth in the service sector. This confirms what we have mentioned previously about weak productivity growth within these sectors, the unskilled nature of the labor force, and the limited use of capital-intensive technology and ICTs. Land transportation is hampered by the many impediments introduced by hundreds of Israeli checkpoints throughout the Palestinian areas, and infrastructure weakness – especially the absence of major roads and railway lines between cities.