## 1wbgea2023004

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---

### Economic divergence: overview and key outcomes
- Years of isolation and continuous conflicts have left Gaza’s economic development far behind that of the West Bank.
- In 2022, per capita income in Gaza was only a quarter of that in the West Bank.
- Gaza’s capital stock is stagnant and infrastructure is derelict (especially electricity).
- Prospects for declining donor aid risk worsening Gaza’s humanitarian crisis.
- A major easing of the blockade and financing constraints is necessary to improve prospects, provided the security situation can be assured in parallel.

### A. Economic developments and structure — key findings and statistics
- Growth and income:
  - During 2007–22, real GDP growth in Gaza averaged 0.4 percent; real GDP per capita declined at an annual average rate of 2.5 percent.
  - West Bank recorded average annual real GDP growth and per capita growth of 5.1 and 2.8 percent, respectively, over the same period.
  - By 2022, per capita income in the West Bank was four times higher than in Gaza.
- Labor and poverty:
  - Unemployment in Gaza reached 45 percent in 2022; percentage living below national poverty line in Gaza was 53 percent, compared to 13 and 14 percent, respectively, in the West Bank.
- Growth accounting (α = 0.3; depreciation 3 percent plus conflict adjustments):
  - Labor’s contribution to growth averaged 2.6 percentage points per year in both territories.
  - Contribution of capital to growth: virtually zero in Gaza; more than 2 percentage points per year in the West Bank.
  - Gaza’s TFP contribution averaged -2.2 percentage points per year; West Bank saw a modest positive TFP contribution.
- Demand- and supply-side contributions to growth:
  - Demand side:
    - Gaza: government consumption contributed an average of 0.8 percentage points to growth; private consumption 0.3 percentage points.
    - West Bank: government consumption 0.4 percentage points; private consumption 5.2 percentage points.
    - Net exports: not a drag on Gaza due to severe trade constraints; in the West Bank net exports subtracted an average of 2.4 percentage points.
  - Supply side:
    - Gaza: industrial sector stagnant; dynamic sectors were services, (re)construction, trade, and agriculture.
    - Construction sector average annual growth in Gaza reached 20 percent (2007–22) versus 8 percent in the West Bank.
    - Agricultural sector annual average growth: Gaza 2.1 percent; West Bank 0.2 percent.
    - Agricultural exports annual growth averaged 13.5 percent over 2015–21.
- Humanitarian and aid context:
  - In 2020, 77 percent of households in Gaza received aid (compared to 10 percent in the West Bank); majority from UNRWA concentrated on food and cash assistance (78 and 57 percent, respectively).
  - Prevalence of food insecurity: Gaza 65.9 percent; West Bank 16.6 percent.
  - Incidence of multi-dimensional poverty: Gaza 45 percent; West Bank 11 percent.
  - No social security system in place; continuation of payments under the National Cash Transfer Program (NCTP) to the most vulnerable in Gaza is of particular importance.

### B. Labor markets — access, productivity, and wages
- Access to employment in Israel and settlements:
  - West Bank workers constituted 22.5 percent of the total number of employed persons in 2022 (versus 0.8 percent for Gaza), earning around US$3.8 billion or 24 percent of GDP.
- Unemployment and participation:
  - Unemployment (2007–22 averages): Gaza 39 percent; West Bank 17 percent.
  - Labor force participation rates have remained below 50 percent since the mid-1990s in both territories.
  - Youth and female unemployment: over two-thirds unemployed in Gaza, compared to less than a quarter in the West Bank.
- Labor productivity and wages:
  - Between 2000–21, average labor productivity per working hour (in 2015 US$): West Bank US$6; Gaza US$5.
  - Sectoral productivity where Gaza outperformed West Bank:
    - Agriculture average labor productivity: Gaza US$12 (in US$2015); West Bank US$6 (in US$2015).
    - Construction average labor productivity (2010–21): Gaza US$9 (in US$2015); West Bank US$4.5 (in US$2015).
  - Wage trends:
    - Since 2000, wages in Gaza have stagnated; West Bank wages grew at an annual rate of 3.3 percent.
    - 2021 average daily wage: Gaza NIS 61.4; West Bank NIS 108.5.
    - 2021 daily private sector wages: Gaza NIS 42.5; West Bank NIS 122.
    - In Gaza, almost 90 percent of private sector employees earned less than the minimum wage; in the West Bank below 20 percent.
    - Minimum wage stands at NIS 1,880 per month.

### C. Investment, financial intermediation, infrastructure, and sectoral multipliers
- Investment levels:
  - Gaza investment has been less than US$500 million per year since 2007 and amounted to less than 11 percent of GDP in 2022.
  - Exceptions: 2016 and 2017 when investment increased slightly to above US$600 million.
  - West Bank investment reached nearly US$5 billion (almost 30 percent of GDP) in 2022, roughly doubling the capital stock since 2007.
- Financial intermediation (2007–22 averages):
  - Gaza: private sector deposits 40 percent of GDP; credit 22 percent of GDP.
  - West Bank: private sector deposits 77 percent of GDP; credit 33 percent of GDP.
  - 76 percent of Gazans saved money at home (Financial Inclusion Diagnostic Study 2022).
- Infrastructure and electricity constraints:
  - Electricity demand in Gaza around three times the electricity supplied, resulting in long blackouts (12 hours on/12 hours off).
  - Between 2017–22, average demand 450 Mega Watts (MW); average supply around 180 MW; in 2017–18 Gaza had only 8 hours of electricity per day.
  - Electricity sources: Israeli Electric Corporation (supplying two-thirds of Gaza’s electricity), Gaza Power Plant (GPP), and until 2018, imports from Egypt.
  - PA pays for IEC electricity through Israeli deductions from clearance revenues; Qatar has been paying for fuel supply to the GPP for the past five years.
  - Households and many businesses rely on private electricity generators despite high cost.
- Economic gains from targeted investment (I-O analysis Leontief Inverse Matrix (I − A)−1):
  - Gaza top output multipliers:
    - Electricity sector multiplier: 1.8.
    - Manufacturing multiplier: 1.74.
    - Mining and quarrying: 1.72.
    - Human health services: 1.71.
    - Construction: 1.63.
  - An increase in economic output of US$1 million in each of these five Gaza sectors would generate additional economic output of around US$8.6 million.
  - West Bank top multipliers:
    - Electricity, agricultural, and public administration sectors: 1.52.
    - Manufacturing: 1.51.
    - Human health services: 1.46.

### D. Trade developments, restrictions, and impacts
- Trade volumes and orientation (2022):
  - West Bank total imports reached 70 percent of GDP; Gaza total imports 54 percent of GDP.
  - West Bank total exports 21 percent of GDP; Gaza total exports 6.5 percent of GDP.
  - More than half of imported goods into the West Bank come from Israel; more than two-thirds of imports into Gaza come from Israel.
  - Most exported goods from both territories are directed to Israel: Gaza 83 percent; West Bank 81 percent.
  - Import dependence on Israel has been slowly declining since 2008 for both Palestinian Territories.
- Trade restrictions and mechanisms:
  - Israel controls all trade into the West Bank passing through its seaports, airport, and over the Allenby-King Hussein bridge connecting the West Bank to Jordan, causing significant delays and additional costs.
  - Outdated A1, A2 and B lists and Dual Use Goods (DUG) list restrict quantity and types of imports, limiting access to key production inputs and equipment.
  - Sectoral impacts:
    - Agricultural sector: fertilizers are heavily restricted under the DUG list.
    - Manufacturing and services: production of steel and pharmaceuticals and ICT development are negatively impacted by import limitations.
- Trade cost and delay metrics (World Bank estimate reproduced in the source):
  - Could increase costs by an average of US$538 per shipment.
  - Costs of exporting and importing a container is 2–  3 times higher for a Palestinian firm than an Israeli firm.
  - Delay is between 2–4 times higher for a Palestinian firm than an Israeli firm.
  - World Bank: rationalizing the DUG list alone would have a significant positive effect on economic growth.
- Gaza-specific restrictions and procedures:
  - Israel controls movement of trade and people in and out of Gaza and severely restricts linkages and economic integration with the West Bank.
  - Israel imposes an additional detailed DUG list for Gaza, complicating and delaying the back-to-back (B2B) trade procedure.
  - Door-to-door trade facilitation project accessible only for the West Bank, not Gaza.
  - For Gaza B2B process: offloading and reloading goods requires an additional third “sterile” truck, increasing costs, delays, and damage to goods.
  - Construction materials into Gaza (cement, wood, steel) are heavily restricted and only allowed via the Gaza Reconstruction Mechanism (GRM).
- Crossings, trade with Egypt, and truckload evolution:
  - Rafah crossing truckloads entering Gaza increased from 4 truckloads in 2008 to 30,208 truckloads in 2022; imports via Rafah mainly construction materials, food products, and livestock.
  - Exports through Rafah: 1,696 truckloads in 2022, mainly iron scrap and scrap batteries.
  - Salah Addin crossing imported truckloads increased from 207 in 2018 to 5,649 in 2022, mainly diesel, petrol, and cooking gas.
  - Gaza operational crossings: two Israeli (Karem Abu Salem for commercial crossings; Beit Hanon/Erez for pedestrian crossings) and two Egyptian (Rafah for commercial trade and movement of people; Salah Addin mainly for fuel and some construction materials).
  - PA only receives import duties and VAT from the Israeli-controlled Karem Abu Salem crossing (except for Gaza truckloads directed to the West Bank for which no VAT is imposed).
- Infrastructure projects and constraints:
  - Energy projects requiring Israeli cooperation:
    - Extension of the 161 KV line from Israel to Gaza.
    - Gas for Gaza (G4G) project (requires conclusion of the Gas Sales and Purchase Agreement (GSPA) and Israeli finalization of crossing point design; PA needs to approve the hydrocarbon law and establish the National Gas company).
  - Further funding needed for Gaza Power Plant phase two (substations, feeders, national control station, related infrastructure).
  - Telecommunications: Israel considering wireless telecommunication spectrum allocations upgrade in the West Bank to 4/5G; Gaza excluded and only outdated 2G is available.
  - Water and sanitation: Dual-use restrictions delaying entry of some parts for the Northern Gaza Emergency Sewage Treatment project (NGEST).
  - Renewable energy and Area C projects in the West Bank hinge on GoI approval; PA identified over 200 MW of solar PV sites and awaits GoI’s approval (GoI had previously approved two locations in the West Bank in Bani Naim (Area A) and Aqbat Jabr (Area C) for solar PV).

### Economic divergence, development pathways, and policy implications
- Historical divergence and current conditions:
  - Over the past fifteen years, Gaza’s social indicators have persistently deteriorated; growth has relied mainly on government consumption; productive capacity has been impeded by the blockade and restrictions.
  - Investment levels, financial intermediation, and wages in Gaza have consistently trailed those in the West Bank, resulting in lack of financing for vital infrastructure services, especially electricity.
- Core policy prescriptions to restart convergence:
  - Lifting of the blockade and easing of Israeli-imposed restrictions are essential for Gaza to forge a new economic development path and restart economic convergence with the West Bank.
  - Major easing of restrictions is needed to address distortions in Gaza’s labor market, productive sectors, and limited access to materials for infrastructure.
  - Cooperation from Israel is required for progress on ongoing and planned infrastructure projects.
- Political reconciliation implications and scenario estimate:
  - Political reconciliation between Gaza and the West Bank could improve basic public services; raise inward investment flows; strengthen governance through a unified regulatory environment; enable the PA to enhance revenue generation through re-deployment of its tax administration; and ultimately boost investment into infrastructure projects (primarily electricity and water).
  - Scenario estimate: Based on staff estimates, a reunification scenario could increase growth to 8 percent in Gaza and more than 5 percent thereafter, though it will increase fiscal costs and necessitate PA reforms to curtail those fiscal costs.

### Scheme II (Defined-Benefit component) — parameters relevant to fiscal context
- Scheme II features:
  - Contribution rates: 16 percent (from employee 7 percent; from employer 9 percent).
  - Mandatory retirement at age 60 with at least 15 years of contributions.
  - Early retirement: civil servants age 55 with at least 15 years of service, with 5 percent pension reduction until age 60.
  - Benefit formula:
    - Basic replacement rate: 30 percent.
    - Incremental replacement rate (accrual rate): 2 percent per year of service, multiplied by average salary of the last 3 years.
    - Maximum replacement rate: 80 percent.
  - Pension indexation: Based on wage increases of active contributors.
- Fiscal note:
  - Scheme II is de jure a contributory pre-funded scheme, but in practice the Ministry of Finance has not been transferring mandated contributions to the Palestinian Pension Agency (PPA), resulting in effectively PAYGo operations and insufficient assets to meet future obligations.

### Coverage, dependency ratios, benefits, and allowances (Scheme II as of 2021)
- Coverage and dependency:
  - As of 2021, scheme II included about 134,000 public sector contributors—82,000 civil servants and 52,000 security personnel—corresponding to 9.6 percent of the Palestinian labor force.
  - Beneficiaries were around 26,000—6,000 civil servants and 20,000 security personnel.
  - Scheme II dependency ratio (old-age and early retirement beneficiaries to contributors):
    - Civil servants: 4.3 percent.
    - Security personnel: 34.4 percent.
  - If invalidity pensioners and survivors are included, dependency ratios would increase to:
    - Civil servants: 7.9 percent.
    - Security personnel: 38.4 percent.
  - Current pension beneficiaries (including legacy schemes) represent only 1.5 percent of the Palestinian population.
- Benefits and eligibility rules:
  - Mandatory retirement ages and full old-age pension eligibility:
    - Male civil servants: mandatory retirement age 60 with at least 15 years of service.
      - Full pension also at age 55 with 20 years of service.
      - Full pension also at age 50 with 25 years of service.
    - Female civil servants: required period of service for a full old-age pension is lower by 5 years at each retirement age (subject to the 15 years minimum contributory period). Example: can retire at age 55 with 15 years of service; can retire at age 50 with 20 years of service.
  - Early retirement provisions:
    - Pension Law allows male civil servants early retirement at 55 conditional on at least 15 years of contributory service and subject to a 5 percent benefit reduction per year until reaching 60.
    - Cabinet decrees have regularly exempted early retirees from this reduction.
  - Security personnel and certain sectors:
    - Can retire at age 50 with at least 20 years of contributions.
    - Cabinet decrees can allow retirement at any age with only 15 years of service without benefit reduction.
  - Scheme II parameters reiterated:
    - Incremental annual accrual rate: 2 percent.
    - Maximum replacement rate: 80 percent of the average salary over the last three years of service.
  - Average replacement rates as of 2021:
    - Civil servants: around 57 percent.
    - Security personnel: 76 percent.
- Allowances, basic pension, and lump-sum benefits:
  - Monthly personal allowance: NIS 300 (paid to all pensioners).
  - Monthly family allowance: NIS 60 for the spouse and NIS 20 for each child (paid regardless of pension amount or other income).
  - Basic pension for those without accrued pension rights:
    - Means-tested basic pension currently amounting to NIS 700 per month (paid by the MoF).
    - NIS 700 is roughly equivalent to a 25-percent replacement rate of the 2021 average wage.
    - Individuals receiving the basic pension are not entitled to the personal and family allowances.
    - Personal and family allowances are paid by the PPA; basic pensions are paid by the MoF.
  - Lump-sum repayment:
    - An employee who ceases work without accumulating the minimum contributory years (15) receives a lump-sum benefit corresponding to the contributions paid over time (only the employee’s share).
    - Lump-sum repayment of contributions can be at any age the employee ceases to work.
    - If the employee later rejoins public employment, the counting of contribution years restarts.
- Survivorship, disability, and occupational benefits:
  - Survivors entitled to a share of a deceased pensioner’s benefits include: widow; widower if unfit to support himself; children and brothers under age 21 (or 26 if pursuing university or higher education); unmarried/divorced/widowed daughters and sisters; parents.
  - Survivorship rights apply to the NIS 300 personal allowance, but not to family allowances or the NIS 700 basic pension.
  - Widow’s and unmarried sisters/daughters’ survivorship rights apply as long as they are not (re)married.
  - Eligibility of children and brothers becomes permanent if unable to provide for themselves due to physical conditions.
  - Disability and occupational benefits:
    - Persons under age 60 affected by disabilities may receive benefits conditional on medical committee approval.
    - Substantial lump-sum insurance benefits may be paid in the event of death or permanent disability caused by occupational accidents.
- Fiscal outlays and demographics:
  - 2021 public pension expenditure:
    - Around NIS 2.3 billion or around 4 percent of GDP.
    - Around NIS 600 million for schemes under PPA financial responsibility (scheme I and civil servants’ component of scheme II).
    - NIS 1.6 billion for those under MoF financial responsibility.
  - Demographic projections and implications:
    - In 2020, around 5 percent of the Palestinian population was over the age of 60.
    - By 2050, the share of population over age 60 is projected to rise to 11 percent.
    - Palestinian old-age dependency ratio (population aged 60+ over working age population 15–59) projected to increase from 9.6 to 18.2 percent.
    - Comparator countries: average share of population over 60 was 9 percent in 2020 and is expected to be 20 percent by 2050; comparator countries’ average old-age dependency ratio projected to increase from 14.2 to 32.2 percent.

### Natural rate of return, asset yields, IRRs, and distributional patterns
- Natural rate of return approximation:
  - Public employment growth (2011–21): average annual rate 0.1 percent.
  - Public employee salaries increase (2011–21): annual average around 2 percent in nominal terms.
  - Natural rate of return: just over 2 percent in nominal terms, or around 1.1 percent in real terms.
- Average annual yield of scheme assets (2012–22):
  - About 6.7 percent nominal on the stock of assets invested by the PPA.
  - Zero on the stock of contribution arrears accumulated by the MoF.
  - Resulting weighted average nominal yield: about 0.5 percent, corresponding to a negative yield in real terms given 1.2 percent average CPI inflation over the same period.
- Internal Rates of Return (IRRs) for scheme II (real terms, using medium-term CPI inflation projection of 2.0 percent to deflate nominal IRRs):
  - Male civil servant retiring at 60 with minimum contributory years (15): IRR about 3.3 percent.
  - Male civil servant retiring at 55 with at least 20 years of service: IRR around 4.0 percent.
  - Male civil servant retiring at 50 with 25 years of contributions: IRR around 4.6 percent.
  - Female civil servants:
    - Retiring at 55 with at least 15 years: IRR 4.4 percent.
    - Retiring at 50 with 20 contributory years: IRR 4.9 percent.
  - Security personnel retiring at 50 with 20 years of service: IRR around 4.7 percent.
  - Employees who reach retirement age without minimum years of service:
    - Receiving NIS 700 basic pension leads to extremely high IRRs for short careers, declining steeply as years worked rise.
- Effects of family/survivors on IRRs:
  - For a male civil servant retiring at 60 with at least 15 years of service:
    - Being survived by a wife increases the real IRR by around 0.3 percentage points compared to an unmarried employee.
    - Being survived by a wife and an unmarried daughter increases the real IRR by around 0.8 percentage point compared to an unmarried employee.
- Distributional effects by wage level:
  - IRRs by wage level (civil servants retiring at 60 after a full career of 40 years allowing 80 percent replacement rate):
    - Employee earning the average wage: pension real IRR in the order of 2.9 percent.
    - Employee earning 50 percent or less of the average wage: IRR above 3.1 percent.
    - Employee earning 140 percent or more of the average wage: IRR around 2.8 percent.
  - Security personnel show broadly similar patterns by wage level.
- Comparison with natural rate of return:
  - Actual IRRs for scheme II are higher than the natural rate of return, reflecting benefit generosity.
  - The discrepancy between IRRs and the natural rate of return would be larger if the 2011–21 average CPI inflation of 1 percent were used instead of the 2 percent CPI inflation projected for the medium term.

### Fiscal position, de-facto operations, risks, and reform options
- Fiscal position and sustainability:
  - The MoF has not been able to regularly pay contributions to the PPA, accruing large arrears and rendering scheme II unsustainable.
  - The stock of MoF arrears to the PPA is estimated at 14 percent of GDP in 2023.
  - The stock of scheme II assets is in the order of 1.5 percent of GDP, more than half of which is associated with participants from NGOs and CSOs.
  - The PPA also manages assets amounting to around 0.5 percent of GDP associated to legacy schemes.
  - Analysis shows that even if the MoF clears all its arrears and remains current on future contributions to the PPA, in the long run the Palestinian pension system will likely require support from the public budget due to projected increases in life expectancy and thus in the old-age dependency ratio.
- De-facto operation and immediate risks:
  - Despite the de jure pre-funded design, scheme II has been de facto operated as a pay-as-you-go (PAYGo) DB system: on a monthly basis the MoF transfers from the budget to the PPA just the amounts needed to pay current pension outlays (for both scheme II and legacy schemes).
  - This operating modality introduces a discrepancy with the legal framework and opaque crossclaims between the MoF and the PPA.
  - Since November 2021, pensions (like public sector wages) have been paid at 80 percent, creating arrears to pensioners.
  - In 2021 the MoF transferred insufficient amounts to match pension outlays, inducing the PPA to liquidate part of scheme II invested assets; according to the PPA the assets liquidated in 2021 amounted to around NIS 490 million, or 0.8 percent of GDP.
  - Any transition to an explicitly PAYGo contributory system would convert existing contribution arrears into equivalent—in net present value—future budgetary obligations associated with the pension outlays they were supposed to finance.
- Options for reform — aligning de jure and de facto schemes:
  - Align the de-jure and de-facto schemes toward a DB contributory PAYGo scheme without any pre-funding element, with:
    - The MoF holding full financial responsibility for the scheme.
    - The PPA acting solely as the administrative and executing agency.
  - Advantages of this alignment:
    - Enhanced fiscal management, predictability, and transparency.
    - Elimination of complex crossclaims between the MoF and the PPA.
    - Stopping further accumulation of MoF contribution arrears to the PPA.
    - The limited stock of assets accumulated at the PPA should be used only for the payment of future pension outlays.
- Need for parametric reforms:
  - A well-designed parametric reform package could reduce the long-run impact of scheme II’s DB component on public finances while ensuring income security for retirees.
  - Reform options to consider include:
    - Gradually increasing mandatory and early retirement ages and indexing them to future increases in life expectancy.
    - Revising the accrual rate.
    - Modestly increasing the contribution rates.
  - Additional options (not simulated in the analysis) that might be considered:
    - Reducing early retirement benefits, including by increasing the annual benefit reduction rate envisaged until the mandatory retirement age is reached and applying it consistently.
    - Limiting options to retire with a full pension at ages younger than the mandatory one to cases of particularly long careers.
    - Revising the basic pension for those who did not reach the minimum number of contributory years, making it commensurate to the years of service.

### Parametric reform impacts — illustrative IRR results and combined effects
- Benchmark: male civil servant retiring at the mandatory age with at least the minimum contributory years.
- Individual parametric changes and illustrative impact on IRRs (real terms):
  - Increasing the mandatory retirement age from 60 to 65: decrease IRRs by around 1.0 percentage points across all career lengths.
  - Lowering the incremental annual accrual rate to 1.75 from 2 percent: reduce the IRR by around 0.4 percentage points across all career lengths; IRR would only start to decline after 45 years of service when the 80 percent maximum replacement rate is reached.
  - Increasing the overall contribution rate (employer’s plus employee’s) by 3 percentage points—to 19 percent: decrease the IRR by around 0.6 percentage points across all career lengths.
- Combined effect:
  - A reform package including all three parametric revisions above would reduce IRRs by around 1.9 percentage points in real terms, bringing IRRs in proximity to the 2011–21 natural rate of return of the scheme.
- Distributional note:
  - The IRRs reduction would be similar across wage levels, preserving slightly higher returns for employees earning lower wages.
- Inflation and natural rate of return:
  - The 2011–21 average CPI inflation used to calculate the natural rate of return is 1 percent; the paper uses a projected medium-term CPI inflation of 2 percent to deflate IRRs given the future nature of pension outlays.

### Summary conclusions and recommended reform direction
- As currently operated the Palestinian pension system is unsustainable, though the PA has remained current on its pensions obligations to date.
- Scheme II is de jure a contributory pre-funded scheme, but the MoF’s failure to regularly pay contributions has accrued large arrears and rendered scheme II unsustainable; however, pensions have been paid de facto under a PAYGo DB arrangement.
- Even if the MoF clears arrears and stays current on contributions, long-run support from the public budget is likely required due to demographic pressures (increases in life expectancy and the old-age dependency ratio) and the generosity of scheme II benefits, as evidenced by IRRs significantly higher than the scheme’s natural rate of return.
- Recommended reform direction:
  - Align de jure and de facto arrangements toward a DB contributory PAYGo scheme (no pre-funding element).
  - Implement well-calibrated parametric adjustments such as:
    - Gradually increasing mandatory and early retirement ages and indexing them to life expectancy.
    - Revising the accrual rate.
    - Modestly increasing contribution rates.
  - Consider additional measures on early retirement benefits, full-pension younger retirement conditions, and basic pension revision for those with fewer contributory years.
- A more in-depth actuarial analysis is necessary to evaluate detailed impacts and to balance fiscal and social considerations.

_Italic: Source: WEST BANK AND GAZA — IMF staff report content provided in the supplied PDF excerpt._

### 1.  Scheme II Old-Age Benefits by Career Length _______________________________________________ 18

### 1.  Scheme II Old-Age Benefits by Career Length

### Economic divergence: overview and key outcomes
- Years of isolation and continuous conflicts have left Gaza’s economic development far behind that of the West Bank.
- In 2022, per capita income in Gaza was only a quarter of that in the West Bank.
- Gaza’s capital stock is stagnant and infrastructure is derelict (especially electricity).
- Prospects for declining donor aid risk worsening Gaza’s humanitarian crisis.
- A major easing of the blockade and financing constraints is necessary to improve prospects, provided the security situation can be assured in parallel.

### A. Economic developments and structure
Findings:
- During 2007–22, real GDP growth in Gaza averaged 0.4 percent; real GDP per capita declined at an annual average rate of 2.5 percent.
- West Bank recorded average annual real GDP growth and per capita growth of 5.1 and 2.8 percent, respectively, over the same period.
- By 2022, per capita income in the West Bank was four times higher than in Gaza.
- Unemployment in Gaza reached 45 percent in 2022; percentage living below national poverty line in Gaza was 53 percent, compared to 13 and 14 percent, respectively, in the West Bank.
- Growth accounting (α = 0.3; depreciation 3 percent plus conflict adjustments) indicates:
  - Labor’s contribution to growth averaged 2.6 percentage points per year in both territories.
  - Contribution of capital to growth: virtually zero in Gaza; more than 2 percentage points per year in the West Bank.
  - Gaza’s TFP contribution averaged -2.2 percentage points per year; West Bank saw a modest positive TFP contribution.

Demand- and supply-side patterns:
- Demand side:
  - Gaza: government consumption contributed an average of 0.8 percentage points to growth; private consumption 0.3 percentage points.
  - West Bank: government consumption 0.4 percentage points; private consumption 5.2 percentage points.
  - Net exports: not a drag on Gaza due to severe trade constraints; in the West Bank net exports subtracted an average of 2.4 percentage points.
- Supply side:
  - Gaza: industrial sector stagnant; dynamic sectors were services, (re)construction, trade, and agriculture.
  - Construction sector average annual growth in Gaza reached 20 percent (2007–22) versus 8 percent in the West Bank.
  - Agricultural sector annual average growth: Gaza 2.1 percent; West Bank 0.2 percent.
  - Agricultural exports annual growth averaged 13.5 percent over 2015–21.

Humanitarian and aid context:
- In 2020, 77 percent of households in Gaza received aid (compared to 10 percent in the West Bank); majority from UNRWA concentrated on food and cash assistance (78 and 57 percent, respectively).
- Prevalence of food insecurity: Gaza 65.9 percent; West Bank 16.6 percent.
- Incidence of multi-dimensional poverty: Gaza 45 percent; West Bank 11 percent.
- No social security system in place; continuation of payments under the National Cash Transfer Program (NCTP) to the most vulnerable in Gaza is of particular importance.

### B. Labor markets
Findings:
- Access to employment in Israel and settlements:
  - West Bank workers constituted 22.5 percent of the total number of employed persons in 2022 (versus 0.8 percent for Gaza), earning around US$3.8 billion or 24 percent of GDP.
- Unemployment (2007–22 averages): Gaza 39 percent; West Bank 17 percent.
- Labor force participation rates have remained below 50 percent since the mid-1990s in both territories.
- Youth and female unemployment is especially pronounced in Gaza: over two-thirds are unemployed, compared to less than a quarter in the West Bank.

Labor productivity and wages:
- Between 2000–21, average labor productivity per working hour (in 2015 US$): West Bank US$6; Gaza US$5.
- Sectoral productivity where Gaza outperformed West Bank:
  - Agriculture average labor productivity: Gaza US$12 (in US$2015); West Bank US$6 (in US$2015).
  - Construction average labor productivity (2010–21): Gaza US$9 (in US$2015); West Bank US$4.5 (in US$2015).
- Wage trends:
  - Since 2000, wages in Gaza have stagnated; West Bank wages grew at an annual rate of 3.3 percent.
  - 2021 average daily wage: Gaza NIS 61.4; West Bank NIS 108.5.
  - 2021 daily private sector wages: Gaza NIS 42.5; West Bank NIS 122.
  - In Gaza, almost 90 percent of private sector employees earned less than the minimum wage; in the West Bank below 20 percent.
  - Minimum wage stands at NIS 1,880 per month.

### C. Investment and financial intermediation
Findings:
- Investment levels:
  - Gaza investment has been less than US$500 million per year since 2007 and amounted to less than 11 percent of GDP in 2022.
  - Except for 2016 and 2017 when investment increased slightly to above US$600 million.
  - West Bank investment reached nearly US$5 billion (almost 30 percent of GDP) in 2022, roughly doubling the capital stock since 2007.
- Financial intermediation (2007–22 averages):
  - Gaza: private sector deposits 40 percent of GDP; credit 22 percent of GDP.
  - West Bank: private sector deposits 77 percent of GDP; credit 33 percent of GDP.
- Low savings in Gaza reflect low wages and underdeveloped financial system; 76 percent of Gazans saved money at home (Financial Inclusion Diagnostic Study 2022).
- Infrastructure constraints:
  - Electricity demand in Gaza around three times the electricity supplied, resulting in long blackouts (12 hours on/12 hours off).
  - Between 2017–22, average demand 450 Mega Watts (MW); average supply around 180 MW; in 2017–18 Gaza had only 8 hours of electricity per day.
  - Electricity sources: Israeli Electric Corporation (supplying two-thirds of Gaza’s electricity), Gaza Power Plant (GPP), and until 2018, imports from Egypt.
  - PA pays for IEC electricity through Israeli deductions from clearance revenues; Qatar has been paying for fuel supply to the GPP for the past five years.
  - Households and many businesses rely on private electricity generators despite high cost.

Economic gains from targeted investment:
- Input-Output (I-O) analysis (Leontief Inverse Matrix (I − A)−1) indicates highest output multipliers in Gaza:
  - Electricity sector multiplier: 1.8.
  - Manufacturing multiplier: 1.74.
  - Mining and quarrying: 1.72.
  - Human health services: 1.71.
  - Construction: 1.63.
- An increase in economic output of US$1 million in each of these five Gaza sectors would generate additional economic output of around US$8.6 million.
- For the West Bank, top beneficial sectors by multiplier:
  - Electricity, agricultural, and public administration sectors: 1.52.
  - Manufacturing: 1.51.
  - Human health services: 1.46.

### D. Trade developments and restrictions
Findings:
- Import and export dependence (2022):
  - West Bank total imports reached 70 percent of GDP; Gaza total imports 54 percent of GDP.
  - West Bank total exports 21 percent of GDP; Gaza total exports 6.5 percent of GDP.
- Trade partners and orientation:
  - More than half of imported goods into the West Bank come from Israel.
  - More than two-thirds of imports into Gaza come from Israel.
  - Most exported goods from both territories are directed to Israel: Gaza 83 percent; West Bank 81 percent.
- Import dependence on Israel has been slowly declining since 2008 for both Palestinian Territories.

_Italic: Source: WEST BANK AND GAZA — IMF staff report content provided in the supplied PDF excerpt._

### 13. Restrictions on access and movement of goods severely hinder trade outcomes and

### 13. Restrictions on access and movement of goods severely hinder trade outcomes and productive capacity in both the West Bank and Gaza

### Trade restrictions, mechanisms, and economic impacts
- Israel controls all trade into the West Bank passing through its seaports, airport, and over the Allenby-King Hussein bridge connecting the West Bank to Jordan, resulting in significant delays and additional costs (including lengthy security delays, customs, and security inspection).
- Coupled with the outdated A1, A2 and B lists, which impose restrictions on the quantity of imported goods from specific countries, Israeli control:
  - Limits trade opportunities and contributes to challenges in expanding trade networks in both the West Bank and Gaza.
  - Restricts access to key production inputs and equipment listed in Israel’s Dual Use Goods (DUG) list, impeding trade and productivity.
- Sectoral impacts of DUG and other import limitations:
  - Agricultural sector: fertilizers are heavily restricted under the DUG list.
  - Manufacturing and services: production of steel and pharmaceuticals and the development of the ICT sector are negatively impacted by import limitations on equipment.
- Trade cost and delay metrics (World Bank estimate reproduced in the source):
  - This could increase costs by an average of US$538 per shipment.
  - Costs of exporting and importing a container is 2–  3 times higher for a Palestinian firm than an Israeli firm.
  - Delay is between 2–4 times higher for a Palestinian firm than an Israeli firm.
- According to the World Bank, rationalizing the DUG list alone would have a significant positive effect on economic growth.

### Restrictions and procedures unique to Gaza
- Restrictions are more severe for Gaza:
  - Israel controls movement of trade and people in and out of Gaza and severely restricts linkages and economic integration with the West Bank.
  - Israel imposes an additional detailed DUG list for Gaza, complicating and delaying the back-to-back (B2B) trade procedure.
  - The door-to-door trade facilitation project is accessible only for the West Bank but not for Gaza.
  - More stringent security is applied for goods exiting Gaza, resulting in further delays and damaged goods.
- B2B process specifics for Gaza:
  - The B2B process requires offloading and reloading goods between trucks after security inspection; for Gaza this involves an additional third “sterile” truck, increasing costs, delays, and damages to goods.
- Construction and reconstruction constraints:
  - Construction materials including cement, wood, and steel are heavily restricted into Gaza and are only allowed via the Gaza Reconstruction Mechanism (GRM), further delaying reconstruction efforts and completion of essential infrastructure projects.

### Gaza’s trade with Egypt and crossing statistics
- Border crossings with Egypt are controlled by the Egyptian government and the de-facto government of Hamas; the PA receives no import duties on trade through Egypt.
- Evolution of truckloads through Rafah crossing:
  - The number of truckloads entering Gaza through the Rafah crossing increased from 4 truckloads in 2008 to 30,208 truckloads in 2022.
  - Imports via Rafah comprise mainly construction materials (such as cement and aggregates), as well as food products and livestock.
  - Exports through Rafah: 1,696 truckloads in 2022, carrying mainly iron scrap and scrap batteries.
- Salah Addin crossing (opened mainly to facilitate fuel imports):
  - Number of imported truckloads from Salah Addin increased from 207 in 2018 to 5,649 in 2022, mainly carrying diesel, petrol, and cooking gas.
- Fuel and import logistics summary:
  - Gaza currently has four operational crossings: two Israeli (Karem Abu Salem for commercial crossings; Beit Hanon/Erez for pedestrian crossings) and two Egyptian (Rafah for commercial trade and movement of people; Salah Addin mainly for fuel and some construction materials).
  - The PA only receives import duties and VAT from the Israeli-controlled Karem Abu Salem crossing (except for Gaza truckloads directed to the West Bank for which no VAT is imposed).

### Infrastructure projects, energy, telecommunications, and constraints
- Ongoing and planned Gaza infrastructure projects require relaxation of Israeli restrictions and additional funding:
  - Energy projects requiring Israeli cooperation and commercial agreements:
    - Extension of the 161 KV line from Israel to Gaza.
    - Gas for Gaza (G4G) project (requires conclusion of the Gas Sales and Purchase Agreement (GSPA) and Israeli finalization of crossing point design; PA needs to approve the hydrocarbon law and establish the National Gas company).
  - Additional funding needs:
    - Further funding needed for Gaza’s power plant (phase two of the Gaza Power Plant electricity infrastructure improvement, including several substations, feeders, a national control station, and related infrastructure).
  - Telecommunications:
    - Israel is considering wireless telecommunication spectrum allocations upgrade in the West Bank to 4/5G; Gaza is excluded and only outdated 2G is available.
  - Water and sanitation:
    - Dual-use restrictions are delaying entry of some parts for the Northern Gaza Emergency Sewage Treatment project (NGEST).
  - Renewable energy and Area C projects in the West Bank:
    - Investments in renewable and green energy, water, and wastewater projects in Area C hinge on GoI approval; the PA identified over 200 MW of solar PV sites and is awaiting GoI’s approval to proceed (GoI had previously approved two locations in the West Bank in Bani Naim (Area A) and Aqbat Jabr (Area C) for solar PV).

### Economic divergence, development pathways, and policy implications
- Historical divergence and current conditions:
  - Over the past fifteen years, Gaza’s social indicators have persistently deteriorated; growth has relied mainly on government consumption; productive capacity has been impeded by the blockade and restrictions.
  - Investment levels, financial intermediation, and wages in Gaza have consistently trailed those in the West Bank, resulting in lack of financing for vital infrastructure services, especially electricity.
- Core policy prescriptions to restart convergence:
  - Lifting of the blockade and easing of Israeli-imposed restrictions are essential for Gaza to forge a new economic development path and restart economic convergence with the West Bank.
  - Major easing of restrictions is needed to address distortions in Gaza’s labor market, productive sectors, and limited access to materials for infrastructure.
  - Cooperation from Israel is required for progress on ongoing and planned infrastructure projects.
- Political reconciliation implications:
  - Political reconciliation between Gaza and the West Bank could:
    - Improve Gaza’s basic public services.
    - Raise inward investment flows.
    - Strengthen governance through a unified regulatory environment.
    - Enable the PA to enhance revenue generation through re-deployment of its tax administration.
    - Ultimately boost investment into infrastructure projects (primarily electricity and water).
  - Scenario estimate:
    - Based on staff estimates, a reunification scenario could increase growth to 8 percent in Gaza and more than 5 percent thereafter, though it will increase fiscal costs and necessitate PA reforms to curtail those fiscal costs.

### Key pension system parameters (Scheme II) relevant to fiscal context
- Scheme II features (Defined-Benefit component):
  - Contribution rates: 16 percent (from employee 7 percent; from employer 9 percent).
  - Mandatory retirement at age 60 with at least 15 years of contributions.
  - Early retirement: civil servants age 55 with at least 15 years of service, with 5 percent pension reduction until age 60.
  - Benefit formula:
    - Basic replacement rate: 30 percent.
    - Incremental replacement rate (accrual rate): 2 percent per year of service, multiplied by average salary of the last 3 years.
    - Maximum replacement rate: 80 percent.
  - Pension indexation: Based on wage increases of active contributors.
- Fiscal note:
  - Scheme II is de jure a contributory pre-funded scheme, but in practice the Ministry of Finance has not been transferring mandated contributions to the Palestinian Pension Agency (PPA), resulting in effectively PAYGo operations and insufficient assets to meet future obligations.

*Source: IMF chapter "Restrictions on access and movement of goods severely hinder trade outcomes and productive capacity in both the West Bank and Gaza" (excerpt supplied).*

### 3. Reflecting its relatively recent start, scheme II’s dependency ratio is still low. As of 2021,

### 3. Reflecting its relatively recent start, scheme II’s dependency ratio is still low. As of 2021,

### Coverage and dependency ratios
- As of 2021, scheme II included about 134,000 public sector contributors—82,000 civil servants and 52,000 security personnel—corresponding to 9.6 percent of the Palestinian labor force.
- Beneficiaries were around 26,000—6,000 civil servants and 20,000 security personnel.
- Scheme II dependency ratio (old-age and early retirement beneficiaries to contributors):
  - Civil servants: 4.3 percent.
  - Security personnel: 34.4 percent.
- If invalidity pensioners and survivors are included, dependency ratios would increase to:
  - Civil servants: 7.9 percent.
  - Security personnel: 38.4 percent.
- Current pension beneficiaries (including legacy schemes) represent only 1.5 percent of the Palestinian population.

### Benefits and eligibility rules
- Mandatory retirement ages and eligibility for full old-age pension:
  - Male civil servants: mandatory retirement age 60 with at least 15 years of service.
    - Full pension also at age 55 with 20 years of service.
    - Full pension also at age 50 with 25 years of service.
  - Female civil servants: required period of service for a full old-age pension is lower by 5 years at each retirement age (subject to the 15 years minimum contributory period). Examples:
    - Can retire at age 55 with 15 years of service.
    - Can retire at age 50 with 20 years of service.
- Early retirement provisions:
  - Pension Law allows male civil servants early retirement at 55 conditional on at least 15 years of contributory service and subject to a 5 percent benefit reduction per year until reaching 60.
  - Cabinet decrees have regularly exempted early retirees from this reduction.
- Security personnel (and specified sectors such as laboratories and radiology, prospecting for oil and gas, and mining) can retire earlier:
  - Can retire at age 50 with at least 20 years of contributions.
  - Cabinet decrees can allow retirement at any age with only 15 years of service without benefit reduction.
- Scheme II parameters:
  - Incremental annual accrual rate: 2 percent.
  - Maximum replacement rate: 80 percent of the average salary over the last three years of service.
- Average replacement rates as of 2021:
  - Civil servants: around 57 percent.
  - Security personnel: 76 percent.

### Allowances, basic pension, and lump-sum benefits
- Monthly personal allowance: NIS 300 (paid to all pensioners).
- Monthly family allowance: NIS 60 for the spouse and NIS 20 for each child (paid regardless of pension amount or other income).
- Basic pension for those without accrued pension rights:
  - Means-tested basic pension currently amounting to NIS 700 per month (paid by the MoF).
  - NIS 700 is roughly equivalent to a 25-percent replacement rate of the 2021 average wage.
  - Individuals receiving the basic pension are not entitled to the personal and family allowances.
  - Personal and family allowances are paid by the PPA; basic pensions are paid by the MoF.
- Lump-sum repayment:
  - An employee who ceases work without accumulating the minimum contributory years (15) receives a lump-sum benefit corresponding to the contributions paid over time (only the employee’s share).
  - Lump-sum repayment of contributions can be at any age the employee ceases to work.
  - If the employee later rejoins public employment, the counting of contribution years restarts.

### Survivorship, disability, and occupational benefits
- Survivors entitled to a share of a deceased pensioner’s benefits include:
  - Widow; widower if unfit to support himself; children and brothers under age 21 (or 26 if pursuing university or higher education); unmarried/divorced/widowed daughters and sisters; parents.
- Survivorship specifics:
  - Survivorship rights apply to the NIS 300 personal allowance, but not to family allowances or the NIS 700 basic pension.
  - Widow’s and unmarried sisters/daughters’ survivorship rights apply as long as they are not (re)married.
  - Eligibility of children and brothers becomes permanent if unable to provide for themselves due to physical conditions.
- Disability and occupational benefits:
  - Persons under age 60 affected by disabilities may receive benefits conditional on medical committee approval.
  - Substantial lump-sum insurance benefits may be paid in the event of death or permanent disability caused by occupational accidents.

### Fiscal outlays and demographics
- 2021 public pension expenditure:
  - Around NIS 2.3 billion or around 4 percent of GDP.
  - Around NIS 600 million for schemes under PPA financial responsibility (scheme I and civil servants’ component of scheme II).
  - NIS 1.6 billion for those under MoF financial responsibility.
- Demographic projections and implications:
  - In 2020, around 5 percent of the Palestinian population was over the age of 60.
  - By 2050, the share of population over age 60 is projected to rise to 11 percent.
  - Palestinian old-age dependency ratio (population aged 60+ over working age population 15–59) projected to increase from 9.6 to 18.2 percent.
  - The Palestinian population will remain younger than comparator countries, where the average share of population over 60 was 9 percent in 2020 and is expected to be 20 percent by 2050; comparator countries’ average old-age dependency ratio projected to increase from 14.2 to 32.2 percent.

### Natural rate of return, asset yields, and internal rates of return (IRRs)
- Natural rate of return approximation:
  - Public employment growth (2011–21): average annual rate 0.1 percent.
  - Public employee salaries increase (2011–21): annual average around 2 percent in nominal terms.
  - Natural rate of return: just over 2 percent in nominal terms, or around 1.1 percent in real terms.
- Average annual yield of scheme assets (2012–22):
  - About 6.7 percent nominal on the stock of assets invested by the PPA.
  - Zero on the stock of contribution arrears accumulated by the MoF.
  - Resulting weighted average nominal yield: about 0.5 percent, corresponding to a negative yield in real terms given 1.2 percent average CPI inflation over the same period.
- Internal Rates of Return (IRRs) for scheme II (real terms, using medium-term CPI inflation projection of 2.0 percent to deflate nominal IRRs):
  - Male civil servant retiring at 60 with minimum contributory years (15): IRR about 3.3 percent.
  - Male civil servant retiring at 55 with at least 20 years of service: IRR around 4.0 percent.
  - Male civil servant retiring at 50 with 25 years of contributions: IRR around 4.6 percent.
  - Female civil servants:
    - Retiring at 55 with at least 15 years: IRR 4.4 percent.
    - Retiring at 50 with 20 contributory years: IRR 4.9 percent.
  - Security personnel retiring at 50 with 20 years of service: IRR around 4.7 percent.
  - Employees who reach retirement age without minimum years of service:
    - Receiving NIS 700 basic pension leads to extremely high IRRs for short careers, declining steeply as years worked rise.
- Effects of family/survivors on IRRs:
  - For a male civil servant retiring at 60 with at least 15 years of service:
    - Being survived by a wife increases the real IRR by around 0.3 percentage points compared to an unmarried employee.
    - Being survived by a wife and an unmarried daughter increases the real IRR by around 0.8 percentage point compared to an unmarried employee.
- Comparison with natural rate of return:
  - Actual IRRs for scheme II are higher than the natural rate of return, reflecting benefit generosity.
  - The discrepancy between IRRs and the natural rate of return would be larger if the 2011–21 average CPI inflation of 1 percent were used instead of the 2 percent CPI inflation projected for the medium term.

### Distributional effects by wage level
- IRRs by wage level (civil servants retiring at 60 after a full career of 40 years allowing 80 percent replacement rate):
  - Employee earning the average wage: pension real IRR in the order of 2.9 percent.
  - Employee earning 50 percent or less of the average wage: IRR above 3.1 percent.
  - Employee earning 140 percent or more of the average wage: IRR around 2.8 percent.
- Security personnel show broadly similar patterns by wage level.

*Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1wbgea2023004.pdf*

### 13. While scheme II DB component is de jure a contributory pre-funded scheme, the MoF

### 1wbgea2023004 - 13. While scheme II DB component is de jure a contributory pre-funded scheme, the MoF

### Fiscal position and sustainability
- The MoF has not been able to regularly pay contributions to the PPA, accruing large arrears and rendering scheme II unsustainable.
- The stock of MoF arrears to the PPA is estimated at 14 percent of GDP in 2023.
- The stock of scheme II assets is in the order of 1.5 percent of GDP, more than half of which is associated with participants from NGOs and CSOs.
- The PPA also manages assets amounting to around 0.5 percent of GDP associated to legacy schemes.
- Analysis shows that even if the MoF clears all its arrears and remains current on future contributions to the PPA, in the long run the Palestinian pension system will likely require support from the public budget due to projected increases in life expectancy and thus in the old-age dependency ratio.

### De-facto operation and immediate risks
- Despite the de jure pre-funded design, scheme II has been de facto operated as a pay-as-you-go (PAYGo) DB system: on a monthly basis the MoF transfers from the budget to the PPA just the amounts needed to pay current pension outlays (for both scheme II and legacy schemes).
- This operating modality introduces a discrepancy with the legal framework and opaque crossclaims between the MoF and the PPA.
- Since November 2021, pensions (like public sector wages) have been paid at 80 percent, creating arrears to pensioners.
- In 2021 the MoF transferred insufficient amounts to match pension outlays, inducing the PPA to liquidate part of scheme II invested assets; according to the PPA the assets liquidated in 2021 amounted to around NIS 490 million, or 0.8 percent of GDP.
- Any transition to an explicitly PAYGo contributory system would convert existing contribution arrears into equivalent—in net present value—future budgetary obligations associated with the pension outlays they were supposed to finance.

### Options for reform — aligning de jure and de facto schemes
- Align the de-jure and de-facto schemes toward a DB contributory PAYGo scheme without any pre-funding element, with:
  - The MoF holding full financial responsibility for the scheme.
  - The PPA acting solely as the administrative and executing agency.
- Advantages of this alignment:
  - Enhanced fiscal management, predictability, and transparency.
  - Elimination of complex crossclaims between the MoF and the PPA.
  - Stopping further accumulation of MoF contribution arrears to the PPA.
  - The limited stock of assets accumulated at the PPA should be used only for the payment of future pension outlays.

### Need for parametric reforms
- A well-designed parametric reform package could reduce the long-run impact of scheme II’s DB component on public finances while ensuring income security for retirees.
- Reform options to consider include:
  - Gradually increasing mandatory and early retirement ages and indexing them to future increases in life expectancy.
  - Revising the accrual rate.
  - Modestly increasing the contribution rates.
- Additional options (not simulated in the analysis) that might be considered:
  - Reducing early retirement benefits, including by increasing the annual benefit reduction rate envisaged until the mandatory retirement age is reached and applying it consistently.
  - Limiting options to retire with a full pension at ages younger than the mandatory one to cases of particularly long careers.
  - Revising the basic pension for those who did not reach the minimum number of contributory years, making it commensurate to the years of service.

### Parametric reform impacts (illustrative IRR results)
- Benchmark: male civil servant retiring at the mandatory age with at least the minimum contributory years.
- Individual parametric changes and their illustrative impact on IRRs (real terms):
  - Increasing the mandatory retirement age from 60 to 65: decrease IRRs by around 1.0 percentage points across all career lengths.
  - Lowering the incremental annual accrual rate to 1.75 from 2 percent: reduce the IRR by around 0.4 percentage points across all career lengths; IRR would only start to decline after 45 years of service when the 80 percent maximum replacement rate is reached.
  - Increasing the overall contribution rate (employer’s plus employee’s) by 3 percentage points—to 19 percent: decrease the IRR by around 0.6 percentage points across all career lengths.
- Combined effect:
  - A reform package including all three parametric revisions above would reduce IRRs by around 1.9 percentage points in real terms, bringing IRRs in proximity to the 2011–21 natural rate of return of the scheme.
- Distributional note:
  - The IRRs reduction would be similar across wage levels, preserving slightly higher returns for employees earning lower wages.
- Inflation and natural rate of return:
  - The 2011–21 average CPI inflation used to calculate the natural rate of return is 1 percent; the paper uses a projected medium-term CPI inflation of 2 percent to deflate IRRs given the future nature of pension outlays.

### Summary and conclusion
- As currently operated the Palestinian pension system is unsustainable, though the PA has remained current on its pensions obligations to date.
- Scheme II is de jure a contributory pre-funded scheme, but the MoF’s failure to regularly pay contributions has accrued large arrears and rendered scheme II unsustainable; however, pensions have been paid de facto under a PAYGo DB arrangement.
- Even if the MoF clears arrears and stays current on contributions, long-run support from the public budget is likely required due to demographic pressures (increases in life expectancy and the old-age dependency ratio) and the generosity of scheme II benefits, as evidenced by IRRs significantly higher than the scheme’s natural rate of return.
- Recommended reform direction:
  - Align de jure and de facto arrangements toward a DB contributory PAYGo scheme (no pre-funding element).
  - Implement well-calibrated parametric adjustments such as: (i) gradually increasing mandatory and early retirement ages and indexing them to life expectancy, (ii) revising the accrual rate, and (iii) modestly increasing contribution rates.
  - Consider additional measures on early retirement benefits, full-pension younger retirement conditions, and basic pension revision for those with fewer contributory years.
- A more in-depth actuarial analysis is necessary to evaluate detailed impacts and to balance fiscal and social considerations.

*Source: IMF staff analysis in 1wbgea2023004.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1wbgea2023004.pdf_