Sharon's Israel

Can a tough guy calm things down? It's a risky bet

On a cold, rainy day in late January, Marwan Barghouti is holding court in his office in a drab concrete building in Ramallah in the occupied West Bank. The leader of a local Palestinian militia group, Barghouti has played a prominent role in the intifada, which started in September. Some 400 people have died since, most of them Palestinian. Offering his visitors mint tea, Barghouti, 41, warns about the consequences if the Israeli public chooses Likud Party leader Ariel Sharon as Prime Minister on Feb. 6: "If Sharon is elected, the resistance will be escalated."

Less than an hour's drive away, on the western edge of Jerusalem, Eyal Shekel is no more sanguine about an end to the violence. The 39-year-old founder of startup Chiaro Networks Ltd. presides over a team of scientists and engineers putting the final touches on an advanced telecom switching system. A political liberal, Shekel considered setting up a plant in Ramallah--until the violence. "I am not even going to think about it now," Shekel says. "If they saw me walking on the street with this yarmulke on, they would kill me."

SO CLOSE. The warnings and worries of these two men reflect the distressing state of relations between Israelis and Palestinians today. In some ways, the two peoples are tantalizingly close. They live cheek by jowl, eat similar food, and speak Semitic languages that overlap. In recent months, their respective leaderships have narrowed the gaps toward an agreement aimed at ending more than five decades of hostilities between them.

But just visit glitzy Tel Aviv or gritty Ramallah and you'll find that the differences between ordinary Israelis and Palestinians are growing by the day. The average Israeli is already 10 times wealthier than the average Palestinian. Now, the disruptions of the intifada--and the blockade that the Israelis have imposed on Palestinian territories--are further accentuating Palestinian poverty. Hostility and violence between the two are intensifying. In recent weeks, Palestinians have taken to murdering Israelis they encounter in or near their areas. For their part, Israeli troops and undercover agents have been assassinating local Palestinian leaders.

Such circumstances seem to make a mockery of the high-level negotiations that continued sporadically between the Israeli and Palestinian leadership until incumbent Prime Minister Ehud Barak broke them off on Jan. 27 to prepare for the elections. Now, if Sharon is elected--as seems likely, since he is ahead by 20 percentage points in opinion polls--the peace process may be stalled indefinitely. At the least, Sharon is expected to throw out the road map for a deal laid out in the Oslo accords of 1993. "The peace process will be over on Feb. 6," says Gerald M. Steinberg, professor of political science at Bar-Ilan University in Tel Aviv. "It failed because the problems were much greater than could be solved in seven years." While it is still possible for Barak to step aside as a candidate at the last minute and allow the more popular former Prime Minister Shimon Peres to run in his place, Barak says he won't give way.

If Sharon is elected as Prime Minister, his victory may signal an even bigger change in Israel. After years of unsuccessfully pursuing talks with the Palestinians, Israelis are trying to disengage from their neighbors. Many Israelis see themselves as much closer to their main trading partners in the U.S., Europe, and even Asia. The Palestinians are a headache that they would rather ignore or seal off.

But whether Israel can escape the influence of its neighborhood is open to question. While it would be relatively easy to close off Gaza, the West Bank would present a bigger challenge because it has so many links to Israel. Moreover, even if the West Bank were permanently closed off, the Israelis would still have to contend with some 200,000 Palestinian residents of Jerusalem and an increasingly restive 1.2 million Arabs of Israeli citizenship. Sharon himself dismisses the idea of separation, which Barak has threatened, as a mere "slogan."

High-tech and global as their economy may be, the Israelis have to worry about tensions with the Palestinians once again turning the entire region against them. The Egyptians have already recalled their ambassador, and President Hosni Mubarak has made clear his skepticism about Sharon. The big fear about the former general is that he will further inflame an already volatile mix. If the Israeli-Palestinian situation were to mushroom out of control, it would be devastating for the Palestinians and could hurt the Israelis more than they believe.

It also could force international intervention led by the U.S. That might frustrate the Bush Administration's intention to back away from the Arab-Israeli question and improve relations with such regional players as Saudi Arabia and Egypt. Arab-Israeli violence plays into the hands of Iraq's Saddam Hussein, whose baleful influence has been on the increase. A stalemated peace process puts the Arab moderates on the defensive and makes them wary of cooperating with the U.S. on issues ranging from security to oil production. Boycotts of U.S. goods are taking root in several Arab countries.

For the Arabs, there is probably no more provocative Israeli politician than the headstrong, 72-year-old Sharon. Indeed, his ill-advised September visit to Islamic holy places in Jerusalem helped trigger the intifada. That such a controversial figure is leading Barak by so much shows the extent to which Israeli hopes for a peaceful settlement have been dashed. "People thought the way to solve the problems with the Palestinians was through the peace process," says Amiram Sivan, CEO of Israel's Bank Hapoalim. "Most now believe you have to use force to keep what we need for the future."

BLOODY HANDS. Sharon certainly hasn't hesitated to use force in the past. One of the last of the seminal figures in Israeli history who is still on the scene, he has been a nemesis of the Arabs since the 1950s. Sharon's conduct of Israel's 1982 foray into Lebanon almost destroyed his career. An official inquiry found him indirectly responsible for the massacre of hundreds of Palestinians by Israel's Lebanese Christian allies. He was forced to resign as Defense Minister. But Sharon managed to remain a political player, and now the old Arab-fighter seems set for a last hurrah.

Since Barak's Dec. 9 decision to resign and call prime ministerial elections gave him an unexpected break, Sharon has largely restrained his usual blunt manner, and he has sketched out his own strategy for dealing with the Palestinians (table, page 30). He wants to back away from the effort to achieve a final settlement, which has led to so much recent violence. Instead, Sharon proposes a "step-by-step" pullback from Palestinian areas that would give Palestinians more control of their own affairs. "As a Jew, I know it's not easy being a Palestinian," he recently said in a videoconference with the Council on Foreign Relations, a New York-based think tank. "We have to take steps to make Palestinian life easier."

Sharon's aides are predicting a three- or four-month hiatus in the peace process. Then, says Zalman Shoval, a former Israeli ambassador to the U.S. who now heads the Likud Party's bureau of foreign relations, the peace process would resume, but "differently." "It was a mistake for Barak and Clinton to put everything on the table," Shoval argues. "If you try to settle everything fully, it is bound to blow up." Instead of a comprehensive approach, Shoval says, "we want to give the Palestinians a much larger measure in running their own affairs. We can enhance economic cooperation. Other issues will be left to a later stage."

The problem: Palestinian leader Yassir Arafat is unlikely to accept a rollback of Barak's and ex-President Bill Clinton's proposals. Although the deal envisioned was never completely spelled out, Barak seemed willing to go some distance toward Palestinian control of east Jerusalem. He also was ready to take Israeli forces out of Gaza and most of the West Bank.

Sharon's associates concede that he will be a tougher negotiating partner. "I think we have to lower the expectations of the Palestinians," says Limor Livnat, a Likud party Knesset member. "They will not get what they dream they will get."

Of course, Sharon's deeds after the election may not live up to his campaign promises. What he actually does will depend on the sort of government he pulls together. He wants to form a so-called national unity government with Labor. If he succeeds, the two political parties might team up to restart negotiations with the Palestinians. But it is far from certain that Labor would agree to such an arrangement: A coalition would likely give Barak, who is viewed as having failed miserably as a politician since being elected in May, 1999, another shot, with a key job such as the Defense portfolio. "A big question is what happens to Labor," says Steinberg. "Will they rip themselves apart?"

Yet even his own associates don't think Sharon will last long as Prime Minister if he is forced to form a narrow coalition incorporating the religious parties and the far Right. "Most likely, a narrow government would only survive for a short time," says Livnat.

So it is very likely that the political paralysis that has beset Israel for the past year will continue. That would be bad news for both Palestinians and Israelis. With little hope of getting out from under Israel's thumb, Palestinian unrest seems likely to continue. And the easiest way for whoever is in charge of Israel to deal with it will be through the current recipe of economic blockades and harsh military reprisals.

CHOKE HOLD. The past few months have certainly exacted a harsh toll on the 3 million residents of the West Bank and Gaza. According to the Palestinian Authority, the fledgling economy, which grew by a promising 6% to 7% in 1999, to about $4.7 billion, likely fell by as much as 50% in the fourth quarter of 2000--and 13% for the year as a whole. The chief culprit is not the violence but the Israeli system of closure, a security measure that inhibits and sometimes seals off traffic between the Palestinian areas and Israel. It also divides the Palestinian territories into 54 separate zones and blocks movement between them. These blockades, according to the Palestinian Authority, have reduced Palestinian exports--in 1999, $800 million, or $2.2 million per day--by 85%. Imports into the Palestinian zones have dwindled, and cargoes are piling up in Israeli ports.

The troubles have seriously set back years of efforts to build ties between Israeli and Palestinian businesses. For instance, stone quarried and worked in the West Bank was the Palestinians' largest export to Israel. But such shipments have been slashed. One reason is the Israelis' interference with transport. Meanwhile, the Israeli construction industry, which employed some 70,000 Palestinian laborers, is suffering from a shortage of hands. As a result, some 140 small stone workshops in the Hebron area have shut down, says Samir Holelis, marketing manager at the largest Palestinian stone works, Nassar Investments.

Holelis says the blow to business confidence is even more important than immediate layoffs. "This will be felt for years to come in revenues, job creation, and general economic development," Holelis says. "To be frank, the whole theory of building an economic base without solving the peace process was nonsense."

Another high-profile project, building an orderly Palestinian government, is facing a dramatic setback as well. The Palestinian Authority, which was set up under the terms of Oslo, has seen its credibility plummet: It has been ineffectual at coping with the crisis and it is widely viewed as corrupt. So a patchwork network of nongovernmental organizations and militia leaders is filling in the power vacuum, distributing food and maintaining a rough order. Barghouti's troops, known as the tanzim, in Ramallah are just one example. A motley crew, they range from teenagers to greying middle-aged men. At night, local residents say, the militia peppers the Pasgot settlement near Ramallah with automatic weapons fire. The Israelis return the fire with tanks, damaging houses and causing casualties. Still, Barghouti is admired by locals for his militia's readiness and his criticism of the Palestinian Authority.

The rise of the likes of Barghouti is likely to complicate future peacemaking. A peace settlement, he says, must require the Israelis to return to the borders that existed in 1967 and recognize Palestinians' right to return to Israel itself. Barghouti also demands international guarantees that any treaty will be properly implemented. "The people have seen too many celebrations and handshakes without results on the ground," he says.

These positions couldn't contrast further from Sharon's--hence Barghouti's prediction that the intifada will escalate. If that happens, Palestinians seem doomed to hardship. Joblessness and business failures will soar, and food shortages are possible. How much the Israeli economy will be hurt is harder to predict. The strife trimmed about two percentage points off Israeli gross domestic product at the end of last year, holding growth to a still-sizzling 6%. But the damage was limited to just a few sectors, including tourism, which is down about 40%, and construction. All told, says Avi Ben-Bassat, the Finance Ministry's director general, the troubles only affect industries amounting to 5% of the $100 billion Israeli economy.

NASDAQ SHOCK WAVES. That relatively modest hit owes much to the transformation of the Israeli economy from an inflation-ridden, uncompetitive backwater to a powerful exporter, especially in high-tech industries. The tight monetary and fiscal discipline of the 1990s played a big role in this shift. But so did the Oslo accords. Being on track toward peace with the Palestinians and the Arab countries eased investors' fears and opened up markets such as China to Israeli trade. "The Oslo agreement was like a revolution for the Israeli economy," says Bank Hapoalim's Sivan.

In 1993, direct foreign investment was only $400 million; last year, it kicked up to $5 billion. In the past two years, a torrent of foreign venture capital chasing Israeli technological know-how has supercharged the economy. Such funding rose to $3.1 billion last year, compared with just $600 million in 1999. With high-tech exports rising by 46% in 2000, these industries accounted for two-thirds of Israel's economic growth, estimates Ptahiya Bar-Shavit, Hapoalim's chief economist.

So it is no surprise that the collapse of the Nasdaq has sent shudders through the Israeli business community. The venture-capital industry, which had been throwing money at just about any plausible Israeli business plan, has quickly tightened its belt. Investment is expected to decline by some 20% this year. That's already leading to a massive shakeout among the smaller high-tech outfits. Zeev Bregman, CEO of Comverse Network Systems Inc., a division of Comverse Technologies Inc., a Nasdaq-listed telecom-services company, estimates that one-half to two-thirds of Israel's 3,000 startups could disappear. Like many other Israeli business executives, Bregman says the impact of the Nasdaq crunch far outweighs that of the Palestinian problem. "What has been really important is the Nasdaq," he says. "There has been no impact from the security situation."

Still, there are some cracks in the wall of denial that Israeli business will be hurt by political problems. Nearly all Israeli tech companies, including Comverse and Chiaro, have their headquarters in the U.S. There are many reasons for locating outside of Israel. The market for Israeli high-tech goods is largely in the U.S. and Europe. The Middle East market for Israeli companies is small because of poor relations with Arab countries. On top of all this, the Israeli tax system poses a punitive 50% levy on stock sales by entrepreneurs.

At present, most of the Israeli-American hybrids locate operations such as marketing and finance in the U.S. and keep their research base in Israel. But some high-tech insiders worry that such companies may locate more and more of their activities outside of Israel. "The effect of the trend will be seen four to five years from now," says Chemy Peres, managing director of Polaris Venture Capital, a leading Tel Aviv-based firm. "It's a terrifying picture. High-tech companies are going to be a smaller part of the Israeli economy." A prolonged intifada could exacerbate the brain drain.

To help keep entrepreneurs at home, Israel badly needs tax and other financial reforms. But political paralysis stymies such efforts. Last year, the government drew up a tax-reform package, but Barak, with his coalition crumbling, was unable to push it through the Knesset.

Sharon is unlikely to improve the economic picture. Although his Likud party has a better record for financial probity than Labor, even his own associates say that he is "the last of the Mapainiks," meaning old socialists. "He believes that government can do everything," says a top Israeli executive. In various economic posts, Sharon has compiled a track record of wasteful spending. As Housing Minister in the early 1990s, he went on a building binge in remote areas to shelter the wave of Russian immigrants. Thousands of these apartments are still unoccupied.

But Sharon is not leading in the polls for his economic or management skills. Israelis are hoping that he is the tough guy who can calm things down and let them get on with the good life. It is a risky proposition.

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