A viable Palestinian economy is a prerequisite for any meaningful two-state solution to the Middle East conflict, but that economy is barely functioning. Israel has withheld transfer of Palestinian import taxes, and most donors discontinued funding after the democratically elected Palestinian Legislative Council, dominated by Hamas, constituted a new government in March. With 160,000 civil servants on strike after six months without pay, there has been a breakdown of central government functions. Meanwhile, the Israel-Palestine economic and trade accords signed in 1993 appear to be increasingly irrelevant, if not moribund.

A new government of national unity could heal internal divisions and present a Palestinian position more acceptable to some donors — a hope echoed by Tony Blair last week. But if Israel is not convinced, donors will remain hesitant, and those vital tax transfers to the Palestinian Authority are unlikely to resume soon. In such a turbulent situation, what can the international community realistically do to help the Palestinian people? Earlier this month in Stockholm, a donors’ conference pledged new aid for 2006 of around $500m, or approximately half the annual average since 2001. If swiftly deployed, this assistance might stave off starvation and a shutdown of core social services, as well as injecting much-needed consumer purchasing power.

Donors have been forced to watch impotently as their investments in Palestinian infrastructure and institutions have been destroyed or eroded. Israel has seen a lucrative market become pauperised by security arrangements. If the path of confrontation is pursued, the price paid by the Palestinian economy will mount.

Recent UN figures predict a drop in donor aid compared to last year of 30 per cent to 50 per cent, and hence a similar reduction in public expenditure, as well as increased restrictions on trade and flows of Palestinian labourers to Israel. In the most severe scenario, the Palestinian economy will shrink to levels not witnessed for a generation.

From 2006 to 2008, losses in GDP could reach $5.4bn, and 84 per cent of the jobs available last year will disappear.

Channelling aid through “social allocations’’ and other back-door, non-governmental channels, combined with the tightening of Israeli measures and the withholding of Palestinian tax revenues, can only intensify the process of “de-development”. Poverty and humanitarian deterioration could reach unmanageable proportions.

Any resort to temporary international funding mechanisms runs the risk of supplanting Palestinian public-sector capacity. This has been the focus of donor aid since 1994, and is one of the essential elements for the sovereign functioning of the envisaged Palestinian state. Today, that vision appears further from realisation than at any point since 2002. Outcomes like these serve nobody’s interests and will have repercussions beyond Palestine — at a cost that no amount of aid will easily reverse. — The Guardian