Beset by yet another round of shocks, which only intensified as the eyes of the world turned to Lebanon, the Palestinian economy is today undergoing a process of systematic "de-development." The economic decline is sharper and more debilitating than was experienced at the beginning of the second intifada in 2001-2002, with unprecedented poverty, deteriorating living conditions and mounting social strife. If current conditions persist, by the end of 2007 the economy will be 35 percent smaller than in 2005 - in fact, it will be at the level of 15 years ago. Per capita national income will fall to below $1,000 per year, about half the 1999 level. More than 50 percent of the Palestinian labor force will be unemployed.

A viable Palestinian economy is a sine qua non for any meaningful two-state solution to the Middle East conflict, but that economy is now barely functioning. Israel has withheld transfer of Palestinian import taxes, and most donors discontinued their funding after the Palestinian Authority Legislative Council elections and installation of a new cabinet earlier this year. As a result, there has been a breakdown of central government functions, and the Israel-Palestine economic accords signed in 1993 appear to be moribund. The functioning and relevance of the Protocol on Economic Relations between the two sides are being questioned as never before. In such a turbulent situation, what can the international community realistically hope to achieve in its efforts to assist the Palestinian people?

Earlier this month in Stockholm, a donors' conference pledged new aid to the Palestinian people for 2006 of around $500 million, or around half the annual average amount provided since 2001. If swiftly deployed, this new assistance might help to stave off starvation and a complete shutdown of core social services, as well as injecting much-needed consumer purchasing power into a faltering economy. But it is unlikely to turn around the current economic deterioration. That, it seems, can only grow worse.

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It is now clear that the Palestinian economy and the mass of Palestinians under Israeli occupation are the big losers in this latest stage of the conflict. But it is increasingly evident that there can be no winner on any side, regardless of the political outcome. That is true even if the current Palestinian government falls. Donors have been forced to watch impotently as their investments in Palestinian infrastructure and institutions have been destroyed or eroded. Israel has seen a once lucrative and dependent - if not altogether captive - market become increasingly pauperized and separated as walls, border terminals and hi-tech security arrangements dominate Israeli-Palestinian economic relations. All actors remain locked in confrontation mode. If this path is pursued, the price paid by the Palestinian economy will mount, with unknown wider implications for other parties.

United Nations projections published last week on the impact of reduced donor aid predict an alarming cost to the Palestinian people. As compared to 2005, the scenarios assume a 30 to 50 percent cut in aid and - hence - public expenditures, a 50 to 100 percent increase in restrictions on the movement of merchandise in trade and a 10 to 20 percent increase in constraints on flows of Palestinian laborers to Israel. The more severe scenario now seems the more realistic, even with the newest aid pledges and plans for state-of-the-art security to facilitate trade through Israel-Palestine borders. But in both cases, the Palestinian economy will implode to levels not witnessed for a generation.

The economic cost of the worst-case scenario is tremendous. Between 2006 and 2008, losses in gross domestic product could reach $5.4 billion, well above the Palestinian GDP for 2005. Employment losses could reach 531,000 job-years, or 84 percent of the total number of jobs available in 2005. Even assuming a full return of donor support and the relaxation of mobility restrictions by 2008, GDP and employment losses would continue to accumulate. This suggests today's declines will have harmful, long-lasting effects on the economy that will persist even if adverse conditions are alleviated later on.

Channeling and conditioning aid to Palestine through "social allocations" and other back-door, nongovernmental channels, coupled with tightening of Israeli measures and withholding of Palestinian tax revenues, can only add to the process of "de-development." Poverty and deterioration in humanitarian concerns could reach unmanageable proportions and would last much longer than the term of any single Palestinian government, irrespective of its political program. Added to this is the risk of supplanting Palestinian public sector capacity through resort to temporary international funding mechanisms determined by overriding political factors. This same capacity, the focus of donor aid since 1994, is one of the essential elements required for the sovereign functioning of the envisioned Palestinian state. Today, that vision appears farther from realization than at any point since first endorsed by the international community in 2002. Outcomes such as these serve nobody's interests and will have repercussions far beyond Palestine, at a cost that no amount of subsequent aid will easily reverse.

Raja Khalidi is a senior economist with UNCTAD (United Nations Conference on Trade and Development) in Geneva.