The Obama administration recently threatened to cut off aid to the Palestinian Authority after the organization began unity talks with Hamas, a terrorist group in America’s book. If only the Palestinians would be that lucky. As a matter of fact, if the administration is genuinely interested in Mid-East peace, it should end aid to Israel too.

Contrary to half-a-century of conventional wisdom, foreign aid has fanned the forces of extremism on both sides making the prospects for peace less-not more-likely.

If money could buy peace, Israelis and Palestinians would now be holding hands and singing kumbaya instead of directing aerial bombs and suicide missions at each other. The West has been lavishing aid on the Palestinians since the founding of Israel in 1948. But it opened its spigot full force after the 1993 Oslo Accords gave Palestinians nominal self-rule by creating the Palestinian Authority with Yasser Arafat at its helm. Over the next seven years, the West dispatched over $4 billion to the Palestinian Authority. It stopped the aid briefly when Hamas took control of Gaza in 2007, only to up it subsequently to $7.4 billion over three years. However, it directed all of it at Fatah, Hamas’ moderate rival in the West Bank. Palestinians now have the dubious distinction of being among the largest recipients of aid on a per capita basis.

But Israel hasn’t done too poorly either. In absolute dollars, it receives about as much aid from America as the Palestinians do from the rest of the world combined. Indeed, America currently hands $3 billion annually in military financing to Israel. But this doesn’t include the hundreds of millions of dollars in loan guarantees that the US gives Israel nor joint military projects such as the Arrow missile program. What’s more, unlike other countries that receive their aid in installments, Israel gets all its military assistance in the first month of the fiscal year and with fewer strings attached.

And what has this aid wrought?

On the Palestinian side, it has empowered the most corrupt social elements while thwarting the development of civil society and private industry, the true bulwarks of peace.

Arafat used the aid not to build Palestinian infrastructure or human capital but to put in place a patronage system. He dispensed aid money to consolidate one-man rule not the rule-of-law. Instead of transparent and accountable institutions, the Palestinians got a government whose fattening rolls, especially of its security forces, were full of Fatah Party members. Indeed, security personnel almost doubled from 44,400 in 1999 to 78,000 in 2006, comprising literally half of all government wage earners.

Giving Arafat an outside source of funds detached him from concerns about the health of the broader Palestinian economy. The private sector completely collapsed under him as companies, unable to compete with aid-subsidized government wages, folded. The upshot was a two-tier economy in which those who joined Arafat’s ranks gained power and riches and those who didn’t-or couldn’t-grew oppressed and wretched.

But neither group acquired any economic stake in peace and development. Indeed, a 2008 study by Steven Stotsky in the Middle East Quarterly presented a series of startling graphs showing a direct correlation between periods of high-aid and high-violence. For example, one graph shows increased aid after 2000 dovetailing, as if on cue, with an increase in the murder rates of both Israelis and Palestinians a year later.

Arafat’s successor, Mahmoud Abbas along with Prime Minister Salam Fayyad, have had some success in cleaning up Arafat’s mess and restoring economic growth, earning kudos from the World Bank. However, a recent study found that 60 percent of West Bank’s GDP still depends on foreign aid. So long as this is the case, it is hard to see how a Palestinian middle-class with a vested interest in political stability and peace could possibly emerge.

But if foreign aid has thwarted the voices of peace on the Palestinian side, American aid has likely emboldened the voices of extremism on the Israeli side.

American aid accounts for 22 percent of Israel’s defense budget. The Obama administration, together with its many predecessors, sees this as necessary to “ensure for Israel the security it requires to make concessions necessary for comprehensive regional peace.” But this longstanding policy has failed to deliver, perhaps because it makes no sense.

One can see how U.S. military aid would help Israel defend itself forcefully in a sea of hostile neighbors. But why precisely would an Israel that feels militarily less vulnerable be more amenable to making painful concessions? Wouldn’t it be emboldened to follow a more hardline, instead of a more conciliatory course?

For example, not a single Israeli government-Labor, Kadima, or Likud-has stopped the expansion of Jewish settlements in the occupied West Bank, even though such activity poisons the atmosphere for peace negotiations and makes any final agreement infinitely harder to implement.

Western aid to Palestinians and Israelis is a monument to perverse incentives and unintended consequences. It has made the West part of the problem in the Middle East rather than the solution. It’s time to end it.

Reason Foundation Senior Analyst Shikha Dalmia is a columnist for The Daily, America’s first iPad newspaper, where this column originally appeared.


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Shikha Dalmia is the senior analyst for the Reason Foundation, a nonprofit think tank promoting free markets. Dalmia is a columnist at Forbes and writes regularly for Reason magazine. She is the co-winner of the first 2009 Bastiat Prize for Online Journalism for her columns in Forbes and Reason.