Mubarak team seeks to revive wilting carrot for Arab-Israeli peace

The economic crisis has taken a toll on Qualified Industrial Zones, a US trade initiative aimed at warming Israel's "cold peace" with Arab states.

Israel is usually better known for exchanging bullets with its neighbors than zippers and paint.

But as Egypt's President Hosni Mubarak and his entourage hold meetings in Washington on Tuesday, the future of a trade deal aimed at changing that will top the list of economic issues they discuss. The Qualified Industrial Zone (QIZ) program, as it is known, allows manufacturers in Arab states who have made peace with Israel to export to the US duty-free – provided they use enough Israeli material.

Egypt is now hoping to expand its program as US officials push for a broader regional peace. The only two Arab states at peace with Israel, Jordan and Egypt, signed on to the QIZ deal in 1997 and 2004 respectively. But the US had thought the financial rewards would have urged more Arab countries to come on board.

The program helped Jordan's exports to the US grow from $16 million in 1997 to $1.3 billion last year and has boosted the bottom line of entrepreneurs such as Magdi Tolba, head of the Cairo Cotton Center, a ready-made garment business. Despite the recession, his sales are on track to grow to $35 million from $26 million last year.

"Most of this growth is in the American market and is because of the QIZ," he says. "The sky can be the limit for the [program's] potential."

Perhaps for Mr. Tolba. But the sun is now setting on Jordan's QIZs, where a new free-trade agreement is scheduled to come into full effect next year, rendering the zones redundant. While Egypt is set to expand the QIZ initiative, they have grown more slowly than the US and Israel had hoped.

How the zones work

To qualify for the QIZ, companies must be located in one of the participating country's designated areas and buy 10.5 percent of their material from Israel.

But with global trade barriers lower than ever, particularly in the ready-made garment industries that have been the principal beneficiaries of the QIZs, tariff-free entry to the US market isn't the enticement it once was. A global quota system that restricted low-cost Indian and Chinese garment producers' access to the US market expired a few years ago, and even Egypt, famous for its cotton, has struggled to compete since.

The Jordanians have also had to contend with the Egyptians, whose stronger industrial base and cheaper labor undermined their exports once both countries received the same tariff treatment.

The number of companies in Jordan's program slipped below 40 this year, down from about 90 five years ago. Next year there may be as few as 10, says Gabby Bar, co-chairman of the QIZ committee at Israel's Ministry of Industry, Trade, and Labor. Though the economic fallout from their decline will not be grave, he says something no less valuable could be lost.

"In what we call the 'cold peace,' this QIZ project came to be a kind of joint goal with no, let's say, patronizing each other," he says. "In Jordan, if the QIZs are going to be disappearing, of course it is a shame, it is a waste of an opportunity."

The crisis

It's been a tough year for clothing sales, and Jordan has been particularly hard hit. As overall US clothing imports fell 11 percent in the first four months of the year, Jordanian clothing exports to the US fell 20 percent.

In Egypt, the QIZs have helped ease the pain. Though overall garment exports dropped 32 percent in the first five months of the year, according to the American Chamber of Commerce in Egypt's monthly newsletter for July, garment exports to the US jumped nearly 15 percent, to $258.3 million, in the first four months of the year.

"The numbers are still there, but not as handsome as we hoped for," says Ali Awni, head of the QIZ unit at Egypt's Ministry of Trade and Industry. "[Those figures] are still not a bad deal."

But buyers such as Walmart and Gap have recently been ordering smaller quantities of goods and been demanding lower prices, according to officials in the program. As a result, investment in Egypt's qualified zones has slowed.

Slack demand has in turn led Egyptian manufacturers to order less from their Israeli partners. Egyptian QIZ companies ordered nearly 20 percent less from Israeli suppliers last quarter compared with their peak numbers, Bar says.

Here to stay?

Some Jordanian companies will remain QIZ producers, and more will continue to work profitably under the new free-trade agreement, Bar says. And on the Israeli side, manufacturers involved with QIZs represent only a sliver of Israel's economy.

Assuming US demand recovers, the program in Egypt will likely avoid its Jordanian counterpart's fate, observers and participants say.

This is largely because Egypt has no pending deals that could replace the qualified zones, though similar programs in other garmentmaking countries could cut into the QIZs' competitiveness.

The Egyptian government, for its part, is banking on a profitable future for the program, and is planning to expand the zones into southern Egypt next year.

Still, Tolba of the Cairo Cotton Center has been disappointed.

He expected the QIZ program to garner between 700 and 1,000 participants within its first three years. Instead, fewer than 90 companies use the zones frequently to export to the US.

"I am dreaming of pushing up our capacity," he says.

Tolba speculates that weak management may be part of the problem.

Another reason may be that strong local demand has kept many textile and garmentmakers content selling only to the Egyptian market, says Reham el-Desoki, chief economist at Cairo-based investment bank Beltone Financial.

And of course, there is Israel. Despite decades of formal peace, many Egyptians still consider the Jewish state to be a belligerent and unwelcome presence. Last winter, Israel's war in Gaza dominated Egyptian headlines for weeks.

It is hard to estimate how many companies have stayed out of the QIZ program because they do not want to deal with Israel, but analysts and participants say it may have had some effect.

"It's possible, with some people," says Ms. Desoki. "Although usually the business world is a bit different from politics."

Others disagree. The signing of Egypt's QIZ deal coincided with that country's release of Azzam Azzam, an Arab-Israeli accused of spying, notes Egyptian political analyst Emad Gad.

"The political criteria is the first criteria for the Egyptian government," he says. "If we have an atmosphere, a good atmosphere, in the political arena, then we can see many agreements between Egypt and Israel."

If this atmosphere cools, Mr. Gad warns, so might agreements such as the QIZ.