The financial crisis currently facing the Palestinian Authority is not just economic; it is also a symptom of the deep political problems facing the leadership in Ramallah. The PA has based its appeal to the Palestinian public on a strategy that combines working with Gulf Arab states, Israel, and the West to produce improvements in the quality of life for Palestinians under occupation, while at the same time pursuing independence through international diplomacy. Now a lack of funding has limited the PA’s ability to meet its payroll, undermining the credibility and authority of its approach and its leaders.

The situation became especially perilous in late July, when promised donations failed to materialize, including $330 million that Gulf Arab states had pledged to provide every six months. This shortfall was caused by a combination of donor fatigue, impatience with the lack of progress on Fatah-Hamas unity, and a long-standing tradition of Arab states not meeting their pledges to the PA. Previously, in May, Israel also temporarily failed to deliver the Palestinian tax revenues it controls. As a result of the shortfall, the PA was forced to announce that government salaries -- on which more than a million Palestinians in the West Bank and Gaza are dependent -- would be cut in half for August.

The PA’s financial woes undermine the achievements made by the state- and institution-building program initiated by Prime Minister Salam Fayyad in August 2009. Public anger at the proposed wage cuts was palpable: civil servants, doctors, and teachers threatened a mass strike. The government, meanwhile, mandated a reduction in the price of bread, the staple food for most Palestinians -- a further reflection of the financial hardships that the crisis is causing to ordinary people.

Undelivered pledges from Arab states are at the core of the immediate crisis. (Fayyad has refused to publicly identify which states reneged, but the group certainly includes Saudi Arabia.) This has been a perennial problem for many years, since Arab states have often tied the delivery of their donations to political demands and have at times raised legitimate questions about the corruption that used to be endemic in Palestinian financial management.

The uncertain status of the Fatah-Hamas reconciliation agreement has further undermined donor confidence, because governments prefer to know who precisely will be in charge of the money they are providing. By signing a vague “national reconciliation agreement“ in Cairo in April, the PLO and Hamas agreed, in effect, to agree. But since then, they have not achieved a specific agreement on any issue. The tense and frequently hostile relationship between the parties remains unchanged, meaning that Palestinian society, polity, and leadership remain not only divided but in a de facto cold war.

Both Fayyad’s reputation and that of the entire PA leadership have suffered as a result of the financial crisis. Some leaders in Fatah and Hamas have tried to make Fayyad the issue by claiming that disagreement over whether he should remain in office was the primary obstacle to reunification. But Fayyad is a convenient red herring. In reality, there is near-total disagreement between the two sides. Focusing attention on a manufactured dispute about Fayyad, who is a member of neither party, has been a means to distract from Fatah and Hamas’ inability to agree on any substantive issue.

Hamas is the primary beneficiary of the PA’s financial woes and their political consequences. Indeed, although Hamas is suffering something of a financial crisis of its own due to tensions with Egypt -- and, especially, Syria -- it remains the recipient of significant cash transfers from other patrons, primarily Iran. Still, the consequences of Hamas’s financial crisis are greatly mitigated by the fact that its rival, the PA, continues to pay most public employees in Gaza -- even though Hamas still rules there.

The real core of the PA’s long-term challenge is the ongoing Israeli occupation, which prevents the Palestinians from having control over key sectors of their economy and restricts almost every form of economic development. In April, Mariam Sherman, the World Bank’s country director for the West Bank and Gaza, said, “While we commend the solid performance of Palestinian institutions, we are concerned about the prospect for continued economic growth.” Israel’s ”closure regime,“ she continued, represents ”the most substantial obstacle to Palestinian economic viability.” A World Bank report issued at the same time noted that strong private sector growth is unlikely “while Israeli restrictions on access to natural resources and markets remain in place, and as long as investors are deterred by the increased cost of business associated with the closure regime.”

Such findings echo those of every major multilateral institution, which emphasize that Israeli restrictions on access and mobility are the gravest threat to long-term development and financial stability. Genuine financial viability will ultimately require the creation of an independent Palestinian state alongside Israel.

However, even under occupation, the PA has achieved a great deal in recent years. According to the World Bank, real economic growth in the West Bank in 2010 exceeded 9 percent of GDP, which surpassed the PA’s budget projection estimate of 8 percent. Moreover, under Fayyad, the PA has overcome a legacy of corruption and patronage to establish a transparent public finance system that has greatly reassured foreign donors.

Nevertheless, corruption in other sectors remains an issue. The PA’s improved image is threatened by an ongoing investigation into alleged malfeasance by some officials, including four ministers, among them Minister of the Economy Hassan Abu-Libdah. There are also charges and countercharges of corruption between Fatah and an ousted former PLO official, Mohammed Dahlan.

Other obstacles to economic well-being also remain. A June UN report showed rising unemployment among Palestinians in the West Bank and East Jerusalem -- from 21.7 percent to 25 percent during the last year. Moreover, what economic growth has occurred has been based on an increase in construction and retail businesses, not manufacturing or long-term, self-sustaining enterprises.

The PA’s state- and institution-building program has shown great promise, but it requires sustained international financial and political support to continue and expand. Crucially, if it is to remain politically viable, it must also be seen by the Palestinian public as part of a broader program to establish an independent state. There is no Palestinian constituency for a program to create better living conditions in small autonomous zones within a permanent or semi-permanent Israeli occupation.

Although the PA’s potential plan to push for UN recognition of Palestinian statehood is not directly related to the present crisis, it does contribute to the overall uncertainty about the direction in which Palestinian politics and national strategy are headed. A UN move could create additional significant financial problems, including a withdrawal or reduction in U.S. aid and possible withholding of Palestinian tax revenues by Israel. At the same time, reported plans for mass civil disobedience among Palestinians in coordination with a UN initiative in September further contribute to uncertainty among donors and investors, and raise additional tensions with the United States and Israel.

The bottom line is that the PA’s financial crisis threatens the achievements and potential of the state-building program, which has been the basis of significant but limited economic growth in the West Bank in recent years, as well as the credibility of the moderate leaders who have created and led it. The success of the program in terms of economic development must be linked to a viable political path to national independence -- not symbolic gestures at the UN that have no effect on realities on the ground -- or even its creators and leaders will abandon it. Fayyad and other PA officials conceptualized their project as a bottom-up supplement to top-down diplomacy, not as an alternative to it.

The mainstream Palestinian leadership in Ramallah has staked its entire political future on this policy of independence through a combination of state-building efforts at home and diplomacy abroad. If the Palestinian public sees this strategy as having permanently and irrevocably failed, particularly if there are ongoing or regular financial and economic crises, they will look to an alternative leadership and program. The alternatives are either chaos or Hamas, with inevitably dire consequences for the Palestinian national movement and for U.S. and Israeli interests as well.

Those parties who do not want the Palestinians to go ahead with a UN initiative -- such as the United States, some European countries, and Israel -- should make every effort to ease the financial crisis. The Palestinian leadership needs a clear and reasonable incentive to avoid a confrontation at the UN in September, which would probably be very damaging to Israeli, Palestinian, and U.S. interests in the broader Middle East. Otherwise, the Palestinians might feel they have no other diplomatic options and an overwhelming domestic political necessity to go forward with plans that carry significant risks.

Meanwhile, those parties, including some Arab states, who are encouraging Palestinians to go forward with a UN initiative in spite of the risks have an obligation to protect them from the political, diplomatic, and financial consequences. But so far, the opposite has occurred: the pattern of unmet pledges undermines the ability of Palestinian leaders to make constructive decisions, places them at the mercy of domestic political calculations and public anger, and weakens their ability to lead. It is pushing them toward a confrontation with the United States (and for that matter, much of the West) and with Israel that they can ill afford, leaving them alone and exposed.

There is, however, the potential for compromise. Fears of a Palestinian failure at the UN producing a backlash in the West Bank are justifiably widespread. Yet a perceived success at the UN, met with an initial wave of euphoria but followed by disenchantment as living conditions remain unchanged or worsen because of Israeli or U.S. retaliation, could produce an equal backlash. Instead, a compromise strategy could produce a limited but real Palestinian achievement in New York. Such a strategy would involve an upgrade of the PLO observer mission at the UN, a reiteration of the Obama principles (negotiations based on 1967 lines with agreed-upon land swaps) , and a UN declaration clarifying that the international community will not accept any outcome other than a two-state solution.

Massive international investment in state- and institution-building could ensure a major upgrade in the quality of life for Palestinians in the West Bank and could defuse the impact of any disappointment. Whatever happens in New York in September, the day after needs to look better, not worse, for Palestinians on the ground. Ultimately, the Palestinian national aspiration for independence must be met. But institution-building, investment, and financial support for a leadership that is opposed to violence and committed to peace with Israel can buy time and patience -- probably for years, but certainly not for decades.