With the death of Yasser Arafat, hopes for instant peace are on the rise again. At Tuesday’s conference in London, the U.S. and the European Union pledged hundreds of millions of dollars to help the Palestinian Authority democratize and fight terror.

But before more money is proffered, it may be prudent to carefully analyze why the last time the world showered the PA with billions of dollars what ensued was not peace and prosperity but a bloody conflict. Essentially what undermined Oslo was the erroneous supposition that agreements with reformed terrorist organizations could initiate a process of democratization and that massive government-to-government aid could create a prosperous economy.

In reality, foreign aid financed a 150,000-man corrupt bureaucracy, a 50,000-strong army that was yet not “strong enough” to stop the terror, and 12 secret services. The war Arafat started cut off hundreds of thousands of Palestinians from gainful employment. It more than halved the Palestinian standard of living that had risen fourfold and more under Israeli occupation. And yet, once again peace processors follow the same script. The West is rushing to channel massive aid to the PA that has yet to become really democratic. Such aid will only bolster an inefficient and corrupt public sector controlled by PA operators. It will crowd out and destroy any private initiative that may form a viable opposition. Already we are informed that the PA has signed a contract with the Israeli cement monopoly. This is a continuation of Arafat’s rapacious policy that granted Israeli monopolies exclusive rights as long as they shared the monopoly rents with his corrupt regime.

In Israel, Shimon Peres, the chief architect of the failed Oslo accords, has been put in charge of reviving the Palestinian economy. Mr. Peres, a statist, believes in taxing and spending, so it was natural that he would opt for a Palestinian welfare system. Instead of letting economic activity diffuse and devolve power, Mr. Peres would have large sums of aid funneled through the putatively reformed PA.

But such massive aid threatens to revive the PA’s nearly bankrupt centralized government. Control of billions in foreign aid will enable it to perpetuate its corrupting role as the largest employer and dispenser of wealth in the territories. It will also inflame political competition over control of these huge funds, and this will inevitably lead to polarization and radicalization.

Instead aid should be structured as much as possible as loan guarantees to individual entrepreneurs or as risk subsidies assisting the private sector. This way aid will empower a private sector that thrives on law and order and true democratization. A civilian Palestinian administration should be encouraged to write a constitution, to hold really free elections and to establish law and order. Palestinian moderates who have been terrorized and forced into hiding should be made safe to stand for election against PA and Fatah cliques.

As soon as the Palestinians act peacefully, Israel should stop imposing closures on Palestinian areas. A freer movement of resources and people will by itself encourage economic growth.

While Israel bears no moral responsibility for the plight of the Arab refugees, a problem created by Arab aggression, it should do all it can to help them, as it has done for an equal number of Jewish refugees evicted from Arab lands. Once the violent opposition of the PA, which nursed and exploited the refugees’ plight, is gone, Israel should help initiate housing construction for refugees in Gaza and the West Bank. Government-owned land near the refugee “camps” (actually teeming slums) should be fitted with infrastructure. Refugee families should be invited to construct their own housing. They could also be offered low-interest building loans, or compensation for lost property. Such a massive construction program would provide jobs and income for Palestinian workers and contractors and might jump start an economic revival in related trades and services.

Palestinian Arabs have a comparative advantage in labor-intensive trades. Israel should therefore open its markets to their products. Construction of Palestinian-Israeli industrial parks, like the one built near the Gaza Strip by Israeli industrialist Stef Wertheimer but destroyed by Palestinian terrorists, should be encouraged. Such parks could alleviate the security problems involved in daily busing tens of thousands of Arab workers to Israel while providing Arab entrepreneurs with modern infrastructure.

Israeli bureaucracy should be kept away from informal markets—extremely popular with Israeli shoppers—that have sprung up during the first intifada along the edges of Palestinian areas. These markets, sort of informal free-trade zones, should be encouraged to flourish, since they have provided the best environment for trade-based peaceful relations.

As the European experience teaches, national conflicts are not susceptible to quick fixes. It took Europe centuries and in the end, it was not so much politics but economic cooperation and growth that helped resolve them. New interests and benefits created by economic integration helped people transcend old barriers while making others irrelevant. Given time and patience this can also happen in the Middle East.

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