I will address each of your questions and comment on your alternate hypothesis.
Question 1: Does correlation mean causation in that case? Can he prove that?
Answer: In my article "Foreign Aid and Palestinian Violence: An Uncomfortable Correlation," I made it clear that correlation did not mean causation. My exact words were:
"These statistics do not mean that foreign aid causes violence; but they do raise questions about the effectiveness of using foreign donations to promote moderation and combat terrorism."
However, it would not have been unreasonable for me to have hypothesized a causal relationship.
Question 2: Did he conduct any hypothesis testing before he arrives to the conclusions?
Answer: A number of economists have looked at the relationship between aid and GDP and come to the conclusion that aid can be counterproductive because it leads to a lack of effort, overvalued exchange rates, and other social and economic changes that are detrimental to growth. I also cited a study from a peer reviewed economics journal that found a link between increased terrorism and increased aid.
Question 3: What is the theoretical bases for his analysis?
Answer: My analysis was prompted by the following observations:
It is widely acknowledged that the Palestinian Authority (PA) has misused funds. The diversion of funds to terrorist organizations has been documented. For example, documents captured by the Israeli army during Operation Defensive Shield in 2002 reveal financial links between the Palestinian Authority and terrorist groups.
Prior to the second Intifada, most aid went towards development programs. After September, 2000, most foreign donations were allocated to the PA budget or used for emergency aid. Increased availability of funds to the PA means more opportunity to divert funds to terrorists and militants.
George Abed, the former head of the Palestinian Monetary Authority, and James Prince, consultant to the Palestine Investment Fund, questioned the effectiveness of foreign donations. In an article appearing in the San Francisco Chronicle, Prince was quoted as stating, "many of the donor programs have not only been ineffective, they have harmed the economy." The article also estimates that overseas Palestinians have $60 billion in resources which they are not investing in the West Bank and Gaza. ( "Expert says Palestinians don't need financial aid," SF Chronicle, Sept. 5, 2005)
I will now address your two hypotheses: that increased aid is given during periods of economic decline and that the Israeli closure policy required more aid to be given at a time when hostilities were rising.
Increased aid is given during periods of economic decline. The question, though, is what impact increased aid has. Does it turn around a failing economy or does it reinforce a culture of dependency and stifle self-improvement?
Your hypothesis that rising aid and rising violence is coincidental needs to be subjected to the same rigorous analysis that you require for my correlation. It is important to remember that Israeli security measures, like checkpoints, raids and fences, are a response to Palestinian terrorism.
Budgetary aid was provided to compensate for the shortfall in funds arising out of Israel's decision to hold back tax revenue in response to the PA's failure to take effective action against terrorists. If the aid was effective in stabilizing the situation, then the violence should have declined. But this was not the case. When I compared the aid level and the number of homicides occurring during the following year, the correlation between aid and the number of homicides became even tighter.
There is also a logical explanation for the link between increased aid and violence. If aid had not been increased, there would have been less money available to divert to militants and conceivably more societal pressure to use scarce funds to take care of the most basic needs of the population.
I will close with a final question to consider. If foreign aid was less forthcoming, might the Palestinian public have recognized more quickly the damage being done to their own society as a result of the terror campaign. Did the aid inadvertently serve as a buffer to mask this damage and thus prolong the terror campaign to the detriment of both Israelis and Palestinians?