Alan George reports from Damascus.

Hopes are high that Syria could be at peace with Israel within a year and that the peace could extend to south Lebanon, where Israel has been fighting a war of attrition with the Syrian-backed Hizbullah organisation.

In Syria, however, social and economic pressures are building which could ultimately bring changes to the lives of most Syrians far more profound than those resulting either from peace or from that that other burning issue in Damascus, the succession to the presidency.

"It's at the point where something has to give", said one Western observer. "The real story here is how this country is going to function post-peace, post succession. The root problem is a hopelessly inefficient economy which cannot provide sufficient employment for a rapidly growing workforce. Syria now has 15 million people. The population growth rate has dropped from 3.7 per cent per annum in the early 1990s - then the highest in the world - to 2.4 per cent.

This is still far higher than the absorptive capacity of the economy. At least half the population is aged under 16 and between 150,000 and 200,000 new job seekers arrive on the labour market each year. In the cities, the situation is exacerbated by long-term rural-urban migration, accelerated by a two-year drought which has badly hit rural incomes.

Syria's ramshackle economy, overwhelmingly dominated by the public sector, has coped with new job seekers by employing them even when there was no real work for them to do. Governments since the original Ba'athist coup in 1963 have been dedicated to social justice and even more to their own survival. The provision of jobs - even unproductive ones - has been a crucial means of assuring stability.

In the past, the creaking edifice was financed by aid from the old Eastern Bloc and from the Gulf and by oil revenues which grew rapidly in the 1980s. Now, however, the Soviet Union is gone and Gulf aid, although it continues, is nowhere near the levels which would be needed to keep Syria afloat. Oil revenues likewise, while still useful, have stabilised.

To ease the pressures, the government permits a series of informal safety valves. Officially, the authorities control all imports. In reality, goods flood into Syria duty-free, especially from Lebanon where 35,000 Syrian troops are stationed. Tax evasion is widespread. Officially, it is illegal for Syrians to personally hold foreign exchange, but the practice is widespread.

"Another consequence of the general impoverishment is that corruption is widespread, from the top to the bottom of the system", said one local observer. "It's the normal and expected thing. At one end of the scale it's a matter of small tips, for example to bank employees to ensure that they shift a piece of paper from one desk to another. At the other end it can be a matter of large kickbacks on contracts."

These safety valves have created large areas of uncertain legality, in which action by the authorities is a matter of discretion. "It's a system in which everyone technically breaks the law and everyone, officially, is an accomplice to wrongdoing," said one Western observer.

This offers the authorities considerable scope for control. Syria is an archetypal security state with numerous interlocking intelligence and security agencies (which are themselves a major source of employment). At present, the atmosphere is relaxed and there are few overt signs of the iron fist upon which the regime ultimately depends. But everyone here knows that the authorities can crack down on political dissent using sometimes trifling economic or financial 'crimes' as the pretext.

Slowly but surely, however, the situation is approaching breaking point. In the bloated public sector, wages - between $60 and $80 per month for a mid-rank official and $200 per month for a minister - cannot be squeezed any more to create the funds to pay for yet more employees. The erosion of salaries has meant that many people have two jobs. Women with families are increasingly going out to work to supplement their husbands' incomes. This in turn exacerbates the job shortages. Couples are delaying marriage for lack of funds and when they do marry they often live at a parental home.

While the poorer sections of society - which constitute the vast majority - are squeezed, a small but highly visible nouveau riche has emerged whose lifestyles involve conspicuous consumption. Syria has traditionally had a large merchant middle class and the private sector, albeit in emasculated form, has always been accepted by the country's successive Ba'athist regimes. The new wealthy, however, owe their good fortune to their links to the regime. Many are relatives of senior officials. Certainly this new element in the middle class has an interest in stability, and certainly Syria needs an expansion of its middle class, but in the short term the nouveau riche are the object of considerable envy and irritation. For many poorer Syrians, they symbolise the cynicism of their rulers.

The need for change has been acknowledged for years but action has been confined to tinkering. There is a genuine worry about the social impact of reform. If establishments had to operate competitively, without government subsidies, tens of thousands of unproductive workers would be laid off, causing much hardship and potentially posing a threat to stability. Sometimes, however, such arguments are used by opponents of reform whose real worry is the loss of their own privileges. Entrenched throughout the system are individuals - some of them very highly-placed - who have much to lose personally from reform. No-one wants to rock the boat - and least of all the government. All major decisions are a matter for President Assad. But conventional wisdom in Damascus is that Assad is far more interested in Syria's regional affairs than in the economy. Certainly he has intervened in the economy only at times of serious crisis. Early this decade, for example, he personally spearheaded moves to end electricity supply cuts which had reached an alarming scale.

For the moment, it appears that Assad is focusing on the talks with Israel. If all goes well on that front, he may well pay more heed to domestic reform, basically involving liberalisation and a far greater role for the private sector.

To date, change has been limited to fiddling at the margins. A new investment law (Law No 10) was promulgated in 1991 but has had little impact. Absurdly unrealistic exchange rates for the national currency have been modified (although official rates still differ by about 10 per cent from those on the black market). By far the most potent pressure for change is coming from within Syria itself, as the system's failings cause ever wider disgruntlement. But Europe - which takes 55 per cent of Syria's exports and supplies one third of her imports - is encouraging the government to grasp the nettle. The European Union (EU) has been assisting with a range of sectoral reform and modernisation programmes. Of far greater significance, however, will be an EU-Syria Association Agreement similar to those either in place or being negotiated with other Mediterranean states.

The accord will allow Syrian exports far easier access to the crucial European market. But the EU insists its privileged trading partners must operate competitively. Europe will not accept the dumping of subsidised goods on its markets. By entering talks for an Association Agreement, therefore, Syria has tacitly accepted the economic and fiscal overhaul which is anyway inescapable if the country is to emerge from its economic torpor.

"An Association Agreement would offer an ordered framework for reform and help Syria to achieve its real potential," said Giovanni di Girolamo, counsellor at the European Commission delegation in Syria. "Plainly reforms are required in Syria, including important legislative changes, and the EU stands ready to assist with the process."

The EU is sensitive to Syrian concerns over reform but is convinced that the benefits far outweigh the short-term costs. According to Mr Di Girolamo: "An agreement will enable Syria to become part of a huge economic area encompassing Europe and the Mediterranean, and to attract badly-needed investment from outside on a significant scale."

Syria's engagement with Europe also has important implications for human rights. All the EU's Association Agreements have human rights clauses and the issue is a major item on the Damascus-Brussels agenda. "We know how dear this issue is to the European parliament, the parliaments of the member states and to public opinion in the EU," said Mr Di Girolamo.

For Syria, reform has become a question of when, not if, and the longer the delay the more acute will be the pain of adjustment. It is hard to fault the comment of one Western diplomat here: "They say that reform threatens stability. We say that lack of action by them poses a far bigger threat."