This paper is one of the first to discuss service sector productivity in Palestine. We have empirically addressed the main factors that responsible for growth in productivity in the Palestinian service sector, and discussed the impact of intra-sectoral heterogeneity on the growth of productivity using a panel data provided by the Palestinian Central Bureau of Statistics. The results show that FDI has a positive and significant influence on the growth of labor productivity. Capital-intensive service sectors have a high influence on the growth of labor productivity sectors compared to other sectors. The political instability in Palestine negatively affects the growth of productivity in service sector. Meanwhile, public services and traditional services such as retail trade, the sale and repair of motor vehicles and land transport are the main areas responsible for weak growth in service productivity. We found that to increase productivity in traditional services, new policies should be adopted, based on the use of ICT by service firms or public institutions. Government should adopt an efficient plan aimed at absorbing the thousands of unskilled workers who lose their jobs inside Israel, and this should be based not on expansion of the public sector but on the rehabilitation of these workers, employing them in the various economic sectors.