The report, based on an ILO mission to the region earlier this month, added that economic output in Palestinian areas fell by 12% last year.
The proportion of the Palestinian population subsisting on less than $2 (£1.4; 2.1 euros) a day rose to 46% last year, and could widen to 62% in 2002.
The ILO said the Palestinian territories are in the grip of a "socio-economic meltdown".
"Palestinian and Israeli populations are paying a very high price for occupation and violence," the report said.
It called for a relaxation of movement restrictions, and the establishment of a Palestinian employment fund.
The Israeli construction industry has been hit hard by the loss of about 55,000 Palestinian workers, while the tourist sector is struggling with a 50% drop in visitor numbers.
The country's lucrative hi-tech industries have also suffered as a result of last year's economic downturn in the US.
The ILO report is to be formally unveiled at the organisation's annual conference in Geneva next month.