Impact of Future Labor Policy Options on Palestinian Labor Market – World Bank working paper

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The Impact of Future Labor Policy Options on the Palestinian Labor Market

by Elizabeth Ruppert Bulmer

Middle East and North Africa

Working Paper Series

No. 24

June 2001

The World Bank

Produced by the Office of the Chief Economist

Summaries in Arabic and French

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Table of Contents

Summary

The Impact of Future Labor Policy Options on the Palestinian Labor Market

I. Introduction – 1

II. Stylized facts of the Palestinian labor market – 1

i. Segmentation between domestic employment and employment in Israel – 2

ii. Constrained labor mobility – 2

iii. High unemployment rate negatively correlated with employment in Israel – 2

iv. Rising wages concurrent with falling unemployment – 3

v. Persistent wage gap between domestic and Israeli jobs – 4

vi. Unskilled Palestinian and foreign workers in Israel are substitutes – 4

Synthesis of the stylized facts – 5

III. Equilibrium model of the Palestinian and Israeli labor markets – 5

IV. Exogenous policy shocks and predicted quantitative effects – 7

Calibrating the model – 8

Results – 9

Sensitivity analysis – 11

V. Significance of the results – 12

Figures

Figure 1: Palestinian Employment by Location – 2

Figure 2: Palestinian Unemployment and Underemployment – 3

Figure 3: Unemployment by Region – 3

Figure 4: Correlation between Palestinian Employment in Israel and Unemployment – 3

Figure 5: Change in Employment in Israel and Unemployment – 3

Figure 6: Average Daily Wage (NIS) – 4

Tables

Table 1: Initial Parameter Values – 8

Table 2: Predicted Results of Labor Policy Changes – 10

Table 3: Sensitivity Analysis – 11

Table 4: Sensitivity Analysis for Large Parameter Changes – 12

References – 15

Annex I – 16

Annex II – 17

Summary

This paper seeks to quantify the labor outcomes arising from changes to labor policy in the context of a potential final status agreement between the Palestinian and Israeli governments. An equilibrium labor model provides the theoretical framework to test different labor policy options for the highly integrated Palestinian and Israeli labor markets. The analysis describes the main factors affecting labor supply and demand decisions in the West Bank and Gaza and Israel – namely, the importance of Israeli labor demand for Palestinian workers, the persistent wage gaps between domestic employment and better-paying Israeli jobs that are available only in limited supply, and the structural unemployment observed in the West Bank and Gaza. These distortions are captured in a model that hinges on the fixed supply of Palestinian labor to Israel due to Israeli immigration policy. The model is solved to characterize the impact of exogenous changes in Palestinian labor flows to Israel as a result of changes in Israeli permit policy, security controls and border closures. The model's results are calibrated using available data to generate quantitative estimates of the long-run impact on employment levels, unemployment, and wages in the Palestinian and Israeli economies. The comparative statics results indicate that an increase in labor flows to Israel raises the domestic Palestinian wage as some workers already employed domestically are drawn to higher-paying Israeli jobs which have become more readily available and at a lower commuting cost. The increase in external Palestinian employment is therefore only partially offset by a decline in Palestinian unemployment, and domestic Palestinian employment is predicted to decline. The resulting wage gap between domestic and Israeli jobs narrows somewhat, but the remaining gap continues to affect labor supply and demand decisions.

* The author gratefully acknowledges the data and assistance provided by the Palestinian Central Bureau of Statistics, and comments from Sébastien Dessus, Peter Fallon, Radwan Shaban, and an anonymous reviewer.

I. Introduction

Palestinian and Israeli policy makers are grappling with an array of policy questions in the context of future final status negotiations to define the terms of a permanent political accord between Israel and an independent Palestinian state. The final political decisions will have direct and indirect economic implications, and labor policies will be central. The Israeli and Palestinian economies are highly integrated, especially the two labor markets; under conditions of relatively open but controlled borders – that is, prior to the 2000/01 crisis – more than 100,000 Palestinian workers, or one-fifth of the total labor force, commute daily to relatively high-paying jobs in Israel. Although Palestinian labor flows to Israel are constrained through permit requirements and border closures, employment in Israel provided one-third of total Palestinian labor earnings in 1999. Labor mobility to Israel affects employment levels (both domestically and in the Israeli unskilled sector), relative wages, and growth outcomes in both economies, implying that the potential impact of final status policies regarding Palestinian labor flows is significant. Any change in policy that affects labor supply and demand, namely through tightening or easing Palestinian labor mobility across borders, will lead to different labor allocations in the Palestinian economy and in Israel, especially vis-à-vis Israel's unskilled foreign labor force. Potential final status economic arrangements – both broadly and with respect to labor policy – will fall somewhere in the range between complete separation (i.e., closed borders) and full economic integration (i.e., open borders).

The objective of this analysis is to quantify the impact of potential final status labor policies on Palestinian employment, unemployment and wage outcomes in the long run. To this end, the analysis develops a theoretical model that characterizes the labor market in the West Bank and Gaza (WBG) and its links to the unskilled labor market in Israel. The analytical framework captures the main factors affecting labor supply and demand decisions in the West Bank and Gaza and Israel – namely, the importance of Israeli labor demand for Palestinian workers, the persistent wage gaps between domestic Palestinian employment and better-paying Israeli jobs that are available only in limited supply, and the structural unemployment observed in the West Bank and Gaza. By calibrating the model using labor force survey data from the Palestinian Central Bureau of Statistics (PCBS) and other available data, the analysis generates concrete estimates of the possible long-term impact of labor policy changes on employment, relative wages, and unemployment.

The paper is organized as follows. Section II presents an overview of the Palestinian labor market and recent trends in employment and worker flows to Israeli jobs. These stylized facts are reflected in the equilibrium labor market model described in section III. In section IV, the model is solved to determine the impact of exogenous policy changes on domestic and Israeli employment and wages, and the predicted effects are calibrated to generate quantitative estimates. The final section draws conclusions from the results of the analysis.

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