CHAPTER 1
ISRAELI-PALESTINIAN
LABOR MARKET ALTERNATIVES:
SHORT TERM AND LONG TERM ASPECTS
Raphael Bar El and Eli Sagi
Ben Gurion University of the Negev, Israel
INTRODUCTION
This paper attempts to provide a framework for the discussion of the
warranted nature of the flow of labor between Israel and Palestine. Given the
disparity between the two economies and the history of their labor relation, the
direction of the labor flow that needs to be discussed here is practically one way –
from Palestine to Israel. The questions that should be addressed thus are: to what
extent, if at all, Palestinian labor in Israel should be regulated, what should the
criteria for such regulation be, and what are the subsequent policy1 measures.
An optimal policy is one that will best promote economic well-being and
economic development of both parties subject to the maintaining their security and
sovereignty at levels, which are acceptable for them. Such policy should balance
the "pros" and "cons" along two axes. The first one is that of the parties' interests.
The policy should recognize and account for the obvious differences between the
interests of Palestine and Israel. The second one is that of the time axis, i.e., short
run vis-à-vis long run2. The policy should balance the conflicts between aspects of
1 A "policy" for that matter is a set ends and means that are agreed upon by both parties and imple-
mented by them respectively.
2 "Long Run" is defined as the period of political and economic "steady state", i.e., after the
conclusion of a peace agreement and the reestablishment of mutual trust. "Short Run" is the time after
the end of the current violent confrontation, during which the political process is taking place.
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Labor Market and Cooperation
short run and long run. Finally, labor market analysis is just one several dimensions
of the future ties between the two economies, and consequently, labor market
policy should be a part of a coherent policy scheme. The following is a brief
account of the pros and cons of the two sides for the short run and for the long run
respectively.
1. SHORT RUN ANALYSIS
1.1. Working assumptions and preliminary analysis
The analysis of the labor market in the short run is based on the following
basic assumptions:

The need for new jobs for Palestinians in the coming years will be huge due to:
o
The loss of jobs in Israel and the prevailing extremely high level of
unemployment;
o
The collapse of the domestic economic activity since the outbreak of
the current violent confrontation;
o
The demographic nature of the Palestinian population that results in
very high rate of growth of the labor force.
 Based on the differences between the two economies and their proximity, the
Israeli labor market provides the most convenient and fast source for job creation
and income increase to Palestinian labor, as is proven by the experience of the past
35 years;
 On the other hand, this source is instable, exposing the Palestinian labor to
fluctuations stemming from Israeli business cycles, security situation instable
political process;
 Since the mid-1990s the Palestinian labor in Israel has been gradually replaced
by "foreign workers", which, for the Israeli employer are much cheaper than
Palestinians;
 A full integration of the two labor markets with free mobility of Palestinians
workers into Israel is no longer feasible. A certain degree of dissection between the
two economies, especially with regards to labor markets is a reality that will not
change even after the current violence ends. Once being exposed to suicide
explosions within Israel during the current Intifada, Israelis have attributed a very
high "risk premium" to engaging in any economic activity with Palestinians, and
particularly to employing them. This is not going to be changed for at least the
period of the short run, as defined here, and (any) Israeli government is not likely
to allow free, unregulated, mobility of Palestinians into its territory.
Israeli Palestinian Labor Market Alternatives
21
Compared to the pre Intifada period, these assumptions imply higher nonpecuniary costs involving Palestinian employment in Israel for both worker and
employer. Also, the competition with other foreign workers will force the wages
for Palestinian labor down. Thus, even with no intervention, with no formal
barriers imposed on labor movements, one should expect the new market
equilibrium to be at lower price (for the Palestinian worker) and smaller quantities
(in terms of share of Palestinian labor force) than in the pre Intifada period.
2. ARGUMENTS IN FAVOR OF FREE LABOR MOBILITY
2.1. Palestinian perspective
From Palestinian point of view there are two main arguments to support free
access to Israeli labor market:
2.1.1. Fast absorption of Palestinian labor force
It is impossible to expect the domestic economy to be able to accommodate
the acute need for jobs, which will face the Palestinian economy upon the resumption of some normal activity, especially at the prevailing extremely high levels of
unemployment. The experience of the 1990s shows that under the Palestinian
authority there was, indeed, an increase in domestic employment. This, however,
was mostly in the public services, and was mainly a once and for all step increase
rather that an over-time rise in the rate of domestic job creation, or a process of
dynamic endogenous growth. The continued fairly free access to the Israeli labor
market may be blamed on the one hand, and the deteriorating security situation on
the other may indeed be blamed, but only to a certain extent. It is unlikely that the
domestic market would have been able to absorb the local entire labor supply. At
present, the Palestinian unemployment rate is much higher than that of the mid
1990s, and will definitely grow worse before the "short run" commences.
However, there is a major source for labor demand within the Palestinian
territories once the current violent hostilities end and the peace process resumes.
At this time, the Palestinian economy will embark on an enormous task of
reconstruction of the devastated physical infrastructure and some of the private
properties. The finances for these projects will probably come form massive
foreign aid that will be bestowed on the Palestinian authority, with substantial
additional amounts that will probably be pledged far beyond the existing balance of
already committed by donor countries. Nevertheless, the effect of this factor on
employment is a matter for quantitive analysis, which is beyond the scope of this
paper. It seems reasonable to expect, though, that it will fall far short from ensuring
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Labor Market and Cooperation
full employment, and also, that this is only a short run factor that may create a
problem in the long run. It seems, therefore, that a wide-open access to the Israeli
labor market is essential for alleviating the unemployment problem at least in the
short run.
2.1.2. Domestic derived demand
A relatively rapid increase in employment and incomes via the Israeli labor
market will increase local aggregate demand and thus in economic activity that will
be magnified through the Keynesian multiplier effect. Moreover, this derived
demand for domestic goods and services will be exhibited mainly in consumption
goods and construction. These sectors, which have been devastated during the
current Intifada, can easily and rapidly recover, as they do not need many adjustments in terms of new investments or labor training. Also, these are sectors which
will remain at the core of the domestic economy even in the long run, and
therefore, the contribution of their quick recovery is not just transitory. This
argument holds as well for the effects of the domestic reconstruction projects that
were mentioned above.
2.2. Israeli perspective
From Israeli perspective, the arguments in favor of allowing a fairly free
access of Palestinians to its labor market are three-fold:
2.2.1. Reinforcing the political process
To the extent that the reopening of its labor markets to Palestinian workers is
instrumental in alleviating the harsh Palestinian economic reality in the short run, it
is in the interest of Israel to allow it. To the extent that indeed this period will prove
free of security problems, then this attitude will also serve as confidence building
mechanism and support the political process.
2.2.2. Reducing foreign labor negative externalities
The employment of foreign (mostly unskilled) labor in developed countries
has become a growing burden for them as it involves negative externalities
reflected in many dimensions such as economic, socioeconomic, socio-ethnic,
language, cultural, moral and other. From an Israeli point of view a Palestinian
worker substantially differs from a foreign worker from another origin in two
ways. First, by being a commuter worker who returns to his home and family on a
daily basis, resorting to his government and public sector for education, health and
physical infrastructure etc. Second, the cultural and language differences are
Israeli Palestinian Labor Market Alternatives
23
smaller, allowing much more convenient and fluent communication, and thus also
higher productivity. Therefore, it is in the interest of Israel to prefer Palestinians to
other foreign workers even at higher monetary costs.
2.2.3. Labor market stabilizer
Free mobility of Palestinian to Israeli labor market can serve as stabilizer for
economic fluctuations and cycles in the Israeli economy. The ups and downs of
economic activity usually impose special problems on labor markets. The turnover
costs from the business sectors perspective (firing and rehiring) of Israelis are
rather high, especially in light of labor laws, and thus may result in periods of
disguised unemployment during slowdowns and retrained expansion of manpower
during high periods. From the workers point of view job security is highly
appreciated too. On the macro level, from the budget point of view, increased
unemployment implies higher transfers. Foreign workers often serve as a buffer, a
shock absorber, for the country's own labor force. While this argument may apply
to both Palestinians and foreign workers from other origins, the later are less
effective in this respect, as their costs of moving in and (especially) out of the
country are much higher than those of the commuting Palestinian, and thus the
negative externalities that were mentioned above are even more troubling as they
get unemployed. One should bear in mind, though, that this argument is completely
conflicting with the Palestinian interest (see below) and also, to an extent, with the
first argument above (regarding the reinforcement of the political process).
2.2.4. Filling gaps in Israeli labor market structure
The Israeli economic structure is developing in directions that leave a few
sectors with significant labor force shortages. Those are mainly the sectors of
agriculture, construction and welfare services, in which there is a permanent
shortage of workers and which steadily require foreign labor force. The ability to
employ Palestinian labor force in those jobs therefore contributes to the Israeli
economic growth by solving important bottlenecks.
3. ARGUMENTS AGAINST FREE LABOR MOBILITY
3.1. Palestinian perspective
The counter arguments from Palestinian point of view are both economic
and political in nature.
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Labor Market and Cooperation
3.1.1. Employment instability
The main economic argument for constraining Palestinian labor flow to
Israelis that of the instability factor that was mentioned above. Political tensions,
security problems that are likely to accompany the peace process and business
cycles in Israel that might occur during that period will hold Palestinian labor
"hostage", and will result in fluctuations in employment. This increases the
economic uncertainty faced by the Palestinian business sector and will add a
discouraging factor for potential investors, in particular – foreign ones.
3.1.2. Employment conditions
The return of Palestinian workers into the Israeli labor market will occur
under different conditions than in the past, because of the presence of foreign
workers. Competition with those foreign workers may lower wages and reduce the
supply of jobs.
3.1.3. Dutch disease
The availability of convenient job opportunities in Israel and their implied
wage rates has detrimental effect on the Palestinian economy by creating a version
of the Dutch Disease. In particular, it prevents the efficient utilization of human
capital as educated Palestinians finds unskilled jobs in Israel that pays better than
skilled jobs in the domestic economy. Thus, while the medicine of free access to
the Israeli labor market offers an effective quick relief to the pains of unemployment they may have a negative long-term dynamic effect (see below).
One should bear in mind, though, that the expected foreign aid to Palestine
might also pose a Dutch Disease dilemma, of the more "standard" nature. Given
the expected order of magnitude of the foreign aid this may be much more acute
than the version posed by openness of the Israeli labor market.
3.1.4. Workers social rights
Should the social rights of Palestinians working in Israel (social security,
unemployment compensation, layoff compensations retirement allowances etc.) be
equal to those of an Israeli worker or of a fellow Palestinian working in the
domestic economy? Who collects the deductions and whose responsibility is it to
secure and provide those rights? Obviously, all these require political coordination
between Israel and Palestine and might be subject to political and security ups and
downs. Preserving labor rights of those employed in Israel presents a problem, and
requires political coordination between Israel and Palestine.
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3.1.5. Political sovereignty
Palestinians may regard the free movement of workers to Israel as compromising some of their sovereignty.
3.2. Israeli perspective
From Israeli point of view the arguments against free Palestinian labor
movement to Israel in the short run are mostly security oriented, political and social
rather than economic ones.
3.2.1. Security
While the short run is defined here as the period after the end of the current
violent confrontation and the resumption of the peace process, the memories of the
harsh experience and deep mistrust of that period for both sides will not disappear
immediately. For Israelis, it may take a certain period of different experience to be
convinced that employing Palestinians no longer pose a security threat within
Israel. Thus, this argument may lead Israel to open up the labor market only
partially and let it develop gradually.
3.2.2. Employment instability
The adverse effect of employment instability affects not only the Palestinian
employee but his Israeli employer as well. During the short run period security
incidents or set backs in the political process may still occur that will result in
measures that will temporarily prevent Palestinian workers to arrive to their
working place. The uncertainties that arise from this possibility implies "risk
premium" that the Israeli employer will associate to Palestinian labor.
3.2.3. Social aspects
The case against foreign workers has been cited above as an argument in
favor of opening up the labor market for Palestinians. That argument suggested that
from the Israeli perspective, the negative externalities associated with a Palestinian
worker are lower than those of another foreign worker. Nevertheless, while these
side effects are belittled, they still exist and have a socio-political impact. In
particular, since foreign workers compete with the local unskilled labor, their
employment aggravates problems of unemployment, wage levels and inequality.
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4. LONG RUN ANALYSIS
4.1. Working assumptions and preliminary analysis
The long run labor market analysis is based on the following assumptions:
4.1.1. Labor supply
Labor supply will continue to rise at very high rates. The common wisdom
suggests that economic development will reduce the extremely high rate of
population growth, which characterizes Palestinians. Nevertheless, this is a very
long-term process and will take many years before being reflected in the labor
supply. On the other hand, economic progress may lead to increase in the propensity to participate in the labor force, inter alia, among females. Thus, one should
expect rapid expansion of the labor force for yet many years to come. The creation
of sufficient number of new jobs will therefore remain an acute problem.
4.1.2. Short run vs. long run domestic labor demand
In the short run several mechanisms of job creation will be at work: the task
of reconstruction of properties damaged during the violent confrontation (business,
private and public); reorganization of public services which will result in a larger
share of the public sector in the labor force. The first two are of temporary nature,
and the third one is a once and for all increase. Once the reconstruction and infrastructure projects will end, they will discharge the labor they employ and alternative employment sources will be needed. While these projects will effectively
serve labor market short run the purpose, they embody an inherent long-term
problem.
4.1.3. Human capital
Recent economic growth theory emphasizes the role of human capital in
promoting long-term sustainable growth, especially for an economy aiming
towards becoming a developed one. For such a process to succeed the economy
must invest in human capital, increase the supply of skilled labor and ensure their
proper employment opportunities.
4.1.4. Permanent status economic agreement
While the disparities between Israel and Palestine are a fact of life, it is
assumed that economic accord that will prevail in the long run will be acceptable to
Palestinians. This means, in particular, that the safeguards offered by this agree-
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ment will sufficiently secure the Palestinians from the adverse implications of
unilateral steps taken by Israel.
5. ARGUMENTS FOR FREE LABOR MOBILITY
5.1. Palestinian perspective
5.1.1. Absorbing excess supply
Rapid growth of Palestinian labor supply is not just a matter of the short run
imposing a continuous challenge for the domestic labor market. In particular, a
decline of domestic demand for labor is expected, as mentioned, when short-term
projects will be completed. An easy access to the Israeli labor market may prove an
essential means in supporting the domestic economy in meeting this challenge.
5.1.2. Domestic economic productivity
The Israeli labor market can contribute to the increase in the domestic total
factor productivity. To the extent that qualified Palestinians will be employed in
the more advanced Israeli industries (rather than the traditional sectors) it will serve
the purpose of upgrading the domestic human capital and promoting technology
transfer between from Israel to Palestine. The past experience has shown the
contrary, as Palestinians did not take part in these industries. For that argument to
hold, therefore, fundamental change in the approach to Palestinian employment in
Israel should be adopted, accompanied by appropriate policy means.
5.2. Israeli perspective
The arguments in favor of opening the Israeli labor market for Palestinians
presented in the case of the short run hold, as well, for the long run. These include:
Reinforcing the peace process, reducing foreign labor negative externalities, and
labor market stabilizers. There is one additional factor that might be added in the
long run contest, though.
5.2.1. Labor supply diversification
Under long run steady state relations between the two economies, opened
labor markets can also enhance the diversity of labor supply for the Israeli
economy – both in terms of skills and professions. This allows a more efficient
utilization of the resources and thus higher productivity.
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6. ARGUMENTS AGAINST FREE LABOR MOBILITY
6.1. Palestinian perspective
The long-term arguments, in this case as well, are mostly the same as the
short run, with some difference in emphasis.
6.1.1. Dutch Disease
If the Israeli labor market will continue to attract Palestinian workers in the
long run then the Dutch Disease will have a permanent adverse effect on the sectorial and industrial composition of the domestic economy. As mentioned, the largescale unilateral international transfers to Palestine in the short-term will also
instigate this same "disease". However, the flow of foreign aid will not be permanent, and will definitely subside in the long run. Hence, the Israeli labor market
may remain the major cause for that phenomenon in the long run, if it stays
completely open.
6.1.2. External shocks
This kind of labor market regime will keep the domestic economy widely
exposed to external shocks i.e., fluctuations in the Israeli economy. This will be
reflected not only in the sphere of unemployment, but in the domestic activity as
well because of the multiplier (derived domestic demand) effect. It is very likely
that in the long run Israel will remain a major (probably THE major) trading
partner for the Palestinian economy. Thus, the Palestinian exports and thus –
domestic activity in general, are also exposed to the same source of uncertainty, a
factor which amplifies the direct labor market effect. To some extent, this can be
interpreted as an impairment of the economic sovereignty of Palestine, when
economic policy decision making is strongly influenced by Israeli events.
6.1.3. Technology transfer
This was cited above a strong "pro" argument from Palestinian point of
view. To the extent that 'Palestinians will integrate in the more advanced Israeli
industries it will facilitate the transfer of technology to the domestic economy.
Nevertheless, there is a need for an additional mechanism for that to happen
effectively. If these employees will keep working in the Israeli firms it is not clear
how the transfer will occur, unless additional mechanism is created. On the
contrary, it may have a negative effect on the domestic total factor productivity, as
Palestinians may loose their most qualified manpower (a certain type of braindrain).
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6.1.4. Human Capital
The openness of the labor markets may adversely affect the Palestinian
human capital in yet another way: Past experience shows that skilled Palestinians
could earn more taking an unskilled job in Israel than a skilled job in the domestic
economy. To the extent that this wage gap will still exist in the long-term, it will
prevent the efficient utilization of the domestic human capital. Moreover, this
means that the rate of return on investing in human capital will remain rather low.
The result will be a too slow increase in Palestinian human capital, which will
harm the prospects for long-term sustainable economic growth.
6.1.5. "Queuing" effect
The wage gap may create a "Queuing effect" phenomenon, i.e., Palestinians
preferring unemployment, waiting for employment opportunities in Israel. This
implies a reduced level of utilization of Palestinian labor force.
6.2. Israeli perspective
From an Israeli point of view there are a few arguments against allowing free
Palestinian access to its labor market.
6.2.1. Distorting production functions
The availability of rather cheap unskilled labor may slow down the process
of increasing the economy's capital intensity and adoption of new technologies.
6.2.2. Socio-political negative externalities
The socio-political negative externalities associated with foreign workers
still hold, even though, as mentioned, they are lower with regards to Palestinian
compared to other foreigners, and even those might be less bothering in the long
run, after a permanent political solution has been achieved.
7. PRELIMINARY POLICY CONCLUSIONS
7.1. Short term: Regulation of labor mobility
The policy should aim at achieving an optimal combination of fighting
unemployment and increasing local demand, with a minimum of instability and
social tensions, while laying the grounds for long term sustainable growth of
economic activity with full employment. Generally, the above analysis implies that
the flow of labor should be regulated to some extent rather than let to the deter-
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mined by a completely free market mechanism. Two alternative approaches of
policy measures can be considered, one oriented towards regulation of quantities of
labor force, and the other oriented towards regulation through price systems.
The first approach would be a direct limitation of the numbers of
Palestinians working in Israel by quantitative measures (quotas). Such a rigid
measure may encounter various difficulties in the process of implementation, and
may not be sensitive enough to changing conditions. We prefer the second
approach, regulation through prices, which can be implanted through the following
measures:

The number of workers can be limited by price rather than quantity
mechanism, i.e., by imposing a Palestinian tax on working permits for
Palestinians. Such a tax would reduce the supply of Palestinian workers to the
Israeli labor force, and at the same time would enable the distribution of
benefits from work in Israel to the Palestinian economy as a whole and not just
to the few selected workers. The diminution of the gap between wages levels
received by Palestinians in Israel and wage levels in Palestine that would result
from such a measure can also be effective in preventing the "queuing" effect;

Israel should consider imposing Israeli labor laws on Palestinian labor force,
such as social security (assuring social benefits, unemployment payments,
etc…) and retirement funds, equal to the prevailing Israeli rates, so as to avoid
employment distortions stemming from unequal taxation. This would on one
hand assure better social conditions to the Palestinian workers, and on the other
hand it would reduce the Israeli demand for Palestinian workers as a conesquence of the higher costs;

Reducing the number of foreign workers (non-Palestinians) in Israel. This
again can take either the form of quota or indirect taxation;

The above analysis implies that long-term growth may be secured to a large
extent by accumulation of human capital and skilled labor. Preparatory
measures should be taken by investing in the education system. In particular, it
is suggested that some of the foreign assistance should be allocated to enhancing and improving the higher education institution, mainly by training faculty
for technical and business faculties.
7.2. Long term: Prevention of economic distortions
Free market (free movement of labor) may lead to a long run equilibrium
with high levels of employment of Palestinians in Israel, decreasing unemploy-
Israeli Palestinian Labor Market Alternatives
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ment, increasing Palestinian GNP and stimulating local demand. However, this
equilibrium may also be subject to a market failure, leading to a high dependence
of the Palestinian economy (relatively low GDP), inefficiency of investments in
human capital (since the benefits of public Palestinian investments in education
would be wasted in occupation in lower skills but higher wages in Israel), and
consequently low endogenous economic growth. The following policy measures
should therefore be considered, for the achievement of an optimal equilibrium
between the benefits of labor mobility and the stimulation of endogenous growth:

Balancing labor mobility with capital mobility: development of joint border
industrial park, investments in Palestinian Territories, sub-contracting agreements;

Macro economic reforms in the Palestinian Territories in order to improve the
business environment in Palestine and thus facilitate economic growth;

Labor market rules and taxation in both Israel and Palestine should attempt to
be coordinated to the extent possible. A narrower gap between the systems will
serve as an incentive for efficient allocation of (mainly Palestinian) labor
between the two economies;

To the extent that wage rates will still differ between the two economies the
danger of wasting human capital remains. Low skill wages in Israel may be
higher than high-skill in Palestine. Thus, subsidization of skilled employment
in Palestine may be called for;

Employment of skilled labor in Israel should be encouraged to a certain degree
in Israeli advanced industries, for the sake of improving the human capital and
acquiring of specific expertise and accumulating experience. Given the
proximity of the two economies this should not be considered as brain drain,
but rather – can facilitate technology transfer;

Incentives should be created for joint ventures between Israeli and Palestinian
firms in the advanced sectors, as well as subcontracting in these industries.
This is another useful means of technology transfer and securing demand for
local skilled labor. A good example for such joint ventures can be the supply of
software services in Arab markets, which needs high quality services of
translation, adjustment, on location training, troubleshooting and upgrading,
most of which should be carried out at the customer's court.