LABOR DEMAND AND THE WAGE GAP IN THE WEST BANK AND GAZA STRIP

EDWARD A. SAYRE [*] The returns to schooling for Palestinian men in the West Bank and Gaza Strip declined sharply from 1981 to 1987 but recovered slightly from 1987 to 1991. This article examines the degree to which these returns were associated with the demand for Palestinian labor. Contrary to previous research, the current study finds that labor demand and not just the increased schooling of Palestinians determined the returns to schooling. Specifically increased demand for unskilled Palestinian labor in Israel and decreased demand for Palestinian workers in other Arab states combined to explain one-fifth to one-quarter of the decline in the wage gap from 1981 to 1987. (JEL F16, J31, O15) I. INTRODUCTION While the recent increase in wage inequality in the United States and elsewhere has been the subject of extensive research (see, e.g., Juhn, et al. [1993], Feenstra and Hanson [1996], and Berman, et al. [1994]), the widening of the wage gap was not ubiquitous. In the face of this seemingly global phenomenon, the returns to schooling declined in the 1980s in the West Bank and Gaza Strip (WBGS). Three changes in the demand for Palestinian labor may help explain why the wage gap closed. First, most of the evidence on the increase in inequality comes from industrialized or newly industrialized countries undergoing trade liberalization. Though Palestinian trade expanded, the territories are much less developed and have little capital. Because of the difference in capital and labor endowments, rewards to factors of production in the WBGS are likely to respond differently to increased trade. While trade increases the demand for skilled labor in developed countries, trade expansion may shift labor demand toward unski lled workers in the WBGS, leading to wage compression. Second, the fall in oil prices led oil-rich countries of the Persian/Arab Gulf to cut back the hiring of Palestinian workers. Because these workers were relatively well educated and skilled, the decrease in external demand for educated Palestinians could push the returns to schooling downward. Third, more Palestinians began working inside pre-1967 Israel during this time. These jobs are predominantly low skilled, so an increase in the demand for Palestinian labor in Israel raises the wages of unskilled and less-educated workers relative to more-educated workers. In addition to fluctuations in the demand for Palestinian labor, increases in the supply of skilled workers also contributed to the declining education premium. Earlier work (Angrist, 1995) showed that increased access to higher education led to a sharp rise in the average years of schooling of Palestinians. Documenting the decline in the returns to schooling from 1981 to 1991, Angrist (1995) attributes this finding solely to changes in the supply of educated workers. [1] Attributing all of the change in the returns to schooling to increased education levels of Palestinian youth results in a counterintuitive policy recommendation. Angrist also cites sources indicating that the unemployed/underemployed educated Palestinians were the vanguard of the Palestinian uprising of 1987-1992 (Intifada). Thus, Palestinians suffered this political upheaval (and the economic misery associated with it) because of overinvestment in human capital. As numerous studies (see Krueger and Lindahi [2000]) emphasize the importance of investment in human capital for economic development, Angrist's implication is potentially contentious. There are reasons to look beyond labor supply. Evidence from 1995 and 1996 (Shaban and al-Qudsi, 1996) shows that the returns to education have risen once again, despite an acceleration in the supply of educated workers. Even Angrist's (1995) evidence shows that the premium for education began to rise as early as 1990 and 1991. Because education levels increased throughout this period, the evidence implies that labor demand factors (including trade and the demand for Palestinian workers in the Gulf and in Israel) may have had a role in shrinking the wage gap. …