How much do young people suffer when they graduate during bad economic times?

Daiji Kawaguchi, Ayako Kondo

Economists frequently discuss the ‘scarring effects’ the Great Recession has had on young people in Europe. This column tentatively challenges the received wisdom of permanent scarring. Young graduates mitigate some of the negative welfare effects of graduating during bad times by living with their parents for longer.

The cost of the 2008 Global Crisis has been disproportionally borne by young people in many developed countries. In particular, those graduating from school and looking for jobs have suffered from long-term loss of earnings, according to recent studies on the ‘scarring effect’. Consequently, the fear of intergenerational inequality has emerged as a social concern. However, the loss of earnings does not necessarily imply a welfare loss if it is compensated by inter-generational transfers.

Indeed, whether a cohort-specific labour market shock results in a cohort-specific welfare loss is a controversial issue. In theory, the cohort-specific shock can be partially shared with other cohorts through financial transactions. Miyazaki et al. (2010) argue that cohorts hit by the recession can purchase asset liability from other cohorts at lower prices. Glover et al. (2011) further argue that the fall of asset prices could benefit the youth. In contrast, Hur (2014) shows that, once a realistic liquidity constraint is imposed, the youth cannot purchase an asset liability to reap higher returns. Therefore, whether the financial market absorbs the cohort-specific labour market shock is an empirical question.

Scarring effects in the labour market

Recent studies reveal that the cohort graduating from school in a bad economy persistently suffers for a long time in terms of employment status and earnings because of the loss of training opportunities or difficulty in changing jobs hampered by information asymmetry in the labour market. In the US, for example, Kahn (2010) established that graduating from college during a recession has a persistent negative effect on earnings. This ‘scarring effect’ is observed in many other countries such as Canada (Oreopoulos etaal. 2012), Japan (Genda et al. 2010), Austria (Brunner and Kuhn 2014), and Norway (Raaum and Røed 2006). The size and persistence of the effect substantially varies across countries, and tends to be stronger in in economies with more rigid labour market institutions (Kawaguchi and Murao 2014).

Also, the persistence of the negative effect of a recession at entry varies across gender and educational backgrounds. While those who suffer more from entering the labour market in a recession depends on the institutional settings, in the US, the negative effect of a recession at entry on earnings is more persistent for male college graduates than for women or high school graduates (Hershbein 2012, Kondo 2015, Genda et al. 2010, Speer 2015). This is mainly because they are more likely to be in stable employment than other groups – the advantage of obtaining a high-wage job at entry is lost when the worker is dismissed or quits due to exogenous reasons such as marriage and childbirth. Hence, the empirical exercise below focuses on white male college graduates.

Consumption loss due to the scarring effect?

Our recent study (Kawaguchi and Kondo 2015) first reconfirms the scarring effect in labour market outcomes using the recent Current Population Surveys (1996-2013) – white male college graduates entering the labour market in a bad year earn less and are more likely to live with their parents for up to 12 years post-graduation. Graduating from college when the state unemployment rate is one percentage point higher decreases real annual earnings by 3.4% during the first three years after graduation. This negative effect fades away gradually and becomes statistically insignificant 12 years after graduation. The cohort hit by the negative shock absorbs this negative income shock by cohabiting with parents after graduation. A one-percentage-point higher state unemployment rate increases the probability of cohabitation with parents by 0.7 percentage points after one to three years, and 0.8 percentage points after four to six years. This cohabitation, presumably accompanied by in-kind transfers from parents to children, seems to mitigate the adverse impact of labour market shocks on consumption.

Scrutiny of the Consumer Expenditure Survey reveals that a household whose head is hit by a higher state unemployment rate at college graduation does not reduce the equivalent scale expenditure adjusted for household size. This conclusion does not change even if we use other living standard measures, such as food expenditure share or home ownership, as outcome variables. Furthermore, we examined if graduating from college in a bad year reduces financial asset holdings to find any effects.

The results overall suggest that graduating from college in a bad year hurts youth in terms of earnings for a decade, but the adverse impact on earnings does not translate into consumption loss because of informal risk sharing with parents through co-residence. A bad start due to adverse labour market conditions indeed leaves scars on youths’ faces, but the scars do not cut as deep as we might think.

Total welfare impact?

It is tempting to make a welfare statement about the scarring effects from the findings from consumption data, but we need to be a bit cautious here. To make a welfare statement, in fact, we need to know more. To name a two areas, we need to quantify the youths’ disutility arising from living with parents if there is any and, second, we need to quantify the utility from not working. Further research needs to be done on the full details of the scarring effect before we can make any major welfare claims.

Editor's Note: The main research on which this column is based (Kawaguchi and Kondo 2015) first appeared as a Discussion Paper of the Research Institute of Economy, Trade and Industry (RIETI) of Japan.

References

Brunner, B and A Kuhn (2014), “The Impact of Labor Market Entry Conditions on Initial Job Assignment and Wages,” Journal of Population Economics 27(3): 705-738.

Genda, Y, A Kondo, and S Ohta (2010), “Long-term Effects of a Recession at Labor Market Entry in Japan and the United States”, Journal of Human Resources 45(1): 157 -196.

Glover, A, J Heathcote, D Krueger and J-V Ros-Rull (2011), “Intergenerational Re- distribution in the Great Recession”, NBER Working Papers 16924, National Bureau of Economic Research, Inc.

Hershbein, B J (2012), “Graduating High school in a Recession: Work, Education, and Home Production”, the B E Journal of Economic Analysis & Policy 12(1): 1-32.

Hur, S (2014). “The Lost Generation of the Great Recession”, technical report, University of Pittsburgh.

Kahn, L B (2010), “The Long-term Labor Market Consequences of Graduating from College in a Bad Economy”, Labour Economics 17(2): 303-316.

Kawaguchi, D and T Murao (2014), “Labor Market Institutions and Long Term Effects of Youth Unemployment”, Journal of Money, Credit and Banking 46(S2): 95-116.

Kondo, A (2015), “Differential Effects of Graduating during Recessions across Gender and Race”, IZA Journal of Labor Economics 4: 23.

Miyazaki, K, M Saito, and T Yamada (2010), “On The Intergenerational Sharing Of Cohort-Specific Shocks On Permanent Income”, Macroeconomic Dynamics 14(01): 93-118.

Oreopoulos, P, T von Wachter, and A Heisz (2012), “The Short-and Long-term Career Effects of Graduating in a Recession”, American Economic Journal: Applied Economics 4(1): 1-29.

Raaum, O and K Røed (2006)., “Do Business Cycle Conditions at the Time of Labor Market Entry Affect Future Employment Prospects?”, The Review of Economics and Statistics 88(2): 193-210.

Speer, J D (2015), “Wages, Hours, and the School-to-Work Transition: The Consequences of Leaving School in a Recession for Less-Educated Men”, forthcoming in The B E Journal of Economic Analysis and Policy.