Birth date, business cycles, and lifetime income

OMB - Blog Post:

We often hear about people who are unlucky in love, but what of those who are unlucky in the business cycle? What is the impact of being born two decades before a significant economic downturn, such that you graduate from college and enter the labor force in the middle of a period of high unemployment?
As the class of 2009 is keenly aware, entering the labor market during a recession has immediate negative effects. Job offers are harder to find: according to the National Association of Colleges and Employers, less than 20 percent of the class of 2009 graduated from college with a job offer in hand, compared to 25 percent in the class of 2008 and more than 50 percent in the class of 2007. Whereas year to year starting salaries on average tend to increase, with the tough competition in this year’s labor market, average starting offers for the class of 2009 are slightly down.

I recently read a paper that suggests that, for this cohort, the wage effect of graduating during a period of high unemployment will continue well beyond the end of the recession and even the labor market rebound. In examining the cohorts of college graduates that entered the labor market before, during, and after the recession of the early 1980s, Lisa Kahn of the Yale School of Management found that an increase in unemployment produces a significant and enduring negative wage effect.

The chart below illustrates this effect: a one percentage point increase in the national unemployment rate is associated with a 6 to 7 percent loss in initial wages. The annual wage loss declines over time, but is still statistically significant 15 years later. Comparing the wages earned by the class of 1982 (a peak unemployment year) with the wages of the class of 1988 (a peak employment year) over the first 20 years of a career, the wage difference resulted in a difference of nearly $100,000 in cumulative earnings in net present value.

Entering Labor Force During Recession Has Enduring Effect on Wages:
For the 1982 Cohort, $100,000 NPV Loss in First 20 Years of Career

Data from Kahn 2009

The long-term effect isn’t just a residual of low first-year wages: the author suggests that poor job match, lower prestige placements, and fewer opportunities for training and promotion also play a role. Other researchers have found similar effects: Oreopolous et al find persistent wage effects for Canadian college graduates; Bowlus and Liu find persistent wage effects for high school graduates moving directly into the work force, and other studies assess how the macroeconomy affects impact newly minted MBAs and economics PhDs.

The evidence thus suggests that a recession hits young people particularly hard, knocking them off course with effects that last for years to come. As we rebuild a new foundation for economic growth, it’s critical that we keep this in mind.