Do youths graduating in a recession incur permanent losses?

Large, but short-lived effects for low-educated workers

In North American labor markets (Canada and the US), employment is largely at will (an employee can be dismissed for any reason and without warning), and minimum wages are low. This holds in particular for the market in low-skilled jobs involving simple routine tasks that can be executed without much prior training. Such skills do not erode during periods of inactivity. Thus, low-educated youth entering such a labor market in a downturn are expected to experience only temporary penalties in wages and earnings. However, because they are at the bottom of the qualification ladder, they cannot shield themselves against negative shocks by moving to a lower-skilled job (downgrading). In addition, because they are more financially constrained, low-educated youth are less mobile geographically than higher educated or older workers. This makes the short-term impact of a recession more severe for low- than for high-educated youth.

The findings for the US are largely in line with these theoretical predictions. Adverse conditions at labor market entry for low-educated youth with 12 years of schooling or less have immediate and important negative effects on wages and earnings. These fade after about two years [2], [3]. In the case of a severe recession (defined as a four percentage point rise in the unemployment rate), the year-one average wage falls by 16%, hours worked decline by 28%, and earnings fall by 45%. These effects are largely gone after the first year, however [3]. Similar effects are found for other disadvantaged groups, such as black people and women [4].

Smaller, but more persistent effects for college graduates

College graduates are better prepared than low-educated youth to protect themselves against business cycle shocks. For instance, they can shift to lower-quality jobs rather than become unemployed or can move to a region where the labor market is less negatively affected. The initial penalty of graduating in a downturn is therefore expected to be less important than for less-educated groups. However, theory predicts greater persistence of the adverse effects.

College graduates typically enter high-quality jobs in companies that invest in human resources training and offer long-term incentive contracts. In a recession, these high-quality career jobs are in reduced supply. Thus, college students graduating during a bust phase in the business cycle end up working in lower-quality jobs paying lower wages and offering fewer opportunities for promotion and training than students graduating during a boom phase. When labor demand recovers, these college-educated youths will have forgone valuable human capital accumulation and will have invested instead in task-specific competencies that have little value in higher-quality jobs, putting them behind their luckier cohorts who graduated during a boom [5], [6].

Young workers can respond to this setback by enhancing their investments in human capital and intensifying their search for higher paying jobs. However, this takes time and, therefore, introduces some persistence in the penalty induced by the recession. Moreover, the lag in career progression reinforces this persistence and slows the catch-up process. The inability of wages to adjust to lower demand in a recession, which is implicit in the contracts for high-quality career jobs, along with asymmetric information, shield the internal labor market from external competitive forces. These factors protect the lucky cohorts that graduated during a boom, while making it harder for the unlucky ones to reduce their initial disadvantage. Job tenure and the greater effort needed to search for jobs as people get older may even induce workers to stop searching for better paying jobs [5], [6].

Empirical findings are again largely consistent with the theoretical predictions. Studies for Canada and the US show that graduating from college during a recession imposes a modest but long-lasting penalty on earnings that fades out over about ten years [2], [6], [7]. These earnings losses are due largely to a combination of lower wages and fewer hours of work. The penalty on hours worked, however, generally does not last beyond the first three years after graduation. The employment rate is affected only modestly [5]. These findings imply that high-educated cohorts that graduate during a recession escape unemployment by entering lower-quality (part-time) jobs. The evidence also shows that the penalty differs by field of study, with high-paying majors being less affected by initial conditions than lower-paying ones, although their relative advantage was cut in half during the Great Recession [5]. The early impacts on earnings were much larger during the Great Recession than during previous recessions [7].

Figure 1 shows the persistence of the effect on earnings of a one percentage point rise in unemployment in Canada for high-educated young job seekers, both college graduates and those with some college education. Since a typical recession in Canada involves a five percentage point rise in the unemployment rate, the initial loss in earnings is about 9%. For both groups of young workers, the loss halves within five years and finally fades to zero or close to zero only after ten years. Over these ten years, cumulative earnings losses are about 5% [6]. Since employment is barely affected, and since the penalty on hours worked lasts, as mentioned, not more than three years after graduation, these earnings losses for high-educated workers must be induced by a drop in the wage rate.

In the US, the effects are very similar for a four percentage point rise in the unemployment rate. The initial loss in earnings is about 10%, compared with 9% in Canada, falling slightly more rapidly to about 4% after three years and then also gradually approaching zero after ten years for college graduates. The effect on employment is slightly greater than in Canada. In the first year after graduation, workers are about five percentage points less likely to work full-time, but this effect does not persist past the first three years after graduation. Wages are about four percentage points lower in the first year after graduation and this penalty persists longer than the penalty on hours worked [7]. These initial effects are about five times smaller than those for low-educated youth, but they persist longer.

Graduating in a recession in a very rigid labor market—The case of Belgium

Belgium is among the most rigid labor markets in the OECD based on the composite index of strict employment protection laws, measures of labor union power, and generosity of unemployment benefits, and measured on the basis of flows in and out of unemployment [1], [5]. Protection varies, however, according to educational attainment. High-educated white-collar workers are strongly protected against dismissal. But, until recently, blue-collar workers have had little employment protection. Blue-collar workers are tied to the firm through a very lenient short-time (reduced time or job sharing) work compensation system: employer contributions are not experience rated, so employers are not penalized for temporarily reducing work hours, while workers may receive a replacement income during unemployment of close to 100%. Thus, there are strong incentives for both parties to preserve the match. Moreover, the hiring of low-educated youth is impeded by (sectoral) minimum wages, which are among the highest among OECD countries. High unemployment benefits of unlimited duration for low-educated workers reduce incentives to find and accept jobs [5].

In this institutional setting, particularly the binding minimum wage, a recession at labor market entry imposes only a negligible penalty on the hourly wage of low-educated workers up to 12 years later. By contrast, the number of hours worked is strongly reduced in the first years after graduation and remains significantly lower than for these entrants during an economic upturn as long as 12 years later. This is consistent with well-established evidence that experiencing unemployment early in a career imposes long-term penalties. Generous unemployment benefits and the lenient short-term compensation scheme reinforce this process and thus the persistence of the penalty. The generosity of unemployment benefits creates strong incentives to remain unemployed. And when labor market conditions improve, the short-term compensation scheme prevents the unemployed from replacing employees whose work time was temporarily reduced during a downturn because those workers remain tied to the firm [5].

A typical recession in Flanders, a region in northern Belgium, increases the unemployment rate by 1.4 percentage points. It was found that a one percentage point increase of the unemployment rate at graduation persistently reduces the working time and earnings of low-educated youth by about 3.2% throughout the first 12 years after graduation, while the hourly wage is hardly affected. Hence, in the case of a typical recession the aforementioned penalty amounts to 4.5% (3.2% multiplied by 1.4) [5]. This contrasts with the outcome in North American labor markets, where the initial penalty is ten times higher but fades away after just a few years.

The persistence mechanism is much different for high-educated youth. As this group has a higher earning capacity, their hourly wage is not protected by the minimum wage floor. Therefore, if labor market entry conditions are bad, these youths have to choose between accepting low-wage jobs or unemployment. Because unemployment benefits are less generous for this group, unemployment is only a temporary option. High-educated youth are therefore bound to accept lower-quality jobs. Catching up with the lucky cohorts that entered the labor market under more favorable conditions is impeded by mechanisms similar to those affecting high-skilled workers in North America. In addition, the very strict employment protection for white-collar workers restricts their labor mobility and thus increases the likelihood that the unlucky cohorts will get stuck in lower-quality jobs [5]. Thus, although a typical recession initially has a similar proportional negative impact on the earnings of high-educated workers in Flanders and North America (a drop of about 8% in the first year after graduation), this penalty is much more persistent in Flanders: while unlucky college graduates in North American labor markets gradually catch up to the lucky ones within ten years, in Flanders the unlucky graduates still earn about 6% less ten years later than the lucky ones [5].

Graduating in a recession in a moderately to highly rigid labor market—The case of four European countries

For countries with moderate to high labor market rigidity, such as Austria, Germany, Norway, and Sweden, there is evidence of more persistence of penalties than in North America [5]. In Austria, a one percentage point increase in the unemployment rate at entry reduces the daily wage by 0.9% and the effect persists for at least 20 years [5]. As is the case for high-educated workers in the US, the effects are smaller for white-collar workers and fade after five to ten years. However, in contrast to the US, and possibly related to labor market rigidity, blue-collar workers suffer more and more persistently from a recession [8]. A German study of low- to medium-skilled workers graduating from the apprenticeship system finds more persistent effects of a recession on employment and wages than for low-educated workers in the US, but less persistent than in Austria and Japan [9]. A negative effect on employment is found during the first five years after graduation, while the wage penalty is important in the first four years after graduation but then fades away after seven years. In the case of both Austria and Germany, the wage penalty may be somewhat underestimated because of methodological issues.

In Norway, a business cycle slump at the time of labor market entry for youths aged 16–19 raises prime-age unemployment rates by as much as 1–2 percentage points [10]. A more recent study reports similar persistent negative effects on employment for college graduates, but finds that earnings are negatively affected only in the first three years after graduation. However, the earnings estimate may be downwardly biased for methodological reasons [11]. In Sweden, white-collar workers entering the labor market during a boom phase are promoted faster than those entering during a slump, resulting in a persistent wage premium for the cohort entering during a boom [12].

Graduating in a recession in a segmented labor market—The case of Spain

Spain’s labor market is segmented between a very flexible segment for workers hired on fixed-term contracts and a very rigid segment for those employed on permanent contracts [13]. Moreover, as in Belgium, entry wages are bargained above the legal minimum wage, providing a wage floor for the low-educated youth. As in Belgium, the penalty for low-skilled workers who enter the labor market during a recession is driven by a lower likelihood of employment rather than by lower wages. However, in contrast to the Belgian case, high-educated workers in Spain do not suffer from large wage penalties. Instead, the penalties take the form of a lower probability of employment and by a higher likelihood of moving from one fixed-term contract to another. In Spain, unlike in Belgium, time limits on the use of temporary contracts are not enforced, so it costs firms little to dismiss workers before the termination of these contracts. Thus, this study finds less persistent effects of recessions in Spain than in Belgium: five years for college graduates and seven years for non-graduates. It is also possible that this study underestimates the wage penalty if people who manage to find a job during a recession are on average more able than those who find a job during a boom.