The Impact of an Early Career Recession on Schooling and Lifetime Welfare

Abstract

This paper evaluates the long-term welfare consequences from experiencing a recession as youths, taking into account the impact on schooling, future job mobility, human capital accumulation, labor supply and wages. The paper also explores the mechanisms that account for lifetime wage changes by decomposing those changes into different channels: changes from schooling, from work experience, and from job mobility. To achieve these goals, this paper develops and estimates a search equilibrium model with heterogeneous agents and aggregate shocks. The model is an extension of a directed search model, the Block Recursive Equilibrium framework of Menzio and Shi (2010), which remains tractable when it is solved outside of the steady state. The counterfactual analysis shows that experiencing the 1981-1982 recession at age 16-22 causes a 2.2% to 3.0% loss in lifetime welfare. Endogenizing schooling decision avoids overestimation of the welfare loss for two reasons: first, there exists the selection of labor market entry timing and high ability individuals are more likely to postpone entry into the labor market during a recession; second, the additional schooling caused by an early career recession increases future wages and employment rate. The wage decomposition shows that the loss from job mobility explains the majority of the wage loss during the recession, and the loss in experience and tenure persists long after the recession.