The Long-term Effects of Youth Unemployment

Using National Longitudinal Survey of Youth data on young men, we estimate the longterm effects of youth unemployment on later labor market outcomes. A spell of involuntary unemployment can lead to sub-optimal investments in human capital among young people in the short run. A theoretical model of dynamic human capital investment predicts a rational “catch-up” response to such a spell. Using semiparametric techniques to control for the endogeneity of prior behaviors, our estimates provide strong evidence of this response. We also find evidence of persistence in unemployment. Despite the catch-up response, however, we find the negative effect of prior unemployment on earnings to be large, to be persistent and to taper off slowly over time. The theoretical model predicts each of these three effects. Combining our semiparametric estimates with a dynamic approximation to the lifecycle, we find that unemployment experienced as long ago as ten years continues to affect earnings adversely. ¤ Department of Economics, The University of North Carolina at Chapel Hill and The Carolina Population Center. Email: [email protected]. ∗ Charles River Associates. Email: [email protected]. We are grateful to Donna Gilleskie and David Guilkey for their valuable comments on prior drafts of this paper. We thank Brian Surette for his FORTRAN programs. Tetyana Shvydko provided excellent research assistance. Many useful comments on earlier drafts came from seminars at Duke, UNC, the Stanford Institute for Theoretical Economics, the World Bank, the Federal Reserve Bank of New York, and the University of Iowa. The Employment Policy Institute provided partial funding for this research project.