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Young workers who enter the labor force in a recession suffer years of lower wages
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President Barack Obama has been on a tour of college campuses touting proposals to lower student loan repayments for college graduates. He hopes to rekindle the enthusiasm of young voters, who in 2008 favored him over Sen. John McCain by more than two-to-one.
Ironically, these same young Americans may suffer most from the administration’s inability to get the economy back on its feet. College graduates who enter the workforce during an economic downturn accept lower wages in lower-quality jobs, and the effects on their income and promotions can last for well over a decade.
All workers face wage cuts and job losses during a recession, when the supply of labor outstrips demand. But in this recession, new college graduates have been particularly hard hit. According to an analysis by the Center for Labor Market Studies at Northeastern University, 54% of bachelor’s degree-holders under age 25, about 1.5 million in total, were jobless or underemployed last year.
To help out college students, President Obama is promising to retain the interest rate on government-issued student loans that was temporarily lowered in 2007. Mitt Romney, the presumptive Republican presidential nominee, also favors this measure. This would keep the interest rate on new government loans at its current 3.4%, instead of returning on July 1 to its previous 6.8% rate. The House has passed a bill to keep the rate at 3.4%, but paid for it with cuts to ObamaCare the White House says are unacceptable.
Some perspective is in order. The lower interest rate would apply only to government-subsidized Stafford loans, far less than half the total amount of college loans. And the average monthly payment would be reduced by about $7, according to calculations by economist Douglas Holtz-Eakin, a former director of the Congressional Budget Office.
More important, lower payments on college loans after graduation won’t come close to repairing the long-term economic damage that new graduates will suffer as a result of entering the workforce during a downturn.
For most workers, the negative effects of a recession fade fairly quickly as the economy recovers, but research shows that the impact can last far longer for young workers. A 2006 study by University of Toronto Prof. Philip Oreopoulos and his co-authors found that Canadians entering the labor market during a typical recession had their initial earnings reduced by 9%. It took a decade for wages to return to normal levels earned by young workers entering the workforce in a non-recessionary economy.
A 2009 study by Katrien Stevens of the University of Sydney found that young Germans graduating college during a time of high unemployment suffered 3% to 6% lower pay for the first three years of work, with the negative effects not disappearing for another three years after that.
Lisa Kahn of the Yale School of Management found even longer-lasting effects for Americans. Using the National Longitudinal Survey of Youth to follow white males graduating college from 1979 through 1989, Prof. Kahn found that a one percentage point increase in the national unemployment rate correlated with wage losses of 6% to 7% per year for new college graduates. Recovery is excruciatingly slow: Even 15 years following graduation, their pay was 2.5% below normal.
Roughly two-thirds of lifetime wage growth occurs in the first decade of employment, when individuals build their skills and match them to the right jobs. Graduating into a down economy puts that process off track. As Ms. Kahn writes, “workers who graduate from college in bad economies are unable to fully shift into better jobs, at least over the first 15 years of their careers.”
If we assume that unemployment today is 1 percentage point higher than it could have been given more effective policies—such as a stimulus that actually stimulated, and spending and entitlement reforms to generate confidence in the economy—today’s new college graduates on average will lose around $40,000 in inflation-adjusted income over the next 15 years. That money wouldn’t simply have helped graduates meet their loan payments; it’s more than enough to repay the average college graduate’s entire $25,000 loan balance.
Young voters helped elect Mr. Obama but may pay a large price for doing so, both today and in the future. What college graduates need most is not the Band-Aid of lower student loan payments but an economy capable of creating new jobs that will let them score the best jobs, repay their loans, and build a future. That the best the president can offer them is $7 per month in lower student loan payments shows how far this White House’s aspirations have fallen.
Mr. Biggs is a resident scholar at the American Enterprise Institute.
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