Ability Matters: Effects of Youth Labor‐Market Opportunities on Long‐Term Labor‐Market Outcomes

• Published date: 01 July 2018
• DOI: http://doi.org/10.1111/sjoe.12248
• Date: 01 July 2018

©2017 The Authors. The Scandinavian Journal of Economics published by JohnWiley & Sons Ltd on behalf of F ¨oreningen

för utgivande av SJE/The editors of The Scandinavian Journal of Economics.

This is an open access article under the terms of the Creative Commons Attribution License, whichper mits use, distribution

and reproduction in any medium, provided the original work is properly cited.

Scand. J. of Economics 120(3), 794–825, 2018

DOI: 10.1111/sjoe.12248

Ability Matters: Effects of Youth Labor-

Market Opportunities on Long-Term

Labor-Market Outcomes*

Venke Furre Haaland

University of Stavanger, NO-4021 Stavanger, Norway

venke.f.haaland@uis.no

Abstract

Utilizing registry data from cognitive ability tests for all Norwegian males born between

1962 and 1973, I study whether labor-market conditions at the age of graduation have

differential effects on earnings and employment for different ability groups. I find that

low-ability males are more vulnerable to local business cycles at the expected time

of labor-market entry. In particular, I demonstrate that low-ability males suffer larger

long-term earnings losses than the rest of the population.

Keywords: Business cycle; careers; graduation

JEL classification:E32; J31; J24

1. Introduction

The early years of a career are important for future labor-market outcomes.

Studies show that about 66 percent of lifetime wage growth occurs

during the first 10 years of a career (see, e.g., Topel and Ward, 1992).

Notably, young people’s employment prospects in these early years could

be influenced by the business cycle. Young people are often called

the population at risk, as they have little work experience, and during

recessions they are often the last to be hired and the first to be

fired. Research on youth vulnerability shows that they experience more

unemployment and underemployment and less employment than adults

during recessions (see, e.g., Bell and Blanchflower, 2011a,b; Hoynes et al.,

2012). Despite declining in countries in the European Union following

the financial crisis, youth unemployment rates remain at a very high level:

20.3 percent in 2015 (for young people under the age of 25).1

*I am grateful to Mari Rege, Kjetil Telle, Christopher J. Ruhm, Nabanita Datta Gupta, Shelly

Lundberg, and seminar participants at the Frisch Centre and Institute for Social Research

for helpful suggestions, to the Research Council of Norway (OF-10018) for funding, and to

Statistics Norway for their hospitality.

1Figure obtained from the Eurostat database at http://ec.europa.eu/eurostat/data/database

(retrieved 9 September 2016), Labor market/Employment and unemployment/LFS series-

V. F. Haaland 795

In this paper, I explore the possible long-term effects on labor-market

outcomes of entering the labor market when local unemployment rates are

high, with a particular focus on identifying differential effects across young

people of different abilities. There are at least three important mechanisms

through which poor labor-market entry conditions can affect long-term

labor-market outcomes. First, poor labor-market entry conditions might

lead to unemployment or poor job quality. This effect might be especially

pronounced for low- as compared with high-ability individuals if it is

more difficult for them to find a high-quality job (see, e.g., Devereux,

2002), or any job (see, e.g., Hines et al., 2002; Elsby et al., 2010;

¨

Ockert, 2011; Hoynes et al., 2012), at times with a high unemployment

rate at graduation time. Such initial differential effects could persist or

become amplified in the long run if low-ability individuals struggle to

escape the low-quality job, or if a low-quality job hampers their human-

capital accumulation (see, e.g., Becker, 1962). Second, lower earnings or

expectations of lower earnings might affect the incentive to work now

and in the future, and a concave replacement rate in welfare programs

would provide low-ability individuals with stronger incentives to stay

out of work compared with youths of higher ability. Last, poor labor-

market opportunities might reduce the opportunity cost of schooling and

thereby encourage youths to complete their current educational track or

undertake higher education, which, in turn, could improve future labor-

market outcomes (Becker, 1962; Micklewright et al., 1990). The magnitude

of the opportunity cost of schooling might depend on the ability type,

providing differential incentives to continue with education.

The time at which to measure labor-market entry conditions is not

straightforward. Both the year of observed entry into employment and the

year of leaving education are endogenous. Individuals might experience

prolonged unemployment when the unemployment rate is high, which will

delay entry into the first job. Moreover, several empirical studies have

documented an increase in school enrollment rates and school completion

during recessions (Gustman and Steinmeier, 1981; Clark, 2009; ¨

Ockert,

2011; Johnson, 2013; Reiling and Strøm, 2015). In the empirical strategy,

I follow Raaum and Røed (2006) and address such endogeneity problems

by including all men (regardless of educational achievements) born in the

period 1962–1973, and by looking at unemployment rates at the typical

age when Norwegian men leave school and enter the labor market (and not

the time of actual entry). Moreover, I employ a model using a weighted

unemployment rate at entry where the timing of actual labor-market entry

is based on the distribution of labor-market entry ages.

detailed annual survey results/Total unemployment/Unemployment rates by gender, age, and

nationality.

©2017The Authors.The Scandinavian Journal of Economics published by John Wiley & Sons Ltd on behalf of F¨oreningen

för utgivande av SJE/The editors of The Scandinavian Journal of Economics.

796 Effects of youth labor-market opportunities on labor-market outcomes

The analysis uses high-quality registry data covering the entire

Norwegian population. Importantly, the data include information about

cognitive ability.2This allows me to investigate heterogeneous effects

across youths, employing a measure of ability that is available for

everyone, and not only for those who have entered college, as in

Oreopoulos et al. (2012) or Liu et al. (2016). The empirical model

includes regional and year fixed effects. The estimates are identified

from differences in how local unemployment rates change over time

across regions. After accounting for regional and cohort fixed effects, the

identifying assumption is that the difference in earnings observed between

regions with high and low unemployment rates would be the same if they

were not subject to the difference in the local unemployment rate. I include

region-specific linear time trends and observable individual and parental

characteristics determined prior to labor-market entry, to assess the validity

of this identifying assumption.

I find that for low-ability males, a one percentage point increase in

the local unemployment rate at the expected time of labor-market entry

reduces earnings at age 30–35 by about three percent and increases the

likelihood of a weak labor-market attachment, defined as having earnings

below the 20th percentile, by about 17 percent. In contrast, for high- and

medium-ability youths, there are limited or no effects on employment

or earnings in general, except that high unemployment rates at times of

labor-market entry reduce the likelihood of ending up with particularly

high earnings at age 30–35.

I also investigate whether family background affects vulnerability to

the local unemployment rate at the time of expected labor-market entry.

Interestingly, the long-term earnings for youths of low-educated fathers

are particularly negatively affected by the unemployment rate at the time

of expected labor-market entry. A review of the average effect on long-

term earnings reveals no differential effects across low-, medium- and

high-ability young men with low-educated fathers. However, the negative

effects on the long-term earnings of the low-ability youths are attributable

to the greater likelihood of ending up with particularly low earnings, while

the effects for high-ability youths are attributable to a lower likelihood

of ending up with particularly high earnings.

There is a large body of recent literature on the effects of labor-market

entry conditions on long-term labor-market outcomes (Burgess et al., 2003;

Oyer, 2006; Raaum and Røed, 2006; Stevens, 2008; Genda et al., 2010;

2The measure, cognitive ability, is constructed from the Norwegian Army ability tests

administered at the time of military conscription (normally at age 18). I am grateful to

the Norwegian Armed Forces for access to their data. The views and conclusions expressed

in this paper are those of the author and cannot in any way be attributed to the Norwegian

Armed Forces.

©2017The Authors.The Scandinavian Journal of Economics published by John Wiley & Sons Ltd on behalf of F¨oreningen

för utgivande av SJE/The editors of The Scandinavian Journal of Economics.