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Recession hits young people particularly hard, knocking them off course for years to come

By Peter Orszag Director, Office of Management and Budget (MCT)
On November 18, 2009

All of us are keenly aware of the immediate struggles we face because of the current economic downturn. I'm sure many of your families are facing excruciating choices that, even a few years ago, would have been unimaginable.

But what may be less appreciated is the long-term impact of this crisis -- on our economy, on our fiscal situation and on our future.

So, as we move from rescuing the economy to rebuilding it, it's essential that we keep these long-term effects in mind -- because only by addressing them can we succeed in building a new foundation for stable economic growth.

A new body of social science literature demonstrates that an economic downturn has a long-term impact on workers and their families. Consider the effect of what economists call an "exogenous labor shock" -- but normal people call a "lay-off" -- on the life course not of those laid off ... but on their children.

A range of studies have found that having a parent experience unemployment is significantly associated with whether you graduate from high school, whether you go to college, whether you get a job after college, and how much you get paid in that job. And the effect is persistent -- with higher high school dropout rates and lower college enrollment rates evident even years later.

Reflecting this, the children of workers who were once laid off have lower average wages as adults -- even decades later than those whose parents never experienced such setbacks.

And even if you or your parent didn't experience a layoff, the long-term repercussions of a recession are evident.

In other words, the impact extends to those not directly affected by unemployment -- by those entering the workforce for the first time ... the rising generation of workers. The adverse effect of entering the labor force during an economic downturn imposes a drag on career earnings that goes far beyond the duration of the recession itself.

One recent study, for example, found that graduating during a period of high unemployment leads to depressed initial wages -- roughly 6 percent on average for every 1 percentage point increase in unemployment. This negative wage effect declines only slowly over time: to 5 percent after five years, 4 percent after 10 years, and 3 percent even 15 years after graduation.

Remember, that's for each percentage point increase in the unemployment rate. When most of today's seniors entered NYU, the unemployment rate was about 5 percentage points lower than it is today.

You can do the math.

Another way of looking at it: when one compares the wages earned by the class of 1982 (a peak unemployment year) with the wages of the class of 1988 (a peak employment year) over the first 20 years of a career, the difference -- on a net present value basis -- averages $100,000.

The evidence thus suggests that the recession hits young people particularly hard, knocking them off course for years to come.

Now, for the students in the audience, if I haven't totally depressed you -- let me highlight one bright spot.

Researchers also have found that so-called "recession graduates" are slightly more likely to go on to college or graduate school than counterparts in a boom year. In fact, the data suggest that community college enrollment has recently surged, pushing the overall college enrollment rate to record levels.

And this is good news because the evidence is clear: the more you learn, the more you earn.

The bottom line is that the administration and Congress did the right thing in forcefully responding to the current downturn: mitigating the depth and duration of the recession will help to lessen the extent to which its effects reverberate in the years ahead.

The other lesson is that we need to invest in the education and skills of the youngest members of our workforce -- making sure that they do not slip off that crucial first rung of the career ladder and are able to quickly climb it as the economy recovers.

That is why the administration has taken a number of steps to open the doors of college to more Americans.

To make college more affordable, we passed into law the American Opportunity Tax Credit that provides a $4,000 tax credit for college students. And in July, the president announced the American Graduation Initiative that will devote $12 billion over the next decade to support community colleges as well as innovative strategies to help students complete college.

Not only did we increase the size of Pell grants and expand the Perkins loan programs to help lower-income students, but we also have undertaken a potentially more important task: simplifying the dreaded FAFSA -- or federal student aid application: A form more complex than a tax return -- and a huge obstacle for many worthy students applying for aid and hoping to attend college.

To get a sense of how big a barrier this application is, consider a recent H&R Block randomized experiment in which low- and moderate-income high school seniors were provided a modest amount of help in filling out the forms.

The students who were helped were almost 30 percent more likely to attend college and receive a Pell Grant the next year than a statistically comparable control group.

It's a stunning result.

In addition to these direct efforts, we also helped schools indirectly by providing $140 billion in the Recovery Act in state fiscal relief. This infusion of funds works to counteract not just the revenue lost because of this current downturn but also the long-running trend of rising costs crowding out state investment in higher education.

The interplay among squeezed budgets, higher college tuition rates, cuts in services, and the effects this has on young people's earnings, as well as economic growth, is just one manifestation of the long-term effects of fiscal strain.

And that takes me to another consequence of the financial and economic meltdown that we have experienced -- and that's the impact it has had on our fiscal situation.

Just a few weeks ago, the administration released the year-end statement of the federal government -- a final accounting of what we took in and what we spent for fiscal year 2009, which ended in September.

The results were not a surprise, but they were still sobering: the deficit for last fiscal year was $1.4 trillion, or 10 percent of our economy.

Next year's deficit is expected to be about the same size, and current projections show $9 trillion in deficits over the next 10 years, averaging about 5 percent of GDP.

Deficits of this size are serious -- and ultimately unsustainable.

So how did we get here?

Of the $9 trillion in deficits projected over the coming decade, nearly $5 trillion comes as a result of failing to pay in the past for just two policies -- the 2001 and 2003 tax cuts and the creation of a Medicare prescription drug benefit.

The cost of the tax cuts will total about $4 trillion over the next decade, including the additional interest on the debt the federal government will have to pay since the tax cuts were deficit financed. The Medicare prescription drug bill will add about an additional $700 billion to the deficit -- bringing us to about $5 trillion total for the cost of just these two policies.

In addition, roughly $3.5 trillion can be attributed to automatic economic stabilizers.

As the economy enters recession, certain spending programs, such as unemployment insurance and food stamps, automatically increase and revenues tend to decline. Although this helps to ameliorate the economic downturn by stimulating demand, it also leads to higher deficits.

Finally, there is the Recovery Act which accounts for just 10 percent of the entire deficit over the next decade.

All told, the entire $9 trillion deficit reflects the failure to pay for policies in the past and the cost of the worst economic downturn since the Great Depression and the steps we had to take to combat it.

Now, assigning blame never solves a problem, but it is important to understand that we didn't get where we are merely as a result of bad luck.

It was the result of decisions – conscious, but unfortunate -- and it will take deliberate action for us to work our way out of this situation.

 


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