IFS Working Paper (WP17/27)

Entering the labour market in a weak economy: scarring and insurance

Date: 30 November 2017
Publisher: The IFS
JEL classification: D10, J23, J31, J64

This paper estimates the effects of entering the labour market when the economy is weak on subsequent living standards using consistent long-running household survey data from the UK. In line with previous research, we find persistent scarring effects on employment and earnings. However, we also provide the first estimates of impacts on net household incomes and household expenditures – standard proxies for material living standards – and we find little or no impacts. This is primarily due to two particular forms of insurance: the UK tax and transfer system and, even more importantly on average, the incomes of parents, with whom many young adults live in the years after leaving education. The interplay between heterogeneity in labour market scarring and insurance is key to understanding why parental incomes insure so much of the shock: lower-educated young adults experience the worst labour market scarring effects, but they are also highly likely to live with their parents in the years after labour market entry (irrespective of economic conditions), and the negative labour market effects are not so persistent as to outlast the typical period of co-residence. However, young adults not living with parents do see negative and persistent scarring effects feed through to their net incomes and expenditures. It may therefore be useful for future research on scarring to focus on this group, as well as the degree to which resources are shared within households between parents and their co-resident adult children.

Key findings of the research include:

  • Leaving education when the economy is weak has a direct impact on employment and pay at least five years afterwards. Young adults five years after leaving education are still 1 percentage point less likely to be employed if they started out when the unemployment rate was 10% rather than 6% (unemployment has risen by 4 percentage points on average during the last three recessions). The average negative impact on the pre-tax earnings of young adults and their partners (if they have one) five years after leaving education is 4% – or £1,100 per year. These effects have faded away almost completely after a further five years.
  • Some of the impact is offset by lower taxes and higher benefits. Once you account for taxes and benefits, the effect of leaving education when unemployment is high on the combined incomes of young adults and their partners (if they have one) five years later falls from 4% to 2%.
  • Another important potential safety net is that most people live with their parents in the first few years after leaving education, irrespective of economic conditions. This is particularly important in the years immediately after leaving education, when the effects on employment and pay are the largest: between 2010 and 2015, 74% of young adults lived with their parents a year after leaving education, 54% three years in and 38% five years in.
  • As a result, starting working life during a recession has little impact on the total resources available to the households that young adults live in, on average. Young adults’ net household incomes (including the incomes of all members of their household – most importantly parents) are hit by only 1% five years after leaving education. While there is no guarantee that resources in the household are always shared equally, at the very least this implies that many parents have the capacity to provide an important safety net for their children after they leave education.
  • The safety net provided by parents is particularly significant because lower-educated people are both most affected by starting out in a recession and most likely to live with their parents. Five years after joining the labour market, the pre-tax earnings of young adults and their partners are 4% lower for those who left education at 16 but there is no effect on those who left when they were 19 or older. At the same five-year stage, 60% of those who left education at 16 still live with their parents, compared with 21% of those who left when they were 19 or older.
  • For those young adults not living with parents, there are significant lasting effects on overall incomes and household spending. For this group, starting working life when the economy is weak causes household net incomes and spending to be 2–3% lower even five years later.