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.