The cost of youth unemployment

Paul Gregg and Lindsey Macmillan

In hard times, young people face two hurdles to finding work.  First, firms tend to hold onto their existing experienced staff but stop recruitment to reduce their workforce. This collapse in new vacancies hits young people hardest. Second, with more unemployment comes more choice of potential employees for firms who are hiring. Firms favour previous experience placing young people in a catch 22 situation of not being able to get the experience they need to get work because they can’t get the work in the first place. For the least educated or those who are unlucky enough to experience long periods out of work now, it is increasingly hard to get that break that opens the door to the labour market.

As the number of youths who are out of work continues to rise the exchequer is left counting the cost. Each 16-17 year old in receipt of benefits costs an average of £3,660 a year whilst each unemployed 18-24 year old who claims costs an average of £5,600 a year. Even though many young people don’t claim benefits, just 19% of 16-17 year olds not in education or employment and 65% of 18-24 year olds with the sheer number of young people out of work, plus the additional tax and NI revenue lost through the lack of earnings, the numbers are non-negligible. In total, the current cost of youth unemployment to the exchequer is £5.3 billion per year. The productivity loss to the economy, often calculated as the wage foregone to measure the output lost, is £10.7 billion. The large numbers not claiming benefits and the low value of benefits relative to potential earnings makes an important point that work incentives are very strong for this group.

On top of these current costs, there are also long-term scars to youth unemployment in the form of future unemployment spells and lower wages. We can see from previous generations’ experiences of youth unemployment that the longer the period spent out of work in youth, the more time spent out of work later in life and the lower potential wages were when in work. This evidence on the future costs of youth unemployment comes from two UK birth cohorts that track all babies born in a window for the rest of their lives. By chance, the participants in the first cohort were aged 21 when the 1980s recession hit and in the second cohort, the participants were aged 20 when the 1990s recession hit. Around one in five young people in the first cohort spent over 6 months out of work before age 23, and it was similar in the second. Furthermore these people spent about 20% of their time unemployed 5 years later and 15% even 12 years later.

For males in the second birth cohort, an extra month out of work before age 25 raised the proportion of time out of work between age 26 and 30 by three quarter of a per cent; an extra year out of work in youth led to 10 months more unemployment later in life. It is a very similar story for wages with an extra month unemployed when young associated with 1% lower wages in their early thirties. It’s possible that these legacies may not reflect just the pure effect of youth unemployment but also that those experiencing more unemployment are less well educated and come from deprived backgrounds. The great advantage of the birth cohort studies is that so much is known about the young person’s childhood from their education to their attitudes and beliefs, their health, their wider circumstances and almost as much is known about their parents.  The evidence suggests that about half of the later lower wages and higher unemployment exposure stems from these background differences between people and about half is a result of the unemployment itself.

The cost to the individual’s future is therefore large. However, it doesn’t end there. There is also a future cost to the public purse in terms of future benefit claims and tax revenues lost from lower earnings as a result of this scarring. Estimates from the second birth cohort suggest that the average unemployed young man will cost the exchequer a further £2,900 in future costs with the average unemployed young woman costing £2,300 a year. Aggregating these up in the context of the current youth unemployment crisis leads to further future costs to the exchequer of £2.9 billion. The future productivity losses in terms of output lost are estimated to be £6.7 billion. If we add the exchequer costs together to give the combined future and current costs of youth unemployment (discounted to adjust future costs to be equivalent to today’s) the total cost to the exchequer is therefore £28 billion. These numbers suggest that doing nothing about youth unemployment is and will continue to cost us dear.

The finances of low income households

Sarah Smith

Recent news has drawn attention to a likely increase in the use of payday loans – short-term loans at staggeringly high rates of interest – to cover temporary income shortfalls, giving an insight into how low income households manage their finances during the economic downturn.

Another possibility – discussed in a recent paper – is that low-income households might buy a National Lottery ticket. Rather than being irrational, as is usually thought, this might actually be a reasonable choice for people who are faced with “lumpy” spending needs – such as replacing a consumer durable or paying off debts – and who have no savings and no access to credit on reasonable terms.

The basic argument is that a Lottery ticket gives someone the opportunity to forego a small amount of nondurable spending for the chance of a sizeable lump sum that could make them a lot better off  – for example by allowing them to buy a replacement washing machine or television.

Is this what people actually do? Well, perhaps it is no coincidence that the National Lottery operator Camelot recently announced its “highest-ever interim” lottery sales.

Rather than looking at Lottery sales, however, the paper looks at the question in a different way and asks whether sales of durable goods are more responsive to Lottery wins than to similar-sized cash windfalls from other sources – which would be consistent with people buying Lottery tickets as a way of financing durable goods. To take care of general differences in the effect of Lottery winnings (such as feeling lucky), the research compares the difference in response across two types of people – those who should otherwise be able to draw on savings and/or other forms of credit and those who cannot.

The findings provide quite a bit of support for the argument that at least some people might use the Lottery as a way of financing lumpy spending. Focusing on windfalls of between £200 and £5,000, purchases of consumer durables (fridges, washing machines, televisions etc) are shown to be significantly more responsive more to a Lottery win than to other types of windfall – and only for those who would otherwise have few alternative options. This is precisely what you would expect to find if the Lottery was being used to finance such purchases (and it is hard to think of another explanation for this result).

So, while the current economic downturn may bring bad news for most, it may well continue to be a good time for Camelot.

Is the Chancellor right to relax pay regulation in the public sector?

Carol Propper

In a recent surprise announcement to the House of Commons the Chancellor announced that he wants to scrap national pay deals for public sector workers. Labour unions across the land are hitting back, arguing that this will damage public services. In fact, the evidence we have on the effect of national pay regulation suggests exactly the opposite.

National pay awards tend to overpay public sector workers in low cost areas of the country and underpay those in high cost areas. Recent research shows the size of these differentials. For example, the Institute for Fiscal Studies suggests that women working in the public sector in the West Midlands are paid upto 14  percent more than their private sector counterparts. What has received much less attention is that these pay differentials may have an important impact on the quality of public services provided in different parts of the country.

National pay arrangements effective impose a pay ceiling for workers in high cost areas. Simple economics suggests this should impact on the ability of the public sector to deliver services in these areas. The lower wages offered to public sector workers relative to their private sector counterparts in high cost areas will mean, all other things equal, that the public sector will struggle to recruit and retain the best quality workers. This in turn will mean problems in producing services.

Recent work undertaken at the CMPO and the London School of Economics confirms this intuition in a very stark setting. Analysis of the impact of national pay regulation of the wages of over half a million nurses in the NHS showed that hospitals in high wage areas had higher death rates for patients who were admitted following a heart attack.  Furthermore, the output of hospitals in low cost areas such as the North East did not appear to compensate for the lower quality output of their counterparts in the high cost South East. Our research suggested that deregulating pay to reduce the gap between nurses pay and that of their counterparts in the private sector would both save lives and cut costs. So in this case both economic intuition and the Chancellor’s instincts are right: deregulating public sector wages will improve the quality of public services.

Further details of the research can be found at: Propper, C and Van Reenen J (2010). Can Pay Regulation Kill? Panel Data Evidence on the Effects of Labour Markets on Hospital Performance. Journal of Political Economy 118 (2): 222-273.

Peer effects and teen motherhood

Carol Propper

Peer effects – the impact of friends, colleagues and family members – are clearly central to social life. But quantifying the causal effect of peers is difficult. Peers operate in the same social environment so are affected by the same common outside influences and the impact of behaviour between two (or more) individuals is generally two way – if two people are friends it is likely that each affects the others behaviour. This makes isolating the effect of one person on another very difficult.

Social scientists have spent their time devising ingenious ways of trying to measure peer effects. A favorite amongst American social scientists is to exploit the fact that individuals at University in the USA generally share rooms and that allocation of roommates is often random within gender. This has allowed them to examine peer effects in smoking, underage drinking, religious beliefs and mental health.

But these studies are limited by the fact that American college students are a special group. In addition, the college roommate design does not allow examination of the effect of a very important group of peers: siblings. The time siblings spend with each other is far larger than the time even close friends spend together.

In recent research undertaken between CMPO and the University of Bergen, we have tried to estimate the effect of siblings on each other’s behaviour.  Specifically, we were interested in whether having an older sister who has a teen birth increases the chance that her younger sister has a teen birth too. Teen birth is an important issue and it is clear that these run in families. So isolating the effect of peers from other shared influences, such as family income, attitudes and the more general social environment is also important.

To quantify the effect of an older sister, we exploit an educational reform. In Norway in the 1960s the minimum school leaving age was raised from 14 to 16.But in contrast to many other European countries this did not happen all at once. Instead it was rolled out, pretty randomly, across local areas (municipalities) over a 13 year period. This meant that at any one point during this period, there were some children who could leave school at 14 while others, who had very similar backgrounds and lived in similar areas, had to stay on till 16.

Exploiting this ‘natural experiment’, earlier research found that the extra years of education reduced the chance of a girl having a teen birth. So essentially this gave us a ‘natural experiment’ in teen births. Using this we looked at the effect of the reforms on the probability that an older sister would have a teen birth and then of this teen birth on the chances that her younger sister would also have a teen birth. We found large effects: having an older sister who had a teen birth raised the chance of her younger sister having one too from around one in five to two in five. This effect was larger when the sisters were close in age and where families had less resources. This all makes sense: closer age sisters are more likely to spend time together and girls in families with lower resources have more to gain from sharing the costs of having a child (for example, child care).

Finally, the positive peer effect dwarfed the negative effect of an extra two years at school on teen births. This suggests that if policy makers want to reduce teen births, they need to be able to influence what happens within the family.

The research can be found at http://www.bristol.ac.uk/cmpo/publications/papers/2011/abstract262.html

Welcome to the CMPO Public Service Reform blog

Simon Burgess

Welcome to the CMPO Public Service Reform blog, CMPO Viewpoint.

There has always been intense and passionate argument about how best to deliver public services. Working out how to provide effective and responsive services within a reasonable budget has been described as the “holy grail” of politics. That was in the good times. The current debates on how to reform public services take place in a context of severe fiscal austerity. This is very evident in the UK with the newly-elected Conservative-LibDem Coalition producing radical new plans across the public sector, alongside major budget cuts. But it is true worldwide too, with many governments struggling to get their public services producing more with less.

There are many unanswered questions: can very significant budget cuts be implemented without a deterioration in the quality of service? What will be the effects of the new institutional reforms in schools, health care and welfare provision?  Can GPs essentially manage the NHS? Will free schools revolutionise education in this country? Who will budget cuts hurt the most? Has the time come for a truly radical reform of welfare? How do these and past reforms affect social mobility and access to the best jobs in society?

We at CMPO will play our part in addressing these questions, bringing evidence and insight to the issues.  This new blog is a way of providing timely and informed contributions to the debates. This is where CMPO members and associates can offer commentary on current issues, a summary of the scientific evidence on particular topics, plus new research results. We will obviously continue with the day job, producing the lengthy scientific papers that are the backbone of our research, but we also have a duty and a wish to communicate the results of that research as widely as we can.

We hope that this new venture adds an extra dimension to our contribution to policy-making.