Unlucky cohorts
We all know about the genetic lottery that we are exposed to. Some people are born good-looking and we know that attractive people are more successful in their careers. As one journalist once put it: supermodels don’t fly economy class. On average, attractive people earn 3% to 4% more than people with below average looks, which I can confirm from personal experience whenever I look at my pay check and then at the mirror – and I leave it up to you to decide if I am likely to earn a below average salary or not.
And 3% to 4% more or less in annual earnings may not sound a lot but over a career spanning 40 years this may amount to lifetime earnings that are three to five times higher! Typically, the difference in lifetime earnings is smaller because looks are a depreciating asset as was explained in a famous craigslist post by a banker responding to a pretty girl looking for a rich husband (coincidentally, the report in NY Magazine from the year 2007 featured a picture of Donald Trump with his wife Melania).
But even if people won the genetic lottery and are smart and good-looking, they are exposed to another lottery, namely the lottery of economic cycles. A recent research report with the sexy title “Unlucky Cohorts: Estimating the Long-term Effects of Entering the Labor Market in a Recession in Large Cross-Sectional Data Sets” investigated the relationship between recessions and earnings, as well as use of the existing social safety net.
What the researchers looked at was how much earnings shrank if people in the US entered the workforce during a recession compared to people who entered during a more prosperous time. As our chart shows, entering the workforce during a recession has a significant impact on your earnings prospects. For every percentage point increase in unemployment rates at the time you start your career, your annual earnings decline by c. 4% for men and c. 3% for women.
This means that if you enter the workforce during a typical recession when unemployment rates are about three percentage points higher than normal, you can expect to earn c. 10% less than people who do the same job with the same qualifications but have entered the workforce a year or so earlier during boom times.
And this effect of lower earnings persists for about ten years into your career, meaning that over the next decade a typical recession will set back your lifetime earnings by about 66% compared to someone who entered the workforce during boom times. The study also shows that it is racial minorities and people who have dropped out of high school without a diploma who suffer the most. And these people are also subsequently more likely to end in poverty or require social assistance.
Much has been said about the Millennials who are likely to be the first generation since the Great Depression that will be unable to have a higher lifestyle than their parents, but if you think about it, many Millennials joined the workforce during and after the Great Recession when unemployment rates in the US where five to six percentage points higher than normal. Over the subsequent decade, these people have earned about half of what someone earned who entered the workforce in 2006 or 2007. And the effect of compound interest means that due to these lower earnings they are not only able to save less for retirement or a house, but that the difference will only grow over time. Millennials, when compared to their Baby Boomer grandparents have lost the economic lottery big time, yet it is the Baby Boomer generation who think they have got a raw deal in life and Millennials just complain all the time.
Earnings impact of a recession at the beginning of a career
Source: Schwandt and von Wachter (2018), Fidante Capital.