Part 4 The Economics of Education

The Economics of Education Crisis and Reform

Part 4The Economics of Education

IntroductionThe US education crisis?US and a sample of world countriesWhat? Input output relationComprehensive analysis of the crisis need to address the following areas:Who provides education? Analyze the market for educationRationales for interventionGovernment failureHow is education financed?Centralized v decentralizedIntroductionHow significant are school resources to achievementEducation production functionRole of: peers, teachers, home environment, curriculum, resourcesIs there an achievement gap within the US? Inner city v suburban schools? Why?Significance of externality from peers Effect of urban segregation on the gap and the average achievementSheff v ONeil and reform measuresPlacing the US in international context

Education as a Publicly Provided Good

K-12 education is delivered in a system of primarily public education

90% of school aged children in the US attend public schools

International Comparison of Education ExpenditureCountryExpenditure /student ($)Expenditure as % of GDPUnited States88553.5Norway84763.9Italy72183.2Australia68943.9Sweden63394.9Japan62662.7Netherlands59123.2International Comparison of Education ExpenditureFree Market for K-12: Demand sideNo public schools and no regulation requiring school attendanceValue placed on education:Additional earning to the individual as a result of extending educationBetter decision makingInterpersonal relationshipsPure satisfaction from learningFree Market for K-12: Supply SideOn the supply side we assume:The market is perfectly competitiveNo externalities in production (MSC=MPC)Constant marginal cost

Market for K-12Quantity0$ Demand$5,000Supply (MC)Q equilibriumExternalities from EducationPositive externalities in consumption: the benefits from education spill over to a third partyPositive externalities from:More rapid economic growthBetter functioning democratic processBetter safety and hygieneGreater charitable contributionBetter decision making and more efficient functioning of markets

Externalities From Education

10Consumer1111Marginal social benefit > Marginal private benefitMagnitude of SpilloversThe absolute size of the positive externality declines as a student progresses through K-12 education.Evidence: The greatest externality occurs during the earlier years of education

What does that imply about the shape of the MSB curve?

Externalities From EducationQuantity0$ Demand$5,000Q equilibriumSupply (MC) MSB 2 The spillover effect is relatively small. The MSB is given by MSB2 The market for education is efficientExternalities From EducationQuantity0$ Demand$5,000Q equilibriumSupply (MC)Q optimal MSB 1 The spillover effect is relatively large. The MSB is given by MSB1 The market for education is inefficientExternalities From EducationQuantity0$ Demand$5,000Q equilibriumSupply (MC)Q optimal MSB 1A subsidy of $1000$4,000Supply (MC) with the subsidyImperfections in the Capital MarketA childs education as an investmentReturn later in the childs lifeNot possible to use human capital as collateral to secure loan to finance educationFinancial institutions offer loans at a premiumThe higher than social cost of funds discourages spending on schooling

Absence of a parent-child contractA child consumes education when he does not have the means to payParents more likely to finance the education of a child if the child commits to repay them in the futureNo such contractParents are likely to underinvest in a childs education

Rationale for government provisionDoes the need to ensure the provision of quality education justify government intervention?NoGiven the availability of information, the market will supply quality goods. Demand will adjust to provide quality education.If information is not available, the government can simply require information disclosure

Rationale for government provisionDo the positive externalities from education justify government intervention?YesA subsidy that equates the MSB with the marginal cost can correct the market failureHowever, the existence of the externality does not necessitate public provision of education

Rationale for government provisionDoes the need for Social and Cultural Cohesion justify government intervention?YesUS population is very diverseThe need to share common experience to avoid breaking apart along those differencesK-12 system as a melting potBuilds a shared moral framework that can hold society together

Rationale for government provisionDoes the need for Social and Cultural Cohesion justify government intervention?A private education market will lead toSchools that do not necessarily perpetuate important cultural values, e.g., tolerance, equality Provision of a differentiated product: schools distinguished by a cultural, racial or religious characterSegregation: schools have children with similar backgroundsUnequal opportunity for success as high income families have more options. Government failureHoxby (1996) analyses the challenges of financing public schoolsIntervention in the education market does not necessarily result in the optimal consumption of educationInefficiencies typically present with government provisionFree riding: as with any publicly provided good and especially by parents who do not have childrenMoral hazard: individuals will free ride when the government commits to providing a minimal amount of education- safety net

Centralized v. Local FinanceHow does the government finance education?Local financeTaxes collected from a certain districtUsed to finance local public goodTax rate determined by the districts median voterCentralized financeTaxes imposed on statewide or nationwide tax baseRedistribution across states: A district gets a share of the tax money, not necessarily equal to money collected from that districtTax rate determined by the states median voterA district has little control over tax rates or provision of public good

Advantages of Local FinanceEfficient: in combination with the Tiebout (1956) process individuals choose the tax rate and size of public good to match their preferences by moving across districts- no under provisionReduces capital market failure: parents finance 12 years of schooling through lifetime taxesSolves a principal (tax payers)-agent (school administrators)modelHouseholds unable to verify school outcomeProperty values direct measure of unverifiable school outcomeHigher tax revenues from increased property values Possible Problems of Local FinanceFiscal spillovers:When taxes based on property values, people in low valued houses can free ridethe median voter chooses a level of school spending that is lower than if the district was homogenous Answer: Can be solved using zoning regulationResults in human capital segregationCentralized finance leads to human capital integrated schoolsAnswer: People will sort themselves Tiebout style if there is high correlation between demand for human capital and human capital The Education Production FunctionEmpirical evidence indicates that:increasing school spending has a modest impact on achievement.Urban schools spend more per student than suburban schools yet the achievement gap persistsQuestions:What is the nature of the relationship between school spending and achievement?What variables determine achievement?Do scores capture educational output?

Education Production FunctionHow to measure achievement?Lifetime incomeScores on standardized testsGraduation ratesEducation Production FunctionFactors affecting achievement:H: Home environmentP: Peer groupC:CurriculumE: Education resourcesT: Teacher qualityMarginal gains in achievement will decrease with an increase in a single factor, holding other factors constant

Empirical EvidenceHome environment: Depends on parent income and educationEducated high income parents:encourage studying, provide extra help and discourage distracting activitiesoffer needed medical care: 50% of low income children have vision problems that interfere with their educationOffer stable housing: 30% of low income children attend at least 3 different schools by third grade- only 10% for middle class kidsOffer safe housingNurturing preschool environment: Shonkoff and Phillips (2000): early childhood development has a strong impact on the ability to acquire skills which amplifies differences in school achievement

Empirical EvidenceExternalities from the peer groupFavorable peers are smart, motivated, not disruptiveEvidence that peer effects most important for grades 5-12Placing a high achiever in a class of low achievers:Sund (2009) shows that low achievers have the most to gain so class average increasesPlacing a high achiever in a class of medium achievers:Burke and Sass (2008) shows that class average increasesChina, Ding and Lehrer (2007) show that medium achievers gain more (suggesting an increase in class average) than low achievers from the presence of a high achiever (which results in a decline in class average)

Empirical EvidenceTeacher quality: Significant variation in qualityQuality measured by: student scores, education, experience and communication skills productive teachers have superior communication skillsGraduate degrees dont significantly affect teacher qualityHanushek (2010) and Chetty et. al.(2010): Replacing an average teacher with a superior teacher increases student score 50th percentile to 58th and increases lifetime earning/student by $21,000Hanushek and Rivkin (2010): if we replace the bottom 8% of teachers by average teachers, test scores increase by 45%, eliminate international achievement gap, increases GDP by $112 trillion Empirical EvidenceBoyd (2005) a draw of home tendencyIn cities more openings than qualified applicants means the need to import suburban raised teachers. Only lower quality suburban teachers acceptLower quality of school building, noise, ventilationIn cities higher teacher turnover

Empirical evidenceClass sizeSmaller classes result in higher test scoresLargest benefit to minority groupsKrueger (1999): reducing class size by 1/3 for 4 years:Extra cost $7400/ studentIncrease in lifetime earning per student $9,603 for men and $7,851 for womenBenefits and costs within the same ball park

Other Empirical EvidenceColeman (1966): the first cited. Variation in school resources (teacher student ratio, spending per student, library) has an insignificant effect on the gap between while and black childrenLiterature on effect of spending on scores has mixed results:Krueger (1997): smaller classes matter to minorityHanushek (1997): no significant effectHoxby (2000): using data from Connecticut also finds no effect.Other Empirical EvidenceRothstein (2004) examines inequality in school spending: Interstate Inequality: Range: 159% of the average in New Jersey to 61% in Mississippi. Variation in states ability to payFederal funds 7% of school expenditure, limited ability to equalize spendingInter district inequality: due to property tax system. NY, WY, IL have the largest gaps. State funding sometimes used to equalize gaps: for example, MA spends $8, 416 in high poverty areas and $7,946 in cities and towns with fewest poorAchievement gapDue to the challenges facing urban schools a gap exists between rich and poor, white and minority:According to Standard and Poor (2006) reading proficiency on NAEP exam in 2005:Asians 39%, whites 37%, Blacks 11%, Hispanics 14%Economically disadvantaged 15% compared to 38% those notAccording to Urban Institute (2004), high school graduation rates:Suburban 73%, central city 58%, largest gap in New York, lowest rates for minority

Reform: HistoryThe gap is caused by housing segregation, location and local fundingDe jure segregation up to 1954laws required separation of black and white children across schoolsBrown v. Board of EducationCourt overturned the precedent requiring integrationDe facto segregation:Schools continued to be segregated even in the absence of segregation laws

Reform: School structureConcerns about the quality of educationBy 1970 greater equity in distribution of school resourcesConcern about gap between US and other countries:National Commission on Education Excellence concerned that the US falling behind due to teacher quality, training, not enough homework, length of school dayNeed for competition: monopoly of local schools results in very little improvement in quality

Reform: CompetitionMagnet SchoolsSpecialized curriculum, new approach to learningTacoma 1968 and Boston 1969Accepted by courts to address issues of segregationCharter schoolsEstablished privatelyFunded by government St Paul, Minnesota 1992Reform: AccountabilityStandards movement:Emphasized lack of accountabilityNo Child Left Behind Act School districts develop criteria to measure performanceTest each yearIdentify schools needing improvementSanctions to failing schools: losing students, changing management, losing fundsReform: AccountabilityProblems with No Child Left Behind Act Output of the education production functionStandardized tests do not adequately test learningTeaching to the testLimited budgets: improvement to test scores achieved by cutting funding from extracurricular activitiesScores also depend on student background and social factorsHarder for inner city schools to meet the standards

Reform: School ChoiceAllow families to choose beyond the what is assignedBring elements of the free market into educationFamilies can chooseCompetition between schools improves qualityProblems with school choiceWho are the choosers?Self selection: educated and wealthy families will exercise the choiceAccess to informationCan afford to pay extra under a voucherThose left behind Choice based on proximity to residence or work or based on composition of student bodyIntroduces more divisions in society

Effectiveness of the ReformEffect on:International gapInner city suburban gapEmpirical Evidence:Hoxby (2004): Charter students more proficient than student attending district school3.8% in reading1.6% in mathCarnoy et al. (2005) and Roy and Mitchell (2005) find no significant difference:Control for income and raceIn general mixed results about the success of charter schoolsEffectiveness of the ReformEmpirical Evidence:Gil et al. (2001) finds small gains to minority student from voucher programNational Center for education statistics: children in public schools do as well after controlling for demographic variablesBlueston (2008): parental background and community factors are significant

Reform