Part 4 The Economics of Education

1. Part 4The Economics of Education

2. Introduction • The US education crisis? • US and a sample of world countries • What? Input output relation • Comprehensive analysis of the crisis need to address the following areas: • Who provides education? • Analyze the market for education • Rationales for intervention • Government failure • How is education financed? • Centralized v decentralized

3. Introduction • How significant are school resources to achievement • Education production function • Role of: peers, teachers, home environment, curriculum, resources • Is 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 achievement • Sheff v O’Neil and reform measures • Placing the US in international context

4. 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

5. International Comparison of Education Expenditure International Comparison of Education Expenditure

6. Free Market for K-12: Demand side • No public schools and no regulation requiring school attendance • Value placed on education: • Additional earning to the individual as a result of extending education • Better decision making • Interpersonal relationships • Pure satisfaction from learning

7. Free Market for K-12: Supply Side • On the supply side we assume: • The market is perfectly competitive • No externalities in production (MSC=MPC) • Constant marginal cost

8. $5,000 Demand Market for K-12 $ Supply (MC) Q equilibrium Quantity 0

9. Externalities from Education • Positive externalities in consumption: the benefits from education spill over to a third party • Positive externalities from: • More rapid economic growth • Better functioning democratic process • Better safety and hygiene • Greater charitable contribution • Better decision making and more efficient functioning of markets

10. Externalities From Education Consumer 1 1 1 1 10 Marginal social benefit > Marginal private benefit

11. Magnitude of Spillovers • The 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?

12. MSB 2 $5,000 Demand Externalities From Education $ • The spillover effect is relatively small. • The MSB is given by MSB2 • The market for education is efficient Supply (MC) Q equilibrium Quantity 0

13. MSB 1 $5,000 Demand Externalities From Education $ • The spillover effect is relatively large. • The MSB is given by MSB1 • The market for education is inefficient Supply (MC) Q equilibrium Q optimal Quantity 0

14. MSB 1 Demand Externalities From Education $ A subsidy of $1000 Supply (MC) $5,000 Supply (MC) with the subsidy $4,000 Q equilibrium Q optimal Quantity 0

15. Imperfections in the Capital Market • A child’s education as an investment • Return later in the child’s life • Not possible to use human capital as collateral to secure loan to finance education • Financial institutions offer loans at a premium • The higher than social cost of funds discourages spending on schooling

16. Absence of a parent-child contract • A child consumes education when he does not have the means to pay • Parents more likely to finance the education of a child if the child commits to repay them in the future • No such contract • Parents are likely to underinvest in a child’s education

17. Rationale for government provision • Does the need to ensure the provision of quality education justify government intervention? • No • Given 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

18. Rationale for government provision • Do the positive externalities from education justify government intervention? • Yes • A subsidy that equates the MSB with the marginal cost can correct the market failure • However, the existence of the externality does not necessitate public provision of education

19. Rationale for government provision • Does the need for Social and Cultural Cohesion justify government intervention? • Yes • US population is very diverse • The need to share common experience to avoid breaking apart along those differences • K-12 system as a melting pot • Builds a shared moral framework that can hold society together

20. Rationale for government provision • Does the need for Social and Cultural Cohesion justify government intervention? A private education market will lead to • Schools 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 character • Segregation: schools have children with similar backgrounds • Unequal opportunity for success as high income families have more options.

21. Government failure • Hoxby (1996) analyses the challenges of financing public schools • Intervention in the education market does not necessarily result in the optimal consumption of education • Inefficiencies typically present with government provision • Free riding: as with any publicly provided good and especially by parents who do not have children • Moral hazard: individuals will free ride when the government commits to providing a minimal amount of education- safety net

22. Centralized v. Local Finance • How does the government finance education? • Local finance • Taxes collected from a certain district • Used to finance local public good • Tax rate determined by the district’s median voter • Centralized finance • Taxes imposed on statewide or nationwide tax base • Redistribution across states: A district gets a share of the tax money, not necessarily equal to money collected from that district • Tax rate determined by the state’s median voter • A district has little control over tax rates or provision of public good

23. Advantages of Local Finance • Efficient: 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 provision • Reduces capital market failure: parents finance 12 years of schooling through lifetime taxes • Solves a principal (tax payers)-agent (school administrators)model • Households unable to verify school outcome • Property values direct measure of unverifiable school outcome • Higher tax revenues from increased property values

24. Possible Problems of Local Finance • Fiscal spillovers: • When taxes based on property values, people in low valued houses can free ride • the median voter chooses a level of school spending that is lower than if the district was homogenous • Answer: Can be solved using zoning regulation • Results in human capital segregation • Centralized finance leads to human capital integrated schools • Answer: People will sort themselves Tiebout style if there is high correlation between demand for human capital and human capital

25. The Education Production Function • Empirical 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 persists • Questions: • What is the nature of the relationship between school spending and achievement? • What variables determine achievement? • Do scores capture educational output?

26. Education Production Function • How to measure achievement? • Lifetime income • Scores on standardized tests • Graduation rates

27. Education Production Function • Factors affecting achievement: • H: Home environment • P: Peer group • C:Curriculum • E: Education resources • T: Teacher quality • Marginal gains in achievement will decrease with an increase in a single factor, holding other factors constant

28. Empirical Evidence • Home environment: • Depends on parent income and education • Educated high income parents: • encourage studying, provide extra help and discourage distracting activities • offer needed medical care: 50% of low income children have vision problems that interfere with their education • Offer stable housing: 30% of low income children attend at least 3 different schools by third grade- only 10% for middle class kids • Offer safe housing • Nurturing 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

29. Empirical Evidence • Externalities from the peer group • Favorable peers are smart, motivated, not disruptive • Evidence that peer effects most important for grades 5-12 • Placing a high achiever in a class of low achievers: • Sund (2009) shows that low achievers have the most to gain so class average increases • Placing a high achiever in a class of medium achievers: • Burke and Sass (2008) shows that class average increases • China, 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)

30. Empirical Evidence • Teacher quality: • Significant variation in quality • Quality measured by: student scores, education, experience and communication skills • productive teachers have superior communication skills • Graduate degrees don’t significantly affect teacher quality • Hanushek (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 $21,000 • Hanushek 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

31. Empirical Evidence • Boyd (2005) • a “draw of home” tendency • In cities more openings than qualified applicants means the need to import suburban raised teachers. Only lower quality suburban teachers accept • Lower quality of school building, noise, ventilation • In cities higher teacher turnover

32. Empirical evidence • Class size • Smaller classes result in higher test scores • Largest benefit to minority groups • Krueger (1999): reducing class size by 1/3 for 4 years: • Extra cost $7400/ student • Increase in lifetime earning per student $9,603 for men and $7,851 for women • Benefits and costs within the same ball park

33. Other Empirical Evidence • Coleman (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 children • Literature on effect of spending on scores has mixed results: • Krueger (1997): smaller classes matter to minority • Hanushek (1997): no significant effect • Hoxby(2000): using data from Connecticut also finds no effect.

34. Other Empirical Evidence • Rothstein (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 pay • Federal funds 7% of school expenditure, limited ability to equalize spending • Inter 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 poor

35. Achievement gap • Due 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 not • According to Urban Institute (2004), high school graduation rates: • Suburban 73%, central city 58%, • largest gap in New York, lowest rates for minority

36. Reform: History • The gap is caused by housing segregation, location and local funding • De jure segregation up to 1954 • laws required separation of black and white children across schools • Brown v. Board of Education • Court overturned the precedent requiring integration • De facto segregation: • Schools continued to be segregated even in the absence of segregation laws

37. Reform: School structure • Concerns about the quality of education • By 1970 greater equity in distribution of school resources • Concern 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 day • Need for competition: monopoly of local schools results in very little improvement in quality

38. Reform: Competition • Magnet Schools • Specialized curriculum, new approach to learning • Tacoma 1968 and Boston 1969 • Accepted by courts to address issues of segregation • Charter schools • Established privately • Funded by government • St Paul, Minnesota 1992

39. Reform: Accountability • Standards movement: • Emphasized lack of accountability • No Child Left Behind Act • School districts develop criteria to measure performance • Test each year • Identify schools needing improvement • Sanctions to failing schools: losing students, changing management, losing funds

40. Reform: Accountability • Problems with No Child Left Behind Act • Output of the education production function • Standardized tests do not adequately test learning • Teaching to the test • Limited budgets: improvement to test scoresachieved by cutting funding from extracurricular activities • Scores also depend on student background and social factors • Harder for inner city schools to meet the standards

41. Reform: School Choice • Allow families to choose beyond the what is assigned • Bring elements of the free market into education • Families can choose • Competition between schools improves quality • Problems with school choice • Who are the choosers? • Self selection: educated and wealthy families will exercise the choice • Access to information • Can afford to pay extra under a voucher • Those left behind • Choice based on proximity to residence or work or based on composition of student body • Introduces more divisions in society

42. Effectiveness of the Reform • Effect on: • International gap • Inner city suburban gap • Empirical Evidence: • Hoxby (2004): Charter students more proficient than student attending district school • 3.8% in reading • 1.6% in math • Carnoy et al. (2005) and Roy and Mitchell (2005) find no significant difference: • Control for income and race • In general mixed results about the success of charter schools

43. Effectiveness of the Reform • Empirical Evidence: • Gil et al. (2001) finds small gains to minority student from voucher program • National Center for education statistics: children in public schools do as well after controlling for demographic variables • Blueston (2008): parental background and community factors are significant

44. Reform