Chapter 14: Education

1. Chapter 14: Education • Education is an investment in human capital • That investment benefits society, and should therefore be subsidized? • That benefit also benefits the individual, and should therefore not be fully subsidized? • Education is divided into 2 categories: • Elementary and Secondary • Post-Secondary • Education often has funding from all 3 levels of government

2. Chapter 14: Education • Introduction • Market Failure • Income Redistribution • Education Control and Funding • Education Spending • Challenges and Future Directions

3. Education 101: Introduction 2009 Education Spending stats: • 16.1% of government spending • 6.3% of GDP • $95 Billion • 53% on elementary and secondary • 41% on post-secondary Some education spending is private (2004-05): • 10% of elementary and secondary • 39.6% of post secondary

4. Education Spending

5. History - Education Organization • Unlike most other industrialized nations, Canada has no central education agency • Constitution Act of 1867 assigned education to the provinces • Federal government only covers armed forces children, inmates, Indian, and Inuit education • Federal Government has funded post-secondary education since WWII (Canada Social Transfer – CST) • Spending varies greatly among provinces:

6. Moral Hazard

7. Elementary and Secondary Funding • Each province has a different funding model for elementary and secondary schools • Some provinces largely fund schools, others allow for more local funding (and typically therefore control) • Some provinces/local governments use property taxes to fund education

8. Elementary and Secondary Funding

9. Elementary and Secondary Funding • Quebec, Ontario, Saskatchewan and Alberta – taxes support public and separate (religious) school systems • Nova Scotia and PEI support only public schools • Newfoundland, Maritimes, Ontario supports no private schools • Manitoba supports private secondary • Quebec, Saskatchewan, Alberta and BC partially fund private schools that meet government standards

10. History - Post-Secondary Funding • Post-secondary education is a provincial responsibility but: • 1885 – Federal Government gives land to University of Manitoba • After WWII – Federal government gave per student grants based on enrolled veterans • 1951 – Federal government gave grants to universities according to provincial population

11. History - Post-Secondary Funding • 1967-1976 – Grants covered 50% of post-secondary operating expenses • 1977 – grants became conditional lump-sum grants • 2004-05 Canadian Social Transfer (CST) includes funding for post secondary Education (PSE) • 2010-11, $3.4 billion was earmarked for PSE • Provinces aren’t forced to use this for PSE

12. Employee Training • Formal, on-the-job training has increased from 29% of workers (1997) to 36% of workers (2008) • Among OECD countries, Canada has: • the highest proportion of young individuals with some post-secondary • Average job-training participation rates • Per-employee spending by firms on training is lower than other OECD countries and US • Is this an issue?

13. Market Failure and Education • Education seems to be a private good: • An individual increases their human capital, and then benefits • For education to be government funded (through failure of the first fundamental theorem of welfare economics), we have to consider: • Market Power • Asymmetric Information • Externalities In order to justify government involvement

14. 1) Market Power and Education Two things could cause monopolies in education: a) High transportation costs b) Economies of scale While this MAY occur in some rural settings and small communities… In most areas of (highly urbanized) Canada, schooling competition can exist. Market power doesn’t create market failure and argue for public schools.

15. 2) Asymmetric Information Asymmetric Information and Market Failure can be analyzed along 3 lines: a) Insufficient Information for Informed Decisions b) Imperfect Capital Markets c) Education as a Signal

16. 2a) Insufficient Information If parents make schooling decisions, in order for them to make correct decisions, they need to: • Have all information available • Have interest in examining the information • Have the ability to understand the information Otherwise the market fails. Government schooling provides compulsory uniformity of schooling preventing: • Uninformed parents • Short-sighted parents • Self-serving parents

17. 2b) Imperfect Capital Markets Poor families and unsupported students lack the capital to borrow to afford expensive education The government could simply provide school loans at the going rate of interest. • But there’s no guarantee that younger children will help their parents pay back the loan • Post-secondary students could assume the loan themselves, however Imperfect capital markets cause market failure, arguing for public elementary and secondary schools, and post-secondary student loans

18. 2c) Education as a Signal • Innate ability is required to survive education. • Therefore education invests in human capital and signals innate ability. • Some firms require certain education due to the innate ability they require • (although the education isn’t required) • Therefore some students may acquire education for the innate ability signal (to get a job) instead of the investment in human capital. • Public education prevents an OVERCONSUMPTION of education to get this signal

19. 3) Externalities The market fails and public support of education is justified if POSITIVE EXTERNALITIES exist (recall they can’t be aspects that lead to a higher wage). These may include: • Public schools promote diversity, including recent immigrants • Education is vital to good democracy • Education may lead to new technologies, leading to higher productivity, incomes and thus lower crime rates If these are true:

20. Education as a Public Externality If the government subsidizes education, it is no longer underprovided at E1 and can give net benefit abc

21. Education Notes It is possible that the cost of subsidies (through distortionary taxation) may outweigh benefits Surprisingly, elementary and secondary education is fully publicly funded, whereas preschool education and post-secondary education isn’t. Positive externalities could be handled through subsidies, but instead we have elementary and secondary government provision -Perhaps indoctrination/social stability is a reason for government involvement

22. Job Training and Externalities If Job training also carries a positive externality, there is an argument for it to be subsidized -This sometimes occurs through tax breaks or direct expenditures -Quebec and Ontario give training tax breaks -Little Canadian evidence exists for increased productivity from private or public expenditure on training -The return to the government for subsidizing training is unknown

23. Income Redistribution – Elementary and Secondary Education • Public education leads to social mobility and EQUALITY OF OPPORTUNITY • Education in Canada, Australia and the United States have allowed immigrants to move up on economic and social structures • COMMODITY EGALITARIANISM (some commodities should be available to everyone) would put value on education beyond an individual’s gain

24. Income Redistribution – Elementary and Secondary Education • Government support could take a variety of forms: • Lump-sum transfer (doesn’t guarantee education) • Education Vouchers • Mandatory public education • Note that local support of elementary and secondary education results in local income redistribution (from the old to the young)

25. Income Redistribution – Post-Secondary Education • Public support of Post-Secondary Education amounts to subsidized tuition • Since all programs have the same tuition, some programs (with higher costs) are more subsidized than others: • Medicine, Dentistry, Engineering – high subsidies • Arts, Commerce, Law, Sciences – low subsidies • The first group tends to give higher private returns • This is justified if the first group has higher positive externalities (debatable)

26. Income Redistribution – Post-Secondary Education • If tuition goes up, demand for a degree decreases • But why should these public funds go to a university student instead of someone opening a small business? • Typically, university students come from higher-income families and earn higher lifetime wages • Therefore tuition support redistributes income from the poor to the rich, and greater inequality • Large positive externalities would need to exist to offset this fact

27. Student Loans • Imperfect Capital Markets argue for government student loans (not subsidized tuition) • Without positive externalities, the rate of return should be the going rate • While the idea of student debt may discourage potential students, this could be a GOOD thing • Students only borrow for a degree if it is worth it in the long run • Financial constraints explain little of post-secondary attendance at lower incomes (Frenette 2008)

28. Student Loans • Some suggest linking student loan repayment to after-graduation income • This would help income distribution • BUT it may also encourage students to get worse degrees to benefit from better loan repayments • Without externalities from these low-income subsidies, there may be better ways to redistribute income

29. Current Post-Secondary Situation • Government Grants cover 56% of Canadian college and university operating income (04-05) • Tuition accounts for 36% (04-05) (as opposed to 40-50% in the 1950’s) • Student loans account for further public subsidy • Economically, these subsidies are only justified if the positive externalities are high • Otherwise tuition should increase, balanced with a better student loan program

30. Review - Situation Thus Far Education should only be subsidized if causes the first fundamental theorem of welfare economics to fail – the market would fail otherwise. • Education doesn`t suffer from market power • Asymmetric Information argues that elementary and secondary education is a public good, and student loans should be available for post-secondary education • Positive Externalities MAY exist.

31. Post Secondary Situation Unless positive externalities strongly exist… Tuition subsidies should be replaced by a better student loan program (tuition should increase)

32. Control and Funding of Education Control of Education (often through funding of education) can come from any of the levels of government, each with arguments for and against: • Local • Provincial • Federal

33. Local Education Control Pros: • Education can be tailored to the local community • Since the community benefits most from education, it should pay the cost of education (therefore MB=MC, efficiency) • Higher accountability due to strong link between those who pay and those who benefit • Local control may be lower cost

34. Local Education Control Cons: • Since local funding comes from property taxes, richer communities could have better schools, promoting inequality • Tax competition between local communities may push down taxes and therefore push down education quality (typically common provincial standards result in INCREASING expenditure to the highest common denominator)

35. Provincial Education Control Since income varies among school districts, it makes sense for provinces to have a large role in elementary and secondary education. Each province does this differently, sometimes with local contributions, sometimes not. Bird and Slack (1983) argue for complete provincial takeover leading to WEALTH NEUTRALITY where wealth of a local area, or ability to pay, has no impact on quality of education All provinces have policies contributing to WEALTH NEUTRALITY

36. Provincial Education Grants If a province doesn’t fully fund elementary and secondary education, it can instead provide grants to local jurisdictions, including: • FOUNDATION GRANTS that ensure a minimum level of education per student (used in Ontario, Alberta, Saskatchewan and PEI) • PERCENTAGE EQUALIZATION GRANTS that increase as local spending increases

37. Foundation Grants Foundation grants are: • Conditional (must be spent on education) • Based on local property wealth (not education spending or tax rate, so these grants have an INCOME EFFECT but no SUBSTITUTION EFFECT) Grants (G) are calculated based on a provincial per-student expenditure level (E), provincially determined tax rate (t) and a jurisdiction's per student tax base: G=(E-tB)

38. Foundation Grants

39. Foundation Grants Foundation grants only determine a minimum expenditure in each school board. It can then: • Let local jurisdictions chose their tax rate • Let local jurisdictions chose a take rate equal to or higher than t • Force local jurisdictions to chose tax rate t (Ontario) A foundation grant doesn’t recognize and encourage any externalities from education…

40. Percentage Equalization Grants If positive externalities exist in education, increased education spending should be linked to increased grants that: • Are conditional (must be spent on education) • Increase with increased spending (thus increasing education through the grant and the increased local revenues to increase spending) This grant causes an income AND substitution effect for education, possibly decreasing consumption for education in rich areas:

41. Percentage Equalization Grants Notice that c decreasing in the wealthy jurisdiction

42. Percentage Equalization Grants Percentage equalization grants are calculated as: %=1-L(B/V) Where % is the % amount of spending the province provides L is the share of funding to be provided by the jurisdiction with the average per-student tax base B is a jurisdiction’s per-student tax base V is the average jurisdiction’s per-student tax base

43. Percentage Equalization Grants %=1-L(B/V) Notice: • In the case of the average jurisdiction, B/V=1 and the province supplies 1-L% of the funding (if L=0.6, the province supplies 40%) • In the case of a rich jurisdiction where B/V=1.5, the province supplies less of the funding (if L=0.6, the province supplies 10%) • In the case of a poor jurisdiction where B/V=0.5, the province supplies more of the funding (if L=0.6, the province supplies 70%)

44. Provincial Grant Notes None of these programs take into account the COSTS DIFFERENCES in different jurisdictions -In BC, grants are linked to costs, such as teachers’ salaries and student composition Note that all the above graphs assume no distortionary effects from the taxes funding the grants. In reality, taxes would shift the budget constraints to the left, which may affect the viability of the new outcome (especially in rich areas).

45. What do Grants Accomplish? Provincial grants transfer funds to poorer areas, and then lead us to 2 questions: • Do grants cause higher expenditures in education? • Certainly in poorer areas but perhaps with decreases in rich areas 2) Does higher expenditures lead to better education? • We see later that there is evidence higher expenditures may not lead to better education, especially through provincial funding

46. Federal Education Funding -Federal government covers public schooling for armed forces children, inmates, Indians, and Inuit -Aside from those areas and the Canada social transfer, the federal government is primarily in post-secondary education The following table shows some areas of federal government spending in post-secondary education

47. Federal Education Funding

48. Federal Education Funding -Graduates from strong post-secondary systems often take their human capital elsewhere for jobs: • Graduates often leave Saskatchewan and Atlantic Canada • Industrial booms bring graduates to Ontario • Resource booms bring graduates to Alberta • Since provinces may not benefit from their graduates, there is an incentive for them to underinvest in education • But Canada benefits as a whole

49. Federal Education Funding Notes • Although the Canada Social Transfer goes into provincial coffers and may not all go to education, the other grants are more targeted • Research grants are due to large social returns to research (Murphy and Topel, 1999) • And since research results are a public good, free rider problems are possible and public support is a good solution • The Canada Student Loan Program attempts to address imperfect capital markets

50. Education Spending Is education spending high enough? • The debate over this question brings up 2 questions: • Do higher expenditures lead to better education? • Are we getting an adequate rate of return of existing education expenditures?