1. Part 4 The 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
Country
Expenditure /student ($)
Expenditure as % of GDP
United States
8855
3.5
Norway
8476
3.9
Italy
7218
3.2
Australia
6894
Sweden
6339
4.9
Japan
6266
2.7
Netherlands
5912
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. Market for K-12 $
Demand
Supply (MC)
$5,000
Q equilibrium
Quantity

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

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

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

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 Charter 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 scores achieved 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