Chapter 14: Education

Education is an investment in human capitalThat 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 SecondaryPost-Secondary

Education often has funding from all 3 levels of government

Chapter 14: EducationIntroductionMarket FailureIncome RedistributionEducation Control and FundingEducation SpendingChallenges and Future Directions

Education 101: Introduction

2009 Education Spending stats:16.1% of government spending6.3% of GDP$95 Billion53% on elementary and secondary41% on post-secondary

Some education spending is private (2004-05):10% of elementary and secondary 39.6% of post secondary

Education Spending

History - Education Organization

Unlike most other industrialized nations, Canada has no central education agency

Constitution Act of 1867 assigned education to the provincesFederal 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:

Moral Hazard

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

Elementary and Secondary Funding

Elementary and Secondary FundingQuebec, Ontario, Saskatchewan and Alberta –

taxes support public and separate (religious) school systems

Nova Scotia and PEI support only public schoolsNewfoundland, Maritimes, Ontario supports no

private schoolsManitoba supports private secondaryQuebec, Saskatchewan, Alberta and BC

partially fund private schools that meet government standards

History - Post-Secondary FundingPost-secondary education is a provincial

responsibility but:1885 – Federal Government gives land to

University of ManitobaAfter WWII – Federal government gave per

student grants based on enrolled veterans1951 – Federal government gave grants to

universities according to provincial population

History - Post-Secondary Funding1967-1976 – Grants covered 50% of post-

secondary operating expenses1977 – grants became conditional lump-sum

grants2004-05 Canadian Social Transfer (CST)

includes funding for post secondary Education (PSE)

2010-11, $3.4 billion was earmarked for PSEProvinces aren’t forced to use this for PSE

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-secondaryAverage job-training participation rates

Per-employee spending by firms on training is lower than other OECD countries and US

Is this an issue?

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:

1)Market Power

2)Asymmetric Information

3)Externalities

In order to justify government involvement

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.

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

2a) Insufficient InformationIf parents make schooling decisions, in order for

them to make correct decisions, they need to:1) Have all information available

2) Have interest in examining the information

3) Have the ability to understand the information

Otherwise the market fails.

Government schooling provides compulsory uniformity of schooling preventing:1) Uninformed parents

2) Short-sighted parents

3) Self-serving parents

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 loanPost-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

2c) Education as a SignalInnate 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

3) ExternalitiesThe 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:

1)Public schools promote diversity, including recent immigrants

2)Education is vital to good democracy

3)Education may lead to new technologies, leading to higher productivity, incomes and thus lower crime rates

If these are true:

Education as a Public Externality

If the government subsidizes education, it is no longer underprovided at E1 and can give net benefit abc

Education NotesIt 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

Job Training and ExternalitiesIf 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

Income Redistribution – Elementary and Secondary

EducationPublic education leads to social mobility and

EQUALITY OF OPPORTUNITYEducation 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

Income Redistribution – Elementary and Secondary Education

Government support could take a variety of forms:

1)Lump-sum transfer (doesn’t guarantee education)

2)Education Vouchers

3)Mandatory public educationNote that local support of elementary and

secondary education results in local income redistribution (from the old to the young)

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 subsidiesArts, 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)

Income Redistribution – Post-Secondary Education

If tuition goes up, demand for a degree decreasesBut 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

Student LoansImperfect Capital Markets argue for government

student loans (not subsidized tuition)Without positive externalities, the rate of return

should be the going rateWhile the idea of student debt may discourage

potential students, this could be a GOOD thingStudents 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)

Student LoansSome suggest linking student loan repayment

to after-graduation incomeThis 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

Current Post-Secondary SituationGovernment 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

Review - Situation Thus FarEducation should only be subsidized if causes

the first fundamental theorem of welfare economics to fail – the market would fail otherwise.

1) Education doesn`t suffer from market power

2) Asymmetric Information argues that elementary and secondary education is a public good, and student loans should be available for post-secondary education

3) Positive Externalities MAY exist.

Post Secondary Situation

Unless positive externalities strongly exist…

Tuition subsidies should be replaced by a better student loan program (tuition should

increase)

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:

1)Local

2)Provincial

3)Federal

Local Education ControlPros:

1)Education can be tailored to the local community

2)Since the community benefits most from education, it should pay the cost of education (therefore MB=MC, efficiency)

3)Higher accountability due to strong link between those who pay and those who benefit

4)Local control may be lower cost

Local Education ControlCons:

1)Since local funding comes from property taxes, richer communities could have better schools, promoting inequality

2)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)

Provincial Education ControlSince 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

Provincial Education GrantsIf a province doesn’t fully fund elementary and

secondary education, it can instead provide grants to local jurisdictions, including:

1)FOUNDATION GRANTS that ensure a minimum level of education per student (used in Ontario, Alberta, Saskatchewan and PEI)

2)PERCENTAGE EQUALIZATION GRANTS that increase as local spending increases

Foundation GrantsFoundation grants are:

1)Conditional (must be spent on education)

2)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)

Foundation Grants

Foundation GrantsFoundation grants only determine a minimum

expenditure in each school board. It can then:

1)Let local jurisdictions chose their tax rate

2)Let local jurisdictions chose a take rate equal to or higher than t

3)Force local jurisdictions to chose tax rate t (Ontario)

A foundation grant doesn’t recognize and encourage any externalities from education…

Percentage Equalization Grants

If positive externalities exist in education, increased education spending should be linked to increased grants that:

1)Are conditional (must be spent on education)

2)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:

Percentage Equalization Grants

Notice that c decreasing in the wealthy jurisdiction

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

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%)

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).

What do Grants Accomplish?

Provincial grants transfer funds to poorer areas, and then lead us to 2 questions:

1)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

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

Federal Education Funding

Federal Education Funding

-Graduates from strong post-secondary systems often take their human capital elsewhere for jobs:Graduates often leave Saskatchewan and Atlantic

CanadaIndustrial booms bring graduates to OntarioResource 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

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

Education Spending

Is education spending high enough?The debate over this question brings up 2

questions:

1)Do higher expenditures lead to better education?

2)Are we getting an adequate rate of return of existing education expenditures?

Education and Expenditures

We have no “production function” for education (Education =f(expenditures)?)

We have difficulty even measuring education.Some attempts at measuring increased human

capital have been:

test scores, attendance records, drop-out rates, continuation to higher education, unemployment rates, earnings

Education and Expenditures

Hanushek(2002) examined 376 statistical estimations of various inputs’ impacts on various education measurements in 89 publications, including:

-teacher/pupil ratio, teacher education, teacher experience, teacher salary, expenditures per pupil

He found the data showed almost no correlation between inputs and education

Education and Expenditures

We know there are good schools (U of A) and bad schools (University of Podunk) But determining the difference is harder than

examining differences in inputs

Johnson (2005) in Ontario found that some hard-to-measure inputs did determine school quality – teamwork, strong extracurricular programs, and effective use of volunteers

Surprising resultsStudies have shown that, over a large range,

class size doesn’t matter.As we see in the following tables, student-teacher

ratios have decreased over time

Therefore smaller class sizes may not be a valuable idea.Jepson and Rivkin (2002) found that a 1996 law

reducing California class size had no effect on the quality of educationDue to lower quality of additional teachers

Surprising results

Surprising Qualifications

Reducing class size generally means hiring inexperienced teachers, reducing teacher quality

Even though classes of 20 and 30 have no noticeable difference, benefits may exist:

1)With even smaller sizes

2)With tutoring sessionsTARGETTED class size reductions could

produce better results

Return on EducationEconomics is the study of using limited

resources to satisfy unlimited wantsIn general, society’s resources are best spent on

the highest rate of returnThey should at least give a reasonable rate of return

(or social rate of return)Otherwise, spending should be directed elsewhere

Social rates of return are hard to calculate:Private rate of return looks at private income and

private costsSocial rate of return must consider private benefits,

external benefits, and costs

Return on EducationMoussaly-Sergieh and Vaillancourt (2009) used

2001 census data of earning profiles to estimate returns to education:

Return on Education Notes

These studies don’t consider the fact that as education is funded through taxes, the MCF is generally greater than $1.

In addition, some of the rate may simply be due to innate ability and not the education gained

The rates on the previous table make it hard to justify more tax-financed expenditures on higher education

Future ChallengesA 2011 poll showed 70% of Canadians identified

education as an area the government should be spending more.

Future challenges and possible solutions Canadian Education Faces are:

1)Competition

2)School Accountability

If more money won’t solve the problem, what will?

1) Competition?Possible Solutions:Open elementary and secondary schools up to

competition for students to improve qualityGive students “tuition vouchers” that allow

competitionThis requires funding of private options

(including private and charter schools)

1) CompetitionBut this has issues:

Lack of parent informationReduced positive externalities as schools

focus on earning potential over society benefit

Good students would group together in good schools, leaving poor students behind

Upper income parents (who would normally pay for private schools) are subsidized, resulting in regressive income redistribution.

1) School AccountabilityAll provinces have some form of standardized

testing to monitor school performance BUT:

a)School rankings fails to control for socioeconomic conditions (Johnson 2005)

b)Testing is only valuable if there is a reward/punishment system (Hanuchek and Raymond 2005)

c)Teachers may teach on how to take the test, instead of teaching the material (Jacob 2005)

d)Schools and teachers may “strategically game” (cheat) (Jacob and Levitt 2003)

Chapter 14 ConclusionProvinces handle education, sometimes with

the help of local property taxes, sometimes not

All provinces have grants to achieve minimum per pupil expenditure, promoting wealth neutrality in education

Local education funding and control is justified on varying tastes, externalities being local

Local education funding and control is problematic due to equity considerations, and inefficiencies due to tax competition, leading to provincial involvement

Chapter 14 ConclusionMuch of education’s return is privately

realizedPublic support of Education is justified

through externalities (post-secondary) and asymmetric information (elementary and secondary)

The return to investment in post-secondary education may argue for higher tuition and better loan programs

Little evidence exists for a strong relationship between education spending and education outcome

Chapter 14 Conclusion2 future Canadian education concerns are

school competition and accountability