by Art Rolnick, Senior Vice President and Director of Research, and Rob
Grunewald, Regional Economic Analyst, March 2003
development programs are rarely portrayed as economic development
initiatives, and we think that is a mistake. Such programs, if they appear
at all, are at the bottom of the economic development lists for state and
local governments. They should be at the top. Most of the numerous
projects and initiatives that state and local governments fund in the name
of creating new private businesses and new jobs result in few public
benefits. In contrast, studies find that well-focused investments in early
childhood development yield high public as well as private returns.
Why the case
for publicly subsidizing private businesses is flawed and misguided
Over the last
few years, the future of Minnesota's economy has been called into
question. The resulting debate illustrates how little is understood about
the fundamentals that underlie economic development. While many recognize
the success of the Minnesota economy in the past, they see a weakening in
the foundations of that success. Some point to the decline in corporate
headquarters located in Minnesota. Some point to the lack of funding for
new startup companies, particularly in the areas of high-tech and biotech.
Some point to the possible loss of professional sports teams. Some think
the University of Minnesota is not visible enough in the business
community. And still others raise the broader concern that Minnesota's
citizens and policymakers have become too complacent and unwilling to make
the public commitment to be competitive in a global economy.
Those who raise these concerns conclude that Minnesota and local
governments need to take a more active role in promoting our economy.
Often that implies that the state or local governments subsidize private
activities that the market is not funding. Proponents of this view argue
that without such subsidies, either well-deserving businesses will not get
funded or other states will lure our businesses to greener pastures.
State and local subsidies to private businesses are not new. In the name
of economic development and creating new jobs, Minnesota, and virtually
every other state in the union, has a long history of subsidizing private
businesses. We have argued in previous studies that the case for these
subsidies is short-sighted and fundamentally flawed. (See, for example, “Congress
Should End the Economic War Among the States,” Federal Reserve Bank
of Minneapolis Annual Report 1994.) From a national perspective, jobs
are not created—they are only relocated. From a state and local
perspective, the economic gains are suspect because many would have been
realized without the subsidies. In summary, what often passes for economic
development and sound public investment is neither.
private businesses is the wrong way to promote Minnesota's economy, then
what is the right way?
To answer this
question, we need to understand that unfettered markets generally allocate
scarce resources to their most productive use. Consequently, governments
should only intervene in markets when they fail.
Market failures can occur for a variety of reasons; two well-documented
failures are goods that have external effects or public attributes.
Unfettered markets will generally produce the wrong amount of such goods.
Education has long been recognized as a good that has external effects and
public attributes. Without public support, the market will yield too few
educated workers and too little basic research. This problem has long been
understood in the United States and it is why our government, at all
levels, has supported public funding for education. (According to the
Organisation for Economic Cooperation and Development, for example, the
United States in 1999 ranked high on public funding of higher education.
See the Economist, Nov. 12, 2002, p. 51.) Nevertheless, recent
studies suggest that one critical form of education, early childhood
development, or ECD, is grossly underfunded. However, If properly funded
and managed, investment in ECD yields an extraordinary return, far
exceeding the return on most investments, private or public.
A convincing economic case for publicly subsidizing education has been
around for years and is well supported. The economic case for investing in
ECD is more recent and deserves more attention.
Public funding of education has deep roots in U.S. history. John Adams,
the author of the oldest functioning written constitution in the world,
the constitution of the Commonwealth of Massachusetts, 1779, declared in
that document that a fundamental duty of government is to provide for
education. (McCullough, 2001, pp. 222-225) Publicly funded schools have
been educating children in the United States ever since. Today over 85
percent of U.S. children are educated in publicly funded schools. John
Adams argued for public funding of education because he realized the
importance of educated voters to the well-being of a democracy. We suspect
that he also understood the economic benefits that flow to the general
Investment in human capital breeds economic success not only for those
being educated, but also for the overall economy. Clearly today, the
market return to education is sending a strong signal. Prior to 1983, the
wages of a worker with an undergraduate degree exceeded a worker with a
high school degree by roughly 40 percent. Currently, that difference is
close to 60 percent. The wage premium for an advanced degree has grown
even more. Prior to 1985, the wages of a worker with a graduate degree
exceeded those of a worker with a high school degree by roughly 60
percent. Today, that difference is over 100 percent.
Minnesota represents a good example of the economic benefits that flow
from education. Evidence is clear that our state has one of the most
successful economies in the country because it has one of the most
educated workforces. In 2000, almost a third of persons 25 and older in
Minnesota held at least a bachelor's degree, the sixth highest state in
the nation. To ensure the future success of Minnesota's economy, we must
continue to provide a highly educated workforce.
case for public funding of early childhood development
Knowing that we
need a highly educated workforce, however, does not tell us where to
invest limited public resources. Policymakers must identify the
educational investments that yield the highest public returns. Here the
literature is clear: Dollars invested in ECD yield extraordinary public
The quality of life for a child and the contributions the child makes to
society as an adult can be traced back to the first few years of life.
From birth until about 5 years old a child undergoes tremendous growth and
change. If this period of life includes support for growth in cognition,
language, motor skills, adaptive skills and social-emotional functioning,
the child is more likely to succeed in school and later contribute to
society. (Erickson and Kurz-Riemer, 1999, p. 19) However, without support
during these early years, a child is more likely to drop out of school,
receive welfare benefits and commit crime.
A well-managed and well-funded early childhood development program, or
ECDP, provides such support. Current ECDPs include home visits as well as
center-based programs, and most programs involve the child's parents to
varying degrees. Some have been initiated on a large scale, such as
federally funded Head Start, while other small-scale model programs have
been implemented locally, sometimes with relatively high levels of funding
The question we address is whether the current funding of ECDPs is high
enough. We make the case that it is not, and that the benefits achieved
from ECDPs far exceed their costs. Indeed, we find that the return to
ECDPs far exceeds the return on most projects that are currently funded as
Many of the initial studies of ECDPs found little improvement; in
particular, they found only short-term improvements in cognitive test
scores. Often children in early childhood programs would post improvements
in IQ relative to nonparticipants, only to see the IQs of nonparticipants
catch up within a few years. (Farran, 2000, p. 511-512)
However, later studies found more long-term effects of ECDPs. One
often-cited research project is the High/Scope study of the Perry
Preschool in Ypsilanti, Mich., which demonstrates that the returns
available to an investment in a high-quality ECDP are significant. During
the 1960s the Perry School program provided a daily 2 ½-hour classroom
session for 3- to 4-year-old children on weekday mornings and a 1 ½-hour
home visit to each mother and child on weekday afternoons. Teachers were
certified to teach in elementary, early childhood and special education,
and were paid 10 percent above the local public school district's standard
pay scale. During the annual 30-week program, about one teacher was on
staff for every six children. (Schweinhart, 1993, p. 32)
Beginning in 1962, researchers tracked the performance of children from
low-income black families who completed the Perry School program and
compared the results to a control group of children who did not
participate. The research project provided reliable longitudinal data on
participants and members of the control group. At age 27, 117 of the
original 123 subjects were located and interviewed. (Farran, 2000, p. 516)
The results of the research were significant despite the fact that, as in
several other studies, program participants lost their advantage in IQ
scores over nonparticipants within a few years after completing the
program. Therefore a significant contribution to the program's success
likely derived from growth in noncognitive areas involving
social-emotional functioning. During elementary and secondary school,
Perry School participants were less likely to be placed in a special
education program and had a significantly higher average achievement score
at age 14 than nonparticipants. Over 65 percent of program participants
graduated from regular high school compared with 45 percent of
nonparticipants. At age 27, four times as many program participants as
nonparticipants earned $2,000 or more per month. And only one-fifth as
many program participants as nonparticipants were arrested five or more
times by age 27. (Schweinhart, 1993, p. xv, p. 55)
Other studies of ECDPs, while not solely focused on 3- to 4-year-old
children, also show improvements in scholastic achievement and less crime.
For example, the Syracuse Preschool Program provided support for
disadvantaged children from prenatal care through age 5. Ten years later
problems with probation and criminal offenses were 70 percent less among
participants compared with a control group. (Heckman, 2002, p. 46)
As the result of the Abecedarian Project in North Carolina, which provided
children from low-income families a full-time, high-quality educational
experience from infancy through age 5, academic achievement in both
reading and math was higher for program participants relative to
nonparticipants into young adulthood. Furthermore, participants had fewer
incidences of grade retentions and special education placements by age 15.
(Farran, 2000, pp. 513-515)
The High/Scope study conducted a benefit-cost analysis by converting the
benefits and costs found in the study into monetary values in constant
1992 dollars discounted annually at 3 percent. The researchers found that
for every dollar invested in the program during the early 1960s, over $8
in benefits were returned to the program participants and society as a
While 8-to-1 is an impressive benefit-to-cost ratio, policymakers should
place this result in context with returns from other economic development
projects. Perhaps another project can boast a higher benefit-to-cost
ratio. Unfortunately, well-grounded benefit-to-cost ratios are seldom
computed for public projects. However, an alternative measure—the internal
rate of return—can be used to more easily compare the public, as well as
private, return to investments. (The internal rate of return is the
interest rate received for an investment consisting of payments and
revenue that occur at regular periods.)
To calculate the internal rate of return for the Perry School program, we
estimated the time periods in which costs and benefits in constant dollars
were paid or received by program participants and society (see
We estimate the real internal rate of return for the Perry School program
at 16 percent. “Real” indicates that the rate of return is adjusted for
While program participants directly benefited from their increase in
after-tax earnings and fringe benefits, these benefits were smaller than
those gained by the general public. Based on present value estimates,
about 80 percent of the benefits went to the general public (students were
less disruptive in class and went on to commit fewer crimes), yielding
over a 12 percent internal rate of return for society in general. Compared
with other public investments, and even those in the private sector, an
ECDP seems like a good buy. This analysis suggests that early childhood
development is underfunded; otherwise, the internal rate of return on an
ECDP would be comparable to other public investments.
As with virtually all studies, there are caveats to the High/Scope
findings. On the one hand, the High/Scope study may overstate the results
we could achieve today. Problems facing children 30 years ago were
different from the problems facing children today. Single parenthood,
parental drug use, neighborhood crime are higher in many areas of the
country than they were 30 years ago. Therefore, the rate of return of an
ECDP today may be lower than the Perry School program.
Furthermore, in reviewing our method of calculating the internal rate of
return, one could argue that some of the payments and revenue streams
assigned should have started or ended in different years, or that
assigning an even distribution distorts the actual payments and revenue
made. Nevertheless, we find that the final result holds even when payments
and revenue are adjusted to a more conservative distribution.
On the other hand, the High/Scope study may understate the results we
could achieve today. First, the High/Scope study doesn't measure positive
effects on children born to participant families after the study period.
The knowledge gained by parents participating in the program likely
transferred to their younger children. Second, the study may further
understate the effects because it doesn't take into account effects on
future generations. With increased education and earnings, participants'
children would be less likely to commit crime and more likely to achieve
higher levels of education and income than if their parents hadn't
attended the Perry School program. A chain of poverty may have been
The returns to ECDPs are especially high when placed next to other
spending by governments made in the name of economic development. Yet ECD
is rarely considered as an economic development measure.
For example, tax increment financing and other subsidies have recently
been used to locate a discount retail store and an entertainment center in
downtown Minneapolis, and to relocate a major corporate headquarters to
suburban Richfield and a computer software firm to downtown St. Paul. Can
any of these projects, which combined represent an estimated quarter of a
billion dollars in public subsidies, stand up to a 12 percent public
return on investment? From the state's point of view, if the subsidy is
simply moving businesses within the state, the public return is zero. If
the subsidy is required for the business to survive, the risk-adjusted
public return is not merely small but could be negative.
As our lawmakers review proposals to build or improve the state's major
professional sports stadiums, let's not make the same mistake. The various
proposals to build new baseball and football stadiums and improve the
current basketball stadium total over $1 billion. Can new stadiums offer a
comparable public return on investment as an ECDP? How does a new stadium
reduce crime, increase earnings and potentially break a chain of poverty?
We propose that this $1 billion plus be invested in a project with a much
higher public return.
Minnesota Foundation for Early Childhood Development
create a foundation for early childhood development in Minnesota—isn't
born in a vacuum. For several years the state of Minnesota has sponsored
initiatives to help prepare children for kindergarten, specifically, Early
Childhood Family Education, or ECFE, School Readiness and state-funded
Head Start programs. These programs often work together in supporting
early childhood development.
ECFE provides support to parents and their children from birth until
kindergarten enrollment to promote the healthy growth and development of
children. The program offers classes for parents and provides optional
home visits. About $20 million in state aid was allocated to ECFE in 2001.
(Minnesota Department of Children, Families & Learning Web site, 2002)
Between the ages of 3 ½ to 5 years, children can participate in School
Readiness programs that provide a wide array of pre-kindergarten
activities for children in collaboration with other early childhood and
community programs. Funding for School Readiness was about $10 million in
2001 and reached 43,030 children. (Minnesota Department of Children,
Families & Learning Web site, 2002)
The state of Minnesota also allocated almost $19 million to supplement
federal funding ($59 million) for Head Start programs in 2000, with about
13,300 children and their families participating. However, according to a
state report, only 45 percent of eligible children and their families
received Head Start services. Some of these eligible children between the
ages of 3 ½ to 5 years who didn't receive help from Head Start
participated in School Readiness programs. (Minnesota Department of
Children, Families & Learning Web site, 2002) However, it is unlikely that
participation in School Readiness demonstrated the returns available in a
part- to full-day, long-term program.
We propose that the Minnesota state government create the Minnesota
Foundation for Early Childhood Development to fill the gap between the
funds currently available for ECFE, School Readiness and Head Start and
the amount necessary to fully fund a high-quality program for all 3- and
4-year-old children living in poverty in Minnesota. A one-time $1.5
billion outlay would create an endowment that could support ECDPs on an
annual basis. The foundation would receive donations from government,
private foundations, individuals and businesses. With the foundation's
funds invested in corporate AAA bonds, earning about 7 percent per year,
we estimate that the $105 million in annual earnings would cover the
yearly costs required to fully fund comprehensive, high-quality ECDPs for
all children from low-income families in Minnesota (see
The Minnesota Foundation for Early Childhood Development would provide
funding for well-supported and highly effective ECDPs, whether
supplementing funds for an existing Head Start center or helping start a
new program. The Foundation would provide additional resources to enhance
existing programs, such as boost teacher qualification and compensation,
reduce teacher-student ratios and expand curriculum resources.
Furthermore, the Foundation would provide startup funds for new ECDPs to
help reach all eligible children.
We contend that funding for ECDPs should reach the level of model program
status, such as the Perry School program, since this is the level at which
high returns have been demonstrated. Well-funded ECDPs would ensure that
all teachers have a degree in early childhood education and are paid at a
level that keeps turnover to a minimum. Furthermore, ECDPs would maintain
low student-to-teacher ratios and purchase high-quality curriculum
materials. Funds should also be allocated for research to track the
improvement of participating children and identify where additional
support may be needed. Participation by families in these programs should
be voluntary, but incentives should be provided for parents to
participate. ECDPs should work effectively with parents and include them
in the education process with their children.
view of economic development typically includes company headquarters,
office towers, entertainment centers, and professional sports stadiums and
arenas. In this paper, we have argued that in the future any proposed
economic development list should have early childhood development at the
top. The return on investment from early childhood development is
extraordinary, resulting in better working public schools, more educated
workers and less crime. A $1.5 billion investment to create the Minnesota
Foundation for Early Childhood Development would go a long way toward
ensuring that children from low-income families are ready to learn by the
time they reach kindergarten.
Granted that in today's tight fiscal environment, $1.5 billion is a
particularly large sum, which may mean we can't fully fund the program
immediately. But we should be able to fully fund the endowment over the
next five years. After measuring the public impact on the quality of life
that such a foundation can provide, the costs of not making such an
investment are just too great to ignore.
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