How early childhood programs affect economic development, and why spending isn’t more important

Early childhood programs primarily affect local economic development by helping their child participants develop into adults with better skills.  Of secondary importance are the benefits of these programs for parents, for example in providing free child care.  Of much less importance are the effects on these programs via multiplier effects of government spending for these programs, for example the increased spending of preschool teachers at local retailers.

For example, in chapter 4 of Investing in Kids, I estimate that for every dollar invested in universal pre-K, the “economic development benefits” for a state — which is the increased present value of state residents’ earnings — goes up by $2.78. Of that $2.78, $2.69 is due to effects on former child participants who stay in the state, $0.05 is due to effects on parents, and $0.04 is due to the increased government spending on preschool. Effects on parents are greater for other early childhood programs, such as high-quality full-time child care. However, the economic models I use suggest that the economic development benefits of simply spending more taxpayers’  money on early childhood programs are modest relative to the costs.

Why aren’t the spending multiplier effects of early childhood programs greater? First, what I am modeling are the effects of spending more money on early childhood programs when that spending is financed by higher state taxes. By itself, spending more money on early childhood programs has larger multiplier effects. Preschool teachers will spend more money at local restaurants and other local retailers, boosting local output and employment in these industries.  Preschools and other early childhood programs will buy some supplies from local sources, providing another local economic boost.

But state governments must, as a general rule, balance their budgets. Therefore, the increased local demand due to more spending must be matched by higher state taxes. These higher state taxes will reduce the after-tax incomes of state residents, which will reduce their spending on state goods and services.

There is some net demand stimulus from simultaneously increasing state taxes and spending. This is one form of what in macroeconomics is known as the balanced budget multiplier effect. This balanced budget multiplier effect can be especially important at the state level. (This point was made forcefully in a short 2001 paper for the Center on Budget and Policy Priorities by Peter Orszag, President Obama’s first director of OMB, and Nobel prize-winning economist Joseph Stiglitz.)   The increased spending tends to affect demand for state goods and services more than the increased taxes. Much of the increased government spending directly goes to hire state workers and buy state goods. On the other hand, a large percentage of the increased taxes will reduce demand for goods and services produced in other states — for example, due to increased taxes, a state resident may make fewer purchases at online retailers, or spend less on out-of-state travel.

However, the key point here is that although the net effect of more spending and taxes is positive, this net effect is smaller than if this increased spending was somehow funded by some organization or person from outside the state.

A second point is that any stimulative effect of more spending and taxes causes a one-time increase in the level of state output and earnings. This one-time shock to the level of labor demand will raise local employment rates and wage rates, However, the effect on local employment rates and wage rates will tend to dissipate gradually over time due to migration (and eventually, mortality). This dissipation reduces the effects of taxing and spending on the present value of local per capita income.

About timbartik

Tim Bartik is a senior economist at the Upjohn Institute for Employment Research, a non-profit and non-partisan research organization in Kalamazoo, Michigan. His research specializes in state and local economic development policies and local labor markets.
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