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Risk, return and early childhood

A conversation with Art Rolnick

Interview by Lisa G. Klein


Art Rolnick has been director of research and public affairs at the Federal Reserve Bank of Minneapolis since 1985. He directs research on banking, monetary policy, economic growth, business cycles, labour markets, and related public policy issues. His staff regularly collect and analyze data on regional economies for reports presented at the Federal Open Market Committee, which is chaired by Alan Greenspan and is in charge of setting national monetary policy. He talks here about some unlikely banking and economic issues, most unusually, the economic value of human capital and the return on investment of sound early childhood practices.

What can state and local governments do to promote economic development?

Conventional economic development policies use public subsidies and tax breaks to attract businesses and jobs from one location to another. Such polices lead to economic bidding wars and are counterproductive. Allowing cities and states to lure businesses from other cities and states with public funds only moves jobs around; it does not create any new ones. Indeed, many of these businesses might have made the same location decision without the subsidy. And what happens when regions that have lost businesses begin to retaliate with higher subsidies and win some of the jobs back? The end result is that the public return on such investments is zero. And when the subsidy goes to high-risk businesses, ones that are likely to fail, the return can even be negative.

If providing public subsidies to private businesses is the wrong way to promote economic development, what is the right way? The research on this question is quite persuasive. It shows that state and local governments should instead use their limited resources on developing their public goods and, in particular, their communities' human capital, which is their workforce.

When did you start to focus on early childhood development?

It began when I started to review the research on learning and brain development. I have been particularly influenced by the work of Professor James Heckman, Nobel Laureate in economics from the University of Chicago. I reviewed some of the key longitudinal research studies in early childhood development: the Abecedarian study, the Chicago Child Parent Centre study, and the studies done in Ypsilanti and Syracuse.

Results consistently show that high quality early childhood programmes help kids enter kindergarten with the skills they need to learn and that those children continue to be successful in school and ultimately become contributing members of society. Most significantly, the crime rate among those who participate in these programmes falls dramatically. The research shows that positive outcomes for at-risk children can be achieved and that the cost-benefit ratio and rates of return yield a high public return. This is in contrast to the 0% return on public subsidies to private businesses that I referred to earlier. Less crime and a well-educated workforce lead to the long-term payoff of economic growth and development.

Many of the studies you cite are not new and the cost-benefit rationale for investing in early childhood has been raised before. What is different about your approach?

Our frame of reference is economic, not social. We think of early childhood development as economic development in human capital. The studies show that the public gets a better return on its investment if government focuses its resources on human capital (education, especially education in the very early years) than on physical capital (businesses). The problem with promoting early childhood development as economic development is that it is a much longer-term project and a much less visible one than an investment in physical capital. Investments in early childhood education do not result in a factory or an office tower or a sports arena. Early childhood development is mostly invisible to the public and its benefits are mostly in the distant future.

Our approach to calculating net-benefits is also different. The 1963 Ypsilanti study (also known as the High/Scope study of the Perry Preschool Programme), which followed students' performance for over 27 years, reported an 8:1 benefit-to-cost ratio. We used an alternative measure, the internal rate of return, to compare the public and the private return on investment. The internal rate of return is the interest rate received on an investment that consists of payments and revenues that occur at regular periods.

For the Perry Preschool Programme, we estimated the time periods in which costs and benefits were paid or received by programme participants and by the public in inflation-adjusted dollars. The result is an estimate of the average, annual real (adjusted for inflation) rate of return on investment at 4% to the individual and 12% to the public.

The return to the programme participants was 4% because, on average, their earnings were that much more than nonparticipants' earnings. And the return to the public was 12% because, on average, the cost of educating participants went down in the K 12 schools, and because participants were much less likely to commit crimes than nonparticipants. Had the same amount of money been invested in the stock market as opposed to early intervention, the annual rate of return would only have been 7%.

How confident can we be that we can earn this high return today? On the one hand, critics will suggest that in today's world the results are overstated. It is true that problems facing young children today, such as single parenthood, drug use, and neighborhood crime, have increased, and that therefore the return may be lower. It could be argued that in the calculation some of the revenue and payments would have been made at different times, though when payments and revenues are adjusted at a more conservative distribution, the return is still very high.

On the other hand, an argument can be made that the results are understated. The original study of cost-benefits did not take into account the sibling effect and did not measure the positive effects on children born to participating families after the study period. Nor did it take into account the effects of increased parent knowledge on future generations.

So what do you recommend?

Since we think of this issue as a public investment, we are looking for the programmes with the highest rates of return. This implies that we should first fund early childhood development programmes for at-risk kids. Eventually we would make these programmes available to all children on a sliding-fee schedule.

In Minnesota we are proposing the creation of a foundation for early childhood development with an endowment fund of $1.5 billion secured over the next 5 years. An endowment is key so we don't get caught up in cyclical problems with budgets. A constitutional amendment guarantees sustainability of funds for the long term. These would be new funds allocated for early childhood development that would be a net addition to the funds already allocated to Head Start and other existing programmes. Investing the fund in bonds yielding a 7% annual return would yield about $100 million per year in interest. The interest on this investment alone would be enough to guarantee that every 3- and 4-year-old child living in poverty in Minnesota would have access to a high quality early childhood development programme, based on a cost of $10,000 per child per year.


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