Chapter 14: Education
Education is an investment in human capital
That 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 Secondary
Post-Secondary
Education often has funding from all 3 levels of
government
Chapter 14: Education
Introduction
Market Failure
Income Redistribution
Education Control and Funding
Education Spending
Challenges and Future Directions
Education 101: Introduction
2009 Education Spending stats:
16.1% of government spending
6.3% of GDP
$95 Billion
53% on elementary and secondary
41% 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 provinces
Federal government only covers armed forces
children, inmates, Indian, and Inuit education
Federal Government has funded postsecondary 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 Funding
Quebec, Ontario, Saskatchewan and Alberta –
taxes support public and separate (religious)
school systems
Nova Scotia and PEI support only public
schools
Newfoundland, Maritimes, Ontario supports no
private schools
Manitoba supports private secondary
Quebec, Saskatchewan, Alberta and BC
partially fund private schools that meet
government standards
History - Post-Secondary Funding
Post-secondary education is a provincial
responsibility but:
1885 – Federal Government gives land to
University of Manitoba
After WWII – Federal government gave per
student grants based on enrolled veterans
1951 – Federal government gave grants to
universities according to provincial population
History - Post-Secondary Funding
1967-1976 – Grants covered 50% of postsecondary operating expenses
1977 – grants became conditional lump-sum
grants
2004-05 Canadian Social Transfer (CST)
includes funding for post secondary Education
(PSE)
2010-11, $3.4 billion was earmarked for PSE
Provinces 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-secondary
Average 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 Information
If 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 loan
Post-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 Signal
Innate 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) Externalities
The 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 Notes
It 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 Externalities
If 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
Education
Public education leads to social mobility and
EQUALITY OF OPPORTUNITY
Education 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 education
 Note 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 subsidies
Arts, 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
decreases
But why should these public funds go to a university
student instead of someone opening a small
business?
Typically, university students come from higherincome 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 Loans
Imperfect Capital Markets argue for government
student loans (not subsidized tuition)
Without positive externalities, the rate of return
should be the going rate
While the idea of student debt may discourage
potential students, this could be a GOOD thing
Students only borrow for a degree if it is worth it in
the long run
Financial constraints explain little of postsecondary attendance at lower incomes
(Frenette 2008)
Student Loans
Some suggest linking student loan repayment
to after-graduation income
This 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 Situation
Government 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 Far
Education 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 Control
Pros:
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 Control
Cons:
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 Control
Since 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 Grants
If 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 Grants
Foundation 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 Grants
Foundation 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
Canada
Industrial booms bring graduates to Ontario
Resource 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 results
Studies 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 education
Due 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 sessions
 TARGETTED class size reductions could
produce better results
Return on Education
Economics is the study of using limited
resources to satisfy unlimited wants
In general, society’s resources are best spent
on the highest rate of return
They 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 costs
Social rate of return must consider private benefits,
external benefits, and costs
Return on Education
Moussaly-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 Challenges
A 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 quality
Give students “tuition vouchers” that allow
competition
This requires funding of private options
(including private and charter schools)
1) Competition
But this has issues:
Lack of parent information
Reduced 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 Accountability
All 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 Conclusion
Provinces 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 Conclusion
Much of education’s return is privately realized
Public 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 Conclusion
2 future Canadian education concerns are
school competition and accountability