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Art Rolnick

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, labor 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.

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

A: 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.

Q: When did you start to focus on early childhood development?

A: 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 Center study, and the studies done in Ypsilanti and Syracuse.

Results consistently show that high quality early childhood programs 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 programs 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.

Q: 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?

A: 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 Program), 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 Program, we estimated the time periods in which costs and benefits were paid or received by program 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 program 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.

Q: So what do you recommend?

A: Since we think of this issue as a public investment, we are looking for the programs with the highest rates of return. This implies that we should first fund early childhood development programs for at-risk kids. Eventually we would make these programs 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 programs. 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 program, based on a cost of $10,000 per child per year.

Q: Why target at-risk children in this age group?

A: Research shows that by targeting at-risk children you get the highest rates of return. The economics are such that it is not clear that funding a universal program yields the same returns. This is in part because of the high costs associated with the service delivery and the fact that not all children reap the same benefits, particularly those from families that already provide stimulating learning environments at home. The gains those children make are not as high, therefore the return is not as high. In addition, we wouldn't expect to use public funds to subsidize those that are able and already using quality early childhood programs.

Q: How will you raise the funds for the endowment?

A: We are planning on doing this over a 5-year period. We anticipate that private foundations and companies in the corporate community will provide a third of the funding. We are looking to secure one-third from dedicated general revenue from the state and the final third from a federal appropriation associated with the No Child Left Behind Act of $400 million over the 5 years.

Q: Have you built in provisions for accountability?

A: To ensure accountability, funding will only go to programs that show positive results. Programs receiving funds will be selected from competitive proposals based on a set of specific criteria. We propose a pay schedule that pays one-third of the tuition up front, one-third at the start of the second year, based on meeting specified objectives, and the final third only if the child passes a ready-for-kindergarten assessment test. We propose that the governor of Minnesota appoint a board of directors to oversee the allocation of funds as well as assessment and evaluation. We also propose a continuing evaluation that tracks children's progress from kindergarten through eighth grade.

Q: What is your next step?

A: Proper funding for early childhood development has become a national issue. The economic climate, with state budgets falling short on revenue projections and with early childhood programs being cut, makes the timing right for drawing attention to this issue.

The national economy is growing at a healthy pace and should start creating jobs this year. There should be no debate as to whether we can afford these programs—we can. We need to educate the public about the economic importance of early childhood development; and we need to establish a political priority for this issue.

Lisa G. Klein, Principal, Hestia Advising

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