What are the forces moving the Minnesota economy? Adam Belz tries to identify the trends and show the connections between Minnesota and the larger U.S. and global economies. You can connect with him on Twitter: @adambelz

The positive externalities of child care and market failure

Posted by: Adam Belz under Business trends, Economics Updated: August 25, 2014 - 12:18 PM

We published an article yesterday about problems in the daycare market – especially in rural areas and especially for infant care. It’s become a problem for businesses and for the rural economy, because parents can’t find good enough daycare for their kids, and so either miss work or have to quit their jobs altogether.

One thing I didn’t get into in the piece was the idea that the child care market is an example of classic market failure – that is, a failure of the market to efficiently allocate resources.

There are many types of market failure – caused by monopolies, or negative externalities (for instance, when the costs of a company’s pollution aren’t born by the business or its customers).

But market failure can also happen when the benefits of a good or service spill over to society in general, and the people providing the service aren’t able to charge the customer for those spillover benefits. This is the case with child care, said Rob Grunewald, an economist at the Federal Reserve Bank of Minneapolis.

Child care serves an early childhood education function, and early education prepares kids for school, which sets them on a tax-paying, law-abiding path that is good for the economy and society. But that value is long-term and spills over to all of society — not just to the child and her parents.

The “social marginal benefit” exceeds the “private marginal benefit.” So there's a stalemate. Parents can't pay much more, providers can't charge much more, and yet providers aren't making much money. This is likely because of the spillover benefits.

“Economics tells us that when spillover benefits are present, the market tends to produce too little,” Grunewald said.

Essentially, child care is like education. It provides massive value that doesn’t show up in the price, which helps explain why there aren’t more options for rural parents. Supply isn’t keeping up with demand, because of market failure.

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