Daycare Costs are Driven by Over-Regulation

For some years now, the issue of daycare costs has been rising in prominence in policy debates. This is due to the large role that they play in determining the work decisions of families in general and mothers in particular. Numerous studies have confirmed that mothers are particularly sensitive to the cost of daycare. 

That sensitivity, while its scale is debated, is clear from the empirical studies. Even at the lower end of estimates, the effects of daycare costs on labor supply are quite large. For example, one particular study found (for Norway) that a 20% reduction in daycare costs increased the hours of work supplied by mothers by 5%. Combined with the fact that daycare costs are rising faster than income, it is easy to understand why politicians feel the need to propose “solutions.” 

The bulk of the proposed “solutions” relate to various subsidization schemes to compensate families for the cost of daycare services. The variants are pretty similar in one way: they aim to deal with the problem from the demand side. One can scan newspaper articles for hours and never see any mention of supply-side concerns. Yet, when one speaks of “costs” (rather than price), one is essentially referring to the supplier’s viewpoint. Why the neglect?

The answer is relatively simple: it would force politicians to admit that the problem was created by government interventions in the first place. 

In a paper published in Applied Economics, Devon Gorry and Diana Thomas pointed out that states have established strict licensing requirements as well as service-specific regulations. These take the form of degree requirements for educators, continuous training requirements, minimum child-staff ratios, group size restrictions, and building specifications. 

All of these regulations are structural measures of quality which appear to have little relevance to the actual quality of the service. In fact, most of the relevant dimensions of childcare quality are nearly impossible for states to regulate (or enforce). States prefer to regulate these structural measures of quality, even if they bear little economic significance, because they are easily assessed. The problem is that they also increase costs which, in turn, means that parents pay higher tuition fees.  

The effects of these regulations on fees are not negligible. Having group size grow by one extra infant per educator is associated with rates that are lower by somewhere between 9% and 20%. Degree requirements for educators are associated with an approximate increase in the cost of childcare of between 25% and 46%. 

For older children, the effects of child-staff ratio are smaller but still worthy of note (fees are 2% to 5% lower) while those of degree requirements remain large (between 22% and 40% lower fees in the absence of those requirements). In trying to zero in more precisely on the causal effects of regulations, Gorry and Thomas try to estimate the change in tuition rates for four-year-olds and infants. 

Their idea was that for states that allowed four-year-olds to join a larger group than infants, many differences due to unobservable factors could be implicitly accounted for. They found that states that did relax the group size constraints enjoyed lower costs by closer to $800 — a non-negligible amount. Gorry and Thomas’s results suggest that deregulating daycare services could lead to sizable price reductions. 

But their results are only the tip of the proverbial iceberg as government also increases daycare costs indirectly. The most obvious of those is land-use restrictions. The most productive areas in the United States are cities and these are, thus, the areas that offer the highest wages in the country. The problem is that many cities regulate land-use extensively in ways that restrict the supply of housing. 

These regulations, combined with the high level of demand to live and work in cities, push rents up by large proportions. For daycare providers, this is a particularly large problem as rent represents more than 15% of expenses nationwide – a proportion that is most likely higher in cities. If land-use was deregulated in ways that rents fell by 25% (a measly proportion given the findings in the empirical literature), daycare costs would fall by roughly 4%. This is on top of the effect that rents have directly on housing costs for families. 

Adding these direct and indirect effects of government policies on daycare costs forces one to accept that crisis is created by government interventions. If one really cares about making it easier for households to have both parents working thanks to accessible childcare, one should really look at policies that increase the supply before considering ways to subsidize demand.

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