Is there a market failure in child care?

Applying economics

Many parents are not able to find child care at a desirable cost. But of course, just because something costs more than you would like does not mean that there is a market failure.

NPR’s Planet Money had a story on the excess demand for child care, with waiting lists everywhere. I give the correspondents credit for repeatedly asking the question “Why don’t day care centers just raise prices?” But they do not get an answer that I find satisfying. In the end, we are left with a puzzle that the headline of the story calls a market failure. In fact, I am sympathetic to the view that waiting lists are a market failure, and I will offer a solution. But first I want to explain the economics of child care using simple arithmetic.

Let us assume that the parents get neither utility nor disutility from spending time with their infants. When it comes to making the decision to use child care, all they care about is the price of day care relative to the salary of the lowest-earning parent in the couple. Call this the parent salary.

Labor costs are 70 percent of the cost of a day care center, according to the NPR story. But I am not sure that they are taking into account the opportunity cost of the entrepreneur/manager. So let us say that labor cost is 2/3 (it is probably somewhat lower, but I want to keep the arithmetic simple). The overall cost per worker is 3/2. The story indicates that the child care center needs one worker for every four children. So the cost of caring for one child is (daycare salary/4)(3/2) = 3/8 of the cost of a child care worker. Suppose that the amount of child care is 48 hours a week, allowing the child to be dropped off about half an hour before the parent is at work and picked up about half an hour after work. Multiplying 48 by 3/8 gives a cost per child per week of 18 times the cost of a child care worker. If the child care worker costs $15 an hour, then the day care center will charge $270 per week per child.

Suppose that the parents have two children who need child care. That is $540 per week. The parent salary has to be at least $540 per week to make the choice of child care economical. But that does not take into account taxes.

The parent will pay taxes on market work, but not if he/she stays home to take care of the children. If the overall tax rate, including payroll taxes as well as income taxes, is 40 percent, then the parent needs to earn $900 per week to have an after-tax income of $540 per week. If the parent works 40 hours a week, that is an hourly pay of $22.50.

In this example, a parent has to earn 50 percent more per hour than a child care worker in order for child care to be “affordable.” The factors that account for this are, in order of magnitude: the tax wedge; the overhead costs of the child care center; and the extra time that a child spends in day care after getting dropped off before work and picked up afterward.

In theory, the child care center is twice as efficient as home child care, since the child care center uses one adult for four children and one parent stays home with two children. But these efficiency gains are more than wiped out by the tax wedge and other factors.

Solving the Waiting-List Problem

The NPR story raises the question of why parents face waiting lists for child care and have to put a lot of time into trying to find child care. This does sound to me like a market failure.

The way I see it, it does not pay any individual day care center to help solve the parents’ problem by having vacancies available on demand. If I provide vacancies on demand, I do not think that I can charge parents for the full value of the ease of mind and time savings that I am giving them. For me as an individual day care center, it is better to keep a waiting list.

But although keeping a waiting list may seem optimal for one day care center, it is not optimal that every day care center keeps a waiting list. In theory, it seems to me that there is room in this market for a “day care broker” who charges parents a fee for handling the problem of finding a day care provider.

In the absence of a broker, each day care center has to keep a waiting list. With a broker in the market, a day care center would not keep a waiting list. Instead, it would take children off of the broker’s waiting list, which is one waiting list for the whole market. Parents would experience a much shorter waiting period.

One problem with the broker scenario is that parents could “free ride.” With day care centers no longer keeping waiting lists, parents could get child care quickly, without using the broker. So the broker would have to “lock up” the local day care centers by insisting that they not take any children except through the broker.

Presumably, an online broker, like the airbnb for child care, would be most efficient. The broker would have to put together data on the features of day care centers that parents care about, including location, rules, staff qualifications, and so on. Videos of the day care centers would be very good to have.

This seems like a project an entrepreneur ought to try and take on. At first, though, you probably have to pay the day care centers a bonus for accepting children from your online brokerage service. You need to wean them away from waiting lists.