The Economic Rationale for Investing in Children: A Focus on Child Care. Market Failures:  Liquidity Constraints, Information Problems, and Externalities


A second broad justification for government intervention in child health programs is that there is a market failure in this area that the government might be able to address. Indeed, several market failures are likely to be important, including liquidity constraints, information failures, and externalities.

Liquidity constraints may prevent parents from making optimal investments in the human capital of their children. It is worth pointing out that liquidity constraints are likely to be much more binding in the case of child care than in the case of basic preventive medical services for children. For example, it may cost $50 to $100 to take a child for a checkup, but Blau (2000) reports that in 1993, the average employed mother spent $80.57 (1999 dollars) per week on child care while working, if she made any payment. Moreover, high quality child care is much more expensive, with some parents paying $8,000 per year or more for center-based care.

However, liquidity constraints alone would only justify financial assistance to certain parents, not direct government intervention in the provision of health services. But information failures are also likely to be important. For example, studies of the content of prenatal care have indicated that one of the most important aspects of care is advice regarding appropriate weight gain, and abstention from smoking, alcohol, and illegal drugs (Kogan et al., 1994). The existence of information failures suggests that providing financial relief alone is unlikely to bring about optimal health outcomes.

Information failures are also likely to be important in the market for child care. For example, there is increasing evidence that parents find it difficult to evaluate the quality of child care centers, and that some parents pay for care of such low quality that it may be harmful to their children (Helburn and Howes, 1995; U.S. Department of Health and Human Services, 1998). This finding suggests that government may be able to improve quality by developing, publicizing and enforcing standards (see Klein and Leffler, 1981 for a theoretical development of this argument).

Finally, even altruistic parents may not take into account the consequences of the effects of their child raising decisions on those outside the family. For example, a child who is not immunized and later becomes hospitalized with a preventable illness, and/or infects others, imposes a burden on other citizens, a cost which may not be considered by the parents when they decide on their own investments in the child's human capital. Similarly, a child who becomes a welfare mother or a criminal creates negative externalities which may not be considered by the parents when they make child care decisions, while a successful child may create positive externalities in the form, for example, of higher tax revenues.

Externalities provide perhaps the strongest theoretical justification for direct government investments in the human capital of children. However, even the best justifications in terms of equity or market failures are moot if it is not actually possible to improve children's outcomes through intervention. Also, the theoretical literature is largely silent on the important question of whether government should focus primarily on improving the quantity or quality of child care. This question is really an empirical one in that the answer depends on whether government investments in quantity or quality have larger positive impacts. The next several sections draw out lessons regarding the effectiveness of child health policy that may have implications for child care policy.