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	About 207,000 children and youth are currently enrolled in CT�s HUSKY A health insurance program, and 71,000 (8%) remain uninsured.

...my venture capitalist buddies would jump at 16% real rate of return...

Art Rolnick, Director of Research, Federal Reserve Bank of Minneapolis, "Economic Development Through Early Childhood Investment" Forum, Fairfield, CT, January 23, 2004

Thank you Judy. Yesterday, I said there was a mayor in Connecticut that I�d like to bring back to Minnesota, now there�s a mayor and lieutenant governor that I�d like to bring back to Minnesota.
Let me say it�s a pleasure to be here, not maybe for the reason you may think�it�s balmy here. It was 30 below yesterday when I got on the plane and now its 20 degrees. Now I know why Connecticut is so popular.
It is also nice to be here in a business school setting. I feel very comfortable in a business school setting. Last time I was in one was Guangzhou, China, where I teach an executive MBA class. It�s an exciting place to be. If you haven�t been to China in the last few years, you won�t recognize it. There�s an economic miracle happening there. I happen to have in my classroom some of the leading managers and business people from all over China. Lingnan University is a very prestigious place and is viewed as the place to get an Executive MBA degree. So I get to interact with some of the top business people in China. I spent a lot of time talking about the Federal Reserve System, central banking and international issues, but it shouldn�t surprise you that we discuss all sorts of policy issues. What was the biggest concern they have about their economy? They�re worried about the income gap. The growing disparity between the rich and the poor in China, especially the Gold Coast, not in the inside of China. We talked about ways at getting at that gap. In the short run it�s hard. You�ve got to let it proceed as it is. One thing you should worry about is how well you educate your kids. It clearly resonated with these business managers in China. That�s the discussion that I had in Lingnan on the economics behind this argument.
I want to break this talk into several parts, �cause if I was out there, the first thing I�d be asking is why is a Fed guy talking about early childhood? I have to tell you that�s not my expertise. I�ve spent 30 years sort of in an ivory tower, doing a lot of economic research on how this economy works, market economies and the role of the Fed, why it�s important to get low inflation, why it�s important to have a stable financial environment. A lot of my work is on economic history, so it�s far field from early childhood development. So I�d like to give you a little background on the Federal Reserve and how somebody in my position might get into early childhood. Then I�ll turn to economic development and something which we dubbed the �Economic Bidding War�, which is a critique that I wrote a number of years ago in the conventional way that we allow cities and states in our country to promote economic development is flawed. It is flawed economically, flawed legally, violates our constitution. The third part: If that�s the wrong way, what is the right way to promote economic development? I�ll start to talk about things your lieutenant governor mentioned, the importance of human capital, and that�s going to lead you to early childhood development and why that�s a key form of economic development and why today in this country it�s under funded.
Let me start with the Federal Reserve � established in 1913 by an act of Congress. President Woodrow Wilson signs the Federal Reserve Act December of 1913. If you remember your history at all, in this country we have a concern about concentrating economic political power in one organization. The Federal Reserve was designed not just to be housed in Washington or in New York, but it was created with 12 district banks around the country. You are in the first, Boston district area. I am in the 9th district, which includes Montana, the Dakotas, Minnesota, upper part of Wisconsin and the upper peninsula of Michigan -- a fairly large geographic area. The idea is each bank has a president that is appointed by the local board of directors. These tend to be business people, educators, and community leaders. And each president attends the Federal Open Market Committee meeting (that�s the meeting in Washington) where 12 presidents meet with the 7 governors every 6 weeks. That�s what you read about in the newspapers. We make the decision on whether to raise interest rates or lower them. We have a meeting coming up next Tuesday and Wednesday (my lips are sealed), and our job is to bring economic intelligence to these meetings. These 7 governors are appointed by the president of the United States -- they�re appointed for 14 year terms.
The Fed is one of the few government agencies whose responsibility it is to think of the long term. Each president that attends these meetings is supposed to take an independent view to these meetings, so we don�t coordinate research. We are supposed to study the local economy and bring that to these meetings and leave the national and international. So when our president goes to these meetings, he is supposed to have an independent view on research, economic development, etc. In fact, economic development you could argue is the reason we exist. We have tools �financial tools�to promote financial stability, low inflation, stable banking industry, economic development, etc. But studying economic development is the key to what we are about. In my research department, I hire some of the best people to help me think through and to help the bank president to think through what are good policies for promoting economic development. It is also our charge not just to bring these ideas to Washington, but to bring them to the policy makers to cities, counties, state, to the region. So it shouldn�t surprise you that we get involved in promoting good policies for state and economic growth. That�s why I got involved in this issue.
So let me talk a little bit about when I first started thinking about economic development within our region. It goes back to 1991 when one of our most prominent companies in our region, in the Twin Cities, Northwest Airlines, came to the state of Minnesota for a partnership. Let me tell you I am a laissez-faire economist�I strongly believe in markets, I strongly believe in limiting government intervention in markets. So, when business people talk about partnerships with government, I get nervous. I get nervous because typically it means a subsidy on the government to that particular company. In this case, Northwest was coming to the state for about a billion-dollar package deal, and it was a quid pro quo for jobs up in Northern Minnesota, which back in 1991 was fairly depressed. And for a half a billion dollars to put a maintenance facility up there for operating loan. I won�t bore you with the details. Politically they got it all through, it was a low interest rate loan, and it was a 30 million-dollar subsidy for 30 years for 2000 jobs in the iron range up north. I was very critical of this, and the governor took me aside and said he agreed with me on the economics. But he said what you don�t understand is that if we don�t do something for Northwest Airlines � the corporate headquarters is in the Twin Cities, 17,000 jobs � there�s a good chance that if we don�t do anything, Detroit or Memphis or one of their other hubs will, and we�ll lose corporate headquarters and those 17,000 jobs. And we can�t afford that. So that set me back a little bit. It got me thinking that what we really have is a bidding war between cities and states for jobs, for football teams, baseball teams, automobiles companies. Mercedes was very good at getting a huge subsidy from the state of Alabama a couple of years ago. I think they paid about $200 per job. But essentially, it�s what we dubbed an �Economic Bidding War�. From an economist�s point of view, this makes no sense. These bidding wars don�t create any jobs. Maybe they relocate some jobs. From a parochial point of view, from a mayor�s point of view, from the governor�s point of view, they look like they�re creating jobs, but from a national perspective, that can�t be true.
So, an interesting example happened a few years later, which helped me make my point. This was Minneapolis and St. Paul getting into a bidding war. We had a software company called Lawson Software in Minneapolis, doing very well, 500 jobs thinking of expanding. And the mayor of St. Paul and the CEO of Lawson sit down together and they work out a deal. St. Paul builds them $110 million dollar office tower. St. Paul is very happy, jobs move across the river, lots more tax revenue. They could justify spending $110 million. But from the governor�s point of view, and the state�s point of view there�s no new jobs. We moved people from one city to the other, within the same state. Public money which should have gone to schools and roads and what economists call �public goods�, things that the market doesn�t do very well with, went to a private business. But economically, no new jobs.
So bottom line, we took this to the national level that there�s a problem. It�s not something an individual mayor or governor can fix. You can�t unilaterally withdraw from the bidding war that�s going on. If Texas comes after 3M or General Mills, tries to lure their corporate headquarters, you can�t not participate. This is really something that has to be done at a national level and we introduced some legislation to that effect. It�s not going anywhere at the moment for a lot of political reasons. But that is the Bidding War argument, and what we argued is the wrong way to promote economic development. I know politicians will tell you they like to create jobs, but government doesn�t create jobs. The market creates jobs, individual companies create jobs. What government should do is set the right environment for sustainable economic growth. You want to talk about taxes, keep taxes as low as you possibly can in all businesses. You don�t want government to pick winners and losers. That�s what is inefficient. So if that�s the wrong way to promote economic development, what do you want to tell governments to do? What should the public policy be towards promoting sustainable economic growth, and in the big picture creating jobs or the right environment for creating jobs and economic welfare?
The international literature is pretty convincing. I won�t go into all that because I have a better example that�s more local. When you look at those countries who were very poor over the last 50 years or so, and who have become economic miracles today including China and South Korea, it was investment in human capital. It was investment in the workforce and quality of the workforce. The International Monetary Fund and the World Bank are both rethinking their policies towards promoting economic development in our world. They no longer send tractors and physical capital to these countries, they�re now working with their educational systems. They realize that if these countries are going to make it, they�re going to have to have educated and quality workforce. Internationally, I think the message is pretty clear. I think our agencies are starting to understand that. Let me give the Minnesota example on the importance of the workforce and quality of workforce, because I think that makes the point very well.
If you go back and look at Minnesota�s economy in 1920, we had 80 years of data. Minnesota�s economy was well below the national average, one of the poorer states in this country. It grew roughly at the same rate as the national economy, so it stayed well below the national average up until 1957. After 1957, Minnesota�s economy started to exceed the national average and for every year after 1957. Today, Minnesota is 5th or 6th in this country. So what changed? What caused Minnesota�s economy from being one of the poorest, to now one of the most successful economies in the world? There�s another interesting statistic. We looked at the quality of workforce within this 80-year period. We looked at how many in the workforce had a high school education, how many went on to vo-tech, college, grad school. Up until 1957 it was well below the average. Since 1957, Minnesota poured money into education and we now have one of the most educated workforces in the country, and we have one of the most successful economies. Not just a correlation, there�s causality there. There is a lot of research that shows that long term, the most successful economies are the ones that invest in education.
Now as an economist, I also look at market signals. It used to be 20 years ago, that the value of a college education was worth 40% more than a high school degree. In the last 20 years it has grown to 80% and increasing. So the market�s making it very clear that they are willing to pay for experienced, educated, and qualified workers. The gap is critical. So if you ask me about sustaining long-term economic growth, worry about how you�re developing your workforce. I�ve given you the argument as to why the Fed would be interested in an issue like this. I�ve given you why it�s pretty clear what the best way to promote economic growth in the long term is. So why early childhood development? Why not higher education, k-12 strongly needs support� but there again the literature is pretty clear.
Two years ago, I was asked to go onto a board for �Ready 4 K�, a nonprofit apolitical organization. It was set up by Don Fraser, former mayor of Minneapolis, and Al Quie, a former governor � one was Republican, one Democrat. The whole idea was to promote economic development, and I looked at their work critically and thought they didn�t have the economics right. So they asked me to come on the board and write an essay explaining this to us. It seemed that it was obvious that early childhood development was worthy of study, and my guess was there was a pretty high return. It turned out that there were three very well known studies. Perry Preschool study began in 1963 in Michigan, which had a control group. Economics generally does not have control groups. They took 120 at-risk kids and randomly divided them up into groups. One group stayed at home. The other got a very intensive program worth $12,000 per kid, 3-4 year olds � Head Start is about $7,000 per kid to put it in perspective � small classrooms, master level teachers, home visits, working with the family as well as the kid and the results are pretty impressive. They followed these kids for 30 years. After the first 10 years, they didn�t look that impressive. They measured IQ, which went up a little and came down. Then they got more data. After 30 years, the IQs didn�t necessarily go up, but the outcomes did. The children that got these very impressive programs, were more likely to be literate by 7th or 8th grade, or more likely to graduate high school, or more likely to get better jobs. The crime rate went down almost 50%, in the other study 70%.
So what about the economics of this? Looking at the benefit-cost ratio for the dollar they invested in present value terms you got $8 back. Looks like a big number. The problem with that benefit-cost ratio is how do you compare it to roads, stadiums or other things the government spends money on. We generally don�t have benefit-cost ratios on that. So we took that data and converted into an interest rate, or internal rate of interest. The nice thing about that is it lets you compare to a whole lot of things. We find that the interest rate was 16%, inflation adjusted or what economists call a �real rate of return�. I can tell you, my venture capitalist buddies would jump at 16% real rate of return. When we broke it up, roughly 4% went to the individual because they ended up with a better job and 12% was public return because these kids start school ready for kindergarten, are less likely to need special ed, and less likely to be disruptive. By the way, in Minnesota, roughly 50% of kids entering school can�t pass a very basic assessment test. So the school saves significant amounts of money, and we have dollar estimates of that. We have dollar estimates as to how much more the child earns on average when they graduate high school and go on to vo-tech. We have some very good data on the savings when you reduce crime � those can be enormous. Those are all public returns. Other than the income to the child, savings to the school, likeliness of the child staying off welfare, and crime reduction are all public savings.
In the stock market, 4-5% is the real rate of return. As to bidding wars, they�re going to locate a stadium; it�s in their interest, entertainment value. When businesses are surveyed and you ask them what matters for location decisions, high on the list is the workforce, the location relative to their business needs, and low on the list is subsidies. We suspect most of these subsidies that go to business, these jobs would have been there anyway. If you are coming to Minneapolis to locate a business, you knock on the mayor�s door and say I�m thinking of coming and what can you do for me. We suspect that even if a business moves to a location, it�s a little disingenuous to say that these jobs came because of the subsidies. When it comes to the return, its easy to make the case relative to the bidding war that early childhood development wins hands down. What about other public goods, such as roads, higher education etc? Again, most of the studies I�ve seen don�t come close to the 16%. The reason for that, if you get at these kids early, 0-5 is critical.
Let me conclude why that�s so critical, then I�ll talk a little bit about what we�re proposing for Minnesota.
We had a conference at the Minneapolis Fed back in October and we invited the best people in brain research, along with the best economists doing research in this area. Jim Heckman in particular, Nobel Laureate from the University of Chicago, helped me organize this conference. And it�s very clear from brain research that we�ve learned over the last 10 years, that brain development 0-5 is critical (75-80% of the brain is developed during those years), and if it�s not stimulated, language in particular, it is very difficult to make up for that. We used to think if a kid was troubled a little bit, they�d grow out of it. That was the view of the 70s. We know a lot more about brain development; we know that�s not true. We know it�s critical to get to kids very early. So that�s the economic argument based on medical research and I think it�s pretty powerful.
So in practice, what do you do? Here�s what we thought of in Minnesota � I�m not saying this is the only way to fund this � here�s a business partnership that I would endorse. We�re suggesting an endowment for the state of Minnesota. We figured this endowment is about $1.2 billion, the interest on that in perpetuity would fund virtually all at-risk kids in the state of Minnesota (by at-risk kids I mean all those children in Minnesota � we estimated 3-4 years old, about 20,000 � living below the poverty line) that we can insure that every kid would have a high quality early childhood program.
I�m going to leave you with this thought, because I know that 1.2 billion seems like a lot of money. But Minnesota, just like Connecticut, has serious budget problems. We have a governor who was elected on a no tax policy. 1.2 billion is roughly the cost of a new stadium for the Vikings and the Twins, and there�s a blue ribbon commission right now in the state of Minnesota despite the problems with the budget. Two new stadiums. That�s where I think the rubber hits the road if you will. I think that�s where we have to engage the debate. Unfortunately, I think this is a difficult one, politically. As the lieutenant governor mentioned, this is long term, not short term. I�m not going to be able to show you a pretty little building after a couple of years. You need to take a long-term perspective. And as you can tell from my remarks, I think that�s the right perspective.