Wednesday, October 17, 2007

Lemons and Child Care

Can consumers detect lemons? An empirical analysis of information asymmetry
in the market for child care

Naci Mocan
Journal of Population Economics, October 2007, Pages 743-78
(older version, SSRN)

This paper tests adverse selection in the market for child care. A unique
data set containing quality measures of various characteristics of child
care provided by 746 rooms in 400 centers, as well as the evaluation of the
same attributes by 3,490 affiliated consumers (parents) in the U.S., is
employed. Comparisons of consumer evaluations of quality to actual quality
show that after adjusting for scale effects, parents are weakly rational.
The hypothesis of strong rationality is rejected, indicating that parents do
not utilize all available information in forming their assessment of
quality. The results demonstrate the existence of information asymmetry and
adverse selection in the market, which provide an explanation for low
average quality in the U.S. child care market.

So, a question: I can see the lemons thing. Pedophiles will work in day care centers more cheaply than the rest of us. Lazy people will take jobs as day care
providers, because it seems easy. Something like that.

But, parents are desperate for high quality, low cost day care. Why aren't there more chains? Reputation should solve this problem, at least in part. CarMax has largely solved the problem in used cars. Of course, CarMax doesn't just rely on reputation; they also offer a very good warrantee.

(Big nod ups to KL)


Dirty Davey said...

Top of the head thoughts, at least about the distinction between CarMax and day care.

Day care, like primary and secondary education, is tough because demand is pretty much exogenous to a model that looks at supply and price. While cost and availability of day care can--at the margins--affect an individual's decision to enter the work force, on the whole the demand for day care is a function of birth rate and workforce participation. So standard supply-and-demand models don't necessarily apply.

(In a sense, CarMax is in the opposite market: used car sales is supply-driven, while day care is demand-driven.)

Further--again as with education--day care is a field in which worker productivity is essentially stagnant. So in the medium run either the relative economic position of day care workers erodes (because they make no productivity gains) or the cost of day care rises faster than inflation (since productivity gains do not help keep prices down).

(An additional observation re: CarMax--they are not in the "high quality, low cost" niche--their slot is high quality, high convenience, and fairly high cost. You can get MUCH better prices from other dealers or private sellers, but CarMax saves you the hassle.)

BUT--as to the question of reputation and national chains--I think the big thing is that in a best-case scenario the returns are relatively low, but in a worst-case scenario the potential for catastrophe is enormous.

Returns are relatively low: even if all goes well, you're still in a highly labor-intensive business, both in terms of producing the product (the actual day care center labor) and in terms of management (hiring and training good people, both care providers and local managers).

And the risk is frightful! One child abuser slips through and it's on the evening news, and everyone across the country associates "Happee Kidz Day Care" with the molester, and all your customers start looking elsewhere. Not to mention the legal liability.

And you can have the destructive court cases even if nothing really goes wrong. Read about the McMartin case and it will be pretty obvious why no one in their right minds would want legal responsibility for a bunch of day care centers.

So--it's a low profit margin business with a risk of complete catastrophe. Not much of a surprise that there are no major chains fighting to corner the market.

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