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Making Schools More Efficient

Official government statistics make no attempt to measure productivity in public education. In particular, there's enormous dispute about how to measure the "output" of education.

But assuming that test scores are a reasonable measure of educational output, public schools are getting less productive by the year. In 1972-73, each $1,000 of spending per pupil "bought" 63 points on the National Assessment of Educational Progress math test for 17-year-olds, according to calculations by Harvard University economist Caroline M. Hoxby. By 1998-99, that same level of spending "bought" only 39 points (chart). The trend is similar for other tests and ages. To correct for inflation, all spending is stated in 1999 dollars.

What's the solution? Hoxby argues that educational productivity rises if parents have more choice among schools. That forces schools to become more efficient to retain students. For example, in metro areas with many school districts, such as Boston and Pittsburgh, parents can easily switch school districts by moving to another town in the same area. In other areas, a large number of traditional private schools provides an effective alternative to the public-school system.

By comparing test scores in areas with and without choice, Hoxby concludes that competition makes public schools more productive. She calculates that the productivity of American schools would rise 28% if all metro areas had ample inter-district competition and many private schools. She also finds good results from newer forms of choice, such as vouchers in Milwaukee and charter schools in Michigan and Arizona.

By contrast, a new paper by Alan B. Krueger of Princeton University concludes that an effective way of improving educational outcomes is to increase spending to reduce class size. By studying Tennessee's Project STAR, which randomly assigned students to large or small classes, Krueger calculates that money spent on reducing class size in the early grades from 22 students to 15 produces a 6% annual rate of return by raising students' future incomes. For minority students, he calculates the rate of return is 8%.

Krueger's work on class size contradicts the widely accepted results of the Hoover Institution's Eric Hanushek, who has argued for years that reducing class size doesn't improve results. Hanushek compiled 277 estimates drawn from 59 other studies. But Krueger says Hanushek's analysis put too much weight on estimates that were based on small sample sizes and studies that weren't properly designed to test for the impact of class size. You would think that in the Age of Globalization, international joint ventures would multiply like mushrooms after a spring rain. Partnering with a local business, after all, would seem like a good way for a company to get a foothold in a foreign market.

In reality, the past two decades have seen a decreased reliance on international joint ventures by U.S. multinationals, according to a study by Mihir A. Desai and C. Fritz Foley of Harvard University and James R. Hines Jr. of the University of Michigan. In 1997, the latest year for which data are available, joint ventures made up only 20% of U.S. multinationals' foreign affiliates. That's down from 28% in 1982, a drop that probably reflects both a decline in the number of new joint ventures and a tendency to shut down existing ones. At the same time, a record 80% of all affiliates were wholly owned.

Moreover, the trend continues today, report the authors, drawing that conclusion from their conversations with managers. The problem is, globe-spanning multinational corporations and their local partners have different interests. For one, the multinationals want to move production to the countries where demand is growing, while their joint-venture partners want to keep the factories at home running at full capacity. Also, the multinationals may want their affiliates to offer discounts to other subsidiaries of the same company, while the local partners want to maximize profits at home. As a result, companies increasingly prefer to buy their foreign affiliates outright rather than deal with the hassle of coordinating with a partner. Some investors and economists worry that heavy corporate debt burdens could hurt the nascent economic recovery. At the start of the year, the ratio of nonfinancial companies' debt to their net worth stood at 60%, the highest since at least 1952.

But Deutsche Bank Senior Economist M. Cary Leahey argues that companies are in better financial shape now than in previous recoveries. He notes that low interest rates have helped hold down the cost of servicing debt. The ratio of net interest payments to cash flow is around 25%, vs. about 40% in the 1990-91 recession (chart). Companies also have more assets available to help pay off debt. At the start of 2002, the ratio of financial assets to liabilities stood at 91%, far above the 70% to 77% range during the 1980s and early 1990s. Zeroing in on short-term liquidity, Leahey finds that the ratio of liquid assets to short-term debt is at its highest level in 25 years, as companies have kept plenty of cash on hand.

True, a rate hike by the Federal Reserve would make debt more expensive. But "if you get an increase in rates because the economy is strong," says Leahey, "then you will get a big increase in cash flow, and that will blunt the problem."

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