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<p>This study uses the data from the National Institute for Children Health and Development
Study of Early Child Care and Youth Development to evaluate features of wage and childcare
price changes that are associated with positive effects on children's early cognitive
skills. Identifying beneficial characteristics of changes in market variables is especially
relevant in a policy environment where the main priority of tax incentives related
to the use of childcare is not facilitating the formation of children's cognitive
skills, but reducing reliance on the welfare system through increase in employment
among poor households. </p><p>We estimate jointly the discrete household choices related
to the employment status of the mother and the use of a paid care mode, the demand
functions for quantity and quality of childcare, the production function for cognitive
outcomes, the wage process for the mother, and childcare price equations based on
the hedonic pricing method, while at the same time introducing unobserved heterogeneity
in the disturbance terms of the estimated outcomes. Our strategy for handling selection
problems also utilizes the exogenous variation in childcare prices across the 10 geographical
markets defined by the study sites in the NICHD SECCYD dataset, which in our model
influence choices, but do not affect cognitive outcomes directly.</p><p>Our results
show that failing to account for common unobserved characteristics would lead to underestimating
the impact of all analyzed wage and price changes. We find that prices and wages do
not have a statistically significant impact on the quality of paid care, while the
marginal product of that attribute of care is positive for almost all input combinations
in the production of cognitive attainment. Therefore, a policy utilizing changes in
wages and prices can be effective in improving early cognitive skill only through
the impact of those changes on the intensity of paid care use. </p><p>The comparison
of the effects of wage and price changes on early cognitive skills for three sets
of values of the observable household characteristics representing low, middle and
high income households lead to the following conclusions: (1) a tax credit for working
mothers and childcare subsidies for center-based care can bring disproportionate gains
for children in low and middle income groups; (2) subsidizing paid home care for children
less than three and a half years old can be more effective than subsidizing center-based
care for the same age group in terms of improving cognitive outcomes at the age of
five; (3) conditioning childcare assistance for paid care on the employment status
of the mother does not seem to have a strong negative effect on early skill formation;
and (4) tax incentives affecting wage rates and childcare prices prove to be beneficial
for the formation of early cognitive skills only when they are implemented while the
child is less than three and a half years old.</p>
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