How important are these two effects? Not an easy question to answer, because we cannot directly observe or measure either investment in skills or the skills themselves. We do, however, have imperfect measures related to skills, such as test scores. These indicators may allow one to estimate the latent unobservables.
That's precisely the subject of this paper by Agostinelli and Wiswall, "Estimating the Technology of Children's Skill Formation." The dry title and dense methodology could be a little daunting, but the results are important. Here are my takeaways. First, identification of the latent variables and their effects is sensitive to modeling assumptions. Figuring out which assumptions are reasonable seems a high priority for future research. Second, under their preferred assumptions, they find the following, using data from the National Longitudinal Study of Youth (NLSY):
- A child's skills are strongly affected by both investments and pre-existing skills.
- Both effects are larger for younger kids. The results strongly favor early investment.
- There is some evidence that early investments have a bigger effect—and thus presumably bigger bang for the buck—for less-skilled kids. This result differs from some past findings which had suggested a reinforcing effect between skills and investment.
- Investment in skills is an increasing function of family income as well as the mother's cognitive and noncognitive skills—the latter having a particularly large impact. Noncognitive skills are measured using standard survey-based metrics conducted as part of the NLSY.
- Because investment is greater for children from advantaged backgrounds, "endogenous investment increases inequality in children’s skills."
Finally, the authors use their results to estimate the benefits and costs of an income transfer of $1000 to a child's family in terms of its impact on childhood skill development. The only benefit accounted for is the impact of skills on the child's future income. The net benefits are substantial, as shown in the table below.
It's tempting to read too much into this result, given the way it is presented. There is no attempt in the paper to show that the effect of income is causal. Rather, family income could be correlated with something else affecting investment in skills, such as neighborhood effects, or father's skills. So there is no evidence here that a simple money transfer would have these salutary effects. What they have demonstrated is that kids from disadvantaged backgrounds are at a very big disadvantage indeed in accumulating skills that affect life prospects in a big way. Given the dynamic of skill acquisition, figuring out how to level the playing field early in life is a compelling research and policy priority.