Why is childcare so expensive?

Early education and care are hugely important. It’s where children are first exposed to the education system, in a period that’s crucial for their brain development. It’s also important for the economy – particularly for supporting women back into the workforce. So why is it so expensive, even with government subsidies?

Listen to Grattan CEO Danielle Wood, in conversation with Grattan Fellow Iris Chan, on how to make childcare cheaper.

Transcript

Iris Chan: Welcome to the Grattan Institute podcast. I’m Iris Chan, a fellow at the Grattan Institute, and with me is CEO Danielle Wood, who is also the program director for Grattan’s Budgets and Government program. We’ll be chatting about childcare costs today. We know that early education and care is hugely important.

It’s children’s first exposure to the education system in a period that’s crucial for brain development, but it also is an important economic enabler, particularly for supporting women’s participation in the workforce. But something I hear a lot from my friends is that childcare is pretty expensive, seemingly no matter where you live and whether the provider is for profit or not.

And that’s even after the government’s childcare subsidies. So, maybe we can start with whether there’s any truth to the perception that childcare is really expensive in Australia, Dani?

Danielle Wood: So, look, your friends are not lying to you, Iris. Childcare is expensive. I think probably the first thing that’s worth saying when we have this discussion is that it’s inherently an expensive proposition.

If you think, if you’ve got a young child in care, under two. We only have one carer for every four children. So, you know, in effect you’re paying a quarter of a person’s salary. Those ratios increase as children get older, but it is a very labour intensive product. So, inherently an expensive product.

Across Australia, fees vary a lot. If you’ve got your child in long day care, the average fee is about 120 a day. Family day care is a little bit cheaper, about 90 a day on average. But it varies a lot by location. And if you’re trying to put your child in care, You know, in the CBD in Sydney and Melbourne, you could be paying upwards of 160 a day.

That is the fee for care. That isn’t the cost that most parents pay, and this is really important. We have government subsidies. So what parents are actually paying is the after subsidy cost, what we call the out of pocket cost. That is substantially lower. On average, the subsidy covers about 60 percent of the cost, but it varies according to household incomes.

It’s means tested. But if we could take a step back and say, well, okay, let’s think about those out of pocket costs. How do they compare internationally? When we looked at this back in 2020, We saw that in Australia, those out of pocket costs were absorbing about 18 percent of household income for an average earning couple with two young kids in care.

That was almost double the OECD average of 10%. So those out of pocket costs are high. That has all sorts of implications, including for workforce incentives, as you alluded to there. If you end up paying more than you earn from working, or it takes most of your income to cover an extra day of childcare, you’re probably going to work less.

Iris Chan: So, that sounds pretty extensive. The government recently increased its childcare subsidies though, so can you tell us a bit about what’s changed?

Danielle Wood: Sure, and whenever we start talking about subsidies it gets really complex very quickly. So the first thing I think is worth noting is there’s actually been kind of two big changes to the subsidies in the last couple of years.

So, we go back to the previous coalition government in March 2022. They introduced an increase in subsidies for families that had two or more children in care. So if you had multiple children at the same time, that would tend to be really expensive. And there was an increase in subsidies for that group, as well as a reduction or a removal, I should say, of the subsidy cap, which meant that parents would essentially run out of subsidy through the course of the year.

The more recent changes, which would be the ones that people would be hearing a lot about at the moment, They came into effect on the 1st of July this year. That is about boosting the subsidy for parents with one child in care. We see an increase in the base subsidy. So if you have a family or household income of 70, 000 or less, your subsidy has gone from 85 percent to 90%.

And the other part of it is a more flat taper. So that’s the way that subsidies are means tested based on household income. So what it essentially means is that for every extra dollar a family earns, the subsidy is now being clawed back less than it was before. And really our modelling shows that that leads to both a sizable benefit to families in terms of the amount of subsidies they receive.

And also improved work incentives because you’re keeping more of the extra dollar if one of the members of the household, which would tend to be the mother, were to increase her workforce participation.

Iris Chan: So I guess that’s the first stage of how a subsidy flows through. Do you think those savings are actually leading to lower out of pocket costs for parents or are childcare providers just hiking up their fees by around the same amount?

Danielle Wood: Look, this is a really contentious issue. You know, one of the challenges is that childcare centers will tend to put any fee increases through at the start of the financial year. That was the same time the increase in subsidy hit. And so many people are just saying have we just kind of blown dough?

Or, you know, has the government wasted its money because childcare centers are eating up the difference? We certainly have seen substantial increases in childcare fees this year. Eight, nine, 10% increases. In a way that is not surprising, we are in a high inflation environment and if we think about the key cost drivers of childcare, things like wages, rents, food, all of those things have been rising.

So we would expect to see some degree of pass through. On our numbers, it’s not going to wipe out the subsidy for, the increase in subsidy for most families. Those subsidy changes are big, so families will still be better off. And they are definitely going to be better off, of course, compared to the counterfactual, which is, you know, if we hadn’t changed the subsidy, a lot of those fee increases are happening because of inflation.

The big question that remains, I think, is whether any of the providers are taking advantage of that subsidy increase to justify bigger than needed price increases. And we have the competition regulator in Australia, the ACCC, looking into this in detail at the moment. You know, they’re looking at issues around childcare pricing.

Margins. So, you know, if it is happening, I think the ACCC will be getting to the bottom of it.

Iris Chan: So, we’re eagerly awaiting that report. But in the meantime, my understanding is that the people working as carers don’t actually seem to be paid a lot. So where exactly are these high fees going?

Danielle Wood: Look, the answer is we don’t entirely know, which is a little bit unsatisfactory.

But so you are right that carers are relatively poorly paid. And I’ve certainly been one of many people out there making the case in the past. You know, when we look at the training they do, the importance and the challenge of the work. The wages look very low. In putting my more economist hat on, we also see, of course, the sector has a lot of challenges in attracting and retaining workers, which is another sign that the wages are lower than they should be.

And I think many people look at that and they say, okay, well, we’ve got relatively poorly paid workers, we’ve got parents paying high fees, we’ve got a lot of government subsidies in there. Where is this money going? And I think part of the answer is what I said before, this is an inherently labor intensive And therefore expensive product, but the thing we don’t know is, is there anything going on over and above this?

Are there economic rents being made in this value chain? It could be the commercial landlords, it could be the providers. And I certainly feel a bit of disconnect between the challenges that we know that carers and governments and parents face and the articles that you see from time to time in the AFR talking about, you know, what big opportunities there are for private equity providers in the childcare space.

And that’s, you know, really what the ACCC review underway is designed to ferret out. So they are having a really close look at the sector, looking at these questions of what are the margins being earned, are they higher than expected? And that’s just something that’s really only the ACCC can do.

Researchers like us can’t get access to the type of information that the ACCC can get under its information gathering powers. So I’m certainly, you know, really interested to see what they discover.

Iris Chan: I guess this is a preliminary question given all that work is going on at the ACCC, but do you think there’s a market failure somewhere?

Do you think we can lower childcare fees with more competition?

Danielle Wood: Look, I think the, I mean, the ACCC has put out an interim report, which I think is really useful on this point. And essentially what they say, and it is an interim report, so it’s not conclusive, but There are a number of factors that means that they reduce the extent to which competitive pressures are brought to bear on providers in this market.

So first of all, and this will be very obvious to all the parents out there, but childcare markets are really localized. So centers are only tending to compete within maybe a two or three K. And that’s because parents just aren’t willing and able to travel, you know, long distances for care. So it’s sort of a 15 minute timeframe in most parents minds.

And the ACCC actually did quite a big survey of parents, which suggested that, that location and availability are the two most important factors for parents when they’re deciding where to send their child. So you’ve got a kind of narrower geographic range of competition. On top of that, switching is hard.

Removing your child from one centre to another. It’s not like picking up a different, you know, brand of baked beans at the supermarket. You know, there’s all sorts of challenges in terms of getting the child familiar with the educators and the new environment. So what they found is the majority of parents, you know, do not switch their children.

So that lessens the extent to which competition is working. And thirdly, which is a classic challenge in human services, is that it’s really hard for externals to judge quality. Parents say they care a lot about quality, and that’s not surprising, you know, this is a really important formative experience for their children, but it’s kind of difficult to judge from an outside perspective.

We know the government has done some good work here. They’ve come up with national quality standards, they publish. How centers are performing against those standards. The data isn’t updated terribly frequently, they don’t assess very often. And parents aren’t putting much emphasis on them, probably because lots of parents don’t even know they are there.

So all of those things are acting to soften competition. The ACCC makes clear it doesn’t look like parents are shopping around on price. That is well down the list of things that parents are emphasizing when they try to choose between centers. And in fact, they find actually in sort of local markets with more players.

Prices are actually higher. That’s of course not the way we’d normally expect competition to work. It probably reflects the fact that centers are clustering in areas of higher socioeconomic status and therefore a higher parent willingness to pay. So that’s the preliminary assessment. It may be that they are then setting us up for making the case that because competition isn’t effective, we need stronger price regulation or we need better quality regulation.

But you know, I think that probably depends on. where they get on some of the questions we were talking before around profitability and margins.

Iris Chan: That sounds like a lot to consider. When can we expect the ACCC report, the final report, and is there anything else happening on the horizon?

Danielle Wood: So the ACCC is due to put out its final report on the 31st of December.

So that is my New Year’s Eve’s plan sorted. Happy New Year everyone. I have heard there may be another interim report before that, but that’s not being confirmed. And the other big thing that we do have is The Productivity Commission are running a, a parallel inquiry into early learning and care.

They’re taking a kind of longer term policy look at the sector. And this has been asked for by the Labor government because the other part of their election commitment was over time to look at moving towards low cost, universal early learning and care, something like a 90 percent across the board subsidy.

So that would be a really big change for the sector, a big expansion. You really have to think through if you were going to do that, how do you get from where we are to there, including some of these issues around competition, but staffing, how do you manage the interface with state governments? There’s a whole lot of kind of really thorny policy issues in there.

So that’s what the Productivity Commission. Is looking at, they’re putting out their draft report, I think, before the end of this year. Final, due halfway through next year. So this is a really important space, lots going on, and I think lots of important policy debates to come.

Iris Chan: Alright that’s your New Year’s Eve sorted.

So, thank you very much, Dani, for sharing your insights with us today. If you’d like to talk to us more about childcare costs, you can find us on Twitter at Grattan Inst, that’s Grattan I N S T, and all other social media networks at Grattan Institute. Thanks again for listening.