Saturday, November 3, 2007

International Evidence on Financial Literacy

In my previous blog, I showed that financial illiteracy is widespread in the United States. Evidence from outside the United States on financial literacy is no more comforting. In 2005, the ANZ Banking Group conducted an extensive survey on the financial practices of consumers in Australia and New Zealand. The Australian survey of some 3,500 randomly chosen respondents age 18+ evaluated understanding of topics ranging from investment fundamentals, retirement planning and financial records, to basic arithmetic. In the Financial Terms section of the survey, 67% of respondents said they understood compound interest, but a mere 28% were rated as having a “good level” of comprehension when faced with an actual problem to solve. As in the United States case, those with low levels of financial literacy also had low education and income. This survey also confirmed the gender gap, with women concentrated in the lowest 20% of the literacy distribution. In the New Zealand survey of respondents age 18+, similar results obtained. Some 54% of respondents believed that fixed income investments would provide higher returns than stocks over an 18-year period, and again financial literacy was strongly positively correlated with socio-economic status.

The results extend to Europe. For example, a report commissioned by the UK Treasury showed that UK borrowers display a weak understanding of mortgages and interest rates. The UK Financial Services Authority also concluded that younger people, those in low social classes, and those with low incomes were the least sophisticated financial consumers. Other researchers, using data similar to the US Health and Retirement Study, documented that respondents in several European nations scored low on financial numeracy and literacy scales.

Meanwhile, on the other side of the Pacific, a Japanese consumer finance survey showed that 71% of adult respondents knew little about equity and bond investments, and more than 50% lacked any knowledge of financial products. A Korean youth survey conducted by the Jump$tart coalition in 2000 showed that young Koreans fared no better than their American counterparts when tested on economics and finance knowledge, with most receiving a failing grade. Again, a positive correlation was detected between family income and education, and the students’ performance on the financial literacy test.

While financial knowledge is weak, it is also the case that people tend to be more confident in their abilities than should be warranted. For instance, a German survey conducted by Commerzbank AG in 2003 found that 80% of respondents were confident about their understanding of financial issues, but only 42% could answer half of the survey questions correctly. Similar patterns are consistent in the United States, the United Kingdom, and Australia. Indeed, consumers’ overconfidence regarding their financial knowledge may be a deterrent to seeking out professional advice, thus widening the ‘knowledge gap’.

If you like to read more on this topic, please consult my article “Financial Literacy and Retirement Preparedness. Evidence and Implications for Financial Education,” published in Business Economics in January 2007 and posted on my web page. Also read “Improving Financial Literacy: Analysis of Issues and Policies,” published by the OECD in 2005.