Friday, June 20, 2008

In Favor of Financial Literacy Education

Recent papers are arguing that it is futile to undertake financial literacy education. I do not share that view and let me make just a few simple comments in favor of financial literacy education.

One of the problems of scholars who review the literature on financial education without having done empirical work on this topic or touched the data is that they are likely to miss the large differences that exist in financial behavior. For example, in my work I found that financial education programs do not affect the 'average' household but they do affect those at the bottom of the wealth distribution and those with low educational attainment. These are the groups that financial education programs should reach, but the evidence would not have been found if one were to look simply at averages and to run simple regressions. Moreover, having spent the last six years measuring and looking at financial literacy data, I am concerned about how much we can expect the current financial education program to be effective given they often entail only one-hour of financial education. Small intervention of this magnitude cannot be expected to do much to combat widespread illiteracy. However, this does not mean we should not do any financial education at all.

The vast evidence from psychology that people suffer from biases in their decision-making is sobering and humbling. However, if taken at face value, it seems that people are truly inept and cannot make choice, in fact any choice, not just financial decisions. However, one of the features of the current environment is that people are confronted and required to make choices. People are confronted with a myriad of choices now. For example, they are increasingly asked to decide about the medical treatment to go through and have to be wary of doctors who tend to suggest expensive but unnecessary treatments. There is wide regional disparity on how hospitals treat the same medical condition and people would want to decide in which hospital they want to be treated. If people want to buy cereals, they have a full isle with more than 100 brands to choose from. If they want to buy a cell phone service, they have many features to consider. Should we regulate how people consume? They are likely to make lots of mistakes in that area too.

Continuing on the previous point, how do we deal with the increase in financial responsibility that people are required to take on? Financial literacy education is in my view one of the ways we can help people (and clearly not the only way we should limit to).

There is no obvious alternatives to financial literacy education. The idea is not to transform each person into a financial wizard, but to give him/her the tools to navigate the current financial system. The metaphor that I have used in my work is to have knowledge similar to having a "financial driving license": people drive car without being engineers and they do not need to know everything about cars and driving to be behind the wheels. Even with knowledge, accidents will occur, but this does not mean that it is much preferable to close down the roads that are more dangerous than to allow people to do their own driving.


Term Papers said...

Excellent entry! I'm been looking for topics as interesting as this. Looking forward to your next post.

Term Papers said...

I never thought of it like that, but it really is true.