The Importance of Financial Literacy for Today’s World

The OECD recently released the results of the 2018 financial literacy assessment. In it, the organization tests the financial knowledge of 117,000 students from thirteen OECD (Australia, Canada, Chile, Estonia, Finland, Italy, Latvia, Lithuania, Poland, Portugal, Slovak Republic, Spain, and the United States) and seven non-OECD countries (Bulgaria, Brazil, Georgia, Indonesia, Peru, Russia and Serbia).

By means of these tests, the OECD aims to measure to which extent students can make sound decisions based on their understanding of financial concepts. Particularly, knowledge in four different areas is assessed: money and transactions, planning and managing finances, risk and reward, and the financial lands.

Several conclusions can be drawn from the report. First, only one in ten students reach the highest level in financial literacy among OECD countries. Second, the three Baltic economies perform very well in terms of financial skills. Third, the socio-economic background plays a moderating effect on the final score: students from high-income families tend to perform better than those from low-income families. Finally, a large fraction of the variation in financial literacy scores can be explained by skills that are also measured in math and reading tests.

Why is financial literacy so important? Should finance be given a more prominent space in schools? Detractors of financial education argue that teaching finance at the school level is just a form of indoctrination that favors banks and other financial institutions. Consequently, it shouldn’t be included in the academic curriculum of primary and secondary schools.

It should be noted that this wouldn’t be a problem if governments didn’t hold a de facto monopoly on primary and secondary education. Were this the case, parents could choose whether or not to enroll their children in schools where financial education is part of the curriculum. However, given that competition-enhancing tools such as school vouchers aren’t present in most countries, the debate around the convenience of introducing financial education in schools is of the utmost relevance.

Financial education is important for two reasons. First, many critical decisions we make throughout our life require some basic financial knowledge. When we apply for a mortgage to buy a new house, we need to understand the difference between a variable and a fixed interest rate in order to know which one fits better with our expectations.

Similarly, financial knowledge helps us gain a better understanding of the different investment vehicles available to make the most of our savings. For instance, the lack of financial literacy leads many people to keep their money non-bearing-interest accounts because they see the stock market as a casino.  As a result, they let their savings be eroded by inflation, missing the opportunity to obtain higher returns by investing in low-cost index funds.

In both cases, financial education does exactly the opposite of what detractors say. In the case of applying for a mortgage, it prevents customers from being nudged by banks to choose an option that is suboptimal for them. In the case of choosing where to invest one’s money, it allows savers to use investment vehicles other than those offered by commercial banks, which are often low-quality and expensive.

Second, financial literacy is key from a macroeconomic perspective. The more we know about the investment opportunities available, the more efficiently our savings are allocated in the economy, with the subsequent positive impact on productivity and, ultimately, on living standards for all. Let me give you an historical example of this.

One of the reasons why the Antebellum South in the U.S. lagged behind the North in terms of economics development was that slaveholders refused to invest capital in industry even though there were profitable investment opportunities in the southern manufacturing sector. This was so due to a combination of ignorance and prejudices. The same reasoning can be applied to our case: the lack of financial knowledge prevents many savers from obtaining higher returns on their investments. This in turn leads to a misallocation of resources that could have gone to finance productive investments somewhere else in the economy.

Fortunately, all countries participating in the PISA financial literacy assessment seem to understand the importance of financial education in today’s world and have introduced several programs aimed at teaching financial education in schools.

Financial knowledge empowers people as it allows them to make more informed and less biased decisions. What’s wrong with this?