One hears a lot about financial literacy as a critical skill for the citizenry of today. But an interesting article by Lauren Willis of Loyola Law School (dating from February 2008) suggests that this is a canard.
A prior article demonstrated that belief in the effectiveness of financial literacy education lacks empirical support. This article argues that the belief is implausible.
…. The gulf between the literacy levels of most Americans and that required to assess the plethora of credit, insurance, and investment products sold today—and new products as they are invented tomorrow—cannot realistically be bridged.
…. For some consumers, financial education appears to increase confidence without improving ability, potentially leading to worse decisions. When consumers find themselves in dire financial straits, the regulation through education model blames them for their plight, shaming them and deflecting calls for effective market regulation. Consumers are not required to serve as their own doctors and lawyers and for reasons of efficient division of labor alone they should not be required to serve as their own financial experts. Opportunity costs should not be overlooked; a single-minded focus on financial education inhibits pursuit of other policy tools for improving the financial welfare of Americans.
More broadly, it’s been a common theme of policymaking for some time that consumer welfare problems can be overcome by better-informed, more self-reliant consumers. Certainly, when information asymmetry is the main problem in a market, it’s satisfying to discover you can correct it with a judicious minimum of regulation. But often, the real problem is power asymmetry, and that ultimately needs a heavier hand.
In this case, even supposing consumers can be effectively taught to navigate a morass of complex alternatives, lenders and other financial actors will always have the resources to bring that complexity to the next level - plus the wherewithal to research and exploit normal human cognitive biases. The article lists the cognitive biases associated with financial decisions in some detail: overwhelming information and choices, high financial and emotional stakes, discomforting thoughts, uncertainty about the future, opaque attributes and incommensurate tradeoffs, and the tendency to passivity.
Also, financial education’s tendency to cast debt delinquency as a moral failing is a bit unsettling when you think about it, considering that credit card companies make much of their profits through interest and late fees. How many people try to pay back crippling debt when they ought to be declaring bankruptcy, because they think they’ll be a bad person otherwise? I wonder.
Instead of financial education - which, if this article is correct, is like preparing someone to run a minefield by giving them a chemistry lesson - why not require that financial products be comprehensible and hazard-free?
2 responses so far ↓
1 Julia Caplan // Apr 15, 2010 at 9:08 pm
John, I couldn’t agree more. 1) Consumers have been found time and again to behave irrationally, not putting to use their financial literacy even when they do have it. 2) The GAO issued a scathing 2006 report on credit cards, for which a usability expert reviewed disclosures from the largest credit card issuers, and found that disclosures were often written at a level that only about half of U.S. adults can read. 3) When financial institutions engage in intentionally deceptive practices such as re-ordering debits and deposits in order to create temporary overdrafts, they really have little leg to stand on in the “responsibility” debate. These are just a few reasons why we need Obama’s Consumer Financial Product Agency to regulate provision of these services.
2 Nachiket Mor // Apr 26, 2010 at 9:46 am
I think that both the author and the commentor have missed the point of the Willis piece. The way I see it the solution is not to design simpler and more comprehensible products — they may not solve the customers problem of dealing with inflation risk of school tuitions for example — complexity may be necessary. I think the author meant (and there are others such as Professor Robert Merton making a similar point) that providers need to be held responsible after the fact if it can be established that bad advice was given. See http://www.ifmrblog.com for a lot more material on this.
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