The Economic and Social Value of Financial Literacy

The Economic and Social Value of Financial Literacy

José Manuel Sánchez Santos
Copyright: © 2020 |Pages: 28
DOI: 10.4018/978-1-7998-2440-4.ch009
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The main objective of this chapter is to provide new insights into the economic and social value that financial literacy has for individuals and societies. Financial literacy has implications that are relevant both at a micro (especially for households) and macro-level (for the financial system and for the national economy as a whole). On the one hand, a lack of financial literacy put households a risk from making sub-optimal financial decisions and prevent them to maximize their wellbeing. On the other hand, financial literacy favors a better allocation of resources, reduces the risks associated with episodes of financial instability, and therefore, contributes to the increase of social welfare. The analysis and the empirical evidence showing the benefits (costs) of financial literacy (illiteracy) allows to conclude that policymakers have a key role to play implementing initiatives aiming to improve financial literacy of the population at all stages of life.
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Financial literacy is an important life skill with significant implications at both, micro (for individuals) and macro (for society as a whole) level. On the one hand, financial literacy lacks usually has effects on individuals’ finance management and on their ability to save for long-term goals such as financing retirement, buying a house etc. In particular, financial illiteracy is behind ineffective financial planning and has costs in terms of saving and investment returns, and also in terms of consumers' debt management (Campbell, 2006; Lusardi, 2019). Moreover, money mismanagement may lead to a higher vulnerability of consumers to financial crisis in the event of a negative economic shock such as a job loss or a long-lasting illness. On the other hand, at a macro level, informed buyers of financial products contribute to create both more competitive and more efficient financial markets, increasing the market discipline and forcing the financial institutions to operate more efficiently. More efficient financial markets, ultimately, contributes to allocate capital efficiently and, in turn, to promote economic growth.

More specifically, in retail financial markets, there are a number of circumstances that make consumers of financial products and services particularly vulnerable. Behavioral economics offers a perspective that identifies some of the main biases inherent in the demand for financial products. These biases, in turn, are at the root of some anomalies in financial products demand and, ultimately, constitute an objective justification for the need to increase consumer financial knowledge (Loerwald & Stemmann, 2016). The approach to savers and investors behaviors in retail financial markets using behavioral economics perspective allow not only assess the extent to which financial literacy can contribute to eliminating or at least correcting apparently irrational or anomalous behavior of financial products consumers, but also raise regulatory issues.

As far as the implications of financial literacy at a macro-level, economic theory has demonstrated the importance of both financial intermediaries and financial markets as drivers of economic growth (King & Levine, 1993; Levine, 1997). Financial literacy has the potential to impact the economic growth to the extent that it contributes both to personal saving and to the development of the financial sector. In particular, the scope of the financial system contribution is mainly linked to their role as a channel of savings towards productive investment and as a driver to the efficient allocation of capital. However, the optimal performance of these functions requires, among other things, that participants in financial markets (i.e. buyers of financial products) make informed decisions and, to this end, it is essential that they have a certain financial literacy.

Financial knowledge becomes an issue particularly important at a time characterized by the availability of a wide range of increasingly complex financial products in the retail financial markets. Moreover, in the wake of the last global financial crisis, the costs of financial illiteracy and its distributional effects has emerged as one of the main concerns for policymakers. Given that financial literacy is low not only in less developed countries but also advanced economies with well-developed financial markets (Lusardi, 2019), and taking into account the substantial changes both in the economic and financial environment, improvement in population's financial literacy levels has become a social priority. In this context, policymakers, financial regulators, supervisors, and financial institutions have a key role to play in the task of providing financial education with the aim that people can make informed financial decisions.

In short, the analysis developed in this chapter is intended to emphasize how financial education and financial literacy can contribute to mitigating the possible negative effects for the consumer resulting from the existence of market failures (i.e. imperfect and asymmetric information) in retail financial markets. The most relevant aspect of this approach is that, ultimately, the progress made in this area will result in an improvement in consumer welfare.

Key Terms in this Chapter

Financial Regulation: A form of regulation or supervision which subjects financial institutions to certain requirements, restrictions or guidelines, aiming to maintain the integrity of the financial system.

Financial Literacy: A combination of awareness, knowledge, skill, attitude, and behavior necessary to make sound financial decisions and ultimately achieve individual financial well-being.

Behavioral Bias: Psychological deviations from rationality that affects individuals’ behavior and perspective, based on predetermined mental notions and beliefs. There are conscious and unconscious biases.

Financial Inclusion: The process of ensuring access to appropriate financial products and services needed by vulnerable groups such as weaker sections and low-income groups at an affordable cost in a fair and transparent manner by mainstream Institutional players.

Financial Stability: The absence of crises in the various groups of institutions and markets and the stable evolution of the main monetary and financial macro magnitudes (monetary supply, credit supply, interest rates, etc.).

Numeracy: The ability to reason and to apply simple numerical concepts. Basic numeracy skills consist of comprehending fundamental arithmetic like addition, subtraction, multiplication, and division.

Market Failure: A situation in which the allocation of goods and services by a free market in not Pareto efficient. The existence of market failures is often behind governments economic interventions.

Systemic Risk: The possibility that an event or decision at an individual level trigger instability or collapse an entire sector or economy.

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