Cross-Country Differences In Financial Literacy
01 Nov 2010
There is plenty of evidence that a large proportion of adults in most countries are unfamiliar with even the most basic economic concepts, such as inflation, risk and mortgages. But according to research by Professor Tullio Jappelli, published in the November 2010 Economic Journal, there is considerable variation in financial literacy across countries.
His study finds that people in countries with higher levels of educational achievement tend to be more financially literate. But people in countries with more generous social security systems are generally less financially literate. Countries in Scandinavia and East Asia are among the best performers in financial literacy.
The research has two implications for policy. First, the international comparison suggests that financial literacy improves with the drivers of human capital and financial market reform, both of which change slowly over time.
Second, raising the incentive to acquire financial knowledge through social security reforms associated with financial market deepening – for example, the creation of private pension funds – will eventually lead to improvements in financial literacy.
The recent crisis has amplified the risks that people face when they lack the financial sophistication required to absorb financial shocks. Other things equal, differences in financial literacy create the potential for significant distributional consequences of a financial crisis, because unsophisticated investors are more exposed to market fluctuations than investors that are able to manage and diversify risks.
The risks are especially severe for individuals whose pensions depend on stock market developments and for the elderly. whose assets are based on decisions made in the past and whose margins for adjustment are smaller.
Recent studies have made considerable progress in measuring financial literacy. Economists have tended to measure literacy through a rough self-assessment of respondents'' financial sophistication. But there is a second generation of studies based on detailed and more reliable questions on finance.
These surveys have established convincingly that a large proportion of the adult population knows very little about finance and that many individuals are unfamiliar with even the most basic economic concepts, such as risk diversification, inflation, interest compounding, and mortgage and other debt instruments.
There is also substantial evidence that financial literacy differs widely across households and tends to be rather limited in demographic groups that are poorer and less educated. What makes this evidence even more worrying is that many people are not even aware of their ignorance.
Although considerable progress has been made in measuring financial literacy, the determinants of financial literacy, the effectiveness of financial education and the consequences of financial literacy for households'' financial decisions are not well understood.
This study adopts an international comparative perspective, which involves merging indicators of financial literacy with a wide set of macroeconomic and institutional variables. The purpose of the analysis is to study the factors that are more likely to explain international differences in literacy using cross-country and time-variable indicators.
The research uses the IMD World Competitiveness Yearbook, which compiles summary indicators of financial literacy for the period 1995-2008. The indicators are computed based on interviews with senior business leaders in 55 countries. The survey aggregates their responses by country to provide an overall score for financial literacy.
The data show that financial literacy varies substantially across countries, from the lowest scores in some Latin American and former socialist countries to high values in the Scandinavian countries and East Asia.
Further analysis of the data indicates that educational achievements – as well as test scores in an internationally comparable assessment in mathematics or science – are positively associated with financial literacy. On the other hand, countries with high mandated savings in the form of social security contributions and resulting more limited resources for private wealth accumulation, show lower levels of financial literacy.''Economic Literacy: An International Comparison'' by Tullio Jappelli is published in the November 2010 issue of the Economic Journal.
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