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Vittorio Emanuele Agostinelli

EucA Public Affairs Officer / Public Affairs Officer - EucA – European University College Association

Some European Union countries are among the world’s best performers in financial literacy. Denmark and Sweden both have 70 percent literacy rates. However, the EU also includes countries that perform below the global average, such as Romania with a 22 percent rate and Portugal with a 26 percent rate. Findings about financial literacy in the EU echo similar findings from the US: that lower income groups, women and less-educated respondents score lower than the rest of the population. Financial literacy rates across age cohorts form a hump shaped distribution. Individuals below 25 years and above 70 years score lowest and the correct response rate peaks among 55-65 years old (Lusardi and Mitchell, 2011).

Women tend to score lower than men in all countries and within age groups and are more likely to answer ‘do not know’ than men. By contrast, there is no gender gap in financial literacy among schoolchildren, underlining the need for financial education from a young age (OECD, 2012). Saving, spending and investment decisions are integral parts of our lives, demanding an ever-increasing level of knowledge of the risks and opportunities that come with these decisions. If globally one in three adults are not able to answer questions demanding relatively low levels of financial knowledge, let alone carry out simple numeracy calculations, it is alarming to imagine how these individuals respond when faced with complex choices, from signing a mortgage contract to investing in a pension plan.

At the same time, the financial world is becoming more and more complex and consumers are increasingly offered a dizzying array of financial products with different levels of risk and reward. In addition to the growing financialization, the risks related to spending, saving and investment are shifting from institutions to individuals, from providers to contributors. We outline three main interrelated arguments why financial literacy matters throughout an individual’s life, and what implications financial literacy, or the lack of it, has for inclusiveness and inclusive growth, particularly in the EU. Fifty years old respond that what occupies them the most is future savings and retirement. All people facing retirement worry if they have accumulated enough savings to carry them through retirement. By 2050, one in three people in the EU will be over 65 and the ratio of working people to those aged 65 and over (the old-age dependency ratio) will shift from four to one currently to two to one. However, public pensions ratios are expected to remain broadly stable in the EU in the same period.

This will exert an enormous pressure on pay-as-you-go (PAYG) systems. Pressure on the public pension system could be mitigated by shifting towards more occupational and personal insurance systems (European Commission, 2015). More and more countries are shifting from defined benefits to defined contribution systems, meaning saving, spending and investment decisions are shifting increasingly from institutional set-ups to the individual. In defined contribution systems, the employee is typically responsible for deciding how to invest their life savings. This puts pressure on the individual and demands a certain degree of financial literacy Financial literacy is important for retirement savings, among others, for two main interrelated reasons. First, people who respond to surveys that they think of retirement planning tend to save more, and the causality runs from planning to wealth and not the other way around (Lusardi et al, 2010). Therefore, financial literacy boosts the intention to save; investment in financial literacy is optimal when done ahead of financial decisions. Second, households that score better on financial literacy also accumulate more wealth and are more likely to invest in stocks (van Rooij et al, 2007, 2011).

This has significant implications for the portfolio diversification of household balance sheets. In the EU, large parts of the balance sheets of the households of older people are made up of financial assets. The share of financial assets on the balance sheets of these households is positively associated with countries’ financial literacy scores. Holding of diverse assets by households is preferable not least because it reduces overreliance on retirement income. Furthermore, the population aged over 65 in the EU has €3 trillion in spending power, which means that their spending and investment decisions will increasingly have significant implications for the rest of the economy, in terms of the distribution of wealth and the intergenerational transmission of wealth. Financial literacy is not only the understanding of concepts and the taking of saving and investment decisions. It also covers attitudes towards, and understanding of, debt and other forms of liabilities. Household balance sheets are composed mainly of two kinds of debt – mortgage debt (including in relation to second houses and other real estate property) and non-mortgage debt (consumption debt, credit card debt/overdraft and debts such as business loans). For euro-area households, mortgage debt makes up 85.5 percent of total household debt; this share of debt is highest for young households aged 16-34, followed by those aged 35-44 (ECB, 2016). There is a positive association between the share of households with negative net wealth and financial literacy scores, indicating the increasing importance of financial literacy with increasing levels of household leverage.

This positive association is strongest for young households (16-34 age group). Young households, particularly lowincome households, were hit hardest during the great recession. When house prices collapsed, the low networth households experienced the greatest drop in their net wealth because their wealth was exclusively tied to their housing equity (Atif and Mian, 2015). For the euro area, evidence is starting to emerge that the decline in wealth was greater for households with a mortgage (20 percent decline), than households already owning a home (12 percent decline) (ECB, 2016). There is a growing literature on the positive association between the level of financial literacy and income and net wealth (Behrman et al, 2012; Van Rooij et al, 2012). Furthermore, financial literacy differs not only between income groups, but also within income groups. Studies show that debt problems are caused by lack of financial understanding rather than by lack of income. That is, households that are poorer, but scoring better on financial literacy are more likely to negotiate and get favorable contracts and pay lower interest (Lusardi and Tufano, 2009; Hasting et al, 2011; OECD, 2005). Offers of low financing in an environment of rising house prices, attracted in particular large numbers of young first-time homeowners and those at the lower end of the income distribution during the crisis. It needs to be mentioned that low financial literacy increases the likelihood of individuals falling victim to appealing but fraudulent offers. There is a rich literature detailing the link between economic growth and its impact on socio-economic outcomes.

Growth is considered inclusive when individuals, regardless of their socio-economic background, have an equal opportunity to progress. Poverty, inequality and social mobility are the main components of inclusive growth. Studies show that children from socio-economically disadvantaged backgrounds tend to underperform at school, which hinders their prospects for better education at a later stage and leads to lower employability. Moreover, people with lower education have worse health and live shorter lives (Darvas and Wolff, 2016). In more unequal societies with higher shares of people living in poor households, social mobility also tends to be lower (Corak, 2013). Investing in financial education throughout individuals’ lives, particularly at an early age, increases financial knowledge overall and influences decisionmaking later in life (Van Rooij et al, 2009).

This has major implications for inclusiveness, though the impact varies depending on country, socio-economic level and circumstances related to birth. Why is financial literacy important for inclusive growth? We argue that giving people the education and tools to better navigate the increasingly complex financial world is one of the pre-conditions to achieving inclusive growth. For the poor and disadvantaged, increased financial literacy means improved opportunities to access the benefits of economic growth. Surveys confirm that less educated and lower-income people tend to score lower on financial literacy than the rest of the population. In addition, adult women score lower than men on average and for all age groups, and are more likely than men to answer ‘don’t know’. There is a strong age bias – younger respondents do worse than older respondents – and a locale bias, with rural respondents tending to do worse than urban dwellers. In US, there is racial bias, with white and Asian cohorts tending to perform better than blacks and Hispanics. In Europe, school children from migrant backgrounds underperform compared to natives. In light of these findings, we examine financial literacy in relation to the most important elements of inclusive growth, namely inequality, poverty and social exclusion and social mobility. There is a clear negative relationship between financial literacy scores and inequality in the EU. Countries performing better at financial literacy also tend to have lower inequality.

Financial literacy scores are also strongly associated with poverty and social exclusion indicators. One of the five Europe 2020 targets is to “lift at least 20 million people out of poverty by 2020”. The headline indicator to measure the progress is the rate of people at risk of poverty (AROP) in each country. The findings suggest that countries performing better at financial literacy have lower shares of population at risk of poverty. Actively investing in financial education and literacy programmes might serve as one of the tools to reach the Europe 2020 targets. In addition to the AROP indicator, we look at another measure of vulnerability and social exclusion: the severe material deprivation rate. We reach a similar conclusion, that the financial literacy score is negatively associated with the severe material deprivation rate. There is a visible negative relationship between individuals’ social mobility, proxied by the correlation between students’ maths test scores and socio-economic backgrounds, and countries’ financial literacy scores. In countries with higher financial literacy scores, the relationship between wealth and maths scores is less pronounced. As such, socio-economic circumstances related to birth have an impact on financial literacy. Unsurprisingly, socio-economically advantaged students and those from non-immigrant background tended to score better than their peers.

Financial literacy is financial education, such as basic economics, statistics and numeracy skills combined with the ability to employ these skills in making financial decisions. Research has shown that as people become more financially literate, they make better saving and borrowing decisions, are more likely to plan for retirement and hold more diverse assets in their balance sheet. As more and more households are asked to make their own decisions about such issues, financial illiteracy can become a serious threat to their life-time welfare.

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