God is a Capitalist

Tuesday, March 11, 2014

Financial Education Fails

 Many people share a strong pessimism about the future of Social Security while secure pensions from a lifetime of working for the same company have followed the path of buggy whips. So in spite of decades in which the nanny state tried to protect people from life, people feel  less secure than ever. 

As usual and when all else fails, the experts turned to education. Teaching people about the miracle of compound interest and providing GPS guides to navigate the forest of investment alternatives and complex securities would empower consumers to make wise investment decisions. But as usual it failed according to a paper by three academics who analyzed 168 papers covering 201 prior studies. The paper, “Financial Literacy, Financial Educationand Downstream Financial Behaviors” was made available online in January and will appear in a forthcoming journal, Management Science. The authors concluded that

These interventions cost billions of dollars in real spending and larger opportunity costs when these interventions supplant other valuable activities. Our meta-analysis revealed that financial education interventions studied explained only about 0.1% of the variance in the financial behaviors studied, with even weaker average effects of interventions directed at low-income rather than general population samples.

The authors mean by the phrase “0.1% of the variance in the financial behaviors studied” that financial education can explain less than one percent of the way in which people differ with respect to five areas:  “Saving for an Emergency Fund,” “Figuring Out How Much Savings is Needed for Retirement,” “Positive Savings / Investment Behaviors,” “How do You Think Banks or Credit Card Companies Would Rate Your Credit?” and “Credit and Checking Fees” (for bounced checks and late payments).

Financial education has a short shelf life according to the paper. If it arrives just before a consumer needs to make a major decision it can help, but the expiration date for training is two years. If the event that triggers a decision happens after that date then the training has lost all of its saltiness.  

When the authors added personality traits to the models, education lost even more of its effectiveness. Those traits included math skills, propensity to plan, confidence, risk avoidance, self-efficacy, delayed gratification, restraint, and impulsiveness. 

The authors recommended “just in time” education, that is, somehow providing the training just before the moment consumers need to make a decision and “...soft skills like propensity to plan, confidence to be proactive, and willingness to take investment risks more than content knowledge about compound interest, bonds, etc.” In spite of the acknowledgement that financial training costs billions of dollars worldwide every year, they never suggested just stopping the waste. 

A problem with the conclusions of the study is that the authors ignore comparative advantage and specialization. The proponents of financial education want to make experts of everyone regardless of ability. However, many people lack the time and desire to develop expertise in finance. Everyone should pursue their comparative advantage by specializing in what they are best at. If they don’t want to learn finance or don’t have the ability, they should leave financial advice to those who enjoy a comparative advantage in it.

Another problem with studies such as these is the failure to distinguish between skills and attitudes. The “soft skills” the authors mention are not skills at all, but attitudes. Skills are easy to teach; attitudes are very difficult to change, often requiring extended counseling and/or a major personal crisis. 

The first thing people need to learn is to save, but that requires self-restraint and the ability to put off gratification now for greater satisfaction later, or as they say in Austrian economics, less time preference. Greater time preference means you want to spend more of you money now and less in the future. 

But savings isn’t a skill; it’s an attitude or a value that people absorb from their family and religion. And that leads to a discussion of Deirdre McCloskey’s “Bourgeois Values” series. Savings is one of the great bourgeois values that Keynes and other socialists hated for centuries. Of course, Keynes didn’t hate all savings, only personal savings. He wanted the state to save and invest through massive taxation. 

As a result of the Keynesian revolution, government has done all it can to destroy the bourgeois value of savings. It taxes income and makes saving harder and then punishes those who save by taxing the interest or capital gains on savings. When you die it taxes those savings again. The state rewards businesses that borrow instead of saving to finance operations by taxing profits that are saved and allowing tax deductions for interest payments. Dividends get no deduction for the company but are taxed again as income when the stock owner receives them. 

Fear is the greatest motivator to save, which is the reason Asians save so much of their income. But the welfare states of the West have worked feverishly to remove fear of life’s contingencies by providing for poverty, healthcare and retirement. 

But the Fed is the worst enemy of savings. It keeps interest rates as low as possible in order to encourage people to spend their savings and borrow more, while price inflation that results from Fed policies eats away at savings like termites in a log cabin. Finally, the recessions caused by Fed monetary policies hurt the working poor the most because they have to use up much of their savings during jobless periods. 

Financial training clearly wastes enormous amounts of wealth every year. The first steps toward restoring financial sanity in the US would be to remove the efforts by the state and mainstream macro economists to keep us all insane.

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