Are poor countries doomed to suffer from financial illiteracy?
It makes common sense for higher GDP per capita to go hand in hand with higher financial literacy rates, which results in greater financial inclusion, which in turn results in less poverty and a higher GDP per capita. Those left out of this spiral is doomed to remain financially illiterate, and thus financially excluded, and thus higher rates of poverty prevail. But is it really so? Studies show conflicting links with financial literacy and high per capita GDP.
Source: https://www.moneycrashers.com/financial-literacy-tips-resources-education/
Only 35% of male & 30% of female adults around the globe are financially literate[1] according to surveys by Gallup Research. Financial literacy levels around the globe vary a lot, highest rates are not surprisingly achieved by developed and advanced economies. According to S&P’s Global Financial Literacy Survey, 7 out of the 10 countries with the highest financial literacy rates are Western European countries[2]. Furthermore, no countries in South America has a literacy rate above 50% and only one country in Africa. Highest literacy levels are achieved by Denmark, Norway and Sweden, all Nordic countries and all at 71% financial literacy rates (Finland at 63%). These countries are usually characterized by mixed economic systems with redistributive taxation and strong public sector resulting in low income disparity and social benefits such as effective public education systems, pension schemes etc. all encouraging gender equality and high workforce participation. This makes one think that high financial literacy is a luxury for most developing and lower-income countries.
Surprisingly, though, the survey was unable to find a direct link between poverty and financial literacy. According to findings of the survey, higher per capita GDP is correlated with higher financial literacy for the richer half of the world’s economies; but for the poorer half there is no such evidence. In other words, countries with GDP per capita levels that are at the top 50% of the list do show this link, that the less rich are also less financially literate. But not the same thing for the bottom 50%, that the poorest may not be the least financially literate.
What this means at the end is the fact that poverty, or lower GDP, is no reason to be doomed to failing when it comes to achieving high rates of financial literacy. At the individual level, it is not necessarily the poor people who are financially illiterate, it also doesn’t mean that rich people are financially literate. This hints that national-level policies, such as those related to financial education and consumer protection, shape financial literacy in emerging economies more than any other factor[3], and encourages governments of lower-income countries to dedicate resources to better policy-making for financial literacy. Excluded groups; such as women, youth, the poor; need to know how to access/use financial services & to protect themselves from abusive practices in the financial industry[4] in order to achieve greater financial inclusion and reap the associated economic benefits.
In the example of Bangladesh, where financial literacy rate is at 28% in 2017[5], only 47% are financially included. Among those, 25% has a full-service bank account, and there is a persistent gender gap of 10% in terms of account ownership. 28% literacy is a great improvement from only 19% in 2016 and most of the recent improvements in financial inclusion came from the government’s agent banking strategy[6]. This strategy aimed at reaching the underserved population mostly in the rural regions. Expansion of agent banking in Bangladesh contributed to a 5% surge (20% to 25%) in registered bank users from 2017 to 2018[7] [8]. A recent project on digitizing wage payments in Bangladesh’s garment factories[9], whose main workforce is women, found that lack of financial literacy and awareness about accounts is a major constraint[10] for their inclusion. On the other hand, empirical study[11] shows that a spillover effect of parents’ financial literacy is for university students in Bangladesh to engage in better savings behavior. Both of these examples show that adopting policies promoting financial literacy, both for women and for young people may help overcome difficulties in their financial inclusion.
Why should governments invest in policies promoting financial literacy?
Financial inclusion and financial literacy are inevitably linked; as being aware of and understanding the details of different kinds of financial services offered in a market is vital for effectively making use of them, given that all other necessary conditions are met. Although there are different definitions for financial literacy, the simplest form is a general understanding of financial concepts and a general awareness of financial services offered. World Bank[12] defines financial literacy as “financial awareness/knowledge of financial products, institutions, concepts, financial skills such as calculating interest payments; and money management and financial planning capability”. S&P defines financial literacy as being able to answer correctly 3 out of 4 basic questions on compound interest, numeracy (interest), risk diversification & inflation[13]. All these simple questions test a general understanding of general financial concepts each individual needs to be equipped with to be able to make sound decisions regarding their own financial management.
Benefits of high financial literacy is countless. On top of promoting greater financial inclusion; increased literacy also reduces information asymmetries between providers of financial services and users of these services and prevent any power imbalances that may lead to one’s exploitation in the financial services market. Prevalence of financially literate consumers would encourage competition amongst financial services providers. Consumers demanding higher quality products, faster access to and easier utilization of financial services encourage competition in the market for innovation and for cost effective provision of necessary financial services, for individuals, for small businesses that provide most of the job in most developing countries, as well as corporates that run a large portion of manufacturing processes.
Financial illiteracy may cause individuals to get trapped in poverty[14] by letting them into debt spirals when it is coupled with inadequate consumer protection laws or complete lack of them in a financial services sector. People with inadequate emergency funds, and those already in debt, usually face no other choice but to take out new loans with higher interests and at times to borrow informally to pay off debt when they encounter lasting financial shocks. Moreover, financially illiterate people spend more on transaction fees overall, as they may not be aware of the best suited service offered for their specific situation, and they may lack access to the necessary financial information in the first place. This spiral may cause financially illiterate people to accumulate larger debts and incur higher interest rates on loans. The overall effect of financial illiteracy is higher probabilities of defaults on loans and businesses, having not enough savings and emergency funds to smooth out spending for necessary goods throughout one’s life. The most important link with poverty, and the one that enables its continuation from generation to generation; is the fact that financial illiteracy may result in lower possibilities of investments in education and assets that may pull families out of poverty.
Sources Used:
[1] Justin McCarthy, Anita Pugliese. Two in Three Adults Worldwide Are Financially Illiterate. November 18, 2015.
[2] Visualizing Financial Literacy Rates around the World.
[3] S&P Global Financial Literacy Survey, 2016.
[4] Lyons, Angela. Financial Inclusion, Literacy and Economically Vulnerable Populations in the MENA. University of Illinois. SSRN Electronic Journal. June 2018.
[5] S&P Global Financial Literacy Survey, 2016.
[6] Bangladesh: Wave 6 Report. 6th FII Tracker Survey. Intermedia Research & Gates Foundation, April 2019.
[7] Bangladesh: Wave 6 Report. 6th FII Tracker Survey.
[8] Launched in 2015, 18 banks in Bangladesh provide agent banking through 3,902 agents & 5,791 outlets in the rural. January — September 2018, number of agent banking accounts increased by 38%; leading to a 7% increase in bank accounts in the rural poor since 2015.
[9] Bangladesh: the Impact of Wage Digitization. Intermedia Research & Gates Foundation, May 2019.
[10] Niaz Mahmud. Dhaka Tribune. Lack of financial literacy, awareness major challenges for wage digitizing.
[11] Khatun, Mabia. International Journal of Scientific and Research Publications, Volume 8, Issue 12. Effect of Financial Literacy and Parental Socialization on Students Savings Behavior of Bangladesh. December 2018.
[12] Lisa Xu Bilal Zia. The World Bank. Financial Literacy around the World: An Overview of the Evidence with Practical Suggestions for the Way Forward. June 2012.
[13] S&P Global Financial Literacy Survey, 2016.
[14] Fair Finance Guide Brazil. Overcoming over-indebtedness in Brazil. April 10, 2019.
