Financial literacy has become an immensely popular component of financial reform across the world. As a response to the recent financial crisis, the United States government set up the President’s Advisory Council on Financial Literacy in January 2008, charged with promoting programs that improve financial education at all levels of the economy and helping increase access to financial services. In the developing world, the Indonesian government declared 2008 “the year of financial education,” with a stated goal of improving access to and use of financial services by increasing financial literacy. Similarly, in India, the Reserve Bank of India launched an initiative in 2007 to establish Financial Literacy and Credit Counseling Centers throughout the country which would offer free financial education and counseling to urban and rural populations. The World Bank also hasn’t been missing out on the trend – it recently approved a $15 million Trust Fund on Financial Literacy.
But what do we know about financial literacy? Does it work, and if so, through what mechanisms? Despite the money being ploughed into financial literacy programs, we know very little to address these important questions. While it is true that there is a large and growing body of survey evidence from both developed and developing countries that demonstrate a strong association between financial literacy and household well-being, we are still in the process of learning whether this relationship is causal.
While survey analysis can control for all observable variables in the survey questionnaires such as income, gender, age, education, etc., there may be some unobserved variables, such as ability, that may be driving the positive correlation between financial literacy and use of financial services. In addition, people who choose to participate in surveys or literacy seminars may be quite different in terms of their interests in financial matters, for instance, than those who do not participate. The positive correlations may therefore be driven by endogenous selection. Further, survey evidence cannot distinguish the direction of causality: greater financial literacy may lead to greater use of financial services, or just as likely, individuals who use more financial services may score better on financial literacy assessments based on their experience in financial markets.
Experimental studies on financial literacy, similar to medical drug trials, allow for overcoming the problems of selection and endogeneity that are associated with survey analysis. There are only a handful of completed studies on financial literacy, though more are in the pipeline.
In the developed world, research evidence that financial education can affect decision-making comes from a randomized evaluation conducted at a major university in the United States. Duflo and Saez (2003) implemented an “encouragement design,” in which they randomly offered some administrative employees a small financial incentive ($20) to attend a session which provided information on retirement products. Those receiving the incentive were significantly more likely to attend the training session, and this had a small, but significant impact on their savings decisions, as more individuals in the treatment group enrolled in tax-deferred retirement accounts.
In a paper I coauthored with Shawn Cole and Thomas Sampson, we provide the first study in this direction in the developing world, through a randomized evaluation of a financial literacy training program in Indonesia. Participants in this study consisted of unbanked households, half of whom received an invitation for a free financial literacy seminar 2-3 hours in length. Although take up of the training is high, we find no effect of the program on the likelihood of opening a bank account in the general population. We do, however, find that the training has a significant impact on unschooled and financially illiterate households, increasing the likelihood of opening a bank account by 12% and 5%, respectively. These results suggest that financial literacy training programs should be carefully targeted at these subgroups of individuals. Additionally, a more comprehensive financial literacy program that is delivered over several weekly sessions, rather than a single session of a few hours, may be required to change financial behavior among households in the general population.
The need for a more detailed and extensive financial education program is also reflected in research by Cole, Gine et. al (2009) on rainfall insurance for low-income farmers in Andhra Pradesh, India. Specifically, they randomize the provision of an education module about converting the measurement of rainfall in millimeters to soil moisture. Since farmers typically decide when to sow using soil moisture whereas insurance payouts are calculated using millimeters, the education module should improve farmers’ understanding of the insurance policy.
However, results indicate that the education module had no significant effect on insurance participation, possibly because the intervention was quite minimal. The education component only involved using a ruler to demonstrate a length of 10mm and 100mm, and subsequently showing a chart of how 100mm of rain translates into average soil moisture for a particular soil type. Moreover, the information was presented quite briefly, taking no more than 2 to 3 minutes. Thus, a modest amount of financial education appears to be insufficient in inducing households to participate in financial markets, and a more thorough financial literacy program may be necessary to do so.
Given the dearth of rigorous evidence on the impact of financial literacy training programs, there are currently several ongoing field experiments which will soon provide additional evidence on the efficacy of such programs. Several projects are already underway to measure the efficacy of business training programs for poor and small entrepreneurs:
- Bruhn and Zia in Bosnia-Herzegovina, providing business training for youth entrepreneurs;
- Pande, Field and Jayachandran in India, using a 2-day training course on business and financial skills for self-employed women;
- Gine and Mansuri in rural Pakistan, evaluating a program that provides business training and loans up to 4 times the average loan size; and,
Bruhn, Karlan and Schoar in Mexico, who conduct a randomized evaluation of on-site business mentoring, where local entrepreneurs were paired with a mentor for a 1 year period.
Such programs typically incorporate some aspects of what is usually considered financial literacy (e.g. learning how to separate business and financial accounts, understanding financial statements) with other elements of better business practices (e.g. how to market products better, sales techniques).
There are even fewer ongoing studies attempting to look at other aspects of financial literacy behavior. Exceptions include Cole, Shapiro and Zia, who are conducting a randomized evaluation of a video-based financial literacy training program in India, which includes modules on loans, savings, budgeting and insurance. Elsewhere, Hastings and Mitchell are conducting an experiment among Chilean households, to determine whether or not financial literacy has an effect on an individual's ability to make optimal financial decisions; and Karlan, McMillan and Kutsoati are carrying out a randomized control trial in Ghana where rural bank customers receive six 15-minute financial literacy lessons.
The jury is still out on whether financial literacy is a useful and cost-effective tool for promoting financial access. The studies mentioned here and many more that are in development should enhance our understanding of what works, how it works, and for whom it works.
Bruhn, Miriam, Dean Karlan, and Antoinette Schoar. Returns to Entrepreneurship Mentoring for Small and Medium Enterprises in Mexico. Ongoing project.
Bruhn, Miriam, and Bilal Zia. Business Training for Youth Entrepreneurs in Bosnia. Ongoing project.
Cole, Shawn, Xavier Gine, Jeremy Tobacman, Petia Topalova, Robert Townsend, and James Vickery, 2009. Barriers to Household Risk Management: Evidence from India. Harvard Business School Working Paper 09-116.
Cole, Shawn, Thomas Sampson and Bilal Zia, 2009. Financial Literacy, Financial Decisions, and the Demand for Financial Services: Evidence from India and Indonesia. Revise and Resubmit, Journal of Finance. (Working paper version is available here.)
Cole, Shawn, Jeremy Shapiro and Bilal Zia. Does Financial Education Improve Financial Access for Women? Experimental Evidence from India. Ongoing project.
Gine, Xavier, and Ghazala Mansuri. Business Training and Increased Access to Microcredit for poor households in Pakistan. Ongoing project.
Hastings, Justine, and Olivia Mitchell. Financial Literacy, Short-run Impatience, and the Determinants of Savings and Financial Management. Ongoing project.
Karlan, Dean, Margaret McMillan and Edward Kutsoati. Savings Account Labeling and Financial Literacy Training for Susu Customers in Ghana. Ongoing project.
Pande, Rohini, Erica Field and Seema Jayachandran. Business Training for Women in Ahmedabad, India. Ongoing project.