Financial Literacy: Getting Beyond the Markets
In the wake of the global financial meltdown, there have been many discussions in Canada about the need for greater “financial literacy”. In response to the crisis and its many painful consequences, educators and NGOs have redoubled their calls for financial literacy training among average Canadians. The financial industry itself has long sponsored numerous “investor education” programs (although the objectivity of these initiatives can be rightly questioned). More recently, several Canadian provinces have added financial literacy into core curriculum for high school students (including B.C., Manitoba, Ontario, and P.E.I.). We can expect more such initiatives aimed at introducing financial education into school curricula, even in the lower grades.
Even the federal government is getting in on the act. In his 2009 budget, federal Finance Minister Jim Flaherty announced the creation of a Task Force to evaluate current financial literacy initiatives and make recommendations for a stronger, more integrated national financial literacy strategy. That Task Force has issued an initial consultation paper (available at www.financialliteracyincanada.com) and plans to issue a final report by the end of the year.
In announcing the Task Force, Mr. Flaherty suggested it was motivated by the desire “to enable consumers to look after their best interests.”[1] After all, his government had been beset by complaints from individual investors who lost big in the meltdown. In response to these complaints, this budget initiative would equip individual investors to look after their own finances prudently – rather than expecting government to protect them. More broadly, it was suggested, a financially literate public would contribute to a more smoothly functioning and stable financial system.
This implicit theme of “individual responsibility” is also evident in the consultation report subsequently issued by the federal Task Force. The report argues that “a financially educated population will be better able to weather economic downturns.”[2] Indeed, the Task Force claims that financial literacy will benefit all Canadians (not just investors) by promoting more economic self-sufficiency, less pressure on social programs, enhanced economic stability, and stronger public markets. In other words, if Canadians learn to handle their personal finances better, they won’t need to rely on governments to protect them and financial markets will work better. In short, the whole country will be stronger.
It is fantasy to hope that greater knowledge on the part of individual “mom and pop” investors could somehow stabilize the workings of macro financial markets.
Some individuals will do better if they make better financial choices – just as some individuals will find a job more quickly, if they learn how to prepare a better resumé. But would more prudent financial behaviour by Canadians in aggregate really produce more stable financial markets, and even a stronger overall economy? Teaching everyone to prepare a good resumé cannot eliminate unemployment. And teaching Canadians how to plan their household budgets, live within their means, and make wise investment decisions cannot prevent the next financial collapse – let alone solve deeper-rooted problems of poverty and economic hardship that afflict millions of Canadian households.
In this regard, the timing of this redoubled emphasis on financial literacy is ironic. The Canadian economy, and the global economy, are still trying to recover from a catastrophic failure of the private financial industry. That failure was rooted not in individual ignorance, short-sightedness, or irresponsibility. It was rooted in the sophisticated efforts of major financial institutions to profit from the creation and trade of fundamentally unproductive financial assets. If individual investors had been more aware of the risks involved in their investments, and perhaps more skeptical of the questionable economic underpinning for the whole process, perhaps some could have avoided losses.[3] But it is fantasy to hope that greater knowledge on the part of individual “mom and pop” investors could somehow stabilize the workings of macro financial markets. If this current emphasis on financial literacy steers policymakers away from a badly-needed re-evaluation of the practices of the private financial industry, and of the inadequacies of public financial regulation, then it will have been counterproductive.
Canadians should indeed learn, in an honest and objective way, about the financial industry: warts and all. We should learn what high finance does, what it doesn’t do, the risks, the costs, and the vested interests associated with this hyperactive world:
- Let’s learn how shockingly little the typical Canadian saves and how unlikely it is that average Canadians could possibly save enough in an RRSP to pay for a decent pension.
- Let’s learn how public pensions are far more important to the prosperity of seniors than their personal investments and how those pensions are by far the most secure (and the least costly to administer) of all sources of seniors’ income.
- Let’s learn, more fundamentally, about how the whole system of personal investing through mutual funds is one step removed from the real processes of investment, innovation, and capital accumulation that generate genuine economic progress.
- In a similar vein, let’s learn how expensive our overdeveloped system of financial intermediation has become, with layers on layers of interest spreads, commissions, management expense fees, service charges, and other costs.
- Let’s learn about the enormous (and unprotected) risks of personal financial investing, and that there is no guarantee that expected asset values will be realized when it comes time for us all to start living off our RRSP funds.
- Finally, let’s learn how skewed and concentrated is the distribution of financial wealth in Canada (and thus the distribution of tax subsidies for personal investing). The richest 10 percent of Canadian households own close to two-thirds of all financial wealth. The richest 1 percent likely owns close to one-third. The bottom 50 percent has essentially no net financial wealth.
These are relevant, real-world financial topics about which Canadians’ current knowledge is sadly inadequate. And for the most part, the financial industry would like to keep it this way. It has thrived off the current state of affairs, in which Canadians are encouraged, pressured, misled, and heavily subsidized to buy pieces of paper with no inherent worth, paying 2 or 3 percent of their value each year in management fees – all in hopes that the paper will be worth a lot more when they decide to cash it in. A truly financially literate population would likely reject the risks and costs of this system altogether and find a more sensible and productive way to support its elder members at an acceptable standard of living.
But given the context and tone of Mr. Flaherty’s mandate to the Task Force, it seems clear that the current financial literacy “push” is likely to reinforce the existing culture and practices of personal investing. The discourse of financial literacy locates the root cause of Canadians’ financial distress in individual actions, choices, and failings: not saving enough, not planning ahead, not reading the fine print on those risky investments. It assumes that financial education alone (rather than a more concrete change in the real circumstances of Canadians’ economic lives) will be enough to change those outcomes. It endorses the current practices and culture of personal investing, and in fact stresses that we need more of it. Most dangerously, it begins to create a context in which governments can shrug off their responsibilities (whether that be regulating financial industries or providing for basic income security for Canadians of all ages) by establishing the expectation that Canadians should be able “to look after their own best interests”.
There’s certainly no doubt that Canadian households are experiencing increasing financial stress – and not just because of the financial crisis. Household debt levels have risen dramatically over the last two decades, facilitated by easier access to a broader range of debt products; total personal debt now equals almost 150 percent of Canadians’ disposable income. Household spending grew twice as fast since 1990 as household income. Personal bankruptcy rates have quadrupled in the same time. In survey evidence cited by the Task Force, one third of Canadians report struggling or being unable to keep up with monthly expenses, and 60 percent of Canadians worry about their financial future – almost a quarter worry enough to lose sleep over it.
Does this financial distress result, to any meaningful degree, from a lack of financial literacy? Would financial literacy education significantly change any of those outcomes?
The federal Task Force, and other financial literacy advocates, clearly think so. I fundamentally beg to differ. The reason more Canadian households are in financial distress is not because of their individual behaviour and choices. It is because our economy, and our society, have evolved in ways that have resulted in greater inequality, greater insecurity, and greater hardship for many (not all) Canadians.
Two recent research reports from the Canadian Centre for Policy Alternatives have tried to put hard numbers on the day-to-day minimal requirements of household life. [4] They have documented a fundamental mismatch between the earnings generated in Canada’s increasingly flexible, rugged, and unequal labour market, and the minimal costs of supporting a family. Addressing that mismatch (through policies to increase wages, and/or reduce costs for low-income families) is essential for alleviating personal financial distress. Learning to budget carefully, avoid financial fraud, reduce credit costs, and other helpful lessons from financial literacy training can certainly help hard-pressed families survive the difficult economic world they inhabit. But they cannot alleviate the more fundamental, structural causes of their financial problems.
The Task Force report admits that the changing labour market is a key reason that financial literacy is more necessary today than it was, say, 40 years ago. Back then, the report suggests, “many Canadians had seemingly secure lifelong employment, with predictable pensions.”[5] Not so anymore, and that’s why financial literacy is important – to help Canadians to grapple with a world that has become fundamentally less secure. But what if we asked a prior question – why should we take as inevitable or permanent the present, increasingly polarized circumstances of economic life for Canadians? Why can’t we make jobs more secure, or pensions more predictable? We want financial literacy to genuinely educate Canadians about the causes and potential solutions to their financial problems, rather than encouraging them to accept the fundamental dimensions of an unfair, unequal world, and then adjust themselves to it.
Financial literacy, in principle, should be a great thing… It’s a prerequisite for effective democracy that average people learn more about how the economy really works.
Obviously, regardless of how difficult one’s personal economic circumstances may be, some practices and problems can make them even worse. It pays to avoid loan sharks and payday loan shops. It pays to avoid regular credit card debt. It pays to own your own home, if you can save a down payment and crack the market. Investors of all stripes, big and small, should be fully cognizant that when they purchase anything other than a term deposit or a government bond, what they are buying could be worthless next week. They should also be aware that 2 or 3 percent of their painfully-saved wealth is creamed off the top by money managers who, economically, fulfil no productive function whatsoever.
Financial literacy, in principle, should be a great thing. I spend a large portion of my time conducting grass-roots economics education courses for working adults, and writing and disseminating educational materials about the economy, finance, and other topics. I think it’s a prerequisite for effective democracy that average people learn more about how the economy really works. That means cutting through the phony, pseudo-technical mystique that economists so often wrap around their profession. It means showing that real economic progress depends on work and productivity and innovation – not the mindless, repetitive ups and downs of the stock market.
So financial literacy can be a welcome addition to curriculum, but it should be reviewed and used with caution. Teachers should make sure that it is promoting a genuine, complete, and balanced understanding of personal finances and broader financial issues. Some financial literacy tools (especially those provided “free of charge” by financial institutions and associations) are little more than disguised advertisements for the mutual fund industry, admonishing people to save more, and to always consult their financial advisor. Instead of genuinely acknowledging the deep risks associated with most of the products they sell, they disguise these problems in abstract discussions about “knowing your own tolerance for risk.”
In contrast, a good financial literacy program should provide a complete description of all of the sources of Canadians’ financial well-being, and a well-rounded, arms-length depiction of how the private financial industry functions. A complete curriculum should do the following:
- Explain the full range and relative importance of income sources for Canadians, both before and after retirement. Explain that most lifetime income for most Canadians comes from employment. Income from personal investments is a small share of total income, even after retirement.
- Explain that boosting lifetime employment income is the most important way for most Canadians to become better off. Explain the determinants of employment income, including a worker’s occupation, industry, level of education, whether or not the job is unionized, and the impact of regulatory and institutional factors (like minimum wages).
- Explain that public pensions are the most important source of post-retirement income and how different types of pensions are funded and secured.
- Discuss average incomes in Canada, the average cost of living in Canada, and the difficulty that most Canadian households have in balancing their household finances.
- Explain the difference between income and wealth, the different forms of wealth (non-financial as well as financial) and the importance of home ownership in Canadians’ net worth.
- Provide information on household wealth in Canada, average levels, and its distribution. This will allow Canadians to position themselves within the spectrum of actual wealth outcomes – as opposed to the idealized scenarios of mutual fund brochures (where everyone is a potential millionaire).
- Explain the functions of the financial industry. Consider the orthodox claim that financial markets are “intermediaries” which facilitate capital accumulation. Contrast that to more critical accounts of what the financial industry does, how it performs, and how much it costs. Discuss the history and role of financial regulation.
- Explain the costs and risks of personal investing. Explain that the value of your mutual fund 20 or 30 years from now depends on factors over which you have no control. Explain which assets are guaranteed by government (and why), and which are not. Explain how money managers are paid (including in so-called “no-load” products).
- Explain that it is not always appropriate at the individual level to accumulate personal savings (especially when there is no guarantee that personal investments will be realized when they are needed). At the macroeconomic level, more saving can actually be harmful: in fact, the recent recession was caused in part by a sudden increase in personal saving (the flip side of the sudden decrease in consumer spending).
By all means, let’s encourage Canadians to avoid risky or costly financial practices (be they payday loan shops or the latest ill-founded financial fad). But let’s not lose sight of the big picture that explains why Canadians are financially pressured. And let’s stay focused on the macro-level solutions (from higher wages to financial regulations to stronger public pensions) that would address those challenges more realistically and effectively – rather than fruitlessly trying to pick the right mutual fund. Our students, and all Canadians, deserve an arms-length and critical education in financial affairs and financial issues.
EN BREF – Plusieurs provinces canadiennes ont récemment ajouté la littératie financière au curriculum de base des élèves du secondaire. Dans son budget de 2009, le ministre des Finances, Jim Flaherty, a annoncé la mise sur pied d’un groupe de travail chargé d’évaluer ces initiatives de littératie financière, lesquelles mettent typiquement l’accent sur la « responsabilité individuelle », laissant entendre que, si les Canadiens apprenaient à mieux gérer leurs finances personnelles et n’ont plus à compter sur le gouvernement pour les protéger, les marchés financiers fonctionneront mieux et le pays sera plus fort. Il est pourtant chimérique d’espérer que l’acquisition de meilleures connaissances par les investisseurs individuels stabilisera les macromarchés financiers. La littératie financière peut constituer un élément légitime du curriculum, mais elle devrait porter sur les causes et les solutions possibles aux problèmes financiers des Canadiens, notamment en examinant honnêtement le secteur financier, plutôt que d’inciter la population à accepter un monde injuste, inéquitable et à s’y adapter.
[1] Dept. of Finance, Budget Plan 2010, p. 89.
[2] Task Force on Financial Literacy, Leveraging Excellence: Charting a Course of Action to Strengthen Financial Literacy in Canada, February 2010, p. 5.
[3] On the other hand, I expect that even educated investors will be lured by greed, envy, and herd behaviour to jump into the next ill-founded financial mania – financial literacy or no. Perhaps the main benefit of financial literacy in that event, is in promoting the resigned conclusion that those investors have no one to blame but themselves. That doesn’t leave those households, or the economy as a whole, any better off.
[4] These basic living costs did not include personal savings or pension contributions. Both studies are available at www.policyalternatives.ca: see Hugh Mackenzie and Jim Stanford (2009), A Living Wage for Toronto (Ottawa: Canadian Centre for Policy Alternatives), 28 pp.; and Tim Richards, Marcy Cohen, Seth Klein, and Deborah Littman (2008), Working for Living Wage: Making Paid Work Meet Basic Family Needs in Vancouver and Victoria (Vancouver, Canadian Centre for Policy Alternatives), 52 pp.
