literature review on financial literacy

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Mapping financial literacy: a systematic literature review of determinants and recent trends.

1. Introduction

2. data and methods, 3. bibliometric analysis, 4. mapping financial literacy—financial literacy determinants and outcomes, 5. trends in financial literacy literature, 5.1. financial literacy of the youth, 5.2. financial literacy and gender, 5.3. financial literacy and financial inclusion, 5.4. financial literacy and retirement planning, 6. financial literacy and technology, 6.1. financial literacy and digital finance, 6.2. digital financial literacy, 7. discussion, 8. conclusions, author contributions, conflicts of interest.

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Zaimovic, A.; Torlakovic, A.; Arnaut-Berilo, A.; Zaimovic, T.; Dedovic, L.; Nuhic Meskovic, M. Mapping Financial Literacy: A Systematic Literature Review of Determinants and Recent Trends. Sustainability 2023 , 15 , 9358. https://doi.org/10.3390/su15129358

Zaimovic A, Torlakovic A, Arnaut-Berilo A, Zaimovic T, Dedovic L, Nuhic Meskovic M. Mapping Financial Literacy: A Systematic Literature Review of Determinants and Recent Trends. Sustainability . 2023; 15(12):9358. https://doi.org/10.3390/su15129358

Zaimovic, Azra, Anes Torlakovic, Almira Arnaut-Berilo, Tarik Zaimovic, Lejla Dedovic, and Minela Nuhic Meskovic. 2023. "Mapping Financial Literacy: A Systematic Literature Review of Determinants and Recent Trends" Sustainability 15, no. 12: 9358. https://doi.org/10.3390/su15129358

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Managerial Finance

ISSN : 0307-4358

Article publication date: 21 September 2020

Issue publication date: 28 January 2021

The purpose of this paper is to review the main methods used in the literature to measure financial literacy (FL) of individuals.

Design/methodology/approach

The paper begins by describing how the different items used to measure the FL level of individuals are constructed. Then, it focuses on how do researchers select the items. Finally, it reviews the different calculation methods used in the literature to assess the FL level.

FL as a concept is tough to define and measure. Several studies focus on the definition and the measure of this concept. Different items are used in the literature and are mostly related to the study topics. The used calculation methods differ across the different studies.

Originality/value

This paper sheds light on the principal methodologies used in the literature to measure FL. It highlights the relationship between the items' content areas and the studies' subjects. Thus, this paper suggests guidance for future studies on measuring methods of FL.

• Financial literacy
• Objective measures
• Content areas
• Study topics
• Literature review

Ouachani, S. , Belhassine, O. and Kammoun, A. (2021), "Measuring financial literacy: a literature review", Managerial Finance , Vol. 47 No. 2, pp. 266-281. https://doi.org/10.1108/MF-04-2019-0175

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Financial Literacy and Financial Education: An Overview

This article provides a concise narrative overview of the rapidly growing empirical literature on financial literacy and financial education. We first discuss stylized facts on the demographic correlates of financial literacy. We next cover the evidence on the effects of financial literacy on financial behaviors and outcomes. Finally, we review the evidence on the causal effects of financial education programs focusing on randomized controlled trial evaluations. The article concludes with perspectives on future research priorities for both financial literacy and financial education.

We thank Luis Oberrauch for excellent research assistance and Allen N. Berger, Phil Molyneux, and John O.S. Wilson for helpful comments. All errors are our own. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.

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• DOI: 10.14784/JFRS.2014117326
• Corpus ID: 154502913

A LITERATURE REVIEW ON FINANCIAL LITERACY

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Measuring financial literacy: a literature review

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This article is a literature review on the concept of financial literacy and its measurements. Based upon the review of several studies, the conceptual definitions of financial literacy would be categorized in four groups; (1) knowledge of financial concepts, (2) ability in managing personal finances, (3) skill in making financial decisions and (4) confidence in future financial planning while in the rest of the studies, researchers apply the combination of these categories. Literature also shows that the applied methods for testing the level of financial literacy in individuals are not constant and they are varied based on the definition of financial literacy.

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Sustainability

Lejla Dedovic

Financial literacy is a critical life skill that is essential for achieving financial security and individual well-being, economic growth and overall sustainable development. Based on the analysis of research on financial literacy, we aim to provide a balance sheet of current research and a starting point for future research with the focus on identifying significant predictors of financial literacy, as well as variables that are affected by financial literacy. The main methods of our research are a systematic literature review, and bibliometric and bibliographical analysis. We establish a chronological path of the financial literacy topic in the scientific research. Based on the analysis of the most cited articles, we develop a comprehensive conceptual framework for mapping financial literacy. We identified a large number of predictors of financial literacy starting with education, gender, age, knowledge, etc. Financial literacy also affects variables such as retirement planning, fi...

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• Published: 24 January 2019

Financial literacy and the need for financial education: evidence and implications

• Annamaria Lusardi 1  

Swiss Journal of Economics and Statistics volume  155 , Article number:  1 ( 2019 ) Cite this article

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1 Introduction

Throughout their lifetime, individuals today are more responsible for their personal finances than ever before. With life expectancies rising, pension and social welfare systems are being strained. In many countries, employer-sponsored defined benefit (DB) pension plans are swiftly giving way to private defined contribution (DC) plans, shifting the responsibility for retirement saving and investing from employers to employees. Individuals have also experienced changes in labor markets. Skills are becoming more critical, leading to divergence in wages between those with a college education, or higher, and those with lower levels of education. Simultaneously, financial markets are rapidly changing, with developments in technology and new and more complex financial products. From student loans to mortgages, credit cards, mutual funds, and annuities, the range of financial products people have to choose from is very different from what it was in the past, and decisions relating to these financial products have implications for individual well-being. Moreover, the exponential growth in financial technology (fintech) is revolutionizing the way people make payments, decide about their financial investments, and seek financial advice. In this context, it is important to understand how financially knowledgeable people are and to what extent their knowledge of finance affects their financial decision-making.

An essential indicator of people’s ability to make financial decisions is their level of financial literacy. The Organisation for Economic Co-operation and Development (OECD) aptly defines financial literacy as not only the knowledge and understanding of financial concepts and risks but also the skills, motivation, and confidence to apply such knowledge and understanding in order to make effective decisions across a range of financial contexts, to improve the financial well-being of individuals and society, and to enable participation in economic life. Thus, financial literacy refers to both knowledge and financial behavior, and this paper will analyze research on both topics.

As I describe in more detail below, findings around the world are sobering. Financial literacy is low even in advanced economies with well-developed financial markets. On average, about one third of the global population has familiarity with the basic concepts that underlie everyday financial decisions (Lusardi and Mitchell, 2011c ). The average hides gaping vulnerabilities of certain population subgroups and even lower knowledge of specific financial topics. Furthermore, there is evidence of a lack of confidence, particularly among women, and this has implications for how people approach and make financial decisions. In the following sections, I describe how we measure financial literacy, the levels of literacy we find around the world, the implications of those findings for financial decision-making, and how we can improve financial literacy.

2 How financially literate are people?

2.1 measuring financial literacy: the big three.

In the context of rapid changes and constant developments in the financial sector and the broader economy, it is important to understand whether people are equipped to effectively navigate the maze of financial decisions that they face every day. To provide the tools for better financial decision-making, one must assess not only what people know but also what they need to know, and then evaluate the gap between those things. There are a few fundamental concepts at the basis of most financial decision-making. These concepts are universal, applying to every context and economic environment. Three such concepts are (1) numeracy as it relates to the capacity to do interest rate calculations and understand interest compounding; (2) understanding of inflation; and (3) understanding of risk diversification. Translating these concepts into easily measured financial literacy metrics is difficult, but Lusardi and Mitchell ( 2008 , 2011b , 2011c ) have designed a standard set of questions around these concepts and implemented them in numerous surveys in the USA and around the world.

Four principles informed the design of these questions, as described in detail by Lusardi and Mitchell ( 2014 ). The first is simplicity : the questions should measure knowledge of the building blocks fundamental to decision-making in an intertemporal setting. The second is relevance : the questions should relate to concepts pertinent to peoples’ day-to-day financial decisions over the life cycle; moreover, they must capture general rather than context-specific ideas. Third is brevity : the number of questions must be few enough to secure widespread adoption; and fourth is capacity to differentiate , meaning that questions should differentiate financial knowledge in such a way as to permit comparisons across people. Each of these principles is important in the context of face-to-face, telephone, and online surveys.

Three basic questions (since dubbed the “Big Three”) to measure financial literacy have been fielded in many surveys in the USA, including the National Financial Capability Study (NFCS) and, more recently, the Survey of Consumer Finances (SCF), and in many national surveys around the world. They have also become the standard way to measure financial literacy in surveys used by the private sector. For example, the Aegon Center for Longevity and Retirement included the Big Three questions in the 2018 Aegon Retirement Readiness Survey, covering around 16,000 people in 15 countries. Both ING and Allianz, but also investment funds, and pension funds have used the Big Three to measure financial literacy. The exact wording of the questions is provided in Table  1 .

2.2 Cross-country comparison

The first examination of financial literacy using the Big Three was possible due to a special module on financial literacy and retirement planning that Lusardi and Mitchell designed for the 2004 Health and Retirement Study (HRS), which is a survey of Americans over age 50. Astonishingly, the data showed that only half of older Americans—who presumably had made many financial decisions in their lives—could answer the two basic questions measuring understanding of interest rates and inflation (Lusardi and Mitchell, 2011b ). And just one third demonstrated understanding of these two concepts and answered the third question, measuring understanding of risk diversification, correctly. It is sobering that recent US surveys, such as the 2015 NFCS, the 2016 SCF, and the 2017 Survey of Household Economics and Financial Decisionmaking (SHED), show that financial knowledge has remained stubbornly low over time.

Over time, the Big Three have been added to other national surveys across countries and Lusardi and Mitchell have coordinated a project called Financial Literacy around the World (FLat World), which is an international comparison of financial literacy (Lusardi and Mitchell, 2011c ).

Findings from the FLat World project, which so far includes data from 15 countries, including Switzerland, highlight the urgent need to improve financial literacy (see Table  2 ). Across countries, financial literacy is at a crisis level, with the average rate of financial literacy, as measured by those answering correctly all three questions, at around 30%. Moreover, only around 50% of respondents in most countries are able to correctly answer the two financial literacy questions on interest rates and inflation correctly. A noteworthy point is that most countries included in the FLat World project have well-developed financial markets, which further highlights the cause for alarm over the demonstrated lack of the financial literacy. The fact that levels of financial literacy are so similar across countries with varying levels of economic development—indicating that in terms of financial knowledge, the world is indeed flat —shows that income levels or ubiquity of complex financial products do not by themselves equate to a more financially literate population.

Other noteworthy findings emerge in Table  2 . For instance, as expected, understanding of the effects of inflation (i.e., of real versus nominal values) among survey respondents is low in countries that have experienced deflation rather than inflation: in Japan, understanding of inflation is at 59%; in other countries, such as Germany, it is at 78% and, in the Netherlands, it is at 77%. Across countries, individuals have the lowest level of knowledge around the concept of risk, and the percentage of correct answers is particularly low when looking at knowledge of risk diversification. Here, we note the prevalence of “do not know” answers. While “do not know” responses hover around 15% on the topic of interest rates and 18% for inflation, about 30% of respondents—in some countries even more—are likely to respond “do not know” to the risk diversification question. In Switzerland, 74% answered the risk diversification question correctly and 13% reported not knowing the answer (compared to 3% and 4% responding “do not know” for the interest rates and inflation questions, respectively).

These findings are supported by many other surveys. For example, the 2014 Standard & Poor’s Global Financial Literacy Survey shows that, around the world, people know the least about risk and risk diversification (Klapper, Lusardi, and Van Oudheusden, 2015 ). Similarly, results from the 2016 Allianz survey, which collected evidence from ten European countries on money, financial literacy, and risk in the digital age, show very low-risk literacy in all countries covered by the survey. In Austria, Germany, and Switzerland, which are the three top-performing nations in term of financial knowledge, less than 20% of respondents can answer three questions related to knowledge of risk and risk diversification (Allianz, 2017 ).

Other surveys show that the findings about financial literacy correlate in an expected way with other data. For example, performance on the mathematics and science sections of the OECD Program for International Student Assessment (PISA) correlates with performance on the Big Three and, specifically, on the question relating to interest rates. Similarly, respondents in Sweden, which has experienced pension privatization, performed better on the risk diversification question (at 68%), than did respondents in Russia and East Germany, where people have had less exposure to the stock market. For researchers studying financial knowledge and its effects, these findings hint to the fact that financial literacy could be the result of choice and not an exogenous variable.

To summarize, financial literacy is low across the world and higher national income levels do not equate to a more financially literate population. The design of the Big Three questions enables a global comparison and allows for a deeper understanding of financial literacy. This enhances the measure’s utility because it helps to identify general and specific vulnerabilities across countries and within population subgroups, as will be explained in the next section.

2.3 Who knows the least?

Low financial literacy on average is exacerbated by patterns of vulnerability among specific population subgroups. For instance, as reported in Lusardi and Mitchell ( 2014 ), even though educational attainment is positively correlated with financial literacy, it is not sufficient. Even well-educated people are not necessarily savvy about money. Financial literacy is also low among the young. In the USA, less than 30% of respondents can correctly answer the Big Three by age 40, even though many consequential financial decisions are made well before that age (see Fig.  1 ). Similarly, in Switzerland, only 45% of those aged 35 or younger are able to correctly answer the Big Three questions. Footnote 1 And if people may learn from making financial decisions, that learning seems limited. As shown in Fig.  1 , many older individuals, who have already made decisions, cannot answer three basic financial literacy questions.

Financial literacy across age in the USA. This figure shows the percentage of respondents who answered correctly all Big Three questions by age group (year 2015). Source: 2015 US National Financial Capability Study

A gender gap in financial literacy is also present across countries. Women are less likely than men to answer questions correctly. The gap is present not only on the overall scale but also within each topic, across countries of different income levels, and at different ages. Women are also disproportionately more likely to indicate that they do not know the answer to specific questions (Fig.  2 ), highlighting overconfidence among men and awareness of lack of knowledge among women. Even in Finland, which is a relatively equal society in terms of gender, 44% of men compared to 27% of women answer all three questions correctly and 18% of women give at least one “do not know” response versus less than 10% of men (Kalmi and Ruuskanen, 2017 ). These figures further reflect the universality of the Big Three questions. As reported in Fig.  2 , “do not know” responses among women are prevalent not only in European countries, for example, Switzerland, but also in North America (represented in the figure by the USA, though similar findings are reported in Canada) and in Asia (represented in the figure by Japan). Those interested in learning more about the differences in financial literacy across demographics and other characteristics can consult Lusardi and Mitchell ( 2011c , 2014 ).

Gender differences in the responses to the Big Three questions. Sources: USA—Lusardi and Mitchell, 2011c ; Japan—Sekita, 2011 ; Switzerland—Brown and Graf, 2013

3 Does financial literacy matter?

A growing number of financial instruments have gained importance, including alternative financial services such as payday loans, pawnshops, and rent to own stores that charge very high interest rates. Simultaneously, in the changing economic landscape, people are increasingly responsible for personal financial planning and for investing and spending their resources throughout their lifetime. We have witnessed changes not only in the asset side of household balance sheets but also in the liability side. For example, in the USA, many people arrive close to retirement carrying a lot more debt than previous generations did (Lusardi, Mitchell, and Oggero, 2018 ). Overall, individuals are making substantially more financial decisions over their lifetime, living longer, and gaining access to a range of new financial products. These trends, combined with low financial literacy levels around the world and, particularly, among vulnerable population groups, indicate that elevating financial literacy must become a priority for policy makers.

There is ample evidence of the impact of financial literacy on people’s decisions and financial behavior. For example, financial literacy has been proven to affect both saving and investment behavior and debt management and borrowing practices. Empirically, financially savvy people are more likely to accumulate wealth (Lusardi and Mitchell, 2014 ). There are several explanations for why higher financial literacy translates into greater wealth. Several studies have documented that those who have higher financial literacy are more likely to plan for retirement, probably because they are more likely to appreciate the power of interest compounding and are better able to do calculations. According to the findings of the FLat World project, answering one additional financial question correctly is associated with a 3–4 percentage point greater probability of planning for retirement; this finding is seen in Germany, the USA, Japan, and Sweden. Financial literacy is found to have the strongest impact in the Netherlands, where knowing the right answer to one additional financial literacy question is associated with a 10 percentage point higher probability of planning (Mitchell and Lusardi, 2015 ). Empirically, planning is a very strong predictor of wealth; those who plan arrive close to retirement with two to three times the amount of wealth as those who do not plan (Lusardi and Mitchell, 2011b ).

Financial literacy is also associated with higher returns on investments and investment in more complex assets, such as stocks, which normally offer higher rates of return. This finding has important consequences for wealth; according to the simulation by Lusardi, Michaud, and Mitchell ( 2017 ), in the context of a life-cycle model of saving with many sources of uncertainty, from 30 to 40% of US retirement wealth inequality can be accounted for by differences in financial knowledge. These results show that financial literacy is not a sideshow, but it plays a critical role in saving and wealth accumulation.

Financial literacy is also strongly correlated with a greater ability to cope with emergency expenses and weather income shocks. Those who are financially literate are more likely to report that they can come up with $2000 in 30 days or that they are able to cover an emergency expense of $400 with cash or savings (Hasler, Lusardi, and Oggero, 2018 ).

With regard to debt behavior, those who are more financially literate are less likely to have credit card debt and more likely to pay the full balance of their credit card each month rather than just paying the minimum due (Lusardi and Tufano, 2009 , 2015 ). Individuals with higher financial literacy levels also are more likely to refinance their mortgages when it makes sense to do so, tend not to borrow against their 401(k) plans, and are less likely to use high-cost borrowing methods, e.g., payday loans, pawn shops, auto title loans, and refund anticipation loans (Lusardi and de Bassa Scheresberg, 2013 ).

Several studies have documented poor debt behavior and its link to financial literacy. Moore ( 2003 ) reported that the least financially literate are also more likely to have costly mortgages. Lusardi and Tufano ( 2015 ) showed that the least financially savvy incurred high transaction costs, paying higher fees and using high-cost borrowing methods. In their study, the less knowledgeable also reported excessive debt loads and an inability to judge their debt positions. Similarly, Mottola ( 2013 ) found that those with low financial literacy were more likely to engage in costly credit card behavior, and Utkus and Young ( 2011 ) concluded that the least literate were more likely to borrow against their 401(k) and pension accounts.

Young people also struggle with debt, in particular with student loans. According to Lusardi, de Bassa Scheresberg, and Oggero ( 2016 ), Millennials know little about their student loans and many do not attempt to calculate the payment amounts that will later be associated with the loans they take. When asked what they would do, if given the chance to revisit their student loan borrowing decisions, about half of Millennials indicate that they would make a different decision.

Finally, a recent report on Millennials in the USA (18- to 34-year-olds) noted the impact of financial technology (fintech) on the financial behavior of young individuals. New and rapidly expanding mobile payment options have made transactions easier, quicker, and more convenient. The average user of mobile payments apps and technology in the USA is a high-income, well-educated male who works full time and is likely to belong to an ethnic minority group. Overall, users of mobile payments are busy individuals who are financially active (holding more assets and incurring more debt). However, mobile payment users display expensive financial behaviors, such as spending more than they earn, using alternative financial services, and occasionally overdrawing their checking accounts. Additionally, mobile payment users display lower levels of financial literacy (Lusardi, de Bassa Scheresberg, and Avery, 2018 ). The rapid growth in fintech around the world juxtaposed with expensive financial behavior means that more attention must be paid to the impact of mobile payment use on financial behavior. Fintech is not a substitute for financial literacy.

4 The way forward for financial literacy and what works

Overall, financial literacy affects everything from day-to-day to long-term financial decisions, and this has implications for both individuals and society. Low levels of financial literacy across countries are correlated with ineffective spending and financial planning, and expensive borrowing and debt management. These low levels of financial literacy worldwide and their widespread implications necessitate urgent efforts. Results from various surveys and research show that the Big Three questions are useful not only in assessing aggregate financial literacy but also in identifying vulnerable population subgroups and areas of financial decision-making that need improvement. Thus, these findings are relevant for policy makers and practitioners. Financial illiteracy has implications not only for the decisions that people make for themselves but also for society. The rapid spread of mobile payment technology and alternative financial services combined with lack of financial literacy can exacerbate wealth inequality.

To be effective, financial literacy initiatives need to be large and scalable. Schools, workplaces, and community platforms provide unique opportunities to deliver financial education to large and often diverse segments of the population. Furthermore, stark vulnerabilities across countries make it clear that specific subgroups, such as women and young people, are ideal targets for financial literacy programs. Given women’s awareness of their lack of financial knowledge, as indicated via their “do not know” responses to the Big Three questions, they are likely to be more receptive to financial education.

The near-crisis levels of financial illiteracy, the adverse impact that it has on financial behavior, and the vulnerabilities of certain groups speak of the need for and importance of financial education. Financial education is a crucial foundation for raising financial literacy and informing the next generations of consumers, workers, and citizens. Many countries have seen efforts in recent years to implement and provide financial education in schools, colleges, and workplaces. However, the continuously low levels of financial literacy across the world indicate that a piece of the puzzle is missing. A key lesson is that when it comes to providing financial education, one size does not fit all. In addition to the potential for large-scale implementation, the main components of any financial literacy program should be tailored content, targeted at specific audiences. An effective financial education program efficiently identifies the needs of its audience, accurately targets vulnerable groups, has clear objectives, and relies on rigorous evaluation metrics.

Using measures like the Big Three questions, it is imperative to recognize vulnerable groups and their specific needs in program designs. Upon identification, the next step is to incorporate this knowledge into financial education programs and solutions.

School-based education can be transformational by preparing young people for important financial decisions. The OECD’s Programme for International Student Assessment (PISA), in both 2012 and 2015, found that, on average, only 10% of 15-year-olds achieved maximum proficiency on a five-point financial literacy scale. As of 2015, about one in five of students did not have even basic financial skills (see OECD, 2017 ). Rigorous financial education programs, coupled with teacher training and high school financial education requirements, are found to be correlated with fewer defaults and higher credit scores among young adults in the USA (Urban, Schmeiser, Collins, and Brown, 2018 ). It is important to target students and young adults in schools and colleges to provide them with the necessary tools to make sound financial decisions as they graduate and take on responsibilities, such as buying cars and houses, or starting retirement accounts. Given the rising cost of education and student loan debt and the need of young people to start contributing as early as possible to retirement accounts, the importance of financial education in school cannot be overstated.

There are three compelling reasons for having financial education in school. First, it is important to expose young people to the basic concepts underlying financial decision-making before they make important and consequential financial decisions. As noted in Fig.  1 , financial literacy is very low among the young and it does not seem to increase a lot with age/generations. Second, school provides access to financial literacy to groups who may not be exposed to it (or may not be equally exposed to it), for example, women. Third, it is important to reduce the costs of acquiring financial literacy, if we want to promote higher financial literacy both among individuals and among society.

There are compelling reasons to have personal finance courses in college as well. In the same way in which colleges and university offer courses in corporate finance to teach how to manage the finances of firms, so today individuals need the knowledge to manage their own finances over the lifetime, which in present discounted value often amount to large values and are made larger by private pension accounts.

Financial education can also be efficiently provided in workplaces. An effective financial education program targeted to adults recognizes the socioeconomic context of employees and offers interventions tailored to their specific needs. A case study conducted in 2013 with employees of the US Federal Reserve System showed that completing a financial literacy learning module led to significant changes in retirement planning behavior and better-performing investment portfolios (Clark, Lusardi, and Mitchell, 2017 ). It is also important to note the delivery method of these programs, especially when targeted to adults. For instance, video formats have a significantly higher impact on financial behavior than simple narratives, and instruction is most effective when it is kept brief and relevant (Heinberg et al., 2014 ).

The Big Three also show that it is particularly important to make people familiar with the concepts of risk and risk diversification. Programs devoted to teaching risk via, for example, visual tools have shown great promise (Lusardi et al., 2017 ). The complexity of some of these concepts and the costs of providing education in the workplace, coupled with the fact that many older individuals may not work or work in firms that do not offer such education, provide other reasons why financial education in school is so important.

Finally, it is important to provide financial education in the community, in places where people go to learn. A recent example is the International Federation of Finance Museums, an innovative global collaboration that promotes financial knowledge through museum exhibits and the exchange of resources. Museums can be places where to provide financial literacy both among the young and the old.

There are a variety of other ways in which financial education can be offered and also targeted to specific groups. However, there are few evaluations of the effectiveness of such initiatives and this is an area where more research is urgently needed, given the statistics reported in the first part of this paper.

5 Concluding remarks

The lack of financial literacy, even in some of the world’s most well-developed financial markets, is of acute concern and needs immediate attention. The Big Three questions that were designed to measure financial literacy go a long way in identifying aggregate differences in financial knowledge and highlighting vulnerabilities within populations and across topics of interest, thereby facilitating the development of tailored programs. Many such programs to provide financial education in schools and colleges, workplaces, and the larger community have taken existing evidence into account to create rigorous solutions. It is important to continue making strides in promoting financial literacy, by achieving scale and efficiency in future programs as well.

In August 2017, I was appointed Director of the Italian Financial Education Committee, tasked with designing and implementing the national strategy for financial literacy. I will be able to apply my research to policy and program initiatives in Italy to promote financial literacy: it is an essential skill in the twenty-first century, one that individuals need if they are to thrive economically in today’s society. As the research discussed in this paper well documents, financial literacy is like a global passport that allows individuals to make the most of the plethora of financial products available in the market and to make sound financial decisions. Financial literacy should be seen as a fundamental right and universal need, rather than the privilege of the relatively few consumers who have special access to financial knowledge or financial advice. In today’s world, financial literacy should be considered as important as basic literacy, i.e., the ability to read and write. Without it, individuals and societies cannot reach their full potential.

See Brown and Graf ( 2013 ).

Abbreviations

Defined benefit (refers to pension plan)

Defined contribution (refers to pension plan)

Financial Literacy around the World

National Financial Capability Study

Organisation for Economic Co-operation and Development

Programme for International Student Assessment

Survey of Consumer Finances

Survey of Household Economics and Financial Decisionmaking

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Acknowledgements

This paper represents a summary of the keynote address I gave to the 2018 Annual Meeting of the Swiss Society of Economics and Statistics. I would like to thank Monika Butler, Rafael Lalive, anonymous reviewers, and participants of the Annual Meeting for useful discussions and comments, and Raveesha Gupta for editorial support. All errors are my responsibility.

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Lusardi, A. Financial literacy and the need for financial education: evidence and implications. Swiss J Economics Statistics 155 , 1 (2019). https://doi.org/10.1186/s41937-019-0027-5

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An Untapped Instrument in the Fight Against Poverty: The Impacts of Financial Literacy on Poverty Worldwide

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• Ngoc Duc Lang 1 ,
• Ha Mai Tran 1 ,
• Giang Tra Nguyen 3 &
• Duc Hong Vo 1 , 2  

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The World Bank assessed that meeting the goal of eradicating extreme poverty by 2030 appears to be challenging (or even impossible) for the world. This observation requires an urgent need for policymakers to explore potent instruments to combat poverty globally. Numerous studies have examined various determinants of poverty. However, financial literacy—a relatively new concept—remains underexplored, especially on a global scale. As such, this study is conducted to assess whether financial literacy can reduce the likelihood of falling into poverty using a unique dataset of 113 countries. We find that financial literacy has a significant and negative association with the likelihood of falling into poverty. Beyond association, the causal analysis shows that financial literacy exerts a negative effect on poverty. Our findings remain largely unchanged across different sub-samples based on socio-demographic factors, regions and country income levels, and robustness analyses.

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1 Introduction

In the vast landscape of societal challenges, few issues resonate as profoundly as poverty. Its far-reaching implications permeate every facet of human life, from education attainment and health outcomes to economic development, political stability, and social mobility. According to the World Bank, around 9.2 per cent of the global population lived in extreme poverty in 2020, defined as living on less than $1.90 per day. The COVID-19 pandemic has further exacerbated poverty rates, with an estimated 120 million and 150 million people pushed into extreme poverty in 2020 and 2021, respectively (World Bank, 2020a ). Knowing that the $1.90 per day international poverty line may be too low to determine people experiencing poverty in middle-income countries, the World Bank adjusted this line to $3.20 and $5.50 for lower-middle-income and upper-middle-income countries. Based on these poverty lines, nearly one-fourth of the global population lives below the $3.20 threshold, while over 40% of the world’s population, nearly 3.3 billion individuals, live below the $5.50 benchmark (World Bank, 2020b ). The World Bank even stated that achieving the goal of eradicating extreme poverty by 2030 seems hard to meet (Reuters, 2022 ). These facts show that poverty is still a considerable challenge in the world.

The topic of poverty, with its inherent challenges and potential for positive impact, beckons researchers to engage in a meaningful exploration that transcends disciplines. Research on this topic is intellectually stimulating and carries profound implications for policymaking, social programs, and the well-being of millions worldwide. By shedding light on the nuances of poverty, researchers have the power to inform transformative interventions, challenge systemic inequalities, and pave the way for a more inclusive and equitable future. Inspired by this, our research aims to explore novel and potent instruments for eliminating poverty on a global scale.

The current literature has documented a wide range of factors associated with poverty reduction, including schooling (Hofmarcher, 2021 ; Zhang, 2014 ), employment and nonfarm employment (Lanjouw, 1999 ; Page & Shimeles, 2015 ; Thompson & Dahling, 2019 ), microfinance and financial inclusion (Koomson et al., 2020a ; Li, 2018 ; Polloni-Silva et al., 2021 ), women empowerment (Tang, 2022 ), energy and renewable energy accessibility (Taghizadeh et al., 2023 ; Zhao et al., 2022 ), infrastructure development (Timilsina et al., 2020 ), health status and healthcare availability (Krishna, 2007 ; Silverman et al., 2016 ; Zhou et al., 2020 ), and others.

In recent years, there is a growing literature on the impact of financial literacy on poverty alleviation. Using the China Household Finance Survey (CHFS) from 2015 to 2017, Xu et al. ( 2023 ) show that financial literacy can effectively and efficiently reduce poverty among rural households in the short and long term. Similarly, financial literacy is also found to have positive impacts on poverty alleviation in Chinese households (Wang et al., 2022 ). Jappelli et al. ( 2014 ) even recognize financial literacy as essential to eradicating poverty. Besides poverty, some studies also provide evidence of the positive effects of financial literacy on income and wealth accumulation, which are closely related to poverty. Adopting a new instrument variable method, Van Rooij et al. ( 2012 ) confirm the positive effect of financial literacy on household wealth in the Netherlands. Sekita et al. ( 2022 ) also find the same result in Japan. Meanwhile, financial illiteracy is a crucial predictor of wealth inequality (Jappelli & Padula, 2013 ; Lusardi et al., 2017 ). In addition, Disney and Gathergood ( 2011 ) indicate that financially literate people have higher household income levels. These studies provide many meaningful insights into poverty reduction and the income and wealth of individuals and households. Unfortunately, the current literature only focuses on a single country, such as China, the Netherlands, and Japan.

Our study contributes to the current literature as follows. First, we are the first to explore whether financial literacy reduces the likelihood of individuals falling into poverty on a global scale. Our analyses confirm that financial literacy significantly and negatively affects poverty worldwide. Second, this is also the first attempt to provide thorough analyses of the relationship between financial literacy and poverty across different socio-demographic groups, regions, and country income levels. The results show that the negative association between financial literacy and poverty remains largely unchanged across different socio-demographic groups, regions, and country income levels, implying that our results can be applicable in various contexts. Last, various robustness checks are conducted to ensure that the impacts of financial literacy are not deviated by reverse causality, omitted variable bias and variation between countries. The coefficients of financial literacy on poverty are still significant and negative across robustness tests, including (i) probit models with Gaussian copula terms (addressing endogeneity concerns), (ii) multilevel probit models (considering variations across countries), and (iii) Rubin’s ( 1974 ) causal model (addressing omitted variable concerns).

Following this introduction, the remainder of this paper can be summarized as follows. Section  2 provides a detailed review of financial literacy and poverty studies. In Sect.  3 , we describe the measures of poverty and the econometric strategy employed in this paper. Section  4 presents the empirical results, while Sect.  5 thoroughly discusses these results. Finally, we conclude and provide policy implications derived from our findings in Sect.  6 .

2 Literature Review

We classify the literature under review into three strands of financial literacy and poverty studies. The first strand deals with the determinants of poverty at the macro level. The second strand is the determinants of poverty at the individual level. The third strand includes findings regarding the impacts of financial literacy.

2.1 Macro-Level Determinants of Poverty

First, the existing literature has documented various country-level factors influencing poverty, including economic growth (Adams, 2004 ; Klasen, 2008 ); trade openness and liberalization (Bhagwati & Srinivasan, 2002 ; Harrison et al., 2003 ; Hertel & Reimer, 2005 ); financial development (Bolarinwa et al., 2021 ; Jeanneney & Kpodar, 2011 ; Perez-Moreno, 2011 ), foreign direct investment (Gohou & Soumaré, 2012 ) the informationization level (James, 2006 ; Mora-Rivera & García-Mora, 2021 ), institutional factors such as political stability, and corruption (Han et al., 2022 ; Tebaldi & Mohan, 2010 ).

2.2 Individual-Level Determinants of Poverty

Regarding the second strand, there is a rich literature on individual-level factors that influence the likelihood of falling into poverty. Using a vast database of 32 European countries, Hofmarcher ( 2021 ) points out substantially and significantly mitigating the effects of education on poverty. Similarly, studies by Zhang ( 2014 ), Ladd ( 2012 ) and Zhang and Zhao ( 2006 ) also confirm that education is positively associated with poverty reduction. The literature also emphasizes the gendered dimensions of poverty that female and female-head households are often at higher risk of falling into and staying in poverty than males (Lewin & Stier, 2018 ; Millar & Glendinning, 1989 ). This phenomenon was noted as the “feminization of poverty”—the growing trend wherein individuals experiencing poverty are predominantly women—by Pearce ( 1990 ). Along with gender, marital status, and the number of children at home can exert significant effects on poverty. Unmarried people are found to be poorer than legally married ones in Mexico (Ortega-Díaz, 2020 ), but a reversed trend is observed in Nigeria (Anyanwu, 2014 ). Herbst-Debby et al. ( 2021 ) show that divorce heightens the likelihood of poverty for women and diminishes this likelihood for men. Nevertheless, for both genders, the combination of divorce and more children at home amplifies the risk of poverty. In contrast, divorce or separation is negatively correlated with the probability of falling into poverty in the study by Anyanwu ( 2014 ). Additionally, the study by Anyanwu ( 2014 ) points out that household size is an important factor influencing poverty. Besides, old age has also been found to be correlated with poverty in many countries (Kwan & Walsh, 2018 ; Lloyd-Sherlock, 2000 ). Lastly, employment and nonfarm employment are effective and efficient in helping people escape from poverty, especially in African countries (Lanjouw, 1999 ; Page & Shimeles, 2015 ; Thompson & Dahling, 2019 ).

2.3 The Impacts of Financial Literacy

Besides, there is a rapidly expanding body of research examining the effects of financial literacy on various aspects of individuals, households, and society. These impacts can be categorized into two main groups: (i) impacts on behaviours and (ii) impacts on financial capacity.

The literature analyzing the impacts of financial literacy on behaviours is elaborated first. Utilizing data from 143 countries worldwide in 2014, Grohmann et al. ( 2018 ) confirm the important role of financial literacy in improving financial inclusion under “all” circumstances. Specifically, financial literacy boosts bank account ownership, savings at a formal financial institution, debit card ownership, and usage among populations in countries with both high and low levels of financial depth. Similarly, studies by Cole et al. ( 2011 ) and Hogarth et al. ( 2005 ) also point out the negative correlation between financial literacy and the number of unbanked adults and inactive account holders. However, Cole and Shastry ( 2009 ) note an exception in the United States, where financial market participation is not influenced by state-mandated financial literacy education. Besides, Cohen and Nelson ( 2011 ) document the positive effects of financial literacy on people's awareness of available financial services and the ability to choose suitable financial services. Additionally, the higher rate of stock participation can be attributed to financial literacy, as it encourages the use of financial instruments such as insurance and credit to protect individuals from unexpected incidents and change household risk attitudes (Urrea & Maldonado, 2011 ; Koomson et al., 2020b ). The positive effects of financial literacy on stock market participation are also confirmed in other studies, such as Almenberg and Dreber ( 2015 ), Van Rooij et al. ( 2011 ) and Christelis et al. ( 2010 ). The causal effects of economic education on stock market participation are even established by Christiansen et al. ( 2008 ). In terms of formal financial inclusion, financial literacy, on the one hand, helps those in need recognize the credit demand and their demand-based credit constraints (Lusardi & Tufano, 2015 ; Sol Murta & Miguel Gama, 2022 ; Stango & Zinman, 2009 ). On the other hand, financial literacy improves their understanding of policies and lending information (Bilal et al., 2021 ). Borrowers have a higher propensity to lend from formal financial institutions instead of from casual relationships such as family and friends or loans from informal lenders (Xu et al., 2020 ). This finding is noted as “increasing household credit access by breaking down the information barrier” by Wang et al. ( 2022 ). These favourable outcomes contribute significantly to the broader positive impact of financial literacy—promoting entrepreneurial behaviours (Ćumurović & Hyll, 2019 ). By addressing household demand for credit and removing credit constraints, financial literacy directly mitigates primary constraints on residents’ entrepreneurial activities (Karaivanov, 2012 ; Weng et al., 2022 ). Similarly, the higher propensity to buy insurance and credit for risk protection, along with better investment opportunities, can also boost households’ willingness to start a business (Bilal et al., 2021 ; Cude et al., 2020 ).

Financial literacy plays a pivotal role in equipping individuals with the essential skills and qualities necessary for undertaking entrepreneurial activities (Oggero et al., 2020 ), including better allocation decisions to different types of assets and better entrepreneurial choices. Additionally, Lusardi and Mitchell ( 2011a . 2011b ) and Bucher-Koenen and Lusardi ( 2011 ) successfully prove the higher propensity to plan for retirement in financially literate individuals. At the same time, Niu et al. ( 2020 ) also discover the ability to build a comprehensive, long-term financial plan for people in this group. Despite the robust impacts of financial literacy on bank accounts and debit card usage, financial literacy’s impacts on savings and wealth accumulation vary in different studies. Karlan et al. ( 2014 ) assert no correlation between higher usages of savings products resulting from higher financial literacy and the increase in users’ net savings (due to the possibility of crowd-out and crowd-in) and/or the improvement in their overall wealth (due to the probability of trade-off between money for savings and money for other activities like borrowing, investment, health, and consumptions). This finding aligns with those reported in the study conducted by Dupas et al. ( 2018 ), which utilizes data from Chile, Malawi, and Uganda. Conversely, Banerjee ( 1992 ) and Hastings et al. ( 2013 ) still find a high correlation between financial illiteracy and low savings.

Besides behaviours, financial literacy also can influence individuals' financial statuses. First, financial literacy significantly contributes to a better financial decision-making process (Evans & Jovanovic, 1989 ; Santos et al., 2022 ). Specifically, a higher level of financial literacy empowers individuals to effectively utilize financial instruments by enabling them to evaluate the value of financial products and make well-informed decisions, such as those related to reverse mortgages (Davidoff et al., 2017 ; Duca & Kumar, 2014 ) and investments (Bucher-Koenen & Ziegelmeyer, 2014 ; Guiso & Viviano, 2015 ; Klapper et al., 2013 ). Moreover, research in Germany (Bucher-Koenen & Lusardi, 2011 ), the Netherlands (Van Rooij et al., 2011 ) and Russia (Klapper & Panos, 2011 ) show that individuals with basic financial understandings are more excel in planning and saving for retirement. Second, for debt management, Lusardi and Tufano ( 2015 ) and Stango and Zinman ( 2009 ) discover a strong relationship between debt literacy and debt load. Debt-illiterate borrowers usually struggle with transacting in high-cost ways (paying fees and borrowing at high interest rates) and end up borrowing more but saving less (Galariotis & Monne, 2023 ). Meanwhile, adults with higher debt literacy are less likely to be over-indebted (Gathergood, 2012 ) and to fall into the trap of fictitious billing and loan guarantee fraud (Kadoya et al., 2021 ). A possible explanation can be that financial literacy practices caution, decreased comfort with debt, and sensitivity to the framing of people (Lusardi & Messy, 2023 ). Financial knowledge can also facilitate the alignment of liabilities with debt obligations, a critical aspect of prudent mortgage management (Thorp et al., 2023 ).

2.4 Financial Literacy and Poverty

Because our research focuses on poverty, the impacts of financial literacy on poverty are separately presented in this subsection. Studies in rural Chinese areas (Wang et al., 2022 ; Xu et al., 2023 ) show that financial literacy alleviates the poverty probability of households in both short and long term. Besides poverty, researchers also point out the positive impacts of financial literacy on poverty-related factors such as wealth and income. Research on the impacts of financial literacy on wealth accumulation in Chile (Behrman et al., 2012 ), The Netherlands (Van Rooij et al., 2012 ) and Japan (Sekita et al., 2022 ) all support a consistent result: financial literacy significantly and positively contributes to the wealth accumulation. Conversely, financial illiteracy is positively correlated with wealth disparity (Jappelli & Padula, 2013 ; Lusardi et al., 2017 ) and negatively correlated with income (Disney & Gathergood, 2011 , 2013 ; Gathergood, 2012 ).

In general, Jappelli et al. ( 2014 ) indicate financial literacy as a driving force in tackling impoverishment worldwide. However, as shown above, there are only two studies in a single country (Xu et al., 2023 ; and Wang et al., 2022 ) directly investigating the impact of financial literacy on poverty. The limited poverty literature can impede global progress in sustainable poverty reduction. As such, there is a growing need for research on the impacts of financial literacy on poverty in various countries and worldwide. This observation warrants our study to be conducted.

The current literature shows a variation in the definition of financial literacy. While it can be broadly defined as financial capability encompassing knowledge, behaviour, and self-efficacy (Xiao et al., 2022 ), it can also be narrowly defined as basic financial knowledge for decision-making (Lusardi & Mitchell, 2014 ). In this study, we utilise the narrow definition of financial literacy, capturing four fundamental concepts, including risk diversification, inflation, basic numeracy, and compound interest.

3 A Theoretical Framework and Hypothesis Development

The relationship between financial literacy and poverty reduction can be elucidated through the human capital theory. We establish the theoretical framework for this study in two steps. First, we review the human capital theory and specify its relevance to financial literacy and poverty reduction. Second, we build on existing literature to theorize the relationship between financial literacy and poverty reduction.

3.1 The Overview of Human Capital Theory

The concept of human capital can be dated back to Smith ( 1776 ) in the work of Adam Smith, while the first formal use in research using the term human capital belongs to Irving Fisher ( 1897 ), and then the theory was popularized by the work of Mincer ( 1958 ), Schultz ( 1961 ) and Becker ( 1962 , 1964 ). The theory posits that economic outputs can be improved by bettering people's inputs, such as education and health (Baldacci et al., 2008 ), and treating these inputs as a form of capital. As such, similar to physical or financial capital, they can be invested. Hence, enhancing financial literacy can positively affect poverty alleviation, which is an economic outcome.

3.2 Financial Literacy, Financial Behaviour, and Poverty

Several studies highlight that for the poor, financial behaviour is more crucial than financial knowledge in improving financial well-being (Xiao & Porto, 2022 ) and, consequently, in reducing poverty. In other words, having knowledge without taking action appears insufficient to decrease the likelihood of falling into poverty. Nonetheless, this does not mean that financial knowledge plays no role in reducing poverty. Indeed, lacking basic financial knowledge can hinder people from adopting healthy financial behaviours such as formal borrowing with better terms, mortgage refinancing (Bialowolski et al., 2022 ), person-to-person (P2P) borrowing (Han et al., 2019 ), avoiding risky credit behaviour (Xiao et al., 2014 ) and financial asset holding (Zhu & Xiao, 2022 ). Grohmann et al. ( 2018 ) highlight the essential role of financial literacy in improving financial inclusion across all circumstances. It boosts bank account ownership and formal savings in both high- and low-financial depth countries.

As such, financial knowledge serves as a critical foundation for financial behaviours, considerably enhancing financial well-being (Xiao & Porto, 2022 ) and financial resilience (Klapper & Lusardi, 2020 ), thereby reducing the probability of falling into poverty. Additionally, by being equipped with financial literacy, people are more motivated and confident in dealing with financial matters; this can be deemed as an effect of self-efficacy—a “hidden” form of human capital (Roy et al., 2018 ). This form of capital implies that people are prone to engage in activities commensurate with the level of proficiency they perceive themselves to possess. Hence, financial literacy catalyzes changing financial behaviour, thereby alleviating poverty. Building on the theoretical model and the discussion of financial literacy in the literature review section, three main hypotheses are proposed:

Financial literacy is negatively associated with the probability of falling into poverty.

Financial literacy is positively associated with desirable financial behaviours, such as bank account ownership ( H 2a ) and formal savings ( H 2b ). In turn, these desirable financial behaviours are negatively associated with the probability of falling into poverty.

4 Data and Methodology

Data used in the empirical analysis in this paper are collected by merging information from three datasets: (i) the S&P Global FinLit Survey 2014, Footnote 1 (ii) the Global Findex 2014 Footnote 2 and (iii) the Gallup World Poll (GWP) 2014 Footnote 3 to form a unique dataset of 150,000 adults across 142 countries. Because these three datasets were conducted jointly by Gallup, Inc., and the World Bank in 2014, they share the same sampling method and respondents. Researchers can easily merge these three datasets since each respondent has a unique identifier. With this rich dataset covering 142 countries in 2014, we can thoroughly examine the relationship between financial literacy and poverty reduction. Details of each dataset are discussed below.

Our empirical analysis centres on the S&P Global FinLit Survey, the most comprehensive global-scale survey on financial literacy (GFLEC, 2023 ). Notably, the S&P Global FinLit Survey was built on the collaboration among Gallup, Inc., the World Bank, and other stakeholders in 2014, leading to a shared sample and sampling method with the Gallup World Poll (GWP). With a universal approach, the S&P Global FinLit Survey measures the understanding of four fundamental financial concepts: (1) risk diversification, (2) inflation, (3) basic numeracy, and (4) interest compounding. Details of financial literacy questions are provided in Table  18 in the Appendix. These concepts closely relate to daily financial decision-making. Particularly, the knowledge of risk diversification is the understanding of reducing risk without sacrificing expected returns in business and investment (Reinholtz et al., 2021 ). Inflation knowledge alerts people of purchasing power fluctuation over time and encourages strategic decisions to cope with its menace. Basic numeracy is essential in financial market activities, particularly in calculating interest to prevent over-indebtedness (Lusardi & Tufano, 2015 ), mortgage delinquency, and default (Gerardi et al., 2013 ). Additionally, proficiency in interest compounding enables individuals to anticipate interest payments and make informed choices for the most beneficial financial products. In addition, we obtain the data on bank account ownership and formal savings from the Global Findex 2014 dataset, which shares the same respondents with the S&P Global FinLit.

Because the data on the socio-demographic characteristics of respondents are limited in the S&P Global FinLit Survey 2014, the GWP is utilized. The GWP is an annual statistical collection of nationally representative on a global scale regarding important issues worldwide (Gallup, 2016 ). From the GWP, we collect information on gender, age, education level, marital status, employment status, urbanicity, and household size. These variables collectively form the baseline model in all our regression analyses and become significantly important for investigating the heterogeneous impacts of financial literacy on the likelihood of falling into poverty across different subsamples regarding demographic and socioeconomic factors. With data from the S&P Global FinLit Survey and the GWP, we can ensure the unbiasedness and reliability of our results for several reasons. Firstly, the Kish grid method is employed to select interviewees randomly and directly interact with these interviewees through face-to-face interviews or 80% telephone coverage (Gallup, 2016 ). Additionally, as they pose uniform questions at the individual level worldwide and employ a robust translation and sampling scheme (Gallup, 2016 ), they mitigate our concern about potential minor errors, as seen in other global surveys.

During the data cleansing process, observations with missing values of used variables are eliminated. Additionally, all respondents are non-poor in some countries, such as Norway. This means that these countries would predict non-poor perfectly and would automatically be removed by the probit model. Therefore, we eliminate these countries from the sample to avoid potential bias. Ultimately, 115,336 observations from 113 countries remain for analysis, accounting for about 77% of the initial sample. The full list of 113 countries is provided in Table  17 in the Appendix. The summary statistics are presented in Table  1 .

4.2 Methodology

We construct the financial literacy score by aggregating correct answers from five financial concept questions (Table  18 ) in the S&P Global FinLit Survey. For each correct answer, respondents score one point, resulting in an aggregate score ranging from 0 to 5.

Next, we categorize respondents into poor and non-poor based on international poverty lines. The procedure to derive this variable is as follows. First, we divide each respondent’s annual income in local currency by the purchasing power parity (PPP) conversion factor (local currency per US$) in 2017, as determined by the World Bank, to estimate the annual income in 2017 US$ PPP. Then, we assign the value 1 to \(Poverty_{i}\) if the estimated annual income (2017 US$ PPP) is below the international poverty lines U$ 2.15 (for those in low-income countries), U$ 3.65 (for those in lower–upper-income countries) and U$ 6.85 (for those in upper-middle- and high-income countries) and 0 otherwise. Please refer to Jolliffe and Prdyz ( 2016 ) and Jolliffe et al. ( 2022 ) for rationales behind these international poverty lines.

Because the dependent variable, \(Poverty_{i}\) is binary, we utilize a probit regression. The estimation model is specified as follows:

where \(i\) represents the respondent. \(Poverty_{i}\) is a dummy variable which equals 1 if the respondent is classified as poor, 0 if otherwise. \(Finlit_{i}\) denotes the financial literacy score of the respondent. For each correct answer to the five financial concept questions in the S&P Global FinLit Survey, respondents score one point. The aggregate score ranges from 0 to 5. \(X_{i}\) is the matrix of control variables. Following Xu et al. ( 2023 ), we employ gender, age, urban residence, household size, educational attainment, marital status, and employment status as individual-level control variables. \(Y_{j}\) is the matrix of country dummies. Finally, \(e_{j}\) is the error term of the model.

The paper now proceeds to report and discuss the findings. First, the empirical results regarding the association of financial literacy with the probability of populations across 113 countries falling into poverty are reported. This is followed by a heterogeneity analysis, an analysis of financial literacy components, and a mediation analysis.

5.1 Main Results

The estimated coefficients of financial literacy are shown in Table  2 . Columns 1 and 2 show the empirical results from probit models. Socio-demographic factors (i.e., age, education, employment status, and others) are incorporated as control variables in all models. Furthermore, the country where respondents live can affect economic opportunities, access to education, and the availability of financial resources, which consequently affect poverty. Hence, country dummies are added to control variations across countries.

Column 1 shows that financial literacy negatively affects the probability of falling into poverty. The slope coefficient of financial literacy is statistically significant at the 1 per cent level. Holding other things constant, a unit increase in the financial literacy index corresponds to a 6.2% decrease in the probability of falling into poverty. This coefficient even increases from 6.2 to 7.5% after controlling variations across countries (Column 2). Overall, the results indicate that financial literacy is negatively associated with the probability of falling into poverty, supporting Hypothesis 1.

5.2 Heterogeneity Analysis

Using probit models with Gaussian copula, we then analyze the heterogeneous association of financial literacy with the likelihood of being poor across sub-samples divided based on socio-demographic factors, regions and country income levels. The Shapiro–Wilk tests conducted in all models reject the null hypothesis of normality of financial literacy (the endogenous variable), suggesting that Gaussian copula estimations are appropriate (Park & Gupta, 2012 ). The results for demographic and socioeconomic groups are shown in Tables 3 and 4 , respectively. Next, the results for different regions and income groups are provided in Tables 5 and 6 , respectively.

As shown in Table  3 , financial literacy significantly and negatively affects poverty across different demographic groups. Specifically, financial literacy exerts a larger association with poverty among female, old and married populations than the opposite (male, young and unmarried). To start, we compared the association of financial literacy with the chances of escaping from poverty by gender of respondents. Results show that a financially literate woman can decrease the likelihood of falling into poverty by 17%, compared with the poverty reduction of 13.2% by a man having financial knowledge (Columns 1 and 2). A similar pattern is also observed in a 2014 World Bank report on traditional literacy terms, which found that each additional year of schooling boosts women’s earnings by an average of 11.7% versus 9.6% for men (Montenegro & Patrinos, 2014 ). Regarding age, financial literacy has a greater association with poverty reduction among old people (aged 60 and over) than young ones. Ceteris paribus, a unit increase in financial literacy can lead to a 14.2% decrease in the likelihood of falling into poverty for older people and a 13.8% decrease for younger ones. The association of an individual's financial understanding with the risk of falling into poverty, categorized by marital status, are presented in columns 5 and 6 of Table  3 . The results show that financially literate married individuals have a 17.7% lower likelihood of falling into poverty, which is 5.5% higher compared to unmarried individuals.

Regarding socioeconomic groups, the results are reported in Table  4 concerning urban residence in Columns 1 and 2, employment status in Columns 3 and 4, and education attainment in Columns 5–7. Results show that the association of financial literacy with poverty are more pronounced among residents with low socioeconomic status (rural, unemployed, and low-education-level residents). Specifically, financial literacy exerts a larger association with poverty reduction among rural residents than urban ones. A financially literate person living in rural areas can decrease the likelihood of falling into poverty by 15.4%, compared to a decrease of 11.4% for those living in urban areas. Similarly, a one-unit increase in financial literacy is associated with a poverty reduction of 16.8% among employed individuals, while it just fell by 14% among those unemployed (Columns 3 and 4). Next, we examine in more detail how financial knowledge differentially affects poverty alleviation among individuals who have completed tertiary education or higher, those who completed secondary education and those who completed primary education or lower. Financial literacy has a smaller association with the chances of escape from poverty among people with a bachelor’s degree. Specifically, an increase in financial literacy corresponds to a decrease in the likelihood of falling into poverty by 18.8% for individuals who completed primary education (Column 7) and by 8% for those who completed secondary education (Column 6). These coefficients are statistically significant at 1% level. Meanwhile, the effect decreases to 6.8% for those with a bachelor’s degree. The coefficient of financial literacy even turns out to be insignificant for those with a bachelor’s degree, implying that financial literacy may have no effect in this group (Column 5).

Several studies indicate variations in financial knowledge and financial behaviours across countries with different cultures (Biolowalski et al., 2023 ) and developmental stages (Xiao & Biolowalski, 2023 ). Biolowalski et al. ( 2023 ) find that individualism, long-term orientation, and indulgence are positively correlated with financial capability (which includes financial knowledge and behaviour), whereas uncertainty avoidance exhibits a negative correlation. Interestingly, Xiao and Biolowalski ( 2023 ) show that financial capability exhibits a stronger correlation with human development in highly developed countries, implying that promoting financial capability is more cost-effective and beneficial in these countries. Therefore, we conduct further analysis to examine the heterogeneity in the relationship between financial literacy and poverty across regions and country income levels . Regarding regions, as shown in Table  5 , the coefficients of financial literacy are negative and statistically significant across East Asia and Pacific, Europe and Central Asia, Latin America and the Caribbean, North America, and Sub-Saharan Africa (Table  5 ). However, in South Asia and the Middle East & North Africa, although the coefficients remain negative, they are not statistically significant. Regarding country income levels, financial literacy has the largest association with poverty in low-income countries and the smallest association with poverty in high-income countries (Table  6 ). Holding other things constant, a unit increase in the financial literacy index can lead to a 32.5% (9.3%) decrease in the likelihood of falling into poverty in low-income (high-income) countries. The coefficients of financial literacy are statistically significant across all country income levels. These results suggest that while financial knowledge may be more beneficial to high-income countries in terms of human development—a broad measure encompassing education, health, and income (Xiao & Biolowalski, 2023 ), it is more advantageous for low-income countries in reducing poverty, which is a narrower measure capturing income levels and basic needs.

5.3 Robustness Check

This sub-section presents results from the robustness tests to assess whether the effects of financial literacy on the probability of falling into poverty are causal. First, to address potential endogeneity issues that can mislead financial literacy’s actual impacts on poverty, we follow Shin et al. ( 2022 ) to employ probit models with the Gaussian copula term. Specifically, the Gaussian copula term of financial literacy is \(Copula term_{Financial Literacy} = \emptyset^{ - 1} \left( {H_{Financial Literacy} } \right)\) , where \(\emptyset^{ - 1}\) is the inverse of the cumulative normal distribution and \(H_{Financial Literacy}\) is the empirical distribution functions of financial literacy score. Eckert and Hohberger ( 2023 ) provide instructions on how to build the Gaussian copula term using Stata software. The Gaussian copula term can control the correlation between financial literacy and error terms. The results are reported in Columns 3 and 4 of Table  2 . The Shapiro–Wilk test result indicates that financial literacy is non-normally distributed, confirming the appropriateness of Gaussian copula estimations (Park & Gupta, 2012 ). The alleviating effects of financial literacy on poverty remain consistent when Gaussian copula terms are included in models (Columns 3 and 4). After controlling for endogeneity concerns, the effect size of financial literacy even increases to 13.7% (Column 4). The Gaussian copula term is moderately statistically significant in Column 3 and turns out to be statistically insignificant in Column 4, where country dummies are added. These results indicate that endogeneity issues are not severe in probit models with country-fixed effects. Generally, these results suggest that financial literacy exerts alleviating effects on the probability of populations across more than 100 countries falling into poverty.

Second, in order to test whether the relationship between financial literacy and the probability of falling into poverty is affected by omitted variable bias, we employ a novel approach, namely, Rubin’s ( 1974 ) causal model. This model allows researchers to conduct a robustness of inference to replacement (RIR) analysis and the impact threshold of a confounding variable (ITCV) analysis (Frank, 2000 ; Frank et al., 2013 ; Xu et al., 2019 ). The RIR analysis quantifies how many observed cases need to be replaced with the opposite cases to invalidate the causal inference. The ITCV analysis indicates how correlated an omitted variable would have to be with the independent and dependent variables for the statistical inference to change. Indeed, the RIR analysis is a part of the ITCV analysis family (Frank, 2000 ). Xu et al. ( 2019 ) suggest that for a nonlinear model, the ITCV analysis should not be used because it is correlation-based and thus applies only to linear cases. Instead, the per cent bias to invalidate the inference (i.e., RIR) should be applied in this case (see also Busenbark et al., 2022 for further guidance on deciding whether to use ITCV or RIR); since our model is non-linear, we conduct the RIR analysis, using the konfound command (Xu et al., 2019 ) in Stata with the nonlinear option specified.

The results are presented in Table  7 . In Column 1, it is shown that up to 85.89% of observations in our sample would need replacement to invalidate the effects of financial literacy on poverty. This corresponds to 99,062 out of 115,336 observations, as indicated in Column 2. In other words, to invalidate the inference, 85.89% (99,062) of the cases would have to be replaced with cases with an effect of 0. We thus conclude that omitted variable bias is not a major concern in our analysis.

Similar patterns are also observed in sub-samples (Tables 8 , 9 and 10 ). For demographic groups, from 75 to 84% of the cases would have to be replaced with cases for which there is an effect of 0 to invalidate the causal inference (Table  8 ). This implies that omitted variable bias is highly unlikely to affect the impacts of financial literacy on poverty in demographic groups. Table 9 also indicates that omitted variable bias is not severe among socioeconomic groups. However, for the group with tertiary or higher education, only 8.33% of the cases needed to be replaced with counterfactual cases to invalidate the impact of financial literacy on poverty. For regions, results from Table  10 indicate that the estimated effect of financial literacy on poverty is vulnerable to omitted variable bias in North America because only 1.87% of cases need to be replaced to invalidate the inference. In contrast, the effect of financial literacy is robust in other regions. Additionally, as shown in Table  11 , the effect of financial literacy on poverty is also robust across different income levels.

Third, in line with Chaudhry and Shafiullah ( 2021 ), we also employ OLS and Lewbel’s ( 2012 ) instrumental variable approach to examine whether our results change under different estimation models. Unlike the traditional instrumental variable approach, which necessitates external instrumental variables for endogenous variables in the model, Lewbel’s ( 2012 ) instrumental variable approach self-generates internal variables from the heteroscedasticity of the model. This approach has been widely employed in the literature as a robustness check when traditional instruments are used or when external instruments are lacking (Churchill & Smyth, 2017 ; Wang & Cheng, 2022 ). Prior research suggests that the instrumental variable (IV) estimates obtained by this method are nearly identical to those obtained by using conventional validated IVs (Umberger et al., 2015 ). The Lewbel's ( 2012 ) approach is briefly outlined as below:

where \(Y_{1}\) stands for the dependent variable. \(Y_{2}\) refers to the endogenous variable. \(U\) denotes the unobserved characteristics that can affect both \(Y_{1}\) and \(Y_{2}\) . \(V_{1}\) and \(V_{2}\) are idiosyncratic errors. Lewbel ( 2012 ) posits that there exists a vector \(Z\) of observed exogenous variables meeting the conditions that \(E\left( {X\varepsilon_{1} } \right) = 0\) , \(E\left( {X\varepsilon_{2} } \right) = 0\) , \(Cov = \left( {Z, \varepsilon_{1} \varepsilon_{2} } \right)\) , with some degree of heteroskedasticity in \(\varepsilon_{j}\) . The vector Z may be a subset of X or equivalent to X. Under these conditions, \(\left[ {Z - E\left( Z \right)} \right]\varepsilon_{2}\) can serve as a vector of valid instruments satisfying the standard rank condition. We regress financial literacy on \(\tilde{\user2{X}}\) and then obtain the residuals \(\widehat{{\varepsilon_{2} }}\) , which are consistent estimates of the reduced form error \(\varepsilon_{2}\) . The estimated residuals are then used to create \(\left[ {Z - E\left( Z \right)} \right]\widehat{{\varepsilon_{2} }}\) as self-generated internal instruments for estimation.

The results are presented in Columns 1 and 2 of Table  15 . The Breusch–Pagan test rejects the null hypothesis of homoscedasticity, indicating that Lewbel’s ( 2012 ) approach is appropriate in this case. The coefficients of financial literacy are still statistically significant and negative. This implies that financial literacy exerts causal impacts on the likelihood of falling into poverty worldwide.

Finally, as our respondents are nested in countries, those from the same country may share some common characteristics that potentially affect their financial literacy and the likelihood of falling into poverty. If this holds true, the estimated effects of financial literacy on poverty can be biased and invalid. Multilevel modelling is often adopted to deal with such hierarchical data. As our dependent variable is a dummy variable, which equals 1 if the respondent is poor and 0 if otherwise, multilevel probit modelling with individuals at level 1 and countries at level 2 will be employed. In addition, because there is no obvious evidence that the effect sizes of financial literacy vary across countries, random intercept multilevel probit modelling is utilized. The estimation is specified below.

where \(i\) and \(j\) represent the respondent and country, respectively. \(Poverty_{ij}\) is a dummy variable which equals 1 if the respondent is classified as poor, 0 if otherwise. \(Finlit_{ij}\) is the financial literacy score of the respondent. \(X_{ij}\) is the matrix of individual-level control variables. \(Y_{j}\) is the matrix of country-level control variables. Data on country-level control variables, including GDP per capita, the proportion of private credit to GDP, trade openness, foreign direct investment, internet users (% of the population), mobile cellular subscriptions (% of the population), rule of law index, political stability index, and control of corruption index, are collected from World Development Indicators (WDI). Finally, \(u_{ij}\) and \(e_{j}\) are level 1 (individual) and 2 (country) error terms.

The results are reported in Table  16 . It can be observed that financial literacy has a statistically significant and negative effect on the likelihood of falling into poverty (Column 1). As shown in Columns 2–10, the coefficients of financial literacy remain statistically significant and negative when country-level variables are added to the model in Column 1. This implies that our results are robust to variations across countries.

5.4 Financial Literacy Components

In this sub-section, we examine each financial literacy component, including (i) risk diversification, (ii) inflation, (iii) numeracy (capacity to do simple calculations regarding interest rates) and (iv) compound interest. As shown in Table  12 , all four components are significantly and negatively associated with the probability of falling into poverty. The rationales behind these results are as follows. First, numeracy is essential for everyone in managing everyday finance decisions, such as budgeting, comparing prices, and understanding bills. Second, understanding how interest accumulates can help individuals avoid predatory lending and seek more favourable credit terms, reducing the likelihood of falling into debt traps. Third, understanding how inflation erodes purchasing power may encourage seeking out interest-bearing accounts and other savings mechanisms that keep pace with inflation. This knowledge helps individuals protect their financial resources from losing value over time, resulting in a decrease in the probability of falling into poverty. Finally, knowledge of risk diversification can help individuals diversify assets and investments, reducing vulnerability to financial shocks and building resilience against unexpected events.

However, there are differences in their magnitudes. Specifically, compound interest, numeracy, and inflation have the first, second, and third largest associations with poverty. In contrast, the coefficient of risk diversification is the smallest. This suggests that knowledge of compound interest, numeracy, and inflation is more essential for people than knowledge of risk diversification. On the one hand, as discussed above, compound interest, numeracy, and inflation are fundamental concepts that directly help in making daily financial decisions, avoiding predatory lending and obtaining better interest term loans (Bialowolski et al., 2022 ), all of which are significant factors that can contribute to the risk of falling into poverty. On the other hand, risk diversification is more relevant to individuals with surplus income or investments. For people without investments, the concept of risk diversification is less applicable, as they do not face the same level of financial risk as those with investments. Conversely, individuals without investments often rely on stable sources of income, such as wages, salaries, or government benefits, which are less susceptible to market fluctuations than investments such as stocks and bonds. Therefore, the immediate impact of risk diversification may be limited for individuals in poverty compared to the direct relevance of other concepts. Indeed, risk diversification is the least understood concept, with only 35% of adults answering correctly (Klapper & Lusardi, 2020 ).

5.5 Mediation Analysis

This sub-section examines possible mediating channels in the relationship between financial literacy and poverty. Two mediating channels are considered: bank account ownership and formal savings. To do so, we follow the procedure outlined in Barkat et al. ( 2023 ) and Alesina and Zhuravskaya ( 2011 ). The procedure imposes two conditions for bank account ownership and formal savings to serve as mediating channels. The first condition, known as the correlation condition , stipulates that financial literacy must be significantly correlated with bank account ownership and formal savings. The second condition, known as the magnitude condition , requires the magnitude of the coefficient of financial literacy to decrease when bank account ownership and formal savings are incorporated into the model with poverty as the dependent variable. Equations ( 1 ), ( 3 ) and ( 4 ) are used to verify the mediating channels.

where \(i\) represents the respondent. \(Poverty_{i}\) , \(Finlit_{i}\) , \(X_{i}\) and \(Y_{i}\) are poverty status, financial literacy score, the matrix of control variables and the matrix of country dummies, respectively. \(Mediators_{i}\) is the matrix of bank account ownership dummy (1 if the respondent owns a bank account, 0 if otherwise) and formal savings dummy (1 if the respondent saved at a formal institution in the past 12 months, 0 if otherwise).

The results of the correlation between financial literacy and mediators, as specified in Eq. ( 3 ), are presented in Table  13 . Results presented in Columns 1 and 2 suggest that financial literacy significantly and positively correlates with bank account ownership and formal savings. Next, the results of the magnitude condition, as specified in Eqs. ( 1 ) and ( 4 ), are reported in Table  14 . The magnitude of the coefficient of financial literacy decreases as bank account ownership and formal savings are incorporated into the model (Columns 1–3). As such, bank account ownership and formal savings are qualified as mediating variables in the association between financial literacy and poverty, supporting Hypothesis 2. Indeed, financial literacy encourages desirable financial behaviours (Grohmann et al., 2018 ), which may lead to a decrease in the probability of falling into poverty.

6 Discussions

We have discovered a negative association between financial literacy and the likelihood of falling into poverty across 113 countries globally. Furthermore, we provide evidence supporting a causality from financial literacy to poverty reduction by adopting probit estimations with Gaussian copula terms. Overall, our findings suggest that financial literacy can serve as a pivotal instrument in the process of tackling poverty worldwide. Interestingly, financial literacy is found to have a heterogeneous association with poverty in different demographic groups, socioeconomic groups, regions, and country income levels. Moreover, we demonstrate that desirable financial behaviours, such as account ownership and formal savings, serve as the mediating variables in the relationship between financial literacy and poverty. This sub-section will further discuss and provide possible explanations for these findings.

To begin with, we will provide possible explanations for the mitigating effects of financial literacy on poverty. Regarding the underlying mechanisms through which financial literacy can reduce poverty, the empirical evidence is still relatively scarce. However, there are several potential mechanisms through which financial literacy can affect poverty. On the one hand, as mentioned in Sect.  2.3 , financial literacy positively influences account ownership and usage, formal savings, formal borrowing, stock participation, portfolio performance, insurance usage, debt management ability and retirement planning. Furthermore, empirical analysis from this study verifies the mediating role of account ownership and formal savings in the relationship between financial literacy and poverty.

On the other hand, these impacts correlate with poverty reduction in multifaceted ways. First, savings facilitate escape from poverty by smoothing consumption and financing productive investments (Karlan et al., 2014 ; Pomeranz & Kast, 2022 ), preventing indebtedness and debt-trap situations (Lister, 2006 ). Especially those equipped with emergency savings possess the advantageous ability to shield themselves from prolonged financial hardships resulting from adverse economic events (Diwakar & Shepherd, 2022 ; Shah et al., 2012 ), thereby attaining financial resilience, reducing the poverty risk (Hasler et al., 2018 ; Lusardi et al., 2011 ). Second, insurance defences against the risk of future poverty among customers (Koomson et al., 2020a ), improving risk-taking and managing capacities (Hong et al., 2020 ; Wang et al., 2022 ) to accumulate more in the financial market and entrepreneurship, taking great steps in the poverty alleviation process (Bucher-Koenen & Ziegelmeyer, 2014 ; Guiso & Viviano, 2015 , Klapper et al., 2013 ). Third, shifting lending behaviour from informal sources to formal institutions is also associated with eliminating irrational economic behaviours and financial constraints, facilitating households' escape from poverty (Sarthak & Ashish, 2012 ). Fourth, implementing effective debt management also helps reduce the likelihood of over-indebtedness (Gathergood, 2012 ), mortgage delinquency, and default (Gerardi et al., 2013 ). The fifth mechanism entails the advantages of heightened demand for bank accounts and debit cards. While Kefela ( 2011 ) exhibits that having an account at a bank or other financial institution is an important first step for financially literate people to participate in the financial system, Lusardi and Messy ( 2023 ) assert the influence of this participation on the efficiency and soundness of financial systems. As the financial system improves with more financially literate participants, it facilitates economic growth and alleviates poverty in middle- and high-income countries (Dhrifi, 2015 ). Sixth, Setor et al. ( 2021 ) examine data from 111 developing countries from 2010 to 2018, conclusively identifying digital transactions as a valuable tool in mitigating corruption and poverty by enhancing transparency, given the bidirectional causality between corruption and poverty (Han et al., 2022 ; Justesen & Bjørnskov, 2014 ). Seventh, asset and livelihood diversification is confirmed to have a negative association with poverty (Martin & Lorenzen, 2016 ). Eighth, entrepreneurship, viewed through different lenses, addresses poverty by addressing resource scarcity (remediation), social exclusion (reform), and challenging capitalist tenets (revolution) (see Sutter et al., 2019 for a review of related literature). Ninth, the reduction of anxiety among individuals can also help them escape from the cyclic nature of poverty—mental disorder (Anakwenze & Zuberi, 2013 ; Lund et al., 2011 ). Finally, effective retirement plans are also associated with increased wealth accumulation and poverty alleviation, particularly during old age (Lusardi & Mitchell, 2011b ; Behrman et al., 2012 ). Overall, the alleviating effect of financial literacy on poverty may be explained through many mechanisms, including savings, emergency funds, insurance usage, lending from formal institutions, debt management, usage of bank accounts and debit cards, digital transactions, asset diversification, entrepreneurship, and retirement plans.

7 Conclusions and Policy Implications

Our study explores how financial literacy affects the likelihood of individuals falling into poverty worldwide. Our analyses confirm that financial literacy significantly and negatively affects poverty. This result remains largely unchanged across different socio-demographic groups, regions, and country income levels, implying that our results can be applicable in various contexts. The coefficients of financial literacy are still statistically significant and consistent in terms of signs across robustness tests, including (i) probit models with Gaussian copula terms (addressing endogeneity concerns), (ii) multilevel probit models (considering variations across countries) and (iii) the Rubin’s ( 1974 ) causal model. Moreover, we find a notable heterogeneity in the impacts of financial literacy across subsamples. For demographic groups, the negative correlation between financial literacy and poverty is more pronounced among females, older individuals, and married individuals than their counterparts (males, young individuals, and unmarried individuals). In socioeconomic groups, residents of rural areas, those unemployed, and individuals with or without a primary degree are likely to derive greater benefits from financial literacy compared to their counterparts in the respective dimensions. Across regions, those living in East Asia, the Pacific, and Sub-Saharan Africa demonstrate the first and second largest decreases in the likelihood of poverty, with the same increase in financial literacy. Meanwhile, the coefficient of financial literacy turns out to be statistically insignificant in South Asia, the Middle East & North Africa, suggesting that financial literacy may not have any effect on poverty. Financial literacy has the most substantial impact on reducing the likelihood of poverty among citizens in lower-middle-income and low-income countries. Conversely, its association with the risk of poverty among individuals in high-income countries is the lowest.

Policy implications have emerged based on these insightful findings. First, governments should implement comprehensive financial education programs targeting various socio-demographic groups or incorporate financial topics into school curriculum. These programs should cover essential topics in finance, such as inflation, compound interest, risk diversification and debt management. Second, governments may consider providing funds for financial education initiatives such as community-based workshops, online courses, and financial educational materials to reach a broad audience. Moreover, financial literacy can serve as a powerful instrument to mitigate disparities in poverty rates among females, the elderly, the unmarried, rural residents, the unemployed, individuals with lower education levels, inhabitants in East Asia and Pacific and Sub-Saharan Africa, and those in lower-middle and low-income countries due to its larger association with poverty reduction in these groups compared to their counterparts. Therefore, these groups should receive targeted attention from governments to enhance their financial literacy levels and address poverty and disparities in poverty rates. In particular, we suggest specific policy implications that governments can take into consideration.

While females, the elderly, and the separated or divorced are the most beneficiaries of financial literacy in poverty reduction, their awareness and conditions to make use of these advantages are limited, given that they tend to be biased as they should not and cannot make sound financial decisions. That is, policymakers need to simultaneously break down social stereotypes about their financial ability and facilitate their financial literacy improvement. On the one hand, more research about the financial ability of people with these demographic factors should be implemented and widely popularized to dispel stereotypes and provide evidence-based insights. Popularization can be achieved through continuous dialogue and awareness campaigns in educational institutions, workplaces, and online platforms, ensuring universality in access. Additionally, celebrating the achievements of women, the elderly, and unmarried individuals who leverage their financial knowledge to build wealth and safeguard assets is crucial. Their success stories should be prominently featured in media and journals as exemplary cases, inspiring others and challenging prevailing stereotypes. This concerted effort contributes to a cultural shift that recognizes and values experiences and perspectives in the financial decision-making of females, people aged above 70, and the unmarried. On the other hand, policymakers should make more effort to facilitate better financial literacy among these target groups. As financial education is a fundamental measure to increase financial literacy, governments may expand policies to stimulate people's participation and interest in financial education programs. For example, people with unfavourable demographic factors could receive free government-sponsored financial education, offer tax incentives or subsidies to residents participating in financial education, integrate financial literacy requirements into welfare programs, provide additional benefits or incentives for participants in financial education, and so on. Through the implementation of diverse and targeted measures, governments have the potential to significantly enhance the representation of females, individuals over 70, and those who are separated or divorced in the financial market. This, in turn, can contribute to reducing poverty levels and foster a higher rate of economic development.

Recognizing the amplified association between financial literacy and poverty reduction in specific socioeconomic groups, governments may prioritize allocating more resources to financial literacy programs that target residents with low socioeconomic status (rural, unemployed, and low-education-level ones). Also, to ensure that the content is relevant and accessible, financial literacy programs should be customized to address the unique financial circumstances of individuals in rural areas, the unemployed, and those with low education levels. Moreover, given that residents of low socioeconomic status are usually beneficiaries of social assistance programs, financial education components should be integrated into existing programs, such as unemployment benefits or rural welfare-oriented programs. In this way, countries can achieve sustainable poverty reduction instead of temporarily reducing poverty. By empowering individuals to make informed financial decisions in the long term, this approach addresses immediate financial needs, temporarily reduces poverty, and aims to reduce poverty sustainably.

Given these heterogeneous associations for residents in low-income countries and those in East Asia and Pacific and Sub-Saharan Africa, officials of these nations have the privilege of bridging the gap with other nations in eradicating poverty and moving up the economic ladder. To capitalize on this advantage, policymakers in East Asia and the Pacific, Sub-Saharan Africa, and low-income countries may consider enhancing financial literacy as an important and urgent national task that requires prioritizing attention and resources. Concurrently, the government should increase investments in developing financial infrastructure while implementing stringent regulations to foster a secure and readily accessible financial market for individuals and businesses. National strategies must be implemented consistently, effectively, and creatively to turn their potential into reality. For example, Vietnam's Prime Minister has approved the National Financial Inclusion Strategy until 2025. It clearly states the viewpoints, goals, tasks, and solutions to promote access and usage of financial goods and services for all residents and businesses, with a focus on those living in rural areas, low-income people, women, and other disadvantaged groups (Viet Nam Government Portal, 2022 ).

Data Availability

The data underlying this article cannot be shared publicly due to its proprietary nature, as stipulated by the survey owners.

This dataset is proprietary. To request access, please visit https://gflec.org/initiatives/sp-global-finlit-survey/ .

This dataset is publicly available at: https://www.worldbank.org/en/publication/globalfindex .

This dataset is proprietary. To request access, please visit https://www.gallup.com/analytics/ .

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Journal of Economics and Public Policy

Financial Literacy: A Brief Systematic Literature Review

Posted on May 8, 2020 Author nmims

Abstract Financial literacy implies the ability of individuals to understand, manage, and plan their personal finances. By gaining financial literacy, people are likely to develop critical thinking, judgment, and other skills for making informed personal finance decisions. The current study has attempted to review the financial literacy research papers in a systematic manner incorporating the multiple facets ranging from impact of demographic factors to present state of financial literacy literature in the Indian context. Papers published by selective global publishers in the last two decades have been reviewed to trace the trend, the debates and literature gap in shaping the future studies. Keywords: Systematic Literature Review, Academic E-journals, Financial Literacy and Financial decisions.

Section 1-Introduction Literature has concurred that ‘Financial Literacy’ (FL) is one’s ability to make informed decisions on choosing investment avenues, ability to balance a cash book and manage funds effectively (Beverly & Burkhalter, 2005; Hung, Parker & Yoong, 2009). Read Full Article

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FINANCIAL LITERACY, FINANCIAL EDUCATION AND ECONOMIC OUTCOMES

In this article we review the literature on financial literacy, financial education, and consumer financial outcomes. We consider how financial literacy is measured in the current literature, and examine how well the existing literature addresses whether financial education improves financial literacy or personal financial outcomes. We discuss the extent to which a competitive market provides incentives for firms to educate consumers or offer products that facilitate informed choice. We review the literature on alternative policies to improve financial outcomes, and compare the evidence to evidence on the efficacy and cost of financial education. Finally, we discuss directions for future research.

“The future of our country depends upon making every individual, young and old, fully realize the obligations and responsibilities belonging to citizenship...The future of each individual rests in the individual, providing each is given a fair and proper education and training in the useful things of life...Habits of life are formed in youth...What we need in this country now...is to teach the growing generations to realize that thrift and economy, coupled with industry, are necessary now as they were in past generations.”

--Theodore Vail, President of AT&T and first chairman of the Junior Achievement Bureau (1919, as quoted in Francomano, Lavitt and Lavitt, 1988 )

“Just as it was not possible to live in an industrialized society without print literacy—the ability to read and write, so it is not possible to live in today's world without being financially literate... Financial literacy is an essential tool for anyone who wants to be able to succeed in today's society, make sound financial decisions, and—ultimately—be a good citizen.”

-- Annamaria Lusardi (2011)

1. INTRODUCTION

Can individuals effectively manage their personal financial affairs? Is there a role for public policy in helping consumers achieve better financial outcomes? And if so, what form should government intervention take? These questions are central to many current policy debates and reforms in the U.S. and around the world in the wake of the recent global financial crises.

In the U.S., concerns about poor financial decision making and weak consumer protections in consumer financial markets provided the impetus for the creation of the Consumer Financial Protection Bureau (CFPB) as part of the Dodd-Frank Wall Street Reform and Consumer Project Act which was signed into law by President Obama on July 21, 2010. This law gives the CFPB oversight of consumer financial products in a variety of markets, including checking and savings accounts, payday loans, credit cards, and mortgages (CFPB authority does not extend to investments such as stocks and mutual funds which are regulated by the SEC, or personal insurance products that are largely regulated at the state level). In addition to establishing its regulatory authority, the Dodd-Frank Act mandates that the CFPB establish “the Office of Financial Education, which shall develop a strategy to improve the financial literacy of consumers.” It goes on to state that the Comptroller must study “effective methods, tools, and strategies intended to educate and empower consumers about personal financial management” and make recommendations for the “development of programs that effectively improve financial education outcomes.” 1

In line with this second mandate for the CFPB, there has been much recent public discussion on financial literacy and the role of financial education as an antidote to limited individual financial capabilities. As the title suggests, this is a main focus of the current paper; however, it is important not to lose the forest for the trees in the debate on policy prescriptions. The market failure that calls for a policy response is not limited to financial literacy per se, but the full complement of conditions that lead to suboptimal consumer financial outcomes of which limited financial literacy is one contributing factor. Similarly, the policy tools for improving consumer financial outcomes include financial education but also encompass a wide variety of regulatory approaches. One of our aims in this paper is to place financial literacy and financial education in this broader context of both problems and solutions.

The sense of public urgency over the level of financial literacy in the population is, we believe, a reaction to a changing economic climate in which individuals now shoulder greater personal financial responsibility in the face of increasingly complicated financial products. For example, in the U.S. and elsewhere across the globe, individuals have been given greater control and responsibility over the investments funding their retirement (in both private retirement savings plan such as 401(k)s and in social security schemes with private accounts). Consumers confront ever more diverse options to obtain credit (credit cards, mortgages, home equity loans, payday loans, etc.) and a veritable alphabet soup of savings alternatives (CDs, HSAs, 401(k)s, IRAs, 529s, KEOUGHs, etc.). Can individuals successfully navigate this increasingly complicated financial terrain?

We begin by framing financial literacy within the context of standard models of consumer financial decision making. We then consider how to define and measure financial literacy, with an emphasis on the growing literature documenting the financial capabilities of individuals in the U.S. and other countries. We then survey the literature on the relationship between financial literacy and economic outcomes, including wealth accumulation, savings decisions, investment choices, and credit outcomes. We then assess the evidence on the impact of financial education on financial literacy and on economic outcomes. Next we evaluate the role of government in consumer financial markets: what problems do limited financial capabilities pose, and are market mechanisms likely to correct these problems? Finally, we suggest directions for future research on financial literacy, financial education, and other mechanisms for improving consumer financial outcomes.

2. WHAT IS FINANICAL LITERACY AND WHY IS IT IMPORTANT?

“Financial literacy” as a construct was first championed by the Jump$tart Coalition for Personal Financial Literacy in its inaugural 1997 study Jump$tart Survey of Financial Literacy Among High School Students. In this study, Jump$tart defined “financial literacy” as “the ability to use knowledge and skills to manage one's financial resources effectively for lifetime financial security.” As operationalized in the academic literature, financial literacy has taken on a variety of meanings; it has been used to refer to knowledge of financial products (e.g., what is a stock vs. a bond; the difference between a fixed vs. an adjustable rate mortgage), knowledge of financial concepts (inflation, compounding, diversification, credit scores), having the mathematical skills or numeracy necessary for effective financial decision making, and being engaged in certain activities such as financial planning.

Although financial literacy as a construct is a fairly recent development, financial education as an antidote to poor financial decision making is not. In the U.S., policy initiatives to improve the quality of personal financial decision making through financial education extend back at least to the 1950s and 1960s when states began mandating inclusion of personal finance, economics, and other consumer education topics in the K-12 educational curriculum ( Bernheim et al. 2001 ; citing Alexander 1979, Joint Council on Economic Education 1989, and National Coalition for Consumer Education 1990). 2 Private financial and economic education initiatives have an even longer history; the Junior Achievement organization had its genesis during World War I, and the Council for Economic Education goes back at least sixty years. 3

Why are financial literacy and financial education as a tool to increase financial literacy potentially important? In answering these questions, it is useful to place financial literacy within the context of standard models of consumer financial decision making and market competition. We start with a simple two-period model of intertemporal choice in the face of uncertainty. A household decides between consumption and savings at time 0, given an initial time 0 budget, y , an expected real interest rate, r , and current and future expected prices, p , for goods consumed, x .

Solving this simple model requires both numeracy (the ability to add, subtract, and multiply), and some degree of financial literacy (an understanding of interest rates, market risks, real versus nominal returns, prices and inflation).

Alternatively, consider a simple model of single-period profit maximization for a single-product firm competing on price in a differentiated products market:

The firm chooses price, p , to maximize profits given marginal costs, mc , its product characteristics, x , its competitors’ prices and product characteristics, p -j and x -j , respectively, and the distribution of consumer preferences over price and product characteristics, θ . Doing so results in the familiar formula relating price mark-up over costs to the price elasticity of demand: prices are higher relative to costs in product markets in which demand is less sensitive to price.

Competitive outcomes in this model rest on the assumption that individuals can and do make comparisons across products in terms of both product attributes and the prices paid for those attributes. This may be a relatively straightforward task for some products (e.g., breakfast cereal), but is a potentially tall order for products with multidimensional attributes and complicated and uncertain pricing (e.g., health care plans, cell phone plans, credit cards, or adjustable rate mortgages).

A lack of financial literacy is problematic if it renders individuals unable to optimize their own welfare, especially when the stakes are high, or to exert the type of competitive pressure necessary for market efficiency. This has obvious consequences for individual and social welfare. It also makes the standard models used to capture consumer behavior and shape economic policy less useful for these particular tasks.

Research has documented widespread and avoidable financial mistakes by consumers, some with non-trivial financial consequences. For example, in the U.S., Choi et al. (2011) examine contributions to 401(k) plans by employees over age 59 ½ who are eligible for an employer match, vested in their plan, and able to make immediate penalty-free withdrawals due to their age. They find that 36% of these employees either don't participate or contribute less than the amount that would garner the full employer match, essentially foregoing 1.6% of their annual pay in matching contributions; the cumulative losses over time for these individuals are likely to be much larger.

Duarte & Hastings (2011) and Hastings et al. (2012) show that many participants in the private account Social Security system in Mexico invest their account balances with dominated financial providers who charge high fees that are not offset by higher returns, contributing to high management fees in the system overall. Similarly, Choi et al. (2009) use a laboratory experiment that show that many investors, even those who are well educated, fail to choose a fee minimizing portfolio even in a context (the choice between four different S&P 500 Index Funds) in which fees are the only significant distinguishing characteristic of the investments and the dispersion in fees is large.

Campbell (2006) highlights several other of financial mistakes: low levels of stock market participation, inadequate diversification due to households’ apparent preferences to invest in local firms and employer stock, individuals’ tendencies to sell assets that have appreciated while holding on to assets whose value has declined even if future return prospects are the same (the disposition effect first documented in Odean 1998 ), and failing to refinance fixed rate mortgages in a period of declining interest rates.

Other financial mistakes discussed in the literature include purchasing whole life insurance rather than a cheaper combination of term life insurance in conjunction with a savings account ( Anagol et al. 2012 ); simultaneously holding high-interest credit card debt and low-interest checking account balances ( Gross & Souleles 2002 ); holding taxable assets in taxable accounts and non-taxable or tax-preferred assets in tax-deferred accounts ( Bergstresser & Poterba 2004 , Barber & Odean 2003 ); paying down a mortgage faster than the amortization schedule requires while failing to contribute to a matched tax-deferred savings account (Amromin et al. 2007); and borrowing from a payday lender when cheaper sources of credit are available ( Agarwal et al. 2009b ).

Agarwal et al. (2009a) document the prevalence of several different financial mistakes ranging from suboptimal credit card use after making a balance transfer to an account with a low teaser rate, to paying unnecessarily high interest rates on a home equity loan or line of credit. They find that across many domains, sizeable fractions of consumers make avoidable financial mistakes. They also find that the frequency of financial mistakes varies with age, following a U-shaped pattern: financial mistakes decline with age until individuals reach their early 50s, then begin to increase. The declining pattern up to the early 50s is consistent with the acquisition of increased financial decision-making capital over time, either formally or through learning from experience ( Agarwal et al. 2011 ); but the reversal at older ages highlights the natural limits that the aging process places on individuals’ financial decision-making capabilities, however those capabilities are acquired.

The constellation of findings described above has been cited by some as prima facie evidence that individuals lack the requisite levels of financial literacy for effective financial decision making. On the other hand, Milton Friedman (1953) famously suggested that just as pool players need not be experts in physics to play pool well, individuals need not be financial experts if they can learn to behave optimally through trial and error. There is some evidence that such personal financial learning does occur. Agarwal et al. (2011) find that in credit card markets during the first three years after an account is opened, the fees paid by new card holders fall by 75% due to negative feedback: by paying a fee, consumers learn how to avoid triggering future fees. The role of experience is also evident in the answers to a University of Michigan Surveys of Consumers question that asked about the most important way respondents’ learned about personal finance. Half cited personal financial experience, more than twice the fraction who cited friends and family, and four to five times the fraction who credit formal financial education as their most important source of learning (Hilgert & Hogarth 2003).

Although experiential learning may be an important self-correcting mechanism in financial markets, many important financial decisions like saving and investing for retirement, choosing a mortgage, or investing in an education, are undertaken only infrequently and have delayed outcomes that are subject to large random shocks. Learning by doing may not be an effective substitute for limited financial knowledge in these circumstances ( Campbell et al. 2010 ), and consumers may instead rely on whatever limited institutional knowledge and numeracy skills they have.

3. MEASURING FINANCIAL LITERACY

If financial literacy is an important ingredient in effective financial decision making, a natural question to ask is how financially literate are consumers? Are they well equipped to make consequential financial decisions? Or do they fall short? Efforts to measure financial literacy date back to at least the early 1990s when the Consumer Federation of America (1990; 1991; 1993; 1998) began conducting a series of “Consumer Knowledge” surveys among different populations which included questions on several personal finance topics: consumer credit, bank accounts, insurance, and major consumer expenditures areas such as housing, food and automobiles. The 1997 Jump$tart survey of high school students referenced above has been repeated biennially since 2000 and was expanded to include college students in 2008 (see Mandell 2009 , for an analysis these surveys). Hilgert et al. (2003) analyze a set of “Financial IQ” questions included in the University of Michigan's monthly Surveys of Consumers in November and December 2001.

More recently, Lusardi & Mitchell (2006) added a set of financial literacy questions to the 2004 Health and Retirement Study (HRS, a survey of U.S. households aged 50 and older) that have, in the past decade, served as the foundational questions in several surveys designed to measure financial literacy in the U.S. and other countries. The three core questions in the original 2004 HRS financial literacy module were designed to assess understanding of three core financial concepts: compound interest, real rates of return, and risk diversification (see Table 1 ). Because these questions are parsimonious and have been widely replicated and adapted, they have come to be known as the “Big Three.”

Financial Literacy Questions in the 2004 Health and Retirement Study (HRS) and the 2009 National Financial Capability Study (NFCS)

Note: The answer categorized as correct is italicized in the last column.

These questions were incorporated into the 2009 National Financial Capability Study (NFCS) in the U.S., a large national survey of the financial capabilities of the adult population. 4 The NFCS asked two additional financial literacy questions which, together with the “Big Three,” have collectively come to be known as the “Big Five.” These two additional questions test knowledge about mortgage interest and bond prices. Table 1 lists the “Big Five” questions as asked with their potential answers (the correct answers are italicized).

Because the “Big Three” questions have been more widely adopted in other surveys, we focus here on the answers to these three questions, although we return to the “Big Five” later. The second and fourth columns of Table 2 report the percent of correct and “Don't know” responses to each of the “Big Three” questions for the 2004 HRS respondents and the 2009 NFCS respondents. Because the NFCS represents the entire adult population, we focus on those results here. Among respondents to the 2009 NFCS, 78% correctly answered the first question on interest rates and compounding, 65% correctly answered the second question on inflation and purchasing power, and 53% correctly answered the third question on risk diversification. Note that all three questions were multiple choice (rather than open-ended), so that guessing would yield a correct answer to the first two questions 33% of the time and to the last question 50% of the time. Only 39% of respondents correctly answered all three questions.

Financial Literacy Around the World

Notes: Countries ranked by 2010-2011 International Monetary Fund GDP per capita. + denotes statistics directly drawn from publications: Netherlands: van Rooij et al. 2011 . Financial literacy and retirement preparation in the Netherlands. J. Pension. Econ. 10(4): 527-545; Japan: Sekita. 2011. Financial literacy and retirement planning in Japan. J. Pension. Econ. 10(4): 637-656. Germany: Lusardi & Bucher-Koenen. 2011. Financial literacy and retirement planning in Germany. J. Pension. Econ. 10(4): 565-584. Cole et al. 2011. Prices or knowledge? What drives demand for financial services in emerging markets. J. Financ. 66(6): 1933-1967.

X denotes missing information.

Clearly individuals who cannot answer the first or second questions will have a difficult time navigating financial decisions that involve an investment today and real rates of return over time; they are likely to have trouble making even the basic calculations assumed in a rational intertemporal decision-making framework. The inability to correctly answer the third question demonstrates ignorance about the benefits of diversification (reduced risk) and casts doubt on whether individuals can effectively manage their financial assets. With only 39% of the population able to answer these three fairly basic financial literacy questions correctly, we might be justifiably concerned about how many individuals make suboptimal financial decisions in everyday life and the types of marketplace distortions that could follow.

As noted earlier, dozens of surveys in addition to the NFCS have included the trio of questions discussed above from the 2004 HRS. In addition to the results for the 2004 HRS and the 2009 NFCS, Table 2 shows how respondents in several countries answered these same questions. The first six columns list comparative statistics for six developed economy surveys from the U.S., The Netherlands, Japan and Germany. The next three columns take data from the upper-middle income countries of Chile and Mexico. The last two columns report responses from the lower-income countries of India and Indonesia. Proficiency rates vary widely; in Germany, 53% of respondents correctly answer the three HRS financial literacy questions, whereas only 8% of respondents in Chile do so. In general, the level of financial literacy is highest in the developed countries and lowest in the lower-income countries. The responses to these questions in the 2004 and 2010 HRS suggest that financial literacy for HRS respondents has increased somewhat over time, perhaps from participating in the panel, or perhaps as a result of increased financial discussion surrounding the 2008 financial crisis. In Chile and Mexico, respondents have particularly low levels of financial literacy despite being responsible for managing the investment decisions for the balances accumulated in their privatized social security accounts. Chile also witnessed massive student protests over college loan debt in 2011, and yet only 16% of college entrants can correctly answer these three questions despite the fact that 22% of them are taking out student loans. 5

Although the Lusardi and Mitchell “Big Three” questions from the 2004 HRS have quickly become an international standard in assessing financial literacy, there is remarkably little evidence on whether this set of survey questions is the best approach, or even a superior approach, to measuring financial literacy. The question of how best to assess the desired behavioral capabilities remains open, both in terms of establishing whether survey questions are best-suited for the task or which questions are most effective. Longer financial literacy survey batteries do exist, including the National Financial Capability Study (NFCS) which asks the “Big Five” financial literacy questions described above along with an extensive set of questions on individual financial behaviors. The biennial Jump$tart Coalition financial literacy surveys used to assess the financial literacy of high school and college students in the U.S. include more than fifty questions. Whether using additional survey questions (and how many more) better explains individual behavior is unclear as little research has evaluated the relative efficacy of different measurements.

Table 3 lists the fraction of respondents correctly answering the “Big Three” and “Big Five” financial literacy questions in the 2009 NFCS for various demographic subgroups. There is a strong positive correlation between the performance on the “Big Three” and the “Big Five” questions (although part of this correlation is mechanical as the “Big Three” are a subset of the “Big Five”). Table 3 also lists three other self-assessed measures of financial capability (self-assessed overall financial knowledge, self-assessed mathematical knowledge and self-assessed capability at dealing with financial matters). These self-assessed measures are all highly correlated with each other, and fairly highly correlated with the performance-based measures of financial literacy in the first two columns. All of the measures of financial capability are also highly correlated with educational attainment, suggesting that traditional measures of education could also serve as proxies for financial literacy (we will discuss causality in Section 4).

Measures of Financial Literacy

Note: Authors’ calculations from the 2009 NFCS State-by-State Survey (n=28,146). The top panel of Table 1 lists the “Big 3” questions in Column (1); the “Big 5” questions in Column (2) include the “Big 3” and the additional two questions from the bottom panel of Table 1 . Columns (3) through (5) report the mean of the participants’ self-assessments based on the following scale: 1=Strongly Disagree to 7= Strongly Agree.

In a survey of 18 different financial literacy studies, Hung et al. (2009) report that the predominant approach used to operationalize the concept of financial literacy is either the number, or the fraction, of correct answers on some sort of performance test (measures akin to those in columns 1 and 2 of Table 3 ). This approach was used in all of the studies they evaluated, although two adopted a more sophisticated methodology, using factor analysis to construct an index that assigned different weights to each question ( Lusardi & Mitchell 2009 , van Rooij et al. 2011 ).

In addition to evaluating how previous studies have operationalized the concept of financial literacy, Hung et al. (2009) also perform a construct validation of seven different financial literacy measures calculated from various question batteries administered to the same set of respondents in four different waves of the RAND American Life Panel. Their measures include three performance tests (one of which has three subtests) based on either 13, 23, or 70 questions, and one behavioral outcome (performance in a hypothetical financial decision-making task). They find that the measures based on the different performance tests are highly correlated with each other, and when the same questions are asked in multiple waves, the answers have high test-retest reliability. The outcomes of the performance tests are less highly correlated with outcomes in the decision-making task. They also find that the relationship between demographics and the different performance test based measures of financial literacy is similar, but that the relationship between demographics and the outcomes in the decision-making task is much weaker. The different financial literacy measures are more variable in their predictive relationships for actual financial behaviors such as planning for retirement, saving, and wealth accumulation.

One unanswered question in this literature is whether test-based measures provide an accurate measure of actual financial capability. To our knowledge, no study has provided incentives for giving correct answers as a mechanism to encourage thoughtful answers that reflect actual knowledge; neither has any study allowed individuals to access other sources of information (e.g., the internet, or friends and family) in completing a performance test to assess whether individuals understand their limitations and can compensate for them by engaging other sources of expertise. If individuals have effective compensatory mechanisms, we may see discrepancies between performance test results and actual outcomes and behaviors in the field.

A second measure of financial literacy that has been operationalized in the literature is individuals’ self-assessments of their financial knowledge or, alternatively, the level of confidence in their financial abilities. In the 18 studies evaluated by Hung et al. (2009) discussed above, one-third analyzed self-reported financial literacy in addition to a performance test-based measure. Two issues with such self-reporting warrant mention. First, individual self-reports and actual financial decisions do not always correlate strongly ( Hastings & Mitchell 2011 , Collins et. al. 2009 ). Second, consumers are often overly optimistic about how much they actually know ( Agnew & Szykman 2005 , OECD 2005 ). Even so, in general the literature finds that self-assessed financial capabilities and more objective measures of financial literacy are positively correlated (e.g., Lusardi & Mitchell 2009 , Parker et al. 2012 ), and self-reported financial literacy or confidence often have independent predictive power for financial outcomes relative to more objective test-based measures of financial literacy. For example, Allgood & Walstad (2012) find that in the 2009 NFCS State-by-State survey, both self-assessed financial literacy and the fraction of correct answers on the “Big Five” financial literacy questions are predictive of financial behaviors in a variety of domains: credit cards (e.g., incurring interest charges or making only minimum payments), investments (e.g., holding stocks, bonds, mutual funds or other securities), loans (e.g., making late payments on a mortgage, comparison shopping for a mortgage or auto loan), insurance coverage, and financial counseling (e.g., seeking professional advice for a mortgage, loan, insurance, tax planning or debt counseling). Similarly, Parker et al. (2012) find that both self-reported financial confidence and a test-based measure of financial literacy predict self-reported retirement planning and saving, and van Rooij et al. (2011) find that both self-perceived financial knowledge and a test-based measure of financial literacy predict stock market participation.

Although test-based and self-assessed measures of financial literacy are the norm in the literature, other approaches to measuring financial literacy may be worth considering. One alternative measurement strategy, limited by the requirement for robust administrative data, is to identify individuals exhibiting financially sophisticated behavior (e.g., capitalizing on matching contributions in an employer's savings plan, or consistently refinancing a mortgage when interest rates fall) and use these indicators to predict other outcomes. For example, Calvet et al. (2009) use administrative data from Sweden to construct an index of financial sophistication based on whether individuals succumb to three different types of financial “mistakes”: under-diversification, inertia in risk taking, and the disposition effect in stock holding.

An outcomes-based approach like this may be fruitful for predicting future behavior, more so than the traditionally used measures of financial literacy (although Calvet et al. 2009 do not perform such an exercise in their analysis). If we are interested in understanding the abilities that improve financial outcomes, we should define successful measures as those that, when changed, produce improved financial behavior. Such a strategy will likely generate greater internal validity for predicting consumer decisions in specific areas (e.g., portfolio choice or retirement savings), although it will significantly increase the requirements for research relative to strategies that rely on more general indicators of financial literacy (e.g., the “Big Three”).

4. WHAT IS THE RELATIONSHIP BETWEEN FINANCIAL EDUCATION, FINANCIAL LITERACY AND FINANCIAL OUTCOMES?

Consistent with the notion that financial literacy matters for financial optimization, a sizeable and growing literature has established a correlation between financial literacy and several different financial behaviors and outcomes. In one of the first studies in this vein, Hilgert et al. (2003) document a strong relationship between financial knowledge and the likelihood of engaging in a number of financial practices: paying bills on time, tracking expenses, budgeting, paying credit card bills in full each month, saving out of each paycheck, maintaining an emergency fund, diversifying investments, and setting financial goals. Subsequent research has found that financial literacy is positively correlated with planning for retirement, savings and wealth accumulation ( Ameriks et al. 2003 , Lusardi 2004 , Lusardi & Mitchell 2006 ; 2007 , Stango & Zinman 2008, Hung et al. 2009 , van Rooij et al. 2012 ). Financial literacy is predictive of investment behaviors including stock market participation ( van Rooij, et al. 2011 , Kimball & Shumway 2006 , Christelis et al. 2006), choosing a low fee investment portfolio ( Choi et al. 2011 , Hastings 2012), and better diversification and more frequent stock trading ( Graham et al. 2009 ). Finally, low financial literacy is associated with negative credit behaviors such as debt accumulation (Stango & Zinman 2008, Lusardi & Tufano 2009 ), high-cost borrowing ( Lusardi & Tufano 2009 ), poor mortgage choice ( Moore 2003 ), and mortgage delinquency and home foreclosure ( Gerardi et al. 2010 ).

Other related research documents a relationship between either numeracy or more general cognitive abilities and financial outcomes. Although these concepts are distinct from financial literacy, they tend to be positively correlated: individuals with higher general cognitive abilities or greater facility with numbers and numerical calculations tend to have higher levels of financial literacy ( Banks & Oldfield 2007 , Gerardi et al. 2010 ). Numeracy and more general cognitive ability predict stockholding ( Banks & Oldfield 2007 , Christelis et al. 2010 ), wealth accumulation ( Banks & Oldfield 2007 ), and portfolio allocation ( Grinblatt et al. 2009 ).

Although this evidence might lead one to conclude that financial education should be an effective mechanism to improve financial outcomes, the causality in these relationships is inherently difficult to pin down. Does financial literacy lead to better economic outcomes? Or does being engaged in certain types of economic behaviors lead to greater financial literacy? Or does some underlying third factor (e.g., numerical ability, general intelligence, interest in financial matters, patience) contribute to both higher levels of financial literacy and better financial outcomes? To give a more concrete example, individuals with higher levels of financial literacy might better recognize the financial benefits and be more inclined to enroll in a savings plan offered by their employer. On the other hand, if an employer automatically enrolls employees in the firm's saving plan, the employees may acquire some level of financial literacy simply by virtue of their savings plan participation. The finding noted earlier that most individuals cite personal experience as the most important source of their financial learning ( Hilgert et al. 2003 ) suggests that some element of reverse causality is likely. While this endogeneity does not rule out the possibility that financial literacy improves financial outcomes, it does make interpreting the magnitudes of the effects estimated in the literature difficult to interpret as they are almost surely upwardly biased in magnitude.

In addition, unobserved factors such as predisposition for patience or forward-looking behavior could contribute to both increased financial literacy and better financial outcomes. Meier & Sprenger (2010) find that those who voluntarily participate in financial education opportunities are more future-oriented. Hastings & Mitchell (2011) find that those who display patience in a field-experiment task are also more likely to invest in health and opt to save additional amounts for retirement in their mandatory pension accounts. Other unobserved factors like personality ( Borgans et al. 2008 ) or family background ( Cunha & Heckman 2007 , Cunha et al. 2010 ) could upwardly bias the observed relationship between financial education and financial behavior in non-experimental research.

Despite the challenges in pinning down causality, understanding causal mechanisms is necessary to make effective policy prescriptions. If the policy goal is increased financial literacy, then we need to know how individuals acquire financial literacy. How important is financial education? And how important is personal experience? And how do they interact? If, on the other hand, the goal is to improve financial outcomes for consumers, then we need to know if financial education improves financial outcomes (assuming it increases literacy) and we need to be able to weigh the cost effectiveness of financial education against other policy options that also impact financial outcomes.

What evidence is there that financial education actually increases financial literacy? The evidence is more limited and not as encouraging as one might expect. One empirical strategy has been to exploit cross sectional variation in the receipt of financial education. Studies using this approach have often found almost no relationship between financial education and individual performance on financial literacy tests. For example, Jumps$tart (2006) and Mandell (2008) document surprisingly little correlation between high school students’ financial knowledge levels and whether or not they have completed a financial education class. This empirical approach has obvious problems for making causal inferences: the students who take financial education courses in districts where such courses are voluntary are likely to be different from the students who choose not to take such courses, and the districts who make such courses mandatory for all students are likely to be different from the districts that have no such mandate. Nonetheless, the lack of any compelling evidence of a positive impact is surprising. Carpena et al. (2011) use a more convincing empirical methodology to get at the impact of financial education on financial literacy and financial outcomes. They evaluate a relatively large randomized financial education intervention in India and find that while financial education does not improve financial decisions that require numeracy, it does improve financial product awareness and individuals’ attitudes towards making financial decisions. There is definitely room in the literature for more research using credible empirical methodologies that examine whether, or in what contexts, financial education actually impacts financial literacy.

In the end, we are more interested in financial outcomes than financial knowledge per se. The literature on financial education and financial outcomes includes several studies with plausibly exogenous sources of variation in the receipt of financial education, ranging from small-scale field experiments to large-scale natural experiments. The evidence in these papers on whether financial education actually improves financial outcomes is best described as contradictory.

Several studies have looked toward natural experiments as a source of exogenous variation in who receives financial education. Skimmyhorn (2012) uses administrative data to evaluate the effects of a mandatory eight-hour financial literacy course rolled out by the U.S. military during 2007 and 2008 for all new Army enlisted personnel. Because the roll-out of the financial education program was staggered across different military bases, we can rule out time effects as a confounding factor in the results. He finds that soldiers who joined the Army just after the financial education course was implemented have participation rates in and average monthly contributions to the Federal Thrift Savings Plan (a 401(k)-like savings account) that are roughly double those of personnel who joined the Army just prior to the introduction of the financial education course. The effects are present throughout the savings distribution and persist for at least 2 years (the duration of the data). Using individually-matched credit data for a random subsample, he finds limited evidence of more widespread improved financial outcomes as measured by credit card balances, auto loan balances, unpaid debts, and adverse legal actions (foreclosures, liens, judgments and repossessions).

Bernheim et al. (2001) and Cole & Shastry (2012) examine another natural experiment which created variation in financial education exposure: the expansion over time and across states in high school financial education mandates. The first of these studies concludes that financial education mandates do have an impact on at least one measure of financial behavior: wealth accumulation. But Cole & Shastry (2012) , using a different data source and a more flexible empirical specification, 6 examine the same natural experiment and conclude that there is no effect of the state high school financial education mandates on wealth accumulation, but rather, that the state adoption of these mandates was correlated with economic growth which could have had an independent effect on savings and wealth accumulation.

In addition to examining natural experiments, researchers have also randomly assigned financial aid provision to evaluate the impact of financial education on financial outcomes. For example, Drexler et al. (2012) examine the impact of two different financial education programs targeted at micro-entrepreneurs in the Dominican Republic as part of a randomized controlled trial on the effects of financial education. Their sample of micro-entrepreneurs was randomized to be in either a control group or one of two treatment groups. Members of one treatment group participated in several sessions of more traditional, principles-based financial education; members of the other treatment group participated in several sessions of financial education oriented around simple financial management rules of thumb. The authors examine participants’ use of several different financial management practices approximately one year after the financial education courses were completed. Relative to the control group, the authors find no difference in the financial behaviors of the treatment group who received the principles-based financial education; they do find statistically significant and economically meaningful improvements in the financial behavior of the treatment group who participated in the rule-of-thumb oriented financial education course. The results of this study suggest that how financial education is structured could matter in whether it has meaningful effects at the end of the day, and might help explain why many other studies have found much weaker links between financial education and economic outcomes.

Gartner & Todd (2005) evaluate a randomized credit education plan for first-year college students but find no statistically significant differences between the control and treatment groups in their credit balances or timeliness of payments. Servon & Kaestner (2008) used random variation in a financial literacy training and technology assistance program find virtually no differences between the control and treatment groups in a variety of financial behaviors (having investments, having a credit card, banking online, saving money, financial planning, timely bill payment and others), though they suspect that the program was implemented imperfectly. In a small randomized field experiment, Collins (2010) evaluates a financial education program for low and moderate income families and finds improvements in self-reported knowledge and behaviors (increased savings and small improvements in credit scores twelve months later), but the sample studied suffers from non-random attrition. Finally, Choi et al. (2011) randomly assign some participants in a survey to an educational intervention designed to teach them about the value of the employer match in an employer sponsored savings plan. Using administrative data, they find statistically insignificant differences in future savings plan contributions between the treatment and the control group, even in the face of significant financial incentives for savings plan participation.

Additional non-experimental research using self-reported outcomes and potentially endogenous selection into financial education suggests a positive relationship between financial education and financial behavior. This positive relationship has been documented for credit counseling ( Staten 2006 ), retirement seminars ( Lusardi 2004 , Bernheim & Garrett 2003 ), optional high school programs ( Boyce & Danes 2004 ), more general financial literacy education ( Lusardi & Mitchell 2007 ), and in the military ( Bell et al. 2008 ; 2009 ).

Altogether, there remains substantial disagreement over the efficacy of financial education. While the most recent reviews and meta-analyses of the non-experimental evidence ( Collins et al. 2009 , Gale & Levine 2011 ) suggest that financial literacy can improve financial behavior, these reviews do not appear to fully discount non-experimental research and its limitations for causal inference. Of the few studies that exploit randomization or natural experiments, there is at best mixed evidence that financial education improves financial outcomes. The current literature is inadequate to draw conclusions about if and under what conditions financial education works. While there do not appear to be any negative effects of financial education other than increased expenditures, there are also almost no studies detailing the costs of financial education programs on small or large scales ( Coussens 2006 ), and few that causally identify their benefits towards improved financial outcomes.

To inform policy discussion, this literature needs additional large-scale randomized interventions designed to effectively identify causal effects. Randomized interventions coupled with measures of financial literacy could address the question of how best to measure financial literacy while also providing credible assessments of the effect of financial education on financial literacy and economic outcomes. A starting point could be incorporating experimental components into existing large scale surveys like the NFCS; for example, a subset of respondents could be randomized to participate in an on-line financial education course or to receive a take-home reference guide to making better financial decisions. Measuring financial literacy before and immediately after the short course would test if financial education improves various measures of financial literacy in the short-run. A subsequent follow-up survey linked to administrative data on financial outcomes (e.g., credit scores) would measure if short-run improvements in financial literacy last, and which measures of financial literacy, if any, are correlated with improved financial outcomes. Studies along these lines are needed to identify the causal effects of financial education on financial literacy and financial outcomes, identify the best measures of financial literacy, and inform policy makers about the costs and benefits of financial education as a means to improve financial outcomes.

5. WHAT IS THE ROLE OF PUBLIC POLICY IN IMPROVING INDIVIDUAL FINANCIAL OUTCOMES?

Given the current inconclusive evidence on the causal effects of financial education on either financial literacy or financial outcomes, there remains disagreement over whether financial education is the most appropriate policy tool for improving consumer financial outcomes. As expected, those who believe that financial education works favor more financial education ( Lusardi & Mitchell 2007 , Hogarth 2006 , Martin 2007 ). Others, optimistic about the promise of financial education despite what they view as weak empirical evidence of positive effects, support more targeted and timely education with greater emphasis on experimental design and evaluation ( Hathaway & Khatiwada 2008 , Collins & O'Rourke 2010 ). Finally, some who do not believe the research demonstrates positive effects support other policy options ( Willis 2008 ; 2009 ; 2011 ). In this section, we place financial education in the context of the broader research on alternative ways to improve financial outcomes.

5.1 Is There a Market Failure?

As economists, we start this section with the question of market failure: Is there a need for public policy in improving financial knowledge and financial outcomes, or can the market work efficiently without government intervention? If, like other forms of human capital, financial knowledge is costly to accumulate, there may be an optimal level of financial literacy acquisition that varies across individuals based on the expected need for financial expertise and individual preference parameters (e.g., discount rates). Jappelli & Padula (2011) and Lusardi et al. (2012) both use the relationship between financial literacy and wealth as their point of departure in modeling the endogenous accumulation of financial literacy. In both papers, investments in financial literacy have both costs (time and monetary resources) and benefits (access to better investment opportunities) which may be correlated with household education or initial endowments. In the model of Jappelli & Padula (2011) , the optimal stock of financial literacy increases with income, the discount factor (patience), the return to financial literacy, and the initial stock of financial literacy. 7 In the model of Lusardi et al. (2012) , more educated households have higher earnings trajectories than those with less education and also have stronger savings motives due to the progressivity built into the social safety net. Because they save more, they value better financial management technologies more than those with lower incomes, and they rationally acquire a higher level of financial literacy.

These models suggest that differences in financial literacy acquisition may be individually rational. Consistent with this supposition, Hsu (2011) uses data from the Cognitive Economics Survey which includes measures of financial literacy for a set of husbands and their wives to examine the determination of financial literacy in married couples. She finds that wives have a lower average level of financial literacy than their husbands (cf. the gender differences in Table 3 ), which she posits arise from a rational division of household labor with men being more likely to manage household finances. Women, however, have longer life expectancies than their husbands and many will eventually need to assume financial management responsibilities. She finds that women actually acquire increased financial literacy as they approach widowhood, with the majority catching up to their husbands prior to being widowed.

More generally, limited financial knowledge may be a rational outcome if other entities—a spouse, an employer, a financial advisor—can help individuals compensate for their deficiencies by providing information, advice, or financial management. We don't expect individuals to be experts in all other domains of life—that is the essence of comparative advantage. Specialization in financial expertise may be efficient if it allows computational and educational investment to be concentrated or aggregated in specialized individuals or entities that develop algorithms and methods to guide consumers through financial waters.

Although low levels of financial literacy acquisition may be individually rational in some models, limited financial knowledge may create externalities such as reduced competitive pressure in markets which leads to higher equilibrium prices ( Hastings et al. 2012 ), higher social safety net usage, lower quality of civic participation, and negative impacts on neighborhoods ( Campbell et al. 2011 ), children ( Figlio et al. 2011 ) and families. Such externalities may imply a role for government in facilitating improved financial decision making through financial education or other mechanisms.

Individuals may also be subject to biases such as present-bias that lead to lower investments in financial knowledge today but which imply ex post regret in the future (sometimes referred to as an “internality”). Barr et al. (2009) note that in some contexts, firms have incentives to help consumers overcome their fallibilities. For example, if present bias leads consumers to save too little, financial institutions whose profits are tied to assets under management have incentives reduce consumer bias and encourage individuals to save more. In other contexts, however, firms may have incentives to exploit cognitive biases and limited financial literacy. For example, if consumers misunderstand how interest compounds and as a consequence borrow too much ( Stango & Zinman 2009 ), financial institutions whose profits are tied to borrowing have little incentive to educate consumers in a way that would correct their misperceptions.

What evidence is there on whether markets help individuals compensate for their limited financial capabilities? Unfortunately, many firms exploit rather than offset consumer shortcomings. Ellison (2005) and Gabaix & Laibson (2006) develop models of add-on and hidden pricing to explain the ubiquitous pricing contracts observed in the banking, hotel, and retail internet sales industries. Both models have naïve and informed customers and show that for reasonable parameter values, firms do not have an incentive to debias naïve consumers even in a competitive market. This leads to equilibrium contracts with low advertised prices on a “salient” price and high hidden fees and add-ons which naïve customers pay and sophisticated customers take action to avoid.

Opaque and complicated fees are widespread, and several empirical papers link these fee structures to shortcomings in consumer optimization. Ausubel (1999) analyzes a large field experiment in which a credit card company randomized mail solicitations varying the interest rate and duration of the credit card's introductory offer. He finds that individuals are overly responsive to the terms of the introductory offer and appear to underestimate their likelihood of holding balances past the introductory offer period with a low interest rate. 8 In a similar vein, Ponce (2008) evaluates a field experiment in Mexico in which a bank randomized the introductory teaser rate offered to prospective customers. He finds that a lower teaser rates leads to substantially higher levels of debt, even several months after the teaser rate expires, and that the higher debt results from lower payments rather than higher purchases or cash advances. Evaluating non-randomized offers to potential customers, he shows that banks do not randomly assign teaser rates but dynamically price discriminate by targeting offers to consumers who are more likely to permanently increase their balances.

Given that many firms are trying to actively obfuscate prices, it should not be surprising that there is little evidence that firms act to debias consumers through informative advertising or investments in financial education. In models of add-on prices, firms can hide prices or make them salient. Similarly, firms can invest in advertising that lowers price sensitivity, focusing consumer choice on non-price attributes, or in advertising that increases price competition by alerting customers to lower prices. In models of informative advertising, firms reduce information costs and expand the market by informing consumers of their price and location in product space. In contrast, in models of persuasive advertising, firms emphasize certain product characteristics and deemphasize others to change consumer's expressed preferences. For example a financial firm could advertise returns for the last year rather than management fees to convince investors that they should primarily evaluate past returns when choosing a fund manager. A financially literate consumer may be unmoved by this advertising strategy, but those who are less literate might be persuaded and end up paying higher management fees.

Hastings et al. (2012) use administrative data on advertising and fund manager choices for account holders in Mexico's privatized pension system. When the privatized system started, the government presumed that firms would compete on price (management fees) and engage in informative advertising to explain fees to consumers and win their accounts. Instead, firms invested heavily in sales force and marketing, and the authors find that heavier exposure to sales force (appropriately instrumented) resulted in lower price sensitivity and higher brand loyalty. This in turn lowered demand elasticity (recall equation 2) and increased management fees in equilibrium.

Importantly, informative advertising itself may be a public good. For example, advertising that explains the value of savings to individuals can benefit both the firm that makes the investment and its competitors if it increases demand for savings products in general. On the other hand, persuasive advertising attempts to convince customers that one product is better than another so that the benefits accrue to the firm that is advertising. The market may underprovide informative advertising in equilibrium because of the inherent free rider problem. Hastings et al. (in progress) test this theory using a marketing field experiment with two large banks in the Philippines. They find evidence that if firms face advertising constraints, persuasive rather than informative advertising maximizes profits. This suggests a role for government to remedy underprovision of public goods. In particular, these results suggest that financial products firms would welcome a tax that would fund public financial education as it would expand the market (e.g., increase total savings) and commit each institution to contribute to the public good. Note in equilibrium this could change firms’ incentives for add-on pricing as well by lowering the fraction of naïve customers in financial products markets ( Gabaix & Laibson 2006 ).

Even if firms do not have incentives to facilitate efficient consumer outcomes, a competitive market may generate an intermediate sector providing advice and guidance. This sector could provide unbiased decision-making-assistance that would lower decision making costs and efficiently expand the market. However, classic principal-agent problems may make such an efficient intermediate market difficult to attain.

Two recent studies highlight the limits of the financial advice industry as incentive-compatible providers of guidance and counsel on financial products and financial decision making. Mullainathan et al. (2012) conduct an audit study of financial advisors in Boston, sending to them scripted investors who present needs that are either in line with or at odds with the financial advisor's personal interests (e.g., passively managed vs. actively managed funds). They find that many advisors act in their personal interests regardless of the client's actual needs and that they reinforce client biases (e.g., about the merits of employer stock) when it benefits them to do so. Similarly, Anagol et al. (2012) conduct an audit study of life insurance agents in India who are largely commission motivated. As in the previous study, scripted customers present themselves to the agents with differing amounts of financial and product knowledge. They find that life insurance agents recommend products with higher commissions even if the product is suboptimal for the customer. They also find that agents are likely to cater to customer's beliefs, even if those beliefs are incorrect. Finally, instead of debiasing less literate consumers, agents are less likely to give correct advice if the customer presents with a low degree of financial sophistication. Together these studies suggest that with asymmetric information, there is both a principal agent problem and an incentive for advisors to compete by reinforcing biases rather than providing truthful recommendations ( Gentzkow & Shapiro 2006 ; 2010 , Che et al. 2011 ).

Overall, this section suggests that are several potential roles for government in improving financial outcomes for consumers. First, government can help solve the public goods problems which result in underinvestment in financial education. Second, government can regulate the disclosure of fees and pricing. And third, government can provide unbiased information and advice.

5.2 The Scope for Government Intervention

If there is a role for government intervention, what form should it take? We have already summarized the literature on financial education. Briefly, there is at best conflicting evidence that financial education leads to improved economic outcomes either through increasing financial literacy directly or otherwise. So while the logical public policy response to many observers is to increase public support for financial education, this option may not be an efficient use of public resources even if it will likely do no harm. 9 In some contexts, other policy responses such as regulation may be more cost effective.

One regulatory alternative is to design policies that address biases and reduce the decision making costs that consumers face in financial product markets ( Thaler & Sunstein 2008 ). Because the financial literacy literature currently offers only limited models of behavior that give rise to the observed differences in financial literacy and economic outcomes, it is difficult to turn to this literature to design policies that address the underlying behaviors that lead to low levels of financial literacy and poor financial decision making. However, the literatures in behavioral economics and decision theory have developed several models that are relevant, and policies from this literature that address behavioral biases like present bias and choice overload may provide templates for effective and efficient remedies.

Several papers in this vein have already had substantial policy influence. For example, Madrian & Shea (2001) and Beshears et al. (2008) examine the impact of default rules on retirement savings outcomes. They find that participation in employer-sponsored savings plans is substantially higher when the default outcome is savings plan participation (automatic enrollment) relative to when the default is non-participation. Beshears et al. ascribe this finding to three factors. First, automatic enrollment simplifies the decision about whether or not to participate in the savings plan by divorcing the participation decision from related choices about contribution rates and asset allocation. Second, automatic enrollment directly addresses problems of present bias which may result in well-intentioned savers procrastinating their savings plan enrollment indefinitely. Finally, the automatic enrollment default may service as an endorsement (implicit advice) that individuals should be saving. In related research, Thaler & Benartzi (2004) find that automatic contribution escalation leads to substantially higher savings plan contribution rates over a period of four years. These results collectively motivated the adoption of provisions in the Pension Protection Act of 2006 that encourage U.S. employers to adopt automatic enrollment and automatic contribution escalation in their savings plan.

Hastings and co-authors ( Duarte & Hastings 2011 , Hastings et al. 2012 , Hastings, in progress) examine Mexico's experience in privatizing their social security system and draw lessons for policy design. Hastings et al. (2012) find that without regulation, advertising reduces investor sensitivity to financial management fees and increases investor focus on non-price attributes such as brand name and past returns. In simulations, they find that neutralizing the impact of advertising on preferences results in price-elastic demand. These results suggest that centralized information provision and regulation of both disclosure and advertising are important to ensure that individuals with limited financial capabilities have access to the information necessary for effective decision making and to minimize their confusion or persuasion by questionable advertising tactics.

In a related paper, Duarte & Hastings (2011) examine the impact of an information disclosure policy mandated in Mexico. In 2005 the government attempted to increase fee transparency in the privatized social security system by introducing a single fee index which collapsed multiple fees (loads and fees on assets under management) into one measure. Prior to the policy, investor behavior was inelastic to either type of fee or, indeed, any measure of management costs. In contrast, after the policy, demand was very responsive to the fee index. Once investors had a simple way to assess ‘price’, they shifted their investments to the funds with a low index value. This example suggests that investors can be greatly helped by policies that simplify fee structures and either advertise fees or require that they are disclosed in an easy-to-understand way. This example also highlights the potential pitfalls of ill-conceived regulations. Although the policy shifted demand, it had little impact on overall management costs. This is because the index combined fees according to a formula and firms could game the index by lowering one fee while raising another. Not surprisingly, firms optimized accordingly (another example of obfuscated pricing as discussed earlier). The government eventually responded by restricting asset managers to charging only one kind of fee, obviating the need for a fee index.

Hastings (in progress) evaluates two field experiments as part of a household survey (the 2010 EERA referenced in Table 2 ) to further understand the impact of information and incentives on management fund choice by affiliates of Mexico's privatized social security system. Households in the survey were randomly assigned to receive simplified information on fund manager net returns (the official information required by the social security system at the time) presented as either a personalized projected account balance or as an annual percentage rate. In addition to that treatment, households were randomly assigned to receive a small immediate cash incentive for transferring assets to any fund manager that had a better net return (or a higher projected personal balance). While those with lower financial literacy scores are better able to rank the fund managers correctly when presented with information on balance projections instead of APRs (replicating prior results in Hastings & Tejeda-Ashton 2008 , Hastings & Mitchell 2011 ), she finds no impact of this information on subsequent decisions to change fund managers. Rather, individuals who receive the small cash incentive are more likely to change fund managers (for the better) regardless of the type of information received. These preliminary results suggest that incentives that both address procrastination and that are tied to better behavior may be more effective than financial education as financial education does not carry with it any incentive to act. We note that these results are still short-run and preliminary as they are based on a follow-up survey. Final results will depend on administrative records for switching which are not subject to problems inherent in self-reports. 10

Campbell et al. (2011) lay out a useful framework for thinking about potential policy options to improve financial outcomes for consumers. They suggest that evaluating consumers along two dimensions, their preference heterogeneity and their level of financial sophistication (or, in the parlance of this paper, their financial literacy), may help narrow the set of appropriate policy levers for improving consumer financial outcomes. At one extreme, take the case of stored value cards, a product used by a large number of unsophisticated consumers and for which consumer preferences are relatively homogeneous. Campbell et al. propose that in this case, since everyone largely wants the same thing, consumers are probably best served through the application of strict rules. This is likely to be more efficient and cost effective than attempting to educate consumers in an environment in which firms are less stringently regulated. In contrast, if consumers are financially knowledgeable and have heterogeneous preferences other approaches may make more sense. Although Campbell et al. do not discuss financial education in this context, it would seem that financial education, to the extent that it impacts financial literacy and economic outcomes, is a tool that holds most promise in markets for products with some degree of preference heterogeneity and that require some degree of financial knowledge. At the other extreme, there are products like hedge funds that cater to individuals with tremendous preference heterogeneity and that require a sizeable amount of financial knowledge for effective use. The latter condition may seem like a perfect reason to justify financial education. We would counter, however, that in such a context it may be difficult for public policy to effectively intervene in providing the level of financial education that would be required. For products for which extensive expertise is required, it may be more efficient to restrict markets to those who can demonstrate the skills requisite for appropriate and effective use.

Overall, the literature suggests that there are many alternatives to financial education that can be used to improve financial outcomes for consumers: strict regulation, providing incentives for improved choice architecture, simplifying disclosure about product fees, terms, or characteristics, and providing incentives to take action. Although none of the studies that we reviewed here ran a horse race between these other approaches and financial education, many of them show larger effects than can be ascribed to financial education in the existing literature. Expanding these studies to other relevant markets such as credit card regulation, payday loan regulation, mortgages, and car or appliance loans present important next steps in understanding how best to improve consumer financial outcomes.

6. DIRECTIONS FOR FUTURE RESEARCH

In this paper, we have evaluated the literature on financial literacy, financial education, and consumer financial outcomes. This literature consistently finds that many individuals perform poorly on test-based measures of financial literacy. These findings, coupled with a growing literature on consumers’ financial mistakes and documenting a positive correlation between financial literacy and suboptimal financial outcomes, have driven policy interest in efforts to increase financial literacy through financial education. However, there is little consensus in the literature on the efficacy of financial education. The existing research is inadequate for drawing conclusions about if and under what conditions financial education works.

The directions for future research depend in part on the goal at hand. If the goal is to improve financial literacy, the directions for future research that follow hinge on financial literacy and the role of financial education in enhancing financial literacy.

One set of fundamental issues relate to capabilities. What are the basic financial competencies that individuals need? What financial decisions should we expect individuals to successfully make independently, and what decisions are best relegated to an expert? To draw an analogy, we don't expect individuals to be experts in all domains of life—that is the essence of comparative advantage. Most of us consult doctors when we are ill and mechanics when our cars are broken, but we are mostly able to care for a common cold and fill the car with gas and check our tire pressure independently. What level of financial literacy is necessary or desirable? And should certain financial transactions be predicated on demonstrating an adequate level of financial literacy, much like taking a driver's education course or passing a driver's education test is a prerequisite for getting a driver's license. If so, for what types of financial decisions would such a licensing approach make most sense?

Another set of open questions relate to measurement. How do we best measure financial literacy? Which measurement approaches work best at predicting financial outcomes? And what are the tradeoffs implicit in using different measures of financial literacy (e.g., how does the marginal cost compare to the marginal benefit of having a more effective measure?).

A third set of issues surrounds how individuals acquire financial literacy and the mechanisms that link financial literacy to financial outcomes. How important are skills like numeracy or general cognitive ability in determining financial literacy, and can those skills be taught? To the extent that financial literacy is acquired through experience, how do we limit the potential harm that consumers suffer in the process of learning by doing? Is financial education a substitute or a complement for personal experience?

We need much more causal research on financial education, particularly randomized controlled trials. Does financial education work, and if so, what types of financial education are most cost effective? Much of the literature on financial education focuses on traditional, classroom based courses. Is this the best way to deliver financial education? More generally, how does this approach compare with other alternatives? Is a course of a few hours length enough, or should we think more expansively about integrated approaches to financial education over the lifecycle? Or, on the other extreme, should financial education be episodic and narrowly focused to coincide with specific financial tasks? There are many other ways to deliver educational content that could improve financial decision making: internet-based instruction, podcasts, web sites, games, apps, printed material. How effective (and how cost effective) are these different delivery mechanisms, and are some better-suited to some groups of individuals or types of problems than others? Should the content of financial education initiatives be focused on teaching financial principles, or rules of thumb? In the randomized controlled trial of two different approaches to financial education for microenterprise owners in the Dominican Republic discussed earlier, Drexler et al. (2011) find that rule-of-thumb based financial education is more effective at improving financial practices than principles-based education. How robust is this finding? And to what extent can firms nullify rules-of-thumb through endogenous responses to consumer behavior (see Duarte & Hastings 2011 )?

Even if we can develop effective mechanisms to deliver financial education, how do we induce the people who most need financial education to get it? School-based financial education programs have the advantage that, while in school, students are a captive audience. But schools can only teach so much. Many of the financial decisions that individuals will face in their adult lives have little relevance to a 17-year-old high school student: purchasing life insurance, picking a fixed vs. an adjustable rate mortgage, choosing an asset allocation in a retirement savings account, whether to file for bankruptcy. How do we deliver financial education to adults before they make financial mistakes, or in ways that limit their financial mistakes, when we don't have a captive audience and financial education is only one of many things competing for time and attention?

Finally, what is the appropriate role of government in either directly providing or funding the private provision of financial education? If financial education is a public good (Hastings et al., in progress), would industry support a tax to finance publically-provided financial education? If so, what form would that take?

If instead of improving financial literacy our goal is to improve financial outcomes, then the directions for future research are slightly different. The overarching questions in this case center around the tools that are available to improve financial outcomes. This might include financial education, but it might also include better financial market regulation, different approaches to changing the institutional framework for individual and household financial decision making, or incentives for innovation to create products that improve financial outcomes.

With this broader frame, one important question on which we have little evidence is which tools are most cost effective at improving financial outcomes? For some outcomes, the most cost effective tool might be financial education, but for other outcomes, different approaches might work better. For example, financial education programs have had only modest success at increasing participation in and contributions to employer-sponsored savings plans; in contrast, automatic enrollment and automatic contribution escalation lead to dramatic increases in savings plan participation and contributions ( Madrian & Shea 2001 , Beshears et al. 2008 , Thaler & Benartzi 2004 ). Moreover, automatic enrollment and contribution escalation are less expensive to implement than financial education programs. What approaches to changing financial behavior generate the biggest bang for the buck, and how does financial education compare to other levers that can be used to change outcomes?

Despite the contradictory evidence on the effectiveness of financial education, financial literacy is in short supply and increasing the financial capabilities of the population is a desirable and socially beneficial goal. We believe that well designed and well executed financial education initiatives can have an effect. But to design cost effective financial education programs, we need better research on what does and does not work. We also should not lose sight of the larger goal—financial education is a tool, one of many, for improving financial outcomes. Financial education programs that don't improve financial outcomes can hardly be considered a success.

Unfortunately, we have little concrete evidence to provide answers. We have a pressing need for more and better research to inform the design of financial education interventions and to prioritize where financial education resources can be best spent. To achieve this, funding for financial education needs to be coupled with funding for evaluation, and the design and implementation of financial education interventions needs to be done in a way that facilitates rigorous evaluation.

Acknowledgments

We acknowledge financial support from the National Institute on Aging (grants R01-AG-032411-01, A2R01-AG-021650 and P01-AG-005842). We thank Daisy Sun for outstanding research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Institute on Aging, the National Bureau of Economic Research, or the authors’ home universities. For William Skimmyhorn, the views expressed herein are those of the author and do not reflect the position of the United States Military Academy, the Department of the Army, the Department of Defense, or the National Bureau of Economic Research. See the authors’ websites for lists of their outside activities. When citing this paper, please use the following: Hastings JS, Madrian BC, SkimmyhornWL. 2012. Financial Literacy, Financial Education and Economic Outcomes. Annual Review of Economics 5: Submitted. Doi: 10.1146/annurev-economics-082312-125807.

NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

Financial Literacy, Financial Education and Economic Outcomes Justine S. Hastings, Brigitte C. Madrian, and William L. Skimmyhorn NBER Working Paper No. 18412 September 2012 JEL No. C93,D14,D18,D91,G11,G28

1 See Dodd-Frank Wall Street Reform and Consumer Protection Act. H.R. 4173. Title X - Bureau of Consumer Financial Protection 2010, Section 1013. < http://www.gpo.gov/fdsys/pkg/BILLS-111hr4173enr/pdf/BILLS-111hr4173enr.pdf , accessed September 13, 2012>

2 By 2011, economic education had been incorporated into the K-12 educational standards of every state except Rhode Island, and personal finance was a component of the K-12 educational standards in all states except Alaska, California, New Mexico, Rhode Island, and the District of Columbia (Council for Economic Education, 2011).

3 See http://www.ja.org/about/about_history.shtml and http://www.councilforeconed.org/about/ .

4 The NFCS has three components, a national random-digit-dialed telephone survey, a state-by-state on-line survey, and a survey of U.S. military personnel and their spouses.

5 Based on author's calculations using TNE survey responses from 2012 linked to college loan taking data in Chile. See Hastings, Neilson and Zimmerman (in progress) for details on the survey and data.

6 Cole and Shastry (2010) are able to replicate the qualitative results of Bernheim, Garrett and Maki (2001) when using the same empirical specification even though they use a different source of data.

7 Financial literacy and savings are positively correlated in this model, although the relationship is not causal as both are endogenously determined.

8 See the Frontline documentary ”The Card Game” about how teaser rate policies were developed in response to customer service calls in which consumers were persistently overconfident in their ability to repay their debt.

9 See the discussion in Section 4. There is also a large literature in the economics of education documenting the fact that large increases in real spending per pupil in the United States has led to no measurable increase in knowledge as measured by ability to answer questions on standardized tests.

10 If the preliminary results hold, this policy is a very inexpensive alternative to financial education. Hastings notes that the immediate return (net of the incentive) on each incentivized offer from resorting of individuals across fund managers, before allowing firms to drop prices in response, results in $30 USD in expectation. Aggregated over 30 million account holders, this is a large savings even before allowing for secondary competitive effects, and in equilibrium it is virtually costless to implement.

RELATED RESOURCES

The following datasets with financial literacy questions that are referenced in this article are currently publically available.

2004 U.S. Health and Retirement Survey: http://hrsonline.isr.umich.edu/index.php?p=data

2010 U.S. Health and Retirement Survey: http://hrsonline.isr.umich.edu/index.php?p=data

2009 Rand American Life Panel Wellbeing 64: https://mmicdata.rand.org/alp/index.php?page=data&p=showsurvey&syid=64

2009 U.S. National Financial Capability Study: http://www.finrafoundation.org/programs/p123306

2009 Chilean Social Protection Survey (EPS): http://www.proteccionsocial.cl/index.asp

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