Uses of illiteracy

The level of financial literacy in the UK, says Atul Shah, is "shockingly low". I wonder to what extent this can, for practical purposes, be corrected.

What I mean is that there's a big difference between knowing something and acting on it. We all know that if you consume more calories than you burn up, you'll get fatter. But this doesn't prevent obesity. In the same way, mere brain-knowledge about financial literacy might not prevent people making bad financial decisions. There are (at least) four reasons for this:

 - Desperation. Even if you know that an APR of 4000% is a lousy deal, you might also know that your kids need new shoes. Guess which fact wins.

 - The media. If the business and finance sections of the papers were literate and honest, they'd say: "we don't know much about the future, so stick some of your money into equity tracker funds and get on with your life." They don't say this because they must sell adverts and wrap some text around those adverts - and high-cost actively-managed funds are more likely to advertise than trackers.  More generally, TV adverts - and even the programmes themselves - encourage us to spend more and get into debt.

 - Other pressures.When we feel low, we're apt to spend and borrow more. And we're also prone to spend more if our neighbours do so.

 - Cognitive biases. Even financially literate investors over-invest in expensive but poor-performing actively managed funds because of overconfidence or because an anchoring effect causes them to underestimate how horribly fees compound over time.

For these reasons, financial literacy itself is not enough. What matters is not just financial planning but character planning. Just as we keep our weight down by getting into habits of exercise and healthy eating, so we stay financially healthy by having the habit of spending less than we earn.

Which brings me to a problem. This would not be in the interests of capital.

The simple maths of profits tells us this. Companies - in aggregate - can cope with high wages if those wages are returned to them in the form of consumer spending. If, however, wages are saved they become a net cost and, ceteris paribus, a threat to profits. It's no accident that the crisis of profitability in the 1970s coincided with a high personal savings ratio.

So, not only is financial literacy difficult to operationalize, it is also bad for capitalism not just because it deprives some firms of mug punters, but because it is a systemic danger to profits. 

Comments

[Stevenclarkesblog.wordpress.com]

You say consumers getting themselves into too much debt is in the interests of capitalism. Isn't a large part of the recent financial crisis due to bad lending?

In which case, don't capitalists need character planning? Don't over-extend credit for short term profits if it means the entire economy is gonna blow up in the medium term? (leaving aside that they may get bailed out when that happens!)

[Luis Enrique]

I expect I am going to get shit for suggesting there is any link between savings and investment, but nonetheless doesn't your simple maths of profits actually say that if increased saving is the counterpart of increased investment, profits are just fine?

[chris]

@ Steve - not really. Banks collapsed for several reasons, but a buildup of bad consumer debt wasn't one of them.
@ Luis - this is the old Keynesian point; the decision to save does not mean a decision to invest in the sense of buying new capital goods; the cash not spent might merely lie on deposit.

[Stevenclarkesblog.wordpress.com]

If savings did increase, and consumption declined, then given the investment dearth, wouldn't government deficits have to increase?

Maybe financial illiteracy is a cunning deficit reduction strategy.

[Socialism In One Bedroom]

Another interesting and informative perspective, if not a clearly Marxist one. But, hey, that isn't a crime!

But tell me there is more to financial literacy than spending within your means?

[Luke]

If I stick £x a month into an index fund, am I saving or investing? And, if it's a different question, is that money being saved or invested?

[Andy]

That's an interesting question from Luke.
I don't think the money is being invested as the companies within the index fund aren't really seeing any of that money.
I doubt that it is being saved either as market declines can decimate the value of your money.
I think the money is simply being gambled.
I only think money is invested if you lend or invest directly during the capital raising window of the firm or Government.
Happy to be corrected.

[An Alien Visitor]

It is an interesting question from Luke, surely is you save money and put it in the banks or in a fund then you are at least loaning money to companies or individuals, investing in shares etc. Isn't there a fund that is set up to help struggling businesses keep afloat?

Whether you call it investment, loaning or saving, money that is saved is used by business in one way or another. Unless it sits under the mattress.

[Luke]

Andy, AAV, thanks. I think speculated sounds better.

[JohnM]

¨If I stick £x a month into an index fund, am I saving or investing? And, if it's a different question, is that money being saved or invested¨

If the value neither increases not decreases, it´s being saved.
If the value increases and the money is put to good use, it is being invested.
If the value increases, but the money is used for speculation and not investment, then it is probably being wasted!