Better financial knowledge for better social policies

Elsa Fornero is Professor of Economics at the University of Torino, Italy, and former Minister of Labour, Social Policies and Gender Equality in Italy. She is a member of the Research Committee of the OECD International Network on Financial Education. Anna Lo Prete is Assistant Professor of Economics at the University of Torino, Italy

Structural economic reforms – such as labour market and pension reforms – typically imply sacrifices today in exchange for benefits tomorrow. As such, they can be viewed as “social investments”. The popular view, however, is that they represent a bitter medicine against an ill-defined disease. Politically, this makes reforms difficult to introduce because of electorate discontent. The plain-spoken President of the European Commission, Jean-Claude Juncker, summarised it well when he was in his former role of Prime Minister of Luxembourg: “We all know what to do; what we don’t know is how to get re-elected after we’ve done it.” But this rather cynical view may be wrong. People will not necessarily vote out a politician who takes painful steps if they understand the necessity of a reform.

Electorate awareness of what is involved in a reform could be an important determinant of its electoral cost and future viability. This is another reason to champion financial literacy. If people understand the need for reforms, they will not see them as a punishment (as is often the case with so-called “austerity” measures) that then translates into dissent at the polls. The policy implications are significant: instead of trying to convince people that the implementation of reforms will change nothing for them, financial education programmes can be a means for involving citizens in social change, making people less prone to populist solutions and reforms more effective.

Our recent work “Voting in the aftermath of a pension reform: the role of economic-financial literacy” tests this hypothesis in 21 advanced countries over the 20 years from 1990 to 2010. The study shows that painful reforms take less of a toll on the politicians who introduce them in countries with higher financial literacy scores. This time period has seen pension expenditures and demographic pressures challenge public debt sustainability and almost all developed countries have chosen to introduce major pension reforms. Pensions are a relevant topic for everyone and reforms that imply the downsizing of past promises can generate resentment and opposition. Still, it is reasonable to hope that people who understand why a reform may be needed, for example, because the current system is both unsustainable and unfair for future generations, may be less opposed to its introduction. The often complex nature of pension reforms, however, requires some basic financial knowledge, such as the notions of accumulation, compound interest, debt and risk diversification.

The study shows that the change in the probability of a head of government being re-elected caused by the enactment of a pension reform ranges between minus 51 and plus 84 percentage points for countries with the lowest and the highest levels of financial literacy, respectively. This means that the electoral gains from investing in financial literacy could be sizable. The study also reveals that these results do not hold when less specific indicators of education, such as school attainment, are used. This suggests that the knowledge of basic economic and financial concepts has distinctive features that can help explain government re-election probabilities in the aftermath of pension reforms.

Of course, financial literacy is not a sufficient condition for the success of reforms per se. But it is potentially a key element in the relationship between citizens and politicians that could become a viable alternative to concealing any eventual badly-perceived short-term consequences of reforms. Indeed, if a reform is needed and citizens understand why, they should be less opposed to its introduction. If, however, a reform is destined to result in differentiations and privileges, more financially literate citizens would be better-placed to oppose the reform, and rightly so.

The effects of financial literacy go beyond the individual and also impact policy. Government policy could indirectly generate long-term support for virtuous reforms and more effective citizenship by promoting specific financial education programmes for adults in parallel with basic financial education in schools.

 

References and links

Elsa Fornero, Anna Lo Prete, “Voting in the aftermath of a pension reform: the role of economic-financial literacy”, CeRP WP 171/17. (Forthcoming in the Journal of Pension Economics and Finance).

5th OECD-GFLEC Global Policy Research Symposium to Advance Financial Literacy “Effective financial education for sustainable and inclusive growth

OECD Pensions Outlook

OECD Pensions at a Glance

OECD work on financial education

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