Count the Errors
It seems that numeracy is the next big idea because important people, whoever they are, have suddenly woken up to the fact that having a workforce that needs to understand linear regression, but which actually can’t count the number of shoes it needs to find in the morning, is probably going to be a drawback in a world where math is increasingly going to differentiate the haves from the have-nots. Although the have-nots won’t be able to figure this out, other than they’ll notice that other people aren’t stacking shelves and flipping burgers for a living.
The solution to this, obviously, is to improve numeracy skills to make sure people can do enough maths to get through the average day. Unfortunately while this may help them not get ripped off by their next waiter and ensure that they can check they’ve got all their children with them at home-time, it’s quite likely that it won’t be anywhere enough to help them make the important financial decisions being required of them.
Roll Your Own Finances
In an excellent recent paper, Numeracy, Financial Literacy and Financial Decision Making, Annamaria Lusardi powerfully makes the case for why people need better math skills:
“Prior to the 1980s, many Americans relied mainly on Social Security and employer-sponsored defined benefit (DB) pension plans. Today, by contrast, Baby Boomers are increasingly turning to defined contribution (DC) plans and Individual Retirement Accounts (IRAs) to help finance their retirement years … individuals will increasingly be called to “roll their own” retirement saving and decumulation plans, and their retirement security will depend ever more on their own decisions and behavior.”
This increased self-reliance for financial decision making is mirrored in other areas, such as the widespread ability of individuals to choose how much money to borrow and on what terms. In general the state, and lenders, are increasingly putting the onus on individuals to make their own financial decisions.
Unfortunately, as Lusardi shows, the actual ability of people to figure out relatively simple financial problems is very low. Only 18% of American respondents could answer this correctly:
“Let’s say you have 200 dollars in a savings account. The account earns 10 percent interest per year. How much would you have in the account at the end of two years?”
And only 11% of Britons could answer this and four other, simpler questions. These findings generalise across the world, and it seems that the idea of compound interest is a real puzzler for a lot of people. Lusardi also points to research indicating that financial numeracy is linked to behaviors associated with important financial decisions, like planning for retirement or choosing to invest in the stockmarket – although whether that latter decision is a good one or not is open to question, as we saw in Do Stocks Always Outperform (in the Long Run)? Unsurprisingly her conclusion is that improving numeracy is critical to improving people’s financial decision making.
With which I have no problem – it’s clearly true that having a basic grasp of maths is going to help people make better decisions. However, the idea that this is all that’s required – which isn’t one that Lusardi explicitly makes but is one the uninitiated might conclude from this, is simply wrong.
The Tyranny of Choice
There are at least two reasons why this is the case. The first is our old friend cognitive bias, compromising investor decision making, and the second is the paradox of choice, Barry Schwartz’s idea that too many options are both depressing and likely to lead to worse decision making. As Schwartz points out about people who are maximisers, as opposed to satisficers (see: Satisficing Stockpicking), always looking for the best option:
“Naturally, no one can check out every option, but maximizers strive toward that goal, and so making a decision becomes increasingly daunting as the number of choices rises. Worse, after making a selection, they are nagged by the alternatives they have not had time to investigate. In the end, they are more likely to make better objective choices than satisficers but get less satisfaction from them.”
Essentially the more choice that was offered, the harder it was to for maximisers to make a proper decision; in fact we can surmise that being numerate actually made it more difficult to make a decision, because it increases the volume of data to be crunched. As Schwartz points out, this tends to lead to unhappiness through the interaction of choice with a few of our favorite behavioral biases: regret, loss aversion and framing. Which, of course, these are prime targets for organisations trying to sell financial services.
The foremost skeptic of the idea that financial education will solve all our problems and allow the free market ideal of more and more choice free reign has been Lauren Willis, whose work we looked at in Freedom of Financial Choice is a Myth. In her latest paper on the subject – The Financial Education Fallacy – she returns to the fray:
“Apparently the logic is that ordinary consumers would have made better mortgage choices and would have accumulated sufficient precautionary savings to weather the recession if they had received financial education. Objective observers generally admit that research to date does not demonstrate a causal chain from financial education to higher financial literacy, to better financial behavior, to improved financial outcomes in part due to biases, heuristics, and other nonrational influences on financial decisions. Yet the search for effective financial education continues."
Underlying the argument in favour of financial education as the solution to all of our problems is the idea that it’s the only really politically acceptable solution. The alternative is coercion and on the few occasions its been tried it’s failed because it’s a hard solution to accept in a liberal democracy. However, de-biasing people without coercion is likely to be hard, as it’s attacking some of our most central beliefs about ourselves.
Make 'Em Pay
In any case, Willis points out that if we’re not willing to pay for an education system that produces people capable of doing simple math we’re not going to fork out more for even more complex training. Politically, improving numeracy to the level necessary to support proper financial decision making is going to be pretty darn difficult.
She suggests that there might be another way of funding this, other than requiring taxpayers to dig deeper into increasingly shallow pockets. There are already financial education programs funded by the financial industry, even though these tend to make consumers less profitable for them. Of course, corporations are generally amoral, vicious maximisers (see: Frankenstein's Corporations) so the reason they do this is simple self-interest:
“Firms fear the other forms of regulation they believe they would face if they could not point to financial education as the cure for consumer financial woes. But if the inefficacy of current programs were known and the costs of effective financial education were truly understood, other forms of regulation would move to the fore.”
Nothing moves the financial industry like the spectre of more regulation. Financing adult numeracy programs might be a better alternative to an expensive rearguard action against lawmakers: it would be good PR for an industry sorely in need of some positive spin and it would see financial firms giving something back for a change.
Basic numeracy is certainly something that needs to be improved, but on it's own it won’t make a heap of difference to the real and complex financial decisions that are increasingly being devolved to individuals. Finding a way of funding the complex training that is really required would be a starting point; simultaneously introducing a simple quality mark scheme for a set of low-cost vanilla products would help reduce the tyranny of choice. Doing nothing is not an option. Well, not unless we really, really want another behaviorally induced recession really, really soon?
- Freedom of Financial Choice is a Myth
- Financial Education Doesn't Work
- Jam Today, Tyranny Tomorrow?
- Monty Hall Economics
- What's Your Financial IQ?
- Save More ... Tomorrow?
- Intelligence Can Seriously Damage Your Wealth
- Do Stocks Always Outperform (in the Long Run)?
- Satisficing Stockpicking
- Frankenstein's Corporations