Does economic education influence the way people think and affect their political attitudes? The evidence as to whether it impacts on political party affiliations is unclear.[1] However, the overall trend shown up by surveys is that the more economic knowledge people have, the more their views on certain issues match those of university economists.

A priori, this relatively blurry picture is unsurprising since even prominent economists may contradict one another. One example of this is the way in which US professor Brad de Long is capable of disputing something as basic as the effects of government expenditure with his colleague Eugene Fama (here). Yet there are also issues which economists are fairly unanimous about. For instance, the view that, overall, protectionism harms the affected economies more than it benefits them.

On the basis of a number of surveys in the US, authors William Walstad and Ken Rebeck concluded that economic knowledge significantly changed certain assessments.[2] As compared to others, respondents with above-average economic knowledge were:

• More sceptical with regard to trade barriers
• More sceptical with regard to government intervention aimed at preventing price changes prompted by supply and demand
• More optimistic as regards the consequence of globalisation and technological change.

Another study compared opinions of teachers with those of journalists and economists on economic issues. The first result was: teachers answer more like journalists than like economists. This is reassuring – at least for the journalists. (One could, however, interpret this result in varying ways: a) the media influence teachers, b) journalists were influenced in school, or c) hardly anyone thinks like economists.)

Anyone who finds it difficult to come to terms with the first result may find comfort in the second: teachers who teach economics are somewhat closer to the interviewed economists. Another survey established that teachers with a degree in economics respond increasingly as economists do.[1]

A propos degrees – many of the surveys looked into the political views of economics students. More on that in the next blog article.

On behalf of the iconomix team

Michael Manz

[1] Cf. Walstad, W. (2005), What Works: A Review of Research on Outcomes and Effective Program Delivery in Precollege Economic Education, pp. 43–44.

[2] Cf. Walstad W., and K. Rebeck (2002), Assessing the economic knowledge and economic opinions of adults, The Quarterly Review of Economics and Finance (42), pp. 921–935.

Does economic education make you more egoistic? No education programme, as far as I am aware, has ever been launched with such a target. But the question – based on a subliminal fear – has in fact been researched. And the results show that even if economists did reveal above-average levels of egotism, this would hardly be due to their education, but possibly just to a selection effect. People who choose business or economics as their field of study may differ in attitude to those who opt for, say, chemistry or ethnology (picking just two other subjects at random).

Between 1998 and 2001, Swiss economists Bruno Frey and Stephan Meier studied the contribution patterns of over 28,000 students to two social funds at the University of Zurich.[1] One of these funds supported financially weak students, the other was for foreign students attending the University of Zurich. One can assume that these were worthy causes in the eyes of the students. The voluntary contributions amounted to CHF 7 and CHF 5 respectively per semester.

A first glance at the results shows that, at 62%, the contribution rate of economics students was indeed below the overall average of nearly 69%. This gap, however, already existed at the time of matriculation – prior to any exposure to teaching in their subject. Over the years at university, the contributions by business and economics students decreased further on average, but only among those who had chosen business administration as their main subject. Students of economics present a different picture. In fact, economics students at doctoral level, who no doubt had had a maximum of exposure to their subject, actually contributed more than the average, and increasingly so as they progressed.

So there is no indication of negative side effects from any alleged indoctrination. Frey and Meier have acquitted economics students due to lack of evidence. At least for the time being – until the next trial begins.

On behalf of the iconomix team

Michael Manz

[1] Frey, Bruno S., and Stephan Meier (2003), Are Political Economists Selfish and Indoctrinated? Evidence from a Natural Experiment, Economic Inquiry, 41 (3), pp. 448–462.

It cannot be denied that there are alternatives to economic education when it comes to everyday forms of assistance. One of these is called nudge, and is advocated by US authors Richard Thaler (economist) and Cass Sunstein (lawyer).[1] The idea is that, educated or not, people are inclined to be lazy and make mistakes. Therefore, regulations should be designed to ensure that although people are still free to choose in everyday situations, they will be gently nudged in the right direction. For instance, a school cafeteria should position healthy products towards the front. However, people who search can also find the unhealthy products.

Another example is the US study mentioned in an earlier blog article, which looks at employees who fail to collect an employer contribution amounting to up to 6% of their income, which they could easily apply for. In the questionnaire, the attention of some of the respondents was drawn to the amounts they were missing out on by not taking part in the pension fund scheme. Yet, some months later, virtually no change in their behaviour could be established. The authors therefore concluded that economic knowledge has little impact. However, in doing so, they failed to recognise a key distinction. Information is not knowledge and is most certainly not a decision-making tool.

By contrast, the following hypothesis does sound plausible. If these people had been faced not with an active decision to collect the employer contribution, but rather with an active decision to renounce it, the problem would have been solved without limiting their freedom of decision. This, precisely, is the nudge approach. Furthermore, the employer should offer a well-diversified investment fund as an alternative to the standard retirement plan. Those who wish to, however, may choose riskier placements for their money or stash it under the mattress. So far, so good. Yet, the practice of nudging also raises questions:

• How many complex decision-making situations can be designed in a way that allows people to be guided sensibly?
• Who decides which results are sensible? Lawyers? Ethicists? Politicians? Economists? Many a proposal is likely to make people shudder – although not all of them will be shuddering for the same reason ...
• Do the people making the rules really represent the interests of those affected?
• Does a nudging world not ultimately reduce freedom and – if everyone allows themselves to be nudged – innovation?

Certainly there is nothing to be said against rules that lead to the best possible results for all those who follow the path of least resistance. Yet, in my view, the nudging strategy faces limitations in many economic situations. Thus, in these cases, the argument in favour of a certain level of basic ‘equipment’ – including economic skills – remains plausible. This is particularly the case in a democracy, where people are even involved in making many of the rules themselves.

On behalf of the iconomix team

Michael Manz

[1] Cf. Thaler, Richard H., and Cass R. Sunstein (2009), Nudge – Improving Decisions About Health, Wealth, and Happiness, Penguin Books, ISBN: 978-0143115267.

People with insufficient financial know-how do not invest enough in stock markets. What sounds like a bad joke, given stock market events over the last two years or so, is actually a serious and relatively well-researched hypothesis on the effectiveness of economic education. Over the long term, the higher risks connected with shares should – according to the economic rule of thumb – be rewarded by higher returns than those on a bank account. It is well known that educated and affluent households are more likely to invest part of their wealth in shares.[1] If the rule of thumb cited above holds true, then this would make the gap between richer and poorer households even greater.

A study in the Netherlands suggests an additional role for financial know-how: people who are better at answering financial literacy questions invest more often in shares than other people with comparable wealth and an otherwise similar level of education. Using various estimation methods, the authors conclude that knowledge tends to drive investment, rather than vice versa.[2]

As already indicated, however, the studied education effect should be viewed critically. People who avoid shares do not make any obvious mistakes, since shares carry an inherent risk (large price movements). The hoped-for return is not guaranteed ...

The above chart is indeed a source of frustration for all 'rule-of-thumb disciples', and a gift to sceptics: between May 2007 and March 2009, the SPI (an index for exchange-traded Swiss shares) fell by more than 45%. This speaks for itself. Unless of course – and this is the drawback of charts like this, which can be manipulated – you select a different time period. Over a twenty-year time span, the chart looks like this (the time span from the previous chart is framed in red):

Despite a financial crisis of historic proportions, this share index has undergone a fourfold increase in the last twenty years. That corresponds to an annual return of over 7%. It seems economists have been lucky once again: the rule of thumb isn’t that ridiculous after all, at least not when investments are made cautiously and gradually and over a very long period of time.

There is another rule which is less disputed: when investing in shares, broad diversification can result in the same returns, yet at a lower risk. A study carried out in Sweden investigated how well people diversify.[1] It appears that households there suffer on average few losses as a result of poor diversification. Interestingly, a minority – a less well-educated one – could have yielded considerably better results thanks to diversification. The study did not look into the degree to which economic literacy had a role to play.

On behalf of the iconomix team

Michael Manz

[1] Cf. Campell, J. (2006), Household Finance, The Journal of Finance, 61, pp. 1553–1604.

[2] Cf. Lusardi, A., M. van Rooij and R. Alessie (2007), Financial Literacy and Stock Market Participation, NBER Working Paper 13565.

Would you pick up a 100-franc note off the street? An economist who holds the position that people are rational agents would not. They would assume that there must be a catch – wouldn’t someone have long since picked it up otherwise? A behavioural economist, meanwhile, would pick up the money. They would maintain that people sometimes act irrationally and could – for whatever reason – simply leave the money lying on the street.

But what does this have to do with economic education? The following examples illustrate how these two theories can apply to everyday situations. There are times when you should pick up the money off the street and there are times when it’s best to leave it be. In these two situations, an understanding of economics would be an asset.

Example 1: Researchers at Harvard and Yale carried out a survey among employees whose pension fund contributions were being supplemented by their company up to certain amount by between 25% and 100%[1]. To benefit from this offer, employees just need to invest an hour or so of their time. Staff members over the age of 60 can withdraw the money as soon as they have claimed their company’s contribution. For them, it is a win-win situation if they have paid in up to the limit. Nevertheless, depending on the company, 20–60% of employees do not make use of the offer and miss out on up to 6% of their annual salary every year.

This is astonishing. A person with an annual salary of USD 50,000 who does not complete the form in order to receive an additional USD 3,000 is presumably making a big mistake. According to the study, those who missed out on this opportunity were mostly people with insufficient financial knowledge.

Example 2: Imagine you want to buy a digital camera online. Take for instance a Canon EOS 50D (this is an example, not a recommendation!). According to comparis.ch, the price currently ranges from CHF 1,150 to CHF 1,450. What is even more astounding is that, some months ago, one particular supplier in the United States was offering the camera for USD 429 as opposed to the recommended retail price of USD 1,299. How can that be possible? Differences in price are not unknown when consumers are unfamiliar with the market or pay more for established suppliers. But when an offer like this appears in a competitive market, your economic instinct should tell you that something can’t be right.

As it happens, this particular supplier no longer exists. And it goes without saying of course that you would have never received the camera for USD 429. Instead, you would have probably also had to buy overpriced batteries, unnecessary guarantees, and so on, until the difference in price had been made up, otherwise the camera would have simply been ‘out of stock’. This well-known strategy is referred to as bait and switch and is evidently very worthwhile for the supplier.[2]

The bottom line is this: if you are in a position to make a decision, you could also make the wrong decision, such as missing out on profitable offers or falling for unprofitable ones. Being economically literate is therefore quite useful in everyday life. But there are alternatives. More on that coming soon.

On behalf of the iconomix team

Michael Manz

[1] Choi, J., D. Laibson and B. Madrian (2007), $100 Bills on the Sidewalk: Suboptimal Investment in 401(K) Plans, NBER Working Paper 11554.

[2] The supplier, cameragiants, is apparently already back in operation under a number of different names (here).

One of the main factors behind the financial crisis is a lack of economic know-how, according to many observers – among them the renowned economist Robert Shiller. In a recent column (How About a Stimulus for Financial Advice?), he therefore calls for more resources to be devoted to financial education. Leaving aside the fact that higher spending doesn’t necessarily mean greater knowledge, the question of the effectiveness of economic education in terms of the influence on financial crises is indeed an interesting one.

The fact is, many borrowers, especially in the US, were granted mortgages that they could ill afford. According to a US report, in 2005, 43% of all first-time homeowners bought their house with no down payment. It is more difficult to quantify the extent to which the current mess is linked to economic education. A number of recent studies have shown that:

• Borrowers know alarmingly little about their mortgages and the consequences of interest rate changes[1]
• People who are less financially literate get into greater debt[2]
• Homeowners who receive (independent) advice are less likely to get into repayment problems[3]

People with more financial know-how appear to be more cautious borrowers. One could speculate further that this kind of behaviour would probably have defused the US mortgage crisis. On the whole, however, astonishingly little research has so far been done on this link.

The call for more education is not uncontroversial. The current crisis had a number of causes, including inappropriate incentive schemes, mismanagement and political influence (although this could also be combined with economic competence). Moreover, doubts exist as to the potential of more education. After all, does anyone understand today’s complex financial products? Certainly, some high-flying banking specialists don’t seem to ...

But this last question, in my opinion, misses the point. This is not about understanding complex products, but rather about grasping elementary principles. It’s about knowing, for example, that it is risky to buy a house if you have no equity and are on a low income – regardless of how sophisticated the loan product may be. Or about the fact that, just because prices rose in previous years, this does not guarantee that they will continue to do so in the future.

On behalf of the iconomix team

Michael Manz

[1] Last year, the Federal Reserve Bank of Boston asked 350 homeowners about, among other things, the details of their mortgage. This was rather devious, since the bank already had the answers from centralised data sources – but the owners apparently didn’t. For instance, 30% of borrowers with a variable rate mortgage thought that their interest was actually fixed rate.

[2] Cf. Lusardi, A., and P. Tufano (2008), Debt Literacy, Financial Experience and Overindebtedness, Working Paper.

[3] For more information, cf. Martin, M. (2007), A Literature Review on the Effectiveness of Financial Education, Working Paper 07-03, Federal Reserve Bank of Richmond.

Does education in the financial field improve financial planning or, more specifically, does it lead to greater savings? This is the most widely examined question concerning the effectiveness of economic education on actual behaviour. Most likely, this is because the desired effect (savings) is relatively easy to measure. Moreover, the question is quite a burning issue in the United States, which is not exactly a nation of savers.

In fact, studies undertaken by the economist and financial literacy expert Annamaria Lusardi show that those who concern themselves with financial planning and, therefore, behave in a more ‘educated’ way will have considerably more savings by the age of 50 or so. One possible reason for this is that, quite simply, those who plan are also those who earn more. Yet research suggests that the average savings of ‘planners’ exceed the savings of ‘non-planners’ by 20%, even if the effects of income, education, age, etc. are neutralised. Other studies show a positive correlation between financial knowledge and planning and savings.[1]

There are plausible reasons for this. Financial knowledge helps per se as it heightens a person’s awareness of the subject. Furthermore, those who are less knowledgeable in economic matters tend to underestimate the effect of interest rates. In one of Lusardi’s surveys, participants (around the age of 50) were asked the following question:

“You have USD 200 in your savings account. The annual interest rate is 10%. How much money will be in your account in two years?”

 

Only 18% of the answers were correct. Yet the answer is so simple: 10% of 200 = 20. So: 200 + 2x20 = 240. Or have I missed something?[2]

So far, so good. But the question remains – does it really make sense to save more? Certainly not at every age or in every situation. Those who expect that they will spend more later on in life than they’ll earn should save beforehand, at a stage when things are going well for them. But at some point in time, it is also okay to spend one’s earnings, or else it will ‘only’ be the heirs who benefit – and even they will benefit only if they choose not to keep saving. What does make sense, therefore, is deliberate, long-term financial planning.

Moreover, in the current economic situation, there is no doubt that the US, in particular, would be better off if its population (and government) had saved more in the past. And this leads us to the financial crisis. But more on that later.

On behalf of the iconomix team

Michael Manz

[1] For a survey of these studies, cf. Lusardi, Annamaria (2008), Household Saving Behavior: The Role of Financial Literacy, Information, and Financial Education Programs, NBER Working Paper 13824.

[2] This was the most common answer. Many participants failed to take compound interest into account, however. For the correct answer, one also has to add 10% of 20.

Countless individuals, organisations and institutions are involved in economic education around the world. But what for? What are the potential benefits? Those who consider education a basic human right or a good in itself may find these questions unnecessary. We’re not denying that education per se is something beneficial (and we will, if necessary, be glad to come back to this matter ...). However, since economists always ask about marginal utility and marginal cost, it would be unfair to shield one’s own discipline from this question. So I would like to take up and explore the issue in a small blog series.

There are various desired – or feared – consequences of economic education that have been scientifically researched in a more or less systematic manner.[1] Most existing studies deal with the impact of financial education, a specific sub-section of economic education. As a first, rough conclusion, the majority of these studies can be said to have found the hoped-for impact, but research in this matter is still at an early stage and numerous unanswered questions remain (cf. chart below).

An initial question could be whether any one specific measure (e.g. teaching with iconomix) actually changes the learner’s state of knowledge. Naturally, this is a question we want to pursue. So let’s bravely assume that individual knowledge or a broadly defined set of skills are in fact influenced by educational activities. This leads to the equally interesting question of whether the change in knowledge causes any change in the individual’s behaviour. And does this then have consequences at social and macroeconomic levels?

The following possible effects of economic education on the behaviour of individuals have been discussed and partly researched in economic literature:

• More circumspect financial and risk-related conduct (saving, debt, financial planning, investment decisions, etc.)
• More discerning attitude as a consumer
• Impact on everyday decisions
• Impact on political views
• Impact on professional career and income
• Impact on social and cooperative behaviour

The relevant literature and prominent supporters of economic education have also suggested possible (positive) effects at macroeconomic level (although empirical data is relatively limited):

• More innovation and efficiency in the financial and consumer good markets
• Greater financial stability
• Smoother implementation of monetary policy
• Higher savings rate (more capital accumulation)
• Impact on economic policy

The individual questions raised here will be discussed in greater detail in the blog. And the list of questions is by no means exhaustive. Additions and feedback are always welcome!

On behalf of the iconomix team

Michael Manz

[1] Cf. also Watts, Michael (2005), What Works: A Review of Research on Outcomes and Effective Program Delivery in Precollege Economic Education.