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March 16, 2020

Can financial education help workers save for retirement?

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Workers are faced with complex financial decisions these days. One of the key financial decisions they repeatedly need to make is to save for retirement. In many OECD countries, employers have become disengaged when it comes to building their workers’ nest eggs for retirement. Workers need to decide how much to save but also how to allocate these savings across a complex set of products. Yet, levels of financial literacy, basic skills to make these decisions, are very low and a significant fraction of workers are probably not saving enough for their old age. This has major consequences for old-age safety nets and for anyone who cares about the well-being of the elderly. Policymakers are scratching their heads to come up with cost-effective solutions to these problems.  

But evaluating these solutions is hard. For most economists, the biggest roadblock is that there is no easy way to measure better choices when it comes to saving. Saving more is not always a better choice. For example, in some OECD countries low earners may have after-tax income in retirement which is equal to or even higher than when they were working. An intervention that increases saving among these workers would be cost-effective, if saving more is what we define as effectiveness, but most would argue that the intervention was misguided and had little value or was even harmful.

Proposed solutions are plenty but boil down to two lines of attack which are often opposed but are in fact complementary. First, we can change the way we make workers choose, to nudge them in some good direction. Second, we can educate workers so they make better choices. 

Nudging, for example, by making workers save by default (with an option to opt-out) instead of the default being not saving (with an option to opt-in), dramatically increases enrollment (and saving) due to inertia. These trivial changes in decision frames typically raise saving (at least in the short term) but do not necessarily lead to better choices. What makes nudges potentially superior to a mandate (forcing people to save) is the presence of an opt-out provision. But only a financially literate worker is able to recognize a bad default option. The bottom line is that higher levels of financial literacy may be necessary for nudges to nudge for good if saving needs are unobserved or badly approximated by designers of the savings mechanisms.
 
But can we raise financial literacy so that we can nudge for good? Earlier evidence points to limited effectiveness, in particular when measuring effectiveness by additional saving; but recent financial education interventions tend to deliver better choices with limited costs. For the same reasons that nudging may fail in the absence of financial literacy, financial education may also appear to fail when workers do not save more following an intervention that offers financial education. Saving needs are different across workers, and it is possible for an intervention to be successful yet raise saving only for certain workers. Overall, research has shown that financial literacy may be an important mechanism in explaining wealth inequality. Interventions that are targeted early at basic skills, for example in schools, may yield important long-term benefits, while interventions that focus on retirement savings may be more effective later.

© Pierre-Carl Michaud

Read Pierre-Carl Michaud's IZA World of Labor article “The value of financial literacy and financial education for workers

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