Financial literacy and behavioral economics


Diwa C. Guinigundo

In the last quarter of 2019, this column discussed in three parts the whys and wherefores of financial literacy. We were inspired by the earlier discussions during the first Asia Pacific Financial Education Institute organized by our friend Dave Fernandez, director of Singapore Management University’s Sim Kee Boon Institute for Financial Economics, where I serve as member of its Advisory Board.

The key takeaway from those discussions is that financial literacy is relevant in making economic growth more sustainable by addressing income inequality and poverty. Borrowing the analogy used by Annamaria Lusardi of Italy’s Financial Education Committee and George Washington University, financial literacy is the water in the ecosystem of the real economy and the financial system.

The next question is whether going through one financial literacy program or another would result in a person’s change of behavior about money, saving, and investment. Looking into the empirical evidence has brought meto an exciting journey into behavioral economics.

The works of Richard H. Thaler, Cass R. Sunstein, Robert J. Schiller, Daniel Kahneman, and Amos Tversky provided me some useful perspective in analyzing human behavior apart from those predicted by traditional economics. Responses to public issues of scarcity and choice do not lend themselves easily to what one would normally expect of rational economic agent.

Their arguments make sense, especially those of Thaler and Sunstein concerning our biases and blunders, following the herd and naïve investing. Their proposals on saving the planet and privatizing marriage are quite unorthodox.

But we also recognize former Bank of England Governor Mervyn King’s reservation because of the assumption of behavioral economists that “people are intrinsically irrational.” This could actually lead to the view that governments should take action to correct those biases in individual decisions or to “nudge” them towards what he called optimal outcomes. To King, it is difficult to assert that governments are more rational than their constituents. In short, King argues it is no more than a case of economic agents trying to cope with a more challenging environment.

This is where we are coming from when we received a copy of Rose Fres Fausto’s book. The obverse cover page is entitled Why Financial Education Alone Does Not Work (a crash course in Behavioral Economics) while the reverse cover page says The Psychology of Money.

I am not acquainted with Rose but with her sister Maria L. M. Fres-Felix who used to be a colleague at the then Central Bank of the Philippines. After working with Kuala Lumpur-based SEACEN (South-East Asian Central Banks) Research and Training Center, Maria moved on to the Philippine Deposit Insurance Corporation.

But it looks like writing runs in the Fres family. Maria, whom we also call Dada, is also an economist from Williams College and is an accomplished fiction writer having produced several books of stories, winning not a few Palanca Literary Awards, Philippine Free Press, and even the Grand Prize in the Pilar Perez Medallion Literary Award.

What caught my attention in Rose’s book is my friend Dr. Fernando ”Nandy” T. Aldaba’s foreword. Since Nandy is the dean and professor of economics at the Ateneo de Manila, Rose’s book must be serious stuff in economics. It was actually a refreshing read because all the serious stuff in economics and finance were re-framed in mass language. In Nandy’s word: “Rose has a special gift for simplifying difficult and complex concepts by using real-life models and examples.”

Like Dada, Rose is also an honor graduate of economics from the Ateneo and was an investment banker for many years. She was virtually hooked on behavioral economics starting 2010 upon reading Dan Ariely’s Predictably Irrational. Her list extended to Thaler and Sunstein, Kahneman, Tversky, Schiller, Gary Belsky, and many others after devouring their works and taking up online courses.

Page 50 shows Rose and her husband Marvin V. Fausto with the father of behavioral economics Richard Thaler of the University of Chicago Boot School of Business. In jest, Thaler “bestowed” on Rose the title “the first Filipino behavioral economist.” He had only one advice to Rose: ”the most important thing is to get to work.”

And Rose worked hard. Marvin must have been the inspiring force whom she referred to as “my favorite person in the world” who loves and supports her with all his heart, prefrontal cortex and limbic system. Marvin is the founding president of the Fund Managers Association of the Philippines who now heads the COL Investment Management, Inc.

The couple enrolled in an executive course on behavioral economics at the Harvard Business School in 2019.

Rose’s book is the fruit of her years of learning behavioral economics and doing advocacy on financial education and money matters. But the appearance of Rose’s book can be deceptive. It is actually rigorous, covering many grounds of economics and psychology with some empirical support.

In Parts 1 and 2, we agree completely that financial education is not Shakespeare’s be-all and end-all of money problems. It’s not a panacea to lack of money to smoothen one’s consumption function. Rose focuses on the results of a research entitled “The Effect of Financial Literacy and Financial Education on Downstream Financial Behavior.” She shows that only 0.1 percent of the change in financial behaviors with weaker effects in low-income can samples could be traced to literacy interventions. This is too little to mean anything. What is also appalling is that whatever one learned from this program disappears over time and forgotten after 20 months. There is no lasting impact. Surely, there are other factors involved in imbibing the lessons in financial education.

Rose traces this interesting result to human behavior. The human brain has two distinct but integrated set-ups. One is the limbic system which explains our decisions based on emotion. The other is the prefrontal cortex which makes one more careful and analytical. One is thinking fast, the other is thinking slow—the inspiration of Kahneman’s Thinking, Fast and Slow.

The problem is that in everybody life, we tend to be more emotional, to be quick to the draw especially when one is faced with a huge discount in an outlet shop that is closing down because of the economic lockdown.

In Part 3 of Rose’s book, she asks whether her reader is more of a Mak, or rational, or more of an Emong, or emotional. Here, the psychology of money comes in to show some fallacies and illusions involved in handling money. Rose dwells on each of the 16 principles, several of which I used myself in describing people’s tendencies or the illusion of public policy in my previous columns in this broadsheet and in another.

What is interesting is that the application extends beyond economics and finance. Rose applies, for instance, loss aversion on money matters and on love life. Because loss weighs more heavily than gain, for instance, friends who could have made a great couple ended up with partners to whom they could hardly relate. Framing effect actually goes to the root of many governance problems including pandemic mitigation. It looks like public policy is driven by the problem the authorities wish to solve. But because of denial, authorities continue to call for just opening up the economy and lifting up restrictions on mobility without first strengthening our public health system.

All up, Rose’s book is a must read.

As Nandy Aldaba boldly wrote: “The learnings and insights you will get from this book are priceless… It will give you a better understanding of yourself, allowing you to gain wealth and secure happiness.”