Recently, financial literacy has gained the interest of several groups around the world including governments, bankers, employers, community groups and, of course, individuals planning for their future. This is also true locally where the New Zealand Shareholders’ Association has announced plans to promote basic education in finance across the country, with the backing of some of the country’s wealthiest businessmen and women.
Why is this occurring? One reason may be the rapid creation of myriad of new financial products, the increasingly global nature of financial markets with all the complexity it brings and changes in political and demographic characteristics. How many New Zealanders could define basis point, and indicate what its relationship is with interest rates? Could they answer the following questions: Should your savings be put into KiwiSaver or into paying off house mortgage? Should you be worried about the collapse of so many finance companies over the past 18 months? What is an exchange rate and why does the New Zealand exchange rate change so much? Should I sell my Warehouse shares or buy more?
Yet, the understanding by the general public of the above questions and many more, are relevant to the functioning of healthy economy and the economic wealth of individuals in it. Recent research reported by Doug Widdowson and Kim Hailwood in the Reserve Bank of NZ bulletin Vol 70, No 2, highlights financial literacy among New Zealanders could be better and there is need for wider understanding of the importance of financial literacy in its more complex forms. The most basic elements of understanding finance include having the ability to calculate rates of return on investments and the interest rate on debt; an understanding of the risks or benefits of their financial decisions and the importance of budgeting to achieve financial goals like purchasing home. The more complex issues include answers to the questions I just raised.
Here I will focus on the freedom of firms to fail, an emerging issue for many watching the current slowdown of the New Zealand economy. To start, one must understand some subtle issues around market behaviour.
Markets are strange arrangements of business activity. If someone has an idea and decides to take risk with either their own money, or preferably someone else’s, which turns out to be valued by consumers of the goods or service, that person or organisation could end up making lots of money. If, on the other hand, consumers decide they do not rate the goods or service offered, lot of money can be lost, often very quickly.
Of all the characteristics of capitalism, the freedom to fail, the way the market punishes unwanted behaviour, is the most important, although the consequences are the most undesirable. If those failing, or about to fail, can exert political or economic power to avoid failing, or in the event of failure shift the cost to others, they will certainly do it. In sense, that is what is happening during what I would call the current turmoil in global financial markets, as there is call for governments or central bankers to bail out failing financial institutions and mortgage holders. But if this occurs, it most likely will result in misuse of scarce resources, reducing global growth in the long run and making the next ‘turmoil’ event much worse. In the shorter term such actions will result in transfer of money from taxpayers and debt holders to shareholders which also may result in the inappropriate use of available investment funds hurting the world economy and ultimately individuals.
Returning to my financial literacy theme, if New Zealanders do not have adequate financial literacy they may not appreciate how financial risk has the potential to affect them, even far from the original source of trouble. As result they may end up making sub-optimal financial decisions about the use and management of money.
Currently, there has been increasing public acknowledgement by many groups of the need to address our financial literacy issue. But efforts to date have been fragmented and focused on specific groups of individuals without regard to an overarching national strategy. Such strategy will need to include an effort at university level and school level in addition to activity already being undertaken by the Enterprise New Zealand Trust, if significant increases in financial literacy are to be made over the next decades.
This will necessitate specific contributions by government and the university sector in addition to the business sector. For, if we are truly going to address uncertainty and confusion by participants in financial markets, which has the potential to reduce our global competitiveness, we must make sure financial literacy is high enough to understand the increasing complexity of the financial marketplace. This includes anyone from school leavers on up. dynamic economy cannot afford to demand less from its participants.
Professor Lawrence Rose, pro vice-chancellor, College of Business, Massey University.
