As consumer credit, insurance and investment products have become more complex, most consumers are increasingly unable to understand them.  The consequences of this lack of understanding can be very severe – for consumers and for the economy as a whole.

Policymakers have relied on financial literacy education to “empower” consumers – to turn them into educated and empowered market players, motivated and competent to make financial decisions that increase their own welfare.

Lauren Willis, a professor at Loyola Law School in Los Angeles, wrote an interesting 56-page academic paper in 2008, Against Financial Literacy Education (link).  Professor Willis asserts that there is no evidence that teaching financial literacy actually leads to better decisions or consumer outcomes.  After all, the playing field is tilted against financial literacy:

• Personal financial management is complex, requiring considerable time and effort to understand.  Most consumers start off with quite low skill levels.  The huge gap between those skills and what is needed in today’s marketplace cannot be bridged by financial literacy training alone.
• The financial marketplace is constantly changing at a very rapid pace.  It is tough for regulators and almost impossible for consumers to keep up with the pace of financial innovation.  Financial literacy is chasing a moving target it will never reach.
• Personal bias and inherent psychological traits prevent most consumers from acting as “rational” economic players able to maximize their own benefits.
• Financial literacy messages are a small trickle compared to the vast flood of advertising from banks, investment firms, insurance companies and many others.

The stakes for consumers are high – wrong decisions can lead to personal financial ruin.  Decisions about the future of financial trends seem especially hard to predict.  So most consumers are content – even eager – to offload responsibility to a financial advisor, to a “trusted” confidant, or even to the television ad promising retirement security.

Professor Willis does not stop at questioning the benefits of financial literacy education; she points out how it can actually be harmful.   For some consumers, financial education increases confidence without improving ability, potentially leading to even worse decisions.  Some consumers will feel that the onus for their bad decisions has shifted to them.  She also questions the widespread support of the financial services industry for financial literacy training, even though more informed consumers would reduce their profits from high interest charges on credit cards and high money management fees.

Some of Professor Willis’ specific policy suggestions:

• Offer affordable expert advice, perhaps through a publicly-funded system (like legal aid) of neutral experts who would advise consumers on financial products and services.
• Governments could compel companies to offer low risk “plain vanilla” products and to reduce the variety, complexity and sheer numbers of financial products available in the marketplace.  Setting such products as the default choice would further protect consumers.
• Align incentives by charging sellers with fiduciary duties to act in their clients’ best interests, or by banning commission payments for financial services.
• Impose liability on sellers when their products cause consumer injury, governed by a negligence standard determined by the courts.
• Prohibit the sale of particularly risky or harmful financial products.  The costs of lost innovation suffered by some consumers would be greatly outweighed by the reduction in damage caused to the much larger number of less knowledgeable consumers and to their communities.