Financial Literacy & Rules of Thumb
Keeping it Simple:Financial Literacy and Rules of
Thumb
Greg FischerLSE, IPA,
J-PAL
Alejandro DrexlerUT-Austin
Antoinette Schoar
MIT, NBER, ideas42
New Ideas in Business GrowthMarch 2011
Drexler, Fischer, Schoar 30 March 2011
Financial Literacy & Rules of Thumb
Widespread lack of financial literacy, particularly among people in the US with low levels of education, minorities and women (Lusardi 2008)US households generally unfamiliar with concepts necessary to make efficient savings and investment decisions (Lusardi and Mitchell 2007)Very low levels of financial literacy in India and Indonesia (Cole, Sampson, Zia 2009)
Growing evidence that large share of population unprepared to make financial decisions
Drexler, Fischer, Schoar30 March 2011
2/20
Financial Literacy & Rules of Thumb
Some survey evidence (Bernheim & Garrett 2003; Lusardi 2004) that those attending financial training programs subsequently make better financial decisions
Especially attendees with low income or education levelsBut self-selection suggests results overstated
Duflo and Saez (2004) exploit random assignment to raise savings awareness
Find small effects on savings plan enrollment
Cole, Sampson and Zia find only modest effect of financial literacy training program in IndonesiaKarlan and Mullainathan find mixed results for vendors in India and the Philippines
Mixed evidence on whether or not financial literacy can be taught
Drexler, Fischer, Schoar30 March 2011
3/20
Financial Literacy & Rules of Thumb
Effects on business growth and poverty alleviation still unproven
Evidence of business growth is mixedBanerjee, Duflo, Glennerster, Kinnan (2009)Karlan and Zinman (2010)
How can we improve the effectiveness of microfinance?
Growing questions about efficacy of microfinance
Drexler, Fischer, Schoar30 March 2011
4/20
Financial Literacy & Rules of Thumb
“...rather than waste our time teaching [borrowers] new skills, we try to make maximum use of their existing skills. Giving the poor access to credit allows them to immediately put into practice the skills they already know…” (Yunus 1999)
Many practitioners have taken a different approachThis is starting to change from researchers as well
Bruhn, Karlan, and Schoar (2010) evaluate individualized consulting services for small businesses in MexicoKarlan and Valdivia (2010) study mandatory business skills training for microfinance clients in Peru
Focus has been largely on financial frictions
Drexler, Fischer, Schoar30 March 2011
5/20
Financial Literacy & Rules of Thumb
To what extent can financial literacy training improve firm and individual outcomes for microentrepreneurs in Dominican Republic?What is the trade-off between traditional, principles-based accounting training vs. simple, rule-of-thumb methods?
We aim to answer the following questions:
Drexler, Fischer, Schoar30 March 2011
6/20
Financial Literacy & Rules of Thumb
Worked with ADOPEM, a microfinance institution lending to individuals & small businesses in the Dominican Republic
Operates a range of ongoing training programsWanted to assess efficacy of these programsExpect significant selection bias in who attends such programs
Randomly assigned training opportunity across 1200 clientsTwo treatments:
Traditional, principles-based accounting: similar to programs by FFH, ILO, BRAC
Rule-of-thumb methods: simple decision rulesTake up rate: 44%Heavily subsidized: RD$200 price about 20% of cost
To answer these questions, we conducted a randomized control trial of two training programs
Drexler, Fischer, Schoar30 March 2011
7/20
Financial Literacy & Rules of Thumb
Accounting Rule of Thumb
Class 1 Savings
Class 2 Consumption
Class 3 Debt management
Class 4 Basic accounting 1 Account separation
Class 5 Basic accounting 2 Estimation methods
Class 6 Basic accounting 3 ---
Experimental variation between training treatments built on top of similar core components
Drexler, Fischer, Schoar30 March 2011
8/20
Financial Literacy & Rules of Thumb
If training does not change management practices or improve outcomes, it could be that:
Individuals did not understand or were unable to implement new management techniques after classroom trainingIndividuals understood management techniques but chose not to implementEven when the material is understood and implemented, it does not affect business performance
Randomly assigned follow-up activities to disentangle these explanations
Experimental design aims to begin unraveling mechanisms
Drexler, Fischer, Schoar30 March 2011
9/20
Financial Literacy & Rules of Thumb
Loan size US$600Average weekly sales of US$85
Bad week US$50Good week US$115
About 60% are sole proprietorshipsOf the rest, 80% have either one or two employees
Typical businesses include small retail shops, colmados, beauty salons, and food service
The median client
Drexler, Fischer, Schoar30 March 2011
10/20
Financial Literacy & Rules of Thumb
Typical clients
Drexler, Fischer, Schoar30 March 2011
11/20
Financial Literacy & Rules of Thumb
Be womenBetter educatedHave received prior training and want moreSmaller businessesWith bigger plans
All this suggests our concerns about selection were well founded
Attendance is not randomThose who show up are more likely to
Drexler, Fischer, Schoar30 March 2011
12/20
Financial Literacy & Rules of Thumb
Sep. c
ash
Keep
reco
rds
Sep. a
cco.
..
Calc. r
eve.
..0%
10%
20%
30%
40%
50%
60%
70%
ControlAccountingRule of Thumb
Sh
are
Rep
ort
ing
Pra
cti
ce
Rule of Thumb training improves financial practices
Drexler, Fischer, Schoar30 March 2011
13/20
+8%***+11%***
+11%***
+6%**
* Denotes significance at the 10%-level, ** at the 5%-level, and *** at the 1% level of effect relative to control.
Financial Literacy & Rules of Thumb
Avg. Week Last Week Bad Week0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
Control
Accounting
Rule of Thumb
Weekly
Reven
ues R
D$
Rule of Thumb also improves revenues in bad weeks
Drexler, Fischer, Schoar30 March 2011
14/20
* Denotes significance at the 10%-level, ** at the 5%-level, and *** at the 1% level of effect relative to control.
+RD$1168**
Financial Literacy & Rules of Thumb
Business practices
Business outcomes
Personal outcomes
Personal financial practices
0%
2%
4%
6%
8%
10%
12%
ControlAccountingRule of Thumb
Sh
are
Rep
ort
ing
Pra
cti
ce
Standardized effects show significant effects on business and personal financial practices
Drexler, Fischer, Schoar30 March 2011
15/20
+0.11***
+0.04+0.05*
+0.07**
* Denotes significance at the 10%-level, ** at the 5%-level, and *** at the 1% level of effect relative to control.
Financial Literacy & Rules of Thumb
No change in:Loan sizeLoan typeRepayment performanceRetention
Neither treatment has a significant impact on institutional outcomes
Drexler, Fischer, Schoar30 March 2011
16/20
Financial Literacy & Rules of Thumb
Want to rule out Hawthorne effects as explanation for reported differences in management practicesConstruct index of financial reporting errors
Bad period sales greater than average or goodAverage period better than goodAverage period profits better than good period sales
45% of subjects make at least one mistake; 11% make three or more
Construct objective measures of reporting quality
Drexler, Fischer, Schoar30 March 2011
17/20
Financial Literacy & Rules of Thumb
Rule of thumb reduces errors; accounting has large effect, but only for highly educated
Drexler, Fischer, Schoar30 March 2011
18/20
Financial Literacy & Rules of Thumb
Follow-up & intensity may matter for accounting treatment
Irrelevant for Rules of Thumb
Teacher identify matters for accounting treatmentNot for Rules of Thumb
Rule of Thumb has strongest effect for those who express least interest in training
Rule of Thumb has robust effects
Drexler, Fischer, Schoar30 March 2011
19/20
Financial Literacy & Rules of Thumb
No effect in this setting from traditional accounting training
Neither on business practices nor performanceSome positive results when augmented with intensive follow-up and for more well educated
Easy-to-implement, rule of thumb trainingImproves management practicesMay also improve business performance, particularly in bad periods; mechanism remains unclearMore robust: results independent of education or teachersBut we are far away from claims about finding global maximum
More is not necessarily better
Conclusion & Points to Remember
Drexler, Fischer, Schoar30 March 2011
20/20
Financial Literacy & Rules of Thumb
Thank you!
[email protected]@mit.edu
Drexler, Fischer, Schoar30 March 2011
21/20