S

Income and Wealth Inequality

The Importance of Financial

Knowledge

Pierre-Carl Michaud,

ESG - Université de Québec à Montréal, Canada

Professor of Economics

Industrielle Alliance Chair in the Economics of Demographic Change

OECD/GFLEC Symposium

Paris, November 6, 2014

Motivation

S What we know

S Income inequality has risen, driven in large part by labor income (wages and salaries)

S New evidence points also to widening wealth inequality

S Why policymakers (should) care?

S Growing fraction of retirement income financed from savings (adequacy of retirement income)

Income Inequality

Source: OECD (2014) Income Inequality Update

Wealth Inequality

OECD/GFLEC Symposium

Source: Saez and Zucman (2014, NBER)

Changing Pension Landscape

S Many countries have moved from Defined Benefit (DB) to

Defined Contribution (DC) in their mandatory pension

schemes

S Private pensions are increasingly of the DC type

S Pressure from aging populations may further limit public

pension generosity

S Responsability to save is being transferred to individuals

Challenges

S Financial knowledge is low worldwide

Financial Knowledge

Respondents with correct answers (%, weighted)

0%

20%

40%

60%

80%

100%

Interest Inflation Diversification

U.S.. (2009) Japan (2010)

Canada (2012) Germany (2009)

Netherlands (2010)

Source: Lusardi and Mitchell (2011, JPEF), Boisclair, Lusardi and Michaud (2014, NBER)

Challenges

S Financial knowledge is low worldwide

S It is unequally distributed

Financial Knowledge

by Age and Education

Source: Lusardi, Michaud and Mitchell (2013, NBER)

Challenges

S Financial knowledge is low worldwide

S It is unequally distributed

S It is linked to behavior, such retirement planning, wealth,

and returns to savings

Rates of Returns Vary with Financial

Knowledge

S Those who have higher financial knowledge earn a higher (risk-adjusted) rate of return on their investments (Clark, Lusardi and Mitchell, 2014 NBER), + 130 basis points.

S Data is from administrative records from a large finance firm

S Differences in savings rate matter (Dynan, Skinner and Zeldes, 2004 JPE), but also differences in rates of return

Financial Knowledge as Form

of Human Capital

S Delavande, Rohwedder and Willis (2008): Financial

knowledge is a stock.

S Jappelli and Padula (2013): Social Security may reduce

the incentive of individuals to invest in financial

knowledge

S Lusardi, Michaud and Mitchell (2013): What are the

implications for wealth inequality?

Predictions from the Standard

Approach

S Consumers accumulate the same amount of wealth in

proportion of their lifetime income

S Cannot explain level of wealth inequality we observe

Mechanics

Incentives to save raise the rate of return on

saving trough financial knowledge

accumulation

Knowledge and

Wealth Inequality

Summary of Findings

S Many reasons to save but the most important engine of

wealth inequality may be financial knowledge

S More than 40% of wealth inequality can be attributed to

financial knowledge

S Very important to start equal at the beginning of working

life: Add financial literacy in school?

Use Framework to Study

Effects of Adding Finlit in

Schools

S Increase the endowment of financial knowledge for

everyone

S We find large welfare benefits: High school dropouts

would need 82% more initial wealth to make them as well

off as with higher starting values of financial literacy

Other Insights from Research

S Changes in policy (for example fin education programs) do not lead to a change in behavior for everyone; some are too constrained to make changes or their behavior was optimal.

S It is wrong to predict 100% behavior change. If some people do not change behavior, it does not mean policy is ineffective

S For some financial knowledge decays. This is optimal behavior, not evidence in favor of ‘just in time’ education

Final Considerations

S Income and wealth inequality have risen

S Financial knowledge is an important mechanism in the

transmission of income to wealth inequality

S Financial education provides welfare benefits, particularly

in a world where responsability for retirement savings is

shifted to workers

Do Not Underestimate

Inequality

“An imbalance between rich and poor is

the oldest and most fatal ailment of all

republics.”

Plutarch

Thank you and Contact Info

Pierre-Carl Michaud

Professor of Economics

Industrielle Alliance Chair in the Economics of Demographic

Change

ESG, Université du Québec à Montréal

Montréal, Canada

Tel: 514-987-3000, extension 5019

michaud.pierre_carl@uqam.ca

www.cedia.ca