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Rethinking financial education for the extremely poor

16.11.2015Arnold Wentzel, Lecturer in Economics and Education, University of Johannesburg

Almost 1 billion people live on less than $1.90 per day. Most of them live in Africa, which means that more than 40% of the continent's citizens experience extreme poverty. What is wrongly assumed is that improved financial literacy and education will improve their financial situation.

The OECD measures financial literacy along four dimensions: financial control, financial planning, choosing financial products and financial knowledge. It is taken for granted that anyone who learns how to budget, knows how to maximise financial returns and borrow prudently will improve their financial position.

Unfortunately, the financial conditions under which the extremely poor live are so different from the conditions assumed by conventional financial literacy that education based on it is both impractical and harmful. It assumes that the poor have small but fairly predictable income flows and expenses and that appropriate financial products are mostly available.

But as Collins, Morduch, Rutherford and Ruthven find in their book Portfolios of the Poor, the income flows of the very poor are not only small, but also highly volatile, and available financial products are too inflexible or unreliable; and that makes all the difference. If you live on less than $2 a day and you have no idea if that $2 will even come in daily, and even minor expenses can wipe out your income on any day, you need to exhibit considerable financial sophistication just to survive.

It is this sophistication that conventional financial education does not recognise. The extremely poor cannot employ strategies to optimise financial gains, but instead have to use strategies to keep their financial options open, even at the expense of gains. This is because they live under conditions of radical uncertainty, where events are inherently unpredictable. Under such conditions it is irrational to optimise since that tends to close down options and thereby limits possible responses.

To survive, the poor employ what is called 'robust satisficing' by Schwartz, Ben-Haim and Dacso. This means sacrificing wealth in order to guarantee a satisfactory outcome (survival) under the greatest range of uncertain conditions. For example, conventionally, financially literate people would never pay to save, yet the poor do it regularly through money guards and informal group savings schemes. This is discouraged by conventional financial education even though it is most rational thing to do if you want to stay alive in poverty.

Radical uncertainty requires: (1) access to flexible cash inflows that keep your options open; and (2) structures that hinder the unpredictable forces that close down your options. Money guards may be paid to keep money, but the cash can be accessed within minutes of a life-threatening event. And interest may not be received in a group savings scheme, but members disallow withdrawals forcing commitment in the face of urgent demands on small savings. Few financial products are designed to get this delicate balance right, and this means the poor often have to develop their own range of informal solutions.

Financial educators need to understand the unpredictable and severe conditions of extreme poverty and recognise the shortcomings of their advice under such conditions. If they are to help the poor they must learn from the poor, especially their sophisticated strategies to keep cash flow options open for as long as possible.

This by no means renders financial education worthless. As cash flows increase and become more predictable, conventional ideas become progressively more relevant. Different kinds of financial literacies exist for different conditions, and instead of teaching just one kind, we should teach how to transition from one to the other as conditions change.

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This blog post is based on the study, Why Financial Education Fails the Extreme Poor, Social Science Research Network. 

About the Author

Arnold Wentzel is a lecturer in Economics and Education at the University of Johannesburg.

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