Individual saving behaviour has far-reaching implications for any economy, especially for a developing one which struggles to match its desire for investment-led economic growth with insufficient domestic capital. This gap is often filled by foreign savings which leads to debt buildup and ultimately burdens future generations and traps economies for decades. In the past 15 years, Financial Literacy has surfaced as a key determinant of savings behaviour as much of the empirical work in this area has concluded that an individual’s ability to understand economic information aids in making better financial decisions which ultimately translates into improved economic well-being through better debt management, more savings for retirement, and more efficient investment management of savings.

For Pakistan, these findings are of great significance as we have long suffered from foreign savings backed growth spurts which were unsustainable. The current youth bulge in the country is perfectly positioned to work for the next 30-40 years, which if made financially literate can generate enough domestic long-term savings for Pakistan to sustain high economic growth.

What is financial literacy?

Annamaria Lusardi — a proponent of financial literacy and one of the pioneer researchers in this area — in a 2015 paper defines financial literacy as “...people's ability to process economic information and make informed decisions about financial planning, wealth accumulation, debt and pensions”. Taking a similar tone, Organisation for Economic Cooperation and Development’s International Network on Financial Education (OECD/INFE) states that “a combination of awareness, knowledge, skill, attitude, and behavior” are necessary to make “sound financial decisions and ultimately achieve individual financial wellbeing”.

The two key aspects one can gather from above are awareness and action, where awareness comes from knowledge and action based on awareness leads to effective financial management by an individual.

Why is it so important to be financially literate?

Financial literacy has significance for both individual (micro)economy and aggregate (macro)economy, and the two are connected. On an individual level, the relevance of being financially literate is much more today than it ever has been because on the demand side more and more people are making financial decisions on their own as they lead independent lives, whereas, on the supply side, there has been significant innovation in financial products.

There is also evidence that especially after the global financial crises of recent memory, people are increasingly being made responsible for their personal finances. As highlighted by Lusardi and Mitchel (2014), in many countries, employers are constantly preferring private defined contribution (DC) plans against employer sponsored defined benefit (DB) pension plans, which is essentially shifting the responsibility of investment performance of retirement savings from the employers to the employees. Thus, individuals are increasingly being entrusted with the task of ensuring that they do not outlive their assets. This, coupled with continuous innovation in financial products and not enough attention to financial education has essentially led to ineffective financial management, which ends up making people worse off. Increasingly, people are retiring with higher debts and less savings which makes them financially dependent on the state in the case of countries with well-developed social safety nets and on their children in the case of less developed nations.

On a macro level, ineffective long-term saving practices of households aggregately reflects in lower domestic capital generation for economies. As highlighted by the OECD in a concept paper in 2012, appropriate investment of household savings has a multiplier effect, providing both government and the private sector with the necessary capital to build infrastructure, generate employment and grow GDP, while also providing households with a nest-egg for future expenses and reducing the tax-burden for future generations.

The economic concept of rationality and global reality

In economic literature, the theory of consumption smoothening states that to maintain their consumption at a certain level, individuals save money in times of high earnings and utilise it when income falls, usually post retirement.

Modigliani and Brumberg (1954), in their theory of spending concluded that people make intelligent choices about how much they want to spend at each age and would work and tailor their consumption patterns to make provision for their retirement. Such theories implicitly assumed that all individuals possess the ability to not only understand the need for retirement savings, economic concepts, and continuously evolving financial products but are able to apply this understanding effectively when faced with financial decisions, almost as if it would come naturally.

The reality, however, is quite different. in 2014, the first comprehensive global survey on financial literacy — S&P’s Global Financial Literacy Survey — in 140 countries indicated that only 1-in-3 adults were financially literate. The survey also highlighted a stark difference between the developed world and the developing world, whereby on average 55 per cent of adults in major advanced economies were financially literate, whereas, in the case of emerging economies, this figure was only 28pc.

The implications of low financial literacy are more serious for these emerging economies, especially in the case of retirement savings, as the absence of formal retirement plans means that either people do not end up with any savings at retirement or accumulate insufficient savings to not outlive. Due to low financial inclusion, people in developing countries have less access to credit, which means big financial commitments such as education and house-buying are usually done without any element of formal credit. Although, this results in low accumulation of debt compared to developed countries, where people retire with a significantly higher debt, it also means that by the time people retire they have already spent a majority of their savings, and now will rely on either residual savings or potential financial support from their children to get through their twilight years.

A roadmap for policy makers in Pakistan

As per the S&P’s Global Financial Literacy Survey, only 26pc of adults are financially literate in our country. As per the Global Findex 2017, in a country of over 210 million, only 21pc of the adult population has a bank account; 35pc of the adult population saved any money in the past 12 months and just 15pc of the adult population saved for old age. This is also reflective in investing habits, as only 0.13pc of the population invests in the local stock market. For a country with 64pc of the population below the age of 30, these are alarming numbers.

In collaboration with the Asian Development Bank, Pakistan has launched its first National Financial Literacy Program (NFLP) which aims to conduct workshops on financial concepts across the country. Although, this is a good first step, the approach towards increasing financial literacy should have a more comprehensive and targeted approach.

First and foremost, assessing the gravity of the situation is of paramount importance in order to bridge the gap between what people know and what they should know. To determine this, an assessment survey is essential. A survey similar to SHED (Survey of Household Economics and Decision making) in the US by the Federal Reserve, which collects information on expenses, income, employment, housing and neighbourhoods, retirement savings etc. to measure economic well-being of US households and identifies potential risks to their finances, can be conducted in Pakistan. The State Bank of Pakistan (SBP) and the Pakistan Bureau of Statistics (PBS) can conduct it either individually or jointly. However, data collected from such surveys should be kept confidential as the point of this activity is to help increase financial literacy to impact saving behaviour.

Secondly and most importantly, it needs to be realised that literacy and financial literacy are not the same things. Even people who possess post-graduate degrees may in fact be completely clueless when it comes to making sound financial decisions. The reason is the way our educational system is structured; nowhere is it ever taught what to do with your money once you start making it. Therefore, it is necessary that financial literacy is inculcated in young minds from a very early age, the way every school going child is taught the basic ways of living in society, the efficient use of society’s limited resources should be taught as well. It should be a part of the curriculum and not covered in a monthly seminar. On this, we have a great example of Jump$tart — which runs a personal financial literacy programme for high school and college students in the US. They even have programmes for pre-primary and primary levels, where students are taught very basic concepts such as borrowing in an activity-based session. They also offer online financial education resources for teachers and schools which makes adoption by any school or institution much easier when compared to building new resources.

Finally, there has to be a parallel effort to increase an individual’s capacity to save in the form of a higher real income, as equipping someone with the knowledge of financial management without the capacity to apply it would not create much of a difference. The government with all its relevant departments needs to ensure that inflation for the common man remains in an acceptable range which makes room for households to allocate towards savings. These two efforts run together will ensure that in times of low inflation people do not go on a consumption spree which has been usually the case whenever inflation has declined and our growth has been primarily led by consumption rather than investment.

Pakistan is at a very crucial juncture, and what we do at this point will determine how we position ourselves for the next 30-40 years. The youth bulge is our biggest asset, which if made financially literate will generate enough domestic long-term savings for the country to achieve sustainable economic growth for years to come.