Discover more from Complex Effects
The U.S. Wealth Gap and Financial Literacy
Wealth distribution in America is growing more unequal as the 21st century plays out. The rich are getting richer and the poor are getting poorer (Moore, 2017). This is due to an uneven distribution of financial education and resources. Government intervention in our economy has favored the richest people and poor people are unaware of the intensity of the imbalance (McKernon, 2020). The demographics of the rich are primarily white, and it has become increasingly more difficult for anyone to move up the social ladder (Semuels, 2016).
The purpose of this paper is to analyze three policy changes that could help alleviate this problem. The first of which explores the effects that a nation-wide financial literacy effort would have on decreasing the wealth gap. The hypothesis behind this policy change is; if people in lower and middle classes made better financial decisions, they could leave their children in better financial situations and give birth to more generational wealth in poor communities. The main problem with this potential solution is that it has become increasingly harder for people to move up the social ladder (Semuels, 2016).
The second solution is in regard to how financial technology can help people manage their finances by substituting financial literacy with easy-to-use technological interface. Qianwen Bi, in The Impact of Financial Software Use on Financial Literacy Education — Evidence from China, investigates how financial software helps people conceptualize retirement savings with visualization tools (2020). The problem with this solution is that lower income families may not have the means to acquire such technologies.
The third solution is a nation-wide education effort to inform the public of the unfortunate realities that could come from the extreme disproportions of the wealth distribution in America. Ray Dalio, in Why and How Capitalism Needs to be Reformed (2020), suggests that the economic imbalance poses an existential threat to the U.S. and policy reform is needed. This paper will explore the idea of implementing a nation-wide economic health education effort in order to help citizens conceptualize the role that the government plays in sustaining a healthy capitalist economy. A setback with this solution is that politicians could argue the validity of the economic implications that come with the financial inequality we are experiencing by using partisan influence on their followers.
The overall conclusion is that, while some a combination of all three solutions would be ideal, financial literacy and financial software would likely help people make better decisions with their money (Claxton, 2008) (Bi, 2020). Economic education will likely help people make better economic-political decisions which would decrease the wealth gap in the long run (Dalio, 2020). The findings of this study may provide information to policy makers that find wealth inequality problematic.
Introduction and Problem Statement
One of the major issues driving political agendas today is that of racial inequality. Racial inequality is unmanaged in many ways, but one of the most apparent, quantifiable, inequalities is that of the wealth gap in America. According to a study by Dave Gilson and Carolyn Perot of Mother Jones, the wealthiest 10% of America owns more than two-thirds of the nation’s wealth (2011). Another study by Robin Wigglesworth of Financial Times (2020), found that the wealthiest top 1% own more than half of the stocks and stock mutual funds held in America. Wigglesworth later stated, “[s]ince 1990, the wealthiest have bought a net $1.2-trillion in company stakes, while the rest of the population has sold more than $1 trillion,” (2020).
It would be extremely difficult for the top 1% to spend of all the money that they have acquired during their lifetime which means this wealth is passed on to their children. Their children, grandchildren, and great-grandchildren will get better education, live in better communities, and qualify for better jobs than their middle-class counterparts, giving life to the positive feedback effect associated with capitalism and the wealth gap. Meanwhile, one-third of millennials, gen-x, and baby boomers that are fully employed have less than $1,000 saved for an unexpected emergency (Moore, 2017). These statistics affect people of every denomination but especially those that are African American and Hispanic. A staggering 96.1% of the top 1% are white. This is due to a societal structure that favors the wealthy, punishes the poor and unprepared, and encourages unequal behavior from financial companies (Moore, 2017).
Public policy surrounding tax codes on corporations and wealthy people, third-party funding of political candidates, debt privileges, and more, need to be analyzed to establish an even playing field for Americans. In 2020, America’s economy has had a lot of media time as the Federal Reserve demonstrates their ability to keep the stock market afloat despite the coronavirus economic shutdown. While government officials tout the resiliency of their economy as they point to record numbers on Wall Street, the citizens that are actually benefitting from the stimulus are the top 1% (McKernon, 2020) (Dalio, 2020). An uneducated voter might look at these claims and misunderstand the reality of how the economy looks when it works in their favor. McKernon studied the benefits garnered from certain government interventions that are meant to stimulate the economy and came away with the following results:
“The federal government spends over $400 billion to support asset development, but those subsidies primarily benefited higher-income families — exacerbating wealth inequality and racial wealth disparities.
About two-thirds of homeownership tax subsidies and retirement subsidies go to the top 20 percent of taxpayers, as measured by income. The bottom 20 percent, meanwhile, receive less than 1 percent of these subsidies. Blacks and Hispanics, who have lower average incomes, receive much less of these subsidies than whites, both in total amount and as a share of their incomes” (McKernon, 9 Charts about Wealth Inequality in America, 2020).
Enacting policy change could require decades of political tug of war between two parties that are growing further and further apart. Ultimately, for change to last, the fundamentals of finance need to be embedded into the American education system to create better financial habits, establish what their best interest is, and empower the right politicians to act in their best interest.
The root of these issues must be dealt with, as we yearn to leave poverty and racial inequity in the past. The hypothesis of this analysis is that an increase in financial literacy in American schools will educate people to make smarter financial decisions and voters will help change public policy that is enabling the wealth gap.
Evidence — The State of Financial Literacy Today
John Grable and Abed Rabbani, in the Journal of Financial Service Professionals (2020), found that only one-third of the American, adult, population could correctly answer three simple questions on interest rate, savings, and investment diversification. Grable and Rabbani also stated:
“Financial literacy promotes better financial decision-making, thus enabling better planning and management of life events such as education, illness, housing purchase, or retirement. At the macroeconomic level, the individual’s saving habit benefits the entire nation (Ali, Rahman, and Bakar, 2014). Financial literacy has a positive impact on the economy because funds that are placed in financial assets are channeled through financial intermediaries to make investments (Lusardi and Mitchell, 2005). Subsequently, investments by firms will ultimately benefit the nation through higher productivity and economic growth” (Grable, J., Rabbani, A., Journal of Financial Services Professionals, 2020).
A study by PWC revealed that 54% of the stress experienced by the average American employee is caused by money. This is a higher allocation of stress than from their jobs, relationships and health combined (2020). It should be noted that this survey was taken during the coronavirus pandemic of 2020 and financial stresses are likely heightened (Conley, 2020).
The findings of Eric Mack from Inc.com (2020) show that economists believe the amount of income made per year directly relates to the happiness of an individual up to a certain threshold of “$95,000 for life evaluation and $60,000-$70,000 for emotional well-being.”
Adults, especially in a capitalist society, are burdened with the tasks of providing for their families, saving for retirement, funding unexpected emergencies, and trying to enjoy their time on earth — all of which have a strong relationship with money. If money, and the drive towards more of it, is a leading factor to increasing stress within the human experience, why are we not teaching more of the fundamentals of finance to our citizens in order for them to pursue happier lives? Why is there not a mandatory personal finance course in high schools across the country? A focus on higher financial literacy from an early age has the potential to dramatically decrease poverty, decrease the wage and wealth gaps, increase national GDP, and restructure the public policy that enables monetary inequality (K. Smith, 2019).
Poor financial decisions cause a ripple effect of misfortunes into an individual’s future and the global economy altogether. Nancy Claxton, of the International Debate Education Association wrote the following:
“…poorly informed financial decisions by individuals who generally believe that they are far more financially literate than is really the case have become an increasing concern for U.S. federal and state governments for a number of reasons. The most apparent is the increasing use of credit cards, which in 2003 led to an increase in personal bankruptcies of almost one in ten U.S. households filing for bankruptcy. In 2007, the number of bank foreclosures on mortgages that people could no longer pay pushed the economy toward recession and led to a sharp plunge on Wall Street. It is easy to see how people’s financial illiteracy affects everyone — not just themselves and their families” (Claxton, Using Deliberative Techniques to Teach Financial Literacy, 2008).
Claxton continues by stating that employees that go through financial training when signing up for their companies 401(k) plan tend to contribute more to their plans. She also states that mortgage counseling results in a reduced risk of mortgage delinquency. Financial education is shown to result in better financial decisions and ultimately better financial habits (2008).
Another is the growing complexity of the financial industry and the intricacies of navigating that realm. Investment and insurance companies have products and processes that are hard to understand for the average investor. This results in investors making poor financial decisions and financial salesmen selling products that are inappropriate for the clients needs in order to receive a higher commission. A more educated investor can challenge their advisors and financial companies to work in their best interest. Furthermore, lending companies have a history of treating applicants differently depending on ethnic bias.
The pillars of the American education system include math, science, English, art, history, government, and a variety of other literacies that are not personal finances. There is currently no nation-wide focus on providing middle and high school students with a basic framework of how our financial system works and how to succeed within it.
When someone tries to learn a foreign language, it can take years of daily practice to become fluent. Additionally, the older the learner, the harder it is to learn a new language. Why should financial literacy be treated any differently?
Capitalism, in its nature, rewards those who are the most efficient, effective, and hardest workers in their industry. While these characteristics of capitalism are objectively positive, educating on the importance of balancing these concepts in a healthy manner is important for the health of our economy (2017). Americans aren’t aware of how big the wealth gap is, and this alone is a reason to educate our citizens. Figure 1., by Gilson and Perot (2017), represents what Americans think the wealth distribution is, what they would like it to be, and what the actual distribution of wealth is.
A larger awareness of the distribution of wealth/power/income should be taught in schools. The impact of such economic inequality is warned to be catastrophic by Ray Dalio, founder of Bridgewater Associates (Dalio, 2020).
Alternative Policy Responses
According to Claxton (2008), a curriculum using deliberative education to teach the concepts is the most efficient way to teach financial literacy. Deliberative education is the use of speech, communication, discussion, and debate to encourage student’s participation in the learning process and is a potential solution to the wealth gap. By interacting with each other in simulations and financial scenarios, students get hands-on experience with concepts that will play a big part of their lives as an adult, and help them make better financial decisions (2008).
In class, students will learn about the things that they will encounter while they interact with money during their lifetimes. They would learn about basic money management skills, credit and debt management, risk management, saving, and investing (Claxton, 2008). These skills could be taught as early as 6th or 7th grade and progressively increase in difficulty until their last years of high school. By the time a high schooler is ready to save for their first car, they will know how to budget and save. Once they are old enough to shop for student loans, they will know how their loans collect interest and the projected annual salary of professionals within the discipline they choose to study. They will be prepared to make smart decisions once credit card companies start offering them credit cards. Lastly, they will have an understanding of how compounding interest can help them retire, save, and leave their children in a better position (Claxton, 2008).
A complete refocus of K-12 education towards more financial literacy and more government sponsored resources for adults to utilize would, in time, improve the economy, lessen the wealth gap, and increase the financial well-being of 90% of American citizens. The problem is that this sort of change could take decades until results are realized on a substantial level and education standards are not equal to all demographics. Lower income areas are deprived of the resources that are needed to improve the efficiency of lower-income money habits (Moore, 2017). Tax brackets need restructuring, teachers need training, schools need funding, and incentive for change needs to be agreed upon (2017).
Luckily, our access to information is greater than at any time in history. America is the richest nation in the history of the world and Americans constantly compare themselves to their friends, family, and celebrities. This can create a ‘keeping up with the Jones’’ mentality that feeds into the poor financial decisions that people make every day. Americans may not believe that they are financially illiterate and may not take financial education seriously (Perot, Gibson, 2017).
Our ability to harness technology to our advantage can likely help people plan their financial goals. According to Qianwen Bi, assistant professor at Utah Valley University, financial software has helped Chinese people improve their financial situation (2020). They also found that government/employer sponsored financial education programs have shown to have mixed reviews. Some studies show a negative impact on financial behavior while other studies found a “significant improvement in employee’s financial knowledge in the areas of interest and loans, credit scores, stocks and bonds, and retirement investments due to workplace education” (Bi, The Impact of Financial Software Use on Financial Literacy Education, 2020). Bi’s mixed findings may be contributed to differences in course content, test measurements, teacher preparation, and other inconsistencies (Bi, 2020).
Outside of education, financial technology is helping people monitor their financial habits and provide insights into how they can improve. Some technologies are replacing complex formulas used to calculate retirement projections and giving the average investor the ability to access this information without an expensive advisor (Bi, 2018).
Financial education alone may not be enough to rebalance America’s wealth distribution. A study from Al-Bahrani, Weathers, and Patel show that financial education is more effective for white people than black people (Racial Differences in the Returns to Financial Literacy Education, 2018). Patel explains that, after the financial literacy classes, minorities experienced a 4.1% increase in testing scores while whites test scores increased 5.6%. In effect, this example of financial education shows that financial literacy classes could increase the wealth gap (Patel, 2018).
Financial education has not had overwhelming evidence to suggest that it would help distribute wealth more evenly across the tax brackets. Education on wealth inequality could do more to close the wealth gap than financial education alone. According to Lucia Macchia of The Harvard Review, wealth inequality is viewed differently in countries with differing amounts of wealth inequality (2019). Countries with lower inequality view the wealth gap based more on luck while countries, like the U.S., believe that those that have more wealth must have worked harder to get it. The American dream of moving vertically into new income classes is a mindset that is fed to the public and leaves Americans thinking that the only change that needs to happen has to do with their work ethic (Macchia, 2019). Most humans would agree that harder workers, and those that contribute more to society, should be compensated more than those that don’t (Dalio, 2020) but not at the expense of the minimum wage. Education around the economic implication, that could result from high inequality, could motivate voters to vote for politicians that want to raise the minimum wage or eliminate tax loopholes for the rich (Dalio, 2020).
There are many unfortunate realities that people face while attempting to save for retirement or significant purchases. One of the biggest misfortunes is the lack of one’s ability to increase their income. Increasing income is the fastest way to develop a better financial situation (Semuels, 2016) yet incomes for everyone but corporate executives have essentially been the same for the past few decades even while the cost of living has increased (McKernon, 2020).
Increased financial literacy has been proven to help financial situations in some studies but it is apparent that the framework that income is built upon needs to be restructured for lasting change to be shown in our wealth distribution. Ray Dalio, Founder of Bridgewater Associates, the biggest hedge fund in the world, warns of the dangers of the wealth distribution in his book Why and How Capitalism Needs to be Reformed (2020). Dalio suggests that the economic inequality that we are experiencing today has been equaled many times in history. History would suggest that during times of political polarization, extreme wealth for some, wide-spread poverty for others, and a new emerging world power, in this case China, could suggest civil war is possible (Dalio, 2020). Education around this topic could help start the process of addressing the issue.
While it is apparent that lower-income earners make more mistakes with their money than their rich counterparts (PWC, 2020), it appears that better financial decisions alone won’t allow minimum wage to rise. Minimum wage has grown much slower than executive pay (Perot, 2011), and investment knowledge is unlikely to make up that difference (Dalio, 2020).
Financial advisers are compensated more if they are working with higher-net-worth clients. Richer clients lead to more assets-under-management and higher commissions for selling financial products. This leads to entire social classes being ignored by financial experts. Differing financial resources along with the effects of compounding interest and credit score repercussions create a positive feedback effect where the rich get richer and the poor get poorer (Dalio, 2020). Financial software technology could help replace human advisors for those that aren’t well-connected (Bi, 2020).
Implementing financial literacy education, using financial technology, and increasing awareness of the systems that enable the growing of wealth distribution, the USA can improve its citizen’s financial situations. Implementing all three policy changes could prove to be costly for the government. If only one policy could be instituted, increasing the awareness of the policies that enable the wealth gap to grow is the most important. Improving the education around this subject has the potential to change the voting habits of Americans that are currently unaware of the inequalities and its repercussions. The policy changes that could come from a change in voting habits include a raising of taxes for the top 10% of wealth accumulators, a higher nation-wide minimum wage (Cooper, 2019), and a redirecting of government economic stimulus efforts from the stock market (Dalio, 2020) to the middle and lower class populations directly.
Claxton, N. (2008). Using Deliberative Techniques to Teach Financial Literacy. International Debate Education Association.
Moore, A. (2017, December 07). America’s Financial Divide: The Racial Breakdown of U.S. Wealth in Black and White. Retrieved October 12, 2020, from https://www.huffpost.com/entry/americas-financial-divide_b_7013330
PWC 9th annual financial survey. (n.d.). Retrieved 2020, from https://www.pwc.com/us/en/industries/private-company-services/images/pwc-9th-annual-employee-financial-wellness-survey-2020.pdf
McKernan, S., Quakenbush, C., Ratcliffe, C., Kalish, E., & Steuerle, C. (2017, October 04). Nine Charts about Wealth Inequality in America (Updated). Retrieved October 12, 2020, from https://apps.urban.org/features/wealth-inequality-charts/
Times, F. (2020, February 11). How America’s 1% came to dominate stock ownership. Retrieved October 12, 2020, from https://financialpost.com/investing/how-americas-1-came-to-dominate-stock-ownership
Gilson, D., & Perot, C. (2011, February 08). It’s the Inequality, Stupid. Retrieved October 12, 2020, from https://www.motherjones.com/politics/2011/02/income-inequality-in-america-chart-graph/F
Qianwen, B. (2020). The Impact of Financial Software Use on Financial Literacy Education — Evidence from China,19(1), 1–93.
Mack, E. (2018, February 16). The Exact Amount of Money it Takes to Make a Person Happy Just Got an Update. Retrieved October 12, 2020, from https://www.inc.com/eric-mack/the-exact-amount-of-money-it-takes-to-make-a-person-happy-just-got-an-update.html
Grable, J., & Rabbani, A. (n.d.). Are Americans Financially Illiterate? Journal of Financial Service Professionals, 74(1), 11–14.
Hamilton, D., & Darity, W. (n.d.). Race, Wealth, and Intergenerational Poverty. The American Prospect.
Hauff, J. C., Carlander, A., Gärling, T., & Nicolini, G. (2020). Retirement Financial Behaviour: How Important Is Being Financially Literate? Journal of Consumer Policy, 43(3), 543–564. doi:10.1007/s10603–019–09444-x
Conley, A. (2020, June 16). Financial Stress Escalating Among U.S. Workers During Covid-19 Pandemic; Employers Are Key to the Solution: Edelman Financial Engines. Retrieved December 14, 2020, from https://www.businesswire.com/news/home/20200616005169/en/Financial-Stress-Escalating-Among-U.S.-Workers-During-Covid-19-Pandemic-Employers-Are-Key-to-the-Solution-Edelman-Financial-Engines
Dalio, R. (2020). Why and How Capitalism Needs to Be Reformed (Parts 1 & 2). Retrieved December 14, 2020, from https://www.linkedin.com/pulse/why-how-capitalism-needs-reformed-parts-1-2-ray-dalio/
Smith, K. (2020). Why Parents Should Start Teaching Their Kids About Money At An Early Age. Retrieved December 14, 2020, from https://www.bankrate.com/personal-finance/parents-teach-kids-about-money-early-age/
Macchia, L. (2019, November 20). Why Do People Tolerate Income Inequality? Retrieved December 14, 2020, from https://hbr.org/2019/11/why-do-people-tolerate-income-inequality
Semuels, A. (2016, July 14). Poor at 20, Poor for Life. Retrieved December 14, 2020, from https://www.theatlantic.com/business/archive/2016/07/social-mobility-america/491240/
Cooper, D. (2020). Raising the federal minimum wage to $15 by 2025 would lift wages for over 33 million workers. Retrieved December 14, 2020, from https://www.epi.org/publication/minimum-wage-15-by-2025/