Financial capability and psychological health

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Abstract

Financial capability is receiving increasing interest among policy makers, who wish to reduce problem debt and welfare dependency and increase savings and general skills. We examine whether financial capability has impacts on psychological health independent of income and financial resources more generally using a nationally representative survey. Data from the British Household Panel Survey 1991–2006 are used to construct a measure of financial capability, which we relate to respondents’ psychological health using the 12-item General Health Questionnaire. Estimates from within-group panel data models indicate that financial capability has significant and substantial effects on psychological health over and above those associated with income and material wellbeing more generally. For men, having low financial capability has an effect larger than that associated with being unemployed, while for women it is similar to that of being divorced. Furthermore having low financial capability exacerbates the psychological costs associated with unemployment and divorce, while high financial capability reduces these costs.

Highlights

► Policymakers are becoming increasingly interested in financial capability. ► Financial capability is conceptually different from income and material wellbeing. ► We construct a measure of financial capability from variables in a general household. ► Financial capability is found to have large impacts on psychological health. ► Teaching financial skills to young people will increase their psychological health in later life.

Introduction

Policy makers in Britain are increasingly interested in financial capability. The National Strategy for Financial Capability was introduced in 2003 (FSA, 2003) while in 2007 the long-term aims to improve financial capability were published, citing lasting benefits for individuals and the wider economy (HM Treasury, 2007). In a recent review of the primary school curriculum, the teaching of financial capability skills to children was endorsed (QCDA, 2009). The expected benefits of these initiatives include reducing problem debt and welfare dependency while increasing savings and general skills, with additional effects on poverty, stress, ill-health, life-chances and social exclusion also envisaged. We use data from the first 16 annual waves of the British Household Panel Survey to examine whether financial capability affects an individual’s psychological health independently of the impacts associated with financial resources more generally.

Financial capability is conceptually different from income or material wellbeing and reflects people’s ability to manage their money and take control of their finances (Atkinson, McKay, Kempson, & Collard, 2006). It is concerned with making appropriate financial decisions, understanding how to manage credit and debt and identifying appropriate products and services (Mason and Wilson, 2000, Noctor and Stoney, 1992). The complexity of skills required to be financially capable will vary across households and depend on a range of factors such as household size and composition, housing tenure, income and expenditure patterns and so on. Regardless of how much money they have, people require financial management skills, and these become even more important during an economic downturn when additional pressures are placed on households’ finances. Over the last two decades credit has become more widely available, responsibility for provision in retirement has increasingly fallen onto individuals and the costs of higher education are increasingly borne by students. Therefore the consequences of a lack of financial capability are becoming progressively more serious. However qualitative studies suggest that many people are not well informed about financial products, undertake little long-term planning or budgeting and most financial decisions are reactive rather than proactive (Financial Services Consumer Panel, 2003a, Financial Services Consumer Panel, 2003b).

Recent studies have attempted to measure financial capability and its impacts using survey data. For example Atkinson et al., 2006, Atkinson et al., 2007, using a survey commissioned to explicitly measure financial capability in Britain (FSA, 2006), identify five contributory domains: making ends meet, managing money, planning ahead, choosing products and staying informed. They create scores within each domain and conclude that older people, people with higher incomes and those in couples with no dependent children have greatest financial capability while younger people, people in couples with dependent children, single people and those with lower income have least. Taylor (2011) uses British survey data to construct a measure of financial capability and similarly reports strong correlations with age, household structure and employment status. Melhuish, Belsky, and Malin (2008) use a sample of mothers on low income and find that greater financial capability is associated with higher psychological wellbeing.

There is a large literature describing associations between various indicators of financial distress and psychological ill-health (e.g. Bridges and Disney, 2010, Marmot et al., 1997, Taylor et al., 2007, Weich and Lewis, 1998). Although the causality of such links is sometimes questioned, studies using longitudinal data suggest that debt and financial stress cause psychological problems (Marmot et al., 1997, Stradling, 2001, Taylor et al., 2007, Webley and Nyhus, 2001). Similarly consumer debt, mortgage indebtedness, arrears, repossession and eviction have been shown to cause anxiety and psychological ill-health (Brown et al., 2005, Ford et al., 1995, Nettleton and Burrows, 1998, Pevalin, 2009, Taylor et al., 2007). However, many such studies focus only on psychological distress – they concentrate on the extreme of the distribution rather than the whole continuum.

Our contribution to this literature is to assess the impact of financial capability on psychological health when allowing for other confounding factors and measures of economic resources such as household income, employment status, family structure and housing tenure. Following Taylor (2011), we construct a financial capability measure from variables in a general household survey that relate directly to people’s abilities to make ends meet and their money management. This rests on the hypothesis that there is some underlying factor (financial capability) which is better captured by reviewing a range of indicators of a person’s current financial situation than by any of the specific items of information individually. This is similar to how researchers construct deprivation measures using lifestyle indicators (Burchardt et al., 2002, Cappellari and Jenkins, 2007, Gordon et al., 2000, Layte et al., 2001, Mack and Lansley, 1985, Whelan et al., 2003, Whelan et al., 2001). We extend existing research by (i) distinguishing between financial capability, income poverty and economic resources within a nationally representative sample of adults in Britain; and (ii) assessing the impact of financial capability on psychological health over and above the impacts of income and economic wellbeing more generally. We adopt statistical techniques that account for unobserved factors likely to be associated both with financial capability and psychological health, and which may otherwise bias estimates from multivariate models.

Section snippets

Theoretical framework

We anticipate that a person’s financial capability affects their psychological health through two processes. Firstly, financial capability is likely to be correlated with other observable characteristics that affect psychological health, such as income and material wellbeing. The financially capable will manage their incomes more efficiently and, all else equal, have higher levels of disposable income (or lower levels of debt) than the less financially capable with otherwise similar

Data

We use data from waves 1–16 of the British Household Panel Survey (BHPS), covering the survey years 1991–2006. The BHPS is a panel survey which (re)interviews the same individuals annually. The first wave was designed as a nationally representative random sample of the population of Great Britain living in private households in 1991. These original respondents and any adult co-residents have been followed and interviewed at annual intervals ever since, with information collected about their

Estimation strategy

In estimating the impact of financial capability on psychological health, it is important to consider both observed factors (such as income and material wellbeing) and unobserved factors (such as personality traits and psychological characteristics related to, for example, a person’s locus of control) that are likely to be associated both with financial capability and psychological health (Bridges and Disney, 2010, De Neve and Cooper, 1999). We control for observable factors by estimating

Results

Table 7, Table 8 present estimated coefficients for male and female heads of households respectively. We distinguish between men and women because of differences in household structures, labour supply, preferences and the determinants of psychological health (Arber, 1991, Hauck and Rice, 2004, Juong et al., 1997, Piccinelli and Wilkinson, 2000, Taylor et al., 2007, Wildman, 2003).

Summary and conclusions

We have examined the impact of financial capability on an individual’s psychological health, independent of the impacts associated with income, financial resources and financial shocks more generally. Having high financial capability is particularly crucial during economic recessions when a large proportion of the population experience anxiety and stress about their financial wellbeing. Financially capable people are more able to manage their income, understand how to use credit and debt

Acknowledgements

We thank the editor and anonymous referees for their constructive comments and suggestions. This work originates from a project funded by the Financial Services Authority, which had no involvement in the study design, in the collection, analysis and interpretation of data, in the writing of the paper or in the decision to submit the paper for publication. BHPS data are available from the UK Data Archive. This research also forms part of the scientific programme of the Institute for Social and

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