The entire Arab world is quaking at the moment as the aftershocks of Egypt and Tunisia percolate through the minds of those striving for democracy. The populations of these countries, among many other important political demands for reform, are calling for more jobs and housing. As a consequence, the rulers of many of the autocratic regimes in the region are now promising long-overdue concessions.
These concerns are primarily political but many have economic underpinnings. They are not restricted to the very poorest in society, although their concerns are, of course, pivotal. Members of the middle classes are also concerned about employment, housing, pensions and retirement. Concerns have also been expressed in the aftermath of the financial crisis about trust in financial institutions. Can they be trusted to preserve and create wealth for the ordinary public rather than merely enriching the elite? The Arab world is an extreme example of the manifestation of concerns that are highly important for people in the bottom two-thirds of the income distribution globally.
Economics has moved towards thinking about these problems more broadly. What was once the purview of specialist economists studying narrowly-defined poverty reduction problems has moved into the mainstream. One way to come at these problems is to define them in terms of the largest financial choices that households make. For example, mortgage availability and choices, personal defaults and payday lending, retirement savings, equity market participation and mutual fund investment. These decisions are affected by two equally important questions. First, are financial institutions structured and regulated in such a manner as to encourage fiscally prudent and responsible choices by their clients? This question is being actively pursued at the moment by global regulators and academics alike; presumably it will be at the top of the agenda for the new head of Sebi.
The second important line of inquiry is about whether households have sufficient financial education to correctly make choices that are optimal. Here, there are also important issues to grapple with. The evidence is that there is significant variation across individuals in their level of financial sophistication. As John Campbell described in his Presidential address to the American Finance Association in 2006, “For a minority of households, particularly poorer and less educated households, there are larger discrepancies (between observed and ideal financial behaviour) with potentially serious consequences ... these discrepancies, or investment mistakes, are central to the field of household finance.”
What investment mistakes are most