THE CATHOLIC UNIVERSITY OF MALAWI

FACULTY OF SOCIAL SCIENCES

DEPARTMENT OF ECONOMICS

RESEARCH PROPOSAL ON THE TOPIC

THE IMPACT OF FINANCIAL LITERACY ON ECONOMIC DEVLOPMENT IN

MALAWI

BY

JUDAH MWEPA

BSOCECO/NE/2019/0836
 CHAPTER ONE

1.1 Introduction

Financial literacy remains an interesting issue in both developed and developing economies, and
has elicited much interest in the recent past with the rapid change in the finance landscape.
World Bank et al (2009) defines financial literacy as a “combination of consumers‟/investors‟
understanding of financial products and concepts and their ability and confidence to appreciate
financial risks and opportunities, to make informed choices, to know where to go for help, and to
take other effective actions to improve their financial well-being”.

Financial literacy helps in empowering and educating consumers so that they are knowledgeable
about finance in a way that is relevant to their lives and enables them to use this knowledge to
evaluate products and make informed decisions. It is widely expected that greater financial
knowledge would help overcome recent difficulties in advanced credit markets. More recently,
literature suggests that financial literacy is a component of financial capability. Financial
capability is defined as the internal capacity to act in ones best financial interest, given
socioeconomic and environmental conditions (World Bank, 2013).

Financial literacy prepares consumers for tough financial times, through strategies that mitigate
risk such as accumulating savings diversifying assets, and purchasing insurance. Financial
literacy facilitates decision making processes such as payment of bills on time, proper debt
management which improve the credit worthiness of potential borrowers to support lively hoods,
economic growth, sound financial systems, and poverty reduction.

Facing an educated lot, financial regulators are forced to improve the efficiency and quality of
financial services through demand for better products and services by consumers, in the course,
reducing the service provider’s information advantages (World Bank et al, 2009). This is because
financial literate consumers create competitive pressure on financial institutions to offer more
appropriately priced and transparent services, by comparing options asking the right questions
and negotiating more effectively.

Jappelli (2010) argues that “lack of financial literacy may create more favourable conditions for
deceitful financial practices and unfair competition in financial markets, and be a serious
impediment to effective financial intermediation”.
Mounting evidence shows that those who are less financially literate are likely to face more
challenges with regard to debt management, savings and credit, and are less likely to plan for the
future. Therefore, regulators of financial services, have a responsibility to help consumers of
financial services in making informed financial decisions so as to promote consumer protection,
public awareness and maintenance of market confidence.

Financial literacy can also promote stability of the financial and economic system thereby
promoting economic growth and development (Shambare and Rugimbana, 2012; World Bank et
al, 2009).

1.2 Background

Generally, the international evidence on financial literacy show that a large proportion of adults
knows very little about financial matters with many individuals being unfamiliar with basic
concepts on interest rates, insurance, shares and debt (Jappelli, 2010). World Bank et al (2009)
review of empirical evidence on importance of financial literacy reveals that most consumers in
the developed countries perform poorly in financial literacy tests, although they tend to overstate
their skills, and do not practice basic financial skills (such as budgeting and savings or retirement
planning). In a study conducted in the USA, only 34% of young adult respondents could
correctly answer all three financial literacy questions (de Bassa Scheresberg, 2013).

Although there is scanty evidence on financial literacy in the developing countries, there is
indicative evidence that developing countries tend to have lower levels of financial literacy. In
South Africa about 60% of people in household surveys did not understand the concept of
interest while in Zambia about 67% were unfamiliar with basic financial products including auto
teller machines and debit cards (World Bank et al, 2009). Shambare and Rugimbana (2012) find
that even among the educated students in South Africa, the level of financial literacy was still
moderate. Xu and Zia (2012) also note that financial literacy levels are generally low even in
high income countries; they are much lower in low income countries.

There are several factors that can be associated with the level of financial literacy. In Australia,
low levels of financial literacy were found among individuals with lower education levels, lower
incomes, unemployed, lower savings levels, those that are single and those on the extreme ends
of adult age groups (Roy Morgan Research, 2003). Similarly, de Bassa Scheresberg (2013) finds
that young adults in the USA lacked basic financial knowledge particularly among women,
minorities, and lower-income or less-educated individuals.

Xu and Zia (2012) in a review of international evidence also show that financial literacy is
affected by level of education, level of income and wealth, age, gender, geographic and ethnic
disparities, retirement planning and level of sophistication in investment behaviour. Fonseca et al
(2012) find that females had lower levels of financial literacy than males, but these differences
were not due to differences between their characteristics but by differences in coefficients or how
literacy is produced.

In Malawi the knowledge of financial terms such as interest rate, insurance, shares, stock
exchange, inflation and devaluation is low, and the non-existence of equivalent local language
terms (except for interest rate) made matters worse. The interest rate is mostly known what it
means by 43%, insurance and shares are known by 28% each, stock exchange is only known by
6%, inflation is known by 7% and devaluation is known by 14% of respondents. There are,
however, urban – rural biases in knowledge of these concepts with much higher levels in the
urban areas compared to rural areas.

The incidence of poverty in Malawi remains high, estimated at 50.7% of people living below the
poverty line in 2011 (NSO, 2012). Malawi has one of the lowest per capita GNI of $280 in the
world. It is estimated that 24.5% of Malawians are ultra-poor, who struggle to meet basic food
needs (NSO, 2012). The situation is exasperated by high levels of illiteracy, the national literacy
rate for persons over the age of 15 years being 65.4%, and limited employment opportunities.

1.3 Problem Statement

The problem addressed in this research relates to the complexity of financial literacy
phenomenon to act as a mechanism in economic development. This phenomenon relates to the
perception that financial literacy involves two separate systems (the information system and the
human behavior system), which means that it is not regarded as a single encompassing process.
It also relates to the gap between complex financial and economic information, on one hand, and
the decision makers mental processes, on the other. Africa's financial literacy is the worst of all
continents. Only one country, Botswana, breaks the 50% barrier, with more places falling in the
31%-40% range. Over the past few years, adult Malawians have gained greater access to formal
financial services. While only 17% of adult Malawians had access to formal financial services in
2013, this figure reached 29% in 2018 (Financial Literacy Report, 2018)

The research problem focuses specifically on the complexity of the financial literacy construct
with regard to its role in economic development. The problem is that those who are financially
illiterate have difficulties in saving money, investing, dealing with debts, budgeting, borrowing,
earning and saving.

Those who study financial literacy generally agree that any, if not most, consumers lack the
financial literacy necessary to make important financial decisions in their own best interests
(Perry, 2008). Experts also generally agree that, financial knowledge appears to be directly
correlated with self-beneficial financial behaviour (Hilgert et al., 2003).

However, questions exists concerning the effectiveness of financial education in improving

financial literacy (Lyons et al., 2006). Thus, a paradox exists between the efficacies of
education in improving financial literacy and the impact of education on short and long term
financial behaviour.

1.4 Research Objectives

1.4.1 Main Objective

The main objective of this study is to empirically examine the impact of financial literacy on
economic development in Malawian economy.

1.4.2. Specific Objectives

1.5 Research Hypothesis

The hypothesis that will guide through this research is:

H1: Financial literacy has significant relationship with economic development in Malawi.

H0: Financial literacy has no significant relationship with economic development in Malawi.

1.6 Significance of the Study

The quality of research work lies on the relevance to the society being studied. The importance is
the ability to raw a relationship between financial literacy and economic development in
Malawian economy, whether financial literacy has significant impact on Malawi economic
development

Again this research will be of immense value to both the public and private sector of the
economy mostly individuals.

In conclusion, the study would be of immense help to the government, individuals, economists,
financial analysts, and planners by shedding more light into the widely held view about the
relationship between financial development and economic development

1.7 Scope of the Study

The economy is a large component with a lot of diverse and sometimes complex parts; this
research work will only look at a particular economy (the education sector). This work cannot
cover all the facets that make up the education sector, but will look at the financial literacy as
being used by the government for the stabilization and attaining economic development.

The data for this study would be obtained mainly from secondary sources; particularly Reserve
Bank of Malawi (RBM) as well as the World Bank.

1.8 Organization of the Study

The study will divide into five chapters. Chapter one has presented the following areas namely;
Introduction, background, problem statement, study objectives, study hypothesis, significance of
study, scope of the study, and organization of the study. Chapter two will review related
literature, which will include theoretical literature review and empirical literature review.
Chapter three will present the research methodology, estimation methods, and data sources.
Chapter four will present and interpret the estimated results. Finally, chapter five will conclude
the study and present some policy recommendations based on the findings analysed.

CHAPTER 2

LITERATURE REVIEW

2.1 INTRODUCTION

The aim of this chapter is to review literature in relation to the impact of financial literacy on
economic growth. The chapter has been divided into two parts, the first part presents the theories
guiding this study and other theoretical literature whilst the second part present the empirical
literature on the impact of financial literacy on economic growth. The empirical review looks at
different research papers/topics by different authors on the results of their research concerning
financial literacy impact on economic growth.

2.2 THEORETICAL LITERATURE REVIEW

This section presents the fundamental financial theories that are commonly used to explain
financial literacy.

2.2.1 Self-efficacy Theory

Self-efficacy theory is proposed to be a predictive factor of the level of financial literacy. Self-
efficacy theory, in this case the motivational construct (manage finances, use credit cards less,
and control debt). Self-efficacy is a belief about the abilities, someone can carry out his work
successfully because he looks at the opportunity with some of his actions to obtain results.
Individuals with high self-efficacy will be diligent in doing something, have fewer doubts and
doing activities as well as looking for new challenges (Wood and Bandura, 1989). Individuals
with high levels of self-efficacy have the confidence that they are able to manage and plan their
financial successfully and better. The confidence motivates them for optimal performance.

Bandura (1997) stated self-efficacy is an individual generative capabilities that includes

cognitive, social, and emotional. In the context of financial literacy, this theory is related to how
individuals manage their ability to understand financial products and services, to be well-literate
to a variety of financial products and services that are always dynamic and fluctuate.

2.2.2 Goal Setting Theory of Motivation

Goal setting theory of motivation, in this case the goal commitment and goal specificity
construct (financial planning). Mitchel (1997) stated that motivation is a process that explains the
intensity, direction, and persistence of an individual to achieve his goal. The three main elements
in this definition are the intensity, direction, and persistence. Motivation is the deciding factor for
someone to do something, including in understanding the various aspects related to products and
services of financial industry.

There are some studies discussing about the link between motivation and financial literacy, for
example, Hogarth and Angelov (2003) that found an association between poor families with a
low amount of savings resulting from the low motivation (willpower) in realizing anything,
moreover, Mandell and Klein (2007) found that motivational variables significantly improve the
financial literacy skills, further, it is explained that the motivations are able to change the
behavior of individuals in managing finances and ultimately improve the financial literacy (well-
literate).

Context of this article, the motivational theory approach that is used to design the financial
literacy strategies and concepts is goal-setting theory of motivation. Locke et al. (1981)
explained that the concept of motivation is used to describe the direction, magnitude (level of
effort), and duration (or persistence) of behavior. When someone’s think about the purpose, then
they are required to be able to consider the meaning of the achievements, especially when seems
difficult. Goal setting theory is a form of motivation theory which emphasizes the importance of
the relationship between the goals set and the resulting performance. The basic concept is that a
person who is able to understand the purpose that is expected by the organization, so that
understanding will affect its behavior. From all the goal-setting processes, goal commitment and
goal specificity are the most relevant to the context of financial behavior.

While goal setting is a process used to set the goal, in this case is financial planning. Goal setting
has a very big influence on the performance of the individual in planning financial targets. Jack
et al. (2004) defines the individual financial planning as a process to manage individual’s
finances to achieve personal economic satisfaction. This planning process can help individuals to
control their financial condition. Every individual, family has different conditions for planning
financial to fulfill of needs and specific goals.

2.3 EMPIRICAL LITERATURE REVIEW

There have been various academics who have looked into comparable issues. As an example;

Most of the existing literature on financial literacy focuses on money management; for example,
jelly measured the level of financial literacy among 20-year-old students and found that they are
highly aware of budgeting and managing personal finance. Similar results were obtained by
Furrer (Furrer 1960) and Larson (Larson 1970). But (Langrehr 1979) and (Thompson 1965)
demonstrated that school students have a low level of financial literacy in general or in some of
its aspects, such as personal earnings, consumer lending and investment.

As for earlier fundamental research in this sphere, Danes and Hira (Danes, Hira, 1987) estimated
that financial literacy among population was at the medium level and pointed out the importance
of introducing financial literacy as a separate discipline at all levels of education. Similar results
were obtained by the series of studies of Jumpstart coalition (1997, 2000, 2009 rr.) (Jumpstart
Coalition 2009), and by Lusardi A., Mitchell O. (Lusardi, Mitchell, 2007). Financial literacy
started to be measured on the global scale when the OECD administered a survey of financial
literacy among students within the framework of their international programme ‘PISA 2012’
(Programme for International Student Assessment) (OECD, 2014).

Apart from the studies of financial literacy levels, there is also research on the impact of
financial literacy on specific components of the financial system; for example, Danes,
Huddleston-Casas and Boyce (1990) and Bwerheim, Garrett and Mak (2001) found that students
who completed a financial literacy course increased their savings rate. According to Brown,
Collins, Schmeiser and Urban (2001), people who took specialized courses of financial literacy
tended to have lower loan interests and minimal loan delinquency, while Tennyson and Nguyen
(2001) demonstrated that financial literacy courses have a positive impact on people’s career
progress. Research on financial literacy has a rich history, which started from studies conducted
by separate research groups (predominantly American). Recently, enhancement of financial
literacy has begun to be considered as a major international task, which significantly increased
the scale of research in this sphere.

CHAPTER THREE
METHODOLOGY

3.1 Introduction
The methodology of the study will cover the source of the data, method of data analysis, the
model specification, variable definitions and the expected tests to be run.
3.2 Data Sources
Time series data will be in use as far as this research is concerned. According to Gujarati and
Porter (2009), a time series data is a set of observations on the values that a variable takes at
different times, of which it can be collected at regular time intervals. The research only
employed secondary data sources and the information was obtained from the Reserve Bank of
Malawi (RBM), World Bank and the OECD.

3.4 Description of Variables

3.4.1 Dependent Variable
The dependent variable in this study is financial behavior. Individuals’ well-being including
household, society, nation as well as around the world can be influenced by financial behaviour.
According to Perry and Morris, financial behaviour is defined as the management of a person’s
savings, expenditure, and budget, whereas Xiao asserts that human activities related to money
management such as cash, savings, and credit are regarded as financial behaviour. In a wider
view, financial behaviour includes broad concepts including investment behaviour for short-term
and long-term, savings behaviour, credit usage, expenditure behaviour, etc.

3.5 Diagnostic tests for the study

For the findings obtained from the data to be meaningful, the model stated above must meet
many conditions. This data collection (time series) is commonly tainted by auto correlation and
non-stationarity; we must ensure that this is not the case. Several more tests must also be
performed to confirm the data's validity and dependability.

Co-integration Test

Gujarati, 2004 stated that a data set's variables or parameters are co-integrated if they have a
long-term, or equilibrium relationship. The concept of co-integration is useful since it allows us
to determine whether the regression residuals are stationary. Johansen test will be used to
conduct this test.

Autocorrelation test

This measure assesses the correlation between observations made at various points of time (time
series). It has a range of -1 to 1. Positive autocorrelation means that when a time interval
increases, the lagged time interval increases proportionately. Negative autocorrelation occurs
when a rise in a time interval is accompanied by a corresponding decrease in the lagged time
interval. The Lagrange-multiplier test will be used to diagnose this.

Normality test

The test will be used to see if a data set is well described by a normal distribution and to
calculate the likelihood that a random variable underlying the data set is normally distributed.
The Jarque-Bera test will be used. With a large number of observations, a normal distribution is
frequently seen.

3.5.2 Multicollinearity test

The problem of multicollinearity comes about when there is a high linear association among
explanatory variables (Gujarati, 2003). Since the study deals with multiple variables, it is
necessary to test if there are perfect or exact linear relationships among the explanatory
variables. To detect -multicollinearity, this study used the variance inflation factor (VIF).

3.5.3 Heteroscedasticity test

One of the most important assumptions of the CLRM is that of homoscedasticity. This
assumption states that the variance of each disturbance term condition upon the chosen
explanatory variables, is some constant number equal to σ2 (Gujarati, 2003). A violation of this
assumption in such a way where the variance of error term tends to vary, it means that there is
heteroscedasticity and thus the estimates of regression coefficients are not efficient. This study
used the Modified Wald test for group-wise heteroscedasticity in a fixed effect regression model
to test for heteroscedasticity.