Financial literacy and support for free trade in the UK

• Date: 01 August 2020
• Author: Beatrice Magistro
• Published date: 01 August 2020
• DOI: http://doi.org/10.1111/twec.12951

2050

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wileyonlinelibrary.com/journal/twec World Econ. 2020;43:2050–2069.

© 2020 John Wiley & Sons Ltd

Received: 17 July 2019

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Revised: 10 January 2020

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Accepted: 10 February 2020

DOI: 10.1111/twec.12951

ORIGINAL ARTICLE

Financial literacy and support for free trade in the

UK

BeatriceMagistro

Department of Political Science, University of Washington, Seattle, WA, USA

KEYWORDS

financial literacy, free trade, globalisation

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INTRODUCTION

Western liberal democracies and open economies are under stress. Nationalist parties have achieved

significant power in several European countries, such as France, the Netherlands and Italy. The United

Kingdom voted to leave the European Union. Donald Trump was elected president of the United

States on a platform of economic protectionism and has engaged in a trade war with China. This shift

towards isolationist and nationalist policy ultimately reflects preferences held by individuals, many of

them economic in nature.

Why, despite overall benefits to national economies, some people still oppose free trade?

1On free

trade see: http://www.igmch icago.org/surve ys/free-trade, Alcala and Ciccone (2004) and Frankel and

Romer (1999). Several theories have been formulated about which factors are more likely to explain

such policy preferences. Various scholars have investigated what shapes people's attitudes towards

trade (Burgoon & Hiscox, 2008; Hainmueller & Hiscox, 2006; Mansfield & Mutz, 2009; O'Rourke &

Sinnott, 2001; Scheve & Slaughter, 2001a; Walstad, 1997) and despite nuances, these theories agree

that preferences for economic openness are largely driven either by self-interest considerations or by

cultural concerns.

I depart from extant theories in important ways. I hypothesise that financial literacy affects trade

policy preferences. Apart from a few exceptions (Fornero & Lo Prete, 2019; Mansfield & Mutz, 2009;

Walstad, 1997), none of the existing studies has investigated the effects of financial literacy on eco-

nomic policy preferences. None has articulated a theory with strong microfoundations or formalised

their intuitions, let alone tested them in a rigorous manner.

In order to clarify the underlying theoretical mechanisms, I introduce a heuristic model that describes

how financial literacy impacts policy preferences. Financial literacy affects the accuracy with which

an individual evaluates the short-term and long-term expected costs and benefits of a certain policy.

When financial literacy increases, voters who are harmed or helped by certain economic policies are

expected to weigh the costs and benefits of that policy with more precision and less bias. This allows

financially literate individuals to make better predictions about the effects of a specific public policy on

On free trade see: http://www.igmch icago.org/surve ys/free-trade, Alcala and Ciccone (2004) and Frankel and Romer (1999).

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MAGISTRO

their economic well-being. Conversely, financially illiterate individuals are less likely to be accurate at

evaluating the costs and benefits of a policy. Instead, they may be more likely to rely on other factors

such as culture, political ideology, identity or cues from reference groups to make their policy decisions.

In doing so, I draw on a growing literature. Recent studies have analysed the effects of financial

literacy on retirement choices and savings decisions (Lusardi, 2009; Lusardi & Mitchell, 2014); how-

ever, the literature investigating the relationship between financial literacy and policy and political

preferences is still in its early stages (Fornero & Lo Prete, 2019; Montagnoli, Moro, Panos, & Wright,

2016). Financial literacy may be important not only for household decisions, but also for public de-

cisions, facilitating the introduction of welfare-enhancing reforms (Fornero, 2015). As Stigler (1970,

p.79) wrote in 1970, advocating for economic literacy, "economic logic does not tell us what to do,

but it teaches us to look for the non-obvious costs and benefits of various policies".

To empirically support the argument, I start with an analysis of the British Election Study (BES)

data, the most comprehensive available dataset that has questions on both financial literacy and policy

preferences. I test the hypothesis that financial literacy affects trade policy preferences. Financially

literate winners from globalisation (i.e., those with high incomes, with tertiary education, performing

non-routine jobs or living in areas not highly exposed to the Chinese import shock2) should be more

likely to support free trade than similar financially illiterate individuals. Conversely, financially liter-

ate losers from globalisation (those with low incomes, with secondary education or less, performing

routine jobs, or living in areas highly exposed to the Chinese import shock) should be less likely to

support free trade than similar financially illiterate individuals.

The findings suggest that financial literacy does affect preferences for free trade. However, surpris-

ingly, there is not a differential effect between winners and losers from globalisation, as hypothesised.

Financially literate individuals, regardless of self-reported or objective economic self-interest, are

more likely to think that free trade with the EU is good for the British economy, than similar finan-

cially illiterate individuals.

As a robustness check, to make sure that my results are not driven by the choice of this specific

economic policy, I test the hypothesis on other economic policy preferences, specifically for EU mem-

bership and immigration. Financially literate individuals, regardless of economic condition, are more

likely to favour remaining in the European Union, and to think that immigration is good for the British

economy. Furthermore, a second concern addressed in the robustness checks is that financial literacy

may have little to do with self-interest and the ability to conduct accurate cost–benefit calculations;

rather, it may be a proxy for more liberal views in general, both economic and social, including toler-

ance for out-groups. I address this possibility by looking at the relationship between financial literacy

and social policy preferences. Once I condition on potential confounders, financial literacy has no re-

lationship with social policy preferences, suggesting that financial literacy is not a proxy for tolerance

for out-groups and progressivism.

My theory and findings carry important implications. As recent events in the developed world have

illustrated to researchers, voters' economic policy preferences matter. They affect trade flows, immi-

gration policy and whether to leave or remain in the European Union. The current backlash against

globalisation and European integration could lead to major welfare losses for the overall population.

The results suggest that financial and economic education may have the potential to increase support

for welfare-enhancing reforms and to aid detecting welfare-reducing ones.

The remainder of the paper is organised as follows. Section2 reviews prior approaches in the lit-

erature, Section 3 lays out the theoretical argument, Section 4 presents the data and models, Section

2The Chinese import shock refers to the sudden increase in the Chinese share of total manufacturing imports in the United

Kingdom from the end of the 1980s until 2007 as measured by Colantone and Stanig (2018).