Human Capital Formation: Why Economic Literacy Compounds Like Interest

For many years now, when looking at how well children's skills in reasoning about economics develop, whether these skills were acquired through early exposure or delayed instruction is taken into account by most economic theorists who study skill development. Gary Becker and Theodore Schultz are two of the most prominent theorists to express the advantages of skill acquisition as a human capital investment. According to Becker and Schultz, skill acquisition functions like an investment in physical capital and builds on itself over time through compounding returns; therefore, any time spent at an early age developing skills will generate compounding interest for that individual over a lifetime.

Using the concept of early skill acquisition to create a better understanding of how economic reasoning will serve that individual later in life is only one of the three reasons that Becker and Schultz view early exposure to economic reasoning as critical for cognitive learning.

The first reason that Becker and Schultz offer for why children learn economic reasoning best at an early age is that skill development depends on the experiences that the individual has already acquired. Skills built upon other skills are known as "dynamic complements," and as a ten-year-old learns to reason about the use of his or her allowance or savings, he or she is creating a scaffolding of economic reasoning for use in dealing with more complex intertemporal economic-related decisions as an adult. Without the scaffolding created by the early exposure to economic reasoning, the subsequent learning will be more costly.

The second explanation for why the time of exposure to economic reasoning is important is the difference between the returns to the individual and to society. Households that expose their children to financial reasoning concepts during their formative years may not immediately see the financial return on that experience, but as the children grow older, they will receive a financial return on that exposure as they reach adulthood. Conversely, the costs to the family (time, materials, and attention) associated with exposing children to financial reasoning will be seen immediately by the family. Thus, given that the economic reasoning will have significant financial returns for an individual but not for society, it creates a situation in which the economic reasoning instruction for children is provided only within a small niche rather than universally.

The third explanation for why the time of exposure to economic reasoning is important can be clearly seen in the data regarding financial literacy across different OECD countries participating in the PISA 2022. According to the PISA 2022 results, 18% of the 15-year-olds tested across all OECD countries did not have at least a basic ability to use their financial knowledge in a real-world situation. Interestingly, those who performed well on the measure of financial literacy were 72% more likely than those who did poorly to save money, and 50% more likely to compare prices in different shops before making a purchase than low performers. These behaviors are clear indicators that their reasoning habits were formed at an early age. While socioeconomic status accounted for only about 12% of the differences in financial literacy performance among the tested students, this demonstrates that children's exposure to financial literacy is developed over time and through their environments.

Effects

The human capital theory clearly articulates the future implications of the labor market (i.e., the skills/knowledge) on an individual's future earnings and wealth accumulation, as individuals who are good thinkers regarding the trade-offs between risk vs. reward, incentives, etc., make better choices regarding their career(s), savings, and investments. The result is that an individual experiences a greater lifetime total earnings and overall wealth accumulation. This is one reason why individuals who regularly engage their parents (at least once a month) in conversations about their saving or purchasing decisions achieve significantly higher scores on tests of financial literacy: the household is as important a channel of transmission for this type of human capital as is the school.

Responses to this issue are twofold and demonstrate how various players are addressing the disparity in economic reasoning skills among children. For example, Aflatoun International has developed and implemented an early childhood social and financial education program focused on children as young as 3 years old. Private-sector educational publishers have developed entire product lines dedicated to teaching children to think economically through narrative and story-based curriculum. An example of this is the Tuttle Twins, a series of narrative-based books that teach economic principles, and for parents who are looking for a place to begin, there is a variety of curriculum materials available.

While these interventions are certainly not guaranteed to result in success, there is a common thread of sound economics in both. Skills that have compound returns should be developed early, so that they will have a sufficient period of time to benefit the individual.