Art Carden  

Financial Literacy, Human Capital, and Liberal Education

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When I taught at Rhodes College, I had a serious conversation with a colleague about whether accounting should be considered part of the core of a solid liberal education. We agreed that it should: beyond the fact that imparts vocational skill, accounting helps us understand the methods by which we make sense of a lot of human action.

I'm reading Peter Temin and Hans-Joachim Voth's Prometheus Shackled: Goldsmith Banks and England's Financial Revolution after 1700. A few chapters in, I'm really impressed by their history of this segment of the bourgeoisie and their discussion of the relationships between the bankers and their customers, some of noble birth and some of meaner origins.

A few days ago, I asked whether financial literacy should be part of the core of K-12 education if we're really serious about human capital. Beyond simply "here's how to read a balance sheet" and "here's how to discount some cash flows," I think students would be well-served by understanding where these concepts come from, how they are useful, and how they have influenced the course of history. I remember James Otteson saying once that many of his students subscribe to what he calls the "milk comes from the grocery store" theory of economics in which goods and services appear or disappear according to suppliers' varying degrees of benevolence and capriciousness. My impression is that they also subscribe to the "banks pay interest because they're kind and charge interest because they're mean" theory of money and banking. One history textbook's mangling of the ideas of supply and demand raises my confidence in this impression.

Even if we take the naive view that history is a story of Great Men Who Fought Great Wars, our undertanding would be enriched if more people understood how these Great Men got the Great Big Piles of Resources necessary to fight their Great Wars. As Temin and Voth show, they did this by muscling their way into a still-young and still-evolving financial system.

I will have more to say about Temin and Voth's book as I finish it, but here is Richard Grossman's review at EH.Net.


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COMMENTS (5 to date)
JKB writes:

I would have to agree.

In regards to the history angle, I was just watching a TV program WWII from Outer Space. Just an overview giving a space-alien's view of the big events. But they did highlight the marshaling of the Hollywood army to maneuver across America as one of the first actions after Pearl Harbor. Their mission to sell bonds to finance the war. I'll have to say, it was the first time I saw such a direct link in the discussions of the "Buy Bonds" campaign to the overall success of the war effort. I remember it being mentioned in those long ago history classes but not highlighted. More as an interesting event rather than integral part. The program also highlighted the early help to Britain came at the price of some overseas bases and the dismantling of the preferred trading regime inside the Empire. Another highlight of the "accounting" required for war.

Financial literacy in students would help them come to comprehend and learn from history and to grasp that before any project great or small is undertaken, the finances must be sorted out. As well as, the base economic idea that for every project funded, some other project is left fallow.

Ken from Ohio writes:

JK-

To your point about war bonds.

During the Civil War, Jay Cooke sold about $1.3B in small denomination bonds to average citizens. Total union expenditures were about $3.3B. So Jay Cooke's successful bond program was a huge contribution to the Union's victory. In contrast, the Confederacy had very little success selling their bonds.

It's my understanding that during WWI, Germany was essentially frozen out of the international bond market, thus making their war financing very difficult.

War time financing gets very little exposure in the history books.
I agree, understanding war financing is at least as important as understanding the the other historical aspects

Shayne Cook writes:

Art:

I wouldn't disagree that accounting may be an important element of a solid liberal education.

But I would construct and teach the course[s] with an emphasis on what accounting doesn't do, can't do, and the inherent distortions in accounting, as well as what it does and how it is done.

For example, accountancy is severely limited by its Objectivity Principle. The not-so-recent "mark to market" debacle was an example of an Objectivity Principle violation. Worse, it is the Objectivity Principle that precludes the accounting discipline of even considering the existence of the phenomena economists (and economics) refer to as Consumer Surplus. Balance sheets, income statements, and statements of cash flows are wonderful things. Consumer surplus is better.

Another example is conventional cost accounting. It relates to and is driven by the Objectivity Principle. But as a tool of evaluation, conventional cost accounting is highly misleading. Philip Crosby's "Quality is Free" and Eli Goldratt's "The Goal" both offer excellent explanations of why.

In short, there is a reason behind the old tome that one should never, never let an accountant run your company (or your country). Accounting and accountancy are wonderful things, and should be applied to education promoting financial literacy. But it should be included and encased in education on the principles of economics as well.

Mark V Anderson writes:

Shayne, as a accountant I am slightly offended by your comment that one should never let an accountant run a company or a country. Of course there are shortcomings to accounting, and objectivity is probably the greatest, just as you state. But objectivity is also useful in many situations. In fact most government operations could use a lot more of the objectivity and transparency that accounting provides. The best accountants understand their profession well enough to know both the strengths and weaknesses of their profession.

I've often thought of myself as being a business mathematician. I create mathematical models of the status and flow of business (and would do the same for government if they had better accounting systems). Accounting does tend to be perhaps too much applied mathematics instead of theoretical, but it is valuable for what it does.

Shayne Cook writes:

Hi Mark,

Please take no offense at all from my comments, if you are an accountant. No criticism of accountants or the accounting discipline, within the scope of accountancy, was intended. And as for objectivity and the accounting objectivity principle, I'd say it is not only "useful in many situations", it is absolutely critical - in accountancy.

I'm an investor, among other things. I spend an enormous amount of time poring over accounting reports (balance sheets, income statements and statements of cash flows) all of the time. I spend significantly more time poring over the "Notes to the Financial Statements", by the way.

So I rely heavily on both accountancy, and the objectivity upon which accountancy is based. Kudos to you and your discipline.

However I don't rely exclusively on accountancy.

When I was teaching college business management courses, I would start each new class with the question, "Why are businesses in business?" Invariably, I'd get the same, less-than-half-right answer, "To make money!" - with enthusiasm, I might add.

I would then illustrate that businesses are actually in business to Produce Wealth - and the wealth they produce must be in BOTH of 2 forms:

Wealth Form 1.) Return on Investment (for both the capital and the labor). This, of course, is the "making money" part, as rigorously and objectively delineated by accountancy. (Thank you and your discipline again for that.)

Wealth Form 2.) Production/distribution of goods and services that make other people's lives better. (The discipline of accountancy doesn't address this, I suspect due to the fact that there supposedly isn't a metric of this wealth form that would qualify as objective. But the discipline of economics recognizes this wealth form, within its notion of Consumer Surplus.)

The upshot, and most important concept for my students is/was: "If your business or organization isn't producing any Wealth Form #2, there isn't going to be any Wealth Form #1! Never ever forget that!"

Indeed, Mark, if there was any intended criticism in my first comment, it was of the economics discipline, and not the accounting discipline. I agree completely with Art Carden (and others) who are appalled at the low level of financial literacy, and that at least basic understanding of accounting outputs should be the norm.

But frankly, I'm even more appalled how many "economists" seem to rely exclusively on accounting outputs, and aggregations of accounting outputs, without even mentioning Consumer Surplus - or even the "Notes to the Financial Statements" for that matter.

So I apologize to you.

(And I'm amused that no "economist" took the least offense from my initial comment. Perhaps one or two will take offense to this one.)


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