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Problematic debt: EU vs. Australia

By Daniel Richards, Abdullahi Ahmed & Muhammad Tahir
Posted on June 11, 2019

“Apply for a credit card, get a response in 60 seconds!” Access to debt is, indeed, within easy reach for many households. However, when debt repayment is high, relative to disposable income, it can quickly spiral out of control.

Previous research shows that unmanaged problematic debt is related to various mental health issues1 such as anxiety and depression2, and may cause heart issues or migraines3. The tendency to take on debt can be caused by circumstances beyond our control, like income level, age and employment status.

The tendency to take on debt can be caused by circumstances beyond our control, like income level, age and employment status. Our research team allows for these factors, but we are primarily interested in psychological factors that can explain the tendency to take on problematic debt.

Our research focuses on two psychological areas: financial literacy, capability and well-being on the one hand, and country-based cultural differences on the other.

“In many countries governments have initiatives to improve the population's financial literacy. Our research investigates if financial literacy is truly related to problematic debt.”

1. Financial literacy, capability and well-being

The concepts of financial literacy, financial capability and financial well-being are all related. Our research attempts to identify the relationships between these concepts and how a mixture of all three is needed to understand problematic debt.

Governments and educational institutions in many different countries have initiatives to improve the financial literacy of the general population. The idea is that more knowledge of personal finance will enable better money management skills, leading to less problematic debt. Research shows that parents teaching financial literacy to children reduces debt issues in low to moderate income families4.

Our research investigates if financial literacy is truly related to problematic debt. If we find such a link, it suggests that education could be a method of reducing problematic debt in households. The implications of this link would be rather big.

Where financial literacy focuses on knowledge, financial capability focuses on the way people apply their financial knowledge to their financial situation. Can they manage their money and keep track of their finances? Can they save for future events? Can they can make informed financial decisions? And can they deal with financial institutions? People who are financially capable can make informed financial decisions. In our research, we aim to find whether being financially capable decreases the tendency to take on problematic debt.

A final concept we want to study is financial well-being, as we believe that financial knowledge and financial capability forms only half of the problem. The other half is a person’s subjective experience of their finances. Do they perceive themselves to be in a strong and improving financial position? Do they feel positively about their financial outlook? A subjective experience of finance is vital because similar financial situations can be perceived differently. We want to find out whether or not financial well-being is related to problematic debt.

2. Country and country-based cultural differences

Debt levels differ between countries, and change over time. An interesting trend over the past five years is illustrated in figure 1 and 25. Figure 1 shows that debt to GDP levels of European Union countries is decreasing since 2013; figure 2 shows increasing debt for Australia since 2013.

Figure 1. Household debt to GDP ratio of Euro countries for the period 2013-18
Figure 1. Household debt to GDP ratio of Euro countries for the period 2013-18
Figure 2. Household debt to GDP ratio of Australia for the period 2013-18
Figure 2. Household debt to GDP ratio of Australia for the period 2013-18

Taking on debt is more common in Australia than in Eurozone countries. We investigate country-level cultural dimensions to ascertain their relationship to debt taking of a household. We draw on the work of Hofstede6, 7, 8, 9, who compared countries in terms of six factors: distance, individualism, masculinity, uncertainty avoidance, long-term orientation and indulgence.

Of these 6 factors, long-term orientation and indulgence are of most interest to our research. We suspect that countries high in long-term orientation will have less uptake of problematic debt because their citizens will plan for the future. Conversely, we suspect that citizens in countries with high levels on indulgence will stimulate problematic debt taking behaviour.

“We will focus on the initiatives that policymakers, government agencies and individuals can take to successfully avoid problematic debt”

Methodology and impact

Our quantitative research techniques will include logistic regression and principle component analysis. We will turn to quantitative data from 2 surveys that are nationally representative and widely accepted in the academic world: ING’s 2016 Savings Survey and the Household, Income and Labor Dynamics in Australia (HILDA) survey.

The ING survey contains valuable information on household finances and problematic debt taking, including responses from various countries (although we will focus only on the Eurozone countries and Australia). The HILDA data set contains in-depth information about financial literacy, financial capability and financial well-being of Australian citizens.

In our research, we will focus on the initiatives that policymakers, government agencies and individuals can take to successfully avoid problematic debt. We’ll study the impact of financial literacy, financial capability and financial well-being to identify whether policy should incorporate financial capability or financial well-being too. The incorporation of cultural dimensions is crucial, as it will determine whether certain country level traits are related to problematic debt taking.

Daniel W. Richards (Lecturer in Wealth Management at RMIT University, Melbourne), Abdullahi D. Ahmed (Associate Professor in Wealth Management at RMIT University), Muhammad S. Tahir (PhD Scholar with a major in Personal Finance and Financial Planning at RMIT University)

Footnotes

  1. 1. Turunen, E & Hiilamo, H 2014, 'Health Effects of Indebtedness: A Systematic Review', BMC Public Health, vol. 14, no. 1, p. 489
  2. 2. McLaughlin, KA, Nandi, A, Keyes, KM, Uddin, M, Aiello, AE, Galea, S & Koenen, KC 2011, 'Home Foreclosure and Risk of Psychiatric Morbidity during the Recent Financial Crisis', Psychological Medicine, vol. 42, no. 7, pp. 1441-1448.
  3. 3. Jarl, J, Cantor-Graae, E, Chak, T, Sunbaunat, K & Larsson, CA 2015, 'Trauma and Poor Mental Health in Relation to Economic Status: The Case of Cambodia 35 Years Later', PLOS ONE, vol. 10, no. 8, p. 136-410.
  4. 4. Grinstein-Weiss, M, Spader, JS, Yeo, YH, Key, CC & Freeze, EB 2012, 'Loan Performance among Low-Income Households: Does Prior Parental Teaching of Money Management Matter?', Social Work Research, vol. 36, no. 4, pp. 257-270.
  5. 5. Retrieved from: www.tradingeconomics.com
  6. 6. Hofstede, G 1980, Culture's Consequences: International Differences in World-related Values, Sage Publications,, Beverly Hills, CA.
  7. 7. Hofstede, G 1991, Cultures and Organizations: Software of the Mind, McGraw-Hill Publishers, London, UK.
  8. 8. Hofstede, G 2001, Culture's Consequences: Comparing Values, Behaviors, Institutions, and Organizations across Nations, second edition, Sage Publications,, Beverly Hills, CA.
  9. 9. Hofstede, G 2011, 'Dimensionalizing Cultures: The Hofstede Model in Context', Online Readings in Psychology and Culture, vol. 2, no. 1, pp. 3-26.