The Long Shadow of Socialism: On East-West German Differences in Financial Literacy

Abstract

We use the German reunification as a natural experiment to understand drivers of financial literacy accumulation. With the transformation from a planned to a market-based economy in 1990, the incentives to invest in financial literacy were changed exogenously for East Germans and remained the same for West Germans. Our results show that even 20 years after reunification there is evidence for a significant financial literacy gap between East and West. While some groups, for instance women and those who have migrated from the East to the West, show similar levels of financial literacy compared with their West German peers, others do not. Differences in financial literacy are present across all educational groups and at the top and the bottom of the income distribution. We decompose the financial literacy gap taking account of factors commonly integrated in theoretical models of financial literacy. Most of the gap remains unexplained. Extending empirical and theoretical models by including differences in attitudes and values might improve our understanding of financial literacy acquisition.

Keywords: financial sophistication, financial education, East Germany, decomposition

JEL Classification: D91