Unit 6 The financial sector: Debt, money, and financial markets

6.1 How do you live if you don’t work?

Kwame and Sophia are both in their mid-50s. They have a lot in common.

Both have worked hard to support their families (he has three children and lives in Kumasi, Ghana; she has two, and lives in the suburban Midwest of the United States).

Both have struggled at times to make ends meet, particularly during periods when they have lost work. Sophia works in the financial sector, but was made redundant during the global financial crisis of 2007–2009 and struggled for a couple of years to find a new job. For Kwame, a teacher at a private school, a difficult period came during COVID-19, when, like many other people in Ghana and around the world, he lost his job during the lockdowns.

Both are working again now, but both are thinking ahead, towards a period of their life when they will no longer be working. Kwame would like to stop work at age 60, at which point he can expect to live at least a further 15 or so years. Sophia plans to retire at age 65, at which point she can expect to live around 18 more years.

How will they live if they do not work?

From Unit 3, we know that in addition to surviving, people want to smooth their consumption. How can Kwame and Sophia achieve this during the rest of their lives? In fact, both already have plenty of experience of this, which provides some clues.

Kwame attended a college of education and graduated at 21, after which he started working; Sophia didn’t start work until she had finished university, at 22. How did they live before this? The answer may seem obvious to you. They survived as most children do, primarily through the efforts of their own parents. Their governments did also help a bit. Both went to schools that were government funded, as was Kwame’s further education. In contrast, Sophia’s university education was funded partly by loans. These seemed enormous at the time—but were dwarfed by the size of her first mortgage.

But, for both, the great majority of the costs of their upbringing was borne by their parents.

The pattern has been repeated with their own kids. Indeed, while Sophia’s children attended government-funded schools, Kwame and his wife were so unhappy with the quality of state schools in Kumasi that they had to bear the additional costs of sending their children to a private, fee-paying school. Two of Kwame’s sons attended a state-funded university, but it took them several years after graduating to find work. Kwame continued to support his sons through this period, but they are both working now.

We usually take it for granted that parents take responsibility for their children, so that in the modern world most children do not need to work. (Indeed in most countries they are not allowed to.) But what about the rest of their lives?

Sophia and Kwame have each had periods without earnings, due to unemployment; additionally Sophia has taken short periods of maternity leave (which in the United States are mostly unpaid).

Sophia received unemployment insurance from the government for some of the time when she was unemployed, but she still incurred debts in this period, for example, by reaching the credit limit on her credit card. As for Kwame, during the pandemic (when unemployment was widespread), he received some help from the government, an NGO, and his local church. But he sometimes needed to use his Mobile Money platform on his mobile phone to borrow small sums. Thankfully, he was able to avoid taking a larger loan with a high interest rate.

Taking into account their childhood, periods of unemployment and their plans for retirement, both Kwame and Sophia can expect to spend just over half of their lives not working. Figure 6.1 shows their respective calculations:

How will they get by during their retirement?

Kwame has been contributing a portion of his salary to a mandatory pension scheme. However, his pension will not be enough to live on, and he expects to rely at least to some extent on his children.

His primary preparation for retirement has been to gradually build a house. Since access to mortgages is still limited in Ghana, he has used a different approach. First, in order to buy land, Kwame joined a rotating savings association known as a susu. His group had ten members, and each made a weekly contribution. Once a month, one member would receive a lump-sum payout until, over a ten-month period, all group members had received a payout. The susu Kwame belonged to helped him save money, and in time, he could purchase some land. He then started to build a house in stages—whenever he had funds available, he would make some progress. After several years, his house is gradually nearing completion.

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Houses being built ‘brick by brick’ in Ghana (top) and Indonesia (bottom).

In contrast to Kwame’s experience, Sophia and her husband were able to take out a mortgage to help them buy their family home. She narrowly escaped losing her home when she struggled to make payments on her mortgage while she was unemployed, but she just got by—partly by reaching the credit limit on her credit cards. By the time she is 60, the mortgage on the family home will have been paid off, and she and her husband expect to trade down to a smaller home. She plans to hold a significant chunk of her wealth in reserve, for medical and care costs in old age that are not covered by government support.

Like Kwame, Sophia has been making regular contributions to a government-mandated pension fund and will receive a modest pension from the US government. But her government pension is unlikely to be sufficient to maintain her current standard of living, so she has also been contributing to a personal pension pot, where her savings are mostly invested in stocks and shares.

Sophia may also receive some help from her family, though this is likely to consist largely of a modest inheritance from her parents rather than regular financial support from her children.

Sophia’s life has been more bound up with formal financial institutions than Kwame’s (not only because she makes her living from the financial sector). She has had a bank account since she was young, she took on student loans and a large mortgage, and she will rely on her pension pot to maintain her consumption level. Kwame has also made use of financial institutions, such as the rotating savings association and his Mobile Money platform. Both have experienced times when they could accumulate savings and acquire assets, and both have been able to borrow in various forms; but Kwame’s ability to borrow has been on a much more limited scale.

How will you live if and when you don’t work? For most people in the world, families and the state provide a key part of the answer. But the examples of Sophia and Kwame show that it also depends on the role of debt—and the financial sector—in the economy where you live. In this unit, we explore why and how they matter. We consider the following:

• How do we measure wealth, both at the individual and national level, and how does this relate to debt?
• What do we mean by the word ‘money’?
• What functions does the financial sector perform in the economy?

This unit addresses the question posed by the story of Kwame and Sophia. It also fills out the three-diagram macroeconomic model in Unit 5 by explaining how money, banks, and financial institutions are related to monetary and fiscal policy.

We start with a fundamental concept: debt.