Trust and Economic Outcomes
For some time now, I have assigned students in my Political Economy class a well-known paper by Knack and Keefer on social capital and its connection to economic development. Kenneth Arrow (1972) also argued that trust was a predictor of economic success. In short, trust is an important element in market exchange. Glaaeser et al (2000) have dealt with the same issue, finding that both trust and trustworthiness rise when individuals are socially closer to each other (for example, of the same race or nationality). Of course, trust need not be of the informal and personal type we normally think of when we hear the word; instead, it could be “institutionalized” trust that facilitates exchange between complete strangers over the Internet, for example . It’s not so much that I trust the stranger who is selling something to me on Amazon but there are institutional mechanisms in place that allow the transaction to happen anyway.
The General Social Survey (GSS) has included a question for many years that sheds a bit light on trust of the more personal type (the GSS survey question is vague and it’s not entirely clear how we should interpret it, but it is still pretty widely used in the literature and is hopefully a reasonably good proxy for social capital). I’m not entirely sure why this has happened, but the extent to which we trust each other has declined noticeably over the last couple of decades according to the GSS. Here’s the percent of respondents to the GSS who said they can generally trust other people:
If this indicates declining levels of trust and an erosion of our civic ethics, we should be concerned; as Adam Smith told us long ago, trust and reciprocity are foundations of market exchange. The less we trust each other, the greater the costs of transacting and the more rules we must have in place to structure our transactions (government plays an important role in establishing those rules, of course, but has its own problems including the likelihood of rent-seeking). As Jerry Evensky once wrote:
When trust is shaken, individuals pull back and the system contracts. Where trust grows, individual energy and creativity are unleashed and the system grows. In Smith’s vision of humankind’s progress, trust is the central theme.