With the debate over whether politicians should be required to publish their tax returns, the past week has seen the issue of trust thrust, yet again, to the forefront of politics.
Understanding the concept of trust is easy when applied to individuals. Does he/she or doesn’t he/she tell the truth? But what is less obvious, perhaps, is the relationship between trust and economic performance. When you dig deeper, the role of trust becomes hugely important, because trust connects morality to economic behaviour.
Mutual respect and honesty are the foundations of business ethics. But the influence extends well beyond the personal to the economic system as a whole. Indeed, trust can be seen as foundational to economic development in the first place.
The US economist, David Rose, has highlighted how specialisation is required for prosperity, and this requires a shift from small to large group societies, and trust is required for this small to large group shift. Without sufficient levels of trust, the small to large group society shift doesn’t occur, and economic development is stunted. Rose states that:
“Moral beliefs can solve a fundamental problem associated with social, political and economic development. That problem is overcoming the limitations of our small group nature so as to make it possible to cooperate in large groups. As economists from Adam Smith to Paul Krugman have argued, it is simply impossible for society to enjoy a condition of general prosperity if its economic activity is limited to small group contexts.”
Conceptually, trust lowers transaction costs and increases economic activity and GDP as a result. Consequently, trust reduces the lost output from opportunistic or corrupt behaviour – which is greatest when both the private and public sectors are opportunistic.
Trust is based on an internal source of morality, which needs to be passed from generation to generation in order to preserve capitalism. Therefore trust reduces the transaction costs – red tape – and lost output induced by external bureaucratic regulation.
A track record of trust derails regulation. Internal control trumps external coercion, because trust helps create a society where individual responsibility is prized. This is a win-win situation. Trust reduces the need for external regulation and reduces the societal disposition towards calls for external regulation at the same time.
The success of the Nordic economies is hard to explain with conventional economic models (because of the expected negative impact of the size of the state), until one recognises that these countries have displayed some of the highest levels of trust in the world. Interestingly – in a Nordic context – one study suggests that, even if bigger government leads to lower economic growth, the positive growth effects of trust are likely to dominate the negative growth effects of a bigger government sector.
Moreover, the impact of trust is likely to operate with very long “generational” lags. Even today, the descendants of Scandinavian immigrants in the US have the highest levels of mutual trust in the country! So if trust levels decline over time, for example because of declining religious norms and rising secularisation, the negative economic consequences of a large state could become much more obvious.
Trust is yet another example of the need to look further upstream for the cultural sources of prosperity. Long-term growth analysis, whether it be exogenous or endogenous growth theory, or the role of institutions, tends to ignore cultural factors. Conventional growth economics is a downstream analysis, when the ultimate causes are to be found much further upstream.