Trust and economic growth

Economies in which people trust each other grow at lot faster than ones in which there's lots of mutual suspicion. That's the message of this new paper.
This finding is not new, and it accords with common sense. People who trust each other are more likely to invest in physical or human capital, more likely to engage in market for lemons transactions, more likely to exchange know-how, and more likely to invest in productive activity rather than rent-protection or extraction.
But until now, the link between trust and growth has been difficult to unravel. This is partly because of problems of reverse causality - wealth can cause greater trustworthiness as well as vice versa - and partly because of omitted variables: if political institutions encourage rent-seeking, trust and growth will be low because of bad institutions, rather than because of a direct role for trust.
The paper tries to solve these problems by using inherited trust - the attitude of the children of migrants to the US to other people - as an instrumental variable. The authors find:

African countries, taken as a whole, would have been able to double their output per capita between the 1950s and 2000s if they had had the same level of inherited trust as the Swedish people...A country like Germany would have an income per capita 15% higher in the 2000s if the level of inherited trust of the German people had been identical to that of the Swedish people.

This raises the question. Given that trust matters, what can be done to increase it? Breaking down hierarchies, improving sociability and cutting crime are some possibilities.
Others, however, might point out another - increase ethnic homogeneity. After all, is it a coincidence that traditionally ethnically homogenous Sweden has such high levels of trust? I'd rather not believe so, but is there a nasty trade-off here between an open society on the one hand and trust and prosperity on the other?

Comments

[Eugenio]

Intersting point.
The "common sense" link between trust and growth is easy to spot (IMO, of course): it follows the fact that a pareto-efficient equilibrium is not "so good", in the fact that it doesn't maximize the "public" utility.
One of your older articles is inspiring (http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2007/07/economics-of-th.html) in that sense.
In a model that better resembles our society, one that features "repeated games" for example, an higher level of utility is reached by building trust, or by "helping" it in an exhogen manner. As an example, in Italy, the government supplied meat producers with incentives to build a "brand" of good producers, in the horrible period where BSE disease spread all over Europe.
As of your question: should "increase ethnic homogeneity" be read as "remove xenophoby"?!? Milan and Rome, the two biggest Italian cities, are becoming more and more multiethnic, but the same hold true for small cities in the south (I'm from Sicily), and people have since long started to buld social and professional relationship with people from northafrica and balcanian nations.

[Bob B]

"After all, is it a coincidence that traditionally ethnically homogenous Sweden has such high levels of trust?"

Arguably, that's a bad example for the best of reasons - in the early 1970s Sweden was very open about taking in ethnic Asian refugees who had been expelled from Uganda by Idi Armin.

An altogether more challenging but arguably more apposite example is Japan.

On a visit there in the early 1980s, when the Japanese economy was on something of a roll, many Japanese I met with volunteered a view that their impressive post-war history of economic success was due to their cultural or ethnic "homogeneity".

I encountered this so often that there was clearly something of national consensus about the perception. Sure enough, Nakasone - Japan's PM 1982-87 - when on a US tour at the invitation of President Reagan in 1986 went public by declaring that Japan's success was due to its homogeneity. In America, the predictable result was uproar and the Japanese seem to have subsequently backtracked somewhat by acknowledging various cultural influences - such as importing Chinese writing characters and assimilating the Ainu, an ethnic group indigenous to northern islands in the Japanese archipelago: Hokkaido, the Kuril Is and Sakhalin:
http://en.wikipedia.org/wiki/Ainu_people

In various private conversations, more discerning observers of Japan said that the extent of homogeneity was exaggerated in popular discourse and I came upon an interesting account from an impeccable source of personal experience of the extent of unintelligible regional dialects in Japan, unintelligible that is from the perspective of the received Tokyo dialect.

For all that, a claim about the "homogenous" Japanese has re-emerged in the views of present government ministers in Japan:

"Prime Minister Shinzo Abe on Monday [in February, this year] downplayed criticisms over his education minister's remarks a day earlier and said there was nothing wrong with the minister calling Japan an 'extremely homogenous' country."
http://findarticles.com/p/articles/mi_m0XPQ/is_2007_March_5/ai_n18647655

Of course, Japan's post-war history of continuous economic success has rather changed since the 1980s with the advent of the post-1992 stagnation of Japan's economy through to the last year or so. It will therefore be necessary to adjust our theories of social capital accordingly in so far as those were invoked to account for Japan's long period of economic success.

Moreover, among the factors which contributed to the stagnation of Japan's economy in the 1990s was the extent of what were euphemistically called "non-performing" bank loans. The assets of Japanese banks which had dominated international banking league tables during the 1980s were found to be so burdened with the equivalent of many USD billions of "non-performing loans" that much of the banking system was technically insolvent and Japan's central bank accordingly set interest rates close to zero for years in order to ensure sufficient liquidity in the banking system to prevent complete collapse.

On one set of interpretations at least, the reason Japan's banking system had absorbed so much "non-performing" personal and corporate debt was because of excessive (naive?) trust or cronyism. Further, the prevailing extensive cross-holdings of shares between customer companies and their suppliers in supply chains in Japan and between companies and group banks came to be seen as no longer an unalloyed blessing - and the cross-holdings of shares rendered the whole business system more vulnerable to domino collapse. The lesson, presumably, is that trust bonding in business networks can be misplaced leading to socially painful downstream consequences. There were and are now major questions about the preferred Japanese model for capitalism - indeed, there were Japanese commentators who saw their business system as more akin to a variant of the many models of socialism than to the American model or ideal of unfettered capitalism.

Despite that, I see that Toyota has recently overtaken General Motors as the world's largest motor company - and remember that Toyota has the credit for pioneering just-in-time manufacturing systems. Remember too that in recovering from the ravages of WW2, Toyota made a point of recruiting its additional workforce and middle managers from the disbanded Japanese army. On the evidence, it is not self-evident that unfettered capitalism is the best recipe for business success. We need to remember too that since the mid 1950s, Japan has been almost continuously governed by one political party - the Liberal Democratic Party. Effectively, Japan has been a one-party state.

[ad]

Given that trust matters, what can be done to increase it?

Punish those who break their word. If you reduce the benefits of cheating, you should reduce the number of acts of cheating.

Everyone you meet will now be a bit more trustworthy.

The least trustworthy people are those with the least reason to tell the truth.

[dreamingspire]

Trust is coming back. It is because there are rational people at the heart of government again (although not always round the edges). I have seen a network growing for the last 18 months, but it is only now that its effects are being seen.

[dearieme]

The Ainu, Bob, the Ainu? When I was at school they were the Hairy Ainu. Another victory for PC, then.

[dearieme]

The Ainu, Bob, the Ainu? When I was at school they were the Hairy Ainu. Another victory for PC, then.

[Bob B]

"When I was at school they were the Hairy Ainu."

Possibly to soothe the mounting uproar his comments about Japan's cultural (or ethnic)homogeneity had prompted, Nakasone took to remarking on his own conspicuously bushy eyebrows - a very un-Japanese characteristic - and saying he probably had some Ainu blood in his veins. That was definitely progress of a kind.

[Katherine]

Punishment of those who break their word, in the commercial world, is done through the court system. We (England and Wales) have an advantage there, in that the Commercial Court is extremely highly respected throughout the world and consequently English law and English jurisdiction is often used in otherwise entirely foreign contracts. In that sense, England (and Wales) already has a high level of trust.

[Bob B]

Good that we have in England and Wales a dependable judicial system and an internationally esteemed framework of commercial law but why did Gordon Brown feel impelled to so recently launch a "bid to succeed Tony Blair with a promise of sweeping changes to the political system to restore trust in government"?
http://www.timesonline.co.uk/tol/news/politics/article1776201.ece

"Gordon Brown promised to restore trust in politics, in what will inevitably be seen as a criticism of Tony Blair's leadership style."
http://www.politics.co.uk/news/features/labour-leadership/brown-i-will-restore-trust-in-politics-$473463.htm

We still have challenging issues here of explaining quite why Britain's post-war economic performance was so inferior compared with most peer group economies through to the end of the 1970s at least - notwithstanding the comparative excellence of our judicial system and commercial law - and why Japan's post-war economy performed so spectacularly well through to the end of the 1980s when Japan has what is widely regarded as a creaking judicial system albeit alongside a remarkably low crime rate compared with other advanced economies.

At the very least, I think we may need to clear up differences between necessary and sufficient conditions for achieving good economic performance and low crime.