Friday, September 29, 2006


I have blogged on how important it is that impersonal mechanisms replace relationship-based transactions. Tim Harford's article in Forbes argues that our increasing standards of living are the result of replacing personal relationships with impersonal networks of producers, which rely on formal mechanisms of enforcement (the police and courts).

Formal or institutionalized trust sounds cold and unpleasant, but it is just as useful as the personal variety, perhaps more so. Our parents might have enjoyed a line of credit from the friendly owner of the local grocery store. We don't get the same personal service, but we get something much more useful--we can run a line of credit pretty much anywhere, from a hotel in Shanghai to a diner in Memphis to a supermarket in Berlin.

Those places don't actually trust us enough to lend us money, but Visa or American Express will, and that will do just as well.

This allows for greater division of labor- with an entire industry emerging just to track the credit histories of Americans- and what Böhm-Bawerk called roundabout means of production. From the article about Böhm-Bawerk

But Böhm-Bawerk's third reason—the "technical superiority of present over future goods"—was more controversial and harder to understand. Production, he noted, is "round-about," meaning that it takes time. It uses capital, which is produced, to transform nonproduced factors of production—such as land and labor—into output. Roundabout production methods mean that the same amount of input can yield a greater output.

Böhm-Bawerk reasoned that the net return to capital was the result of the greater value produced by roundaboutness. An example helps illustrate the point. As the leader of a primitive fishing village, you are able to send out the townspeople to catch enough fish, with their bare hands, to ensure the village's survival for one day. But if you forgo consumption of fish for one day and use that labor to produce nets, hooks, and lines—capital—each fisherman can catch more fish the following day and the days thereafter. Capital is productive.

Thus Harford continues,

Seabright's book, The Company of Strangers, makes this point with reference to the author's shirt: "The cotton was grown in India, from seeds developed in the United States; the artificial fiber in the thread comes from Portugal and the material in the dyes from at least six other countries; the collar linings come from Brazil, and the machinery for the weaving, cutting and sewing from Germany; the shirt itself was made up in Malaysia." It's just a shirt, and even then it is far too complex a product to be facilitated merely by a network of people who know and trust each other personally.

Yet in a place like Somalia, personal trust is all that is available. It is a war-torn country in the horn of Africa which lacks anything we would recognize as a government, and entrepreneurs have to rely on much more local, primitive and less effective forms of trust. Somalis often rely on clans to settle disputes. That can work well if you're arguing with someone from the same clan, but cross-clan disputes are often messy and unfairly resolved. (Anybody who thought Somalia's poverty had to do with a lack of natural resources might take a look at resource-rich Nigeria, a country which is nearly as poor, and then at resource-poor Singapore, one of the richest countries in the world.)

That is a reminder that institutionalized trust might be even better than the touchy-feely type, which simply isn't available to everyone. Personal trust can be benign, but it can also be embodied by the old-school-tie network, political patronage or a criminal mafia.

"Factors which increase trust in society are not necessarily a good thing, because they can increase the bonds between gang members, whose main economic success comes from extorting or coercing other people," explains Seabright.

Trust can also be denied to ethnic minorities: the credit card companies may not be entirely blind to race, sex, color and creed, but I am willing to bet they are much closer than the local bank manager in the 1950s.

Economists Kerwin Charles and Patrick Kline have tried to put their fingers on the arbitrariness of personalized trust by looking at car pooling and race. They argue that car pooling is a good measure of trust: can you trust your fellow travelers not to be late, drive badly or murder you and leave your body in a ditch?

Charles and Kline predict that, for example, African-Americans will find it easier to car pool if they live in an area with lots of other African-Americans. The statistics seem to bear them out. Trust matters, and if you live in an area full of people who look like you, you will enjoy more of it. Perhaps the institutionalized version of trust is not so bad after all.

Meanwhile, experimental research by economists Ed Glaeser, David Laibson and Bruce Sacerdote shows that the way people trust each other simply isn't fair. The researchers organized a "trust game." Two students met ahead of time to size each other up socially, then they played the game. The first student could give up to fifteen dollars to the second student; the experimenters doubled the gift, and then the second student had to decide how much to give back.

The game is a measure of trust because the first player has the power to double the size of the pie, but only at the risk of getting nothing back from the second player. What was striking is how much social factors such as race and status encouraged the second player to be trustworthy.

"If the first player has a sexual partner, the second player will send back 17% more than they otherwise would have done," observes David Laibson, a professor at Harvard. Since the second player doesn't know about the existence of a boyfriend or girlfriend, Professor Laibson thinks that it's a proxy for charm, status and social capacity.

The second student will also send more money if the first student drinks more beer--suggesting sociability--or if he or she is of the same race. Pure status matters too. Students who have fathers with a college degree, or who don't have to work to fund their studies, receive significantly more money.

"And America is supposed to be a classless society," comments Professor Laibson. Trust matters, but if you really want to bask in its effects, make sure you start at the top of the heap.

That was about the USA, where the original sin was slavery. What about India? How much of political activity in India is about getting people to gang up on those of another caste or religion? And how much of our under-development is because of our inability to put that past behind us?

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