Blogs | September 28, 2010

The truth about trust

Are most people more willing to trust each other than we might recognise? Chris Dillow explores the economics.

At a final one-day cricket international between England and Pakistan in 2010, there was a remarkable sight – a full ground. Recent allegations of match-fixing did not, it seems, dampen the public’s appetite for the game.

This shows many things, but a key one is that people are much more willing to trust others than traditional economics predicts. Trust has a value and can make people willing to pay more or pay less for an item – and, research suggests, it can even affect the success of economies.

Trust me – the car starts first time
The used car market shows the interplay between trust and commercial transactions. Back in 1970, economist George Akerlof of the University of California, Berkeley pointed out a problem with the used car market. Buyers, he said in a seminal research paper called The Market for Lemons, could never be sure of the quality of the car they were buying. And they'd suspect that the seller wanted to sell it because it was defective.

They would, therefore, only buy the car if it was priced at a discount. But this would mean that owners of good cars wouldn't want to sell them, as they'd get a bad price. But then potential buyers would know this, and offer even lower prices. There would be a vicious circle, leading at the extreme to no market at all. It's a good story – good enough to get Akerlof a Nobel Prize.

But it's just that – a story. In the real world, there's a huge market for used cars, even on websites on which buyers can't see either car or seller before they buy.

Turn on the TV to see trust at work
One reason why Akerlof's theory was wrong about the used-car market is that the traditional economic view of people as rational and selfish is wrong. Instead, says Herb Gintis of the University of Massachusetts, people are "strong reciprocators" – we are inclined to trust others and to want their trust. Evidence for this comes from the TV game show Golden Balls in the United Kingdom.

At the end of the show, two contestants are offered a choice: splitting the jackpot equally or stealing it all for themselves. If one decides to steal and the other to share, the stealer gets the lot. If both steal, both lose everything. The choice is what is known as a prisoners' dilemma game – and, research says, the rational thing to do is to steal. In fact, the study says, more than half the TV show contestants share.

Trust may make countries richer
Trusting behaviour is fantastic for society as a whole. Without trust, lots of economic activity simply wouldn't exist. Not only wouldn't there be a market in used cars, but there wouldn't be insurance markets or banks. And it would be impossible to get people to invest in others' businesses.

Trusting societies, then, tend to be rich. French economists Yann Algan and Pierre Cahuc estimated that Africa would be twice as rich as it is if Africans trusted each other as much as Swedes do. Even the French and British would be 5% better off if they had Swedes' level of trust, said the pair.

But individuals need to be wary
Although trust is good for whole societies, it is not always good for each individual. Fraudsters know this and use trust to their advantage in "advance fee" frauds – scams in which victims hand over their bank account details or money in the hope of getting something back.

These activities only work because folk are willing to trust others. It's not only fraudsters who play upon our trust and desire for reciprocity. So do reputable firms.

Credit card companies and utilities tempt us with attractive initial offers, in the hope that we will reciprocate by staying with them after the initial offers have ended. Bubbles in asset prices can also arise from trust – our trust that others know what they are doing when they say that a high-priced asset (such as gold?) can rise further. So, ask yourself: am I being too reciprocating? There is a thin like between being trusting and being a fool.


Chris Dillow
Chris Dillow

Investors Chronicle writer and economist