The Trust Variable

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Noah Smith worries about the way economists invoke trust.

So although trust, in some form, is probably important in our economic lives, we don’t yet have the tools to measure it, we don’t know exactly how it’s important, and we definitely don’t know how to control or alter a society’s level of trust. Until we understand trust a lot better, it would be a mistake to rely on it too much when trying to explain the world around us.

Read the entire essay. I agree with his qualifications, but I would rephrase his conclusion. It sounds like he could be saying that if something is hard to measure and control, then look for other variables to explain and control the world. Instead, I would say that one should be humble about one’s ability to explain and control the world.

The first step in getting a better handle on trust is to define it well. As Smith indicates, the standard practice is to measure people’s answers to very broad survey questions (“How strongly do you agree with the statement that most people can be trusted?”) That is very unsatisfying.

When I worked at Freddie Mac, we were subjected to given some management training of the “teambuilding” sort, one of the goals of which was to improve trust within the organization. This lead us to think about trust, and one insight that some of us arrived at was that trust involves more than just a belief that someone else is well motivated. Often, trust breaks down because we lose confidence in other people’s competence. Even if you have very general views about other people’s motives, you are likely to assess other people’s competence relative to their specific occupations.

This factor of competence assessment is embedded in my views of the role of finance in economic fluctuations. In Specialization and Trade, I argue that financial intermediation can expand when people trust financial intermediaries. In particular, as we experience financial intermediaries meeting their obligations, we gain confidence in their competence (as well as in their motivation). This leads to more trust, more expansion of financial intermediation, and so on, until, in Minsky fashion, the intermediaries are engaged in dangerous activities, and we get a collapse, including a collapse of trust.

So trust is not “social capital” that you want to see increased indefinitely. At least in the case of financial intermediation, it is best for trust to be at some intermediate level. Not so low that relatively low-risk, high-return investment opportunities are missed. But not so high that you get an excess of relatively high-risk, low-return projects (e.g., sub-prime mortgage loans) that are funded.

9 thoughts on “The Trust Variable”

  2. Superb.

    We certainly shouldn’t trust our measurements of trust yet.

    As for the dimensions of trust; there is lack of malice, positive good will (empathy with our good), ability to visualize contributions which we would appreciate or desire, ability to achieve the same, and willingness to make sacrifices in the process. Trust is big and complex; and almost certainly very important. Game theory tells us that much.

  3. It seems like you’re making the very mistake Smith is warning about. I don’t think historians looking at the newspapers of 2005 would be struck with the high level of trust we had in financial intermediaries. We imposed our distrust on them politically. The GSEs had four CEOs during the 2000s. All four were driven out. Ironically the second pair are accused of understating loss reserves in 2007. The first pair were paying fines in 2007 because they had been accused, among other things, of overstating loss reserves to manage earnings. It was impossible to be a GSE executive in the 2000s without being accused of fraud. The idea that the housing boom happened because of too much trust in financial intermediaries is laughably implausible. The only reason it seems plausible is because communal distrust is so ubiquitous that you will always find support for the idea that we trust them too much.

  5. Trust can be measured in inverse security costs. How much do people let their guard down and feel comfortable leaving valuable things potentially vulnerable to the action of others, and neglect to scrutinize and supervise with maximum skepticism and paranoia.

    It is hard to argue against maximizing trust, because trusting is taking chances with other people who might be bad actors, but one is ‘blaming the victim’ if one points out that someone trusted too much.

  6. @ Kevin Erdman,

    You could rewrite your explanation to come to the opposite conclusion (not endorsing it, just stating it). The GSE’s kept replacing their leaders, but the structure of those organizations were largely unchanged (and their influences were growing over most periods, not shrinking). This is evidence that there was to much trust in the institutions, and that the frequent firing without meaningful restructuring demonstrates a political calculation only.

    • I fear I lost you somewhere along the way baconbacon. 🙁
      The GGSEs lost influence during the boom. Market share was countercyclical. And, it would take some logical gymnastics to make coherent the fact that CEO set 1 were being fined for conservative accounting as the GSEs were failing due to credit losses.

  7. Trust ≠ Trustworthiness

    The latter is an absolute good. The former must be calibrated to the latter.

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