Professor of Economics; Academic Director, Wheeler Institute for Business and Development
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Politicians lie, bankers cheat and global corporations cover up their worst mistakes. It’s wrong – but it’s worse than that. Bad behaviour by individuals and the institutions they’re part of creates distrust and distrust leads to a messed-up economy, which means we’re all worse off. So what can we do about it?
But first: can trust really be so important? Absolutely, says Elias Papaioannou, Professor of Economics at London Business School (LBS). Trust is vital to a thriving society for several reasons, he explains:
1. Trust enables efficiency
All contracts are inherently incomplete. If you sign a contract with someone and then they cheat you, you can go a judge but the process is costly and takes time, even in countries with the most efficient legal and judicial systems. Trust is a necessary ingredient for a well-functioning society.
2. Trust makes trade possible
Especially on an international level, when one company trades with or invests in another, trust is essential. You need to know that when shipping your goods, the person at the receiving end will eventually pay you.
3. Trust fuels modern finance
The capital markets, investing and saving only work if there’s trust. When convincing individuals to save for retirement, you’re asking them to trust in the stock market and the fund manager to invest your money wisely.
4. Trust underpins good government
Benjamin Franklin and George Washington stressed that trust and civic virtue are key ingredients of well-governed politics. For politics to work effectively, citizens need to trust that the government will use their taxes to build roads and schools and to provide some safety net for the underprivileged.
People who have lost faith in their country’s institutions start voting for anyone promising a better life
Professor Papaioannou has carried out some intriguing research into one of the things that happens when trust breaks down: some of the people who have lost faith in their country’s institutions start voting for anyone promising a better life.
In The European Trust Crisis and the Rise of Populism (co-authored with Yann Algan, Sciences Po, Sergei Guriev, European Bank for Reconstruction and Development and Evgenia Passari, Université Paris-Dauphine), a paper presented in September at Brookings Institution in Washington DC, Professor Papaioannou and his co-authors offer evidence that the growth in populism across Europe has less to do with anti-immigrant sentiment and more to do with the rise in unemployment and the fall in trust.
Analysing the evolution of unemployment, general and political trust, attitudes and beliefs towards immigration and voting in more than 200 European regions across 26 European countries between 2000 and 2017, he and his co-authors discovered a correlation between higher unemployment and greater support for populist and anti-establishment political parties.
They also found a strong link between regional unemployment and a decline in trust towards European and national political institutions. “The loss of trust in political institutions might well explain the enduring economic crisis in Europe,” he says. “As beliefs and trust are slow-moving, the impact of the crisis may be long-lasting.”
“Rebuilding trust is a good business proposition”
Should you care about all of this if you’re a Trump supporter or someone who thinks UKIP are a pretty decent bunch? Definitely, says Professor Papaioannou. “Rebuilding trust is a good business proposition. Business leaders need to realise the importance of trust in their customers and in the citizens of the society in which they operate.”
This isn’t about a nice cosy feeling, it’s about avoiding a grim alternative. “A business operating in a society characterised by distrust will have to deal with a lot of regulation and red tape when it wants to expand. A distrustful society’s attitude to a company wanting to operate a new factory or a new plant is to produce formal barriers to entry. It will require them to fill in endless forms and obtain numerous licences.
“In contrast, doing business in a country like Scandinavia, where there are high levels of trust in business and society, is far easier. The public expects high quality and high ethical standards. Businesses comply with the rules. This reinforces general and business trust, which in turn promote civic values and improves the administration.
“Another reason for businesses to care is that distrust and red tape come in tandem with corruption. Firms want to operate in places with low levels of corruption, good supervisory and regulatory mechanisms and low levels of red tape. So it’s crucial for people to have a sense of trust in the core pillars of modern societies and especially in businesses. Policymakers wanting to restore trust should remove administrative barriers to entry that fuel corruption and impede competition.”
1. Celebrate and promote openness and open-mindedness
Trust grows between people from different backgrounds when they are exposed to each other on a daily basis. For instance, there is evidence that the strong correlation between antisemitism in the 1930s and medieval times in Germany breaks down in cities at the intersection of rivers that served as commerce hubs. Governments should promote an outward-facing economy.
2. Support the underprivileged
Recognise and help those households and individuals that have been hit hardest by the financial crisis or by globalisation’s side-effects. For example, workers in manufacturing in industrial countries (the US and UK among others) have been hit by rising competition from low-income countries such as China and automation. In addition, many households, especially in the periphery of Europe, have suffered from deep and lasting recessions. Governments and business should offer safety nets to the unemployed and help them re-integrate into the economy.
3. Choose the right kind of education
Research by Yann Algan, Pierre Cahuc and Andrei Shleifer shows that countries where schooling involves teachers who lecture and children who memorise should alter the curriculum towards more group activities, team projects and critical discussion. Trust can be built from early childhood in this way. The first eight or nine years are where children learn – or don’t learn – non-cognitive skills that are crucial for success such as trust, empathy and perseverance.
Levels of trust vary between countries. A recent World Values Survey (WVS) on trust asked respondents, “Generally speaking, would you say that most people can be trusted or that you need to be very careful in dealing with people?” Within Europe, the Netherlands, Finland, Sweden and Norway came out as the most trusting nations; Cyprus, Turkey and Macedonia the least. Beyond Europe the differences were even more striking.
Trust levels also vary within countries. For example, trust and civic capital differ considerably between the north and the south of Italy. There are also sizable differences between eastern and western Germany. Historical legacies play a crucial role. Even when you look across German towns in the once-communist east, there is a correlation between those where there were more Stasi [secret police] informants and a lower level of trust among the people who live there today.
It makes sense: if you grew up in a society where you never knew if the friend you were having coffee with was an informant, why would you trust anyone? (See also The Lives of Others.) And distrust is passed down through the generations – embedding what Professor Papaioannou calls the inertia in trust. Ingrained attitudes are hard to transform. “Changing people’s beliefs and promoting civic engagement won’t happen overnight.”
He points to another study, this time focusing on Africa, which has demonstrated lower levels of trust among people from those ethnic groups that were most affected by the slave trade – people whose ancestors saw their kin kidnapped to be sold to traders and shipped to the US, over several centuries. Slavery has been abolished but trust can’t be legislated for.
“Virtually every commercial transaction has within itself an element of trust”
For most of the 20th century, economists worked on the assumption that humans were motivated entirely by self-interest and that economic behaviour could be reduced to companies and households selfishly interacting in perfectly competitive markets. Then there was shift in thinking, spearheaded by thinkers such as Robert Putnam, whose paper-turned-book Bowling Alone: America’s Declining Social Capital made everyone sit up and worry about the disintegration of community.
Social capital is the value of the connections we have with other people – friends, family, neighbours and colleagues – the networks that make society function. According to the Organisation for Economic Co-operation and Development, “Social capital provides the glue which facilitates co-operation, exchange and innovation.”
Putnam wasn’t the first to sound the alarm. In 1972, the economist Kenneth Arrow declared: “Virtually every commercial transaction has within itself an element of trust, certainly any transaction conducted over a period of time. It can be plausibly argued that much of the economic backwardness in the world can be explained by the lack of mutual confidence.” He won the Nobel Prize that year.
And it certainly wasn’t a new idea: the ancient Greek philosopher Plato, writing in around 380 BC, stated that what we need for a good society are people who trust each other and exhibit high levels of civic virtue. The great thinkers of the European enlightenment agreed, as did the founding fathers of the US Constitution. Along with trust goes participation, co-operation and inclusiveness. Easy! Only, because we are human, it’s not.
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