Trust has considerable instrumental value as a way of reducing transaction costs in situations where neither contract nor law function well. In such settings, parties frequently rely on noncontractual social norms to minimize transaction costs; in particular, trust acts as a lubricant to reduce social friction. If I trust you to refrain from opportunistic behavior, I will not invest as many resources in ex ante contracting. “Whoever can be trusted with very little can also be trusted with much ....” If you prove trustworthy, I will not need to incur ex post enforcement costs. Trust thus is not only honorable, it is socially useful.
By its very nature, trust implies vulnerability. If I trust you to perform as per our agreement, I am by definition voluntarily assuming the risk of nonperformance. Trust thus may be defined as “the willingness of one person to increase his or her vulnerability to the actions of another person whose behavior he or she could not control.” Assuming I am risk averse, why should I be willing to risk uncompensated loss? Put another way, in what social contexts and under what conditions is trust most likely to arise?
Trust is essentially social and normative, rather than individual and calculative. It arises out of a set of shared background assumptions and norms. Because trust thus derives from shared values, it is most likely to arise in homogeneous groups. A considerable body of research thus suggests that trust is especially likely to become an important lubricant to market exchange when the business at hand is dominated by a single ethnic and/or religious group.
While the old adage opines “familiarity breeds contempt,” personal proximity to others in fact deeply affects behavior. As people become closer, their behavior tends to improve.
Close-knit, homogenous communities strengthen this instinct in several ways. First, they provide a network of reputational and other social sanctions that shape incentives. Because membership in close knit groups satisfies the human need for belongingness, the threat of expulsion gives the group a strong sanction by which to enforce compliance with group norms. Because close knit groups involve a continuing relationship, the threat of punishment in future interactions deters the sort of cheating possible in one-time transactions. Second, because people care about how they are perceived by those close to them, communal life provides a cloud of witnesses whose good opinion we value. We hesitate to disappoint those people and thus strive to comport ourselves in accordance with communal norms. Finally, there is a transaction costs economics explanation for the importance of closeness in trust relationships. Close knit groups know a lot about one another, which reduces monitoring costs and thus further encourages compliance with group norms. Members of close-knit groups therefore tend to internalize group norms, which allows members of the group to trust one another in ways they would not be willing to risk when dealing with outsiders.
Much of the research on this subject has been conducted in connection with the diamond industry. Hence, I was very interested in a new paper by Barak Richman, Ethnic Networks, Extralegal Certainty, and Globalisation: Peering into the Diamond Industry. Here's the abstract:
For nearly one millenium, the diamond industry's distribution system remained largely unchanged. Ethnic networks, predominated by Jewish merchants, managed the downstream distribution system. Since state courts are unable to reliably enforce executory contracts for diamond sales, these networks succeeded because their community institutions were able to assert extralegal governance. But recent trends in the globalisation of commerce have introduced pressures that might cause the one thousand year-old system to unravel. Low-wage workers from India have displaced higher wage western merchants, consumer demands for political oversight has brought scrutiny to previously secretive networks, and the profitability of global branding campaigns has enabled DeBeers to implement a vertically integrated business strategy that skips the middleman and sells directly to consumers. Since these pressures represent the paradigmatic forces of globalisation, examining changes in the diamond industry offers insights both into the future of ethnic exchange and into globlisation itself.
It's a very interesting and important paper for those of us who are interested in the way social norms reinforce and sometimes compete with law.
