Matter of Trust
On April 5th Luigi Luiso gave a special lecture on ‘The Right Amount of Trust’ at the Higher School of Economics. The event was organized as an additional event for the 11th International Conference on the Problems of Economic and Social Development. Video of the event added.
Luigi Guiso is Professor of Economics at the European University Institute, Florence. Currently Professor Guiso is a consultant to the European Central Bank. Previously he has also advised such organizations as the Bank of Italy, the European Commission and the European Investment Bank. His particular areas of interest include such spheres as household finance, corporate investment, social capital and culture and economics.
The central theme of Luigi Guiso's lecture was trust. This theme is currently being actively researched by modern economists:Professor Guiso mentioned several research works confirming the importance of trust for the economy. According to these works, the level of trust in a society is related to the following factors:trust clearly correlates with GDP per capita and its growth, trust also stimulates companies'and organizations'growth and development, increases the involvement in financial markets, influences economic and finance transactions internationally and positively affects managerial practices and organizations. Thus, according to this research, trust is always a positive factor:the higher the level of trust, the more active the economic growth. This conclusion incurs the idea that trust is a key ingredient in all transactions, and the higher the level of trust is, the more actively exchange is occurring, and as a result, the higher the profit.
Continuing his speculations of the topic of trust, Professor Guiso asked a question:is it true that trust always generates more surplus? And if we talk not about a society, country or a company, but about an individual and his private finances - is it always more profitable to trust? Professor Guiso reminded the audience that the recent financial scandals may raise some doubts as to whether trust is always the right strategy. Luigi Guiso and his colleagues decided to study the connection between trust and personal economic success. Their main thesis is that the most trustworthy individuals have overly optimistic beliefs (they trust and trade too much with the risk of being cheated (and this reduces performance), while un-trustworthy individuals hold too conservative beliefs (they trust and trade too little, missing out on profitable opportunities as a result). Based on the shape of the dependence diagram, Professor Guiso called this a ‘hump-shaped relationship'.
Research has shown that while countries may be classified by the level of trust (there are high-trust and low-trust countries), people's trust within a society is very heterogenic, and this heterogeneity is persistent over time. Researchers believe this heterogeneity within a society comes from the fact that parents endow their children with their values and beliefs, and the level of trust is a part of these values.
Professor Guiso and his colleagues chose three methods to solve their task:firstly, a simple model showing the connection between false consensus, trust and economic performance. Secondly, the results of empirical research showing the connection between trust and performance as well as between trust and the possibility of being cheated. And thirdly, a practical experiment the results of which demonstrates people's tendency to extrapolate their own beliefs to other people, as well as the connection between beliefs and culture and the ‘hump-shaped relationship'between trust and performance.
The simple model suggested by Luigi Guiso describes the relations between an investor possessing a capital and a partner having ideas. The partner needs investments, but he can cheat the investor. The model is abbreviated with a formula which takes into account the real share of cheaters in a society and the investor's belief about this share. The closer the investor's belief is to the real situation, the higher his ability to get maximum profit. This is what Luigi Guiso calls the ‘right amount of trust'. According to the professor, this model works not only for ‘investor-partner'relations, but for many other similar situations:for example, when a consumer trusts his money or time to a service supplier.
Empirical data used by Professor Luigi Guiso was taken from the European Social Survey. This survey took place in 26 countries, with a total of about 2000 participants. The research aimed to get a standard set of demographic indicators, but, among the questions, people were asked:‘generally speaking, would you say that most people can be trusted, or that you can't be too careful in dealing with people?'The answer should be given as a score between 0 and 10.
The social survey data allowed Professor Guiso to confirm the following assumptions:personal economic performance reaches its maximum at a medium level of trust and decreases when trust is too high or too low. In the countries with a higher general level of trust the peak of performance is closer to the higher level of individual trust. More trusting people are more likely to be cheated, while less trusting people have a higher chance of losing profitable opportunities.
Professor Guiso also talked about a game experiment carried out by his team. 124 students participated in the experiment. During the game they showed how they trust the others, how trustworthy they are themselves and their beliefs about the trustworthiness of the others. The experiment confirmed that those participants whose beliefs about the trustworthiness of the others are closer to reality get 20% more revenue than those whose trust is too high or too low. In addition, the experiment showed the so-called ‘false consensus'effect, when our own behavioural model is extrapolated on other people.
The combined use of the model, empirical data and the results of the experiment allowed Professor Guiso and his colleagues to draw several important conclusions. In terms of individual finance, incorrect beliefs about trustworthiness of the others may lead to financial losses. It was interesting for the researchers to find an answer to the question:which side is it better to lean towards - trusting too much or too little? The results of the research work show that from an individual's point of view, mistrust is worse for private finance than an excess of trust. Furthermore, an excess level of trust may be costly to an individual, but from a society's point of view, it leads to economic growth. And this factor explains why when analyzing the ‘performance-trust'relationship on a society-wide level, researchers see a monotonically increasing relationship while on a personal finance level the diagram is ‘hump-shaped'.
Answering questions from the audience, Luigi Guiso spoke about how trust influences corporate success:the higher the level of trust in a country, the more opportunities companies have to get good results. However, following the financial crisis the general level of trust has decreased, and this is negatively affecting the market activity as a whole, and decreasing growth opportunities for small companies in particular. Another question was about dynamics of trust:is it dependent on individual experience? The Professor responded that generally the level of trust is rather persistent, and not only immigrants do have the level of trust specific for their home country, but their children may, in terms of trust, be closer to their ancestors'country than to their country of birth. At the same time, the experiment has shown that trust may change, and an interesting tendency was revealed here:those participants who became less optimistic in evaluating others'behaviour during the game, themselves began behaving less trustworthy than they had in the beginning. Thus, the Italian Professor concluded, depending on an individual's experience, not only does the level of trust change, but also an individual's own behaviour.
Maria Pustovoyt for the HSE News Service
Photos by Nikita Benzoruk