Competition builds trust

Patrick Francois, Thomas Fujiwara, Tanguy van Ypersele 27 August 2009

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Recent empirical evidence gleaned from a number of different sources and countries using different methods plausibly suggests that culture affects economic outcomes (see Tabellini 2008 for a recent survey). Measures of culture are usually derived from responses to survey questions (for example the canonical “trust” question that we will discuss below). Many of these studies attempt to unearth the effects of culture on outcomes by exploiting its inter-generational persistence. For example, trusting parents are more likely to have trusting children, and these children are also more likely to inculcate trust into their children, and so on. Such persistence also survives migration – trust levels of US immigrants’ children are better predicted by the average trust levels of their parents’ birth countries than by trust levels in the US. This persistence has been important in helping researchers conclude that culture affects economic outcomes and is not just a reflection of them; a particularly compelling study along these lines is Algan and Cahuc (2009).

A tempting, but flawed, conclusion to draw from such intergenerational persistence is that the cultural factors that are important for economic outcomes are beyond the reach of policy. Trust is determined by the distant past, the distant past cannot be changed, so policy is irrelevant. But maybe the distant past is not all that matters. Montesquieu argued that markets themselves are key in providing the cultural underpinnings, like trust, that make societies work. Drawing on examples from European countries of his time, he argued that markets themselves created civilised people. Early in the twentieth century, the sociologist Georg Simmel provided an important caveat. He argued that it is not markets per se that lead to good culture, but market competition. Uncompetitive markets would not build it, but competitors pitted against each other in a quest for market share would. We have explored this hypothesis in recent research.

Intensified competition and trust

A simple barometer for the state of a culture that has been the focus of much of the new empirical work is the “trust” question – “Do you think that most people can be trusted or that you can’t be too careful in dealing with people?” We investigate how answers to this question, asked for over thirty years in the US General Social Survey (GSS), vary with differences in competition across US states. Since many other things also vary across states, our strategy is to examine an episode where competition changed and track the ensuing changes in trust it caused. We examine the differential timing of financial deregulation across states between 1978 and 1993. As Black and Strahan (2002) argue, this deregulation intensified competition by making it easier for start-up firms to obtain credit. By looking at the number of start-ups and matching them to trust levels, we can see what effect increased competitive entry had on trust.

Our analysis controls for underlying statelevel fixed effects and time trends, as well as national year-specific effects (like the business cycle). Figure 1 illustrates the results for the average state obtained from this regression. The horizontal axis counts the number of years before and after the reforms. The vertical axis reports percentages, and the plots are normalised so that both new incorporations and trust levels start at 0 when a state implements its reforms.

The figure paints a clear picture. Prior to the reforms, no real trend can be detected in trust levels. Once reforms are implemented, incorporations increase at a relatively constant rate, around three percentage points a year (the pink line). After perhaps a slight lag, trust takes off as well, growing at about 1.5 percentage points per annum (the blue line).

Figure 1. Trust and new incorporations

This is a useful first step. We know the timing of incorporation changes is due to the timing of reforms, so no omitted third factor caused changes in both. But what is the mechanism? Did increased competition directly increase trust? Or did it influence some other factor that in turn caused trust to rise? To get a handle on this, we turn to detailed individual data.

Did increased competition directly increase trust?

The 2004 wave of the GSS asked an extended set of questions about places of work. By linking this to the US census of firms, which has information about competition levels, we compute, for each individual, how competitive their sector of employment is. We test the hypothesis that competition between firms in the sector of one’s employment increases trust.
A snapshot of the results is depicted in Figure 2, which comes from the regression of individual trust on competition. The horizontal axis denotes the competitiveness of firms in a worker’s sector of employment. The vertical axis denotes the worker’s trust level. The regression controls for individual characteristics, and again we’ve centred the graph at zero. The graph’s upward slope shows quite clearly that workers whose firms are located in competitive sectors have higher trust levels. Moreover, it explains much of the earlier state level effects. A five percentage point increase in sectoral competitiveness leads to about a one percentage point increase in trust levels.

Figure 2. Employment in competitive sectors and trust

This correlation is very robust, and it controls for individual factors correlated with trust, such as education, race, age, gender, city size, and income. It also controls for occupation, religion, marital status, and self-reported ethnicity. The survey’s immense detail allows us to also account for workplace factors. By doing so, we conclude that the relationship between trust and competition is not arising because more competitive sectors have smaller workplaces, higher unionisation rates, or more intense supervision. Nor are they more congenial workplaces. It is not because of the selection of high-trust individuals into more competitive sectors, nor because of the selection of individuals with low levels of risk-aversion. However, the longer one has worked in competitive sectors, the higher is one’s level of trust. The data points strongly to a single conclusion – working in a competitive environment builds trust.

Possible mechanisms

Why would working in a competitive sector make people more trusting? We think it is because competition disciplines people to act in the group’s interest. Each one of the many workplaces in the labour market constitutes a collection of workers tied together via the performance and continued existence of their firm. Shirking, or free-riding, is always good for the individual but bad for the group. Groups with more free-riders tend to under-perform, and when competition is intense, under-performance becomes very costly. This limits free-riding in competitive environments, and the more time one spends with people who don’t free-ride, the more one is likely to trust others.

This research raises two broad questions that we are continuing to explore. One concerns the general applicability of these findings to contexts outside the US. Do increases in competition increase trust in other developed countries? Does this happen in less developed countries? Is there a link between these findings and the increased pro-social behaviour found in primitive societies that have experienced greater market penetration, as reported by Henrich et al. (2004)?

The second question concerns the causal mechanism. We think interactions in the workplace are key and have developed a model to explore how such interactions could explain our empirical findings. Various data sources could be used to test the predictions of such a model and scrutinise other mechanisms by which market competition may increase trust.

Understanding the mechanism and applicability will shed light on an old question surrounding the ascent of contemporary market economies. Liberal market structures only work when built on the give and take of a functioning civil society. Do markets sustain themselves by replicating these civil values, as Montesquieu contended? Or does the process of market competition itself tend to undermine the very values necessary for markets to exist, as Marx and Schumpeter argued? (See Hirschman 1982 for a review of this older literature). Our hunch, based on the evidence we have seen, is the former, but only further evidence will tell.

References

Algan, Y. and P. Cahuc (2007), “Trust and economic development”, VoxEU.org, 2 October.
Algan, Y. and P. Cahuc (2009), “Culture Change and Economic Development”, Mimeo, University of Paris 1.
Black, S.E. and P.E. Strahan (2002), “Entrepreneurship and Bank Credit Availability”, Journal of Finance, vol. 57, 6, pp. 2807-2833
Francois, P and T. van Ypersele (2009), “Doux Commerces: Does Market Competition Cause Trust”, CEPR Discussion Paper 7368.
Francois, P., T. Fujiwara and T. van Ypersele (2009), “How Does Competition affect Trust? New Evidence on an Old Question”, mimeo, University of British Columbia.
Henrich, J., R. Boyd, S. Bowles, C. Camerer, E. Fehr, H. Gintis (Eds.), Foundations of Human Sociality: Economic Experiments and Ethnographic Evidence from Fifteen Small-scale Societies. Oxford: Oxford University Press.
Hirschman, A.O. (1982), “Rival Interpretation of Market Society: Civilizing, Destructive or Feeble?Journal of Economic Literature, Vol. 20, 4, pp 1463-1484.
Simmel, G.(1955), Conflict and The Web of Group Affiliations, The Free Press, Glencoe Illinois.
Tabellini, G. (2008), Institutions and Culture, Presidential Address, Journal of the European Economics Association, Vol 6, 2-3, pp. 255-294.

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Topics:  Competition policy Institutions and economics

Tags:  trust, monopolistic competition, Culture

Professor in the Department of Economics, University of British Columbia

Ph.D. candidate in economics, University of British Columbia

Professor of Economics, Aix-Marseille University; member of GREQAM