Trust, law and social norms: fundamentals of economic progress

<p><em>Romesh Vaitilingam interviews Partha Dasgupta for Vox</em></p>
<p><em>November 2009</em></p>
<p><em>Transcription of an VoxEU audio interview [http://www.voxeu.org/index.php?q=node/4307</em></p>
<p><strong>Romesh Vaitilingam</strong>: Welcome to Vox Talks, a series of audio interviews with leading economists from around the world. My name is Romesh Vaitilingam, and today's interview is with Professor Partha Dasgupta from the University of Cambridge.</p>
<p>Partha and I met when he was delivering the Royal Economic Society's annual public lecture in November, 2009. The title of the lecture was &quot;Law and Morality in Economic Life, &quot; and Partha was exploring some of the fundamentals that underlie economic transactions, cooperation and progress - ideas of laws, social norms and, above all, trust. I began by asking him to outline how economists have thought about explaining the enormous disparity between the rich and poor countries of the world.</p>
<p><strong>Professor Partha Dasgupta</strong>: The earliest class of explanations - and when I say earliest, we're looking at 1950s, '60s &ndash; a group of economists argued that the route to wealth was wealth creation.</p>
<p>And wealth creation meant, in that context, the investment in infrastructure, physical capital - roads, buildings, and so forth - so that a worker in the United States, for example, would be producing a lot more per hour than a worker in Ethiopia. He has many, many instruments to work with. Capital does a lot of the &quot;work.&quot;</p>
<p>A second line of attack on the question was to observe that humans can acquire skills. So that's a different kind of capital. We call it human capital in our profession. So, education, skills, and good health.</p>
<p>Improvements in health means that a worker can produce more. In alliance with machinery, of course. So you've got two types of capital. So the accumulation of human capital has been a recurrent theme in the last 30 years of research into the growth of nations.</p>
<p>Then there is a third explanation, which, again, is to be added to the others, which is growth in knowledge. So a knowledge society&hellip;we often hear about how successful knowledge societies are.</p>
<p>So if you think of knowledge as a capital asset, that you spend a lot of money in R&amp;D and so forth to create that additional capital, the three together are the explanation for the rise in wealth of nations, such as in Western Europe, United States, and so forth.</p>
<p>Now, realize that these are really approximate answers. These are not deep answers, because you need to ask, well, how come they invested so much, whereas others didn't? Or Ethiopia didn't manage to.</p>
<p>And so a line of thought that has been explored in the last 20 years or so, extensively, through historical studies, analytical studies, and looking at contemporary data, is an explanation which is founded on institutions. That it is, when a country manages to establish &quot;good institutions&quot; good to be judged on the basis of whether they elicit the accumulation of the kinds of capital assets that we've just now talked about if it can do that, then it's on the way to progress. So it's been institutions which have now been seen as the rock bottom of the explanations, if you like.</p>
<p>Now for me, I've found that to be unsatisfactory as well, because you could establish the same institution in various parts of the world, and in some places will work, and in others it won't. And it's a rather banal observation, particularly when people say, &quot;Well, you can't transplant an institution which has been successful in London into Nairobi because their culture differs,&quot; let us say.</p>
<p>That sentence requires analysis, calls for analysis. But the thought here is that institutions per se don't deliver. What's at the heart of well functioning institutions is the creation of trust among people who are involved in the institutions: buying and selling, borrowing and lending, investing, and so forth.</p>
<p>These are all exchanges, and the exchanges range from trivial ones, let us say buying a chocolate bar, to profoundly important exchanges, such as an agreement to abide by a constitution of a country.</p>
<p>So pretty much all of economic life involves exchanges, transactions, among people. And for them to be fruitful requires a strong element of trust. How that is created is the big mystery.</p>
<p><strong>Romesh</strong>: So can we unpack that a little bit more? As you said, this is really deep stuff that people have been only thinking about in recent years, this idea of trust and how you can approach analyzing it as an economist and thinking about the different mechanisms of trust, whereby you could get people to cooperate on some venture, agree to do something, and then believe that each will fulfill their commitment to do that.</p>
<p><strong>Partha</strong>: Right. Societies usually are smarter than social scientists. So many of the things that we now study such as, for example, trust, or ways, contexts, in which trust can be created, established among people societies have noticed this problem and, in parts, have solved it.</p>
<p>In every society, every economy you go to, there will be groups of people who trust one another. Exchange takes place everywhere. Economic life is all pervasive, whether it's in the highlands of Ethiopia or whether in Midwestern United States. No matter where you go, people are making deals, exchanging.</p>
<p>There are several key contexts or mechanisms that societies have found, discovered, and established which can create and maintain trust. One context involves the household. Inside the household, people trust one another, more or less mostly more rather than less because they care about one another. And so, if one says to the other that he or she will do something, it gets done, unless there is some extenuating circumstance.</p>
<p>And then, of course, a great deal of trust arises out of the fact that people, in particular contexts with particular others, are trustworthy. And the education process, in the earlier stages at home - if you said you will do something, you should try and do it. You feel guilty if you don't. So there is an internal mechanism for creating trust or establishing one's trustworthiness amongst others.</p>
<p>But, the interesting ones from the economist's point of view, because that requires more analysis than simple statements about affection or trustworthiness, are norms of behavior. The idea is to make the act of keeping one's word worthwhile for the person in question. That's the trick, to find ways to make it worth your while not to break trust.</p>
<p>Social norms are one. There, the idea is that people who you have let down will impose sanctions on you, e.g. by not transacting with you in the future. So if you care about the future, in some sense, you worry about the reputation that you're building, and you know that your misbehavior - opportunistic behavior now - will be punished by withdrawal of cooperation.</p>
<p>So that's been one, and of course the other very widespread mechanism is the rule of law, having an external enforcer enforcing the agreements, so that you trust each other to abide by agreements that you have reached, because you know that the sanctions will be imposed by external agents.</p>
<p>Of course, the problem is why should you trust the external agency to do its job? The external agency could be, of course, it could be a warlord in a strife ridden society. It could be a priest. But think of it as the state, in the case of a British country.</p>
<p>You need to have confidence that the state will perform its duties through law courts, and so forth. Policing, and so forth.</p>
<p>At the end of the day, though, all of this hangs on something like social sanctions. Mutual sanctions. Sanctions that people impose on others for misbehavior, because it's easy to say the legal system is a substitute for the norm based society, but in order to guarantee that the legal system actually works, you need citizens&rsquo; engagement with the political authorities, and the norms will be implicitly...that there will be sanctions imposed on government officials if they do not behave. </p>
<p>For them to behave is for them to do their role or jobs properly, i.e. run the courts well, do policing appropriately, and so forth, and so on. Any society lives with a combination of norms and laws, and many other things besides. They all hang together in a very intricate tapestry, obviously. We appreciate that.</p>
<p>But broadly speaking, what this line of research is telling us is that if the trust is maintained within small groups only, then you're not going to be able to propel yourself far, because your transactions are going to be limited.</p>
<p>If only 20 people trust one another...imagine society is broken up into blocks of 20 people. Members of each block trust each other, but not the others, not cross block trust. Then you're not going to get very far. None of us is going to get very far.</p>
<p>What you need is to be able to trust the mechanisms, the institutions, in such a way that you can indirectly transact with people in the event we'll never meet. Far away, maybe, and so forth. That enables people to exploit differences, different talents.</p>
<p><strong>Romesh</strong>: And this is why you use this idea, the conclusion of your analysis basically, that it's easier to destroy a society than to build it, because you could tip from a position where social norms break, laws break down, and people lose trust. Building trust is something much harder to do. To establish rule of law, establish social norms,</p>
<p><strong>Partha</strong>: that's right. For two reasons, why building is so difficult. One is to agree on what the norms are, and to understand norms is no joke. We spend a whole lifetime figuring out when somebody says, &quot;I really haven't got this bit of my society&rdquo;, what does that mean?&quot;</p>
<p>It really means that you haven't figured out what the responses of people are going to be, generally, to something that you might not actually do, but you could have done, and maybe you avoid doing it, because you were uncertain as to what the reaction is going to be.</p>
<p>So norms are not easy to fathom in a society, and much of our education, actually, is involved in understanding the norms of society. People used to joke about little young girls being taught etiquette. That's kind of a superficial kind of norm, but much of our education is really about how to behave. What are your obligations? What are your duties, as a citizen, maybe, or as a member of a family?</p>
<p>Figuring it out and coordinating amongst one another, which is another way of saying, &quot;How do you build trust?&quot;, that's a big thing. We see how the destruction of trust is very easy. Rumors can cause a society to flip from a state of cooperation to a state where everybody is looting every store on site. We've seen that happen, and we've seen that happening within hours in a day.</p>
<p>I think we have enough empirical evidence to support the theoretical structure that I'm talking about, sharing with you. That even if the fundamentals are all right, if people don't trust one another, you'll be in a, if you like it, state of affairs, prevailing state of affairs where there are very little incentives to do things to further themselves, because they see roadblocks everywhere.</p>
<p>But, another island with the same fundamentals as this could, if they trusted one another, could propel themselves. So societies have, we like to use words like multiple equilibrium, but different avenues that societies can traverse. Getting locked into a non trust state, it's so hard to get out of it that you can even say a society is trapped.</p>
<p><strong>Romesh</strong>: I was going to say, does this give you a rather bleak view of the hope for countries like Ethiopia, or Somalia, or Afghanistan, or Iraq, countries which are obviously in very low trust positions?</p>
<p><strong>Partha</strong>: Yes, I do have a rather bleak view. It's not politically correct to say so, because you should always end an interview by saying, &quot;I'm optimistic.&quot; Well, I'm not really, because the evidence seems to belie optimism. These countries have been poor for a heck of a long time. They've been independent for a heck of a long time. They've received quite a bit of aid for a heck a long time.</p>
<p>But this isn't to say though - I shouldn't be misunderstood. Every country, there's a great deal of trust within small groups. Villages everywhere, they trust one another, they exchange, they swap insurance, they borrow from each other. Without that, they would of course be dead. What I'm talking really about is the reach of that trust is so limited.</p>
<p>Here, the causality is very interesting. You might say, well, there's no incentive on any single individual's part to test out people outside their community. Let&rsquo;s call these communitarian societies, let's say.</p>
<p>Because the risk is too high and there's very little surplus, so if you make a big mistake, or even a small mistake, you may be dead. You've lent your money to somebody from another village who comes along saying, &quot;I'll return it. I'll give you 200% interest rate, &quot; or something. But of course if you don't trust it, he wouldn't do that. He may be telling the truth, by the way, but if you don't trust him, and there is no means of insuring that trust, then you would be wise not to.</p>
<p>So sometimes it is said that maybe it is these huge communitarian dependencies within the community, that locks people in, and there's some truth in that. The flipside of it is that the reason is that they've decided to lock themselves in is because they can't afford to go elsewhere. </p>
<p>So it's not so much a causal thing. It's not because they're locked in that they can't go outside the community to further themselves, because the causal change is the reverse. If they feel they're unable to go outside, they of course&hellip;this is home, this is place you operate, you don't leave town, immediate village. You have very strong ties, interlinked relationships.</p>
<p>Here is, I think, a nice example that does the trick for me, in terms of understanding what's going on. You, as a citizen, have very many relationships. When you go shopping, you shop from one store, depending on what you buy.</p>
<p>You may go to two different grocery stores for two different types of groceries. It's even possible that you'll do that. You'll borrow from somebody who is very different from the person from whom you're buying. Your insurance is with a company which is also different.</p>
<p>So many of your transactions are with so various different types of people who may not even know one another. Now, that has big advantages for obvious reasons, right? In a community, these are going to be very much interlinked. The person for whom you work is also the person who lends you money, and so forth.</p>
<p>So these are tied relationships and these ties make the trust more robust. So that's the virtue. But of course the flipside of it is that it's also a vicious cycle, because if so much is tied up, you can't break one bit of it off to do a deal with somebody else, because then the whole thing will collapse here.</p>
<p>That's why the causality part is a deep one, too. In fact, it's sort of a chicken and egg thing. They are a true equilibrium is another way of putting it.</p>
<p><strong>Romesh</strong>: Partha, can we close with shifting the focus a little bit, because I still want to think about this issue of trust. That's a relationship in relation to the other big question of the day, which is about climate change and the prospects for the future of the planet in terms of the natural environment. Which I know is a subject which you've also spent a lot of time thinking about.</p>
<p>We've talked about the micro level of trust in the household, and the village, and the local community, but the challenge here - two weeks before Copenhagen starts, the big summit on climate change - is about real macro trust, the trust between countries to fulfill commitments. I'd be interested in your reflections on that and whether you take an optimistic or pessimistic view of that.</p>
<p><strong>Partha</strong>: I take a pretty pessimistic view, again, for goodish reasons. We don't really have a proper infrastructure, international infrastructure, to enforce agreements.<br />
Now, in the climate change case, there are two problems. There is a prior problem of reaching an agreement. In all, what we've been discussing so far, we've been implicitly assuming that people know what they want to do, what the agreement is. The question is, how do you sustain the agreement? And that's where the issue of trust comes in.</p>
<p>Now, so much of the debate in the international arena over climate change seems to suggest that actually people, they haven't reached an agreement as to what to do, what agreement to reach. They don't agree on the allocation of benefits and burdens, because one would be saying, &quot;Well, you are polluters and have already become rich. We want to be rich,&quot; et cetera. These arguments have been rehearsed substantially over the last few years. </p>
<p>So there is that problem. There is no agreement as to what the benefits and burdens are going to be. So far at least, I haven't seen any.</p>
<p>On top of that, imagine that there is an agreement, say side payments for the larger aid to developing countries in order for them to grow, and so forth. Imagine that the agreements are there. The question is, do the countries believe that these agreements are going to be met?</p>
<p>In the context of so many of the promises that have been made in the past, over aid, the actions seem to fall considerably. Now if the countries have some doubts about the trustworthiness of the commitments that other countries are making, then they themselves are not going to be much engaged in it.</p>
<p>So it's conceivable that you'll have an agreement which looks very nice, people say lots of good things, many promises are made, but if there isn't a mechanism to enforce those agreements, it'll again fall apart. There will be of course partial compliance, because there is a good deal of domestic pressure among citizens to do something.</p>
<p>There will be partial compliance. But the idea that we will have compliance of a kind that's, say, within the European Union we have human rights, I don't see that happening.</p>
<p><strong>Romesh</strong>: Partha Dasgupta, thank you very much.<br />
&nbsp;</p>