My retired grandma used to narrate to me fables on trust and honesty. How does she help the economy grow?
Utopian Objective
A society with high trust and honesty
A world with good economic growth
We trust that the shop keeper is selling good quality goods and that we can exchange it if that is not the case. We pay taxes because we trust that government will spend it to provide services for us. We trust that these economic players will be honest during the transaction.
It is easy to see how a country where there is little trust suffers economically. Normal economic activities including buying, selling and working can't be done easily. Running a business is a living nightmare! Trust enables people to do business with each other, thus creating wealth and prosperity.
But how much does trust and honesty affect economic growth?
Trust Me From The Bottom Of Your Heart...
According to an article by Forbes in 2006, trust was worth $12.4 trillion dollars ($12,400,000,000,000) in 2006 to the US! That was 99.5% of the GDP. And the US is no exception to this rule. Trust creates a good environment for investment, which is vital for long term growth. It explains the difference between the UK and Somalia, between the developed countries and poor countries.
Market psychologists Richard L Peterson and Frank Murtha once said:
'Trust is the oil in the engine of capitalism, without it, the engine seizes up'Market psychologists Richard L Peterson and Frank Murtha once said:
| Capitalism can't work without trust |
How Can We Increase Societal Trust?
There is no single solution to increasing trust. Every country has different cultures, different histories, different socio-economic conditions and different education systems. For example, different measures need to be taken in Rwanda, a country which suffered a genocide in 1994 which is facing a trust deficit between the different ethnic groups. Ukraine's trust level has gone down under different reasons, i.e. the civil war that is currently going there.
This makes sense, but are these not extreme examples? It is easy to see why lack of trust is affecting these countries' economic growth. But what is not so obvious is that this problem exists in every country (with some exceptions). And by taking necessary steps, their economies' can function better.
This makes sense, but are these not extreme examples? It is easy to see why lack of trust is affecting these countries' economic growth. But what is not so obvious is that this problem exists in every country (with some exceptions). And by taking necessary steps, their economies' can function better.
Who Trusts the banker?
Distrust hampers economic growth. This is a big problem today! Since the 2008 Global Financial Crisis, trust in the financial sector has reduced drastically. In fact, some surveys have shown that it is at a 50 year low. Big problem!
The financial sector depends on trust to function. Without it, why would people deposit their hard earned savings in them? If banks don't have money to lend, businesses can't invest money. This halts long term economic growth. But a trusted financial sector can produce miracles to the economy.
Improving Trust In The Financial Sector
We have learnt many mistakes from the recent crises. But unless we take steps to prevent these in the future, trust levels will not increase.
Many people have suggested that more regulations need to be put in place. I agree that regulations could be one potential solution, but it has a fundamental problem: it tries to improve social trust using politics. And politicians are not very popular when it comes to trust... that doesn't mean there shouldn't be regulations though. But there is another deeper problem, a problem which has for long been dragging down many companies: different incentives.
In my previous blog post, titled 'The Curse Of The Corporation...Aaaaah', I spoke about why the interests of company directors has been generating short term profits. The same logic can be applied to banks. The system has been devised to reward short-termism. This has greatly affected the credibility of the banks.
Following the crisis, the UK itself spent some £500 billion to 'rescue the banks.' Regulations have been introduced, bonuses have been suppressed and executives have been scrutinised....
... but trust in the financial sector has not increased. One of the biggest determinants of trust is government performance. If governments commit to reform the financial sector to make it safe, fair and efficient, trust will slowly but surely increase.
Many people have suggested that more regulations need to be put in place. I agree that regulations could be one potential solution, but it has a fundamental problem: it tries to improve social trust using politics. And politicians are not very popular when it comes to trust... that doesn't mean there shouldn't be regulations though. But there is another deeper problem, a problem which has for long been dragging down many companies: different incentives.
In my previous blog post, titled 'The Curse Of The Corporation...Aaaaah', I spoke about why the interests of company directors has been generating short term profits. The same logic can be applied to banks. The system has been devised to reward short-termism. This has greatly affected the credibility of the banks.
Following the crisis, the UK itself spent some £500 billion to 'rescue the banks.' Regulations have been introduced, bonuses have been suppressed and executives have been scrutinised....
... but trust in the financial sector has not increased. One of the biggest determinants of trust is government performance. If governments commit to reform the financial sector to make it safe, fair and efficient, trust will slowly but surely increase.
Three Steps Back
A Case For Income Distribution
Many people attack the idea of income redistribution. Milton Friedman once said, "A society that puts equality before freedom will get neither." Many people claim that higher taxes for the rich will only hamper growth since it stops them from investing money. In other words, they claim that if you want growth, you need inequality.
But research suggests that greater equality leads to greater trust, which is especially evident in Scandinavian countries. As we have seen societies with greater trust grows faster. Now I am not suggesting that we suddenly raise taxes for the rich to insane proportions and redistribute money. We need to learn to get the balance right. If government is committed to more equality, it will increase societal trust and this will be reflected in the economy.
Really, by reducing inequality, it means reducing poverty. Poverty means that individuals cannot take part in the economy. It reduces life expectancy, increases crime and reduces trust. These all negatively impact economic growth. Sadly, many governments have neglected the effect and importance of trust. But as we have seen, it is probably the most important social capital to a country. And this justifies efforts to reduce inequality.
But to what extent does government actually affect trust?
In Government We Trust
Richer countries generally have higher trust levels than poorer countries. Is this to do with money? Does higher income increase social trust? Income per capita is correlated with higher trust levels. But there is something else that plays a large part here - Quality Of Governance.
Nowadays honest government is considered to be either a joke or fiction. But there are many good examples of good, honest governments including Nordic countries like Norway and Denmark and Singapore.
In 1965, the tiny island country of Singapore gained independence. The country was poor with a GDP per capita of just $516. The country was torn with tensions between the different ethnicities. Trust between different groups was very low. Now however, it is one of the most developed countries in the world with low crime rates and high life expectancy. How was this possible?
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| Singapore is now a developed country |
