The economic impact of distrust

Americans are less trusting of their countrymen than perhaps ever before. Public trust in government is at its lowest level since 1958, when Pew Research Center started conducting its surveys. And fewer Americans agree with the statement that “most people can be trusted” than at any time in the past 40 years.

Falling levels of trust in the United States today seem to be making Americans more politically divided. But according to economic research, it could risk making us poorer, as well.

Some economic research suggests that countries with low levels of trust can find themselves in a reinforcing cycle of greater regulation and lower economic growth. It's a pattern that economist Alex Tabarrok of George Mason University recently described as a "distrust trap."

In distrustful societies, people are more likely to craft public policy and do business in ways that benefit their own family, social class, tribe, religion or other group. Rather than seeking out projects that generate the highest returns, they are more inclined to make investments that are difficult for other groups to seize, Tabarrok says.

They might, for example, be more inclined to pursue Ponzi schemes and other frauds in the business world, or pay off an official to secure a lucrative government contract. They might also be more likely to support policies that redistribute wealth in their favor, like changes to trade or taxes. Taken together, these decisions weigh on the economy.

In a 2010 paper, economists from Harvard and other universities find some evidence to support this idea of a distrust trap. Low-trusting societies are more inclined to make decisions that lead them on a path toward lower growth, higher regulation and more corruption, and that in turn lowers trust further, they argue.

The researchers start by noting that, in countries around the world, distrust and regulation have a strong negative relationship. They measure trust by looking at the World Values Survey — which asks people around the world questions like "Do you need to be careful when dealing with other people?" — and regulations by looking at data on factors like the number of steps it takes to open a business legally, or the difficulty of hiring and firing workers. Countries with high trust, like the Nordic and Anglo-Saxon countries, typically have fewer such controls on business and workers, while low-trusting countries, including some in the Mediterranean, Latin America and Africa, have far more barriers for businesses.

Of course, there could be a lot of outside factors influencing this relationship. But even when the researchers control for factors such as per capita income, education, ethnic fractionalization and democracy, they find that measures of distrust explained about one-third of the variation in regulations across countries. This isn't an entirely new idea: Past researchers have argued that trust and regulation function as substitutes in financial markets.

The chart below shows the strong relationship between how much red tape a person encounters when opening a new business and a social distrust, as measured by the World Values Survey. The graph shows that countries in which people are less trusting are much more likely to have larger barriers to enter the market. The United States and Great Britain are clustered together in the middle of the graph, on the low end for both measures.

The Harvard researchers propose a theory for how this sort of "distrust trap" can become self-reinforcing. In communities that lack trust and civic-mindedness, people doing business are more likely to impose “negative externalities” on others — costs to society that the business owner doesn’t pay for, like polluting or treating workers badly.

Businesses and civil servants are also more likely to be corrupt, since bribery may be the only way to get ahead in countries with a lot of distrust and regulation. This clamps down on entrepreneurial activity and further increases social distrust. As people become less trusting and are exposed to corruption and the negative externalities of business, they also demand more regulation, the research says.

This may explain the paradox of why people living under corrupt governments still tend to support more government control over the economy, the researchers say: Even when people know the government is corrupt, they still see government regulation as preferable to the influence of rapacious capitalists. “Government is bad, but business is worse,” the researchers say.

The Harvard researchers don’t have an easy answer for how countries can escape this trap. They don't seem to see less regulation as an answer: In studying former Soviet countries that have liberalized, they find that deregulation actually leads to a further decline in trust and the incentive to be civic. They theorize a program of public civic education could work, but they don't have any evidence to offer to support the idea.

Tabarrok agrees that it is extremely hard for a country to extricate itself from this kind of "distrust trap," since there are few government policies that can improve trust. The best thing that a country such as the United States can do, he says, is to try to avoid falling into the trap in the first place. While levels of distrust in the United States are at an all-time high according to surveys, the country still looks like a relatively optimistic and trusting society when compared to a lot of other places around the world. Yet we should still guard against the possibility that distrust could weigh on the economy in the future.

Tabarrok says he believes the country should continue to focus on economic growth and resist the impulse to lash out at political scapegoats on both the left or the right in ways that could harm the economy — whether that means shutting U.S. borders to immigrants, cutting trade or over-regulating wages and workers. Tabarrok describes these as measures that try to "divide the pie" of America's wealth, rather than trying to grow it.

When people believe that their economic situation is going to improve, he says, "people become much less concerned about black vs. white, foreign vs. domestic, immigrants vs. nonimmigrants. They become much more open to the world and their fellow citizens."

"If we focus on growing the pie, everyone could be better off. That’s the kind of thing that America is good at," he says. "Diversity is a strength for growing the pie, it’s a weakness for dividing it."