Social trust and regulations in the frame of economic transactions

PhD research proposal: Social trust and regulations in the frame of economic transactions More and more attention has been given during the last two decades within various academic disciplines to the notion of trust (Uslaner 2018). Trust represents a bet upon the expected behaviour of others. It is part of a certain mind-set reigning within a society and reflected by the way in which its people behave. Societies have different propensities of trust; a society might be characterised by a high level of trust or low level of trust (or mistrust). Trust in others, social or generalized trust, becomes in this manner an important determinant of economic development as it facilitates coordinated action. Bjørnskov (2012) notes that general social trust, which can be understood as reliability, replaces control and removes uncertainty as well as the risk associated with an action or behaviour conducted with or by another person. High levels of trust can therefore reduce the transaction costs implicit in any economic activity and increase the number of transactions. As a result, trust enables closed group interactions and enlarged exchanges among anonymous actors, leading to new forms of cooperation and business activities. It is therefore no surprise that a significant positive correlation has been found between social trust and economic growth (Zak and Knack 2001). When looking at social capital within a country, social or generalized trust can be considered a public good. This research proposal will focus on the relation between social trust and the regulations in the frame of economic and financial transactions. While trust is part of a belief and norm system that motivates individuals to follow certain codes of conduct which guide, enable and constrain actions that generate predictable patterns of behaviour, institutions – through regulations and legal rules – regulate behaviour because of the inherent authority they embody that is provided by the state. State imposed rules and norms can influence beliefs and instil trust among a population. Further, trust and economic regulations are two distinctive mechanisms that can impact a person’s behaviour and lead to an expected outcome within a transaction of asymmetric information. Building upon studies conducted by Aghion et al. (2010) and Pinotti (2012), this research proposal will attempt to assess through different research papers whether social trust and regulations in the form of contracts, procedures, standards, etc., can substitute or complement each other for economic transactions to happen. The research will be structures in three parts: looking first (1) on the nature of social and particularized trust especially in economies with a prevalent informal sector and characterized by ethnic fractionalization; then (2) assessing social trust and regulations as substitutes in the case of economic and financial transactions; and finally (3) considering trust and regulations as complements for transactions to happen. The (1) first part of this research will focus on the nature of social and particularized trust in Eastern African countries at the Horn of Africa and their economies, by looking at Uganda, Kenya and Ethiopia, which are characterized by ethnic fractionalization and a prevalent informal economy. For this purpose I will explore the data of the Afro-Barometer that has not been readily drawn upon for economic studies. Other potential papers will examine the impact of ethnic and linguistic fractionalization on social and/ or particularized trust. Generalized trust, also called social or ‘out-group’ trust, defined as the degree to which you trust someone in the same society and country that is subject to the same rules and laws. Particularized trust designates trust in between members of the same religious, ethnic or linguistic community also referred to as ‘in-group’ trust. Most academics claim that if trust in between members of the same community is high, that ‘out-group’ or social trust is low and vice-versa. Fractionalization generally relates to more distrust towards other groups, though increased contacts and close relationships at the local level such as within a neighbourhood between persons from two different ethnic groups can enhance trust (Dinesen et al. 2020). By considering social trust as a public good, I will analyse what happens to social and particularized trust as conflict or tensions arise. Another paper might investigate the impact of generalized versus particularized trust in informal economic activities where there are no rules and regulations. Conducting informal transactions comes with a lot of risks as there is no guarantee or authority to enforce good behaviour or that of others. However, in the absence of formal rules, there is either trust or mistrust, people might have no other choice but to transact. The (2) second part assesses social trust and regulations as substitutes in the case of economic and financial transactions, trying to find evidence for either the Public Choice or the Public Interest Theory. If the Public Choice Theory holds, restrictive regulations are abused or misused as a rent-seeking device in that we expect a significant negative correlation between social trust and the cost of procedures. If the Public Interest Theory holds, an important amount of regulatory procedures are to be expected in order to conduct a transaction. The lower the level of trust, the more people are going to demand government intervention in the form of regulations to manage day-to-day transactions so that a certain outcome is obtained. I will then investigate if there has been a decrease in social trust over time that has led to an increase in the demand for government intervention in the form of regulations via new legislation (Pitlik and Kouba 2015). As social trust is substituted or replaced by regulations to allow for economic transactions to take place, this may also uncover that if social trust is degraded and regulations sustained, this leads to a decline of economic transactions and wealth. The (3) third set of research considers trust and regulations as complements in the frame of economic and financial transactions to happen. More emphasis is placed on the outcome of such transactions where it is harder to distinguish whether the transaction occurred because of trust or the effect of regulations and contracts. The new set of data in the World Bank’s Enterprise Survey on the Landscape of Transactions (Francis et al. 2018) allows us to detect the different mechanisms used by firms, such as building trust and contracts, to engage with customers and suppliers; the fulfilment of a firm’s agreements to buy and sell goods and services. What makes a firm choose one or another mechanism in such transactions? Are trust and contracts substitutes for each other when a firm deals with customers or suppliers? Do firms prefer to work with peers (particularized trust) or do they work with outsiders (social trust or formal contracts)? Looking at the outcomes, I will also explore to which degree social trust is used as a mechanism to enter new markets, such as for Foreign Direct Investments and in the context of Development Aid between European and African countries. Looking at the Fundamental Problem of Exchange (FPOE), I will explore to which extent firms use social or particularized trust to enter new markets and whether the Belgian state relies on trust for its projects in Eastern African countries (via its Belgian Development Agency, ENABEL or through Belgian Non-Governmental Actors, BNGAs), where often no functioning legal system is in place and which have a weak enforcement of public institutions. I will draw on data from micro datasets such as the World Value Survey, the European Social Survey, the Afro-Barometer, the World Bank’s Enterprise Survey, the ‘Doing Business’ Database, the International Social Survey Programme, in addition to using macro-information on country differences and events. I plan to use different methodologies such as instrumental variable estimation and difference-in-difference estimations to obtain statistical evidence. I also plan to take courses to raise my level of knowledge on statistical methodology and analysis. Selective references: Aghion, Philippe, Algan, Yann, Cahuc, Pierre, Shleifer, Andrei (2010). Regulation and distrust. Quarterly Journal of Economics, 125 (3), 1015-1049. Bjørnskov, Christian (2012). How does social trust affect economic growth? Southern Economic Journal, 78 (4), 1346-1368. Dinesen, Peter Thisted, Schaeffer, Merlin, Sønderskov, Kim Mannemar (2020). Ethnic Diversity and Social Trust: A Narrative and Meta-Analytical Review. Annual Review of Political Science, 23, 441-465. Francis, David C., Karalashvili, Nona, Murrell, Peter (2018). Mapping the Landscape of Transactions. The Governance of Business Relations in Latin America. Policy Research Working Paper (World Bank Group), 8564. Pinotti, Pablo (2012). Trust, Regulation and Market Failures. The Review of Economics and Statistics, 94 (3), 650-658. Pitlik, Hans, Kouba, Ludek (2015). Does social distrust always lead to a stronger support for government intervention? Public Choice, 163, 355-377. Uslaner, Eric M. (editor) (2018). The Oxford Handbook of Social and Political Trust. Zak, Paul J., Knack, Stephen (2001). Trust and Growth. The Economic Journal, 111, 295-321.