To what extent trust level influences income? .

Trust level as a mover of individual investment decisions and source of differences on per capita income has been investigated as a trend of last decade. In the beginning of XXI century authors were trying to explain economic indicators both on macro level and individual level by conventional approaches. Respective economists Daron Acemoglu, Simon Johnson, James A. Robinson were explaining long run growth rate by emphasizing institutional quality such as rule of law, property rights (Acemoglu, et al., 2005). While Gallup, John Luke and Jeffrey D. Sachs were linking economic development with geographical factors (Gallup, et al., 2001). However, there were some economists such as Paul J. Zak and Stephen Knack who were explaining wealth and growth by trust level in society and behavior of individuals in regard to investments decisions (Zak & Knack, 2001). Later, economists concentrated on individual level investigations and explain investment decisions by individual trust to brokers and other in society. Gustavsson, M and H. Jordahl were explaining inequality in Sweden with the help of truth level (Gustavsson & Jordahl, 2008).

Contemporary economics teaches us to consider transaction cost in daily integrations in market and include it into cost function. However, transaction cost is not exogenous and can be reduced with numerous measures such as increasing trust level in a society. Berg Joyce run experiment on investment decision using Investment game which is very similar to trust game but provides more options in every stage in order to check decision making process more precisely and found out that people are not always rational in reality. By trusting to partners they can invest more and gain more in the end, but because of lower trust most of the partners invest less and average gain in game decreases three times than possible average return (Berg, et al., 1995).

In our paper, we will investigate influences of trust level both in macro and micro level and explore its effect on per capita income. For macro level outcomes, we will use World Value Survey and run empirical cross-country tests to find out effects of trust level on economy of the countries. By including instrumental variable, we will try to find out through which channel trust level push economic growth and which other factors influence growth via trust level. We will control other variables and try to find out marginal effect of trust.

For individual level analyzes we will also use Caucasian Barometer survey data which includes more than 10000 respondents in sum from Armenia, Georgia and Azerbaijan. By using multiple regression model, we will try to carry our research to individual level and analyze effects of trust on other to one’s income level. In that level, we will test reverse causality as well, by assuming that higher income may also influence trust level.

Our expected results are having positive correlation between trust level and growth but not strong positive correlation on individual level by assuming that one’s trust to other can be misused in the absence of strong rule of law and in the end, one can be worse of. However, in the existence of reciprocity, individuals tend to show more trust to others in order to gain their trust as well and decrease their cost in the long run.

 

References

Acemoglu, D., Johnson, S. & Robinson, J. A., 2005. Institutions as the Fundamental Cause of Long-Run Growth. Handbook ofEconomic Gmwth, Volume 1A.

Berg, J., John, D. & Kevin, M., 1995. Trust, Reciprocity, and Social History. Games and Economic Behavior, 10(1), pp. 122-142.

Gallup, Luke, J. & Sachs, J. D., 2001. The Economic Burden of Malaria. The American Journal of Tropical Medicine & Hygiene, 64(2).

Gustavsson, M. & Jordahl, H., 2008. Inequality and Trust in Sweden: Some Inequalities Are More Harmful Than Others.. Journal of Public Economics, Volume 92, pp. 346-365.

Zak, P. & Knack, S., 2001. Trust and Growth. The Economic Journal, , Volume 111, pp. 295-321.

 

4 thoughts on “To what extent trust level influences income? .

  1. The relationship between social trust and growth is an interesting topic that appeals to me. In the text you mention that you would run the Instrumental Variable Approach. However, in my opinion, social trust can also be an exogenous variable which is inappropriate for an IV. Social trust itself can directly affect economic outcome by facilitating economic activites and reducing transaction costs. Can you give some reasons to indicate the endogeneity of the trust?

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  2. Thank you for your question. Since I added other variables in regression model for the purpose of controlling other effects, I checked both Rule of Law and Control of Corruption variables have effects on Trust. Moreover, Income level itself can influence trust of people to others which is supported by empirical results. Therefore, I decided to use 2SLS regression after making sure that there is endogeneity in OLS model.

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  3. Thank you for your feedback. I have another question regarding your expected results “one’s trust to other can be misused in the absence of strong rule of law and in the end, one can be worse of”. It means that you expect to identify the positive effect of trust on income but the positive impact would be reversed in case of weak formal institutions. However, some other arguments state that the social trust can be even stronger when the quality of formal institutions are low. To be more specific, when the quality of legal system and property rights is not high enough to facilitate economic transactions, people have higher level of trust can improve the economic outcome. This means the role of informal institutions can reverse the negative impact of low quality of formal institutions on growth. Combining both arguments, I wonder if the double causality may lead to any bias in estimation?

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  4. Since I am did two : micro and macro level analyzes, it was simple intuition that if the institution and legal system are weak, one’s trust to other is easy to be misused. Regarding to results, for Macro level analyze, you were right, if the institution is weak, coefficient of trust is increasing, however, it happens only if I use Regulatory Quality index as a proxy for institution, but if replace it with Rule of law index or Control of Corruption index, effects of trust become insignificant. I was thinking about possible reasons, because all three proxies of institutional quality h
    ave same range and almost same values in my dataset, however, they have different effect on the effect of trust in regression. I assumed that it is because of measurement methods of these three proxies.

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