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The economics of trust

While policy makers are sensitive to slowing growth, growing inflation and widening deficits, few account for the impact of the fall in social trust

Nitin Pai 

Nitin Pai

A new day, a new scam. We are inundated with media reports of scams involving premier league cricketers to generic drug makers, ketchup colonels to air chief marshals, godmen, lawyers, judges, attorneys general, and, why, the prime minister himself.

Then there are scandals we know of but which are perhaps too common to make it to national television: writers engaging in cut-and-paste, teachers selling question papers, cars parked in no-parking zones, motorcycles jumping the red signal and even places of worship encroaching on secular state land.

"So, generally speaking, would you say that most people can be trusted, or that you can't be too careful in dealing with people?"

Only one in five Indians polled by the World Values Survey in 2006 agreed that most people could be trusted. In fact, the number of Indians who said they trusted others fell from 38.9 per cent in 2001 to 20.7 per cent in 2006. O, what a fall was there, my countrymen! Trust in others, which had risen from around 33 per cent in the 1990s, fell precipitously by the middle of the last decade.

We do not have the latest figures, but we can feel the pervasive distrust around us. To get a post-paid telephone connection, you need notarised photocopies of your rental agreement. We need the notary because we distrust people. We also distrust notaries, but mercifully no one has yet called for a super-notary to super-notarise a notarised photocopy of a rental agreement. The telephone company, in turn, is distrusted by regulators, law enforcement authorities, tax departments and ultimately by the customer, thus completing the cycle.

Running an economy on distrust is frustrating and dehumanising. It is inefficient: if you want to rent an apartment in Bangalore, you must deposit the equivalent of 10 months' rent with the landlord. If there were greater trust between people or in the justice system, some of this money could have been invested elsewhere. Social distrust also strengthens incumbents and their cronies: if you are a new entrepreneur, you find it hard to acquire big customers because they prefer to deal with suppliers they trust.

"Widespread distrust in a society," according to Francis Fukuyama, "imposes a kind of tax on all forms of economic activity, a tax that high-trust societies do not have to pay." Indeed, while Indian have been sensitive to slowing growth, growing and widening fiscal and current account deficits, few account for the impact of the fall in social trust.

It might be hard to measure social trust and tricky to include it in the macroeconomic models that use, but it is important to start somewhere. In a 2001 study of 41 countries, economists Paul J Zak and Stephen Knack conclude that "growth rises by nearly a percentage point on average for each 15 percentage point increase in trust." If this relationship holds, India can add one percentage point to its growth rate if it restores its social trust to 2001 levels.

The question is, how? While it's easy for bad policy to increase social distrust - for instance, by asking people not to repay loans, by bailing out cronies' investments and caving into competitive intolerance - the repair is harder and takes longer. Furthermore, the answer might fall beyond the domain of public policy. Problems like these need real mahatmas, of whom we have few in this age. Worse, even mahatmas have only been partially successful in arousing compassion and trust across communities. 

The state can, however, do something to help. Obviously, the first thing it can do is not destroy the trust that exists. Here's something the United Progressive Alliance (UPA) government should pay attention to: a study by the University of Chicago's Cheol-Sung Lee shows that "public investment in skill provision ... leads to higher accumulation of social trust, whereas passive social transfers result in lower social trust". He further finds that active labour market policies can ameliorate the damage caused by passive transfers of the kind that the UPA has introduced.

Playing up the politics of identity also damages social capital. In an analysis covering 27 European societies, Tim Reeskens and Matthew Wright have found "strong evidence that ethnic nationalism goes hand-in-hand with reduced social capital and that it increases the negative social impact of diversity".

Beyond this, there are straightforward things the government can do. First, it can play fair. Second, the government can be a more credible enforcer of private contracts. Third, it can keep its own promises - today contracts signed with the government are considered risky. Land titles issued by even the smaller Indian kingdoms enjoyed a certain sanctity that today's governments are unable to match. Every non-repudiable instrument enhances trust. Every unenforceable law weakens it.

Consider this, though. Even if we somehow found a way to make us trust each other, only one out five is likely to trust the persons advocating the solution. A democracy with high levels of distrust will, thus, find policies hard to implement, especially if they are non-intuitive.

Which is why what we have here is a certified Mahatma Grade Problem (MGP).

The writer is director of the Takshashila Institution, an independent public policy think tank