Without Trust In the Economy, There Is No Economy
Trust, but verify. Those are some of President Ronald Reagan's most famous words, a man with a number of memorable quotes. Now is a good time to revisit those remarks, but with a slightly different twist.
Most commentators refer back to those words to emphasize the verify part. They want our government to stop trusting other countries without ensuring a verification mechanism is put in place. However, in this column, I want to focus on the trust part. I also want to turn it inward.
Trust, it turns out, is highly important to a smoothly functioning economy. Societies with higher levels of trust have higher rates of economic growth and higher per capita income. This has been confirmed empirically in a number of economic research papers over the years. The reasons are obvious if you stop to think about it for a minute.
Every transaction you participate in involves trust. When you buy things, you need to trust in the quality of the good or service you are purchasing. If you don't, you will demand a lower price or refuse to buy the item at all. Either response would lead to lower GDP since the value of untrustworthy products is lower.
When you sell things, you need to trust in the form of payment you are receiving. Barter is inefficient because it is hard to balance both sides of a trade, so societies moved to using money-some item that had an agreed upon value that all sellers would accept in trade for whatever they were selling. Then checks came along, but checks were not always trustworthy because a buyer's check might not be backed with sufficient funds. Older readers may remember when stores would not take checks on out-of-town banks because they did not trust them and had no quick way to verify their creditworthiness.
Today, we mostly use credit and debit cards and the trust is built into the system because the card processor provides a near-instant payment guarantee to the merchant thanks to rapid electronic communication. This level of trust has allowed us to more easily carry out transactions, which helps to grow the economy.
Unfortunately, as important as trust is, it is also in rapid decline. This is true about the trust we have in our politicians, our government, our corporations; pretty much society in general.
According to a Pew Research Center survey from early this year, 73% of Americans do not trust Congress to do the right thing. Why should we? Congress hasn't passed a proper budget since President Obama's first year in office. We also keep pushing up against the debt ceiling and are about to do so again. All we see on television is bickering and name-calling.
Theoretically, all this lack of trust in Congress should make government debt less trusted and lead to the government having to pay a higher interest rate on all our debt. Luckily, at the moment almost every other country looks even less trustworthy, so this hasn't cost us yet.
The federal government cannot be trusted to follow the law, even though that is the executive branch's job. President Obama decided not to deport children brought to the U.S. illegally (the "dreamers"). No Child Left Behind (an education law) has been demolished with a series of waivers to every state that asks. The Obama Administration recently extended the deadline for employers to offer health insurance or pay fines, even though the law does not allow for such discretion. Over and over, President Obama has demonstrated that he believes he can pick and choose which laws to follow as an exercise in government priorities. On top of all this, now we can add in large-scale electronic snooping; hardly the sort of action to build trust in government.
In fact, these government actions destroy trust. If people and businesses do not know which laws really count and which ones can be safely ignored, planning for the future is rather difficult. Businesses will not invest as readily in new factories if they do not have trust in the future regulatory and enforcement regime. After all, if laws are arbitrary, property rights are uncertain.
When property rights are uncertain, investment plummets. That is why American companies do not want to invest in Venezuela and why many are shying away from investing in Russia. In countries where investments can be suddenly nationalized the value of those investments is greatly reduced, so fewer investments are made. Nobody thinks America is about to start nationalizing corporations (even though essentially we did temporarily nationalize AIG, Chrysler, GM, Fannie Mae, and Freddie Mac), but a lack of trust that future government actions will protect the value of previous investments makes businesses think longer and harder before making new investments.
And government is not the only problem. Trust in corporations has also declined. Because some businesses have acted unethically, both in treatment of customers and in manufacture of their products, people have less trust in businesses in general. This lack of trust means that people are wary of doing business with corporations with which they are not personally familiar. It also means people will place a lower value on many products, due to a suspicion all may not be as claimed. This slows the economy by lowering the value of the goods and services produced.
Taken together, the lack of trust in society makes businesses and people hesitant to invest. That means fewer jobs created.
Trust, once lost, is hard to recreate. Businesses and government need to realize the very real costs of losing our trust. Any short-run gain from bad behavior leads to much larger losses over the long-run. If they do not take swift action to reverse this trend, we will all be poorer as a result.
