The trust paradox: a survey of economic inquiries into the nature of trust and trustworthiness

https://doi.org/10.1016/S0167-2681(01)00214-1Get rights and content

Abstract

This paper examines the concepts of trust and trustworthiness in the context of a one-sided variation of the prisoner’s dilemma, and it evaluates four different categories of solutions to the PD problem: changing player preferences, enforcing explicit contracts, establishing implicit contracts, and repeating the interaction of the players. Because these solutions rely on the creation of incentives to induce cooperation, this paper articulates a paradox of trust in that if one trusts another, because there are incentives for the other to be trustworthy, then the vulnerability to exploitation is removed which gives trust its very meaning. The paper explores the implications of trust when understood to exist at two levels—one in which there are incentives to trust, and the other in which appropriate incentives are absent.

Introduction

What is trust? When should someone trust? Why should someone be trustworthy? How are trust and trustworthiness represented in economics? In the language of economics, trust can be viewed as an expectation, and it pertains to circumstances in which agents take risky actions in environments characterized by uncertainty or informational incompleteness. To say “A trusts B” means that A expects B will not exploit a vulnerability A has created for himself by taking the action. For instance, suppose A, in anticipation of realizing some potential gain, g>0, makes an investment, c. If the investment is specific to B, and if monitoring of B by A is costly, then A may trust that B is trustworthy. That is, A may expect (or hope) that B will not behave opportunistically by forcing a contractual renegotiation in an effort to appropriate quasi-rents generated by the investment (see Klein et al., 1978).

The idea that some agents to a transaction may not behave honestly when environments are less-than-ideal is not a new one to economists. Indeed, an extensive literature describes the consequences of and solutions to environments in which agents have an incentive to exploit others. Examples include: ex post opportunism created by specific investments (Klein et al., 1978); problems of principal–agent relationships created by moral hazard (Arrow, 1985, Holmstrom, 1979, Grossman and Hart, 1983) and adverse selection (Akerlof, 1970); free-riding resulting from team production externalities (Alchian and Demsetz, 1972); and general transacting costs associated with implicit contracting (Azariadis, 1975, Hart, 1983), incomplete contracting (Grossman and Hart, 1986, Hart and Moore, 1988), and self-enforcing agreements (Telser, 1980, Klein and Leffler, 1981).

When examining the question of whether or not an agent, A, should trust another agent, B, the economic approach is for A to assess the incentive B has either to honor or violate the trust offered by A. Then, if B has an incentive to be trustworthy will A trust B. This characterization of trust and trustworthiness reflects the economic assumptions that people are rational and strict utility maximizers, with the implication that people are honest only to the extent that honesty, or the appearance of honesty, pays more than dishonesty (see Sen, 1977, Telser, 1980). In economics, one is trustworthy if he does not have an incentive to exploit the trust of others. Or, conversely, “if the incentives are ‘right’, even a trustworthy person can be relied upon to be untrustworthy” (Dasgupta, 1988, p. 54).

In order to illustrate the insight economics offers to issues of trust and trustworthiness, this paper examines the general class of problems based on the prisoner’s dilemma (PD) game. In the PD, two players must decide whether or not to cooperate with (e.g. trust) each other, but ultimately find they have an incentive to doublecross that, ironically, results in a Pareto inferior outcome for the pair. Related to the PD are one-sided variations in which one player has an incentive to cooperate, but the other always has an incentive to doublecross. The purpose of this paper is to survey the variety of solutions to PD problems proposed by economists and to assess the nature of these solutions as they pertain to the issues of trust, honesty, cooperation, and trustworthiness. This analysis reveals that virtually all economic solutions to the PD and its one-sided variations require that the framework of the game be altered so as to create the incentive for individuals to cooperate. Of course, this is the natural solution for economists to offer. In models in which trustworthiness, honesty, or cooperation are strategic variables, economists argue that PD problems are “solved” only when it can be shown under what circumstances one agent will have an incentive to cooperate with or honor the trust offered by another. For example, according to transaction costs economics, the problem of ex post opportunism created by a specific investment is solved when A has secured for himself a contractual safeguard, perhaps enforced by a third party, to protect himself from the potentially opportunistic behavior of B. Other examples identified in the economic literature of incentives created to induce cooperation include, inter alia, the payment of fees to brokers by their clients in order to induce honest trading (Telser, 1972), the creation of costly devices to signal product quality (Spence, 1973), investments in brand name or reputational capital to foster credible commitments in exchange relationships (Williamson, 1983), and the use of peer groups to monitor the repayment of microfinance loans to low income households (Morduch, 1999).

The problem with this approach is that, by changing the structure of the PD game so that agents have an incentive to cooperate, economists remove the vulnerability players face to exploitation by others, thus neutralizing the very nature of what it means to trust. That is, if I know my partner does not have an incentive to exploit my trust, does it make sense for me to say that I now trust her? The idea that trust is related to one’s vulnerability is expressed by the following description. Trust “involves a recognition of one’s vulnerability to the actions and choices of the trustee. It involves importantly, ‘retaining this vulnerability’ by not attempting to erect barriers to protect one’s interests” (Brien, 1998, p. 398; emphasis added). Indeed, the “purest trustee role serves principals in cases in which they (the principals) are unable to constrain their agent’s performance. … By definition, the principals of … trust are vulnerable and impotent” (Shapiro, 1987, pp. 634–635).

This paper explores the meaning of trust and its use in economic models derived from or related to the PD. A principal objective is to advance the argument that there is a distinction between trust created through incentives and trust applied to situations in which players retain a vulnerability to the actions and choices of others. Such a distinction is important, because economists generally have little understanding of trust and its role in economic exchanges (Williamson, 1993, Perelman, 1998), particularly in the absence of incentives for trustworthiness in others. While not the first paper to argue that there are different types of trust (see Zucker, 1986, Williamson, 1993, Lyons and Mehta, 1997, Lorenz, 1999), this paper surveys research in which trust and cooperation are modeled, describes the general categories by which economists create incentives for trust, and articulates the complications that arise by basing trust on either the presence or absence of appropriate incentives for trustworthiness.

Section snippets

Trust and the prisoner’s dilemma

Economists and social psychologists generally equate trust and trustworthiness with cooperation in a one-shot or repeated game of the PD (see Deutsch, 1960, La Porta et al., 1997). Trust arises in “situations in which the risk one takes depends on the performance of another actor” (Coleman, 1990, p. 91). To trust means you rely on others not to take advantage of you. To be trustworthy means you do not take advantage of others when trusted. Generally, “when we say we trust someone or that

Solutions to the prisoner’s dilemma

There are a number of different types of “solutions” proposed by economists for the PD and its variations, each of which has the objective of motivating the players to cooperate (e.g. trust and honor). These solutions consist of refinements or alterations to the PD so as to induce the agents to take actions that ultimately result in mutually beneficial outcomes. The necessity of implementing refinements derives from the fact that, although both players prefer outcomes characterized by trust and

Discussion

Trust and trustworthiness are important elements in economic exchanges. Without trust, “no market could function” (Arrow, 1973, p. 24), which explains, for example, why Fukuyama (1995) concludes that social capital or “trust” is just as important as physical capital in facilitating the creation of large-scale business organizations necessary for economic growth and development. But, what exactly does it mean to trust, and how are trust and trustworthiness fostered? According to the economic

Conclusions

This paper has examined the nature of trust in a PD environment as characterized in the economics literature. From the economic point of view, trust is an expectation that one will not be exploited by another, which exists when there are no strong incentives for players to behave opportunistically. Though we often think of rationality in terms of the consequences of actions, this is not sufficient for explanations of trust, in part because people often trust when they retain a vulnerability to

Acknowledgements

I am grateful for comments by Farhad Rassekh, two anonymous referees, and participants at a session of the Eastern Economic Association meetings and workshops at the University of Hartford and the University of Missouri.

References (76)

  • Arrow, K.J., 1973. Information and Economic Behavior. Federation of Swedish Industries, Stockholm,...
  • Arrow, K.J., 1985. The economics of agency. In: Pratt, J., Zeckhauser, R. (Eds.), Principals and Agents: The Structure...
  • Axelrod, R., 1984. The Evolution of Cooperation. Basic Books, New...
  • Axelrod, R., 1997. The Complexity of Cooperation. Princeton University Press,...
  • C. Azariadis

    Implicit contracts and underemployment equilibria

    Journal of Political Economy

    (1975)
  • G.S. Becker

    Nobel lecture: the economic way of looking at behavior

    Journal of Political Economy

    (1993)
  • Bohnet, I., Frey, B.S., Huck, S., 2000. More order with less law: on contract enforcement, trust and crowding. Working...
  • O. Bøhren

    The agent’s ethics in the principal–agent model

    Journal of Business Ethics

    (1998)
  • A. Brien

    Professional ethics and the culture of trust

    Journal of Business Ethics

    (1998)
  • Cohen, J.P., James Jr., H.S., 2001. If teaching economics discourages cooperation, can the damage be undone? Working...
  • Coleman, J., 1990. Foundations of Social Theory. Harvard University Press, Cambridge,...
  • R. Craswell

    On the uses of ‘trust’: comment on Williamson, calculativeness, trust, and economic organization

    Journal of Law and Economics

    (1993)
  • Dasgupta, P., 1988. Trust as a commodity. In: Gambetta, D. (Ed.), Trust: Making and Breaking Cooperative Relations....
  • R.M. Dawes

    Social dilemmas

    Annual Review of Psychology

    (1980)
  • R.M. Dawes et al.

    Cooperation

    Journal of Economic Perspectives

    (1988)
  • M. Deutsch

    Trust, trustworthiness, and the F-scale

    Journal of Abnormal and Social Psychology

    (1960)
  • R.H. Frank

    If homo economicus could choose his own utility function, would he choose one with a conscience?

    American Economic Review

    (1987)
  • R.H. Frank et al.

    Does studying economics inhibit cooperation?

    Journal of Economic Perspectives

    (1993)
  • B.S. Frey et al.

    The cost of price incentives: an empirical analysis of motivation crowding-out

    American Economic Review

    (1997)
  • Frey, B.S., Jegen, R., 1999. Motivation crowding theory: a survey of empirical evidence. Working paper No. 26,...
  • Fukuyama, F., 1995. Trust: The Social Virtues and the Creation of Prosperity. Free Press, New...
  • Gambetta, D., 1988. Can we trust in trust? In: Gambetta, D. (Ed.), Trust: Making and Breaking Cooperative Relations....
  • R. Gibbons

    Incentives in organizations

    Journal of Economic Perspectives

    (1998)
  • E. Green et al.

    Non-cooperative collusion under imperfect price information

    Econometrica

    (1984)
  • S.J. Grossman et al.

    An analysis of the principal–agent problem

    Econometrica

    (1983)
  • S.J. Grossman et al.

    The costs and benefits of ownership: a theory of vertical and lateral integration

    Journal of Political Economy

    (1986)
  • W. Güth et al.

    Competition or cooperation: on the evolutionary economics of trust, exploitation and moral attitudes

    Metroeconomica

    (1994)
  • O.D. Hart

    Optimal labor contracts under asymmetric information: an introduction

    Review of Economic Studies

    (1983)
  • Cited by (158)

    • Does trust break even? A trust-game experiment with negative endowments

      2023, Journal of Behavioral and Experimental Economics
    • Gender differences in the repayment of microcredit: The mediating role of trustworthiness

      2020, Journal of Banking and Finance
      Citation Excerpt :

      In contrast to this popular belief, we test the hypothesis that gender differences in the repayment of microloans can largely be explained by gender differences in innate trustworthiness. Trust refers to the willingness of a party to be vulnerable to the actions of another party based on the expectation that the other will not behave opportunistically (Berg et al., 1995; Mayer et al., 1995; James, 2002). Trustworthiness, on the other hand, refers to the innate personal characteristics of an individual reflecting her or his preference to reciprocate to the act of trusting in the absence of any economic incentives.

    View all citing articles on Scopus
    View full text