Trust and Growth

Abstract:     
Why does trust vary so substantially across countries? How does trust affect growth? This paper presents a general equilibrium growth model in which heterogeneous agents transact and face a moral hazard problem. Agents in this world may trust those with whom they transact, but they also have the opportunity to invest resources in verifying the truthfulness of claims made by transactors. We characterize the social, economic and institutional environments in which trust will be high and show that low trust environments reduce the rate of investment and thus the economy's growth rate. Further, we show that very low trust societies can be caught in a poverty trap. The predictions of the model are examined empirically for a cross-section of countries and have substantial support in the data. Trust is higher in more ethnically, socially and economically homogeneous societies and where legal and social mechanisms for constraining opportunism are better developed. High-trust societies, in turn, exhibit higher rates of investment and growth.

Number of Pages in PDF File: 40

JEL Classification: D9, D82, D31

working papers series