The Right Amount of Trust

Abstract

We investigate the relationship between individual trust and individual economic performance. We find that individual income is hump-shaped in a measure of intensity of trust beliefs. Our interpretation is that highly trusting individuals tend to assume too much social risk and to be cheated more often, ultimately performing less well than those with a belief close to the mean trustworthiness of the population. On the other hand, individuals with overly pessimistic beliefs avoid being cheated, but give up profitable opportunities, therefore underperforming. The cost of either too much or too little trust is comparable to the income lost by forgoing college. We develop a framework to take into account heterogeneity in the trustworthiness of the pool of people with whom individuals interact as well as the presence of heterogenous costs of trust mistakes. Both sources of heterogeneity drive the relationship between trust and income which is hump-shaped for all individuals. This framework allows us to show that income-maximizing trust typically exceeds the trust level of the average person as well as to estimate the distribution of income lost to trust mistakes. We find that although a majority of individuals has well calibrated beliefs, a non-trivial proportion of the population (10%) has trust beliefs sufficiently poorly calibrated to lower income by more than 13%. Our findings hold in large-scale international survey data as well as inside a country with high quality institutions and are also supported by experimental findings.