Does Interpersonal Trust Increase Productivity? An Empirical Analysis between an within Countries

Abstract

A large number of studies show mixed results concerning the macro-economic significance of interpersonal trust. This study suggests that the dominant framework previously used, Barro-type growth regressions, is not adequate. Instead, this study uses the Solow productivity framework to study the effect of trust. Three effects are recognized. The effect of trust on (i) labor (where trust reduces principal-agent problems related to asymmetric information), (ii) capital (where trust facilitates access to the embedded resources in networks of agents,) and (iii) the quality of institutions (which is affected by trust through the absence of bureaucratic rules, corruption or excessive rent-seeking). To empirically test the sign and significance of the economic effect of trust, the study relates the share of high-trust individuals per country to the between-country level and within-country growth of total factor productivity from the Solow model. Cross-sectionally, the study shows that high-trust countries on average have higher levels of productivity. Longitudinally, the results show that an increase in trust is positively related to the growth of productivity in the last two decades (where t1=1990-1999, and t2=2000-2008). However, this relationship only significantly explains productivity growth for developed countries (OECD). This finding suggests that the economic effect of trust may be dependent on within-country development characteristics. Potentially, this explains why there exists such large variations in the literature dealing with the economic significance of interpersonal trust.