Procedural Rationality and Equilibrium Trust

Abstract

This article examines the determinants of steady state trust in a population of principals and agents, where the former learn from experience using boundedly rational procedures. For any distribution of agent types, the long-run distribution of principal behaviour is characterised. Heterogeneity in the behaviour of principals persists under both the sampling procedure (Osborne and Rubinstein, 1998) and the maximum average procedure (Rustichini, 2003). Despite its greater sophistication, the maximum average procedure can result in poorer performance than the sampling procedure, both from the perspective of the principal and also with respect to aggregate payoffs. Many situations require us to choose the extent to which our fate is left in the hands of others. We can give others substantial discretion over actions that affect our well-being, or we can constrain their choices in ways that leave us less vulnerable. A willingness to leave others unconstrained signals trust in the sense that we expect them to act in a manner reasonably congruent with our interests, even if this entails some material sacrifice on their part. For the same reason, constraining the discretion of others signals distrust in their willingness to put adequate weight on our well-being. Such decisions can be difficult because of the possibility that signals of distrust may them selves induce self-interested behaviour in others, while signals of trust may elicit generous responses. Trust is riskier but can also be more rewarding than distrust. The British welfare state provides a good example of the dilemmas which arise in the context of trust. Doctors, academics and school teachers in the public sector were for a long time regarded as responsible professionals who could be trusted to perform their jobs conscientiously with little outside monitoring. This has changed considerably in recent years. A large bureaucracy has arisen which monitors the performance of such professionals and specifies, often in great detail, what they should do and how they should allocate their time. This development is widely resented because conformity with the rules is time-consuming and restricts the freedom of those concerned to follow their professional judgment. It is also resented as manifestation of distrust. Many professionals believe that extensive monitoring undermines professional commitment and encourages a mercenary attitude (Le Grand, 2006). The defenders of the present monitoring system, including many economists, dismiss such complaints as self-serving or exaggerated. They point to various scandals that have occurred and to the failure of many professionals to perform adequately when left to their own devices. They acknowledge that the present monitoring system does provoke a negative behavioural response in some professionals but believe this is more than offset by its benefits in identifying rogue elements and raising the minimum standard. The idea that trust is often rewarded by generosity on the part of those who are trusted is also familiar in the experimental economics literature (Berg et al., 1995). One * This article was written while both authors were visiting the Santa Fe Institute. We thank the Institute, and especially Sam Bowles, for their hospitality and Carlos Rodriguez for comments on an earlier version. We also thank two referees and the Editor for suggesting a number of improvements.