I recently watched a video by Marginal Revolution University regarding the relationship between social trust and economic growth. It seems natural that a society in which trust is high would be more productive. When individuals believe that their peers are mostly trustworthy, they will feel more inclined to invest in human capital, open new businesses, and spend less time doing “due diligence” to make sure business partners are trustworthy—all of which contributes to the economy. Many economists have put a number to it. According to Paul J. Knack and Steven Zak, who produced some of the most highly regarded research around trust and growth, for each 7% increase in social trust, investment as a share of GDP increases 1%.¹ For each 15% increase, per capita income increases 1%. Social trust is measured by the World Values Survey, under the guise of a multiple-choice question: “Most people can be trusted” or “Need to be very careful”. Unsurprisingly, Norway, Sweden, Denmark, and Finland have the highest levels of social trust.
What influences social trust?
Two main factors are identified by Zak and Knack as causing individuals to have (or lack) social trust.
Government
The sense that one’s government is effective and fair causes social trust to rise. A comprehensive social safety net and criminal justice system contribute to an overall feeling that the government can be trusted and will take care of the people. An effective criminal justice system would make citizens feel safer, dole out just punishments, and successfully rehabilitate criminals, not ruin their lives. Social trust will be high with a low crime environment and a general sense that if anything bad happens (job loss, disability, etc.) citizens will be looked after by the government.
Additionally, strong regulatory agencies to enforce wrongdoing in business contribute to social trust.
“Our results provide strong support for the view that successful development depends critically upon the level of confidence which private agents have the agreements will be honored. Political institutions that contribute to the rule of law and a strong legal system are important determinants of such confidence.” (Zak and Knack)
In the United States, individuals have a strong degree of confidence in business practices being fair. When you buy an item online, you expect to receive that item, and if you do not there are established channels which will ensure a fair solution (credit card companies, BBB, et cetera). Organizations provide and enforce quality standards for virtually every aspect of life and business, and most people feel that they will be vindicated if they are cheated in a transaction. A comprehensive legal system allows individuals or companies to seek retribution for wrong-doing if it occurs, and even to seek retribution when they may have been in the wrong. (I’m looking at you, McDonald’s coffee lady!) The trust these organizations and laws instill reduce the cost of transactions (less due diligence required), thereby providing economic growth.
Education
“Trust also appears to be enhanced by schooling, providing one more reason for governments to support education… greater equality of income and wealth [build] trust, but some mechanisms for redistributing income and wealth would likely impair trust and harm efficiency in other ways. Perhaps the least damaging way to enhance equality is to assist the poor in creating productive human capital.” (Zak and Knack)
A strong educational system serves as a form of investment in human capital. It stands as obvious that higher equality would increase feelings of social trust, and given that education provides individuals with higher social mobility and more job opportunities, education increases social trust as well.
It’s easy to paint a picture of America as a bountiful paradise where the government is always fair, criminals are justly punished, and everyone receives a great education. Statistically speaking, America remains one of the most fortunate countries in the world. But, as I learned about the determinants of social growth, something immediately stuck out in my mind.
What about the minorities?
For minorities, the legal system is not seen as a helpful aid to resolve disputes, rather a bane that many spend their life grappling with. One in three black males will go to prison in their lifetime, and while black and Hispanic citizens comprise of about 30% of the US population (see right graph), they represent nearly 60% of incarcerated individuals.
Many attribute these higher incarceration rates to community factors, drugs, and gangs, but the reality is that minorities are systemically underserved by the educational system, leaving them with little human capital to work with. As evident in the graphs below, blacks and Hispanics have much lower high school and college graduation rates than their white counterparts.
To top it all off, minorities frequently experience racism, which contributes to a sense of general social distrust. This racism is both documented by third-parties and observed by the victims of it:
“Ethnoracial differences in trust have most often been attributed to historical and contemporary experiences of discrimination… In the labor market context, audit studies of hiring discrimination reveal that differential treatment, which occurs at every stage of the hiring process, is three times more likely to favor white applicants than equally qualified black and Latino candidates.” (Smith, 2010)
So, how on earth could minorities have social trust? As it turns out, they have consistently lower rates of social trust.
Considering that social trust impacts GDP through investment, this indicates that the lack of social trust by minorities is hurting our GDP.
How much has the lack of social trust by minorities hurt US GDP?
I put a number to the idea based on historical US GDP, investment as a percentage of GDP, and social trust rates.² According to this framework, if minorities had the same level of social trust as white people in America, GDP would have netted an additional $257,275,928,633 from 1995 to 2013. Here’s a year-by-year breakdown:
Social trust used to be much higher, though—in the 1981 World Values Survey, American social trust was at 45%. American statistics are missing until 1995, and during those years trust declined about 10%. I was curious how much this decline in trust hurt GDP cumulatively, but because there are no clear numbers for trust from 1981-1995, I only calculated the amount of foregone GDP due to decreased social trust from 1995-2013.³
Foregone GDP: $585,468,185,543.76
Average Foregone Per Year: $30,814,115,028.62
You can access a spreadsheet of my calculations here.
While $30 billion a year may not seem like a huge amount for a country with a $16.8 trillion GDP, the federal government only spent $141 billion on education in 2014. The tax revenue collected from this foregone GDP could have been allocated to programs to increase human capital. Even assuming an average 20% tax rate on the foregone investment, this would have been $6 billion extra in 2013—which, if allocated to education, would represent an extra 4.26% of funding.
Sadly, the issue of social trust is a chicken vs. egg type of debate. Many do not support the expansion of programs to increase human capital and further reduce inequality, as they see minorities’ higher crime rates and lower educational attainments to be indicative lack of will to work rather than a lack of opportunities. The positive changes in social trust precipitated by programs to increase human capital and a fairer criminal justice system would also take many years to become evident, as individuals do not change their deeply-rooted views regarding human trustworthiness overnight. Despite the challenges correcting the gap in social trust between minorities and white Americans, doing so would be advantageous for both the economy and social equality.
In Short
Social trust has a direct relationship with GDP—increases in social trust cause increases in investment, which is between 15-20% of GDP. Social trust is derived from sound business practices, education, and the government’s protective abilities. Minorities consistently receive the opposite of these things—lower educational attainment rates, higher imprisonment rates, and systematic racism—all of which results in them having lower rates of social trust. As minorities represent a significant part of US population, the social distrust they hold has a negative impact upon US GDP.
¹ Investment as a share of GDP typically lies between 15-20%, meaning a 7% increase in social trust would increase GDP .15-.2%. For reference, US GDP growth averaged 5.33% between 1981 and 2013.
²These calculations are based off of the numbers by Zak and Knack (1% increase in investment as share of GDP for 7% increase in social trust), the US Bureau of Economic Analysis Data, and the World Values Survey
³The World Values Survey indicates consistently decreased trust during this time period, but Pew surveys contrast that, saying:
“These responses have fluctuated very little during the four decades that survey research organizations have been asking this question, save for a period in the 1990s when measured levels of interpersonal trust dipped for a number of years, triggering a flurry of speculation and scholarship about the reasons for the decline. But since then, social trust has rebounded to roughly the same level it had been before the trough.”
My calculations are based off of the World Values Survey (as it was used by Zak and Knack), and are only indicative of those numbers.
This essay originally appeared on econogist.com.
