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How To Solve the Economic Crisis

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The Economics of Trust

A 2005 letter in premier scientific journal Nature reviews the research on trust and economics:

Trust ... plays a key role in economic exchange and politics. In the absence of trust among trading partners, market transactions break down. In the absence of trust in a country's institutions and leaders, political legitimacy breaks down. Much recent evidence indicates that trust contributes to economic, political and social success.

Forbes wrote an article in 2006 entitled "The Economics of Trust". The article summarizes the importance of trust in creating a healthy economy:

Imagine going to the corner store to buy a carton of milk, only to find that the refrigerator is locked. When you've persuaded the shopkeeper to retrieve the milk, you then end up arguing over whether you're going to hand the money over first, or whether he is going to hand over the milk. Finally you manage to arrange an elaborate simultaneous exchange. A little taste of life in a world without trust--now imagine trying to arrange a mortgage.

Being able to trust people might seem like a pleasant luxury, but economists are starting to believe that it's rather more important than that. Trust is about more than whether you can leave your house unlocked; it is responsible for the difference between the richest countries and the poorest.

"If you take a broad enough definition of trust, then it would explain basically all the difference between the per capita income of the United States and Somalia," ventures Steve Knack, a senior economist at the World Bank who has been studying the economics of trust for over a decade. That suggests that trust is worth $12.4 trillion dollars a year to the U.S., which, in case you are wondering, is 99.5% of this country's income. ***

Above all, trust enables people to do business with each other. Doing business is what creates wealth. ***

Economists distinguish between the personal, informal trust that comes from being friendly with your neighbors and the impersonal, institutionalized trust that lets you give your credit card number out over the Internet.

Similarly, market psychologists Richard L. Peterson M.D. and Frank Murtha, Ph.D. wrote in October:
Trust is the oil in the engine of capitalism, without it, the engine seizes up.

Confidence is like the gasoline, without it the machine won't move.

Trust is gone: there is no longer trust between counterparties in the financial system. Furthermore, confidence is at a low. Investors have lost their confidence in the ability of shares to provide decent returns (since they haven't).
Americans clearly don't trust the bankers and the financial bigwigs.

Indeed, as leading economists have pointed out, the big financial institutions don't trust each other, because they know that all of the other companies might have hidden their problems or gamed their books (see this, for example). See also this.

There's Nothing We Can Do!

The main problem we are facing is that our leaders are pretending that there is not much they can do to fix the economic crisis.

But the truth is that the powers-that-be are getting too many perks from the current system to really fix it.

Let's look at an analogy. A gang member keeps on getting thrown into jail for selling cocaine. The court-appointed psychiatrist says "why don't you stop?". The gangbanger says "I don't know how to stop". In reality, the gentleman is making money dealing cocaine, and maybe getting a sense of safety and community in belonging to a gang.

Or here's an analogy closer to home for me. My very young daughter frequently throw tantrums. When my wife and I tell her to stop screaming, she says "I don't know how to stop." We tell her she just has to decide to stop screaming, and then the screaming will stop. She repeats "No, I don't know how to stop!" and keeps on screaming. Obviously, the pay-off of getting our attention (and getting our goat) makes it worthwhile for her to keep on screaming.

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George Washington


As a political activist for decades, I have rejoiced in victories for the people and mourned in defeats. I chose the pen name "George Washington" because - as Washington's biographies show - he wasn't a (more...)
 

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