Social capital, social norms and the new institutional economics

Although a review of the literature yields substantial evidence suggesting that social norms often make commitments more credible, a far larger literature argues for the importance of two other mechanisms through which individuals and societies lay the foundation of credible commitment: reputation and formal institutions. The role of reputation and its genesis in repeated exchange are the subject of an immense game-

services, to eliminate endogeneity concerns.

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These results do not directly contradict those of Putnam (1993, 2000), because his indexes of social

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theoretic literature. The study of how formal institutions such as courts, industry associations, credit bureaus and political institutions such as checks and balances can solve commitment problems is a key element of the new institutional economics. Unfortunately, it is often difficult to distinguish whether trusting and trustworthy behavior emerges as the consequence of an informal social norm, or because of the presence of reputational and institutional conditions that also give rise to such behavior.

The study of the “network” half of the social capital equation confronts similar ambiguities concerning how they produce trust and cooperation. One well-documented way in which networks operate to improve outcomes is precisely because of their reputational function. Showing the game theoretic (reputational) roots of successful networks is a key element in the influential analysis of Greif (1993), for example. To the extent that networks succeed because of their reputational effects, however, they do not justify the study of social norms, or social capital more broadly, as a separate line of scholarly inquiry into economic and political behavior. Further research is needed to distinguish the role of networks above and beyond their reputational role.

Nevertheless, at least with respect to normative social capital, there are several reasons to think that the role of reputation and formal institutions cannot be the whole story. Neither reputational nor institutional sanctions for non-trusting or non-trustworthy

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behavior exist in anonymous, single play trust and public goods experiments. However, most participants in these experiments exhibit at least some degree of trust and trustworthiness (Ostrom, 2000; Berg, Dickhaut, and McCabe, 1995). Intuitively, as well, the role of guilt feelings, fear of eternal damnation, or shame – consequences that are intrinsic to an individual’s utility function and are linked distantly, if at all, to reputation or formal institutions – should have a significant role in motivating trusting and trustworthy behavior. Even social ostracism, a well-documented deterrent to cheating, is sufficiently removed from the standard reputational story as to constitute a substantially different phenomenon, and one worthy of independent investigation as a “second-order” norm enforcing social norms to contribute to public goods or to behave in a trustworthy manner (e.g. Coleman, 1990: ch. 11; Elster, 1989; Hardin, 1982: 172-9).The remainder of the chapter reviews evidence on the different determinants of trusting and trustworthy behavior. This evidence suggests that such behavior is less likely when institutions and reputation impose weak constraints on human interaction. Nevertheless, numerous other factors, much more difficult to explain within an institutional or reputational framework, also matter significantly. Formal in st itution s

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memberships and professional associations restrain cheating by instituting financial

promulgating formal ethical codes (e.g. bar and medical associations). Credit bureaus

protect lenders from opportunistic debtors, and protect sellers from buyers paying on

credit.¹⁶ The Better Business Bureaus (formal or third-party institutions) of the United

States permit reputational constraints on firms to flourish, since they facilitate the

dissemination of information about firms’ compliance with contractual commitments.

Finally, formal institutions have more direct effects: by tying the hands of state actors and

making it difficult for them to renege on their commitments, formal political institutions

can strengthen trusting attitudes among individuals in a society. In societies with strong

formal institutions, one would therefore expect individuals to act in more trusting ways,

and at the same time to express greater confidence in the trustworthiness of others, even

if such trustworthiness were simply the product of a cost-benefit calculation driven by

formal institutions.

It is worth emphasizing that although a formal institution can sometimes make an

informal norm unnecessary, the decline in informal norms can as well provide an impetus

to the development of formal institutions. Zucker (1986) argues that in the United States,

between 1840 and 1920, the increasing cultural heterogeneity of immigrants and, to a

lesser degree, increasing internal migration, weakened informal institutions and disrupted

social ties. “In a heterogeneous social system, a proportionately smaller number of

transactions occurred between similar others” (Zucker 1986, 78). However, she further

argues that formal institutions emerged to offset the effects of these exogenous

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In the U.S., employers often use credit bureaus to investigate job applicants. Bad credit is viewed as a

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demographic shocks on the informal bases for credible commitment.¹⁷ There is nothing inevitable about the emergence of formal institutions to take the place of fading informal institutions, and Zucker attributes greater inevitability to their emergence as a result of immigration and the breakdown in social ties than is warranted. However, the associations she documents are striking and important, and the ambiguities that they inject into any discussion about the determinants of social norms need to be borne in mind.

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At the same time that immigration was undermining informal modes of contract enforcement, letters of

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suggestive that norms that exist independently of the formal institutional characteristics of society are a key source of trust and trustworthiness.

Reputational considerations are among the most frequently studied sources of trust. The basic reputation story is straightforward: exchange partners that expect to do business or interact in the future are less likely to renege on commitments than partners who have no such expectations. The evidence suggests that this direct reputational constraint explains trusting behavior, as we would expect, but only partially. Glaeser et al. (2000) find that the length of time that paired participants had known each other prior to the experiment had a modest impact on the willingness of senders to transfer money to recipients and a somewhat greater effect on the willingness of recipients to return money (see their Table 4). Other factors, more closely linked to the social capital literature than to the reputational literature, had a much stronger effect: the hours that senders spent studying alone – like bowling alone, a possible indicator of thin social networks which may be associated with weaker norms -- had a strongly negative impact on the amounts they transferred (Glaeser et al., Table 7).¹⁸ In situations where one did not anticipate exchanges with a particular partner to continue into the future, one’s contractual behavior could still become known by and affect transactions with other potential exchange partners. Reputation with others is an important and well-documented mechanism of contractual enforcement, but not one that has been examined in the context of social

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The Glaeser et al. (2000) experiments provide other positive evidence that non-reputational/non-institutional factors influence the willingness of experiment participants to entrust or to return money. Respondents with siblings were much more trustworthy than respondents without siblings: the former returned more than twice as much money to senders (98 percent of what the senders originally transferred) as the latter (only 46 percent). The participant responses to trust and trustworthiness survey questions also had a significant impact on the willingness of recipients to return funds, controlling for many other participant characteristics.

norms. In one approximation to this issue, Glaeser et al. (2000, Table 4) find that the number of friends that paired participants have in common has an insignificant positive effect on both the amount sent by the sender to the recipient (trusting behavior) and on the amount returned to the sender by the recipient.¹⁹ This result suggests that the broader reputational story is even less important than the bilateral reputational effect.

Even if internal sanctions (guilt, shame, fear of afterlife sanctions) from violation of norms prescribing cooperation and trustworthiness have limited force for some individuals, trust and trustworthiness may result from the threat of social ostracism of the untrusting and untrustworthy. Evidence for the importance of ostracism comes from a variety of sources. Experimental evidence indicates that many people are willing to bear sizeable costs in order to punish free-riding behavior by others, even in one-shot games where there are no future rewards for the punisher (Fehr and Gachter, 2000). Survey evidence also suggests social disapproval is a significant deterrent to voter abstention in American elections (Knack, 1992). Wherever people have voluntarily organized themselves to manage common-pool natural resources effectively over a long period of time, a key reason for success is that participants invest in monitoring and sanctioning free riding behavior (Ostrom, 1990).

The work of Henrich et al. (2001) shows that trusting and trustworthy behavior motivated by social ostracism can eventually evolve into social norms. They report the results of public goods experiments on 15 tribes or other small-scale simple societies. The tribes or communities that exhibit the most cooperation in the experimental settings

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The regressions with common friends do not control for months that the paired participants have known

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are also those where the payoffs to cooperation in their main economic activities (foraging, herding, slash and burn agriculture, whaling, etc.) are highest. That is, in communities where the payoffs to norms of social ostracism are highest, trusting and trustworthy behavior are most prevalent. Since the threat of ostracism could not have played a role in the experiments – which were anonymous – it is reasonable to conclude that the trust and trustworthiness exhibited by participants had themselves evolved into social norms.

Numerous sociological explanations of why people might trust or behave in a trustworthy fashion have been advanced. One such explanation is based on social distance: the more numerous the dimensions along which individuals differ and the greater are those differences, the less they interact (Akerlof 1997) and the less able they

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See Sethi and Somanathan (1996) for a rigorous statement of how such a norm could emerge and the

confronting the emergence of norms of ostracism, in the context of a broader discussion of social norms.

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are to trust each other (Zak and Knack 2001). These dimensions might include blood and ethnic ties, language, culture, education, income, wealth, occupation, social status, political and economic rights, and geographic distance. According to Zucker (1986, 63):

There are at least four reasons why socially dissimilar people may be less trusting or trustworthy. Similarity may imply greater risk of social opprobrium or ostracism in the event of improper behavior towards another. In smaller or close-knit communities, the strong likelihood of social interaction between agents and principals can enhance trust in their contractual agreements, as cheating may prompt ostracism. If the agent values the principal’s respect, shame is another potential cost of cheating, even (or especially) when the principal does not ostracize the cheating agent.²¹ John Stuart Mill (1848, 135-136, 444) wrote that “…much of the security of person and property in modern nations is the effect of manners and opinion” and of “the fear of exposure”. As the earlier discussion repeatedly notes, a norm enforced by ostracism is similar to, but in substantial ways different from, the usual reputational story.

The quote from Zucker (1986) suggests a second possibility, however. People believe themselves to be inherently trustworthy and are prepared to act that way when they find other people whom they believe to be inherently trustworthy, as well.

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Shame differs from guilt in that it is activated only when others learn that one has cheated.

However, when social distance grows, their confidence in the inherent trustworthiness of others weakens. In this view, convergent expectations and similarity in preferences for public goods (broadly defined) are an important basis for trust, and the divergent experiences and values implied by greater social distance undermine trust formation.

A third possibility relates to the role of fairness in determining the exact content of norms prescribing cooperation, for example how much one should contribute voluntarily to a public good and under what circumstances. Collective action theorists have long posited that much conformity to social norms prescribing cooperation is motivated by a sense of fairness or reciprocity (e.g., Hardin, 1982), and experimentalists are beginning to accumulate empirical evidence supporting this view (Fehr and Gachter, 2000). While a minority may believe they have a moral obligation (based on religious belief for example) to cooperate even if no one else does, most people appear to be “contractarians” or “conditional cooperators” who feel bound by norms to cooperate only if a sufficient number of others cooperate. Social heterogeneity can reduce the likelihood that a consensus will emerge on what constitutes a fair set of contributions toward the public good. For example, within a group of people with similar incomes and tastes for a public good, equal voluntary contributions to the public good is a prominent solution. Where incomes or tastes vary markedly, however, the rich and poor are likely to disagree on what constitutes fairness, and the sense of obligation to contribute will suffer (Hardin, 1982: 92).²²

Finally, and most simply, altruism may be greater in more homogeneous groups. Where an individual’s utility function takes into account the costs her decisions impose

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Prospects for a high-trust equilibrium would then depend critically on the number of Kantians or

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on others, she is more likely to contribute voluntarily to public goods and to refrain from cheating in principal-agent games.

There is considerable evidence, as well, that social heterogeneity undermines civic cooperation or social trustworthiness in the sense defined by Knack and Keefer (1997). Cooperation with the census and participation in groups are lower where ethnic heterogeneity and income inequality are higher (Alesina and La Ferrara, 2002, 2000; Vigdor, forthcoming; Costa and Kahn, 2003a). Desertion in the Union Army in the U.S. Civil War was higher in companies with greater diversity in age and occupation (Costa and Kahn, 2003b). If one equates, as is reasonable, desertion and non-cooperation with the census as evidence of civic non-cooperation or non-trustworthiness, then this work presents strong evidence that social heterogeneity undermines potentially important social norms.

The documented relationship between trust and government performance suggests that to the extent that social heterogeneity influences trust it should also influence

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government performance. Easterly and Levine (1997) find that ethnic heterogeneity in countries is correlated with a range of indicators of inefficient policies, including a high black market currency premium, high corruption levels, low schooling rates, a lack of financial development, and poor infrastructure. Using cross-city and cross-county data for the U.S., Alesina, Baqir, and Easterly (1999) find lower levels of public good provision in more ethnically-divided areas. Miguel and Gugerty (2002) show similar results across Kenyan communities. Keefer and Knack (2002) conclude that property rights are more uncertain in highly-polarized societies, as measured not only by ethnic tensions and heterogeneity but also by income and land inequality. Berg and Sachs (1988) test the effects of income inequality on indebtedness, concluding that polarized countries are more likely to default on sovereign debt, as indicated by discounts on country debt in secondary markets.

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Homogeneity of credit associations, whether measured by kinship, location, gender, landholding or

shocks are likely to covary more in homogeneous groups (van Bastelaer, 2000).

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However, he finds household expenditures, asset ownership, and access to credit are positively

economic status are particularly beneficial, indicating greater gains from exchange when knowledge and

skills are more specialized.

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evidence is consistent with the thesis that social heterogeneity undermines social norms on which trust and trustworthiness heavily rely. Two other possible explanations cannot be easily excluded, however.

An additional possible determinant of trust and trustworthiness emerges from the “network” or “associational” definition of social capital. Coleman argues that the number, intensity and structure of “horizontal” interactions among individuals in a community facilitate the emergence of desirable norms and trust (1990, 318-319).²⁵ Putnam argues that voluntary associations, in particular, “instill in their members habits of cooperation, solidarity, and public-spiritedness” with positive spillovers for trust and cooperative behavior in the larger social arena (Putnam 1993: 89-90). The underlying rationale for these conclusions is three-fold. First, common membership may reflect and nurture common interests. Second, greater and more intense contact with other people may increase the value of social ostracism as a punishment for untrustworthy behavior, operating in the same way as reputation. Finally, this intense contact may increase information about and confidence in the inherent trustworthiness of others.

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However, less dense but more extensive networks may provide access to more valued information

has found that project teams with the most numerous direct ties with other units took longer to complete

their tasks than those with fewer ties (Hansen, 2002). Reviewing the vast literature on informational

implications of networks is beyond the scope of this chapter.

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Other scholars have subsequently argued that whether or not group memberships and other social ties have beneficial effects on norms of reciprocity and generalized trust, or on outcomes such as the performance of governments and economies, depends on the purpose of the group, the diversity and inclusiveness of its membership, and the intensity and nature of the group’s activities (e.g., Stolle and Rochon 1998 and Varshney 2002). Groups segregated by class, occupation, or ethnicity may build cooperation and trust only among group members, perhaps even encouraging distrust between members and nonmembers.²⁶ In Weimar Germany, civil society organizations were organized along existing cleavages, and “socialists, Catholics, and bourgeois Protestants each joined their own choral societies and bird-watching clubs[.]” (Berman, 1997: 425). Under those circumstances, active associational life worked to reinforce rather than overcome narrow particularistic interests.

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In later work, Putnam (2000: 22) is more careful to note that some social networks facilitating

(1965, 1982) for discussion of the role of social ties and social sanctions in generating collective action on

behalf of narrow interests.

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contemporaneous group memberships, and that lagged memberships are only weakly related to contemporaneous levels of trust.

The evidence that group membership does not correlate systematically with

measures of trust bears upon only one of the several arguments that Putnam has

advanced. For example, group participation – controlling for social heterogeneity and

other factors that undermine the effectiveness of group participation – may also stimulate

broader elements of civic cooperation, such as choosing to vote and in other ways

supervise politicians. These issues have just begun to be addressed (see Varshney 2002).

As with trust, however, there can be external costs imposed on non-members. Alatas,

Pritchett, and Wetterberg (2002) found that household participating in village

organizations sponsored by the Indonesian government reported higher levels of “voice,”

participation and information. However, a large “crowding-out” effect on other villagers

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Earlier work (Knack and Keefer, 1997) relying on a smaller sample of countries had surprisingly found

groups.

actually led to a net decline in participation. Some of the effects of community-level collective action can be zero-sum. Wade’s (1988) study of irrigation and collective action in south India found that well-organized villages were more successful in bribing public officials to increase their water allocations at the expense of other villages.