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Aarhus School of Business, Aarhus University
Master of Science in International Economic Consulting
Master Thesis
The Effect of Social Trust and Economic Growth
Author: Lena Pfister
Academic Supervisor: Christian Bjørnskov
September 2010
Abstract:
In recent years, social trust has gained in importance within social science, especially
in an economic growth context. The thesis examines social trust as a potential
determinant of economic growth using a panel data set including 116 countries over
a time span from 1950 until 2005. The findings suggest a strong association between
social trust and economic growth and stay robust throughout a Jackknife exercise
and an extreme bound analysis implying that it is unlikely that these results are driven
by outliers or omitted variables. Reverse causation is ruled out by adopting an
instrumental variable approach. Further findings suggest that the effect of social trust
on economic performance depends, however, on the development level of the
country. Moreover, the analysis provides further evidence that human capital and
legal quality are indirect links through which social trust has an economic effect.
Finally, the thesis gives insight on the individual characteristics of the respondents
that answer the trust question in the affirmative.
Index
I
Index
Index I
Figures and tables II
0 Introduction 1
1 Overview of the literature 3
1.1 Social Trust 3
1.2 Social trust and growth 5
1.2.1 Direct effects of social trust on economic performance 5
1.2.2 Indirect effects of social trust on economic performance 6
1.3 Who trusts others? 8
2 Methodology and Data 10
2.1 Data description 10
2.2 Methodology 16
2.2.1 Basic assumptions 16
2.2.2 Random effects 19
2.2.3 Logit estimation 20
3 Econometric Analysis 23
3.1 Social trust and economic growth 23
3.2 Extreme Bound Analysis 29
3.3 Instrumental variables 31
3.4 Jackknife exercise 33
3.5 Divided sample 34
4 Transmission channels 38
4.1 Human capital 38
4.2 Legal quality 40
5 Determinants of trust 44
5.1 GSS 46
5.3 WVS 50
6 Conclusion 54
Appendix 60
Figures and tables
II
Figures and tables
Figure 1: Social Trust and Log GDP
per capita
1950 23
Figure 2: Social Trust and Log GDP
per capita
2005 24
Table 1: correlation matrix PWT 25
Table 2: PWT regression 1 26
Table 3: PWT regression 2 27
Table 4: EBA 30
Table 5: Sagran Hansen statistic 32
Table 6: Instrumental variables 32
Table 7: Jackknife exercise 34
Table 8: Divided sample 36
Table 9: Human capital 39
Table 10: Human capital, divided sample 39
Table 11: Legal quality 41
Table 12: Legal quality, divided sample 43
Table 13: Overview GSS, WVS 1 44
Table 14: Overview GSS, WVS 2 45
Table 15: Overview GSS, WVS 3 46
Table 16: correlation matrix, GSS 47
Table 17: Social trust, GSS 48
Table 18: correlation matrix, WVS 50
Table 19: Social trust, WVS 51
Table 20: Social trust, WVS, USA/Canada 53
0 Introduction
1
0 Introduction
The notion of social capital started to develop throughout the 20
th
century. It did not,
however, have its breakthrough until 1993 when Robert Putnam published “Making
Democracy Work: Civic Traditions in Modern Italy”. In his book, Putnam investigates
different regions in Italy with the same institutions and governmental structure and
tries to explain why there are nevertheless huge disparities in economic performance
between Northern and Southern Italy. His findings suggest that the economic
disparities are due to different endowments of social capital in the two regions.
Putnam’s work appeared to be a starting shot for social scientists to explore the topic,
since it subsequently enjoyed a surge in popularity. Today a wide literature can be
found and known journals like the “American Economic Review” and “Quarterly
Journal of Economics” publish articles on social capital. It was in the latter that Knack
and Keefer published their paper “Does Social Capital have an Economic Payoff?” in
1997. They were the first to examine different features of social capital separately in
a standard empirical growth framework, and they provided proof that social trust in
particular is positively associated with economic performance. Subsequently, more
papers have been written on the issue, however, relatively few compared to the size
of the social capital literature. Moreover, research within this topic has mainly been
performed on the basis of cross sectional data.
The aim of this thesis is to obtain further insight into the relationship between social
trust and economic performance and thus to contribute to a deeper understanding of
economic growth and social trust. To achieve this goal the analysis is based on a
panel dataset and thus more comprehensive than previous studies. The questions
investigated are:
1. Does Social trust influence economic growth? If so, how and to what extend?
2. Who does trust others?
The thesis is structured as follows: The first chapter gives an overview of the existing
literature and the current state of research. The concept of social trust is introduced
in detail and its measurement is discussed. Subsequently, an overview of social trust
within an economic growth context is given and direct and indirect links through
which social trust might have an economic effect are presented. Finally, the literature
on who trusts others is explored.
0 Introduction
2
The second chapter describes the data used for the analysis. Furthermore, the
methodology applied is amplified. In this context the random effects model, which is
applied in the third and fourth chapter and the logit model, which is applied in the fifth
chapter are introduced. In the third chapter the effect of social trust on economic
growth is investigated. Additionally, to verify the robustness of the results, an extreme
bound analysis and a Jackknife exercise are conducted. Moreover, an instrumental
variable approach is applied to control for endogeneity. The fourth chapter further
examines the association between social trust and economic growth. To shed more
light on how social trust might influence economic growth, the relationship between
social trust and human capital and social trust and legal quality as two potential
transmission channels are analysed. In the fifth chapter individual level data is
applied to find out more about the characteristics of the trusting citizen. Moreover, it
is investigated if the grandparents’ trust levels still influence their grandchildrens’ trust
today. This could give more information about the stability of trust. The analysis of
this chapter aims to get a deeper understanding of social trust, which could be useful
for policy makers. In the conclusion, which is presented in the final chapter, the
results of the analysis are summed up and evaluated.
1 Overview of the literature
3
1 Overview of the literature
In 1993 Robert Putnam published the book “Making Democracy Work: Civic
Traditions in Modern Italy”. He looks into the question why some democratic
governments succeed and why others fail and aims at to contribute to the
understanding of the performance of democratic institutions. He concludes that their
success is based on their endowment of social capital, which he defines as “features
of social organization, such as trust, norms, and networks that can improve the
efficiency of society by facilitating coordinated actions” (Putnam, 1993: 167). Even
though there is no consistent definition for social capital, Putnam’s is the one most
referred to.
Today social capital is well established as a determinant of growth. So much that the
World Bank started a “Social Capital Initiative” in 1996 with the goal of further
investigating the formation of social capital and its impacts on project effectiveness
and development (World Bank, 2010).
However, there have also been discussions about whether to treat social capital as
an entity since its different features have different effects (Bjørnskov, 2006b). Several
papers have shown that the three pillars of social capital, namely trust, cooperative
norms and associations within groups have different or no effect on economic growth,
whereas social trust appears to be the most promising candidate (Knack and Keefer,
1997; Newton, 1999; Whiteley, 2000).
The first chapter is structured as follows: In section 1.1 the concept of social trust is
introduced in detail and the way to measure it is discussed. Subsequently, an
overview of social trust within an economic growth context is given in section 1.2.
1.1 Social Trust
When the concept of social trust gained popularity within social science there were
several discussions about what it consist of and how it can be measured. It became
apparent that it is very important to distinguish between two kinds of trust
(generalized and particularized trust). Social trust is mainly defined as generalized
trust, i.e. it measures how much people trust others about whom they possess no
information. This is opposing to particularized trust or reputation that is based on trust,
1 Overview of the literature
4
which in turn originates from previous experience or information obtained about
others. How important this differentiation is shows the paper from Alesina et al. (2009)
where they confirm Banfield’s (1958) theory of “amoral familiarsm” and show that
there is a negative association between trust within the family and generalized trust.
In recent years the following question has shown to be a good measure of social trust:
“Generally speaking, would you say that most people can be trusted, or that you can’t
be too careful in dealing with people?“ (trust question).This question originates from
the German political scientist Elisabeth Noelle-Neumann who formulated it in 1948. It
was adapted by for instance the General Social Survey (GSS) in 1972, the World
Value Survey (WVS) in 1981 and the Barometers. These are today the main sources
for researchers within this area and the number of countries for which the data is
available rises every year.
Yet, the validity of the trust question was questioned on several accounts. Glaeser et
al. (2000) conducted an experiment with 189 students of the introductory economics
course at Harvard University to investigate the validity of survey questions about
hard-to-measure characteristics like trust and trustworthiness. First the students had
to answer survey questions about trusting attitudes and trusting behaviour.
Subsequently, trust and trustworthiness were measured by experimental behaviour
by playing the Berg et al. (1995) “trust game”. Finally the two results were compared.
They concluded that “standard attitudinal survey questions about trust predict
trustworthy behaviour in our experiments much better than they predict trusting
behaviour” (Glaeser et al., 2000). However, there was a severe problem with the
setup of the experiment. They allowed students who knew each other to play
together. Their reasoning was that non-random pairing procedure generates more
variation in social connections. This had however the consequence that particularized
trust rather than social trust was measured.
In a recent study, Ostrom et al. (2009) repeat the experiment but ensure that the
game is played anonymously. They find that “the response to the survey question
regarding trust is highly significant and in the expected direction [positively
correlated]”, which confirms the validity of the trust question. Another study by
Sapienza et al. (2007) gets to the same result under the condition that the stakes of
the game are sufficiently high. By the same token, they show that trust and
trustworthiness are strongly related. In the trust game they find that “players
1 Overview of the literature
5
extrapolate their opponent’s behavior from their own”, which means that people who
trust others are also more trustworthy.
In general, an increasing support for the trust question as a measure for generalized
trust, trustworthiness as well as a proxy for economically relevant beliefs can be
observed. The latter is covered in the next section.
1.2 Social trust and growth
Already Putnam associates social capital with economic performance. However,
Knack and Keefer (1997) were the first to examine different features of social capital
separately in a standard empirical growth framework (Bjørnskov, 2009a). In a cross
section of 29 countries they show that social trust and civic norms are positively
associated with economic performance whereas being a member of a network shows
no effect. Zak and Knack (2001) found, in conformance with Knack and Keefer’s
results that social trust is positively associated with economic growth, when they
repeated the study with a larger sample of 41 countries. Additionally, they show that
this relationship is causal, i.e. social trust promotes economic growth and is not just a
consequence of it. Bjørnskov (2009a) provides an overview of the existing literature
about social trust and economic growth in the “Handbook of Social Capital”. He gives
an overview of several studies that find a positive association, which differs, however,
in size. Bjørnskov calculates the average effect in these studies and concludes that
an increase of trust by 10 percentage points increases the annual GDP growth rate
by approximately half a percentage point.
The following sections introduce direct and indirect effects social trust might have on
economic activity.
1.2.1 Direct effects of social trust on economic performance
As Knack and Keefer (1997) point out, in an economy many commercial transactions
are determined by mutual trust between two or more parties. This can be a
transaction between parties where goods or services are supplied in exchange for
future payments. As within a company, managers have to trust their employees. In
general, the principle agent problem arises when there is asymmetric or incomplete
1 Overview of the literature
6
information. Thus, need for trust rises with the extent to which the performed task is
not monitorable, which is mainly the case for highly educated employees. Also,
investment and saving decisions are dependent on the assurance of banks and
governments that these assets are protected. The same is valid for the trust of
agents that laws and rights will be abided or otherwise enforced like for example
property rights.
As outlined before, trust and trustworthiness are highly correlated (Sapienza et al.,
2007). This means that the likelihood of dishonest behaviour in commercial
transaction is lower in a high trust society since less money for protection is needed.
Contracts for example do not have to be as specified and cover every contingency
(La Porta et al., 1997). The probability of legal disputes decreases and therewith
reduces the deadweight burdens of enforcing and policing agreements (Whiteley,
2000). Besides, managers can save money on monitoring their employees since they
are more reliable in a high trust society. Moreover, Zak and Knack (2001) show that
social trust and the investment rate are positively correlated. They find that
investment/GDP share rises by nearly one percentage point for each seven
percentage point increase in trust. This might be due to two reasons. Firstly, property
rights are better protected in high trust societies. This increases the return to
investment in innovation and hence incentives to invest in new products. Additionally,
entrepreneurs have to direct less of their resources to protect themselves from
possible dishonest behaviour of their employees and business associates. Secondly,
since trust and trustworthiness create a safer investment climate, agents tend to
invest more and choose investment projects with a longer time horizon, which might
appear too risky in a low trust society. Long term financing is essential for the
infrastructure industry, which in turn is an important driver of economic growth.
In a nutshell, social trust decreases the costs of economic transactions and increases
the investment rate and therewith enhances the economy with a larger capability for
production.
1.2.2 Indirect effects of social trust on economic performance
In addition to the direct influence of social trust on economic growth elaborated
above, social trust might have a positive effect on the quality of institution and thus
indirectly on economic performance (Knack and Keefer, 1997; Whiteley, 2000).
[...]... paragraph, the relationship between social trust and economic growth is investigated Furthermore, the robustness of the results is tested in an extreme bound analysis, a Jackknife exercise and with instrumental variables Subsequently, the channels through which social trust might influence economic growth are examined, and finally the determinants of trust are further explored 3.1 Social trust and economic growth. .. data of 116 countries from 1950 until 2005 It is presented for averages of five years' sub-periods One of the variables of main interest is the measure of social trust The social trust scores are measured in how many percent of the population of a country answer the trust question in the affirmative They are obtained from the five waves of the World Values Survey (WVS) conducted between 1981 and 2007 The. .. impression of the association between social trust and economic growth, figure 1 plots social trust levels against the log of GDP in 1950 The positive correlation is obvious and it suggests that low economic performance of countries like the Philippines and Peru might be influenced by low trust levels, whereas the positive performance of countries like Finland and Denmark might be influenced by high trust. .. models are fixed effects estimation (FE) and random effects estimation (RE) The main difference between these two methods is the basic assumption about the relationship between the unobserved effect c and the explanatory variables The unobserved effect is called a random effect when there is no correlation and fixed effect when those two are correlated Or expressed in a formula: Random effects Cov(xit,ci)... which gives them a better opportunity to reward and punish others 1.3 Who trusts others? After social trust gained popularity within social science, several relationships between social trust and other variables were investigated After finding out that high trust levels enhance for example economic growth and increase institutional quality, other questions came to light Where does social trust come... 2007 with 2005 as base year As a measure of economic performance, the real GDPper capita is used Several variables that have shown to be determinants of growth are used to isolate the effect of social trust on growth The PWT table provides data on the consumption, government and investment share of GDP As an indicator for the openness of a country, the exports plus the imports are divided by GDP This is... low trust level Finally, the average temperature of the coldest month of the year is applied There is a consensus that norms develop the best where their payoff is the highest This means that social trust has most likely developed best in countries were it had the highest payoff In countries where the winters are very hard, farmers were more dependent on each other in form of collective action and. .. 3.4% in Cape Verde to a high of 64.3% in Sweden with the average trust being 25.5% A full list A1 of all the countries and their trust scores can be found in the appendix Other control variables that are taken from the WVS are education, religiosity and income of the respondent These variables are applied in the analysis about the determinants of trust Education is measured on a scale from 1 to 8 reaching... finds that social capital increases the accumulation of human capital through the family and the society Coleman argues that a higher endowment of social capital eases the transfer of human capital from the parents to their children Moreover, he finds that families with multiple social relations are more likely to be rewarded and sanctioned for their behaviour and hence to comply with norms and trustworthiness... trustworthiness This decreases the chance of their children dropping out of school Coleman’s study was one of the first to combine these two kinds of capital, yet, it his study is limited to particularized trust 1 Overview of the literature 8 Knack and Keefer (1997) find in their regressions that social trust influences human capital accumulation positively They base this on the idea that the return to human . Introduction 1
1 Overview of the literature 3
1.1 Social Trust 3
1.2 Social trust and growth 5
1.2.1 Direct effects of social trust on economic performance. Indirect effects of social trust on economic performance
In addition to the direct influence of social trust on economic growth elaborated
above, social trust
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