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University of Auckland Winter Week Lectures

Fifth Lecture6 July 2007

Associate Professor Ananish Chaudhuri

Department of Economics University of Auckland

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Recommendations for further reading• Thomas Schelling

• Micromotives and Macrobehavior• The Strategy of Conflict

• Michael Chwe

• Rational Ritual: Culture, Coordination and Common Knowledge by

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Recommendations for further reading• Joseph Henrich et al. (Editors)

• Foundations of Human Sociality

• Matt Ridley

• The Red Queen• The Origins of Virtue• Nature versus Nurture• Genome

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Recommendations for further reading• Robert Putnam

• Bowling Alone: The Collapse and Revival of American Community

• Francis Fukuyama

• Trust – The Social Virtues and the Creation of Prosperity

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Recommendations for further reading

• Robert Frank

• Passions within Reason: The Strategic Role of Emotions

• Choosing the Right Pond: Human Behavior and the Quest for Status

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Recommendations for further reading• Brian Skyrms

• The Evolution of the Social Contract

• Tim Harford

• The Undercover Economist

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Lecture slides available from my home page • University of Auckland

http://www.auckland.ac.nz• Business School• Departments• Economics• People• Ananish Chaudhuri• Ananish Chaudhuri’s Personal

Homepage

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Trust

• A large number of transactions in our day-to-day lives require us to trust strangers or near strangers

• For instance when we buy things on TradeMe or Ebay and hand over our credit card details we are essentially trusting the seller not to rip us off

• Joyce Berg, John Dickhaut and Kevin McCabe designed an elegant game to study trusting behaviour

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Have $10.00Have $10.00

Send $X, 0 < X < 10?

Gets $3X

Two players

Send anything Back?

Sender Receiver

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Have $10.00

Gets $3X

Two players

Sender Receiver

Game ends immediately after my decision. Why should I send anythingback? Better to keep it all.

Have $10.00

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Have $10.00Have $10.00

Send $X, 0 < X < 10?

Two players

Sender Receiver

The receiver really has no incentive to send anything back. Therefore it would be silly to send any money since I will lose whatever amount I send. I should just hang on to my $10.00.

Have $10.00Have $10.00

But wait, suppose I trust the receiver and send him $10.00

Gets $30.00

Two players

Sends me back $18.00

Sender Receiver

End up with $18.00 Ends up with $22.00

WIN WIN!

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The Trust Game

• Amount sent by the sender can be used as a measure of the sender’s trust

• Proportion of money returned by the receiver can be used as a measure of the receiver’s trustworthiness• Cannot use absolute amounts since

different receivers get different amount

14Treatment 1 (No history) 32 pairs

15Treatment 2 (Social History) 28 pairs

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Chaudhuri and Gangadharan (2007)

• Find a significant gender difference in the trust game sender decision with men sending more money than women. (n = 100)

• Of the original endowment of $10.00, men on average send $5.30 to the paired receiver. The corresponding numbers for women is $3.47.

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Histograms by Gender

Men

0 1 2 3 4 5 6 7 8 9 10 0

.361702 Women

0 1 2 3 4 5 6 7 8 9 10

Amount Sent in the Trust Game Broken up by Gender

On average men (n = 47) send $5.30 while women (n = 53) send $3.47

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Chaudhuri and Gangadharan (2007)

• A large number of men send all of the $10.00 initial endowment.

• In fact the modal amount sent for men is $10.00 while for women it is $2.00.

• Out of 47 men, 16 (34%) sent their entire endowment of $10.00 to the paired receiver. Out of 53 women only 5 (6.4%) did so.

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Chaudhuri and Gangadharan (2007)

• Another curious finding is that those who trust (i.e. send money) are not necessarily trustworthy (i.e. they do not return money)

• But those who are trustworthy are also trusting

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Chaudhuri and Gangadharan (2007)

• Define a player as “trusting” if she sent 50% or more of her endowment (n = 42)

• Otherwise “non-trusting” (n = 58)

• Trusting subjects return 16% on average while non-trusting subjects return 18%.

• No significant difference in return behaviour

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Chaudhuri and Gangadharan (2007)

• Define a player as “trustworthy” if she returned at least one-third of any amount received ( n = 27)

• If not then we call that player “non-trustworthy” ( n = 55)

• Only 82 receivers received any money from the paired proposer

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Chaudhuri and Gangadharan (2007)

• Trustworthy subjects on average sent $5.33 (as the proposer) which is significantly higher than the $3.82 sent by non-trustworthy subjects send $3.82

• Trustworthy subjects are also more generous in a dictator game• Dictator game: Split $10.00 between Player

A and Player B

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Chaudhuri and Gangadharan (2007)

• For some players the decision to trust is a general social orientation – that is they are both trusting of others and trustworthy in return

• For some others the decision to trust is in the nature of a gamble and these players, while willing to trust, are not trustworthy

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Putnam – Bowling Alone

• Those who are trusting contribute more to charity, give blood, volunteer for community events etc.

• The word “trusting” here should probably be replaced with the word “trustworthy”

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Why does any of this matter?

• A growing body of research suggests that “social capital” as embodied in the tendencies to “trust” strangers and “reciprocate” such trust influence a wide range of economic phenomena

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Why does any of this matter?• Fukuyama (1995) argues that

differences in the level of trust among citizens might explain differences in their levels of development

• Putnam (2000) – “Bowling Alone” – social capital

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Why does any of this matter?

• Knack and Keefer (1997) find strong correlation between rates of growth and fractions of citizens who said they generally trust people.

• Knack and Keefer (1997) find that trust and civic cooperation are associated with stronger economic performance

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Using Experiments to measure social capital and Predict Financial Decisions

• Dean Karlan looks at the ability of the trust game to predict decisions in the context of a Peruvian micro-credit program FINCA (n = 864)

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Uses survey questions on trust, fairness and helpfulness

• Generally speaking, would you say that most people can be trusted or that you can’t be too careful in dealing with people?

• Do you think most people would try to take advantage if they got a chance, or would they be fair?

• Would you say that most of the time people try to be helpful, or are they mostly looking out for themselves?

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Using Experiments to measure social capital and Predict Financial Decisions

• Karlan finds that “trustworthy” players are more likely to repay a debt one year later

• The more trustworthy the individual, (1) the lower the default, (2) the less likely is the person to drop out and (3) the higher the voluntary savings

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Using Experiments to measure social capital and Predict Financial Decisions

• However the results for trusting behaviour are counter-intuitive

• The more trusting the player, the lower are voluntary savings and the more likely is the player to drop out

• Karlan also makes the point that the decision trust may reflect a predilection for accepting a gamble rather than a general social orientation

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Using Experiments to measure social capital and Predict Financial Decisions

• As for the survey questions, answering affirmatively is negatively correlated with default and dropping out

• The questions however do not predict savings behaviour

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Using Experiments to measure social capital and Predict Financial Decisions

• The survey questions predict default or trustworthy actions but fail to predict savings or trusting actions

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Concluding Remarks

• The starting hypothesis of game theoretic analysis of strategic decision making situations is individual self-interest

• We have seen that emotional factors such as trust, reciprocity, altruism as well as beliefs about others’ preferences play a crucial role in economic transactions

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Concluding Remarks

• Conclusions drawn on the basis of economic theory that does not incorporate such emotional factors may not be accurate

• I will conclude with an example applicable to labour markets

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Concluding Remarks

• Most labour relations in real life are governed by contracts

• Such contracts are typically explicit – with a clear statement of salaries to be paid and penalties in the case of non-performance

• But you can also write implicit contracts

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Concluding Remarks• Implicit contracts are less well specified and

rely on mutual trust and reciprocity of employers and workers

• According to traditional economic theory implicit contracts should perform badly with widespread shirking

• But in reality they perform quite well

• Employees seem to respond negatively to the employer’s mistrust and are no more likely to work harder under explicit contracts

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Concluding Remarks

• Thank you very much for attending these lectures

• I teach a post-graduate course on these topics in the Department of Economics in case you or someone you know are interested in pursuing this further

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Questions?