The $29 trillion cost of trust

by Sinclair Davidson, Mikayla Novak and Jason Potts

There has been a lot of talk about blockchain being a trustless technology.

But when people talk about “trust”, what do they mean?

Thomas Hawk, ‘Trust No One’ | Flickr

In simple terms, trust is a situation in which someone believes in the reliability, truth or ability of somebody else to do a given task or meet an objective.

When you trust another person to deliver a promise to do something, you put yourself in a vulnerable and risky situation that the other person won’t meet their end of the bargain.

If the other person acts to betray us on a fair-and-square deal, this create a zero-sum situation of more for them but less for us.

On the other hand, if our trust in someone is upheld this elicits a powerful incentive to strike decent and productive bargains with them into the future.

This is why economists recognise that trust makes our trading world go around.

Acting in a trustworthy manner, towards friends and strangers alike when it comes to exchanging goods and services, both extends and deepensmeaningful, productive economic coordination.

Trust is valuable, but costly to maintain

Since the seminal writings of Nobel Prize winning economist Ronald Coase, the institutional economics literature has illustrated many ways in which people make efforts to reinforce trust amongst one another.

The work of another Nobel laureate, Oliver Hart, shows that sellers and buyers can structure contracts to promote incentives for the trading parties to act trustworthily.

Of course, Coase is himself famous for alluding that the modern corporation exists to organise trades internally within the firm, avoiding any potential mistrust in bilateral market trades.

More generally, yet another Nobelist, Oliver Williamson, stresses the importance of institutions to suppress the potential of market players to act opportunistically by betraying trust.

There is now a massive body of work which robustly points to empirical relationships between trust and aspects of economic performance, such as economic growth and development, trade, and employment.

Inasmuch as these studies are valuable they tend to overlook a fundamental lesson given to us by the figureheads of modern institutional economics.

And that lesson is: trust is valuable, but costly to maintain.

Ed Suominen, ‘ Like Being in a Time Machine’ | Flickr

There are many ways to think about this “cost of trust,” but generally speaking we can say that people are busily creating economic roles, developing organisations and building wholesale institutions to signal that they are trustworthy participants in the economy.

At a more micro level, the cost of trust may be reflected in such things as IT security spending, expenditures on accounting and auditing functions, reputation-building through branding and other techniques, the cost of complying with government regulation, and the list goes on.

The cost of trust, we believe, potentially amounts to an enormous slice of aggregate economic value.

In our latest working paper, “The Cost of Trust: A Pilot Study,” we attempt to measure the cost of trust for the American economy using a technique previously used by Deirdre McCloskey and Arjo Klamer.

The U.S. Census Bureau said there were about 139.1 million civilian employees in 2010, broken down into different occupations (management, sales, resources and construction, production, and transportation).

To estimate an implicit cost of trust figure, we assign different weights to those occupations based on a subjective assessment about the share of time or marginal product spent maintaining or improving trustful relationships.

We think that managers spend all of their time upholding trust, so we assign them a weight of one (high cost-of-trust occupational category), with other weights (0.75, 0.50 and 0.25) for other occupations based on the percentage of their time upholding trust.

Applying the cost of trust weights to occupational categories, we estimate that about 35% of U.S. employment is related to activity aimed at upholding trustful economic relationships.

If we extrapolate that figure to global GDP this translates to a dollar figure of some $29 Trillion as a cost of trust. And that’s a lower bound!

Taking a deeper look at the cost of trust by sub-occupations, we consider the cost of trust accounts for more than half the time or product of people in protective service, health care, business and finance, and managerial occupations.

At the other end of the spectrum, less than 20 per cent of activities by those in certain primary industry and manufacturing occupations are covered by the need to uphold trust.

We stress that this 35% cost-of-trust figure for the American economy is a lower-bound estimate, because some elements of the cost of trust are not necessarily readily discerned from available statistics, or even measurable.

That 35% includes what can be seen, not the unseen cost of trust.

Even our point-in-time estimate of the cost of trust in America will understate the dynamic costs incurred to uphold trust, as aptly suggested in that old adage, “trust takes years to build, seconds to break, and forever to repair.”

Blockchain can cut the cost of trust

In our economy we maintain elaborate storehouses of data and information — generically dubbed ledgers — about economic relationships and financial information, which are expensive to keep.

The ledger serves as an aide memoire to help people with diverse interests and motivations reach agreement about the facts of economic life, in turn helping to facilitate trust.

Well, at least that’s the theory.

A key problem with conventional ledgers us that they are largely maintained by big firms and governments, presenting easily-identifiable points of attack for those opportunistically seeking gains by acting mistrustfully.

The inherent genius of the blockchain — the new wave of ledgers — is that they reduce the cost of opportunism by maintaining cryographically-secure distributed databases on peer-to-peer computing networks.

The blockchain is sometimes called a “trustless” system, but in truth blockchain technology enables us to put our trust in its data records, which are algorithmically rather than humanly verified and secured.

What the blockchain revolution also reveals to us is that the cost of trust is not invariant to technological change and innovation.

This is because widespread blockchain adoption could enable us to capture significantly additional value by economising on the cost of trust.

We could do this, for example, if blockchain reduces the need for costly third-party, centralised trust hierarchies, such as banks, insurers, accountants, lawyers, regulators and other credentialists.

It is for these reasons, and more, that we consider the cost of trust to be a compelling new research agenda for cryptoeconomists, other economists, and social scientists more generally.

Sinclair Davidson, Mikayla Novak and Jason Potts are from the RMIT Blockchain Innovation Hub, the world’s first social science research centre into the economics, politics, sociology, and law of blockchain technology.