Over the last 10 years a lot has been said about ‘Social Capital’ and its impact on the functioning of an economy. It has been argued that variations in social capital can account for differences in income levels, rates of economic growth, political involvement etc.
However, before going any further, what is social capital? There have been many explanations, nonetheless, the most widely used definition was first proposed in 1993 by Robert Putnam. It is as follows:
Social capital refers to ‘trust, norms and networks that shape the quality and quantity of a society’s social interactions’.
The majority of people would say that social capital is vital, as they would have a preference to live in a society where others can be trusted, where people are inclined to cooperate with each other, and where networks are all-embracing. Therefore, the trust variable impacts on the business investment and ultimately the country’s economy.
Recent research (Storonyanska et al. 2022) focuses on the area of trust and its positive effect on economic growth. Traditionally models (Robert Solow 1956) have focused on two ways in which to achieve higher GDP per capita growth – increased investment in business and improvements in productivity. Trust impacts these two processes (see mind map) – by boosting increasing long-term investment in fixed assets and productivity with reduced expenses, the economic value of a worker’s experience and skills and organisational improvement.
The lack of trust can make some investments too risky and countries with low trust levels usually invest in short-term projects. Investment in R&D requires a special trust as the future outcomes are sometimes very difficult to forecast. Therefore a lack of trust can direct investment into less ambitious projects, the implementation of which is easier to control. Instead, ambitious innovative projects generate increased demand for highly educated and productive employees and boost economic productivity in general. Trust can also add to productivity by decentralisation of decision making in organisations is among these mechanisms. Decentralised decision making allows using the capacity of employees that are “closer to the problem” to solve it faster.
Measuring trust
The easiest way to measure social capital is to use the World Values Survey (http://www.worldvaluessurvey.org/ ) which addresses values and cultural changes in societies all over the world. The survey asks the question “Generally speaking, would you say that most people can be trusted or that you can’t be too careful in dealing with people?” This question seeks to capture ‘generalised trust’, which is whether two randomly selected individuals can trust each other in their own country.
The relationship between trust and economic development (see fig below) is indirect proof of the benefit of its benefits. The trust data is taken from the WVS (2017-2021) and the level of economic development in the country – 2019. High level of trust is unique to Scandinavian countries and Northern Europe with high living standards, social stability, and consistent economic growth. However Estonia and Lithuania have turned out to be even higher (34% and 31.7%, respectively) than in prosperous France (26.3%) or Italy (26.6%). Going against the trend are China and Belarus which have higher levels of trust than countries with similar GDP per capita. The same goes for Singapore and Macau with very high levels of GDP per capital but much lower levels of trust compared to the trend line.
Trust and Developing Economies
The study by Zak (2003) also illustrated that if trust is suitably low (below 30% for the average country in figure 1), then the investment rate will be so low that income will languish or even decline. Economists call this a ‘poverty trap’, and the primary reason for a poverty trap is ineffective legal structures that result in low levels of generalised trust, and therefore little investment. Additionally, the threshold level of trust necessary for positive economic growth is increasing in per capita income; that is, the poorer a country currently is, the more trust is required to generate sufficient investment to raise living standards. This makes the low-trust poverty trap difficult to escape from. However, researchers have examined the effects of social capital (trust) on income differences across villages in developing countries. It was established that where villages have higher levels of social capital they also have higher levels of income per capita.
The social philosopher John Stuart Mill wrote in 1848 that:
‘The advantage to mankind of being able to trust one another penetrates into every crevice and cranny of human life: the economical is perhaps the smallest part of it, yet even this is incalculable.’
Sources:
Iryna Storonyanska, Olena Ivashko, and Elena Mieszajkina. Trust as a Catalyst of Economic Growth: A National and Regional Breakdown. 2022
Christian Bjornskov. Happiness in the Nordic World. 2021
Zak.P. Trust – Journal of Financial Transformation Vol. 7 April 2003
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