Regulation and Distrust

by on June 26, 2009 at 7:39 am in Economics, History, Political Science | Permalink

In an interesting paper, Aghion, Algan, Cahuc and Shleifer show that regulation is greater in societies where people do not trust one another.  The graph below, for example, shows that societies with a greater level of distrust have stronger minimum wage laws.  Note that the result is not that distrust in markets is associated with stronger minimum wages but that distrust in general is associated with greater regulation of all kinds.  Distrust in government, for example, is positively correlated with regulation of business.  Or to put it the other way, trust in government (as well as other institutions) is associated with less regulation.

minwagedistrustrespectdistrustAghion et al. argue that the causality flows both ways on the regulation-distrust nexus. Distrust makes people turn to government but in a society with a lot of distrust government is often corrupt and this makes people distrust even more.  Crucially, when people distrust others they invest not in the highest return projects but in human and physical capital that is complementary to distrust–for example, they invest in human capital that helps them bond with their group/tribe/family rather than in human capital that helps them to bond with “outsiders” and they invest in physical capital that is more difficult to expropriate rather than in easier to expropriate capital, even though in both cases the latter investments may be the all-else-equal higher return investments.  Such distrust traps are quite similar to Bryan Caplan’s idea traps.

Thus, societies with a lot of distrust generate regulation and corruption and citizens who don’t have the skills or preferences to break out of the distrust equilibrium.  Consider, for example, that in societies with a lot of distrust parents are less likely to consider it important to teach their children about tolerance and respect for others.

1 Mathieu P. June 26, 2009 at 9:08 am

Interesting ? Not for what is posted here, at least. The second regression is a shame that would get busted if an undergrad made it. The core problem is that the author use the World Values Survey, notoriously unreliable. I cannot understand how this made it to the QJE.

2 vak June 26, 2009 at 11:45 am

“Aghion et al. argue that the *causality flows both ways* on the regulation-distrust nexus”

Oh my god ! an undergrad should know that this invalidates the use of regression

3 Rick June 26, 2009 at 2:05 pm

The causality seems pretty simple to me: high levels of regulation produce rent-seeking behavior (i.e. corruption), which generates distrust.

4 ila June 26, 2009 at 5:17 pm

I’d be willing to bet an exponential would fit the first graph a lot better. At least use something that does not trend the value of a fraction of a population becoming negative.

5 Anthony June 26, 2009 at 8:04 pm

Take first graph, flip axes, and draw line from Dk to Hg, and calculate fit.

6 urgs June 27, 2009 at 10:12 am

So what happens when people trust say the finance industry more than it deserves. Ooops, i guess we know the answer.

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The things that have been trusted most in the past quarter century seem to be greed and self interest driven by the belief that they are trying to impose regulations and take your money

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