Thursday, March 24, 2011

Importance of Trust

(ed: This is a cross post from the PeerIndex blog)

There is extensive buzz around influence and more recently reputation (examples here and here). As Head of Products at PeerIndex, I've spent a lot of time understanding and learning about these areas in the context of wider society.

What became clear early was that the key to understanding was to understand trust and its role in society and markets. From the perspective of trust, reputation is the trust that builds from interaction within a community. Influence is an outcome of having trust of people within a community.

In this series I'll explore why trust is of fundamental importance to society and markets and the way trust is built and measured.

The first post in this series looks at why trust is so important.

Importance of Trust

As Kenneth Arrow noted "virtually all commercial transactions and social interactions embody some form of trust". How important though is that trust to the interactions and transactions? The 2008 Financial Crisis provides a timely reminder of the importance of trust. As supposedly trust worthy (according to the ratings) investments went sour, investors lost complete trust in the market and were no longer willing to supply their cash to other participants, freezing the market. As soon as participants stopped trusting each other the markets froze overnight.

Why is trust fundamental to society? Trust enables us to rely on someone else. By relying on someone else we are able to do more than we would otherwise be able to. Trust allows us to overcome physical limitations of time and resources [Beckert, 2005]. If I can't trust others, I end up having to do everything required to live myself: food, shelter, tools, clothing. Leaving no time for anything else. No trust condems you to a subsitance life. To live in more complex societies you need trust, this way members of the society can specialize and share or trade to get the things they need [Beckert, 2005].

Trust is the result of human behaviour. It takes time and resources to build trust. On the scale of a hamlet or small village, this is not unreasonable. You will see each other everyday in which you can do the grooming necessary to build trust [Dunbar, 1993]. As the size of communities scale beyond the small village, you don't have the time nor the resources necessary to build trust between all the members. The cost of building and maintaining trust exceeds the value of the connections the trust would otherwise enable.

To overcome this limitation, we've created various measures or signals of trust [Gambetta, 2001]. These measures or signals of trust become proxies to our own efforts. These measures of trust allow us to overcome the physical constraints and create new connections.

The second part of this series will go into more detail about measures of trust, the cost of building trust and the value of reducing the cost of trust.