IN THE MARKET WE TRUST
BY MELVIN J. HOWARD
Economics has a reputation by pretending to be an exact science
rather than what it really is global psychology. The truth is economics leaves
out the aggregate behaviour of humans. It seeks to cloak its uncertainties and
shifting fashions with mathematical formulae and elaborate econometric
computerized models. This much is certain; people operate within markets, free
or regulated, patchy or organized. They attach numerical (and emotional) values
to their inputs (work, capital) and to their possessions (assets, natural
endowments). They communicate these values to each other by sending out signals
known as prices. The market is people many of them and there is no calculation
for how individuals will behave to an exact science. But scientists are working
on it but until that day comes we have to rely on good old fashion trust.
Yet, this entire edifice the market and its price mechanism
critically depends on trust. If people do not trust each other, or the economic
"envelope" within which they interact - economic activity gradually
grinds to a halt like the credit markets. Banks will not lend to Banks or
corporations or the retail section. There is a strong correlation between the
general level of trust and the extent and intensity of economic activity.
Francis Fukuyama, the political scientist, distinguishes between high-trust and
prosperous societies and low-trust and, therefore, impoverished collectives.
Trust underlies economic success, he argued in a 1995 tome. Trust is not a
monolithic quantity. There are a few categories of economic trust. Some forms
of trust are akin to a public good and are closely related to governmental
action or inaction, the reputation of the state and its institutions, and its
pronounced agenda. Other types of trust are the outcomes of kinship, ethnic
origin, personal standing and goodwill, corporate brands and other data
generated by individuals, households, and firms.
Trust in the market
To transact, people have to maintain faith in a relevant economic
horizon and in the immutability of the economic playing field or
"envelope". Put less obscurely, a few hidden assumptions underlie the
continued economic activity of market players. They assume, for instance, that the market will continue to exist
for the foreseeable future in its current form. That it will remain inert -
unhindered by externalities like government intervention, geopolitical
upheavals, crises, abrupt changes in accounting policies and tax laws,
hyperinflation, institutional and structural reform and other market-deflecting
events and processes. They further assume that their price signals will not be
distorted or thwarted on a consistent basis thus skewing the efficient and
rational allocation of risks and rewards. Insider trading, stock manipulation,
monopolies, hoarding - all tend to consistently but unpredictably distort price
signals and, thus, deter market participation.
Market players take for granted the existence and continuous
operation of institutions - financial intermediaries, law enforcement agencies,
courts. It is important to note that market players prefer continuity and
certainty to evolution, however gradual and ultimately beneficial. A venal
bureaucrat is a known quantity and can be tackled effectively. A period of
transition to good and equitable governance can be more stifling than any level
of corruption and malfeasance. This is why economic activity drops sharply
whenever institutions are reformed.
Trust in other players most important
Market players assume that other players are (generally) rational,
that they have intentions, that they intend to maximize their benefits and that
they are likely to act on their intentions in a legal (or rule-based), rational
manner.
Trust in market liquidity
Market players assume that other players possess or have access to
the liquid means they need in order to act on their intentions and obligations.
They know, from personal experience, that idle capital tends to dwindle and
that the only way to, perhaps, maintain or increase it is to transact with
others, directly or through intermediaries, such as banks.
Trust in others' knowledge and ability
Market players assume that other players possess or have access to
the intellectual property, technology, and knowledge they need in order to
realize their intentions and obligations. This implicitly presupposes that all
other market players are physically, mentally, legally and financially able and
willing to act their parts as stipulated, for instance, in contracts they sign.
The emotional dimensions of contracting are often neglected in economics.
Players assume that their counterparts maintain a realistic and stable sense of
self-worth based on intimate knowledge of their own strengths and weaknesses.
Market participants are presumed to harbor realistic expectations, commensurate
with their skills and accomplishments. Allowance is made for exaggeration,
disinformation, even outright deception - but these are supposed to be marginal
phenomena.
When trust breaks down like now it is often the result of an
external or internal systemic shock - people react expectedly. The number of
voluntary interactions and transactions decreases sharply. With a collapsed
investment horizon, individuals and firms become corrupt in an effort to
shortcut their way into economic benefits, not knowing how long will the system
survive. Criminal activity increases.
People compensate with fantasies and grandiose delusions for their
growing sense of uncertainty, helplessness, and fears. This is a
self-reinforcing mechanism, a vicious cycle which results in under-confidence
and a fluctuating self-esteem. They develop psychological defense mechanisms.
Cognitive dissonance ("I really choose to be poor rather than
heartless"), pathological envy (seeks to deprive others and thus gain
emotional reward), rigidity ("I am like that, my family or ethnic group
has been like that for generations, there is nothing I can do"),
passive-aggressive behavior (obstructing the work flow, absenteeism, stealing
from the employer, adhering strictly to arcane regulations) - are all reactions
to a breakdown in one or more of the four aforementioned types of trust.
Furthermore, people in a trust crisis are unable to postpone gratification.
They often become frustrated, aggressive, and deceitful if denied. They resort
to reckless behavior and stopgap economic activities. In economic environments
with compromised and impaired trust, loyalty decreases and mobility increases.
People switch jobs, renege on obligations, fail to repay debts, relocate often.
Concepts like exclusivity, the sanctity of contracts, workplace loyalty, or a
career path - all get eroded. As a result, little is invested in the future, in
the acquisition of skills, in long term savings. Short-termism and bottom line
mentality rule. The outcomes of a crisis of trust are, usually, catastrophic.
Economic activity is much reduced, human capital is corroded and wasted, brain
drain increases, illegal and extra-legal activities rise, society is polarized
between haves and haves-not, interethnic and inter-racial tensions increase. To
rebuild trust in such circumstances is a daunting task. The loss of trust is
contagious and, finally, it infects every institution and profession in the
land. It is what brings down great empires. It is my summation no matter what
government is in power, nor matter new rules, new people and procedures. Trust
is the key ingredient of market stability and our Quantumnomic future.
