Mon, Feb 26, 2007 - Page 9 News List

Trustlessness, inequality and their discontents

There may be more to social unrest than a country's sheer measure of inequality: The reliability of the contract between rich and poor may be just as important

By Robert J. Shiller

Leaders around the world seem to be convinced that inequality and lack of broad participation in economic growth, if allowed to persist, will lead to social discord and even violence. But is inequality the real problem?

As Indian Prime Minister Manmohan Singh put it at the International Conference of Dalits and Minorities, held in New Delhi in December: "Even as absolute poverty may be reduced by growth, inequalities can get sharpened. This can be politically and socially extremely destabilizing."

So India must "take steps that reduce social and economic inequalities, without hurting the process of growth and without reducing the incentives for individual enterprise and creativity."

Likewise, at the World Economic Forum in Davos last month, Brazilian President Luiz Inacio Lula da Silva said: "It will be through economic growth, job generation and income distribution that we will live in a peaceful world."

He then urged lower barriers to agricultural exports to help the poor in developing countries.

Such arguments have the ring of common sense.

If people believe that they will share in overall economic growth, then they should be more likely to support social peace.

If they do not, unrest will become more likely.

However, social scientists have found it difficult to prove that point.

In fact, some statistical analyses of the correlation between inequality and social conflict conclude that there may even be an inverse relationship: Societies that are more unequal tend to show less conflict, because the rich are better able to control the poor.

There is some evidence that social unrest follows from inequality.

The economists Alberto Alesina and Roberto Perotti have shown that, after controlling for several other factors, high inequality countries do tend to have more social instability, as measured by, say, the number of politically motivated assassinations or the number of people killed in conjunction with domestic mass violence.

Nevertheless, one wonders why the evidence that inequality causes social unrest is not stronger.

One part of the problem may be that it is not always inequality per se that causes social discord, but also how inequality is perceived to have come.

Unrest may reflect more a sense of betrayal -- that others are not living up to their implied promises or are not behaving honorably.

Indeed, a sense of trust in others' intentions is central to a functioning economy. Lawyers write a lot of contracts, and courts spend a lot of time enforcing them, but these institutions cannot cover everything. Most economic relationships depend on good will, a basic inclination to do the right thing even if no one is checking.

Trustworthiness is hardly universal. But the business world is built on our intuitive knowledge of when we can trust people fairly well and when we can't trust them much at all.

We design contracts around imperfect trustworthiness and construct elaborate institutions that take account of the hills and valleys of human honor. When these function well, we have a general sense that, even though people are not always trustworthy, basic fairness prevails.

An article by Ernst Fehr at the University of Zurich and Alexander Klein and Klaus Schmidt at the University of Munich in last month's issue of the journal Econometrica shows how people design economic relationships based on their knowledge of the circumstances in which people are trustworthy.

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