Trust Is Not Universal: How Culture Shapes Business Risk

Read this blog post to learn more about:

• Why trust is shaped by culture rather than being universal

• How trust influences entrepreneurship, investment, and business relationships

• Why different societies rely on contracts, institutions, or personal relationships to build trust

• How cultural differences in trust affect international business and economic development

Trust has a pervasive role in the economy‚ but is often assumed rather than modeled (Arrow, 1972; Williamson, 1985)․ Contracts‚ institutions‚ and rational self-interest have been used to model trust (North, 1990; Williamson, 1993)․ Cross-cultural data show that trust is social and culturally contingent (Putnam, 1993; Guiso, Sapienza & Zingales, 2006)․ Countries build trust either through informal mechanisms‚ like social conventions and interpersonal relationships‚ or through formal mechanisms‚ like contract law and reputational enforcement mechanisms‚ resulting in different patterns of business‚ entrepreneurial‚ negotiation‚ and investment behavior in different countries (Granovetter, 1985; Fukuyama, 1995)․

Trust at the elemental level can be understood as uncertainty reduction; people are more likely to engage in economic exchange if they believe others will behave predictably and fairly (Luhmann, 1979; Dasgupta, 1988)․ Francis Fukuyama argues that some societies are characterized by a greater degree of what he calls "generalized trust": the belief that people can generally rely on people they do not know‚ rather than only on friends‚ family‚ and people close to them (Fukuyama, 1995)․ Countries with high degrees of generalized trust‚ such as those in Northern Europe‚ use impersonal contracts to expand their economic relationships (La Porta et al., 1997; Knack & Keefer, 1997)․ In a lower-trust society‚ people have to rely more on familial or network-type relations or long-term relations‚ which makes economic interaction smaller and deeper (Greif, 1994; Fukuyama, 1995)․․

Differences in trust develop and an environment conducive to entrepreneurship is established (Aghion et al., 2010)․ Where trust is high‚ entrepreneurs are more likely to find investors‚ form partnerships with others‚ and enter into markets (Guiso et al., 2004)․ Venture capital is a high trust industry․ Successful VC requires not only trust in the founders but also trust in the legal and regulatory systems (Gompers & Lerner, 2001)․ In low-trust environments‚ entrepreneurial activity may remain informal and family-based because individuals are averse to trusting others (Djankov et al., 2002)․ This probably discourages collaborative innovation beyond the cliques‚ despite the opportunities often being there in principle (Acemoglu & Robinson, 2012)․

Institution-based cultures are also contractual in nature‚ more explicit‚ and more time-efficient than relationship-based cultures (Hall & Hall, 1990; North, 1990)․ These cultures avoid replicating trust in a relationship: if trust is based on contracts‚ the written word is seen as binding (Williamson, 1985)․ Violating the contract becomes a matter for law to adjudicate more or less impartially (La Porta et al., 1998)․ In contrast‚ non-instrumental relationship-based trust is linked to informal negotiation and situations in which status signaling is important (Granovetter, 1985; Hofstede, 2001)․ While it may seem inefficient‚ this is a risk-management strategy that is appropriate when official mechanisms to enforce the rules are weak or erratic (Greif, 2006)․

Another example of the relationship between trust and culture is the choice of foreign direct investment location‚ with foreign investors highly preferring to invest in countries with strong institutions and high levels of governance transparency and social trust (Globerman & Shapiro, 2003; Daude & Stein, 2007)․ The economic sociology and political economy literature has provided strong evidence for the effect of high levels of trust in courts‚ regulators and governments on foreign direct investment‚ which requires a risk premium or is rejected otherwise (Wei, 2000; Alfaro et al., 2008)․ Individuals may have less domestic diversification‚ a preference for local or concrete goods‚ and lower confidence in financial institutions (Guiso et al., 2008)․

Cultural psychology also contributed to understanding the underlying reasons for these trust patterns‚ including Geert Hofstede's research on individualism-collectivism and uncertainty avoidance in social relations to ambiguities and formal rules (Hofstede, 1980; Hofstede, 2001)․ Low uncertainty avoidance cultures are more comfortable with probability and therefore are more willing to accept risk and uncertainty in commercial negotiations (Hofstede, 1980; Hofstede, 2001)․ Conversely‚ high uncertainty avoidance cultures generally prefer to minimize uncertainty and risk by using policies‚ procedures‚ personal guarantees or relationships (Hofstede, 2001; Licht et al., 2005)․ These attitudes affect the recognition of risk and the way risk is managed (Weber & Hsee, 1998)․

Trust is neither "better" in one form than another‚ but adapts to institutions and historical conditions (North, 1990; Greif, 2006․ Mismatches between the trust norms of a culture and its economic institutions‚ however‚ can create friction (Rodrik, 2008)․ For example‚ moving toward a Western-style contract system in a low-trust situation where institutions are weak will not reduce risks‚ as informal systems will likely remain in place (Helmke & Levitsky, 2004)․ However‚ as globalization increases‚ society has an incentive to improve the trust mechanisms that individuals have (Fukuyama, 2011)․

Trust is a cultural phenomenon embedded in the economic culture of a society and acts as a foundation for deciding who‚ how‚ and with whom to take risk in entrepreneurship‚ negotiation and investment (Putnam, 1993; Fukuyama, 1995)․ The cultural basis of trust therefore is important to explaining cross-national differences in economic behavior and designing institutions that enable organizations to participate in sustainable markets in a globalizing world (Acemoglu & Robinson, 2012; Greif, 2006)․

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