Cultivating Trust: Norms, Institutions and the Implications of Scale

We study the co-evolution of norms and institutions in order to better understand the conditions under which potential gains from new trading opportunities are realized. New trading opportunities are particularly vulnerable to opportunistic behavior and therefore tend to provide fertile ground for cheating. Cheating discourages production, raising equilibrium prices and therefore the return to cheating, thereby encouraging further cheating. However, such conditions also provide institutional designers with relatively high incentives to improve institutions. We show how an escape from the shadow of opportunism requires that institutional improvements out-pace the deterioration of norms. A key prediction from the model emerges: larger economies are more likely to evolve to steady states with strong honesty norms. This prediction is tested using a cross section of countries; population size is found to have a significant positive relationship with a measure of trust, even when controlling for standard determinants of trust and institutional quality.