Cultural Biases: Who Do You Trust?

Can cultural biases and trust issues between different cultures be reduced by education? A study conducted by three universities sheds some light on this topic. 

Culture is a vague concept, and in the last fifty years economists have generally dismissed cultural explanations as vacuous," explains University of Chicago Graduate School of Business professor Luigi Zingales. "In a recent study, we have tried to reverse this trend by showing that culture can be used to explain global trade and investments."

To establish this difficult connection between culture and economic outcomes Zingales, Luigi Guiso of the University of Rome, and Paola Sapienza of Northwestern University proceed in three steps. In a recent paper, 'Cultural Biases in Economic Exchange,' they first show that cultural variables (such as history and religion) affect the degree to which one country trusts another. Second, they document that this level of trust affects the level of international trade, portfolio investments, and foreign direct investments. Finally, they show that it is the cultural component of trust that drives its relationship with international trade and investments.

"The correlation between trust and economic exchange seems to be both economically important and pervasive," says Zingales.

Measuring Trust

Zingales, Guiso, and Sapienza based their study on a set of surveys designed to measure public awareness and attitudes toward European Union (E.U.) institutions and countries. Respondents were asked how much they trusted fellow citizens and how much they trusted citizens of all other E.U. countries.

By aggregating the response by country, the authors obtained a matrix of mutual trust levels between each pair of E.U. countries. This mutual level of trust could reflect both specific information and cultural stereotypes. But, using this matrix of trust, the authors were able to disentangle these components. The first component reflects the objective features of the country whose citizens receive trust. If every country trusts the Swedes a lot, it is probably because Swedes are very trustworthy (as a result of their legal system and/or their habits). The second component is the average bias in the country whose citizens give trust: Greeks seem to trust other countries very little, while Swedes trust other countries a lot. Finally, there is a component specific to the match: the British tend to trust the French very little and the French seem to reciprocate this attitude.

To show a distinct effect of culture, Zingales and coauthors focus their attention on this match-specific component. "This is not the only component of trust affected by cultural biases," says Zingales, "but it is certainly the easiest one where we can show culture matters, independent of any economic considerations. For this reason, we focus on just this."

In their paper they document that this match-specific component of trust is affected by the similarity in ethnic origin and religion and by the history of wars between two countries in the last millennium. So the French and the English do not trust each other very much because of the long history of wars between the two countries, while the Italians and the Spanish trust each other more because they the share the same religion.

As a measure of ethnic proximity Zingales, Guiso, and Sapienza use a measure developed by Luigi Cavalli Sforza, a geneticist at Stanford University. It captures how far in the past two ethnic groups have drifted apart. This measure captures both differences in cultures (such as language) and differences in the physical appearance, which might trigger differences in trust.

Consistent with their hypothesis that culture works through people's prior belief systems, the authors find that the impact of cultural bias is reduced if people have more information about another country, as measured by the number of times a country name appeared in the headlines of major newspapers in the other country. They also find that more educated people (i.e., with more years of schooling) are less affected by these cultural factors in their beliefs.

Economic Effects of Trust

If culture affects trust, then it is likely to also affect economic variables. As economic Nobel laureate Kenneth Arrow wrote: "Virtually every commercial transaction has within itself an element of trust, certainly any transaction conducted over a period of time." For this reason Zingales, Guiso, and Sapienza look at the effects of trust on trade and investments. Since their data on trust are across countries, they focus on international transactions.

The authors start with the international trade of goods and services, by using trade data from Statistics of Canada and the World Trade Database of the United Nations. As a benchmark, they use a well established empirical model known as the 'gravity equation.' It relates the level of trade between two countries to the size of their GDP and some indicators of the cost of transportation, such as geographic distance between the two countries and the presence of a common border and common language. Even after taking these variables into account, the level of trust between two countries has a positive and statistically significant effect on trade.

If this relationship between trust and trade is really caused by the mechanism pointed out by Arrow, then the intensity of this relationship should vary depending upon the type of good traded. When the good traded is a commodity, with easily verifiable quality (for example, oil of a given quality), trust is less important. By contrast, when the good is highly differentiated (like a specialized machine) whose quality is not immediately observable, the transaction requires a great deal of trust by the buyer toward the seller. The authors, thus, separated the sample data for differentiated goods (such as German cars) and commodities (such as wheat, coal, and grain). Consistent with trust causing more trade, they found that the effect of trust is consistently stronger for differentiated goods.

Zingales, Guiso, and Sapienza apply a similar logic to the study of international portfolio investments. In deciding to invest in a country stock market, an agent has to trust the accounting numbers released by companies in that countryas well as the quality of the legal institution in that country. The authors hypothesize that this trust in a country's economic and legal institutions is directly related to the reported level of trust vis-à -vis a generic citizen of that country. If their hypothesis is correct, the proportion of money invested by citizens of a country into equity of other countries should be directly related to the level of trust in that country.

To address this question, the authors used data from Morningstar that included a geographical breakdown of equity investment of European mutual funds. The results suggest that the degree of relative trust affects the pattern of international diversification, with portfolio investments heavily tilted towards countries whose citizens are considered relatively more trustworthy.

Finally, the authors studied the effect of trust on foreign direct investments (FDI). FDI are directed investments (i.e, purchase of plants or creation of new ones) done by residents of one country into another. Since FDI are long-term investments, they are more subject to contract completeness than any form of trade, and as such become very trust intensive. A country is more willing to make foreign direct investments in another country whose citizens it trusts more.

Culture and Economics

"As people try to understand why countries succeed and fail economically, it's necessary to draw on concepts such as trust that come from disciplines outside economics," says Zingales. "Furthermore, as we try to promote more world trade, it's important to realize that some biases are not solely economic."

To close this link, Zingales, Guiso, and Sapienza isolate the component of trust that is driven by cultural considerations and look at how much this component is related to trade and investments. In all the three cases, they find that the effect of trust is much larger. Hence, this relation between culture, trade, and investments is sufficiently important that governments interested in promoting either trade or foreign investments (or both) have to consider it. But what can they do?

The study suggests that cultural biases can be reduced by education, which presents an opportunity for change. Another implication of the study is that lack of trust is a major impediment to trade, especially between countries with a history of military tensions. Alternatively, a government interested in promoting international trade and investment should try to reduce the barriers caused by lack of trust by providing alternative warranties.

"We used to believe that economic incentives were everything and we could ignore other aspects like culture," says Zingales. "From a business perspective, it's crucial to recognize that trust is an essential element for doing business, and perceptions of trustworthiness are often driven by cultural stereotypes. Even if we were to ignore all other channels, this alone proves the important effects culture has on business."

'Cultural Biases in Economic Exchange,' Luigi Guiso, Paola Sapienza, Luigi Zingales. Research by Luigi Zingales. Luigi Zingales is Robert C. McCormack Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business.

Article reproduced with the permission of The University of Chicago Booth School of Business.