Crawl Across the Ocean

Thursday, June 25, 2009

17. Trust: The Social Virtues and the Creation of Prosperity

Note: This post is the seventeenth in a series. Click here for the full listing of the series.

The point of Mancur Olson's 'Logic of Collective Action' was that a group of people - especially a large one - will struggle to work together unless their collaboration produces specific benefits to the group members as opposed to public benefits that will accrue to all group members regardless of what effort they put in.

So I thought that a logical follow-up would be to look at groups where there *is* a specific benefit to group members. Now I could be talking about religion here (where the reward for good religious behaviour is some sort of post death reward/punishment that is specific to each member of the religion) but I'll leave that aside for now and talk instead about companies.

In the Efficient Society, Joseph Heath opened his chapter on big business with a personal anecdote about Quebec's annual St. Jean Baptiste Parade:

"The year I attended, one of the major components of the parade was a series of floats celebrating the 'giants of industry.' All the big corporations in Quebec - Bombardier, Hydro-Quebec, Quebecor - were represented.

The suggestion that people should take pride in the fact that their economy is dominated by large corporations in one that would be quite foreign to most Canadians outside Quebec...

In part, this is because people outside of Quebec take the existence of giant corporations for granted. In Quebec, however, where society has only recently emerged from a long period of relative economic backwardness, these corporations are the symbol of a modern economy. The only way to be a real player on the world stage is to have some big companies that can compete in the major leagues. Thus there is a natural harmony of interest between Quebec nationalists and the various and sundry home-grown tycoons."

Here's a personal anecdote on corporations. A few years back now, I was on a class trip to Mexico and we visited a relatively high tech plastics factory in Guadalajara. The company, which at the time employed hundreds, had been built up from scratch by the founder over the course of a few decades but now that he was getting older, he was trying to decide who should take over the company.

His preferred option was to pass the reins to one of his children, but none of them were interested. The next best option seemed to be to pass it over to his partner of many years, however this was not optimal because, although his partner was willing, and had the skills necessary, and had been a good friend of the founder for decades, he wasn't family.

It was a bit like watching a scene from the Godfather. What was not considered, even as a remote option, was taking the company public and allowing it to be run by professional managers with no personal relationship to the owner and founder.

Given the size of the country and economy, Mexico has one of the world's most undeveloped stock exchanges with less than 200 hundred companies on it, most of which are either former crown corporations or foreign branch operations (e.g. Wal-Mart Mexico).

* * *

OK, enough anecdotes, let's get to the book that is the subject of this post, Francis Fukuyama's, 'Trust: The Social Virtues and the Creation of Prosperity"

The short version of the book is that in cultures where there is a high degree of trust of strangers, there is a greater likelihood of large, professionally managed corporations being created and greater prosperity as a result.

In more detail, 'Trust' contains two interwoven storylines. The first storyline is a relatively empirical and concrete survey of a number of countries which range from those with a high degree of trust and sociability (The United States, Japan, Germany are the focus, with the other Protestant, Central European countries (Holland, Denmark, Sweden, etc.) also placed in this category) to those with a lower degree of trust and sociability (China, Italy, France and Korea are the focus, with Canada, New Zealand and Latin America considered further examples) to those where trust has broken down almost entirely (there is less focus on this group, with some discussion of the South of Italy, and with American inner cities and Russia being other examples).

Starting at the bottom, in areas of very low trust, organizations beyond the state and the family are weak, nonexistent or criminal (mafia, gangs), and even the state and the family are often weak and/or corrupt.

The middle group is one where trust and social virtue is strong enough that the family (often including the extended family) and the state are capable of sustaining economic organization, but the growth of large, successful, professionally managed corporations is rare. Fukuyama notes that these cultures are often just as wealthy, or nearly so, as the high trust cultures that can generate large corporations. He also notes that in cultures such as this where the level of social trust is too low to sustain corporations without assistance, the state can often play a helpful role by stepping into the breach.

Let's go back to the Heath quote above and review the three large Quebec corporations he mentioned: Hydro-Quebec, Quebecor and Bombardier.

Hydro-Quebec is, of course, a fully state create, owned and managed monopoly.

The first line of the Quebecor wikipedia page reads as follows, "Quebecor Inc. is a communications company based in Montreal, Quebec, Canada. It was founded by Pierre Péladeau, and remains run by his family.

Finally, Bomardier. Here are some quotes from an article about the departure of Paul Tellier from the CEO position,
"WHEN PAUL TELLIER took over the reins of BOMBARDIER INC. in January 2003, it appeared the family-controlled aerospace and rail giant was finally going to allow an independent boss to call the shots. Wrong.


The reason for Tellier's departure given by Laurent Beaudoin - son-in-law of the company's founder, Bombardier's executive chairman and now the lead player in a newly created three-person Office of the President - was that Tellier hadn't planned on continuing with the company after his three-year term as CEO was over at the end of 2005.


Whatever the cause for Tellier's departure, the result is indisputable: the family is back, firmly in charge. And perhaps, observers suggest, that's what was really at issue. In the new president's office with Beaudoin is his son, Pierre, who many think is being groomed to take over. Two independent directors followed Tellier out the door; with the promotion of Beaudoin's son to the board, that leaves the family holding five of the 13 seats, compared to four of 14 before the recent events. Last year, Tellier tried, without success, to revamp the company's ownership, replacing the dual-class share structure that guaranteed family control with a one-share-one-vote system. The existing formula allows the family, which owns 16 per cent of the equity, or less than one-fifth of the business, to call the shots. Which it just did, by showing Tellier the exit."

After the low trust but still functional societies, Fukuyama looks at the high trust cultures. In each of Germany, Japan and the United States he points to unique historical factors that supported the development of trust beyond just the family level (for example, strong, relatively small religious groups in the U.S. such as the Mormons).

If you try coming up with brand names in your head, odds are whatever comes to mind will either be a Japanese, American or German (or Dutch/Swedish/North-Central European) company that you think of. And if there are exceptions that come from other countries, many of them will be state founded or supported companies.


The second, more intriguing thread in the book, is a theoretical contrast between individualism and communalism.

Much of the first few chapters are taken up with Fukuyama's repeated assertions that the neoclassical economic model of people as rational self-interested utility maximizers is not 100% accurate. For example:

"it is very questionable whether human beings act as individual utility maximizers rather than seeing themselves as part of larger social groups"

"while contract and self-interest are important sources of association, the most effective organizations are based on communities of shared ethical values"

Nonetheless, it appears as though he fears being considered 'not serious' if he doesn't mostly accept the rational self-interest theory and he hastens to note that,
"The edifice of free market economics is .. about eighty percent right, which is not bad for a social science and substantially better than its rivals as the basis for public policy"

Still, he points out that even this 80% view puts him in opposition with many economists who take after Margaret Thatcher's notion that 'there is no such thing as society' and believe that there is one set of free market economic rules that will work best for every country and every culture.

In chapter 5, 'The social virtues', Fukuyama sets out to define just what virtues we are talking about here when he refers to trust and sociability. He notes that the virtues which make up Max Weber's well known 'Protestant work ethic' are mainly individual in nature, but there are also social virtues as well.

"The capacity for hard work, frugality, rationality, innovativeness, and openness to risk are all entrepreneurial virtues that apply to individuals and could be exercised by Robinson Crusoe on his proverbial desert island. But there is also a set of social virtues, like honesty, reliability, cooperativeness and a sense of duty to others, that are essentially social in nature. (p46)"

He further notes that, "spontaneous sociability is critical to economic life because virtually all economic activity is carried out by groups rather than by individuals. (p47)"

Later on, in his discussion of France, Fukuyama touches on some of the cultural characteristics that don't support economic growth:

"Jesse Pitts ... argued that the successful French bourgeoisie was co-opted by the mores and values of the aristocracy. The latter held capitalism in low esteem and prized the noble, individualistic act of prouesse, or prowess over the process of steady, unremitting rational accumulation. The French bourgeois family did not seek to overturn the status quo through growth and innovation, but rather aspired to the settled, landed, rentier status of the aristocracy (p116)"


"The solidarity of the traditional French bourgeois family, with its tendency to look inward and its concern for its status and traditions, has been a staple of French literature and social commentary"

* * *

On page 154, there is an interesting quote from Nathan Rosenberg and L. E. Birdzell on how, as Europe moved out of feudalism, a need developed for a separate set of morals for trade,

"The need for a form of enterprise which could command trust and loyalty on some basis other than kinship was only one facet of a broader need: the rising world of trade needed a moral system. It needed a morality to support reliance on its complex apparatus of representation and promise, credit, representations as to quality, promise to deliver goods, or to buy goods in the future, and agreements to share in the proceeds of voyages.

A moral system was also needed ... to supply the personal loyalties necessary to the development of firms outside the family, as well as to justify reliance on the discretion of agents, ranging from ships' captains to the managers of remote trading posts and including merchant' own partners. The ethical system of feudal society had been built around the same military hierarchy as the rest of feudalism, and it did not meet the needs of merchants. It was out of the turbulence of the Protestant Reformation that there developed a morality of patterns of religious belief compatible the needs and values of capitalism."

It's worth noting the conflict between the desire for "a form of enterprise which could command trust and loyalty on some basis other than kinship" and the desire to move past the "same military hierarchy as the rest of feudalism" - worth noting because the corporations that filled the bill for non-family enterprise all adopted a military style hierarchy.

On the next page, Fukuyama launches into a discussion, pace Olson, of how free rider problems can mean that a society "manifesting a high degree of communal solidarity and shared moral values should be more economically efficient than their more individualistic counterparts"

It's interesting that even though Olson limited his discussion to organizations producing public goods and Fukuyama is discussing corporations that provide specific rewards to workers (i.e. they pay you to work for them) he still sees the same need for a moral code to support communal activity in corporations that Olson saw for non-economic groups that only offer public goods.

He notes that,
"if [workers] strongly identified their own well-being with that of the group, or even put the group's interests ahead, then they would be much less likely to shirk work or responsibilities. This is why family businesses are a natural form of economic organization"

He then points to the limitations of the economic notion of 'allocative efficiency' which fails to differentiate between positive and negative groups,
"...not all groups serve economic ends. Many groups are engaged in redistribution rather than the production of wealth, from the Mafia and the Blackstone Rangers to the United Jewish Appeal and the Catholic Chruch. Their purposes range from sinister to divine, but from an economist's point of view, all of them lead to 'allocative inefficiencies', that is, a mismatching of resources to their most productive uses."

* * *

Starting on page 199, Fukuyama starts to take a more abstract look at the nature of the corporation,
"While capitalism is supposed to be based on free markets and competition, life inside a Western corporation is at once hierarchical and cooperative. As anyone who was worked in one knows, corporations are the last bastion of authoritarianism: the single CEO at the top has, with the leave of the board of directors, more or less total freedom to order his organization around like an army. At the same time, the people working within the hierarchy are supposed to cooperate, and not compete against one another."

This is a strange passage. First of all, corporations are hardly the only remaining hierarchical structure and it's not exactly authoritarian when you are free to leave whenever you want. But more importantly, as far as I'm aware, people are *always* expected to cooperate in a hierarchy - this is not some unique feature of a corporation. Union members within a local are expected to cooperate, soldiers within a unit are expected to cooperate, etc. The manager in a hierarchy is not in competition with his workers, nor is he a referee adjudicating between competitive rivals. The manager is a coach who ensures that his players are playing for the good of the team and working towards the same objective he is.

Fukuyama then moves on to correctly note that the real puzzle here is that if the market is the most efficient way to arrange production, why do corporations exists and why are they so successful. Fukuyama follows the conventional thinking that this is due to Coasian transaction costs, a theory which suggests that many economic endeavours are more efficient when conducted cooperatively in a high trust environment (within a corporation) than when they are organized through interactions between self-interested market players. (more on this theory another time, perhaps, although I covered some aspects of it already, here.

* * *

Later on, Fukuyama comments on some similarities between Japan and Germany,
"The number of similarities between German and Japanese culture, many of which can be traced to the highly developed sense of communal solidarity shared by both, are intriguing, and have been remarked upon by numerous observers. Both countries have reputations for orderliness and discipline, reflected in clean public places and tidy private homes. These are societies whose members enjoy playing by the rules, thereby reinforcing a sense of belonging to a distinct cultural group. ... On the other hand, their communal solidarity within the national community weakens their regard for people who stand outside it; neither country has been known for its friendliness to foreigners, and both became notorious for their brutality to the peoples they conquered and ruled. (p 210)"

He picks up the same thread a few chapters later,
"In the past, both Germany and Japan have been known for authoritarian government and for having sharply hierarchical societies ... And yet, as we have seen, the German and Japanese factory floors are much more egalitarian than their English, French or American counterparts. ... The answer is related to the fact that the egalitarianism in communally oriented societies is often restricted to the homogeneous cultural groups that tend to comprise them and does not extend to other human beings even if they share their society's dominant cultural beliefs. Moral communities have distinct insiders and outsiders; insiders are treated with a respect and equality that is not expected to outsiders. Indeed, there is an inverse proportion between the solidarity of those inside the community and the hostility, indifference or intolerance shown to those on the outside."

I think that Fukuyama's observation about the exclusiveness of groups with strong moral bonds is accurate, but I'm not sure it explains the contradiction between a hierarchical society and an egalitarian workplace that he begins the quote with. After all, the hierarchical, obedient, rule following German or Japanese society is made up exclusively of Japanese or Germans, just as their egalitarian workplaces are.

Later on page 292, Fukuyama makes the point that, aside from being groups within the state, rather than states themselves, many religious groups in the U.S. have a similar strong cohesion within the group, hostility to those outside the group dynamic that Japan and Germany have - with the Mormons being a particularly strong example.

* * *

When Fukuyama starts to discuss the history of trust and sociability in the U.S., he launches into a comparison of an individualistic, Western, rights-based set of morals which can be traced back to monotheism, with a communal, Eastern, duty-based set of morals which is linked to Confucianism.

"The United States has undergone a "rights revolution" in the second half of the twentieth century. This revolution has produced a moral and political basis for the promotion of individualistic behaviour, with the consequent weakening of many earlier tendencies toward group life. ...

In contrast, an Asian ethical system like Confucianism sets forth its moral imperatives as duties rather than rights. That is, an individual is born into the world with a series of obligations to other people: parents, brothers, government officials, the emperor. Being a moral person, or achieving the status of a gentleman-scholar, depends on the extent to which one is able to carry out those duties. Those duties are not derived from prior ethical principles. In this respect, Confucianism is not different from much of the Western philosophical and religious tradition up to the early modern period. Many of the virtues defined in classical political philosophy, such as courage, honour, benevolence or citizenship, were duties. And God's law for both Judaism and Christianity was almost always enjoined in the form of duties.

Western political thought takes a sharply different turn, however, in the writings of Thomas Hobbes ... for Hobbes, man is not born with duties but with rights alone ... Whatever duties to takes on, he acquires as a result of his voluntary entry into civil society. Duties, for Hobbes, are entirely derivative of rights and are undertaken only to secure individual rights. Thus, one has an obligation not to do violence to another human being only because to do so would return one to the state of nature, in which one's own right to life would be jeopardized."


"Man in the state of nature for early moden Anglo-Saxon liberal political theorists was the exact counterpart of the economic man of classical economic liberalism. Both were portrayed as isolated individuals, seeking to protect their own basic rights (in the case of political liberalism) or their private "utility" (in the case of economic liberalism)."

To be honest, it wasn't entirely clear what this digression about rights and duties had to do with the rest of the book, but I found it interesting nonetheless.

* * *

Fukuyama finishes up by reiterating his argument that social capital (high levels of trust and sociability) is a driver of both political stability and economic success and then foolishly, in my opinion, trying to make a case that,
"in practice, liberal democracy works because the struggle for recognition that formerly had been carried out on a military, religious or nationalist plane is now pursued on an economic one. Where formerly princes sought to vanquish each other by risking their lives in bloody battles, they now risk their capital thorough the building of industrial empires.


...what has happened in the modern world is not simply the embourgeoisement of warrior cultures and the replacement of passions by interests, but also the spiritualization of economic life and the endowment of the latter with the same competitive energies that formerly fueled political life."

Two objections come immediately to (my) mind. First of all, it was only half a book ago that Fukuyama was arguing that French economic activity was stultified by too much influence from 'political' morals, one of many examples in the book where transfering the energies of political life to commerce was considered a bad thing.

Secondly, it's hardly the case that the world has seen an outbreak of peace since Hobbes wrote Leviathan. We haven't seen a World War since all of the major powers obtained nuclear weapons but I'm not sure that it's really reasonable to argue that this is the multi-century delayed flowering of the fruit of liberal democracy allowing people to build commercial empires instead of political ones.

* * *

In the end, Fukuyama covers a remarkable range of territory, but in so doing, I feel that he kind of weakened his point until it was hard to know exactly what point he was trying to make beyond noting that there are more large corporations in parts of the world where there are higher levels of trust and sociability, a point which probably didn't require 360 pages to make. Still, there's lots of interesting bits here and there which I tried to highlight in this post.

To finish off, here's an article from today's Wall Street Journal, the title reads "World Wealth Down 19.5% In '08,Wipes Out Two Year Gains" (deflation, anyone?) but I noted that in the body of the article was the following throwaway line, "While the world's wealth is still concentrated in three areas - U.S., Japan and Germany - the ranks are continuing to shift."

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