Social trust and markets: does regulation undermine the social foundation of exchange?

Abstract

We contribute to the literature on the overlap of social trust and regulation. The literature on trust and regulation uses cross-country samples. We analyze the United States from 1972 to 2018 using time series data. Examining a single country allows us to focus on trends, which literature on social trust and regulation has not done. The literature suggests that market exchange facilitates and discovers trust amongst trading parties. When trust breaks down, so does the economy. Buchanan argues that if moral order exists, communities can interact and flourish with trust. However, if the moral order breaks down, it creates moral anarchy. Environments devoid of social trust may substitute regulation to facilitate exchange. Low social trust may necessitate high regulation. Thus, in highly regulated economies, exchange occurs not by social trust but by regulation. Regulation removes the social feedback loop that leads to generalized social trust. Thus, high regulation erodes social trust over time. A negative correlation between social trust and regulation exists, but an issue of simultaneity remains. We examine whether a lower social trust is to blame for the proliferation of regulations in the U.S. or if the increase in regulation contributes to declining social trust. Consistent with the literature, we find a negative correlation between trust and regulation, with increases in regulation leading to future decreases in social trust, for the cohort of individuals under the age of 42. This exposes a vicious cycle between regulation and trust for the younger cohort. However, for the full sample, increases in social trust growth rates are associated with a small increase in regulation growth.