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The list of mechanisms for coping with time inconsistencies, informational
asymmetries and potential abuses of information includes contracts of various kinds, and
regulations. Trust itself might be added to this list, viewed as a simpler and less
expensive avenue for carrying on exchange in the presence of informational and other
problems. Parties that are fully trusting of each other still need to work out the details of
their relationship, but they do not need to stipulate incentives and penalties in advance,
and if successful, they will not need to spend resources on adjudicating conflicting
claims.
At a broad level, the degree of trust that prevails among parties to economic
transactions depends on a number of factors. Trust has been observed to vary across
countries (e.g., Yamagishi, 1988, Greif, 1994, Fukuyama, 1995, and Buchan and Croson,
1999), and it has been suggested that high-trust cultures enjoy better economic results
because they can execute more transactions at lower cost. An interesting question
concerns the relationship between the maturity or level of development of a market
system and the level of trust in a society. Is there less trust, or more, between agents
transacting in a developed economy that relies on large and anonymous markets, as
compared to a less-developed economy that relies on interactions among small numbers
of traders? Was there more trust in the old economy than in the new economy? What
economic responses are being engendered by the changes in trust levels?
In this chapter, we will develop a framework for understanding the determinants
of trusting by, and trustworthiness of, economic agents. We do so first at a general level,
and then as applied specifically to electronic commerce. We show how the insights of
evolutionary behavioral science and the findings of experimental economics can be
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integrated with game-theory to provide a realistic yet rigorous account of trust. And we
investigate how the human cognitive machinery that evolved in settings of face-to-face
interactions in small groups not only impinges on, but helps to make possible, those leaps
of faith in the absence of which electronic commerce could not be conducted.
Definitions
The new economy has been variously characterized as the information economy
and the knowledge economy.3As we see it, the new economy represents the
culmination of a long process of accumulation of scientific and applied knowledge in
diverse fields. The digital revolution acted as a catalyst and an enabler of breakthrough
achievements in many fields, by permitting the rapid storage, retrieval, communication,
and analysis of vast amounts of information, both quantitative and qualitative. In this
sense, the new economy is the information economy.4This economy requires
comprehending, analyzing, and synthesizing large amounts of information, which in turn
typically require greater knowledge both general and specialized as well as the ability
to execute complex tasks. The complexity of tasks has increased, and, in this sense, the
new economy is also the knowledge economy.
When we say that A trusts B we mean that A believes that the probability that
B will not harm her, or that B will live up to his commitments, is high enough to warrant
some potentially risky action on As part (Gambetta, 1988, Dasgupta, 1988, and Kreps,
1990; Williamson, 1993, Ben-Ner and Putterman, 2001, and others use similar
3Hakkio (2001) provides a useful overview; see also articles in Litan and Rivlin (2001).4De Long and Summers (2001) compare the digital revolution to (what William Nordhaus called) theillumination revolution, but argue that the latter did not create a new economy (De Long and Summers,2001).
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definitions). The trust that A places in B is a state of subjective belief which can be
indexed by the probability that A attaches to Bs choosing a desirable response.
However, we can sometimes measure this trust by observing As choices. The extent of
trust is a function of both characteristics of A and B and of characteristics of the situation.
Among these characteristics is Bs degree of trustworthiness, an attribute that is
determined by the costs and benefits associated with building and maintaining a
reputation, the cost and ability to deceive, the agents preferences and values regarding
acceptable modes of behavior, and the anticipated actions of other parties that bear on the
costs of engaging in prohibited behavior.
Reputation
Reputation is the perception others have of an individual or institutions
character or, in the term used by economic theorists, type. A retailer may have a
reputation for selling high-quality goods, another a reputation for being a cheap outlet for
low-quality goods. An individual may have a reputation for being honest and reliable,
another a reputation for being late to meetings; and so on. Depending on circumstances, a
reputation may be widely or narrowly known among potentially interested parties, and it
may be strongly or more tentatively held. The stronger the reputation of B for a certain
character, the likelier it is that party A will know what kind of action to expect of B (the
more concentrated the distribution of expectations of Bs actions held by A); and
assuming a favorable reputation, the stronger will be As trust in B.
Economic analysis is helpful inanalyzing the incentives B faces to live up to his
word. If there will be other opportunities for interactions between A and B in which
having A judge B to be relatively trustworthy would be to Bs advantage, then it may be
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worth Bs while to invest in such trust by carrying through on his promise. Consider, for
instance, the trivial example in which the same transaction will be repeated between A
and B an unknown number of times. Simply giving A and B the common knowledge that
the transaction will be repeated without a pre-specified end point may lead A to reason
that it is in Bs interest to keep his promise. Thus, B becomes more trustworthy in As
eyes, ceteris paribus, the longer the prospect of ongoing interaction, without implying
any change in Bs underlying character.5
Reputation with third parties has essentially the same effect. Suppose that A and
B are among twenty individuals or firms that engage in a certain type of transaction
repeatedly, each time being randomly assigned to a new partner. If the actions of each
party are made known to the others in a sufficiently transparent manner, then B has
reason to fulfill his promise to A even though he may not interact with A herself again. B
fulfills his promise because it raises the likelihood that other parties will choose to trust
him when he is assigned the same position in interactions with them. By contrast, if
information does not travel beyond the pair of interacting parties, and if the chance of
interacting with the same party twice is small, B has less incentive to follow through on
his promise to A.
The structure of interactions can be expected to impact not only on Bs behavior,
but on As expectations about Bs behavior. When A and B are informed that the result
of their interaction will be broadcast to other parties and that the interaction will be
repeated many times among randomly paired members of this group, A has more reason
to trust B than if their interactions were private information only, since she knows that B
5This is an extremely simple rendition of the standard model of reputation; see, for example, Kreps (1990)and Gibbons (2001).
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has an incentive to reciprocate now so as to earn a reputation that will help him in future
interactions.
Third-party enforcement
The trustworthiness of an agent may be bolstered by assurances provided by third
parties such as the government, courts of law, or even mafia enforcers. Party A may trust
B to deliver goods for which A has paid, for example, because there is sufficient
probability that B will be incarcerated if he fails to do so. Rather than relying on signals
of trustworthiness, such as reputation for behaving in a certain way or keeping promises,
a party to a transaction may obligate itself through an enforceable contract or be forced to
behave in a trustworthy fashion due to regulation. A can trust B if the expected penalty
for misbehavior is higher than the expected gain that can be obtained by violating the
promise.
Preferences and values
So far we have grounded trustworthiness in considerations based solely on Bs
self-interest. But Bs trustworthiness may also be grounded in his or her preferences,
values, or moral character. We can distinguish between preferences that are self-
regarding, ones that are other-regarding, and ones that are process-regarding (Ben-Ner
and Putterman, 1998). The self-regarding dimension is the usual concern for ones self-
interest; the other-regarding dimension is Bs concern, if any, for As well-being. If A
knows B to have a sympathetic regard for her, she has more reason to believe that B will
follow through than if she knows B to be indifferent to her or to despise her. The law
favors parental trusteeship in matters pertaining to their children because it attaches a
high probability to other-regarding preferences toward a child. But other-regarding
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preferences may also be important among friends, neighbors, members of the same
ethnic, or occupational group, etc.
Process-regarding preferences are those concerned not with the effect upon a
particular other person, but with adherence to a norm, rule, or principle. Of special
relevance for trust are norms of truth-telling and of adherence to ones word. Another
relevant norm may be fairness. If A believes that B cares about fairness and that B
believes the deal that has been agreed to is a fair one, this will raise Bs trustworthiness in
As eyes. A perception by A that B is concerned about fairness could be one reason why
A does not try to push B to agree to a worse deal, for A may believe that B would
consider such a deal to be unfair, and would therefore be less likely to implement it.
Economicsexperiments provide evidence for the presence of other- and process-
regarding preferences. When asked to accept or veto a division of money proposed by an
anonymous co-participant, subjects in the ultimatum game (see Camerer and Thaler,
1995) regularly reject offers perceived as unfair, even though this means rejecting a
positive sum in favor of nothing. Invited to divide a sum when the other subject is denied
the right of refusal, most subjects (in the dictator game) still choose to share positive
amounts. The degree of other-regardingness or of adherence to norms of fairness seems
to vary with gender (Andreoni and Vesterlund, 2001, Eckel and Grossman, 2001, Ben-
Ner et al. 2001a, 2001b), with social distance (Hoffman, McCabe and Smith, 1996), with
confidentiality from the experimenter (Hoffman et al., 1994, Eckel and Grossman, 1996),
with ethnicity of divider and recipient (Fershtman and Gneezy, 2001), with culture
(Henrich et al., 2001), and with personality as measured by psychological profiles (Ben-
Ner et al., 2001a, 2001b).
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Another process-regarding preference of importance to trust for which economics
experiments provide evidence is reciprocitythe tendency to deal generously with those
who treat us kindly and to incur costs to punish those who cheat us. Under some
circumstances, a rational self-interested actor will feign reciprocity in a repeated
interaction if others are believed receptive to signals of type.6 But this should not be the
case among self-interested players in a one-shot game. Nevertheless, Fehr, Gchter and
others (summarized in Fehr and Gchter, 2000) find that most subjects respond positively
to more generous offers in simulated employment relationships, and that they both punish
and anticipate punishment for violations of expected reciprocity or adherence to a norm
of mutual cooperation. McCabe, Smith and collaborators find many of their subjects
reaching higher-paying equilibria by risking and reciprocating cooperation (see Hoffman,
McCabe and Smith, 1998). And Ben-Ner et al., 2001b, find a tight correlation between
the amounts their subjects were given in a one-shot dictator game and the amounts each
shared with the same anonymous subject when their roles were unexpectedly reversed.
These experimental findings suggest that many individuals are trustworthy even
in the absence of repetition, reputation, and enforcement. Where do such preferences
come from, and how might they be anticipated, so as to influence trust in market
interactions? Work in the socio-biological and evolutionary psychological genres by
biologists, anthropologists, psychologists, and economists suggests that a perfectly selfish
and rational human species is implausible, and that evolution rather imbued human
beings not only with altruistic sentiments towards their offspring and other close kin, but
also with other predispositions including (a) a concern with how one is viewed by others,
6See Kreps, Milgrom, Roberts and Wilson (1982). If there is common knowledge that all individuals arestrictly self-interested, then there is no rational basis for engaging in reciprocity in a finitely repeated game.
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(b) an inclination to attempt cooperation when facing positive-sum interactions of the
social dilemma variety with persons in similar positions, (c) a tendency to keep track of
whether cooperation is reciprocated and to seek to punish cheaters, and (d) a receptivity
to certain kinds of moral reasoning, paralleling the pre-disposition to grasp grammar.
Cultural selection is also argued to have influenced the evolution of social norms because
societies with different degrees of success (e.g., in fostering internal cooperation and
controlling internal conflict) were differentially successful in propagating their values
(Boyd and Richerson, 1985; Henrich, forthcoming). The preferences of the acculturated
individual are phenotypic expressions of the genes, and are affected by a variety of
environmental influences and cues. This includes interaction between self-interested and
other- or process-regarding preferences: for instance, one who has frequent self-interested
incentive to behave as if honest by nature may come to be habitually honest and to value
this as part of her self-image (Ben-Ner and Putterman, 1998 and 2000).
Trusting
In addition to As perception of Bs trustworthiness, the probability A attaches to
Bs choosing a desirable response is influenced by a number of other factors. First,
trusting is enhanced by the trustors ability to detect deception.7 Although it is rooted,
perhaps, in a universal human alertness towards and talent for the detection of cheating in
social dilemmas (Cosmides and Tooby, 1989), A will be more confident of her ability to
detect potential deception the more access she has to information regarding potential
partners reputations, the more experienced she is in gauging trustworthiness, and the
7Deception is not the only thing that transactors fear; they are also concerned with incompetence andunintended errors. But for simplicity, we ignore honest mistakes in most of this discussion.
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better her knowledge of the distribution of types of potential partners. Some of our
ability to evaluate a partners honesty depends on capacities to read facial expression,
vocal intonation, and body language, which makes it of interest to see how reputation
transmission and character appraisal function in the context of electronic commerce.
Whether A has a broad inclination to trust, independently of facts and information, may
also color her likelihood of detecting deception.
Information
An agent who is better informed about her potential partners will, on average,
earn more from a sequence of interactions, permitting choice of partners, than will an
otherwise identical but less informed agent. Information about trustworthiness may be
passed via word-of-mouth through social networks, culled from media reports,or
obtained from formal records and compilations such as bankruptcy records, consumer
reports, and so on. The better social networks, media, and formal information processing
institutions like banks work, the better the information individuals have about parties
with whom they may transact, and the greater the trust they place in their transactions.
The most important sources of information about the trustworthiness of potential
trading partners are direct experience and word-of-mouth in social networks.8 Denser
social networks, with more interactions among the individuals involved, offer more
opportunities to exchange information. Another factor is the strength of the links among
members, including their affective qualities. It is possible that the shorter the distance
among members of the network the more trustworthy they will be. Distance is a
8See Granovetter (1995), who argues that people rely on contacts acquired through various social and worksettings to obtain information about potential career opportunities. Putnam (1995) contends that the level oftrust between individuals increases when the level of their social interaction increases. See Sobel (2002)and Manski (2000) for different perspectives.
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multidimensional concept, which reflects salient attributes of the individual, in some
cases including, for instance, ethnicity or socio-economic class, and how he or she relates
to others as a function of these attributes.
Preferences and values
As own preferences and values also affect the probability that A trusts B.
Differing experiences probably interact with differing inherited dispositions to make
some people more trusting than others. Some marketing professionals take advantage of
this variation. For example, in the summer of 2000 a trial of the company Publishers
Clearinghouse uncovered the existence of mailing lists of so-called suckers, people who
are trusting, and of people who are not trusting. Another aspect of preferences is As risk
attitude. Individuals who are equally trustingi.e., attach equal likelihood to B not acting
harmfullymay differ in their actions due to differences in their risk attitudes, with the
more risk-averse individuals acting as if they were less trusting.
Interactions between trusting and trustworthiness
Seeing trusting as judgment by A of the trustworthiness of B leads to
consideration of actions that B may take to influence As perceptions. We have already
referred to certain situational factors that can affect As estimate of the likelihood that B
will follow through on a promise. Sometimes measures under Bs control can raise his
trustworthiness as perceived by A. For example, B can raise his likelihood of being
trusted by A by taking steps that increase their chances of future interaction or that assure
that what he does in the present exchange becomes public knowledge, and that A knows
that it does. Becoming genuinely trustworthy by way of, say, an active religious
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affiliation, and conveying such trustworthiness through ones overall demeanor, may be
one more way for B to gain the trust of others.9
There may also be measures under As control that can increase Bs
trustworthiness. Consider, for instance, that the more B has to lose by reneging on his
agreement with A, the more sensible it is for A to trust him to fulfill his promise. One
way to make B more trustworthy, then, is to hold out the prospect of an ongoing stream
of rentsearnings above that of the next best alternative exchangeby offering B a
favorable share of the gains from trade (Klein et al., 1978).
Since reputation and the prospect of future interactions play a large role in
deterring breaches of trust, the coming into view of a previously unpredictable last period
can be a serious source of concern to party A. In true end-game play, there is nothing
to deter Bs misconduct apart from a trustworthy character. Although the appearance of
end-game conditions may be impossible to predict with much accuracy, the probability
that they will arise is nonetheless greater in some kinds of relationships than in others,
and this may be taken into account by the prudent agent A. Where the chance of the
unpredictable arrival of such an end-game is substantial, it is desirable to find a partner
who not only has strong strategic reasons to be trustworthy, but who also is honorable
and trustworthy by character, and who will not change his behavior when strategic
motivations are removed. All else being equal, partners deemed to have such qualities
would be in greater demand in such instances. Whether a companycan have a
trustworthy nature as opposed to simply surrounding itself with well-advertised
incentives to return trust, is an open question. But it is important to what follows that the
9B might also, of course, engage in acts intended to create the impression of good character without havingsuch a character in actuality. Tadelis (1999) and Bacharach and Gambetta (2001) discuss this sort ofsituation.
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human psyche may have a strong inclination to relate to companies as if they were
persons, and thus to impute characters to them, whether or not there is a possibility of
their having them.
From the Old Economy to the New Economy: Technological, Economic and Social
Changes and their Effects on the Determinants of Trust and the Level of Trust
In this section we investigate the effects of changes associated with the new
economy on the factors that determine trust in diverse business transactions, and we
evaluate the net effect on trust in various areas of economic activity.
Information collection, transmission, retrieval and analysis, and communication
It is worth restating the well-known fact that the availability of information of
almost any kind has increased enormously in recent years, and that the tools for
processing information have advanced in great leaps as well. This provides a much
improved basis for decision-making, and for faster decision-making and execution of
decisions in the new economy than in the old.
When considering buying a product afflicted by considerable asymmetric
information, buyers have several options. First, they can go to established organizations
and hope that their sustained existence is proof of their reliability. Second, they may
inquire about the reputation of organizations with which they consider transacting,
seeking information through their social or business networks, professional organizations,
and business publications, and so on. The new economy adds to this the wealth of
information on the Internet, which complements and supplements the first two options.
The Internet is abuzz with information brokerage about a large number of manufactured
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goods as well as services such as hospitals, financial products, and daycare centers. Much
of the information is presented in raw form, which lends itself to extremely useful
analysis, but also to misunderstanding or misrepresentation by unskilled and
unsophisticated users.10 Individual buyers and sellers reputations become enshrined in
records, such as those maintained by online auctions houses like eBay.11
Chat rooms
operated for the benefit of specialized professionals provide an efficient forum for the
distribution of information about economic agents. The Internet provides an invaluable
source of comparison of prices and product specifications available at a fraction of the
cost of that which was available in the old economy.
The rapid collection and transmission of high-quality information reduces
asymmetric information in most areas of commerce, contributing to the production of
trust in various markets. But along with the collection, storage, and transmission of
valuable information there is also trading of valueless information that requires resources
to wade through, as well as malicious information in the form of rumors intended to
misinform.12The vast amount of information may overwhelm some users who cannot
digest it, cannot discern important from unimportant information, cannot separate good
information from bad, or cannot analyze it correctly. The less informed and the less
10Information about mortality rates for specific hospital procedures falls in this category. A low mortalityrate may mean that a hospital is better than higher-mortality hospitals, but it also may mean that thehospital deals only with easy cases. As economists know full well, only careful analysis (in the case ofhospitals, of the case mix) can help make sense of even the best and most detailed data. (We thank BurtonWeisbrod for providing this example).11
On eBay the general transaction records of each buyer and seller are public for all to read, as are thecomments of their transactors. Of course, it is possible to assume new user identities, but that reduces thesize of the record and therefore curtails the possibility of building a reputation. And it is always possible toplay an endgame, as some sellers have done in order to commit fraud. Buyers in particular are known to beweary of new sellers, and they are less likely to make purchases from sellers who have received negativecomments. Buyers assume all risk, as eBay does not provide guarantees or warranties for goods traded onits site, yet fraud seems to be quite infrequent, suggesting that the mechanism described above works well.Statistics about fraud on the Internet, separately for auctions, are provided at the end of this section.12Not all rumors are malicious in intent or consequence. A common rumor is spread in order to affect theprice of a stock to the advantage of the rumor monger.
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sophisticated in the analysis of information will benefit less and, to the extent that they
appreciate their own weakness, will be less trusting. In a similar vein, since the process of
collection and analysis of information, as well as making decisions on the basis of the
analysis, has been speeded up immensely. Some agents are likely to make more mistakes
than others, making them less trusting than those who can make better decisions.
Furthermore, the requirement for greater speed may not allow enough time for many
agents to engage in the full range of actions aimed at detection of deception. This also
translates directly into less trust. The scandals involving the manipulation of information
by large corporations that are identified with the new economy (e.g., Enron, Global
Crossing, and Worldcom) have, according to various analysts, the media and politicians,
lowered trust in the system.13
These scandals have shown that even the sophistication of
large organizations is insufficient for the detection of deceit by sophisticated agents.14
Face-to-face interactions and social contexts
In the old economy many business interactions were with humans staff or, at
times, telephone operators in various business and many interactions were repeated at
the grocery store, bookstore, barber, beautician and so on with the regular staff. The
new economy changed the nature of many of these interactions. For one thing, many
13See, for example, Business Week Online (www.businessweek.com), Can You Trust AnybodyAnymore? January 28, 2002, Felix Rohatyn, The Betrayal of Capitalism, The New York Review of
Books, February 28, 2002, pp. 6-8, Jeff Madrick, Enron: Seduction and Betrayal, The New York Reviewof Books, March 14, 2002, pp. 21-24, Accountability for Accountants, Editorial, The New York Times, p.A22, June 4, 2002., and Patrick McGeehan, Goldman Chief Urges Reforms in Corporations, New York
Times, June 6, 2002, page 1.
14The constant struggle against manipulation of information leads to many innovations. For example, thefight against theft of information protected by passwords may lead to measures such as the shutting downof accounts that experience dictionary attacks numerous attempts to crack the password. However, thiscan open the door of attempts to shut down rivals accounts (for example, during bidding wars). Theattempt to circumvent the vulnerability of old search engines that focused on keywords on web sites toself-serving seeding of keywords led to google.com type attempts to use mentions of other sites as the keyto search engines, only to become vulnerable in turn to the establishment of sites whose main purpose wasto channel referrals to other sites, in a large pyramid-like scheme.
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interactions take place without the intervention of a live individual, for instance on the
Internet or with automated telephone systems. Furthermore, many of the live interactions
are not repeated with familiar persons, because of the increased size of many
establishments (which reduces the chance to encounter a given staff member repeatedly)
because many consumers as well as firms take their business to where the terms seem to
be best, and because people are more mobile.
These changes have three effects. First, the ability to establish trust through
repeated interactions is weakened. Second, less face-to-face interaction among agents and
increased impersonality lead to reduced ability to detect deception, and thus reduce the
level of trust, ceteris paribus. However, greater availability of information may be a
strong offsetting factor. Third, many interactions in the new economy are devoid of social
context because they represent quantitative information; this leads to reduced ability to
detect fraud and cheating, and therefore reduces the level of potential trust.
Economists and other experimenters have performed dozens of experiments with
the voluntary contribution mechanism (VCM), a representation of a stylized collective
action problem (or n-person prisoners dilemma). In these experiments, a number of
subjects are assigned to a group, given an endowment of money, and asked to divide the
money between a personal account and a group account. Money placed in the group
account is scaled up and then divided equally among all group members, while money
placed in the personal account belongs to the individual alone. All group members
together are better off when all members place all of their endowment in the group
account, but the individual group member is best off when he alone keeps his money,
while sharing in the money that the others have placed in the group account.
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In benchmark VCM experiments, in which subjects remain anonymous to fellow
group members, contributions to the group account are typically well above the
neoclassical prediction of complete free-riding, but the average contribution tends to
decline from around 50-60% to about 10-15% of endowment with ten repetitions.15
Experiments have shown that groups tend to achieve much greater cooperation more
money placed in the group account when their members engage in pre-play
communication, that is, when they meet for a few minutes and communicate before
making their allocation decisions.16
Since the neoclassical prediction is that
communication will have no effect, because subjects still lack the means to enforce any
agreements reached, this finding suggests that subjects feel some confidence in their
abilities to size up one anothers characters during their meetings.17
What is not clear
from these early communication experiments is the respective roles played by (a) the
dropping of anonymity among group members, (b) the opportunity for open-ended verbal
conversation, and (c) other aspects of communication such as facial expressions and body
language, the communication of signs of sincerity by vocal intonation, and so on. The
relative importance of these different elements were tested in two recent experiments.
Brosig et al. (2002) conducted a baseline experimental treatment in which no
communication was allowed, then a face-to-face treatment in which subjects met around
a table for a few minutes of unstructured communication, and finally a treatment in which
15See, for example, Isaac and Walker (1988).
16See, e.g., Isaac and Walker (1988) who find that the average contributions stabilized at 100% when pre-play communication was allowed (Figure 1). See also Walker et al. (1991), and Bochet et al. (2002).
17Perhaps a typical subject leaves such a meeting thinking most of those people are probably like me; theywont be so quick to go back on the word they gave me to my face just to earn an extra dollar or two. Andif we cooperate rather than cheat, well all come out ahead.
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subjects could communicate simultaneously on video monitors and by an audio channel,
but without meeting in physical proximity. A treatment in which subjects could
communicate via an audio channel, but without video images of one anothers faces, and
another treatment in which subjects could see one anothers faces through a camera for a
few moments but were not permitted to communicate verbally, were also added.
What the authors found was that audio-visual communication was almost exactly
as effective in generating cooperation among subjects as was the face-to-face meeting,
whereas audio communication alone was only a little more successful than the non-
communication baseline, and a visual display of fellow subjects faces without audio
communication had no efficacy relative to the baseline. The authors suggest that
combined facial and verbal communication may be necessary to generate maximal trust
due to human beings informational processing and emotional equipment, which was
formed in ancestral environments where face-to-face communication was almost the only
kind possible.
In a separate experiment, however, Bochet et al. (2002) compared non-
communication and face-to-face communication treatments with (a) a numerical cheap
talk treatment in which subjects could display possible non-binding decisions numerically
on one anothers computer terminals, with further time to react to one anothers possible
choices, before each period of binding choice, and (b) a chat room treatment in which
subjects could engage in open-ended written communication within their groups in on-
line chat rooms before every few periods of play, without learning one anothers
identities. They found that the numerical cheap talk treatment yielded no real
improvement in cooperation over the no-communication baseline, but that the chat room
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treatment generated almost as much additional cooperation as did face-to-face meetings.
These findings, and the contents of the on-line communication sessions, suggest that it is
the ability to use language to frame the problem as one of group cooperation, and to issue
express declarations of commitment to courses of action, rather than face-to-face
interactionper se, that explains most of the increase in cooperation in the face-to-face
and audio-visual communication treatments. Just why Bochet et al.s chat room was
more effective than Brosig et al.s audio-only treatment remains unclear.
Market size
The size of the market on which both manufactured goods and services are
transacted has been increasing in the new economy. This trend is particularly significant
for products that in the old economy were produced and consumed in a restricted
geographical area. First, transportation costs have declined, and transportation has
improved in both safety and speed. This resulted in the more efficient movement of
goods to people and of people to services. For example, many thousands of people fly
airplanes to watch a circus in Las Vegas, attend a theatrical production in New York City,
or visit a theme park in Orlando; the effective size of demand for this sort of services has
expanded in some cities substantially beyond the local market. Second, transmission of
data through various electronic media such as the Internet, CDs, and DVDs makes it
possible to experience activities from locations other than where they are produced,
generated, or displayed. One can view a painting or a sculpture from multiple angles
without going to a library, let alone a museum, by going on line. One can take an on-line
course or participate in a seminar discussion via a satellite link or the Internet, inspect
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homes while house-hunting, or buy on-line just about anything from just about anywhere,
at very low transaction costs.
The increase in the size of the market implies that an individual may have
encounters with more firms in the new economy as compared to the old economy. As a
result, there will be potentially fewer repeated interactions, fewer face-to-face
interactions, and lower probability that different members of the same social community
will interact with the same firms. Consequently, one can learn less from ones own
experience, or from the experience of ones friends, colleagues, or members of the
physical community, and therefore the particular forces that feed trust are likely to
weaken. However, the information revolution has not eliminated such familiar
compensating mechanisms as branding and the use of centralized venues of exchange,
and new mechanisms have also arisen, as we will see in the next section.
Mobility and community
The geographical mobility of people has increased in the new economy. In many
parts of the developed world, indicators such as the proportion of the population of a city
that was not born in the city in which they reside and the average length of residence in a
locality, suggest that the percentage of residents who have long-term connections to the
localities in which they live has declined. The turnover in the workplace has also
increased.18Greater mobility reduces the strength of traditional networks whose members
transmit information from one to another and over time. When this mechanism is
weakened, a source of trust is also weakened. The weakening of communities may also
18See the special issue ofJournal of Labor Economics, Volume 17, Number 4, Part 2, October 1999,dedicated to an examination of the question of whether tenure and job security have declined.
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cause the weakening of commonly shared values and norms, which are important for
trusting and trustworthiness.
Trust in business-to-business (B2B) relations
Most of the foregoing discussion applies to relationships between individuals and
firms as well as among firms; after all, firms are composed of individuals and are
represented in their dealings also by individuals. However, there are important
differences between organizations such as business firms and individuals that merit brief
attention.19
In particular, unlike an individual, an organization can change its composition
and thus, for instance, be able to claim that it has eliminated from its ranks employees
and executives who are not trustworthy. In an attempt to assume a character and claim
continuity of it, many organizations develop corporate cultures that supersede the
individuals that populate them at any given time. Furthermore, corporations seek to
develop teams of employees that are recognized in the market by professionals; such
teams often move together and may bring down companies they desert and raise the
fortunes of companies they join or establish.
There are additional elements involved in business-to-business (B2B) relations
that are substantially different in relations among individuals or in consumer-to-business
relations. One important case concerns the supply chain, which is increasingly conducted
through the use of the Internet and related tools. In a supply chain, the retailer derives
competitive advantage from being very responsive to changing consumer demand, and
from maintaining low inventories, thus lowering costs. In order to sustain these features,
the entire chain of production upstream from the retailer through its various stages must
19For a more detailed examination of differences between individuals and firms, see Ben-Ner andPutterman (2001).
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be very responsive, fast, and trustworthy. Supply chain relationships involve many parties
that depend on each other to ensure the timely supply of appropriate inputs. It is critical
in this highly interdependent system that all parties can trust each other; this trust must
prevail not only among those who transact directly with each other, but also among those
who are not in direct contact but who depend upon each others performance for their
own successful performance.
Somewhat different issues arise in the relationship between purchasers and
suppliers. In the old economy there was a system of long-term relationships between
purchaser and suppliers that ensured that suppliers were reliable, and that they provided
appropriate parts, components and other materials. That system entailed long-term
relationships that permitted the establishment of records and reputations; these
relationships were shielded from short-term competitive pressures on suppliers. In
contrast, in the new economy purchasers may switch among suppliers very rapidly.20
The technology for such switches exists. Since the technology of production allows swift
and inexpensive adaptations of the supplier to different purchaser requirements, and
transportation costs are steadily declining, increasingly making the location of production
relative to the point of final sale relatively unimportant. The purchasers predicament is
how to accumulate relevant information about potential suppliers, and how to evaluate
reliability and reputation in a comparative fashion (see Dellarocas, 2001, for a detailed
analysis of this issue)
20This is particularly true when the purchaser is a relatively large manufacturer (such as a car company) orretailer (such as a national department store). Because of the limited number of brands that can besustained even in large markets, manufacturers of branded products, department stores and other sellers ofconsumer goods are on the short-side of the market, giving them power that suppliers of commodities andother goods do not have. We return to this point in the next section.
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A variety of business intelligence software products has been developed to
allow companies to keep track in real time of the performance of their business partners
in a wide range of areas of interest to them. Price, quality, timeliness, and reliability can
be analyzed rapidly and links with new suppliers can be established via the Internet in a
very short time thanks to the compatibility of various types of enterprise software. In a
system like this trustworthiness is a business necessity since minor deviations from
promised or implied standards can lead to loss of business.21
Privacy and identity theft
Whereas anonymity in the sense of facelessness and lack of full-fledged identity
as consumers and firms with flesh and blood, and bricks and mortar has increased in the
new economy, there has been a concomitant decline in privacy. The two trends did not
just happen concurrently, but they are actually the results of the same developments and
often different sides of the same phenomenon. If in the old economy a newspaper
subscriber wanting to suspend delivery for a vacation had to communicate directly (in
writing, by telephone, or in person at wee hours of the morning) with the person who
delivers the newspaper at the door. In the new economy, all that is necessary is to call a
24 hours a day automated machine (which recognizes the caller ID) and key in the dates
of vacation. While in the old economy a customer may be recognized, for better or worse,
at some retail and service outlets. In the new economy, many of the encounters are
anonymous because of automation, high staff and customer turnover, or because they
occur on the Internet. However the data about customers in these transactions are often
21See, for example, Rick Whiting, Biz Intelligence Turns to Suppliers,Information Week, October 15,2001, pp. 57-58, and www.informationweek.com/techcenters/sw/bizapps/bizintelligencefor additionalarticles on this subject.
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The issue of privacy extends to identity theft. Personal data, particularly credit
card information, are stolen off servers around the world, and then traded on illicit
markets. Given the greater risk involved in online commerce (as well as the greater
instability of companies involved in it), online businesses pay higher credit card fees for
transactions with their customers than do non-online business.24
Theft of credit card
records has also been a factor contributing to the bankruptcy of a company that traded in
computer money.25The risk of identity theft reduces trust in online commerce, especially
with respect to unknown companies and those trading in regions where theft is more
common (particularly the former Soviet Union).
Trust and fraud online
The developments associated with the new economy have opposing effects on
trusting and trustworthiness, and therefore on the level of trust that prevails in the
economy and society. The phenomenal increase in the availability of information has
elevated the trustworthiness of individuals and organizations with records that can be
stored and accessed for credible verification of reputation based on past actions. This has
become indispensable for corporations in their dealings with each other, and is a growing
tool in the hands of individuals in their dealings with firms. In the case of both firms and
individuals the explosion of information and tools with which to analyze it seems to favor
those with the ability to use the information and the tools; their ability to trust their
trading partners has increased, and their opportunities to gain from trade has also
24Online retailers pay 2.5% plus 30 cents per transaction as compared to 1.5% plus 30 cents paid bytraditional stores, according to research by the Gartner Group, reported by Linda Rosencrance, Survey:Retail Fraud More Prevalent for Online Vendors,Computerworld, 7/24/2000, Vol. 34 Issue 30, p20. Seealso Matt Richtelm, Credit Card Theft Thrives Online as a Global Market, New York Times,May 13,2002, and Bob Tedeschi, Seller of Online Currency May Have Been Victim of Fraud, New York Times,August 27, 2001.25See Tedeschi, idem, describing flooz.com, a purveyor of online currency.
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increased. However, those with limited sophistication may actually be lost amidst this
wealth of information, and their trust in individuals, firms, and the entire system is likely
to diminish along with their trust-dependent gains from trade.
It is hard to know whether the net effect on trust of increased market size and
mobility, and of reduced face-to-face contact, will be positive or negative. Writing in the
middle of 2002, when the media reveal new instances of fraud in large companies
committed on a daily basis, the trustworthiness of the entire business sector seems to be
questioned, or, as some business and political leaders state, trust in the entire system is at
a low. The sources of these problems are complex and are not grounded only in the
developments associated with the new economy, and certainly not only with those
aspects of the new economy emphasized in this chapter. But the timing seems to cause
many people to reflect on the credibility of new economy and of the economy as a
whole.26
Is there more fraud online than in the offline world? We have already noted that
credit card transactions are more expensive on-line than in traditional stores, because of
the higher incidence of fraud in the former.27This is significant, because the vast majority
of transactions on line are paid for with credit cards.28
And in all likelihood, Internet
auctions are also far more prone to fraud than traditional auctions. At the same time it is
important to recall that the new economy has provided many new opportunities for
example, to participate in auctions for beany babies (the highest category of auction
26See note 12, above.27In its survey of 160 companies, half of which use the Internet to sell products, the Gartner Group foundthat credit card fraud is 12 times higher online than in the physical retail world; see Rosencrance, cited infootnote 23, above.28The Gartner Group, in the survey reported above (reported by Rutrell Yasin, Merchants Still Fearful ofCredit Fraud,Internet Week, July 10, 2000, issue 820, p. 31), found that 90% of transactions online areexecuted with credit cards.
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fraud), or purchase exotic or inexpensive items from faraway places which did not exist
before.
The main source of information on Internet fraud statistics is the Internet Fraud
Complaint Center (IFCC), a partnership between the National White Collar Crime Center
and the Federal Bureau of Investigation that began operation in May 2000. During
calendar year 2001, IFCC processed 16,775 referrals deemed fraudulent; each of these
referrals was sent to an average of three law enforcement and regulatory agencies. A
plurality of fraud referrals concern auctions (42.8% of fraudulent referrals), 20.3%
concerned non-delivery of merchandise and payment, 15.5% regarded an investment
scam referred to as the Nigerian Letter Fraud, another 9.5% were credit or debit card
fraud, and the remainder were other forms of fraud. Of these complaints, 9,864 involved
a victim who reported a monetary loss with a mean loss of $1,804 (a median of $435).29
Of course, fraud is committed more often than it is detected.30
Internet-only companies enjoy rather low trust, according to the Harris Interactive
Poll.31Only 26% of respondents trust at least somewhat such companies, as compared to
60% who trust food companies, 59% who trust banks and retailers, and 53% who trust
computer software companies. Even the unpopular telephone companies and the media
enjoy the trust of more respondents (35% and 30%, respectively). Only biotech, oil,
entertainment, and tobacco companies fare worse.
29
During 2001 the agency also received another 17,165 referrals that were deemed to be non-fraudulent innature, as well as 17,138,551 unique hits on its web site, www.ifccfbi.gov, where the statistics cited in thissection can be found in two documents, IFCC 2001 Internet Fraud Report, and Internet Auction Fraud.The definitions of different types of fraud appear in Appendix A of the Fraud Report. Fairly similarstatistics are reported by the National Consumers League at www.fraud.org.30According to the National White Collar Crime Center (The National Public Survey on White CollarCrime, February 2000), only one in ten incidents of fraud ever make their way to the attention ofenforcement or regulatory agencies.31Harris Interactive Health Care News, November 2001, Table 1, athttp://www.harrisinteractive.com/news/newsletters/healthnews/HI_HealthCareNews2001Vol1_iss26.pdf.
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Responses by Firms and Others to Changes in Levels of Trust
In the previous section, we concluded that there is a segment of online
transactions where trust is more difficult to generate and that there are many individuals
who find it more difficult to assess trustworthiness in the new rather than the old
economy. There seems to be ample awareness that weak trust hampers certain activities,
and that gains can be made by enhancing it through various individual and collective
actions. In this section we evaluate such actions.
One of the most visible measures adopted to improve trust online consists of the
securing of online communications, and security verification, which are efforts to create
trustworthy online vendors. As of this writing, VeriSign is the leading provider of
Internet trust services, which include Web presence services, security services,
payment services, and telecommunications services. The companys web site digital
certificate services are used by most, if not all, of the Fortune 500companies with a web
presence.32 Secure socket lock (SSL) connections, which secure the pathway through
which data are sent over the Internet, are used to encrypt the shopping portion of a
session, such as browsing activity. A secure electronic transaction (SET) secures only
the payment portion of the session. With SET, credit card information, including the
credit card number and expiration date, is encrypted so that even the merchant never sees
this data, thus helping to prevent potential merchant fraud. Displaying the VeriSign and
like companies seals (such as Trust-E) helps a vendor to convince customers that
transmitting such data on its web site is a safe procedure.
32See Verisign Marketing Summary(visited June 16, 2002).
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Numerous Internet companies, VeriSign included, also demonstrate their
trustworthiness by establishing alliances with well-known firms and, in some cases, with
respected nonprofit organizations, particularly institutions of higher education.33
While
the appearance of a new store or of one with the sign Under New Management may
raise the concerns of wary consumers, the latter can quickly see whether the company
operates in a new and dedicated facility, whether it is a well staffed store, and so on. In
the case of a new Internet company, there are fewer such obvious signs. Thus, perhaps
the quickest method of gaining customers trust in the Internet company is to associate
with a trustworthy entity an established firm or organization not suspected for its
motives. In other cases the established firm is an Internet company that serves essentially
as a conduit for the unknown company. For example, Amazon.com provides on its site
links to other companies and extends its guarantee to buyers of their products.
External certification is a step towards improving trust, but of course it cannot be
a substitute for the trustworthiness of a specific company, because it does not speak to the
question of timeliness, quality, and reliability, and it does not constitute a guarantee of
certain conduct or a warranty of certain performance of the product. Alliances between
reputable companies and unknown partners, when they are substantive, provide the
greatest source of trustworthiness for the unknown partners, since it is deemed unlikely
that reputable companies will spend their reputations vouching for the trustworthiness of
a new company if they cannot verify trustworthiness. They are likely to extract a
significant price for their participation in the alliance, however, the more so the more
33The need to share knowledge, capacity, and other resources are not the only reasons for alliances amongfirms. A survey of large and reputable firms web sites reveals an amazing array of alliances which, at leastin some publicized cases, involve mainly the rubbing off of the large companys reputation on thesmaller and newer partner, often for a fee paid by the latter. See also Ben-Ner (2002).
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costly is verification of the junior partners trustworthiness. For this reason, many firms
seeking to operate on the Internet will have to look for other ways to establish their
trustworthiness.
The acquisition of trust is made easier by the identification of a company and its
products with a brand, but successful brand recognition requires large investments.
Individuals appear to have a limited span of attention and seem able to process
information on a small number of brands only. Although the information gathering and
processing capabilities of the new economy may enable some consumers to widen their
gazes, the evidence to date seems to point in the direction of increased market
concentration.34
Whereas prior to the recognition of trust issues salience the new
economy seemed to be giving rise to greater decentralization of economic activities and
more entry by small firms that could operate in spatially unlimited markets, it now
appears that the trend has been reversed. The shakeout of the technology and Internet
sectors in March of 2000, and other developments prior to and since that date, resulted in
the elimination of a large number of small firms and a dramatic rise in mergers and
acquisitions.35
The emergence of click and mortar companies that merge physical presence
with online activities as a dominant mode of commercial operation seems to answer the
need for trust associated with established traditional companies, including ease of return
of merchandise. This hybrid form provides great flexibility in accessing rich information
about a vast array of products through the Internet all the while it maintains physical
34The electronic bookmarks and favorites lists have unlimited capacity, but managing them becomes formany people a matter of limited attention span.35On the change in the size distribution of firms (without attribution to trust issues), see White (2002). Forstatistics on mergers and acquisitions, see White (2002) and statistics published in current issues of
MergerstatandMergers and Acquisitions magazines.
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presence from which consumers appear to derive comfort and afford it more readily their
trust, because of seeing is believing and because warranty policies seem to be more
believable when an actual store can be visited to effect a return or exchange of a product.
The alliances formed between Amazon.com and large companies such as Target and
Microsoft, and other similar arrangements and joint ventures may further signify a trend
towards greater economic concentration.
Conclusions
Trust issues arise in all exchange relationships in which both sides of the
exchange cannot be carried out simultaneously in one place, or where there is asymmetric
information about quality or other attributes of what is changing hands. In the old
economy, such issues were often partly addressed by repeat dealings with entities at least
represented by known faces and names. Many sought trustworthiness by trading with
members of the same ethnic group, church, or club, and individuals and firms advertised
their characters by conspicuously being good citizens, attending church or giving to
charity.
By facilitating trade with almost no geographic limits, the new economy allows
for greater choice among trading partners, but at a loss of personal interaction. By
facilitating information flow and processing, it supplies more bases for evaluating
trustworthiness, but consumers can be overwhelmed by the quantities of information
available and by the complexity of the strategies needed to evaluate it. Consumers are
also wary of the ways in which the information they supply to sellers can be abused.
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Although to some the question of trust in electronic commerce may seem
reducible to a set of technical issues such as encryption, we have argued that to do
business on line, parties still need to trust, that is to say to gamble on the reliability of
their partners. Both rational calculation of how much ones partner stands to lose from a
breach of faith, and gut appraisal of the partners character, remain present even where
the partner is a company, to which the concept of character may be hard to apply. Brand-
named verification services, branded sellers, large-scale firms, alliances between
established and old companies, click-and-mortar hybrids, and economic concentration
are among the common responses to these and other problems.
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