The role of trust in business
Anna E. Shaleva∗
September 7, 2016
Abstract
This study investigates the effect of trust on entrepreneurship. Results based on
General Social Survey (GSS) data suggest that the probability to be self-employed
increases because of trust. The possible channel suggested for this finding is the change
in risk aversion due to interpersonal trust. More risk averse individuals are workers
while less risk averse are entrepreneurs.
(JEL: H8, P50, Z10)
Keywords: Trust, Entrepreneurship
∗
Funding from the European Commission, Joint Research Centre (JRC) is gratefully acknowledged.
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1
Introduction
Entrepreneurs are the engine of economic activity and growth. Economic theories
from Schumpeter to Baumol have highlighted that entrepreneurship is at the heart of
change and innovation in a capitalist system. A growing body of research also emphasizes the role of entrepreneurs and the development of a vibrant small and medium size
enterprise sector in economic development (World Bank, 2003). However, while most
economists agree that entrepreneurs are central to the functioning of the economy, the
economic profession is still far from a complete understanding of what drives an individual to start a new business. There are only a few notable exceptions in economics,
such as Landier and Thesmar (2009), who look at demographic and psychological predictors such as who enters into entrepreneurial activity. These factors include risk
aversion, IQ, or socioeconomic factors.
One of the first papers analyzing the process of selection into self-employment is
Lucas (1978) model, which shows that individuals who have higher entrepreneurial
productivity start their own firms. Actually, both the economys output and individual
profits are maximized if more productive individuals organize the production by others.
For the same reason, Lucas model predicts that more productive entrepreneurs run
larger firms. However, Lucas (1978) does not explain the individual characteristics
that make an individuals productivity higher in entrepreneurial activity.
The determinants of entrepreneur activity have been separated as: Individual characteristics (such as initial wealth or risk aversion) that make an individual more inclined
to entrepreneurial activity; economic characteristics (such as taxes) of the area where
an individual lives; and cultural values of the community where an individual lives.
In this paper we are interested in the individual characteristics as a determinant of
entrepreneurship. The objective of the paper is to fill the literature gap by studying the
role of interpersonal trust for entrepreneurship. Trust has been shown to affect a wide
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variety of economic outcomes e.g., growth, investment, but its role for business has not
been fully investigated. The question we study is whether trust causes entrepreneurship
or not. In our setting, trust could be considered as a proxy of risk aversion. Kihlstrom
and Laffont (1979) show that, on balance, more risk averse individuals are expected
to become workers, while the less risk averse become entrepreneurs. The empirical
exercise in this paper tests Kihlstrom and Laffonts prediction relevant, however, for
trust.
The rest of the paper proceeds as follows: Section 2 describes the data, Section 3
the empirical specification and results and Section 4 concludes.
2
Empirical Analysis
2.1
Data
To conduct the empirical analysis, I use GSS 1972-2014 Cross-Sectional Cumulative
Data (Release 3, July 31, 2015). The GSS collects data on attitudes and behaviors of
contemporary American society. The survey records hundreds of trends since 1972. It
contains a standard core of demographic, behavioral, and attitudinal questions, plus
topics of special interest. Trust is conventionally measured by recording respondents’
answers to the question “Generally speaking would you say that most people can
be trusted/you can’t be too careful in dealing with people?”. The scale includes:
1 if “can trust most people”, 2 if “cannot trust most people” and 3 if the answer is
“depends” (See Appendix, Table A1). However, a new binary dummy for trust has been
generated, which equals 1 for trust and 0 for ”cannot trust” or ”depends”. Whereas,
entrepreneurship is measured through a binary dummy equal to 1 if “self-employed”
and 0 if “worker”.
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2.2
Econometric Specification
I consider the following linear model:
SE = β0 + β1 Age + β2 F emale + β3 Black + β4 Educ + β5 Size + β6 T rust + u
(1)
The dependent variable ”Self-employed” is explained by age, gender, race,education,
size of the place respondent lives in and trust. In this model, trust might be correlated
with u. The rest of the explanatory variables are exogenous, but this variable is
potentially endogenous in equation (1). In other words, trust is the only regressor
correlated with an omitted variable that is included in u.
The Instrumental variable (IV) method tackles the problem of endogeneity by using an
observable variable z, not in equation (1) that satisfies the conditions: 1) Cov (z,u)=0
and 2) Corr (z, hhincome)6= 0.
2.3
Identification and main results
This paper proposes the variable fear (afraid to walk at night in neighborhood) as
an instrument for trust. I argue that this variable predicts interpersonal trust and at
the same time is uncorrelated with self-employment.
Table 1 presents the main results - both OLS and IV estimation. Trust affects
positively the probability of self-employment - i.e. the effect under the OLS estimation
is of size 1% while under the IV estimation its size is 18%. Age almost does not
affect the probability of self-employment while gender has an effect where being female
reduces the chance of self-employment by 6%-7%. Black respondents are also less likely
to be self-employed compared to white and other races. Education has an ambiguous
effect on self-employment - a slight positive effect under the OLS estimation and a
slight negative effect under the IV estimation. The size of the place respondent lives
has an economically insignificant effect on self-employment.
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Table 1: Results: OLS and IV estimation
Self-employed
Trust
OLS
0.0144***
(4.04)
IV
0.186**
(3.17)
age
0.0020***
(19.88)
0.0012***
(4.07)
female
-0.0671***
(-20.05)
-0.0694***
(-13.80)
black
-0.0467***
(-9.24)
-0.0241
(-1.58)
educ
0.0021***
(3.76)
-0.0051*
(-2.31)
size
0.0000*
(2.47)
0.0000*
(2.51)
0.0345***
(3.62)
0.0945***
(5.29)
36542
18244
constant
N
* p<0.05, ** p<0.01, *** p<0.001. t statistics in parentheses.
Table 2: First stage regression
Trust
age
female
black
educ
size
fear
constant
N
* p<0.10, **p<0.01, *** p<0.001 t statistics in parentheses
5
.0043***
(20.77)
.0108
(1.48)
-.2215***
(-21.41)
.0346***
(30.66)
-4.07e-06
(-1.44)
.0914***
(12.06)
-.3517***
(-14.66)
18244
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Conclusions
This paper studies the causal relationship between trust and entrepreneurship by
instrumenting the potentially endogenous trust. The evidence favours a positive relationship going from trust to entrepreneurship. This result illuminates the role of trust
in business and offers a space for policy formation.
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Appendix
Table A1: Descriptive statistics (1)
Variable
self-employed
trust
age
female
black
educ
size
fear
Obs
36,725
36,725
36,616
36,725
36,725
36,645
36,725
18,324
Mean
.117631
.3830633
46.04381
.5379714
.1330701
12.89802
366.7926
1.608601
7
Std. Dev.
.3221751
.4861401
17.11369
.4985629
.3396551
3.150216
1239.043
.4880767
Min
0
0
18
0
0
0
0
1
Max
1
1
89
1
1
20
8175
2
References
[1] Kihlstrom, R.E. and Laffont, J. (1979), A general equilibrium entrepreneurial
theory of firm formation based on risk aversion, Journal of Political Economy,87
719-48
[2] Landier, A., and D. Thesmar (2009), Contracting with optimistic entrepreneurs:
Theory and evidence, Review of Financial Studies,22 (1): 117 50
[3] Lucas, R.E. (1978), On the size distribution of business firms, Bell Journal of
Economics,9, 508-523
[4] World Bank (2003), Doing Business in 2004: Understanding Regulation Oxford
University Press
Address
Anna E. Shaleva
Joint Research Centre of the European Commission
Via E. Fermi 2749, Italy
anna.shaleva@jrc.ec.europa.eu
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