Trust – The Most Powerful Institution

One of the most influential studies in institutional economics comes from Yann Algan (Professor at the Paris School of Economics) and Pierre Cahuc. Their research shows that trust is one of the strongest drivers of a country’s per capita income.

Algan found that trust is something that gets passed down from one generation to the next. In his study, he looked at levels of trust among Americans and linked them to the historical and cultural background of their ancestors’ countries at the time of migration. The data came from the General Social Survey, where people were asked: “Do you think most people can be trusted, or do you believe you can’t be too careful in dealing with people?”

Sweden was used as the benchmark country. Algan concluded that around 45% of the differences in per capita income across countries can be explained by differences in trust levels. According to his calculations, if people in other countries trusted each other as much as Swedes do, their incomes would be significantly higher. For example:

•  Russia’s income could increase by 69%

•  Mexico – 59%

•  Yugoslavia – 30%

•  Czech Republic – 29%

•  Italy – 17%

•  France – 11%

•  Hungary – 9%

•  Germany – 7%

•  UK – 6%

What is the reason? In high-trust societies, transaction costs are lower. In institutional economics, these are all the costs involved in making and enforcing agreements: time, effort, monitoring, and enforcement.

However, not all trust works the same way when it comes to economic growth. American political scientist Robert Putnam, in his famous comparison of Northern and Southern Italy, pointed out two types of trust:

•  Bonding social capital – trust within your own group (family, community)

•  Bridging social capital – trust extended to outsiders and broader society

In Northern Italy’s old merchant republics, bridging trustflourished, helping to reduce transaction costs and drive economic success.

About 20 years ago, scholars like Francis Fukuyama believed that the radius of trust gradually expands—from family to friends to broader society. But today, economists still don’t fully understand how closed, inward-looking trust evolves into open, inclusive trust. It often seems to happen by chance.

Japan’s Economic Miracle: A Case of Social Change

This topic sparked a debate in the 1990s between two American economists: Nobel laureate James Buchanan and collective action theorist Mancur Olson. They argued over a historical puzzle:

After WWII, Germany and Japan both saw rapid economic recovery and growth. But after the fall of the Soviet Union, countries in Eastern Europe and Central Asia—despite similar political transitions—didn’t experience the same economic miracle.

Olson argued that the key difference wasn’t economic policy, but social transformation. Before their economic booms, Germany and Japan went through deep changes in their societies: trust levels rose, civic engagement increased, public forums were created. Once enough social capital was built up, growth followed. Olson believed such changes didn’t happen in most post-Soviet countries.

For an economy to thrive, it takes more than money and laws. Trust plays a crucial role. It’s invisible, but it underpins everything. Where trust exists, progress follows. Without it, even the best reforms may fall flat.