Trust And Entrepreneurship: A WestûEast Perspective

Trust and Entrepreneurship

Trust and Entrepreneurship A West–East Perspective

Edited by

Hans-Hermann Höhmann University of Cologne and Research Centre for East European Studies at the University of Bremen, Germany

Friederike Welter Rhine-Westphalia Institute for Economic Research (RWI), Essen, University of Siegen, Germany and Jönköping International Business School (JIBS), Jönköping, Sweden

Edward Elgar Cheltenham, UK • Northampton, MA, USA

© Hans-Hermann Höhmann and Friederike Welter, 2005 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited Glensanda House Montpellier Parade Cheltenham Glos GL50 1UA UK Edward Elgar Publishing, Inc. 136 West Street Suite 202 Northampton Massachusetts 01060 USA

A catalogue record for this book is available from the British Library

ISBN 1 84376 895 X Typeset by Cambrian Typesetters, Camberley, Surrey Printed and bound in Great Britain by MPG Books Ltd, Bodmin, Cornwall

Contents List of figures List of tables List of contributors Acknowledgements

vii ix xi xiii

Introduction Hans-Hermann Höhmann and Friederike Welter

1

PART ONE CONCEPTS, EVOLUTION, MEASUREMENTS 1

2

3

The concept of trust: some notes on definitions, forms and sources Hans-Hermann Höhmann and Elena Malieva

7

Culture versus branch? Looking at trust and entrepreneurial behaviour from a cultural and sectoral perspective Friederike Welter

24

The dark side of trust: corruption and entrepreneurship – a cross-national comparison between emerging and mature market economies Vartuhi Tonoyan

39

4

Social capital in Western and Eastern Europe Gert Tinggaard Svendsen

59

5

A societal view: the institutionalisation of trust Bernhard Lageman

73

6

Measuring trust and trustworthiness Jonathan Leland, Daniel Houser and Jason Shachat

87

PART TWO TRUST AND ENTREPRENEURIAL BEHAVIOUR IN TRANSITION ENVIRONMENTS 7

Trust-building in different forms of systemic transition Hans van Ees and Reinhard Bachmann v

99

vi

8

Contents

Establishing trust in a distrustful society: the case of Russian business Vadim Radaev

9

Trust-milieus of Russian SMEs: cross-regional comparisons Alexander Chepurenko and Elena Malieva

10

The effect of trust in courts on the performance of Ukrainian SMEs Iryna Akimova and Gerhard Schwödiauer

11

Emergence of and changes in trust in SMEs in Estonia Urve Venesaar

12

Trust as a matter of experiences? Findings from the ICT sector of East Germany and Poland Henning Nuissl and Anna Schwarz

114 136

156 176

197

PART THREE TRUST AND ENTREPRENEURIAL BEHAVIOUR IN MATURE MARKET ECONOMIES 13

Trust in small-firm business networks in East and West Germany Teemu Kautonen and Friederike Welter

14

Trust, co-operation and networking in an immigrant business community: the case of Chinese-owned businesses in the UK David Smallbone, Fergus Lyon and Xiao Li

235

Global competition and entrepreneurial behaviour in industrial districts: trust relations in an Italian industrial district Gabi Dei Ottati

255

Local policies and trust relations: the case of the Vato territorial pact Luigi Burroni

272

15

16

Index

219

287

Figures 4.1 4.2 4.3 6.1 6.2 7.1 14.1 14.2 16.1

Power centralisation, social capital, corruption and the economy General trust and GDP per capita (Eastern and Western Europe) Density of organisations and GDP per capita (Eastern and Western Europe) A Prisoners’ Dilemma Solving the Prisoners’ Dilemma The drivers of network performance (strategic context and content) Ethnic minority population in England and Wales (1991–2001) Self-employment as a percentage of total employment in Great Britain, by ethnic origin (1999–2000) The impact of the Vato territorial pact

vii

62 71 72 90 91 107 243 244 278

Tables 2.1 3.1 3.2 3.3 4.1 7.1 8.1 8.2 8.3 9.1 9.2 9.3 9.4 9.5 9.6 9.7 9.8 9.9 10.1 10.2 10.3 10.4 11.1 11.2 11.3 11.4 11.5

Dimensions of culture from an individual and societal perspective Indices and variables measuring trust and civic society Ordered probit regressions on (perception of) corruption of self-employed business people Ordered probit model on perception of corruption General trust, density of organisations and GDP per capita A taxonomy of network characteristics Basic characteristics of the sample Infringement of contracts in Russian business Most important personal features of business partners Preferred persons/groups in business transactions Regulation of customer and supplier relationships Usual payment terms offered to customers Sources to which money has been lent Criteria used to select employees External relations of entrepreneurs and managers to the representatives of different state authorities Sources of business assistance and advice Help in solving problems during business start Trust milieus in the surveyed regions: similarities and differences Descriptive characteristics of the sample Descriptive statistics for main variables in equations Performance equations Determinants of trust in courts Aspects for decision-making when preparing a new business deal Criteria for decisions on types of agreements in business relationships Sources of assistance during business start and in 2002 Sources of assistance and advice in the business by membership of business associations Extent to which entrepreneurs consider the relations between official bodies and private firms as either help or constraint to business success ix

26 47 51 54 65 108 116 120 121 139 141 143 143 145 148 149 150 152 164 167 168 170 180 183 186 187

191

x

11.6 12.1

12.2 12.3 13.1 13.2 15.1 15.2 15.3 15.4 16.1 16.2

Tables

Problems in dealing with authorities Four types of entrepreneurs (in the sample) differentiated according to co-operative experience and co-operative involvement Regional distribution of ICT entrepreneurs/firms in West Poland in 2001 Share of Polish ICT entrepreneurs (in the sample) with positive or negative co-operative experiences Forms of regulation in inter-firm relationships Decision criteria for the form of regulation in inter-firm relationships Textile establishments and employment in the Prato district Number of subcontractors or ordering firms respectively of the responding final and phase firm entrepreneurs Trust and opportunism in subcontracting relations of the Prato firms Interaction rules in subcontracting relations Private initiatives funded by the territorial pact (September 2002) State of the art of private and public initiatives (September 2002)

192

205 206 208 226 229 259 261 262 263 280 281

Contributors Iryna Akimova, UNDP, Ukraine Reinhard Bachmann, Birkbeck, University of London, UK Luigi Burroni, University of Florence, Italy Alexander Chepurenko, Higher School of Economics, Moscow, Russia Gabi Dei Ottati, University of Florence, Italy Hans-Hermann Höhmann, University of Cologne and Research Centre for East European Studies at the University of Bremen, Germany Daniel Houser, George Mason University, USA Teemu Kautonen, University of Vaasa, Finland Bernhard Lageman, Rhine-Westphalia Institute for Economic Research, Germany Jonathan Leland, National Science Foundation, USA Xiao Li, Centre for Enterprise and Economic Development Research, Middlesex University Business School, UK Fergus Lyon, Centre for Enterprise and Economic Development Research, Middlesex University Business School, UK Elena Malieva, Research Centre for East European Studies at the University of Bremen, Germany Henning Nuissl, Centre for Environmental Research Leipzig-Halle, Leipzig, Germany Vadim Radaev, Higher School of Economics, Moscow, Russia Anna Schwarz, European University Viadrina, Frankfurt (Oder), Germany Gerhard Schwödiauer, University of Magdeburg, Germany Jason Shachat, National University of Singapore David Smallbone, Small Business Research Centre, Kingston University, UK Gert Tinggaard Svendsen, The Aarhus School of Business, Denmark xi

xii

Contributors

Vartuhi Tonoyan, Institute of Small Business Research of University of Mannheim, Germany Hans van Ees, University of Groningen, The Netherlands Urve Venesaar, Tallinn Technical University, Estonia Friederike Welter, Rhine-Westphalia Institute for Economic Research (RWI), Essen, University of Siegen, Germany and Jönköping International Business School (JIBS), Jönköping, Sweden

Acknowledgements We would like to thank the Volkswagen Foundation, which funded our research and the conference within its programme ‘Unity amidst variety? Intellectual foundations and requirements for an enlarged Europe’, thus enabling our collaboration and the international conference on trust and entrepreneurship in September 2003, of which this book is an important result. We also thank those involved in preparing the conference and assisting us throughout the whole research project: Alina Klymova and Milena Stoytcheva, both University of Essen, Julia Kusznir and Mathias Neumann, both Research Centre for East European Studies at the University of Bremen, Marlies Tepaß, RWI Essen.

xiii

Introduction Hans-Hermann Höhmann and Friederike Welter THE STORY BEHIND THIS BOOK In September 2003, an international conference on ‘Trust and entrepreneurial behaviour in East and West European economies’ took place at the University of Bremen, jointly organised by the Research Centre for East European Studies, Bremen, (Forschungsstelle Osteuropa an der Universität Bremen) and the Rhine-Westphalia Institute of Economic Research (RheinischWestfälisches Institut für Wirtschaftsforschung), Essen. Over two days, some 40 scholars from around the world discussed trust-related project results and shared ideas on how to conceptualise trust and how to measure it. This conference was the final highlight of a collaborative research project, which had set out from 2001 until 2003 to research trust in entrepreneurial behaviour in Western and Eastern Europe. The research group consisted of Urve Venesaar from Estonia, Gabi Dei Ottati from Italy, Alexander Chepurenko from Russia, David Smallbone and Fergus Lyon from the UK, and working from Germany – besides the two editors of this book – Teemu Kautonen, Bernhard Lageman and Elena Malieva. Our idea was to investigate entrepreneurial behaviour of small firms in differing cultural and institutional settings across Europe, assuming that trust has a decisive impact on entrepreneurship, as it determines ways into, and forms of, entrepreneurship as well as entrepreneurial behaviour. This book presents papers from the conference and from the research project, illustrating a truly international and pan-European collaboration. Whilst the project team assembled 10 researchers from five different European countries, the 23 contributors to this book come from 11 countries around the world. There are three main themes running through the book, illustrating the broad facets of trust.

CONCEPTS, DEFINITIONS AND MEASUREMENTS Trust has been studied by several disciplines including, for example, psychology, sociology, cultural anthropology, philosophy, political science, 1

2

Trust and entrepreneurship

economics and business administration, and there exist manifold definitions. Here, Höhmann and Malieva set out to discuss definitions, forms of trust and its sources. Welter asks whether trust is a sector-based phenomenon or a feature inherent in different (regional and/or national) cultures. Key topics include questions of how to explain the role of trust in business relationships, and the cultural and sectoral factors determining trust and differing trust levels. Chapters 3 and 4 add a comparative perspective to our conceptual puzzle. Tonoyan deals with the ‘dark side of trust’ through analysing the linkages between corruption and entrepreneurship in emerging and mature market economies, while Svendsen applies the concept of social capital to problems of transition. Little is known so far about the emergence of trust and how it is embedded from a societal perspective, which topic is picked up by Lageman in his contribution. How to handle trust in empirical research? How to ask for trust? How to measure it? This is one of the most challenging topics in any project attempting to analyse the trust-based foundations of individual behaviour and entrepreneurship. Considering the diversity of definitions for trust in the literature, it is hardly surprising that a variety of different measures and methods have been used in empirical trust research. Also a variety of methodological approaches have been used ranging from laboratory experiments to surveys and different qualitative methods, all of which have their pros and cons depending on the specific research issue. In this volume, Leland, Houser and Shachat discuss questions around measurement of trust, employing a gametheoretical approach.

TRUST AND ENTREPRENEURIAL BEHAVIOUR IN DIFFERENT ENVIRONMENTS: COMPARING TRANSITION AND MARKET ECONOMIES Low levels of trust often constrain market entry, enterprise growth and competition whilst encouraging unproductive forms of entrepreneurship. In those countries where the institutional environment functions well, such as in Germany and in most mature market economies, institutional trust abounds and personal trust mainly plays a complementary and second-best role for entrepreneurs, whilst in environments with a weakly developed formal institutional frame personal trust substitutes for some of the institutional deficiencies, thus explaining distinctive forms of entrepreneurship and entrepreneurial strategies. Researching the impact of trust on enterprise behaviour assists us in understanding East European transformation processes as well as differences

Introduction

3

in the economic performance between enterprises, industries and economies in a reunited and enlarged Europe. How do low levels of trust affect small firms? In which ways does a lack of trust shape relations between firms, within enterprises and between firms and authorities? What triggers trust to evolve in business relationships, and how does this differ across countries? These are some of the questions tackled by the contributions in Parts Two and Three. With respect to transition economies, van Ees and Bachmann set out to construct a model of trust-building in different stages of systemic transition. The chapters by Radaev, Chepurenko and Malieva are based on empirical studies from Russia. They describe how in an environment where institutional trust is lacking and norms are unstable, individuals use social contacts and individual networks dominated by mutual trust in order to pursue business, but their results also demonstrate how this has changed (for the better and the worse) over the past decade. Changes in trust-related business behaviour in Estonia is the topic of Venesaar’s contribution, while Akimova and Schwödiauer investigate how institutional trust can contribute to a better performance of Ukrainian small and medium-sized enterprises (SMEs). Nuissl and Schwarz add empirical results from more advanced transition economies, comparing entrepreneurs in the ICT sector in East Germany and Poland. In mature market economies the trust framework is more developed. It usually allows a better allocation of resources and lower transaction costs compared with transition economies. However, this distinction at country level neglects that trust levels could differ both across regions (that is, within countries) and sectors. For example, although both East and West Germany share the same formal institutional framework of a mature market economy, there appear to be differences in the informal institutional framework – trust culture – between these regions, which is analysed in more detail in the contribution of Kautonen and Welter, focusing on small-firm networks and the role of trust. Networks and trust also play an important role in the next chapter, written by Smallbone, Lyon and Li. They focus on the immigrant Chinese community in the UK, illustrating how even in a mature market economy different trust environments may exist for different social groups. Italy is the topic of the final two chapters. Dei Ottati presents an in-depth study of the industrial district of Prato in Italy, where trust-based local codes of conduct govern entrepreneurial behaviour, while Burroni analyses a territorial pact for employment, using this as an example to show how trust has risen among local public/private administrations and organisations, and the effects on local economic development. Overall, the results of our joint collaborative research project as well as the contributions within this book demonstrate that, especially in periods of rapid

4

Trust and entrepreneurship

economic and societal changes, entrepreneurial behaviour cannot be understood without taking into account the phenomenon of trust. However, the contributions also illustrate the conceptual and empirical difficulties in researching a complex and multi-level phenomenon such as trust. With this volume, the editors hope to present interim analytical and empirical results, which answer conceptual questions and invite further research.

PART ONE

Concepts, Evolution, Measurements

1. The concept of trust: some notes on definitions, forms and sources Hans-Hermann Höhmann and Elena Malieva TRUST AND THE CHALLENGE OF MODERNITY The explosion in the number of publications on trust in the last few years, and the fact that this has taken place in almost all disciplines concentrating on human behaviour and social developments, are both obviously the result of the growing complexity of modern societies and the increasing awareness of the divergences between societies undergoing the secular processes of modernisation, globalisation and systemic transition (Alesina and La Ferrara 2000; Blumquist 1997; Ganesan and Hess 1997; Seligman 1997; Warren 1996). At the end of the 1960s, Luhmann, who helped spark off the debate on trust with his book, Vertrauen: ein Mechanismus zur Reduktion sozialer Komplexität, and who remains until this day, not only in the German literature, one of the most important authors on the subject, could still speak of the ‘sparse literature’ on trust (Luhmann 2000, p. 1); however, since the 1980s in particular, many researchers from different disciplines (including theology, philosophy, psychology, political science and sociology) have dealt with trust and its role in private life and the development of society. Economists have also increasingly turned to trust as an object of research. They are led by the assumption that besides the traditional ‘hard’ factors, such as corporate structure or production technology, the so-called ‘soft’ factors, which include those which belong to the realm of economic culture (Höhmann 1999; Panther 1999b; Pleines 2004), influence the behaviour of enterprises and the nature of the relationships between them. Not least, it is assumed that the ‘trust factor’ determines the direction and content of transactions, the range of networks which market partners create, the market strategies of corporations and the dynamics of innovation and entry into the market. The level of trust (or its opposite, mistrust) which can be observed within a society is employed not only in a microeconomic respect, but also as an important component of economic systems and as a defining factor for the general performance of an economy, either as an explanation for successful developments like those in China, Japan and South-East Asia (Fukuyama 1995) or for a description of temporary or continuous problems of consolidation like 7

8

Concepts, evolution, measurements

those in the post-Communist transition countries of Central and Eastern Europe (Höhmann 1997; Sztompka 1995). The current surge of research and publications on the nature and impact of trust does however have its predecessors. From a sociological perspective, Endreß identified three generations of classics on research on trust, which he arranged chronologically (Endreß 2002): the ‘founder generation’, represented by Emile Durkheim, Max Weber and Georg Simmel, the third of whom dealt with the phenomenon of trust the most thoroughly and intensively, and has remained of great influence on the research on trust; the ‘generation of the turn of the century’, represented by Alfred Schütz, who has largely escaped the notice of the later research on trust, and Talcott Parsons, who became important through his concentration on the functions and conditions of the preservation of unanimity in social systems; and the ‘generation of 1920’, whose main representatives were Harold Garfinkel, Peter M. Blau und Erving Goffman. Although the rudiments of this generational structure do not bring out precisely the heterogeneity of the various authors or the different degree to which they dealt with trust in their work, Endreß does show the basic theories and historical development considerations underlying the approaches of the research on trust by the older authors and demonstrates the profitability of employing this literature with regards to the development of theory and practical analysis (Schäfer 2004). Above all, four complex processes have over the last two decades generated the astonishing dynamism of the research on trust: 1. 2.

3.

4.

The progress of modernity, which has in a historically unprecedented way torn human beings from their traditional forms of living. The change in convictions, values and norms which has reduced the predictability and reliability of human relations within the process of social interaction. Globalisation, which has not only widened the network of international activities and forms of communication, but also increased the obscurities and interpersonal fears of contact connected with multiculturalism. The process of transition in Eastern Europe, which through the accompanying collapse of accustomed modes of thought, patterns of behaviour, forms of social association, political structures and economic conditions of existence has awakened great hopes, while at the same time fundamentally rocking the daily life, shaking the general attitude to life of many and leading to a spiralling syndrome of deep mistrust.

All these processes have a common influence on trust: they raise the complexity and contingency of personal and social daily life, and increase the amount of knowledge necessary for successful social and commercial interactions.

The concept of trust

9

With regard to the progress of modernisation, which towers above the other processes in importance, Giddens’s analysis and categorisation of trust as part of his study of modernity has come to the fore (Giddens 1990; 1992). Social relationships are increasingly being taken out of local frameworks of interaction in familiar milieus and transferred to a basis of limitless space–time spans. The disintegrating effect of this process is strengthened through the coincidence of modernisation and globalisation with the dissolution of familiar values and modes of behaviour, which Giddens calls ‘disembedding’. For the maintenance or rebuilding of social coherence, trust plays the role of an intermediary joint, on the one hand as trust between people who more or less know each other, and on the other as trust in the performance of ‘disembedding mechanisms’. These mechanisms not only represent the basis and impetus of the space–time restructuring of human frameworks of interaction, but also their efficiency and the trust placed in them have to maintain or re-create social coherence. Above all, Giddens deals with two ‘disembedding mechanisms’: the creation of symbolic tokens and the establishment of expert systems (Giddens 1990; 1992). Among the symbolic tokens, special emphasis is placed on money (which for Simmel also played an important role), for money especially creates the prerequisite for the conduction of transactions between agents who are distantly separated by time and space. Expert systems are systems of technical performance or professional knowledge, which form broad areas of the material and social surroundings in which human beings in modern conditions live and act. Money and expert systems can make use of their interactive functions to their greatest extent if they are not only efficient, but also if people trust them.

CONCEPTS OF TRUST If we look at the various concepts of trust in different disciplines it is possible to see both agreement and divergence. In the foreground of many theories is the role which trust can play in a pluralistic society (which is characterised as containing growing functional differentiation and stratification, and a high degree of the division of labour as a social resource) by promoting co-ordinated and productive patterns of behaviour in a society which offers only limited information concerning one’s partner’s behaviour and no power to control his or her actions. Numerous concepts and definitions of trust have been developed on this basis, which partly exhibit common characteristics, and partly reflect the specific approaches of research and interpretation of the disciplines in which they originate:

10

1.

2.

3.

4.

5. 6.

Concepts, evolution, measurements

They concentrate on the fundamental questions of the nature of trust, its necessity as a contribution to the social capital of society and its relationship to uncertainty, knowledge and time. They differentiate between different forms of trust, which on the whole refer to the different attitudes of the trustor and the various people, surrounding conditions and structures which he or she trusts. They seek to establish the presence and character of specific milieus of trust, such as high and low trust environments, and try to convey how the development and loss of trust takes place. They look at the sources of trust and the relationship of trust to psychological attitudes, family structures, cultural milieus and historical memories. They deal with the question of which political and economic strategies can be implemented in order to build or rebuild trust. They examine if, to what extent and with what methods trust can be measured as an empirical category and whether it is valuable as a variable in the explanation of social, political and economic change.

This chapter tries to compile some elements of the discourse on trust at present taking place in the different academic disciplines. In view of the fullness of the very different thematic aspects and methodologies, the chosen approach is admittedly more associative than systematic. Because in discussing the question of the role of trust in, and meaning for, the behaviour of entrepreneurs and firms, primarily economic aspects were at the centre of our conference, and the fact that consequently these aspects broadly determine the content of the articles in this collection, the following will deal primarily with expositions and problems from the psychological and sociological debate. This broad approach for the introduction has been consciously chosen and will be brought into sharper focus by the individual contributions to the volume, which, dealing with concrete questions, will further define and analytically and empirically enrich what is said here. Certainly, such a procedure exhibits a strong eclectic character. It might, however, have the advantage of reflecting tangible concepts and questions in the light of broader questions and definitions, and in this way provoke new, fundamental reflections. This is desirable because one can still feel among many authors uncertainty in relation to a clear, theoretical definition of the concept of trust and its empirical productivity. Even Luhmann (2000, p. v) expressed doubts as to ‘how distant that which can be said about trust today is from methodically reliable verification’. He spoke of an unavoidable ‘cleavage between theory and empirical research’, which, however, he did not believe to be unbridgeable, and finally asked whether in general it was ‘worth more serious consideration’ as to ‘whether one should advise sociology to use commonly used words and concepts from

The concept of trust

11

the traditional, ethical way of imagining the world’ and to transform moral into sociological concepts. In the context of similar doubts, Gambetta stated in 1988 that the importance of trust as a trading resource in most situations where co-operation is at one and the same time a vital and fragile commodity is, although often recognised, rarely sufficiently analysed. Social scientists touched on it in passing, only ‘to allude to it as a fundamental ingredient or lubricant, an unavoidable dimension of social interaction, only to move on to deal with less intractable matters’ (Gambetta 1988, p. ix), and Misztal concluded ‘that modern social sciences have not contributed significantly to our understanding of the concept of trust and the conditions under which trust relations thrive or struggle or survive’ (Misztal 1996, p. 29). The fact that the above-mentioned authors have not only made contributions to fundamental aspects of the research on trust, but also that the body of literature in the mean time has grown considerably, shows that nevertheless the advances in discoveries have been greater than is sometimes sceptically suggested, and that the research on trust has meanwhile reached at least that ‘intermediary state between knowledge and ignorance’ which Simmel postulated for its object of research (Simmel 1992, p. 393). In the attempt to organise the different approaches of research it might be sensible to begin with several fundamental areas of shared ground and to demonstrate the most important common assumptions of the concept of trust. Almost all definitions agree on at least three elements (Frambach 2003): reciprocity, expectation and knowledge. The first common element is the aspect of reciprocity: trust concerns social interaction, the relationship between a giver and an object of trust. Trust (like its opposite, mistrust) refers to human action and not natural events, which instead are the object of hope (or fear) and not trust (Sztompka 1995). Trust means to rely on someone or something. Trust always begins with two. Even the important category of self-confidence, which plays a central role in many concepts of trust, does not represent a personal characteristic like physical strength or intelligence. It refers instead to a behavioural attitude connected with two-way interaction: on the one hand, self-confidence develops from the basis of a trusting relationship from early youth, for which reason a close relationship exists between the concepts of ‘self-confidence’ and ‘basic trust’ (Erikson 1965); on the other hand, self-confidence is an extremely important resource for lifelong relationships with other human beings and social organisations. Self-confidence extends the room for action in the realisation of options of all kinds. Like trust in general, the presence of self-confidence reduces the need for knowledge and certainty, and in the end it is the presence of self-confidence which is the important prerequisite which allows the trust of a partner to be won. (In Goethe’s Faust the young student is encouraged with the recommendation ‘and if you trust yourself, other people will trust

12

Concepts, evolution, measurements

you’.) Self-confidence is admittedly one of the most important subjective factors of trust, but alongside it there are other subjective factors which are important as the basis of action: the temperament and level of activity of a person, his or her moods, the intensity with which he or she feels his or her needs, the ability to assert him or herself and his or her capability for conflict, but also pleasant personal attributes such as generosity, obligingness and charm, which inspire sympathy and win trust. The second common characteristic of many concepts of trust relates to the relationship between trust and expectation. Trust is a state of expectation towards possible, normally desirable, although at the same time uncertain, future reactions of the object of trust. This uncertainty can be traced back to the contingent actions of others, of whom it is hoped that they will prove themselves to be trustworthy through responsibility, predictability, efficiency and quality. Rotter, for example, defines trust as generalised expectations ‘held by an individual that the word, promise, oral or written statement of another individual or group can be relied on’ (Rotter 1980, p. 1). Barber, too, describes trust as expectations with regards to the behaviour of others, focusing on three kinds of expectation of other people. The most general is expectation of the persistence and fulfilment of the natural and the moral social orders. Second is expectation of technically competent role performance from those involved with us in social relationships and systems. And third is expectation that partners in interaction will carry out their fiduciary obligations and responsibilities, that is, their duties in certain situations to place other’s interests before their own. (Barber 1983, p. 9)

The third common characteristic of the concepts of trust is the thematisation of the special relationships which exist between trust and knowledge. Due to the fact that one can estimate a person, social institution or technical system to be trustworthy, without having complete information about him or it at one’s disposal, and on the basis of this trust him or it, trust exhibits, as Simmel first stressed (Simmel 1992, p. 393), as a ‘pre- or post-form of knowledge’, an ‘intermediary state between knowledge and ignorance’ of the object of trust. Simmel’s much quoted statement is: ‘The all-knowing do not need to trust, and the fully ignorant cannot rationally trust.’ Simmel, however, also correctly pointed out that there are types of trust ‘beyond knowledge and ignorance’. By this he meant the belief in another person which resembles religious belief. Here, trust takes on unreflective, naive forms, which can lead to spontaneous actions with high risks and repeated disappointments, and which lack the character of rational risk assessment, the latter characterising Coleman’s concept of trust (Coleman 1990; 1991). Coleman, whose analysis of trust is dominated by an economically orientated,

The concept of trust

13

rational-choice theory of action, defines trust as a one-sided transfer of control over resources, actions or events. In the context of a model of social exchange, simple and complex trust relationships are understood as the transfer of the right of control in situations which are open and risky because knowledge about the action of the other is lacking and their reciprocal action will occur only after the trustor has performed an action first. For Coleman, risk and a referral to the future are further characteristics always connected with trust. In his study, he focuses on the theoretical model of the rational individual and poses the question under which conditions it would be right for an agent to trust: ‘The potential trustor must decide between not placing trust, in which case there is no change in his utility, and placing trust, in which case the expected utility relative to his current status is the potential gain times chance of gain minus the potential loss times the chance of loss’ (Coleman 1990, p. 99). Sztompka (1995, p. 256) defined trust ‘as the acceptance or bet on the future behaviour of the other’, which is voluntarily taken up, subjectively rationally understood and motivated by self-interest (Welter et al. 2004) and which brings a certain measure of risk, since it can lead to both gain and loss.

FORMS AND FOCI OF TRUST To cope with the complexity of trust, it might be appropriate to distinguish between different forms or foci of trust and to elucidate the relations between them. Krampen (Krampen 1997) offers from the standpoint of a psychologist a productive systematisation and theoretical categorisation of the existing terms and definitions of trust. Within his ‘triad of trust’ he differentiates between three categories of trust: self-confidence, trust in others and trust in the future. Self-confidence is the foundation of all trust. It refers both to the concentrated, subjectively internalised ability to recognise and accept one’s own potential and to ‘correctly’ (that is, in keeping with the intended transaction) assess the opposite number and to influence his or her actions in order to achieve the desired result of the transaction. Self-confidence is an important basis of the scope for action and development which an individual has at his or her disposal. In an enterprise, self-confidence is the prerequisite that the capital present (physical capital, human capital and social capital) can be extensively used and in turn contributes to the capital stock. Interpersonal (social) trust is the most frequent subject for study in the specialised literature. Krampen defines it as trust in others. Again, he differentiates between references specific to situations or areas and generalised references. Friends, acquaintances, politicians, the mass media or socio-political institutions are the people or institutions that are concerned in these cases.

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Concepts, evolution, measurements

‘Trust in others’ has a communicative and reciprocal character: people who have made the concession of trusting behaviour expect the partner to reciprocate (Krampen 1997, p. 27). The third category is trust in the future. Here, too, one can distinguish between various areas, such as trust in one’s personal future, in the future of relatives and friends, or in the future of society. However, trust in the future does not have an autonomous quality, as both self-confidence and trust in others are in general always (also) aimed towards the future, and only exist if earlier positive experiences can be transferred into the future. As Preisendörfer (1995, p. 265) notes: ‘Trust creates expectations or hopes for something in return in the future.’ However, an explanation of trust at the level of individual psychology is insufficient. Rather, it is necessary to understand trust as a general component of social relations at quite distinct levels, and the current sociological discussion has taken precisely this direction. Trust is no longer studied merely at the individual level, but also at the level of the social system in general. For example, Preisendörfer (1995, p. 264) sees trust as not being primarily connected to individual actors, but rather as a significant ‘characteristic of social relations’. Socially relevant trust relationships (or their opposite) can exist not only between individual agents (persons), but also between persons and corporate actors (for example, businesses, associations, political parties). This type of trust, which exceeds purely personal trust relationships, will expand to become ‘system trust’ (or ‘system distrust’) if the agents’ trust expands to include the totality or at least central elements of the institutional environment. Whoever ‘places trust in the stability of the value of currency and in the continuity of a variety of possibilities of expenditure, basically takes it for granted that a system works, and does not place his trust in persons known to him, but in the working of the system’ (Luhmann 2000, p. 64). Besides ‘trust in money’ and ‘trust in informing authority’, ‘trust in legitimate political power’ play a special role in Luhmann’s analysis of system trust (Luhmann 2000, p. 69). While the first two manifestations of trust act as typically decentralised forms of the reduction of complexity, the organisation of political and administrative power implies a centralisation of the process of reduction. In this case it is political power that determines the binding parameters of decision by its actions. A special aspect of system trust arises if trust has to be placed simultaneously in the social control ability of a system (for example, the management efficiency of a railway administration) and the performance of technical installations (the condition of the track system, technical control systems and trains). In this case, trust in human structures is combined with trust in technology. As Max Weber (1988, p. 465) pointed out, in this case to trust is an attitude that has to make do to a large extent without knowledge:

The concept of trust

15

No normal consumer today has even the slightest knowledge about the production of his everyday goods, usually he does not even know out of which materials they are made and which industry produces them. He is interested in no more than the expectations of the behaviour of these artefacts which are important to him from a practical point of view.

This aspect was later expanded and deepened by Giddens in his analysis of the ‘disembedding mechanism expert systems’ (Giddens 1990; 1995). In many approaches the distinction between personal trust and institutional trust plays an important role (Höhmann and Welter 2004), although one must remember that trust always has a personal component. Only people can trust; things, technical systems and institutions cannot. Personal trust can therefore be understood only as trust in people, and institutional trust as trust in institutions. Trust in institutions means that the influence of institutions on people, which assumes rules and norms and is strengthened by sanctions, increases their reliability and therefore their trustworthiness. Those who trust a system basically think that it places a reliable normative screen over the society, in the form of binding rules, protected by sanctions, which makes the people who comprise the society, and whom one must trust, reliable. Personal trust concerns the personal knowledge of and familiarity with the partner, stemming from either a personal, often long-standing, relationship between the two partners or from assumptions of the trustworthiness of the partner which, although they do not stem from personal experience, derive from a trusted milieu. These milieus include family, friends, groups, associations, those coming from the same town, region or country, minorities (especially in the case of diasporas), religious communities, ethnic groups or groups whose members have shared a common formative experience (for example, the survival of a catastrophe). Here, it makes sense to speak of collective trust, which in turn means trust in collectives, because it is the informal institutions which the collective has adopted and which have been preserved through traditional modes of behaviour, norms and rituals, which socially determine individual behaviour and it is their reliability which one trusts. These informal institutions are not equipped with the same powers of sanction as those institutions, above all state institutions, which possess formal political power. However, informal institutions are not fully without sanctions, which range from simple disapproval to social contempt and the use of physical violence. The granting of personal trust is based on the assumption that the partner or friend will not disappoint the trust granted, but rather return it with their own trust, even when there are no legal rules or written contracts to govern the situation. Informal rules and norms therefore define the relationship. However, the combination of personal trust with known milieus does not always produce a trusting relationship. Often, close ties can give rise to negative attitudes, for example the way in which a disappointment in the behaviour of a partner after

16

Concepts, evolution, measurements

long, positive experience, can lead to the breaking off or limitation of the relationship to a degree which contradicts reasonable calculation. The closeness of the relationship and the emotional ties of the partner create an especially large degree of distrust, which is difficult to overcome. Also the trusted/familiar self is sometimes viewed critically or in a way which has negative consequences for the behaviour within a transaction, as the quote attributed to Groucho Marx humorously demonstrates: ‘I wouldn’t want to belong to any organisation that wanted people like me as one of its members.’ This last consideration further demonstrates the danger of overestimating the rational character of the granting of trust, or the role of trust as a rational and self-interested bet. The consequences for the research on trust can either be to take more into consideration the elements of trust and distrust ‘beyond knowledge’ addressed by Simmel, or to develop a more limited definition of trust, from which other factors which determine behaviour from the realm of human emotions, such as fear, affection, anger and disappointment, are more sharply distinguished. Institutional trust concerns the institutional environment, especially the organisations and institutions of the state and their regional representatives, which are equipped with the legal power of sanction. This means those system frameworks which are necessary for individual action for which the efficiency of the state is responsible. Formal institutions belong to the realm of the ‘disembedding mechanisms of symbolic tokens’, which Giddens describes, among which, apart from money (which, like Simmel and Luhmann, is important for Giddens) include the standards, norms, guidelines and laws which are fixed and sanctioned by the state (Giddens 1990; 1995; Luhmann 2000; Simmel 1992). Reliable institutions, which possess the power to regulate the relations between the people, organisations and enterprises which fall within their jurisdiction and which act on the basis provided by these institutions, broaden the range of options of action (in the realm of enterprises, this includes contacts with new partners, product and process innovation, and the regional extension of business relationships). Institutional and collective trust have in common that they replace or supplement the positive experience of the giver of trust with the receiver of trust through the expectation that the force which directs the behaviour of collective and institutional embeddedness render unknown partners reliable and therefore trustworthy. It is sensible to distinguish between different degrees of trust for all three forms of trust. Trust is ‘strong’ if the trustors assume that most people are reliable, sociable and well intentioned, that the institutional environment meets the level of performance which the trustor expects from it and that active and extensive co-operation can bring considerable advantages. On the other hand, a ‘weak’ form of trust, which is characterised only by the absence of distrust

The concept of trust

17

and fear of contact with potential partners, provides a substantially smaller stimulus to (Offe and Fuchs 2001, p. 419). Also, the feeling described by Giddens of a ‘vague and generalised sense of trust in distant events over which one has no control’ (Giddens 1990, p. 133) belongs to the weaker forms of trust, which does act as a stabilising factor, but rather results more in individual passivity and social stagnation (Sztompka 1995). Finally, trust can disappear entirely. Other social mechanisms act as bases of action in compensation in order to satisfy the general needs of order, predictability and efficiency, of which some, however, must be characterised as socially pathological (Sztompka 1995, p. 261). Sztompka includes among these systems the exercise of social control, paternalisation (the desire for a leading father figure, who, if he arrives, is blindly trusted), the bribing of decision-makers and ghettoisation (the retreat of social groups from an environment which is perceived to be foreign and threatening, and their sealing off from the outside world).

HIGH-TRUST AND LOW-TRUST MILIEUS In modern society trust is not evenly spread. Individuals and groups can have differing objects of trust (the whole system, certain parts of the system within the society, different organisations, various firms and their products, definite professional groups and individuals). The intensity with which individuals trust an object of trust is not evenly distributed and not equally intensive; indeed, it may be the rule that trust and distrust accompany one another. Trust can, however, spread and if ‘trust clusters’ are created by the concentration of many intensive trust relationships of different kinds between a large number of social actors within a society, then we can speak of ‘high-trust milieus’ (the opposite of which are ‘low-trust milieus’). It is characteristic of high-trust milieus that they contain a high degree of trust in the socio-political system, the progress of common economic and social prosperity and the ability within this environment to see one’s own wishes and hopes fulfilled. Both high-trust and low-trust milieus are self-reinforcing cycles (Giddens 1984; 1995, p. 247), which, in the case of negative cycles, have to be broken in order to have positive effects on the direction and usefulness of social and economic transaction behaviour and (according to a different terminology) to increase the ‘social capital’ (Coleman 1988; Putnam 1993; 1995a; 1995b). Analyses of social and economic history give rise to the supposition that the start of both positive and negative ‘trust cycles’ depends, on the one hand, on potentials or sources of trust, which are one of the historical paths of development of societies, but which, on the other hand, can also be triggered by positive or negative shocks (some examples: hyperinflation in Germany was a negative, traumatising

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shock with a long-lasting effect; the coming to power of Putin in Russia could be seen as a positive shock). While high-trust milieus act to promote prosperity, stabilise the social and political system, and create dynamic competitive structures within the economy, low-trust milieus detract from the stability of democracy, economic growth and entrepreneurs, and from competition, and create conditions for entrepreneurial activity which hinder political consolidation and economic restructuring. Empirical studies which have looked at entrepreneurial activities in low-trust environments (Lageman 2001; Welter and Smallbone 2001) demonstrate the extensive development of shadow economic activities, the emergence of various forms of ‘political entrepreneurship’ and the formation of a criminal economic structure. Alongside many Third World countries, the transition countries of Central and Eastern Europe, despite differences in national, regional and temporal respects, are considered to betray the typical characteristics of low-trust milieus. Because only two countries from these regions (Russia and Estonia) were included in our research project, the following offers several explanations for the causes of the absence of trust in post-communist societies and the consequences associated with this (Höhmann 1997; 1999; 2001; 2003; Sztompka 1995). The first reason is connected to the inheritance of communism. Admittedly, the totalitarian system was not able to control the totality of the political, economic and social processes. The further the structural diversification, caused above all by economic modernisation, of the Central and East European societies progressed, the more central control diminished and autonomy and disintegration increased. However, the dysfunctional and ‘leaky’ totalitarianism always remained in the position through selective control, supervision and persecution to prevent the spontaneous and voluntary networking and interaction of people, groups and organisations. Social interaction entailed personal risk, and a culture of behaviour and mentality marked by mistrust spread, which needed to be overcome. Because one could not trust the politically uncontrolled, arbitrarily intervening system, networks based on personal trust formed, which survived the collapse of communism. In the economy, these networks allowed only limited entrepreneurial transactions. A consequence of this was the stagnation of production and the restriction of the development of productivity. The dysfunctional system of the Soviet period largely disintegrated during the collapse of communism after 1990. Efficient, reliable new systems, however, only gradually came into being. An ‘institutional gap’ arose whose importance for the task of political, economic and social consolidation set by the transformation was largely neglected in the research on the transformation from the 1990s. The distant reigning uncertainties, insecurities, ambiguities and intransparancies of the daily life of post-communism did not promote the

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construction of an atmosphere of trust. In addition to the unstable mosaic of old and new institutional arrangements, there existed a largely normative disorganisation. The spreading anomie exacerbated the inefficiencies and weakness of those controlling authorities which should preserve law and order. Transactions were interspersed with criminal activity of all kinds, including violent crime. The behaviour of the power-hungry and profit-orientated economic elite, who had used the transition processes to pile up vast private fortunes and largely ‘privatised’ the state, had a similar influence. Ethical attitudes, directed at the common good, did not seem to be visible in the behaviour of the oligarchs. While a small part of society ostentatiously put up for show their grabbed prosperity and the opportunities of luxury consumption associated with it, broad sections of the population, who met the collapse of Communism with great hopes, but more or less remained poor, were disappointed. In turn, a result of this was a negative effect on the creation of trust in their own personal future and the efficiency and justice of the post-communist system. In the mean time, a process of transformation has begun to take place. In central Europe the sprouting of democracy, social and economic consolidation and acceptance into the European Union have changed the public climate of opinion, although one can not speak of a deep-rooted transformation into a high trust milieu. In Russia, too, the situation has changed as a result of the recovery which began in 1999 (Höhmann 2001; 2003). The trust of the population in the future of their country has increased, although a continuing distrust toward the economic and political elites remains, the only exception apparently being the person of the president.

SOURCES OF TRUST Finally, some remarks on the sources of trust. The question of how resilient trust is as a guiding force for communicative behaviour can only be answered on the basis of an examination of the sources of trust, as the ability to trust and the quality of trustworthiness are not fleeting phenomena. Rather, both are properties rooted in the personality of a human being and his or her personal history, and in the culture surrounding him or her. Trust, too, is (according to North 1990; 1992, p. 44) one of those ‘informal constraints [which] come from socially transmitted information, and [which] are part of the heritage that we call culture’; for trust, also the observation of Cornelssen (1991, p. 47) holds true: ‘Culture does . . . guiding work in the process of the evolution of a system.’ When Sztompka (1995, p. 255) says that trust ‘can be understood as a cultural resource, which is essential for the realisation of the potential for action in practice and in this way also for the dynamic potential of society’,

20

Concepts, evolution, measurements

the reverse is also true, that culture is a fundamental resource for trust. Culture is here understood in the broad sense of the totality of knowledge, experience, perceptions, values, norms and modes of behaviour with regards to politics, society and economics of a whole nation or certain groups within the society, which influence the decisions and actions of agents or groups of agents (Höhmann 1999). Economic culture has constitutive and regulative elements (DiMaggio 1994). It influences both the (often unconscious) structure of the ‘economic world view’ of agents, and their motives for action and, by defining limitations, the daily consciousness of accessible values, norms and attitudes (Panther 1999a). First, experience is a very significant factor among the sources of trust. Experiences lead to expectation patterns and influence new situations. These experiences might be one’s own experiences with a potential transaction partner which were made in a similar situation; they might also be experiences made by other persons and passed on. Schmid (1998, p. 302) has demonstrated convincingly that the experiences an individual has and interprets according to sense and meaning belong to his very own possessions; they contribute to his power of judgement and the fund of his knowledge of life. Unlike the logic and systematics of scientific knowledge, knowledge gained by experience can take into account the logic of life, as it is experienced in the life one lives.

Positive experiences lead to positive assessments of success for the future, both on the side of the trustor and on the side of the trustee. The positive experience and trust that is won on more than one occasion will then clearly shape patterns of action and the personal character of the individual concerned. Experiences play an important role in the creation of both personal and system trust. Experience is a triggering factor for the above mentioned reproduction cycles, which lead to trust becoming stronger or weaker, or even vanishing completely. On the one hand, experience is a subjective factor: every person has his or her own experiences. On the other hand, experience is also always imparted by public processes of communication. Thus, for example, economic situations that are not seen as being particularly unfavourable by the individual can be influenced negatively – and positively in the opposite case – by the media and opinion-forming politics. Experience as a central source of trust is, however, not only embedded in ‘milieus of perception’, which definitely can be influenced; deeper rooted factors are also expressed in experience. These factors are connected, on the one hand, with genetic patterns, family structure and socialisation and, on the other hand, can be traced back to history (‘historical memory’), culture and religion, traditions and rituals. Researchers are most probably right in assuming that all these factors influence the existence or absence of trust to a very

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significant degree. However, developments of research in this area are on the whole fairly unsatisfactory. In many cases, studies have not progressed any further than hypotheses, which appear plausible within the context of general typifications, but cannot satisfactorily be proven empirically. Although we can assume the existence of high-trust and low-trust milieus – and we have been working with these categories for good reasons in our project – the formulation of theories and empirical research must be continued in connection with the question of what apart from straightforward experience can be seen as a source of trust, and especially what effects cultural and religious patterns have on the creation of trust. One might, for example, ask which trust-creating (or trust-reducing) effects come from specifically religious (Protestant, Catholic, Orthodox, but also Jewish and Islamic) or non-religious family structures or socially comprehensive milieus, which hypotheses can be formulated on connections with economic behaviour and which strategies are available for the empirical checking of hypotheses.

REFERENCES Alesina, A. and E. La Ferrara (2000), ‘The Determinants of Trust’, NBER Working Paper Series, 7621, Cambridge, MA: National Bureau of Economic Research. Barber, Bernard (1983), The Logic and Limits of Trust, New Brunswick, NJ: Rutgers University Press. Blumquist, Kirsimarja (1997), ‘The Many Faces of Trust’, Scandinavian Journal of Management, 13 (3), 271–86. Coleman, James S. (1988), ‘Social Capital in the Creation of Human Capital’, American Journal of Sociology, 94, 95–120. Coleman, James S. (1990), Foundations of Social Theorie, Cambridge, MA: Belknap Press of Harvard University Press. Coleman, James S. (1991), Grundlagen der Sozialtheorie, München: Oldenbourg. Cornelssen, Inse (1991), Der Fall Japan: Kultur als Triebkraft wirtschaftlicher Entwicklung, Frankfurt am Main: Peter Lang. DiMaggio, Paul (1994), ‘Culture and Economy’, in Neil J. Smelser and Richard Swedberg (eds), The Handbook of Economic Sociology, Princeton, NJ: Princeton University Press. Endreß, Martin (2002), Vertrauen, Bielefeld: Transcript-Verlag. Erikson, Erik H. (1965), Childhood and Society, Harmondsworth: Penguin. Frambach, Hans (2003), ‘Concepts of Trust – Some Critical Comments’, paper presented at international conference ‘Trust and Entrepreneurial Behaviour in East and West European Economies – Concepts, Developments, Comparative Aspects’, 26–27 September, University of Bremen. Fukuyama, Francis (1995), Trust: The Social Virtues and the Creation of Prosperity, New York: Free Press. Gambetta, Diego (1988), ‘Foreword’, in Diego Gambetta (ed.) Trust: Making and Breaking Cooperative Relations, Oxford: Blackwell, pp. ix–xii. Ganesan, S. and R. Hess (1997), ‘Dimensions and Levels of Trust: Implications for Commitment to a Relationship’, Marketing Letters, 8 (4), 439–48.

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Giddens, Anthony (1984), The Constitution of Society: Outline of the Theory of Structuration, Berkeley, CA: University of California Press. Giddens, Anthony (1990), The Consequences of Modernity, Stanford, CA: Stanford University Press. Giddens, Anthony (1992), Die Konstitution der Gesellschaft: Grundzüge einer Theorie der Strukturierung, second edition, Frankfurt am Main: Campus. Giddens, Anthony (1995), Die Konstitution der Gesellschaft: Grundzüge einer Theorie der Strukturierung, third edition, Frankfurt am Main: Campus. Höhmann, Hans-Hermann (1997), ‘Gemeinsamkeiten und Divergenzen im Prozess der osteuropäischen Wirtschaftstransformation: Stichworte für eine Zwischenbilanz’, in BIOST (ed.), Der Osten Europas im Prozess der Differenzierung. Fortschritte und Mißerfolge der Transformation, München: Hanser Verlag, pp. 189–202. Höhmann, Hans-Hermann (1999), ‘Fokus “Transformation und Wirtschaftkultur” ’, in Hans-Hermann Höhmann (ed.), Eine unterschätzte Dimension? Zur Rolle wirtschaftskultureller Faktoren in der osteuropäischen Transformation, Bremen: Edition Temmen, pp. 8–23. Höhmann, Hans-Hermann (2001), ‘Die “russische” Marktwirtschaft: Übergangsordnung oder Wirtschaftssystem auf Dauer?’, in Hans-Hermann Höhmann and HansHenning Schröder (eds), Russland unter neuer Führung. Politik, Wirtschaft und Gesellschaft am Beginn des 21. Jahrhunderts, Münster: Agenda Verlag, pp. 120–33. Höhmann, Hans-Hermann (2003), ‘Wirtschaftssystem und ökonomische Entwicklung’, Russland, Informationen zur politischen Bildung, 281 (4), 48–54. Höhmann, H.-H. and F. Welter (2004), ‘Trust and Entrepreneurial Behaviour – A Comment’, in H.-H. Höhmann and F. Welter (eds), Entrepreneurial Strategies and Trust: Structure and Evolution of Entrepreneurial Behavioural Patterns in ‘Low Trust’ and ‘High Trust’ Environments of East and West Europe, Part 1: A Review, Arbeitspapiere und Materialien, 54, Bremen: Forschungsstelle Osteuropa, pp. 6–12. Krampen, Günter (1997), ‘Die Vertrauenstrias. Handlungs-, persönlichkeits- und entwicklungstheoretische Einordnung und empirische Untersuchungsbefunde’, Trierer Psychologische Berichte, 24. Lageman, Bernhard (2001), ‘ “Soziales Kapital” als Kategorie kulturorientierter Transformationsforschung’, in Hans-Hermann Höhmann (ed.), Kultur als Bestimmungsfaktor der Transformation im Osten Europas: Konzeptionelle Entwicklungen – Empirische Befunde, Bremen: Edition Temmen, pp. 72–89. Luhmann, Niklas (2000), Vertrauen: ein Mechanismus der Reduktion sozialer Komplexität, Stuttgart: Lucius & Lucius. (First published in 1968.) Misztal, Barbara A. (1996), Trust in Modern Societies, Cambridge: Polity Press. North, Douglas (1990), Institutions, Institutional Change and Economic Performance, Cambridge: Cambridge University Press. North, Douglass C. (1992), Institutionen, institutioneller Wandel und Wirtschaftsleistung, Tübingen: J.C.B. Mohr (Paul Siebeck). Offe, C. and S. Fuchs (2001), ‘Schwund des Sozialkapitals? Der Fall Deutschland’, in Robert D. Putnam (ed.), Gesellschaft und Gemeinsinn, Gütersloh: Verlag Bertelsmann Stiftung, pp. 417–514. Panther, Stephan (1999a), ‘Kultur und Evolutorische Ökonomik’, Handbuch ‘Evolutorische Ökonomik’, 1 (not yet published). Panther, Stephan (1999b), ‘Kulturelle Faktoren in ökonomischen Erklärungen – Eine Standortbestimmung’, in Hans-Hermann Höhmann (ed.), Kultur als Bestimmungsfaktor der Transformation im Osten Europas: Konzeptionelle Entwicklungen – Empirische Befunde, Bremen: Edition Temmen, pp. 24–38.

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Pleines, Heiko (2004), ‘Zur Rolle wirtschaftskultureller Faktoren in der post-sozialistischen Transformation’, in Hans-Hermann Höhmann and Heiko Pleines (eds), Wirtschaftskultur in Osteuropa. Bremer Ansatz und Bremer Projekte, Arbeitspapiere und Materialien, 61, Bremen: Forschungsstelle Osteuropa, pp. 16–25. Preisendörfer, Peter (1995), ‘Vertrauen als soziologische Kategorie. Möglichkeiten und Grenzen einer entscheidungstheoretischen Fundierung des Vertrauenskonzepts’, Zeitschrift für Soziologie, 24 (4), 263–72. Putnam, Robert D. (1993), Making Democracy Work: Civic Traditions in Modern Italy, Princeton, NJ: Princeton University Press. Putnam, Robert D. (1995a), ‘Bowling Alone: America’s Declining Social Capital’, Journal of Democracy, 6 (1), 65–78. Putnam, Robert D. (1995b), ‘Tuning In, Tuning Out: The Strange Disappearance of Social Capital in America’, Political Science and Politics, 28 (4), 664–83. Rotter, Julian B. (1980), ‘Interpersonal Trust, Trustworthiness and Gullibility’, American Psychologist, 35, 1–7. Schäfer, Mike Steffen (2004), Rezension zu: Martin Endress (2002), Vertrauen, website: http://www.qualitative-research.net/fqs-texte/2-04/2-rewiew-Schaefer-d.htm. Schmid, Wilhelm (1998), Philosophie der Lebenskunst. Eine Grundlegung, Frankfurt am Main: Suhrkamp. Seligman, Adam (1997), The Problem of Trust, Princeton, NJ: Princeton University Press. Simmel, Georg (1992), Soziologie. Untersuchungen über die Form der Vergesellschaftung, Frankfurt am Main: Suhrkamp. (First published in 1908.) Sztompka, Piotr (1995), ‘Vertrauen: die fehlende Ressource in der postkommunistischen Gesellschaft’, in Brigitta Nedelmann (ed.), Politische Institutionen im Wandel, Kölner Zeitschrift für Soziologie und Sozialpsychologie: Westdeutscher Verlag, pp. 254–78. Warren, M.E. (1996), ‘Democracy and Trust’, paper prepared for delivery at the Annual Meeting of the American Political Science Association, San Francisco. Weber, Max (1988), ‘Über einige Kategorien der verstehenden Soziologie’, in Max Weber (ed.), Gesammelte Aufsätze zur Wissenschaftslehre, Tübingen: Mohr. Welter, F. and D. Smallbone (2001), ‘Entrepreneurship and Enterprise Strategies in Transition Economies: An Institutional Perspective’, paper presented at RENT XV, Turku, 22–23 November. Welter, F., T. Kautonen and M. Stoycheva (2004), ‘Trust in Enterprise Development, Business Relationships and Business Environment – a Literature Review’, in H.-H. Höhmann and F. Welter (eds), Entrepreneurial Strategies and Trust: Structure and Evolution of Entrepreneurial Behavioural Patterns in ‘Low Trust’ and ‘High Trust’ Environments of East and west Europe, Part 1: A Review, Arbeitspapiere und Materialien, 54, Bremen: Forschungsstelle Osteuropa, pp. 13–25.

2. Culture versus branch? Looking at trust and entrepreneurial behaviour from a cultural and sectoral perspective Friederike Welter INTRODUCTION Trust is a phenomenon which has gained importance in many academic disciplines, for example, psychology, organisational theory, sociology, economic theory and business management. Entrepreneurship scholars have only recently started paying attention to trust-related issues in entrepreneurship and entrepreneurial behaviour. This chapter looks at the role trust plays in and for entrepreneurial behaviour in different environments, paying particular attention to some of the factors influencing trust. In discussing this question, the chapter asks whether trust is a sector-based phenomenon or a feature inherent in different (regional and/or national) cultures. Key topics include questions of how to explain the role of trust in business relationships, and the cultural and sectoral factors determining trust and differing trust levels. Empirically, the chapter draws on the overall results from different country studies, including both surveys and multiple case studies, which took place within an international research project on entrepreneurial behaviour and trust in West and Eastern Europe.1 However, there is a caveat. Although all empirical contributions within this project drew on a common concept of trust, differentiating between personal, collective and institutional trust, and employed similar instruments in researching trust empirically, crosscultural comparisons are fraught with the danger of levelling out countryspecific histories. With regard to trust, one must be aware that it is not only an ‘objective’ phenomenon, which we can measure and understand across cultures and countries. Trust, in particular its understanding and interpretation, is very much also socially constructed, indicating that in interpreting our empirical results from a cross-cultural perspective we also need to take into account specific cultural backgrounds, development paths and experiences. 24

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CONCEPTUALISING THE CULTURAL PERSPECTIVE Defining Culture Over the past 50 years, the understanding of ‘culture’ has shifted from being an agricultural ‘phenomenon’ connected to the raising of plants and animals to being associated with the structural characteristics of a society. In the 1960s, Kroeber and Kluckhohn systematically pulled together different meanings of the concept ‘culture’ (Frick 1999, p. 83). Culture describes the way of life of a people as well as ways of thinking, feeling and believing; it comprises individual social legacies and learned behaviour, but also refers to the stored learning of society and groups; culture consists of mental maps of individuals and societies. Moreover, culture is a set of standard orientations for recurrent problems and a normative mechanism to regulate behaviour. In his study of Asian societies, Weggel (1989, p. 22) defined culture as the totality of learned behaviours, attitudes, value systems and know-how which is shared and transmitted between members of a larger group. He also drew attention to the regulatory function of culture, understanding culture simultaneously as the expression and condition for individual behaviour within a particular society or group. There is still no single comprehensive definition of what constitutes culture, although most authors agree on the following common elements.2 First, culture is a multidimensional phenomenon, as it exists on different levels such as nations, regions and groups. Secondly, culture is both an individual and social phenomenon, linking individual behaviour to societal attitudes and values and vice versa. In this understanding, culture characterises a way of organising society, in so far as it includes the rules (norms, values) for structuring and guiding behaviour within society. Thirdly, culture is conveyed through both verbal and non-verbal communication, indicating that culture is also a feature, which can be learned. The concept of culture comprises six main dimensions which reflect its individual and social perspective as well as the complex interrelationships between the two (Table 2.1). Culture has a historical dimension, as it comprises social heritages, traditions and habits, which are passed to further generations, thus again drawing attention to the importance of communication. On an individual level this is reflected in the mental dimension of culture, namely, the shared ways of life inherited from previous generations and the individual ways of making sense of these traditions, which in turn guide individual behaviour and actions. Culture also has normative and functional dimensions, in so far as it sets the rules for individual behaviour, which result in shared means by which individuals in a given group adapt to their environment. Here, the structural and mental dimensions of culture become apparent, as culture consists of shared and interrelated symbols, traditions and behaviours, which on the social level

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Table 2.1

Concepts, evolution, measurements

Dimensions of culture from an individual and societal perspective

Individual perspective

Societal perspective

Mental dimension Learned human behaviour, that is, way of life Functional dimension Ways of adapting to environment Behavioural dimension Individual sense-making

Historical dimension Social heritage and tradition Normative dimension Rules for living and acting Structural dimension Symbols, ideas, values

refer to, for example, the influence of religion in determining a specific culture, and on the individual level again to the individual sense-making of cultural symbols and traditions. This brings us to yet another question which is important in our attempt to define and understand culture, namely its determinants. From a business perspective, Chang (2002) identifies six main determinants of culture, namely, the social structure, religion, language, education, economic philosophy and political philosophy. Social structure, which is often subsumed under the label ‘civil society’ (see Lageman in Chapter 5 for a more detailed discussion on this topic), refers to the basic social organisation. The idea of religion being a determinant of culture draws on Max Weber’s thesis of a positive relationship between Protestantism and capitalism. Language brings us back to the idea of communication being important in understanding culture. The other three dimensions draw attention to the fact that behaviours are shaped by the educational background of individuals as well as their upbringing in a specific economic and political system. This takes on particular importance in transition economies, which are characterised by economic, political and societal changes, as these changes (the so-called transition) often render behaviour learned in a command-economy and non-democratic system useless or contradictory to what has developed in a modern market-economy based society. In this context, we might assume that culture has a more important impact on entrepreneurial behaviour in transition economies compared with market economies, because a successful transition depends to a larger extent on social changes than on simply installing the legal standards needed for a market-based economy. Culture from the Perspective of Institutional Theory The concept of formal and informal institutions, as introduced by Douglass North, allows us to discuss the structural and normative dimensions of a society

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from a theoretical perspective. In this sense, institutions are the incentive structure of a society (North 1990). Through setting the ‘rules of the game, they contribute to reducing uncertainty and risk for individuals, thus both structuring individual actions and influencing patterns of behaviour’. They ‘define what actors can do, what is expected from them, or they must do, and what is advantageous for them. In this way, they give stability and predictability to economic interaction’ (Dallago 2000, p. 305). With regards to entrepreneurship, institutions represent ‘formal’ and ‘informal’ constraints on and enabling forces for entrepreneurship, and they influence the nature of actions taken by entrepreneurs. Whilst relevant formal institutions include the political and economic constitution, the legal framework, the financial system and economic policies, informal institutions refer to codes of conduct. They reflect non-codified and non-verbal attitudes, norms and values, which are deeply embedded in a society, regulating behaviour. In this context, culture is frequently interpreted as the totality of informal institutions, which are said to reflect a society’s attitude towards entrepreneurship, thus creating the normative framework (Busenitz et al. 2000; WadeBenzoni et al. 2002). North himself (1990) talked about informal institutions as being ‘part of the heritage that we call culture’, although this mainly understands culture in its historical dimension. Examples of culture as an informal institution include the ways information is processed (Boyd and Richerson 1994). This affects individual patterns of entrepreneurial behaviour, as it determines the extent to which behaviour draws on principles of rational decision-making (collecting and making use of all information) or whether it is mainly characterised by bounded rationality due to limited information processing capabilities. Other examples of culture as an informal institution include the influence of religion, where religious traditions might prescribe specific behaviours for entrepreneurs. Moreover, Denzau and North (1994) understand codes of conducts and values (the normative dimension of culture) as reflecting the collective, tacit interpretation of individual mental perceptions, thus referring to the mental dimension of culture as outlined in the section above. However, simply matching culture and informal institutions neglects the complex and recursive links which exist between formal and informal institutions. It is difficult to distinguish formal and informal institutions, as both are mutually dependent. This indicates the endogenous and recursive nature of both institutions and behaviour (Zafirovski 1999). Informal institutions also partly result from formal institutions, which they in turn (can) modify. For example, whilst each legal framework normally contains explicit regulations for implementing laws, over time these regulations are complemented by an implicit understanding of their content. This refers to unwritten rules, that is, informal institutions fill in legal gaps which become apparent only through

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applying laws and regulations to daily life. In this regard, they evolve as a culture-specific, collective and individual interpretation of formal rules. North (1990, p. 140) himself states that ‘we need to know much more about culturally derived norms of behavior and how they interact with formal rules’. This implies that culture comprises more than informal institutions and in a broad understanding we need to include formal institutions in our definition of culture, as they also are expressions of cultural norms. With regard to analysing cultural influences on entrepreneurial behaviour in different environments, this draws attention to the fact that we need to take into account the impact of both formal and informal institutions on entrepreneurial behaviour. The Role of Trust in a Cultural Perspective So far, I have outlined theoretical and empirical perspectives which discuss the possible influences of culture on structuring, regulating and determining patterns of entrepreneurial behaviour. Where does trust come in? From an institutional perspective, trust plays a role as a sanctioning mechanism, thus acting as an informal institution. In this context, trust complements the institutional framework, although Woodruff (2000) sees this view at odds with the majority perspective in literature. Formal institutions, such as legal regulations, are normally enforced and enforceable by the state. However, this always will be imperfect because human beings behave opportunistically, pursuing their own interests, which might contradict the rules as set by the state. However, one needs to take into account that in democratic systems politicians and governments cannot and will not act against the cultural attitudes of the majority of the people without being punished in the next elections. Here, the maintenance of trust supplements formal institutions, acting as an enforcement mechanism. As Smallbone and Lyon (2002) state, trust reduces transaction costs through providing information and a means to enforce contracts, so that the possibility of opportunistic behaviour diminishes. Moreover, as Granovetter (1985) points out, personal trust complements institutional trust in those cases in which an individual does not want to rely merely on institutional arrangements. On the other hand, research on trust in a transition context often emphasises the role of trust in substituting the incomplete institutional framework. For economies that are in the process of transformation from centrally planned to market-based systems, formal institutions that are essential for the large-scale and sustainable development of private sector businesses are either non-existent or inadequately focused on the needs of entrepreneurs. This results in institutional distrust, especially in the early stages or in those countries where economic, political and societal reforms are lagging behind (Raiser 1999;

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Rose-Ackerman 2001). Höhmann and Malieva (2002) argue that a successful formal institutional transformation does not guarantee a successful transition process, because this alone cannot change the culturally embedded entrepreneurial behaviour. In this context, personal trust takes the place of deficient institutions such as weakly specified legal regulations and inadequate law enforcement, all of which encourages the entrepreneurs’ lack of institutional trust. Institutional distrust arising from a malfunctioning institutional framework is re-enforced by a ‘syndrome of mistrust’ (Leipold 1999), which is based on experiences from the socialist period where individuals had strong mutual ties with family and friends, but where they mistrusted public institutions (Raiser et al. 2001). Examples include the reliance on networking in transition economies, in order to mobilise resources and to cope with the constraints imposed by highly bureaucratic structures (Ledeneva 1998; Smallbone and Welter 2001a). Again, relationships between trust and institutions are complex and recursive. Trust is more than an informal institution, but rather is embedded in informal institutions, thus contributing to a trust-based culture and institutional frame. Both level and forms of trust, which exists in a society, are affected by the nature of the overall institutional framework. Formal institutions will only operate successfully if individuals are able to establish a basic level of trust, not only in the reliability of any exchanges, but also in sanctions and penalties (Kahle 1998). This indicates an important role for institutional trust. Personal trust gains importance in those cases where formal sanctioning mechanisms fail or are absent and/or where particular social groups are excluded from mainstream society. However, whereas personal trust can exist regardless of any formal institutions, the availability of institutional trust is highly dependent on the institutional structure of the society. Williamson (1993, p. 476) summarised the complex relations best, stating that ‘transactions that are viable in an institutional environment that provides strong safeguards may be nonviable in institutional environments that are weak’. In this context, we can assume differences in the trust-related institutional framework between transition countries in Eastern Europe and mature market economies in Western Europe, as well as differences in the roles personal, collective and institutional trust, respectively, play. With respect to economic behaviour, we may assume that in those cases where the formal institutional environment functions well, trust mainly plays a complementary and secondbest role for entrepreneurs, whilst in environments with a distorted formal institutional framework, trust is one of the foremost replacements for some of the institutional deficiencies, thus explaining distinctive forms of entrepreneurship and entrepreneurial strategies.

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CONCEPTUALISING THE SECTORAL PERSPECTIVE The last piece which is missing in our concept, refers to sectoral influences on entrepreneurial behaviour. I understand the term ‘sector’ as referring to a distinct economic subset, a grouping of enterprises which manufacture similar products or provide comparable services within one industry, thus sharing similar characteristics. This resembles some of the characteristics of the concept of culture as discussed above, drawing attention to the close interrelationship between sector and culture. Sectors are embedded in the social fabric of a country and society as well as in the overall institutional frame. One such example refers to the different systems of corporate governance we can observe across the world. In most European countries and in Japan, interests of stakeholders play an important, albeit diminishing, role. This is often regulated by law, as is the case of worker councils (that is, stakeholders within the firm) or generally with regard to environmental protection (that is, societal stakeholders). The USA, on the other hand, is dominated by a model of corporate governance which is mainly orientated towards shareholder interests. This shareholder concept emphasises an economic philosophy which is based on the assumption that management is only responsible for the maximisation of profit for shareholders. As I have said above, differences in governance models are a result of differing cultural traditions and development paths, which explain today’s emphasis on either shareholders or stakeholders. Which role does trust play with regard to sectors? Different corporate governance systems across countries would explain commonalities in sectoral behaviour in one culture and would allow us to expect differences in sectoral behaviour between cultures (countries). However, research has also shown common organisational patterns within sectors and across cultures, which comprise an element of trust. Examples include the trade relations in medieval Europe, which functioned even across long distances without modern communication and transport infrastructures as well as overcoming problems of contract enforceability, which is well documented in the extensive studies by Greif (for example, 1989; 1992; 1993; 1996). In a medieval world, trust-based relationships between unknown partners were made possible through a variety of ‘pre-modern’ institutions, such as guilds or merchant courts. Guilds fostered long-distance trade relationships mainly in those cases where they built on multilateral reputation mechanisms, thus widening the scope of potential business partners across the usual bilateral business relationship. This was the case in the Italian city-states, where merchant guilds acted as a subdivision of the city’s administration, or in the inter-city guild of the German Hansa (Greif 1992). One particularly interesting case is the coalitions of the Maghribi traders3

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in the eleventh century. Greif (1989; 1993) describes an interesting mechanism to solve agency problems in a world where international trade relations were complex to conduct and their outcome was uncertain. Maghribi traders reduced complexity and uncertainty by operating through business associates and partnerships. Although most relationships between business associates were not based on legal contracts to regulate the extent and nature of the tasks, there appeared to have been surprisingly few reports of misconduct (Greif 1989, p. 864). Business associates fulfilled a double role, as they acted as overseas agents, thus reducing the costs involved in international trade. As the legal system in the eleventh century could not provide (sufficient) safeguards in case of misconduct and fraud by the overseas agents, the Maghribi traders organised a ‘private order’ institution (Greif 1989). This so-called traders’ coalition relied on trust-based reputation mechanisms: agents established a reputation as honest persons based on their past behaviour, whilst merchants rewarded this reputation through repeated business, thus ‘conditioning future relations upon past conduct’ (Greif 1989, p. 869). As all coalition members closely monitored the behaviour of the agents and acted as agents themselves, this mutual network provided all the information needed to discover cheating agents, who then were excluded from further business. Thus, although the traders’ behaviour was governed by trust, it was not personal trust, but more a collective-based form of trust. Community penalties and economic incentives, that is, the value and profits connected with being a member of this particular coalition, played a major role in preventing agents from cheating (Greif 1993). Modern examples of organisational commonalities refer to common sectoral ‘cultures’ in the banking industry, which are, for example, documented in a specific dress code. Another example refers to similar behavioural patterns to be observed in construction businesses across countries. This becomes most obvious in its cross-country inclination to use corrupt practices in order to secure large-scale orders, but it is also reflected in common organisational structures, such as the widespread use of subcontracting chains. In this context, globalisation plays an important role in levelling out crosscultural differences between the same sectors, resulting instead in sectoral cultures with similar trust climates. The examples discussed above clearly indicate trust-based sectoral mechanisms which regulate behaviour within sectors. Going back to institutional theory, Scott (2001, p. 52) identifies ‘three pillars of institutions’, which are enforced by different mechanisms. He distinguishes between regulative institutions, enforced by coercion; normative institutions, enforced by normative pressures; and cultural-cognitive institutions, enforced by mimetic mechanisms. From a trust-based sectoral perspective, normative mechanisms are the most interesting, defining collective trust. They explicitly or implicitly force

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entrepreneurs to adhere to the codes of conduct as set out by a specific community, for example, industries, business associations, families or ethnic groups. They assist in creating legitimacy, which is of particular importance for nascent entrepreneurs and entrepreneurs in unfamiliar environments, such as the Maghribi overseas traders, who faced a high degree of ‘liability of newness’. Mechanisms to ensure normative behaviour include formal regulations such as certification or accreditation (Scott 2001). Normative institutions are also enforced by informal mechanisms such as collective trust, referring to regulations for in-group behaviour, where formal mechanisms might play a secondary role, as is best illustrated in the examples from the medieval world outlined above. With regard to sectoral influences and entrepreneurial behaviour in today’s world, we might thus expect both similarities across cultures, but also differences in those cases where specific trust cultures still exist.

UNDERSTANDING TRUST AND ENTREPRENEURIAL BEHAVIOUR FROM A CULTURAL AND SECTORAL PERSPECTIVE This section briefly explores empirical results from our project as well as from other empirical studies in the light of the cultural and sectoral perspectives outlined in the previous sections. Topics include the emergence of trust, its nature and the link between cultural and sectoral trust environments, and entrepreneurial patterns. Trust-building is a topic which empirically has received surprisingly little attention. This might partly be due to the fact that empirically it would need a longitudinal research approach. Although we researched trust with a crosssectional methodology, case studies allow a glimpse of those factors which facilitate the emergence of trust. Not surprisingly, trust-building is easier when and where entrepreneurs can draw on a common background or common experiences, and this holds true across our study countries. For example, when entrepreneurs choose new business partners, they mainly rely on either recommendations from trusted persons (which includes friends) or previous business experiences, regardless of whether they operate in West or East Germany, Italy, Estonia or Russia. Bohnet and Huck (2003) came to similar results in their game-theoretical experiment, concluding that past experience is more relevant for trustors (the entrepreneurs deciding on a new deal in our sample) than for trustees (the potential business partners). Regional and sectoral factors additionally facilitate trust-building in those cases where they allow entrepreneurs to draw on common rules and conventions, as was illustrated in the case of the medieval traders’ world above. This

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is a fact which is also widely known from the literature on Italian districts, and Dei Ottati’s study of the Prato district (Chapter 15) once again illustrates its relevance for entrepreneurial behaviour, even in the twenty-first century. Here, the local ‘code of fair behaviour’ creates a specific trust milieu within a region and for the district’s firm, thus indicating a mixture of cultural and sectoral influences on trust and entrepreneurial behaviour. With regard to the nature of trust, our results indicate that the roles of personal and institutional trust show similarities, but also differences, across countries and sectors, albeit without a clear pattern. However, their roles also differ across the stages of business development, thus drawing attention to economic factors as well. Personal trust plays the most important role during venture creation, which is a well-known fact from the entrepreneurship literature (cf. the review in Welter et al. 2004). Moreover, our results also indicate that personal trust appears to play a less important role during business growth and in stable (regional) environments, where institutional trust gains importance, although without dominating entrepreneurial behaviour. On the contrary, institutional trust needs personal trust to develop, regardless of the regional and sector environment. This implies that typically entrepreneurial behaviour is based on a mixture of personal and institutional trust. One attempt at linking culture and different forms of trust classifies an environment according to the level of trust. There has been an extensive discussion on whether we may group institutional environments into a ‘low-trust’ category versus a ‘high-trust’ category (for example, Fukuyama 1995; Panther 1998). A ‘low-trust’ environment is said to restrict market entries, enterprise growth and free competition, whilst encouraging unproductive and parasitic entrepreneurship. A ‘high-trust’ environment is said to foster competition and enterprise growth. Using this distinction, several transition countries, especially those in the early stages of transition (Smallbone and Welter 2001b), would be characterised as being ‘low trust’, while mature market economies such as (West) Germany could be called ‘high-trust’ countries. However, this distinction on a country level overlooks the fact that trust levels could differ across regions (that is, within countries) and sectors. For example, in the case of Italy, how do we classify this country, which is characterised by low institutional trust but a high level of collective, sectoral trust? Is it then generally a low-trust economy? Another example from our project might serve to illustrate the difficulties in classifying whole countries according to their overall level of trust. Our results demonstrate that in complex institutional environments, which includes both West and East European countries,4 entrepreneurs rely heavily on formal governance mechanisms, such as written contracts, without this reflecting a high level of institutional trust. Moreover, although both East and West Germany share the same formal

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institutional framework of a mature market economy, there may be differences in the informal institutional framework, which reflects the dominant trust culture, between these regions. This is a product of the far slower transformation of values and norms in comparison to the formal framework. Here, our case study results showed some indications of cultural-based differences in entrepreneurial behaviour, mainly with regard to whom to trust in business, and it is here where personal trust, as reflected in the use of personal contacts, appears to play a slightly more important role in East Germany when compared with West Germany. Several authors describe this extensive use of social contacts and networks dominated by mutual personal trust in environments where institutional trust is lacking and the normative framework is unstable (for example, Peng 2000; Radaev in Chapter 8 in this volume; Welter 2003; Welter and Smallbone 2003; Yan and Manolova 1998). Höhmann and Malieva (2002) also emphasise the importance of (personal) previous experience. Interestingly, our results for Russia and Estonia also demonstrate that entrepreneurs today rely less on personal trust than they did some years ago. This obviously questions the hypothesis of Russia being generally a low-trust country (for example, Schrader 2004); instead, it draws attention to what remains to be done in order to develop a ‘fully fledged culture of trust and genuine morality’ (Veselov 2004, p. 57). However, learned behaviour and the social context inherited from the former socialist period, both of which indicate cultural influences, even now appear to affect the behaviour of entrepreneurs, drawing attention to the constraining effect of path dependency, in the sense of legacies from the past, on entrepreneurial behaviour (Welter 2003; Welter and Smallbone 2003). The formation of entrepreneurial patterns in new and small ventures is a complex and interactive process, in which entrepreneurs and their environment coevolve. Here, institutional change can be favourable, as it opens up new fields which entrepreneurs can pursue. However, institutional change may also be detrimental for economic development at the macro level in situations where it triggers and/or reinforces norm-deviant behaviour on the individual level. Conflicts within the institutional settings encourage entrepreneurs to return to familiar and known courses of actions. In this context, vicious circles might develop. One example is the widespread use of evasion strategies in fragile institutional environments, generally as a consequence of an adverse economic and tax environment (Welter and Smallbone 2003). However, their widespread use also reinforces the negative attitude of governments towards small and private firms, which in turn might impede the development of a more consistent institutional frame. Thus, although this entrepreneurial behaviour might support firm performance and/or survival in the short run, it might be detrimental in a long-term perspective,

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restricting the ability of the firm to grow and develop. Path dependency plays a role, as the entrepreneur’s ‘life issues’ (Kisfalvi 2002) such as his or her background and experiences are reflected both in the strategic awareness entrepreneurs can draw on and in patterns of entrepreneurial behaviour. Whilst this does not generally reflect a low(er) level of institutional trust, this kind of behaviour is re-enforced by an imperfect and turbulent institutional environment.

CONCLUSIONS Analysing entrepreneurial behaviour from trust-based cultural and sectoral perspectives, we may conclude that the specific structures of formal and informal institutions, the path dependence of informal rules within cultures and sectors, and incompatible formal and informal institutions assist in explaining certain forms of enterprise behaviour in Western and Eastern Europe. To summarise: an imperfect or overly complex environment favours entrepreneurial behaviour which appears rational from the entrepreneur’s point of view, but which consists of short-term oriented entrepreneurial responses, aimed at dealing with external institutional pressures. Personal trust dominates business relations, whilst institutional trust is slow to emerge. This ‘trust culture’ forces entrepreneurs to pay more attention to solving daily business problems instead of planning their business development in the longer term. All this also results in forms of entrepreneurship which Baumol (1990) labelled ‘unproductive’, as they restrict at an individual level the growth prospects of enterprises in the long run and from a macro perspective the contribution of entrepreneurship to economic development. Regarding the initial question, namely, whether it is cultural or sectoral influences which mainly determine trust and consequently entrepreneurial behaviour, there is no simple answer. Whilst there is a relationship between the institutional framework (that is, cultural factors), sectoral influences, the extent and nature of trust and patterns of entrepreneurial behaviour, it is nevertheless difficult to isolate single dominant factors. Entrepreneurial behaviour results from a dynamic interrelationship between internal (that is, both organisational and personal characteristics) and external conditions. Both the theoretical and empirical discussion presented in this chapter suggest a complex picture, in which both a cultural and a sectoral perspective are needed to explain the role trust plays in determining patterns of entrepreneurial behaviour. There is also a time dimension because cultural-cognitive and normative institutions are a longer-term influence on entrepreneurial behaviour. Cultural norms are also more difficult to change, because they include learned habits and behavioural routines, which make an uncertain world more predictable and where individuals are reluctant to change their behaviour unless there is a

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pressing need. This plays a role in those cases where previously ‘learned’ habits and routines negatively influence entrepreneurial behaviour. In this context, governments need to pay specific attention to developing a consistent institutional framework, which incorporates country-specific cultural codes of conduct as well as the implementation of institutional changes. A consistent institutional environment allows entrepreneurs to shift from an approach based on (too much) personal trust to more proactive entrepreneurial behaviour, as they no longer need to focus their scarce resources on solving day-to-day problems. In this context, future research into trust-based factors influencing entrepreneurial behaviour should include a longitudinal perspective, thus allowing for habitual behaviour, the socially constructed dimension of trust and its dynamic component.

NOTES 1.

This project was supported by the Volkswagen Foundation. For more details see the project web page (www.rwi-essen.de/trust). Empirical results are reported in the contributions written by Kautonen and Welter, Dei Ottati, Chepurenko and Malieva, Smallbone et al. and Venesaar in this volume. 2. Here, I exclude all definitions which understand culture as comprising works of arts and music. 3. The Maghribi traders were a group of Jewish traders in what today constitutes Southern Europe. They consisted of immigrants who originally came from Baghdad, moved to North Africa (mainly Tunisia) and from there on to Spain, Sicily, Egypt, Palestine and, sometimes, even to Eastern Europe. Their main trading realm remained the Muslim Mediterranean world. Cf. Greif (1989, pp. 861–2; 1992). 4. Complexity here refers to the overall institutional environment. This can be complex in the sense of being overly bureaucratic without the institutional environment functioning properly, as is frequently the case in a transition environment.

REFERENCES Baumol, W. (1990), ‘Entrepreneurship: Productive, Unproductive and Destructive’, Journal of Political Economy, 98 (5), 893–921. Bohnet, I. and S. Huck (2003), ‘Repetition and Reputation: Implications for Trust and Trustworthiness in the Short and in the Long Run’, Faculty Research Working Paper Series, 03-048, Boston: Harvard University. Boyd, R. and P.J. Richerson (1994), ‘The Evolution of Norms: An Anthropological View’, Journal of Institutional and Theoretical Economics, 150, 72–87. Busenitz, L.W., C. Gómez and J.W. Spencer (2000), ‘Country Institutional Profiles: Unlocking Entrepreneurial Phenomena’, Academy of Management Journal, 43 (5), 994–1003. Chang, L.-C. (2002), ‘Cross-cultural Differences in International Management Using Kluckhohn-Strodtbeck Framework’, Journal of American Academy of Business, 2 (1), 20–28.

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Dallago, B. (2000), ‘The Organisational and Productive Impact of the Economic System: The Case of SMEs’, Small Business Economics, 15, 303–19. Denzau, A.T. and D.C. North (1994), ‘Shared Mental Models: Ideologies and Institutions’, Kyklos, 47 (1), 3–31. Frick, S. (1999), ‘ “Kultur der Selbständigkeit” als Herausforderung für die Entrepreneurshipforschung? Zur theoretischen Fundierung eines aktuellen Begriffs der Wirtschaftspolitik’, in T. Lang-von Wins and L. von Rosenstiel (eds), Existenzgründung und Unternehmertum, Stuttgart: Schäffer-Poeschel, pp. 72–104. Fukuyama, F. (1995), Trust: The Social Virtues and the Creation of Prosperity, New York: Free Press. Granovetter, M. (1985), ‘Economic Action and Social Structure: The Problem of Embeddedness’, American Journal of Sociology, 91 (3), 481–509. Greif, A. (1989), ‘Reputation and Coalitions in Medieval Trade: Evidence on the Maghribi Traders’, Journal of Economic History, 49 (4), 857–82. Greif, A. (1992), ‘Institutions and International Trade: Lessons from the Commercial Revolution’, American Economic Review, 82 (2), 128–33. Greif, A. (1993), ‘Contract Enforceability and Economic Institutions in Early Trade: The Maghribi Traders’ Coalition’, American Economic Review, 83 (3), 525–48. Greif, A. (1996), ‘Micro Theory and Recent Developments in the Study of Economic Institutions Through Economic History’, in D.M. Kreps and K.F. Wallis (eds), Advances in Economic Theory, Cambridge: Cambridge University Press. Höhmann, H.-H. and E. Malieva (2002), ‘Trust as a Basic Anthropological Category’, in H.-H. Höhmann and F. Welter (eds), Entrepreneurial Strategies and Trust: Structure and Evolution of Entrepreneurial Behavioural Patterns in East and West European Environments – Concepts and Considerations, Forschungsstelle Osteuropa, Arbeitspapiere und Materialien, 37, Bremen: Universität Bremen, pp. 11–18. Kahle, E. (1998), ‘Vertrauensbasierte Netzwerke als Chancen für kleine und mittlere Unternehmen’, in H.-J. Pleitner (ed.), Renaissance der KMU in einer globalisierten Wirtschaft, St Gallen: HSG, pp. 535–44. Kisfalvi, V. (2002), ‘The Entrepreneur’s Character, Life Issues, and Strategy Making: A Field Study’, Journal of Business Venturing, 17, 489–518. Ledeneva, A.V. (1998), Russia’s Economy of Favours: Blat, Networking and Informal Exchange, Cambridge: Cambridge University Press. Leipold, H. (1999), ‘Institutionenbildung in der Transformation’, in H.-H. Höhmann (ed.), Spontaner oder gestalteter Prozeß? Die Rolle des Staates in der Wirtschaftstransformation, Schriftenreihe des BiOst, 38, Baden-Baden: Nomos, pp. 133–51. North, D.C. (1990), Institutions, Institutional Change and Economic Performance, Cambridge: Cambridge University Press. Panther, S. (1998), ‘Historisches Erbe und Transformation: “Lateinische” Gewinner – “Orthodoxe Verlierer?” ’, in G. Wegner and J. Wieland (eds), Formelle und informelle Institutionen. Genese, Interaktion und Wandel, Marburg: Metropolis, pp. 211–51. Peng, M. (2000), Business Strategies in Transition Economies, Thousand Oaks, CA, London and New Delhi: Sage. Raiser M. (1999), ‘Trust in Transition’, EBRD Working Paper, 39, London: EBRD. Raiser, M., C. Haerpfer, T. Nowotny and C. Wallace (2001), ‘Social Capital in Transition: A First Look at the Evidence’, EBRD Working Paper, 61, London: EBRD.

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Rose-Ackerman, S. (2001), ‘Trust and Honesty in Post-Socialist Societies’, Kyklos, 54 (fasc. 2/3), 415–44. Schrader, H. (2004), ‘Spheres of Trust, Social Capital and Transformation in Russia’, in H. Schrader (ed.), Trust and Social Transformation: Theoretical Approaches and Empirical Findings from Russia, Münster: Lit Verlag, pp. 79–101. Scott, R.W. (2001), Institutions and Organization, Thousand Oaks, CA, London and New Delhi: Sage. Smallbone, D. and F. Lyon (2002), ‘A Note on Trust, Networks, Social Capital and Entrepreneurial Behaviour’, in H.-H. Höhmann and F. Welter (eds), Entrepreneurial Strategies and Trust: Structure and Evolution of Entrepreneurial Behavioural Patterns in East and West European Environments – Concepts and Considerations, Arbeitspapiere und Materialien, 37, Bremen: Forschungsstelle Osteuropa, pp. 19–24. Smallbone, D. and F. Welter (2001a), ‘The Distinctiveness of Entrepreneurship in Transition Economies’, Small Business Economics, 16 (4), 249–62. Smallbone, D. and F. Welter (2001b), ‘The Role of Government in SME Development in Transition Countries’, International Small Business Journal, 19 (4), 63–77. Veselov, Y. (2004), ‘Changing Trust in the History of Soviet Society’, in H. Schrader (ed.), Trust and Social Transformation: Theoretical Approaches and Empirical Findings from Russia, Münster: Lit Verlag, pp. 55–78. Wade-Benzoni, K.A., A.J. Hoffman, L.L. Thompson, D.A. Moore, J. Gillespie and M.H. Bazerman (2002), ‘Barriers to Resolution in Ideologically Based Negotations: The Role of Values and Institutions’, Academy of Management Review, 27 (1), 41–57. Weggel, O. (1989), Die Asiaten, München: Deutscher Taschenbuchverlag. Welter, F. (2003), Strategie, KMU und Umfeld: Handlungsstrukturen und Strategiegenese in kleinen und mittleren Unternehmen, Schriften des RWI, 69, Berlin: Duncker & Humblot. Welter, F. and D. Smallbone (2003), ‘Entrepreneurship and Enterprise Strategies in Transition Economies: An Institutional Perspective’, in D. Kirby and A. Watson (eds), Small Firms and Economic Development in Developed and Transition Economies: A Reader, Aldershot: Ashgate, pp. 95–114. Welter, F., T. Kautonen and M. Stoytcheva (2004), ‘Trust in Enterprise Development, Business Relationships and Business Environments – a Literature Review’, in H.H. Höhmann and F. Welter (eds), Entrepreneurial Strategies and Trust: Structure and Evolution of Entrepreneurial Behavioural Patterns in ‘Low Trust’ and ‘High Trust’ Environments of East and West Europe, Part 1: A Review, Arbeitspapiere und Materialien, 54, Bremen: Forschungsstelle Osteuropa, pp. 13–25. Williamson, O.E. (1993), ‘Calculativeness, Trust and Economic Organization’, Journal of Law and Economics, 36, 453–86. Woodruff, C. (2000), ‘Relationships and Institutions’, paper for the World Bank’s Summer Research Workshop on Market Institutions, 17–19 July, Washington. DC. Yan, A. and T.S. Manolova (1998), ‘New and Small Players on Shaky Ground: A Multicase Study of Emerging Entrepreneurial Firms in a Transforming Economy’, Journal of Applied Management Studies, 7 (1), 139–43. Zafirovski, M. (1999), ‘Probing into the Social Layers of Entrepreneurship: Outlines of the Sociology of Enterprise’, Entrepreneurship and Regional Development, 11 (4), 351–71.

3. The dark side of trust: corruption and entrepreneurship – a cross-national comparison between emerging and mature market economies1 Vartuhi Tonoyan INTRODUCTION Most economic research on corruption has been done from the viewpoint of a bribe-taker (a national officer). However, for an appropriate analysis of the roots of the phenomenon corruption, one also needs to scrutinise it from the perspective of a bribe-payer (an entrepreneur). Only an investigation of both sides involved in corrupt transactions, as well as their motives and codes of conduct, will contribute to a better understanding of corruption and, thus, enable us to combat it efficiently (Bardhan 2003). Against this background, this chapter attempts to give insights into the determinants of (the perception of) corruption from the viewpoint of entrepreneurs as potential bribe-payers. An analysis of (the perception of) corruption from the perspective of selfemployed business people is also crucial for understanding the causes and consequences of corruption in economic life. Previous research points out that the survival, success and growth of enterprises in the post-Soviet block depend on how well they adapt to the corrupt institutional environment (Djankov et al. 2002; Hellman et al. 2000; Kaufmann and Wei 1999). Investments in corrupt and illegal rent-seeking activities are therefore a crucial component of a successful business strategy in the Commonwealth of Independent States (CIS) countries. At the same time, it is argued that a high level of administrative corruption as well as excessive bureaucratic burdens hinder start-ups (De Soto 1987). Despite already being among the highest in the world, corruption rates in the post-Soviet republics continue to rise (Bjørnskov and Paldam 2002). Although there is an increase of corruption in advanced western economies too, there still exists a tremendous gap in levels of corruption between East and West (Treisman 2000). Researchers have tried to explain international variations in corruption as being mainly due to the different formal institutional environments. However, 39

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informal institutional aspects, such as culturally embedded attitudes, norms and codes of conduct, have generally been neglected in previous research. Therefore, this chapter sets out to contribute both theoretically and empirically to the relationship between entrepreneurship, corruption and trust as an informal institution, making cross-national comparisons between Western, Central, East European and post-Soviet countries in transition. Furthermore, it also examines the influence of ‘civil society’ on (the perceived level of) corruption from the perspective of entrepreneurs. The structure of the chapter is as follows. First, I discuss the theoretical background and empirical research on the impact of trust on corruption, developing at the same time hypotheses concerning this relationship. The next section briefly describes the data and econometric methods of analysis used, and reports results from both descriptive and regression analyses. In the third section, I summarize the findings and present the limitation of the study, and then the chapter concludes with suggestions for future research.

RESEARCH ISSUES Two Sides of Trust: Generalised vs Particularised In the research on corruption, the category ‘trust’ has generally been examined from only one side, namely, the ‘high level of generalised trust’ in people and institutions. This form of trust has been postulated as a robust, negative factor on corruption (see below). In this chapter, I regard trust as a multidimensional theoretical construct (Coleman 1990) which can have both positive and negative impacts for corruption. According to Parsons’s theory of social system (1977), I strictly differentiate between two major forms of trust as a cultural value, namely, between generalised trust and particularised trust. The generalised, universalistic aspect of Parsons’s values implies that they are neither situation specific nor function specific, but have a collectivistic character. The particularised aspect is, on the other hand, situation, function and time specific. Referring to Parsons, I classify the concept ‘trust’ into two major groups, namely, generalised trust (in anonymous others, in the legal framework, in state-run institutions, in the civil society and in trust between anonymous economic actors) and particularised trust (in friends and kin, in a public officer as an ‘honest bribee’). Moreover, I argue that these two forms of trust have different implications, that is, either positive or negative with regards to corruption. To sum up, I expect that a high level of generalised trust will lead to a lower level of (perceived) corruption. Conversely, a high level of particularised trust might become a breeding ground for a high level of corruption, especially when a lack of generalised trust in institutions and anonymous others is prevalent.

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Theoretical Background and Hypotheses Generalised trust Generalised trust in people It is argued that ‘high-trust societies’ are usually less corrupt (see Rothstein 2000 for the case of Sweden). If people have confidence in others, they are more likely to endorse strong standards of moral and legal behaviour (Uslaner 1999; 2001). People who perceive the legal system to be fair and impartial are more likely to trust their own fellow citizens (Rothstein and Stolle 2002). Bjørnskov and Paldam (2002) regard a lack of generalised trust in people (as a form of social capital) in the post-Soviet republics as a robust explanatory factor for high levels of corruption. Conversely, low corruption rates in the Scandinavian countries are mainly due to the high levels of generalised trust (ibid.). Hypothesis 1: The higher the generalised trust of self-employed business people in anonymous others, the lower the likelihood of becoming engaged in corruption. Trust in the legal framework Conducive business environments are characterised by a legitimate rule of law, which is enforced and protected by an independent and credible judiciary. In transitional economies, which are characterised by extremely high entrepreneurial risks, resulting from everchanging business rules and regulations, the absence of written contracts and, frequently, by the non-returns of debts, and swindling and theft, the efficiency of the state institutions of justice obliged to guarantee legality and rightfulness is vital for start-ups and mature firms (Volkov 1999). However, since the break-up of the Soviet union, entrepreneurs in most post-Soviet countries of transition have been exposed to inefficiency of the state courts of justice in resolving business disputes, the protection of property rights and their inability to enforce legal decisions. How can entrepreneurs ensure the smooth functioning of businesses if they do not trust the judiciary to operate efficiently, impersonally, predictably and in accordance with the rule of law? Research suggests that in such environments, entrepreneurs usually invoke informal, ‘closed’ networks to compensate or to substitute for the failure of legal institutions by begging or cajoling public officials, using connections to bend rules or paying bribes that break rules (Rose 2000, p. 147). On the other hand, the performance of a criminal act depends on the anticipated costs of sanctioning, that is, the expected value of the negative outcomes (costs) and the probability of being caught, prosecuted and sentenced (Becker 1968). By planning a corrupt transaction, an entrepreneur takes into consideration the anticipated costs of sanctioning from the court. However, in environments characterised by the absence of the ‘rule law’, he

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or she expects the costs of sanctioning, that is, both the costs of punishment and the probability of being punished, to be very low, which subsequently increase the likelihood of becoming engaged in corruption. Hypothesis 2: The likelihood of becoming engaged in corruption is strongly linked to the entrepreneurial perception of the efficiency of legal institutions. The lower the trust of self-employed business people in state institutions of justice (the judiciary and police), the higher the likelihood of becoming engaged in corruption. Trust in state institutions Research also stresses the importance of the relationship between the quality of the state-run institutions and public service, on the one hand, and corruption, on the other (Transparency International 2000). The executive bodies must carry out a declared political programme, provide principled, high standards of ethical conduct and supervise the civil service. They must provide ‘ “clear leadership” and maintain “clean government” to perform their own actions lawfully, transparently, and fully accountably’ (Transparency International 2000, p. 59). Moreover, it is essential for the executive bodies to respect the independence of the judicial bodies and to comply with their judgements. In many countries where democratic integrity does not function satisfactorily ‘much of the blame lies with the Executive in its refusal to accept the concept of judicial and prosecutorial independence’ (Transparency International 2000, p. 60). The quality of public services can be characterised through their ability to allow the state to accomplish its objectives as efficiently as possible. The public sector should enable the state to perform its tasks with the minimum degree of distortion of the market, the lowest absorption of economic resources and the maximum degree of accountability and transparency in the relevant processes and outcomes (Tanzi and Schuknecht 2000). Trust in the behaviour of government officials is important in determining citizens’ obedience to rules (Raiser 1999). Hypothesis 3: The higher trust in the fairness and efficiency of the government and the public sector, the lower the likelihood of becoming engaged in corruption. Trust in the civil society Civil society refers to voluntary organisations and networks that do not belong to the formal state apparatus. This includes nongovernmental organisations (NGOs), professional or environmental associations, labour or women’s unions, chambers of commerce, religions, students groups, cultural societies, sport and recreation clubs, informal community groups and so on. Here, an important question is whether civil society organisations and networks can combine their weight in the collective struggle against corruption. And if so, what are the conceptual mechanisms underlying this causality?

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To explain this theoretically, I draw on Putnam’s (1993) theory of social capital by linking civil associations, networks and voluntary organisations to political participation and good governance. Although Putnam (1993) does not specifically discuss corruption, he does demonstrate that the effectiveness of local governments in Italy is lower in places where the measures of civic engagement and generalised trust are lower. Thus, Putnam suggests that the voluntary organisations of civil society are crucial for ‘making democracies work’. Although the mechanisms underlying this causal relationship remain rather underdeveloped theoretically, the main logic behind this can be interpreted as follows: civil society organisations like unions, churches, associations and community groups play a vital role in the production of social capital, both within their networks (internal effects) and beyond them (external effects). Internal effects arise because civil society organisations bridge divisive social cleavages, integrating people from diverse backgrounds and with different values by promoting among their members values and norms such as tolerance, co-operation, shared responsibilities and reciprocity (Norris 2001, p. 2). Thus, civil society promotes interpersonal trust between people involved in networks, fostering the capacity to work together in the future and creating with that the bonds of social life. Civil society networks may also have external effects on the wider polity, for example in terms of interest articulation and aggregation. Putnam (2000, p. 89) argues that in communities marked by active participation in public affairs, citizens ‘expect their government to follow high standards, and they willingly obey the rules that they have imposed on themselves’. He furthermore acknowledges that in democracies rich in social capital, watchful citizens are more likely to hold elected leaders accountable for their actions, and leaders (government and public officers) are more likely to believe that a politically and socially conscious citizen will act as a watchdog, and monitor their behaviour. Hypothesis 4: Corruption will be lower in countries with a participatory democracy and a high level of trust in the principles of a vigorous civil society. Particularised trust Trust in kin and bonding networks According to Putnam (2000), the functions of social networks can be not only positive, but also negative. Networks can also bind certain groups together in ways that are undesirable for society as a whole, for example, by reinforcing the practices of nepotism or ethnic hatred. Putnam (2000) acknowledges this in differentiating between ‘bridging’ networks, which are porous and socially inclusive, promoting interactions between heterogeneous social groups with different backgrounds, and ‘bonding’ networks, which tend to exclude outsiders. Indeed, the idea about such

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types of ‘closed networks’ can also be met in Coleman’s theory of social capital (Coleman 1990). For example, the blood-brotherhood in the ex-Yugoslavia or Mafia structures in the south of Italy or in Russia exemplify such close-knit, mutually dependent communities. Since ‘bonding networks’, like ‘kinship’, represent an opportunity to reduce transaction costs, that is costs associated with the search for and discovery of business counterparts and of defining contract conditions and enforcing the agreement; they create an atmosphere of mutual trust and cooperation between business partners embedded in these social structures. On the other hand, previous research suggests that ‘closed’ and socially exclusive networks can become a ‘breeding ground’ for corruption, although this idea remains rather underdeveloped theoretically since we do not exactly know the mechanisms underlying this causality. In this context, Lambsdorff (2002) mentions that kinship and networks may facilitate corrupt deals and refers to Schramm and Taube (2002), who described the Chinese guanxi networks as embedding individuals in social structures that provide safeguards against opportunism and simultaneously facilitate corrupt transactions. The second example given by Lambsdorff (2002) draws on Anderson’s (1995, pp. 42–7) ‘secret societies and criminal organisations’, which are characterised as ‘guarantors’ of corrupt transactions. Hypothesis 5: The inclination to corruption increases the closer the surrounding network. Networks become closer when trust is shared predominantly with people belonging to the same social structure (kinship, ethnic group, business associations), but not with anonymous others. Reciprocal trust between an entrepreneur and a public servant Reciprocal trust between an entrepreneur and a public servant may be a crucial determinant of corruption. The corrupt behaviour of the entrepreneur is affected by his or her expectations about the trustworthiness of the national officer as an honest bribe-taker. If an entrepreneur expects the public officer to deliver the services as agreed after having taken the ‘additional payment’ (bribe), the former will be more likely to engage in corrupt deals. Conversely, the likelihood of becoming involved in corrupt transactions decreases if there is not a high level of trust towards a public officer as an ‘honest bribee’. What are the determinants of a trustworthy relationship between an entrepreneur and a public officer? The trustworthiness between the two sides involved in corrupt agreements can develop on the basis of a mutual calculation of the counterpart’s interests (Coleman 1990; Gambetta 1988; Hardin 2001). The anticipated benefits from a corrupt transaction for the entrepreneur and the public servant, as well as the anticipated costs of legal punishment (Becker 1968), create the need for mutual protection and, consequently, high trust between both these actors. Moreover, if such interest-based trust

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(Rose-Ackerman 2001) between an entrepreneur and a public servant has paid off over time, corrupt transactions between them are also highly likely to be performed in the future. Hypothesis 6: The higher the level of expectation of the entrepreneur to meet an ‘honest bribe-taker’ in public institutions, the higher the likelihood of becoming engaged in corruption. Control Variable: Financial Situation In the macroeconomic studies of corruption, the levels of economic development have been considered as robust predictors of corruption. It is empirically proven that the higher the level of gross domestic product (GDP) (per capita), the lower the level of corruption. Daniel Treisman (2000, p. 404) puts it as follows: ‘economic development increases the spread of education, literacy, and depersonalized relationships – each of which should raise the odds that an abuse will be noticed and challenged’. To capture the relationship between economic development and corruption on the micro level, I examine the impact of the financial situation of selfemployed business people (as a proxy to the GDP) on (their perception of) corruption.

DATA AND METHODS Empirically, I draw on two sources of data, namely on the third wave of the World Values Survey (1998) and the World Business Environment Survey (2000). The World Values Survey is an investigation of basic social, cultural, political values and beliefs of people throughout the world. The World Business Environment Survey examines the impact of state institutions on the enterprises’ economic performance. World Values Survey From the World Values Survey (WVS, 1995–96), 20 emerging and mature market economies were chosen and classified into eight regional groups as follows: 1. Western Europe (Britain, West Germany, Spain, Switzerland, N = 311) 2. Scandinavia (Norway, Sweden, Finland, N = 354) 3. Central Eastern Europe (Poland, Slovenia, Bulgaria, N = 333) 4. Baltic (Lithuania, Latvia, Estonia, N = 212) 5. Trans-Caucasus (Armenia, Georgia, Azerbaijan, N = 509)

46

6. 7. 8.

Concepts, evolution, measurements

Other post-Soviet republics (Tambov (Russia), Russia, Belarus, Ukraine, Moldova, N = 447) USA (N = 175) East Germany (N = 51)

The number of observations for each regional group and/or country is displayed in brackets. Under self-employed I include ‘employers/managers of an establishment with 10 or more employees’, ‘employers/managers of an establishment with less than 10 employees’ and ‘farmers running their own businesses’. With respect to the theoretical framework, I examine the impact of the two forms of trust (generalised and particularised) as well as the civic society on the (perception of) corruption. Endogenous and exogenous variables The endogenous variable measures the perception of the prevalence of ‘bribetaking and corruption’ in a given country and corresponds to the question ‘How widespread do you think bribe-taking and corruption is in this country?’ It is an ordinal, 4-scaled variable in which the lowest value states that ‘almost no public officials are engaged in it’ and the highest value that ‘almost all public officials are engaged in it’. As exogenous variables, I employ the two forms of trust discussed above: generalised trust in anonymous others and institutions as well as particularised trust in kin and friends. Additionally, I examine the effects of indices and variables measuring civil society on corruption. Finally, I introduce a control variable for the financial situation of entrepreneurs and countries. Table 3.1 displays exogenous variables and indices which are classified in three groups. Group 1 embraces variables and indices measuring the impact of both the generalised and particularised trust on the (perception of) corruption. Group 2 utilises indices and displays a variable examining the effect of civic society on corruption. Group 3 embraces a control variable depicting the degree to which the self-employed are satisfied with the financial situation of their own household. Information on the variables and the technique used to construct the indices is displayed in Table 3.1. The indices were computed either by the principal component analysis (PCA) or by the additive method. For PCA, the number of principal components were identified which were finally tested with regard to one-dimensionality. Eigenvalues, which are above the value one and score from 1.510 (the lowest value) to 2.169 (the highest value), as well as the values of explained variances (72 per cent for the lowest value and 82 per cent for the highest value), reflect the good quality of indices utilised. Finally, a reliability analysis was conducted to ensure the accuracy of the measurement

Table 3.1 Indices and variables measuring trust and civic society Index/ variable

Name

Variables

Index analysis 1. Eigenvalue (EV) 2. Explained variance (%) 3. Reliability: Cronbach’s alpha/ variable description

Predicted influence on corruption

I. Indices and variables measuring trust 1. Generalised trust in people

Generally speaking, would you say that most people can be trusted?

Dummy variable: 0 ‘Have to be careful’ 1 ‘Most people can be trusted’

Negative

Index

2. Trust in legal framework

How much confidence do you have 1. In the legal system 2. In the police (4-point scale: 1 ‘None’ . . . . . . 4 ‘Great deal’)

1. EV: 1,510 2. % variance = 75,509% 3. Cronbach’s α = 0,6751

Negative

Index

3. Trust in state-run institutions

How much confidence do you have 1. In the government 2. In the political parties 3. In the parliament (4-point scale: 1 ‘None’ . . . . . .4 ‘Great deal’)

1. EV: 2,169 2. % variance = 72,288% 3. Cronbach’s α = 0,8061

Negative

Variable

4. Trust in the civil service

How much confidence do you have in the civil service? (4-point scale: 1 ‘None’ . . . . . .4 ‘Great deal’)

1 2 3 4

Negative

47

Variable

– none – not very – quite – great deal

Table 3.1 (continued) Name

Index

5. Trust in green/ecology movements and the women’s movement

How much confidence do you have 1. In the green/ecology movement 2. In the women’s movement (4-point scale: 1 ‘None’ . . . . . .4 ‘Great deal’)

1. EV: 1,589 2. % variance = 79,464 3. Cronbach’s α = 0,7415

Negative

Index

7. Trust in the mass media

How much confidence do you have 1. In the press 2. In the mass media (4-point scale: 1 ‘None’ . . . . . .4 ‘Great deal’)

1. EV: 1,656 2. % variance = 82,813 3. Cronbach’s α = 0,7925

Negative

Variable

8. Importance of friends

I make a lot of effort to live up to the expectations of my friends

4-point scale: 1 ‘Strongly disagree’ to 4 ‘Strongly agree’

Positive

Additive index (values from 0 to 5)

Negative

48

Index/ variable

Variables

Index analysis 1. Eigenvalue (EV) 2. Explained variance (%) 3. Reliability: Cronbach’s alpha/ variable description

Predicted influence on corruption

II. Indices and variables measuring civic society Index

1. Participation in voluntary organisations

Active member in the following voluntary organisations: 1. Church or religious organisation

2. 3. 4. 5.

Sport or recreational organisation Professional association Charitable organisation Any other voluntary organisation

2. Political commitment in the past

In the past, I have . . . 1. signed a petition 2. joined in boycotts 3. attended lawful demonstrations

Additive index (values from 0 to 3)

Negative

Index

3. Attitudes toward democracy

Attitudes towards having a democratic political system 1. Democracies are indecisive and have too much squabbling 2. Democracy may have problems but it’s better than any other form of government 3. Using violence to pursue political goals is never vs always justified

Additive index (values from 0 to 4)

Negative

How satisfied are you with the financial situation of your household?

10-point scale: 1 ‘Completely dissatisfied’ ..... 10 ‘Completely satisfied’

Negative

49

Index

III. Control variable Variable

Source:

Financial situation (subjective)

World Values Survey (1998).

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Concepts, evolution, measurements

of the respective index. Cronbach’s Alpha, which reflects the accuracy of the index measurement, shows very good values varying from 0.6751 (the lowest value) to 0.8061 (the highest value) for the respective index. World Business Environment Survey In the second step, I employ the second source of data, the World Business Environment Survey (World Business Environment Survey 2000), to additionally test the effect of particularised trust toward friends/kin and a national bureaucrat on corruption.

EMPIRICAL FINDINGS World Values Survey Table 3.2 displays the results from the two ordered probit models of parallel assessments of the effects of indices and variables discussed above on the perception of corruption from the perspective of entrepreneurs. Model 1 lists out estimation results from the first ordered probit regression of all determinants supposed to affect corruption that were designed to test hypotheses 1 to 6. Model 2 additionally introduces a control variable for the ‘financial situation’ of entrepreneurs and countries. Generalised and particularised trust Looking at the parameters and the z-statistics of the variables and indices employed in the regression analyses, one can notice clear evidence of the implications of generalised trust in anonymous others (first), trust in the judiciary and police (second) and trust in the quality of state institutions (third) on corruption. Thus, the higher the generalised trust of self-employed business people in other people, the lower (their perception of) corruption. The higher their trust in the effectiveness of the legal system and the police, the lower (the perception of) corruption. Also a high level of confidence among selfemployed business people in the good quality of government, in political parties and the parliament leads to a low (perception of) corruption. Even after introducing controls for regional groups, these factors still remain statistically significant. Another form of trust, namely, trust in the civil service, becomes relatively significant in the second model. This implies that the higher the trust in the good quality of the civil service, the lower the corruption. On the other hand, looking at the parameter sign and the z-statistics of the ‘importance of friends’ that is employed as proxy to trust in friends, one notices that it is highly significant and, most importantly, positively related to

Table 3.2 Ordered probit regressions on (perception of) corruption of self-employed business people Ordered probit model

51

Std. err.

Z

P>|z|

Model 2 Coef.

–0.41 –0.26 –0.15 –0.11 0.07 –0.02 0.28

0.07 0.04 0.04 0.05 0.03 0.04 0.04

–5.86 –5.86 –3.66 –2.25 1.87 –0.58 7.42

0.000 0.000 0.000 0.025 0.061 0.561 0.000

Indices and variables measuring civic society 1 Participation in voluntary organisations 0.00 2 Political commitment in the past –0.08

0.01 0.04

–0.23 –2.11

0.818 0.035

Indices and variables measuring trust 1 Generalised trust in people 2 Trust in legal framework 3 Trust in policy 4 Trust in civil service 5 Trust in green and women’s movement 6 Trust in mass media 7 Importance of friends

Model 1 Coeff.

Std. err.

Z

P>|z|

–0.27 –0.10 –0.16 –0.19 0.02 –0.06 0.15

0.08 0.05 0.04 0.05 0.04 0.04 0.04

–3.64 –2.23 –3.63 –3.67 0.47 –1.63 3.83

0.000 0.026 0.000 0.000 0.636 0.102 0.000

0.03 –0.04

0.02 0.04

1.85 –1.06

0.064 0.287

Table 3.2 (continued) Ordered probit model

52

3 Attitudes towards: Control variable Financial situation (subjective) Baltic States Central Eastern Europe East Germany Other post-Soviet republics Trans-Caucasus USA Western Europe α1 α2 α3 N (number of observations) = 1145

Model 1 Coeff.

Std. err.

Z

P>|z|

–0.23

0.04

–6.03

0.000

–1.94 –0.22 1.12

0.17 0.16 0.16

McKelvey and Zavoina’s R2:0.329 McFadden’s R2:0.139

Model 2 Coef.

–0.18 –0.02 1.08 0.03 0.40 1.28 1.09 0.37 0.34 –1.83 0.02 1.50

Std. err.

Z

P>|z|

0.04 0.02 0.13 0.18 0.18 0.16 0.13 0.13 0.14 0.21 0.19 0.19

–4.75 –1.06 8.32 0.14 2.25 8.08 8.43 2.81 2.40

0.000 0.290 0.000 0.890 0.024 0.000 0.000 0.005 0.016

McKelvey and Zavoina’s R2:0.435 McFadden’s R2:0.1950

Note: Endogenous variable: how widespread do you think bribe taking and corruption is in this country? The lowest value: ‘almost no public officials are engaged in corruption’; the highest value ‘almost all public officials are engaged in corruption’. Source:

World Values Survey (1998); calculations by ifm Mannheim.

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corruption. This implies that we observe here a ‘dark side of trust’, namely, a form of the particularised trust which gives rise to corruption. Moreover, this effect remains robust even when adjusting for the control variable (the financial situation of the entrepreneur) and countries in model 2. Civic society Two indicators of civic society appear to be relevant for corruption. The first index measures the active behaviour of self-employed business people in the past in terms of their political commitment, and demonstrates a negative effect on corruption in model 1. This implies that those self-employed business people who actively participated in politics, for example by having signed a petition, having joined a boycott and having attended lawful demonstrations, might be less susceptible to corruption. However, this index seems to be relevant for only some of the controlled regions as it is no longer significant in the second model. Also, the second index that refers to entrepreneurial attitudes towards democracy turns out to be a robust explanatory factor for corruption: self-employed business people who consider a democratic system to be bad, indecisive and likely to cause too much squabbling, as well as those who are likely to justify the use of violence to pursue political goals, might be considered more likely to engage in corruption. Financial situation and country dummies Concomitant with macroeconomic studies of corruption, a stronger ‘financial situation’ of self-employed business people is negatively associated with the (perceived level of) corruption. It can thus be acknowledged that the ‘wealthier’ self-employed tend to perceive a lower level of corruption or that they tend to be less inclined to corruption. By taking a look at the regional dummies that remain statistically significant for almost all the country groups in the second model, one can conclude that the discrepancies between regional groups in terms of the level of corruption could not have been explained thoroughly by means of trust, civic society and financial situation. World Business Environment Survey With the second source of data, the World Business Environment Survey, I additionally validate the importance of particularised trust for (perceived level of ) corruption. The first variable relating to particularised trust describes the ‘share of a firm’s finances over the last year coming from family and friends’, and reflects a trustworthy relationship between a self-employed business person and his or her friends and kin. In the ordered probit model, it demonstrates a highly significant and, again, positive impact on corruption. So

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Table 3.3 Ordered probit model on perception of corruption

Index 1: Perception of bank officers Index 2: Perception of legal system Business ethics: competitor’s fair play Transaction costs: time for red tape Legal alternatives to bribe Investments from family and friends Trust toward a national officer to be an ‘honest bribee’ α1 α2 α3 α4 α5 N (number of observations) = 620

Model 3 B-coeff.

T-value

Sign.

0.23 0.23 0.02 0.03 0.06 –0.01

4.97 4.15 0.40 1.06 1.87 3.72

0.000 0.000 0.686 0.288 0.062 0.000

–0.20 4.97 0.000 –1.66 0.65 1.51 2.10 2.89 McKelvey and Zavoina’s R2:0.20 McFadden’s R2:0.06

Note: Endogenous variable: perception of corruption: ‘It is common for firms in my line of business to have to pay some irregular “additional payments” to get things done’ (Question 14, WBES 2000). Low level: always; high value: never. Source:

World Business Environment Survey (2000); calculations by ifm Mannheim.

far, a ‘dark side of trust’ has become evident in this case, again implying that entrepreneurs with family and friends as investment sources are more likely to engage in corrupt and illegal rent-seeking transactions (see Table 3.3). The second variable relating to particularised trust depicts the level of trust of an entrepreneur that a public servant is an ‘honest bribee’. In other words, the probability of becoming involved in corrupt transactions rises if an entrepreneur expects the public servant to deliver services as agreed, after having taken the required amount of bribe.

CONCLUDING REMARKS In this chapter, I reveal the dark and positive sides of trust, which are important for investigating the phenomenon of corruption. Up to now, previous research has mostly emphasised the positive sides of trust: it has been postulated that the higher the generalised trust in people and/or formal institutions

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(for example, the judiciary or government), the lower the level of corruption (Bjørnskov and Paldam 2002; Rothstein 2000). However, the exact opposite can also be hypothesised, namely, that another side of trust might also exist, a ‘dark side’ that fosters corruption. Therefore, this chapter set out to explore both sides of trust, examining its impact on corruption from the perspective of entrepreneurs as potential bribe-payers. I treat trust as a multidimensional theoretical construct which might have both positive and negative implications for corruption. Strictly speaking, I differentiate between the two types of trust, that is, generalised trust and particularised trust, drawing a basic assumption that a high level of generalised trust undermines corruption while a high level of particularised trust, conversely, supports it. As generalised trust, that is, trust that is neither person nor situation specific, I sum up trust in people, the legal framework, state-run institutions and civil society. I also examine the impact of particularised trust, a form of trust which is both person and situation specific, on corruption. In this chapter, particularised trust is measured by trust in kinship and friendship (first), and by the trust of the entrepreneur in the public servant to be an ‘honest bribee’ (second). The empirical findings, drawn from an econometric analysis of the two sources of data, namely the World Values Survey (1995–96) and the World Business Environment Survey (2000), reveal that it is worth differentiating between generalised and particularised trust when researching corruption. First, in line with previous research, it is evident that a high level of generalised trust does have hampering effects on corruption. My findings support the hypothesis that a high level of generalised trust in anonymous others has a negative impact on corruption. Moreover, trust in the legal system and the police as well as trust in state-run institutions (the government, parliament and political parties) demonstrate a strong negative reference to corruption. Therefore, a key challenge when countering corrupt practices between entrepreneurs and public bureaucrats is to rebuild and/or to strengthen the entrepreneurial trust in the legal framework and institutional infrastructure of the state, such as the government, political parties, parliament and the public sector. Furthermore, corruption seems to be lower in countries with a participatory democracy and a high level of trust in the principles of a vigorous civil society. Active political commitment of the entrepreneur to broad democratic participation, for example, by having signed petitions and/or joined in boycotts, induces lower levels of corruption. Conversely, negative attitudes toward democracy, that is, viewing democratic systems as being indecisive and/or justifying the use of violence, generate higher levels of corruption. On the other hand, in environments characterised by lower levels of generalised trust in anonymous others, political institutions and public service, high particularised trust (in friends, kin and public officer) turns out to be positively

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Concepts, evolution, measurements

related to corruption. A high level of trust in friends, measured by a proxy describing the self-employed business people striving to live up to the expectations of their own friends, shows a positive, indeed the strongest, impact on corruption. Therefore, we can observe here a ‘dark side of trust’, namely, a form of particularised trust that actually nurtures corrupt transactions. Furthermore, another variable employed as a proxy to measure trust toward friends and kin is highly positively correlated with corruption. It is called investment sources from family and friends and measures the share (percentage) of enterprises financed over the last year by entrepreneurs’ family and friends. The latter surely reflects a trustworthy relationship between the entrepreneur whose firm is financed from his or her friends or family who have provided the finance. In this case, we also observe that entrepreneurs with investment sources from family and friends are more likely to perform corrupt transactions. In this regard, I conclude that in ‘milieus of low generalised trust’ where both a low level of generalised trust in anonymous others and institutions is prevalent, entrepreneurs tend to compensate for this deficit of trust with particularised forms of trust through becoming involved in (business) networks with friends and kin (Ledeneva 1998). This, in turn, might become a breeding ground for corruption. Another form of particularised trust seems to ensure corrupt deals, namely trust of the entrepreneur in the public servant as ‘an honest bribee’. In this regard, if the self-employed business person trusts the public servant to deliver services ‘as agreed’ after having taken the required ‘additional payment’ (bribe), then he or she will be more likely to become involved in a corrupt transaction. This is concomitant with the recent findings of Lambsdorff (2002). The positive interdependence between corruption and particularised trust of self-employed business people (embedded in networks with friends, kin and public bureaucrats) in the absence of generalised trust in anonymous others and political institutions reminds us of similar close-knit and mutually dependent Mafia structures in southern Italy and Russia, and guanxi networks in China. However, the reasons for why exactly such closed networks facilitate corruption remain unexplained, and should be, ideally, addressed in future research in order to answer the question ‘why is corruption more widespread in some countries than in others?’

NOTE 1.

I am especially grateful for constructive comments, criticism and suggestions given by Johann Graf Lambsdorff and Robert Strohmeyer. I also thank Stephen Krug and Kathrin Heyd for language assistance. Last but not least, I would like to thank Friederike Welter for having invited me to the international conference on ‘Trust and entrepreneurial behaviour’, and thus for having inspired me to write this chapter.

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REFERENCES Anderson, A. (1995), ‘Organized Crime, Mafia and Governments’, in G. Fiorentini and S. Peltzman (eds), The Economics of Organized Crime, Cambridge: Cambridge University Press, pp. 33–54. Bardhan, P. (2003), ‘Economic Approach to Corruption’, paper presented at the Symposium: ‘Re/Constructing Corruption: Towards an Interdisciplinary Framework’, 30 April to 2 May, University of East Anglia, Norwich. Becker, G.S. (1968), ‘Crime and Punishment: An Economic Approach’, Journal of Political Economy, 76, 169–217. Bjørnskov, C. and M. Paldam (2002), ‘Corruption Trends and Social Capital’, paper submitted to the International Workshop on Corruption at the University of Göttingen, November, website: http://www. asb.dk/eok/nat/staff. Coleman, J.S. (1990), Foundations of Social Theory, Cambridge, MA: Belknap Press of Harvard University Press. De Soto, H. (1987), The Other Path, New York: Harper & Row. Djankov, S., R. La Porta, F. Lopez-De-Silanes and A. Shleifer (2002), ‘The Regulation of Entry’, Quarterly Journal of Economics, 117 (1), 1–37. Gambetta, D. (ed.) (1988), Trust: Making and Breaking Cooperative Relations, Oxford: Blackwell. Hardin, R. (2001), ‘Conceptions and Explanations of Trust’, in K. Cook (ed.), Trust and Society, New York: Russell Sage, pp. 3–39. Hellman, J.S., G. Jones, D. Kaufmann and M. Schankerman (2000), ‘Measuring Governance, Corruption and State Capture: How Firms and Bureaucrats Shape the Business Environment in Transition Economies’, Policy Research Working Paper, Washington, DC: World Bank. Kaufmann, D. and S.-J. Wei (1999), ‘Does Grease Money Speed Up the Wheels of Commerce?’, NBER Working Paper, 7093, Cambridge, MA: National Bureau of Economic Research. Lambsdorff, J.G. (2002), ‘How Confidence Facilitates Illegal Transactions, An Empirical Approach’, American Journal of Economics and Sociology, 61 (4), 829–54. Ledeneva, A.V. (1998), Russia’s Economy of Favours: Blat, Networking and Informal Exchange, Cambridge, Cambridge University Press. Norris, Pippa (2001), Digital Divide: Civic Engagement, Information Poverty and the Internet Worldwide, New York: Cambridge University Press. Parsons, Talcott (1977), Social Systems and the Evolution of Action Theory, New York: Free Press. Putnam, R.D. (1993), Making Democracy Work: Civic Traditions in Modern Italy, Princeton, NJ: Princeton University Press. Putnam, R.D. (2000), Bowling alone: The Collapse and Revival of American Community, New York: Simon & Schuster. Raiser, Martin (1999), ‘Trust in Transition’, EBRD Working Paper, 39, London: EBRD. Rose, R. (2000), ‘Getting Things Done in an Antimodern Society: Social Capital Networks in Russia’, in P. Dasgupta and I. Serageldin (eds), Social Capital: A Multifaceted Perspective, Washington, DC: World Bank, pp. 147–72. Rose-Ackerman, S. (2001), ‘Trust, Honesty and Corruption: Theories and Survey Evidence from Post-Socialist Societies’, website: http://www.colbud.hu/honestytrust/rose/pub01.PDF.

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Rothstein, B. (2000), ‘Trust, Social Dilemmas and Collective Memories: On the Rise and Decline of the Swedish Model’, Journal of Theoretical Politics, 12, 477–501. Rothstein, B. and Stolle, D. (2002), ‘How Political Institutions Create and Destroy Social Capital: An Institutional Theory of Generalised Trust’, paper presented at the 98th Meeting of the American Political Association in Boston, 29 August to 2 September. Schramm, M. and M. Taube (2002), The Institutional Economics of Legal Institutions. Guanxi and Corruption in the PR China, Internet Center for Corruption Research, website: http://wwwuser.gwdg.de/~uwvw/downloads/contribution10_schramm.pdf. Tanzi, V. and L. Schuknecht (2000), Public Spending in the 20th Century: A Global Perspective, Cambridge: Cambridge University Press. Transparency International (2000), Confronting Corruption: The Elements of a National Integrity System, Berlin and London: TI Source Book. Treisman, D. (2000), ‘The Causes of Corruption: A Cross-National Study’, Journal of Public Economics, 76, 399–457. Uslaner, E. (2001), ‘Trust and Corruption’, paper presented at the Conference on Political Scandals, Past and Present, University of Salford. Uslaner, E. (1999), ‘Trust but Verify: Social Capital and Moral Behaviour’, Social Science Information, 38, 29–56. Volkov, V. (1999), ‘Who is Strong When the State is Weak? Violent Entrepreneurship in Post-Communist Russia’, Europe-Asia Studies, 51 (5), 741–54. World Values Survey (1998), World Values Survey (WVS), website: http:// wvs.isr.umich.edu/ques3.shtml. World Business Environment Survey (2000), World Business Environment Survey (WBES), website: http://www.ifc.org/ifcext/economics.nsf/Contents/ic-wbes.

4. Social capital in Western and Eastern Europe1 Gert Tinggaard Svendsen Commerce and manufactures can seldom flourish long in any state which does not enjoy a regular administration of justice; in which the people do not feel themselves secure in the possession of their property; in which the faith of contracts is not supported by law; and in which the authority of the state is not supposed to be regularly employed in enforcing the payment of debts from all those who are able to pay. Commerce and manufactures, in short, can seldom flourish in any state, in which there is not a certain degree of confidence in the justice of government. (Adam Smith 1776 [1997]).

INTRODUCTION Our overall contribution in this chapter is to apply the concept of social capital to the problems of transition in Eastern Europe. Social capital is broadly defined as people’s ability to co-operate in achieving a common goal (Coleman 1988, p. 95). Eventually, this ability to co-operate materialises in terms of trust and economic growth. Face-to-face interaction facilitates social sanctioning thus reducing the likelihood of free-riding behaviour. Enhancing the level of trust within a given group in this way means that more transactions can take place at a lower cost as it is no longer necessary to monitor and enforce all transactions. A group with members that trust each other may be capable of accomplishing more economic growth than a similar group without trust (see Paldam 2000; Svendsen 2003). Voluntary co-operation among agents has been explained in traditional economic theory by referring to full information and repeated game interactions. It then follows that the agents automatically will harvest the fruits of cooperation when adopting a ‘tit-for-tat’ strategy (Axelrod 1984). Such self-enforcing co-operation means that agents do not need behavioural rules or third party enforcement to ensure the optimal allocation of the scarce resources. Institutional economics responded critically to this idea by its theorem that ‘institutions matter’ in a world without full information and without repeated interactions. Because agents lack information, it will be costly to exchange 59

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property rights to the scarce resources, for example, to identify potential buyers or sellers in the market, protection against cheating or theft and so on (Coase 1937; 1960). Such transaction costs will always be positive when actors do not possess full information. Thus, to support the exchange of goods in a world without full information, agents construct fixed rules for behaviour, that is, institutions. These institutions can both be formal and informal, and both types may influence economic performance. For example, decentralised enforcement of behavioural norms by agents themselves may be just as important as formal laws written by the state. The problem is, however, that modern economic systems cannot rely solely on non-formal institutions. Therefore, formal institutions, enforced by the state, are crucial in determining long-term economic growth. In other words, no society may expand beyond a primitive exchange of goods, if the state does not establish and enforce formal institutions (Schjødt and Svendsen 2002). In the following, we broadly define social capital as voluntary co-operation. By this, we refer to a self-enforcing and informal institution in contrast to a third party enforced formal institution. This ability to co-operate and provide collective goods on a voluntary basis depends on the degree of shared norms and values in a society based on religious values, justice, professional standards, behavioural codes and so on. As argued by Rothstein (2003, p. 49), norms of trust and reciprocity created by social networks increase social trust that works to increase the intensity as well as the quantity of the networks, resulting in a virtuous circle that, in its turn, fosters a better working democracy. Such ‘social glue’ connects people and creates predictable behavioural patterns. In particular, regular face-to-face interaction tends to generate trust due to the presence of social sanctions. Any defector may be socially ostracised from the group, thus increasing the costs of free-riding (Svendsen and Svendsen 2004). In contrast, weak or few social ties spur distrust and set society into a more vicious circle leading to a dysfunctional democratic process, an idea compatible with the Durkheimian sociological tradition of the social sciences where such virtuous and vicious circles have long historical roots (Rothstein 2003, p. 49). The presence of social capital as a production factor in the sense of reducing transaction costs means that a high-trust group or country can achieve more economic growth than a low-trust group or country (Coleman, 1988). In other words, more social capital accumulation in, for example, Eastern Europe will lead to higher competitiveness, more jobs and more economic growth. Adam Smith (1766 [1997]) noted, as we highlight in this chapter, that people do not trust each other in the same way in different countries. Most prominently he found that the Dutch ‘are most faithful to their word’ which, as seen in the third section, still has much truth to it.

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Social capital is in the following used in a ‘positive’ sense, namely, when group formation enhances overall economic growth in a country, thereby suggesting a new explanation for differences in wealth among nations (Svendsen and Svendsen 2003). One prominent example of social capital creation is the voluntary dairy movement in Denmark. Here, vivid entrepreneurship was facilitated around local dairies as transaction costs were lowered significantly in society following the high level of social capital built (Svendsen and Svendsen 2004). An attempt to identify how positive social capital can be created may turn out to have an immense impact on future economic policies and general academic discussions in all social sciences. For example, social capital seems to be positively correlated with happiness (see Bjørnskov 2003a). In contrast, social capital can be ‘negative’ if the group formation is damaging to economic growth (though profitable for the private earnings of the group itself), for example, in the cases of Mafia and other criminal gangs. This so called ‘Hells Angels’ problem, or the ‘dark side’ of social capital, is ignored in the following as there is no way yet to find a conceptually clear definition that can be used to differentiate between ‘the good, the bad and the ugly’ respondents (Rothstein 2003, p. 50). The next section develops a general theoretical model linking social capital and economic growth. The third section then turns to measurement and the empirical evidence comparing the levels of social capital and Gross Domestic Product per capita between Western and Eastern Europe. The final section contains conclusions.

MODEL The introduction to this chapter demonstrates that institutional economics and social capital theory basically deals with the same problem, namely, that social capital is important to economic growth as an informal institution that serves as a new production factor along with traditional human and physical capital. Social capital theory approaches trust as a good that is created ‘bottom up’ among private agents at the micro level. A necessary condition is that the state does not persist in trying to define norms in society but that agents themselves establish social networks via self-selection processes (Schjødt and Svendsen 2004). This voluntarism is not shared by institutional economics. Here, economic co-operation breaks down if clear-cut and formal behavioural rules are not defined and strongly enforced by the agents themselves or by a third party. A strong state is needed to solve such tasks. At the same time, the strong state must be ‘tamed’ by introducing constitution, power-sharing and political

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Power centralisation

Social capital

Economy

Corruption Source:

The author.

Figure 4.1 Power centralisation, social capital, corruption and the economy pluralism. Thus, institutional economics argue that social capital would tend to be created ‘top down’ in modern economies when designing appropriate political institutions (Schjødt and Svendsen 2004.). The relationship between political and economic institutions, social capital and the economy is suggested in the model in Figure 4.1. In Figure 4.1, the main argument is that the degree of power centralisation affects the level of social capital both directly and indirectly. As such, highly centralised political systems corresponding to those existing in Eastern Europe before 1989, would tend to eliminate social capital directly. Citizens would not dare to engage in formal economic exchanges due to arbitrary state intervention in the absence of political veto actors. At the same time, power centralisation will indirectly affect the level of social capital through the quality of existing economic rules because power centralisation is beneficial to rentseeking and corruption, both lowering the quality of economic institutions and eventually leading to economic decline. In particular, corruption implies that existing economic rules are not enforced neutrally over time. Rather, rules are bent favouring special interest groups and bureaucrats, and it now pays to break the formal rules (cf. the dictatorship theory developed in Paldam and Svendsen 2000; see also Bjørnskov 2003b; Fisman and Gatti 2002; Putnam 1993). When bureaucrats have discretionary power, as was the case in former communist Eastern Europe, they can on their own decide the outcome of a given case. This monopoly power is the source of corruption and bribery, and it can easily be hidden so that one favour today by the bureaucrat is returned at some point in the future (Tanzi 1996). Rothstein (2003, pp. 59–60) argues that if a person starts thinking that such corrupt exchanges are the norm in his or her society, rather than the exception, trust in government institutions will eventually go down. More specifically, the relationship between the quality of government institutions and general social capital in a society has three dimensions. First, if public officials are known to be corrupted, person A will infer that even individuals given the

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responsibility to guard the public interest are not to be trusted and, if they cannot be trusted, then nor can ‘most people’ be trusted. Second, person A will infer that most people cannot be trusted because they are engaged in direct or indirect corruption of these government institutions. Third, in order to survive under such a system, person A will find himself forced to engage in corruption, even if it is against his moral orientation. But because A cannot trust himself to behave according to the formal rules, he is likely to infer that nor are ‘other people’ likely to play by the rules. Thus, Rothstein concludes, it makes no sense to trust ‘most people’ if they are generally known to bribe, threaten or in other ways corrupt the impartiality of government institutions in order to extract special favours. The very reason why ‘most other people’ can be trusted is that they are generally known to refrain from such forms of behaviour (Rothstein 2003). Thus, trust and social capital cannot be accumulated within such a low-quality institutional framework. One may argue, in the line of New Institutional Economics, that strong power centralisation and ‘super presidentialism’ could be useful in a starting phase when establishing the proper formal institutions to back social capital accumulation (Svendsen 2003). A counter-argument is that also strong dictatorships become corrupt over time. Stalin, for example, probably increased the general social capital among Russians towards the state initially when implementing forced industrialisation and economic growth. However, over time, interest groups accumulated in Russia achieving special favours and access to maximise their slice of the national income pie eventually causing economically harmful redistribution and the economic decline of Russia and Eastern Europe in general (see Olson 1982; 2000).

MEASUREMENT AND COMPARISON General Trust and Density of Voluntary Organisations We compare the level of social capital in Eastern and Western Europe by applying two main measures (see Paldam 2000). The first measure is the general level of trust in a society. This concept and its economic implications was introduced by Fukuyama (1995). Fukuyama, however, only deals with social capital from a pure theoretical perspective. Inglehart (1997) applies the concept simply by defining and operationalising social capital as trust, just like we do it in this chapter. This general trust level has been used in the World Values Survey by asking the following question: ‘Generally speaking, would you say that most people can be trusted, or that you cannot be too careful in dealing with people?’ (Inglehart et al. 1998). The second social capital measure deals with the density of voluntary

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organisations. Putnam (1993) introduced this method when identifying the differences between the efficiency of institutions in Northern and Southern Italy and their impact on economic development. Putnam suggested that the difference in economic wealth could be explained by the density of voluntary organisations, that is, the average number of memberships in voluntary organisations. By assuming that more voluntary organisations would lead to more trust-building through repeated social interaction, he established a simple proxy for the level of social capital. The World Values Survey (Inglehart et al. 1998) has asked about a similar topic to that of voluntary organisations; namely, the density of civic participation in voluntary organisations. In the following, we look at the empirical results from using these two measures and in particular compare the level of social capital found in the European Union (EU) and Western Europe to the level found in Eastern Europe. This helps to identify whether two different political systems in terms of power centralisation (capitalist democracy with power decentralisation vs communist central planning with power centralisation) would lead to two different levels of social capital and, eventually, different economic growth rates. Measurement and empirical evidence is based on data from the World Values Survey 1991–93 (Inglehart et al. 1998) assuming that the level of social capital in Eastern Europe still reflects the pre-1989 stock of social capital. Even though the former Eastern Bloc countries have started implementing market-based reforms since 1989, the stock of social capital has presumably not changed yet, as it may take centuries to build. In a preliminary investigation by Paldam and Svendsen (2002), they argue that the slowness of the transition of the old communist countries of Eastern and Central Europe is caused by the lack of social capital. Thus, the concept should be particularly relevant to the comparison of economic performance in Western and Eastern Europe. Comparison In the following, ‘Western Europe’ and ‘Eastern Europe’ are defined, respectively as the 18 and 11 countries listed in Table 4.1, first column. Countries are ranked according to their general trust score. Concerning our first measure of general trust (Table 4.1, second column), Western Europe scores 45 per cent on average, compared with 26 per cent in Eastern Europe. In Western Europe, the Scandinavian countries are topping the list followed by the Netherlands, Canada and the USA, all above the EU average. Sweden is number one with two-thirds (66.1 per cent) of all respondents trusting other people in general. Portugal has the lowest score with onefifth of the respondents (21.7 per cent). France is at a strikingly low level with its average score of 22.8, far below the average score of almost half of all respondents (45 per cent) for Western European countries. Both France and

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Table 4.1 General trust, density of organisations and GDP per capita (rounded numbers)a General trust (1991–93) %

Density of organisations (1991–93)

GDP per capita (1991)b

Western Europe Sweden Norway Finland Denmark Netherlands Canada USA Ireland UK Iceland Switzerland Germany Italy Spain Belgium Austria France Portugal Average West

66.1 65.1 62.7 57.7 53.5 53.1 51.1 47.4 43.7 43.6 42.6 37.9 35.3 34.2 33.5 31.8 22.8 21.7 45.0

10.9 11.7 10.7 11.4 20.8 11.4 11.7 8.0 7.0 11.4 46.6 9.4 4.5 2.7 10.1 6.0 6.1 4.1 11

18 334 20 619 17 197 20 190 18 107 19 909 23 630 13 129 16 789 21 608 24 247 19 111 18 148 13 458 20 135 19 614 18 552 11 743 18 584

Eastern Europe Russia Poland Lithuania Bulgaria Czech Republic Estonia Belarus Hungary Latvia Slovak Republic Romania Average East

37.5 34.5 30.8 30.4 27.8 27.6 25.5 24.6 19.0 17.4 16.1 26.0

2.9 N/A 3.7 3.1 N/A 5.5 N/A 2.4 4.4 3.4 1.4 3

9 797 5 291 8 209 5 632 N/A 7 529 7 119 8 518 7 817 7 938 5 577 7 343

Average All

38.0

9

14 570

Notes: a The graphical relationship between GDP and each of the two social capital measures is attached in the Appendix. b GDP per capita, PPP (current international $). Sources:

Inglehart et al. (1998); World Bank (2002).

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Portugal are below the average score in Eastern Europe amounting to onequarter (26 per cent). Russia tops the list for Eastern Europe with 37.5 per cent whereas Romania is at the bottom with its 16 per cent score. Still, all Eastern European countries are below the average of 38 per cent generalised trust for all countries, whereas most Western European countries are above the average. Concerning our second measure, the density of voluntary organisations of any type (Table 4.1, third column), the World Values Survey with data from 1991 to 1993 may serve as a proxy for the Putnam Instrument. This claim is justified by the fact that respondents were asked whether they participated in different civic activities, that is, voluntary activities, including: (a) social welfare services for the elderly and deprived; (b) education, art and cultural activities; (c) local community affairs; (d) activities related to conservation, environment and ecology; and (e) work with youth. Here, the density of civic participation is measured as the percentage of these civic activities in which an average respondent in a country is involved. Western Europe has an average participation rate in the listed voluntary organisational activities of 11.4, or more than three times higher than the 3.4 score for Eastern Europe. Switzerland is in front with a remarkable 46.6 score. In other words, each Swiss is, on average, a member of almost 47 voluntary organisations. This high number is probably caused by Switzerland’s unique canton voting system (see Frey and Stutzer 2002). The Netherlands is second with a 20.8 score followed by the USA, Canada and the Scandinavian countries. In Eastern Europe, Estonia holds the highest score of 5.5 among the available data, whereas Romania again is at the bottom with a 1.4 score. This notable difference between Western and Eastern Europe seems to confirm the idea that the abolishment of voluntary organisations during the communist rule destroyed this type of social capital. Again, the average for Eastern Europe (3.4) falls well below the average for all countries (8.9). Romania, which takes the last place in both measures, probably experienced most power centralisation during communism under the extreme and politically suppressive dictatorship of Nicolae Ceauss¸escu (from 1967 to 1989). In contrast, the Scandinavian countries, the Netherlands together with the USA and Canada, have strong democratic institutions allowing extensive power decentralisation. Finally, the state of the economy is measured in Gross Domestic Product (GDP) per capita in 1991 and with figures adjusted for differences in purchasing power (PPP) (Table 4.1, fourth column). As seen in Table 4.1, average GDP per capita for Western Europe is about two and a half times higher than the average of Eastern Europe ($18 584 compared with $7343). Switzerland, the USA, the Scandinavian countries and Belgium had the highest GDP per capita levels in 1991, whereas Southern Europe had the lowest GDP levels. Still, Portugal, holding the lowest GDP per capita in Western Europe, is above Russia, the top scorer in Eastern Europe ($11 743 compared with $9797). All

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Eastern European countries are below the average GDP per capita level for all countries ($14 570). Poland is at the bottom ($5291) closely followed by Romania ($5577). Overall, the general observation is that GDP levels follow the pattern of the two social capital measures: The higher the level of social capital, the higher the level of GDP per capita. Paldam and Svendsen (2006) apply measures of social capital to a number of countries in both Western and Eastern Europe where data will be collected by using a questionnaire for household interviews. They try to relate the level of social capital to detailed individual income information. This is done to estimate how much social capital can explain income and eventually to investigate the potential role of social capital as a new production factor in the economy. The authors compare their findings with the classical production factor of human capital measured as the educational level of the respondent. Here, the preliminary results indicate that social capital indeed enhances economic growth explaining about 5 per cent of income in both Western and Eastern European countries. Such preliminary results are quite remarkable, as most experts tend to agree that human capital explains about half of the economic growth in a country whereas physical capital explains a quarter (Svendsen and Svendsen 2004; for further discussions see Beugelsdijk et al. 2004; Knack and Keefer 1997; Whiteley 2000; Zak and Knack 2001). In other words, social capital may be an important explanatory factor concerning the last ‘missing quarter’ in economic growth theory. However, serious problems concerning measurement techniques must be considered before drawing any final conclusions. For example, the usual problem of causality is present. It may be that society accumulates social capital because the level of income determines the level of social capital. This is in contrast to our starting point and model in Figure 4.1, where it is assumed that social capital determines income. Also, there is a severe risk that our income measures for Eastern Europe underestimate reality. At present, the blooming black economy in Eastern Europe may well mean that individuals earn more than they report officially in our questionnaire (Paldam 2004). Therefore, Paldam and Svendsen (2006) try to perform surveys in more countries to test whether the preliminary results are robust, including direction of causality and quality of income measures.

CONCLUSION The motivation of the chapter was to discuss whether social capital is a new option contributing to sustainable economic growth and social development in any country, and to suggest how it may be created and destroyed. The East–West dimension is most relevant as one implication of European enlargement and

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potential economic growth in these new market economies. Based on institutional economics and social capital theory, we hypothesised that the presence of social capital will enhance economic growth. This is so because more social capital and co-operation between citizens lower the transaction costs and thereby facilitate the informal exchange of goods and services in a society. We derived a theoretical model suggesting that power centralisation over time may lead to less social capital in a society. First, power centralisation means less social capital and co-operation between citizens and between citizens and the state. Second, power centralisation means less social capital due to bureaucracy and higher risk of corruption when formal rules and contracts are not enforced neutrally. The empirical results presented above from the World Values Survey seemed to confirm our hypothesis concerning social capital and the economy. We chose the year of 1991 as a starting point to get as close as possible to 1989 assuming that social capital did not change after the end of communism in Eastern Europe. Our first social capital measure, general trust, suggested that roughly every second person in Western Europe would trust other people in general, whereas every fourth person would do the same in Eastern Europe. Likewise, in our second measure of voluntary organisational density, Western Europe had an average participation rate of more than three times higher than the score for Eastern Europe. Finally, when linking average GDP per capita to these two social capital measures, the general pattern was that the higher the level of social capital, the higher the level of GDP per capita. Overall, Western Europe had about two and a half times higher GDP per capita compared to Eastern Europe. Thus, the simple power centralisation and social capital theory developed here could be one possible explanation for the differences in wealth between Western and Eastern Europe. When Eastern Europe is lagging behind Western Europe in economic terms, this could, according to our model, be explained by the power centralisation during communism again leading to widespread corruption and, eventually, the destruction of social capital. The way for politicians in Eastern Europe to increase social capital would consequently be to decentralise power among democratic institutions thereby increasing the costs of rent-seeking. Of course, such a general claim must be tested further in future research. However, if we apply these results to the current situation in Eastern Europe, long-term economic growth will depend on the creation of social capital between the economic agents. Also, current events in Russia, for example, suggest a fundamental lack of social capital jeopardising future economic growth. Here, politicians need to fight rent-seeking and corruption so that formal institutions are enforced neutrally. False imprisonments of entrepreneurs and arbitrary confiscation of property highlight the need for a more

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decentralised political system with veto actors capable of opposing nonpredictable policy outcomes. In perspective, the level of social capital is likely to be destroyed and not created in a centralised political system. Therefore, the fate of Eastern Europe, which resulted in less voluntary provision of public goods owing to the absence of social capital, could then be a lesson for the urgent need to decentralise power and accumulate social capital eventually improving the general business climate. As it is, a trading partner in Western Europe, the Netherlands for example, is less likely to cheat you than a trading partner in Eastern Europe, Romania for example.

NOTE 1.

I thank the other participants and the organisers at the Trust Conference in Bremen for constructive comments. Also, I appreciate helpful comments from Esben Bergmann Schjødt, Martin Paldam, Christian Bjørnskov, Carsten Daugbjerg, Nanna Alexandrova, Kim Sønderskov, Gunnar L.H. Svendsen and Ann-Marie Gabel. Special thanks to the late Mancur Olson. Last, but not least, I am most grateful to the Danish Social Science Research Foundation for funding our ongoing social capital project. The chapter draws, in parts, on Svendsen (2003). Any remaining errors are mine.

REFERENCES Axelrod, Robert (1984), The Evolution of Cooperation, New York: Basic Books. Beugelsdijk, S., H.L.F. de Groot and A.B.T.M. van Schaik (2004), ‘Trust and Economic Growth: A Robustness Analysis’, Oxford Economic Papers, 56, 118–34. Bjørnskov, C. (2003a), ‘The Happy Few: Cross-Country Evidence of Social Capital and Life Satisfaction’, Kyklos, 56 (1), 3–16. Bjørnskov, C. (2003b), ‘Corruption and Social Capital – Is There a Causal Link?’, paper presented at the European Public Choice Society meeting in Aarhus, April, Denmark. Coase, R.H. (1937), ‘The Nature of the Firm’, Economica, 6, 386–405. Coase, Ronald (1960), ‘The Problem of Social Cost’, Journal of Law and Economics, 3, 1–44. Coleman, J.S. (1988), ‘Social Capital in the Creation of Human Capital’, American Journal of Sociology, 94, 95–120. Fisman, Raymond and Roberta Gatti (2002), ‘Decentralization and Corruption: Evidence Across Countries’, Journal of Public Economics, 83, 325–45. Frey, B. and A. Stutzer (2002), Happiness and Economics: How the Economy and Institutions Affect Human Well-Being, Princeton, NJ: Princeton University Press. Fukuyama, F. (1995), Trust: The Social Virtues and the Creation of Prosperity, London: Hamish Hamilton. Inglehart, R. (1997), Modernization and Postmodernization: Cultural, Economic and Political Change in 41 Societies, Princeton, NJ: Princeton University Press. Inglehart, R., M. Basañez, A. Moreno and M. Moreno (1998), Human Values and Beliefs: A Cross-Cultural Sourcebook. Political, Religious, Sexual, and Economic Norms in 43 Societies. Findings from the 1990–93 World Values Survey, Ann Arbor, MI: University of Michigan Press.

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Knack, S. and P. Keefer (1997), ‘Does Social Capital have an Economic Payoff? A Cross-Country Investigation’, Quarterly Journal of Economics, 112 (4), 1251–88. Olson, M. (1982), The Rise and Decline of Nations, New Haven, CT: Yale University Press. Olson, M. (2000), Power and Prosperity: Outgrowing Communist and Capitalist Dictatorships, New York: Basic Books. Paldam, M. (2000), ‘Social Capital: One or Many? Definition and Measurement’, Journal of Economic Surveys, 14 (5), 629–53. Special issue on political economy. Paldam, M. (2004), The Development of Russia, Poland and the Baltics: Light Ahead after the Change of the Economic System, Cheltenham, UK and Lyme, USA: Edward Elgar. Paldam, M. and G.T. Svendsen (2000), ‘An Essay on Social Capital: Looking for the Fire behind the Smoke’, European Journal of Political Economy, 16, 339–66. Paldam, M. and G.T. Svendsen (2002), ‘Missing Social Capital and the Transition in Eastern Europe’, Journal of Institutional Innovation, Development and Transition, 5, 21–34. Paldam M. and G.T. Svendsen (eds) (2006), Trust, Social Capital and Economic Growth: An International Comparison, Cheltenham, UK and Lyme, USA: Edward Elgar. Putnam, R. (1993), Making Democracy Work: Civic Traditions in Modern Italy, Princeton, NJ: Princeton University Press. Rothstein, B. (2003), ‘Social Capital, Economic Growth and Quality of Government: The Causal Mechanism’, New Political Economy, 8, 49–71. Schjødt, E.B. and G.T. Svendsen (2002), ‘Transition to Market Economy in Eastern Europe: Interest Groups and Political Institutions in Russia’, Nordic Journal of Political Economy, 28 (2), 181–94. Schjødt, E.B. and G.T. Svendsen (2004), ‘Institutionel økonomi og social kapital teori: Et integreret perspektiv på økonomisk vækst’, Politica, 2, 201–16. Smith, A. (1766), ‘Lecture on the influence of commerce on manners’, reprinted in D.B. Klein (ed.) (1997), Reputation: Studies in the Voluntary Elicitation of Good Conduct, Ann Arbor, MI: University of Michigan Press. Svendsen, G.T. (2003), Political Economy of the European Union: Institutions, Policy and Economic Growth, Cheltenham, UK and Lyme, USA: Edward Elgar. Svendsen, G.L.H. and G.T. Svendsen (2003), ‘On the Wealth of Nations: Bourdieuconomics and Social Capital’, Theory and Society, 32 (5), 607–31. Svendsen, G.L.H. and G.T. Svendsen (2004), The Creation and Destruction of Social Capital: Entrepreneurship, Co-operative Movements and Institutions, Cheltenham, UK and Lyme, USA: Edward Elgar. Tanzi, V. (1996), ‘Corruption: Arm’s-length Relationships and Markets’, in G. Fiorentini and S. Peltzman (eds), The Economics of Organised Crime, Cambridge: Cambridge University Press, pp. 161–82. Whiteley, P.F. (2000), ‘Economic Growth and Social Capital’, Political Studies, 48 (3), 443–66. World Bank (2002), The 2002 World Development Indicators CD-ROM, Washington, DC: World Bank. Zak, P.J. and S. Knack (2001), ‘Trust and Growth’, Economic Journal, 111, 295–321.

APPENDIX 30 000

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GDP per capita (1991)

25 000

CHE

20 000 FRA

USA

ISL

BEL

CAN NOR

DNK

AUT

DEU

SWE

NLD

ITA

FIN

GBR

15 000 ESP

IRL

PRT

10 000

SVK LVA ROM

5000

HUN EST

RUS LTU

BLR POL BGR

Eastern European country Western European country

0 0

10

20

30

40

50

60

70

General trust (1991–93) Note: Country code: AUT: Austria; BEL: Belgium; BGR: Bulgaria; BLR: Belarus; CAN: Canada; CHE: Switzerland; DEU: Germany; DNK: Denmark; ESP: Spain; EST: Estonia; FIN: Finland; FRA: France; GBR: UK; HUN: Hungary; IRL: Ireland; ISL: Iceland; ITA: Italy; LTU: Lithuania; LVA: Latvia; NLD: Netherlands; NOR: Norway; POL: Poland; PRT: Portugal; ROM: Romania; RUS: Russia; SVK: Slovak Republic; SWE: Sweden; USA: USA. Source:

Table 4.1.

Figure 4.2

General trust and GDP per capita (Eastern and Western Europe)

30 000

GDP per capita (1991)

25 000

USA

CHE

DNK ISL NOR AUT CAN DEU FRA SWE FIN GBR BEL

20 000 ITA

NLD

15 000 ESP

IRL

PRT RUS

10 000

72

HUN

LTU

LVA

SUK

5000

EST

ROM BGR

Eastern European country Western European country

0 0

5

10

15

20

25

30

35

40

45

Density of organisations (1991–93) Note: See note in Figure 4.2. Source: Table 4.1.

Figure 4.3 Density of organisations and GDP per capita (Eastern and Western Europe)

50

5. A societal view: the institutionalisation of trust Bernhard Lageman INTRODUCTION If we use social categories in economics we always have to solve a translation problem and a problem of understanding. ‘Trust’ seems to be a category that does not fit well into the conceptual patterns of conventional economic theory. Even if institutional economics offer a better framework for the integration of ‘trust’, this remains difficult. In order to model, operationalise and measure trust, one has to reduce it to a simple category that cannot reflect the complexities of real social life (cf., for instance, Yamagichi and Yamagichi 1994). However, analysing trust within the framework of institutional economics delivers useful insights into the phenomenon of trust. The same applies to the application of trust concepts in experimental economics. Nevertheless, in working with strongly reduced trust categories in economics, the task of how to connect economic trust concepts to a greater social context remains challenging. As is clear from the literature and also the contributions to this volume, trust is a complex phenomenon. Different authors define trust in many, sometimes even contradictory, ways. It would be useless to look for an essential meaning of trust because there is no essential meaning (Hardin 1999, p. 24). Therefore, this contribution mainly follows the distinction made by Höhmann and Welter (2004; Welter et al. 2004), that is, differentiating between personal, collective and institutional trust.1 Personal trust is defined as an attitude of an individual towards another person which assumes that the second person will behave in a way which respects the interests of the trusting person. From an economic point of view, the risk aspect of the transactions between the trustee and the trustor gains importance. The existence of trust does not necessarily involve being personally acquainted with the trusted person. Interpersonal trust may be ‘invested’ in another person because both individuals, the trusting and the trusted one, share a common set of values through belonging to the same social group, working in the same branch or acting in the same physical location. In this case we 73

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speak of collective trust. ‘Institutional trust’ refers to the expectations of the trusting person with respect to formal institutions such as local or central governments, laws, judicial institutions, the church, or institutions of basic or higher education. This concept is not identical with, but similar to, the concept of ‘confidence’ as used, for instance, by Luhmann (1988, p. 98). In general, the economic literature associates trust with very positive connotations, similar to the related term of ‘social capital’. This is understandable because most forms of trust appear to contribute to social cohesion and political stability and, from an economic point of view, to economic growth. However, under specific conditions, some forms of trust may also have harmful consequences in economic as well as in social contexts. This is partly due to the relations between different forms of trust, in particular between interpersonal and institutional trust. These relations form the starting point of our discussion in the first section of this chapter. This contribution is of conceptual nature and it is not based on the author’s own empirical work. It discusses theoretical approaches and empirical observations from the literature on trust, in order to develop propositions with regard to the social context of trust. The chapter discusses the societal dimension of trust. It does not deal with the relations between personal trust and the institutional conditions of branch and regional configurations.2 The contribution is structured as follows: the second section deals with the interrelations between factors that determine trust on the individual and social level. The following section analyses the connections between personal trust and institutional settings in the transformation economies. The next sections discuss trust creation and destruction in the wider context of the modernisation process and analyse the influence of the civil society on trust. The final section discusses the importance of interpersonal trust for the economy.

THE INSTITUTIONALISATION OF TRUST Management research on interpersonal trust shows that the best way to generate and strengthen interpersonal trust consists in doing business in order to become acquainted with the strengths and weaknesses and the reliability of the business partner.3 As Dasgupta (1988) states, trust is a resource which is not exhausted but increased through use. However, it would be a mistake to assess personal trust only under the sole perspective of the interpersonal relations of two or more individuals (cf. also the analysis in Nooteboom 2002). Most interpersonal relationships are influenced by the smaller or greater social context within which they develop. So, the question of the social embeddedness of interpersonal trust arises.

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Interpersonal trust on the one hand and institutional trust on the other are not independent but mutually related. Are these relations more of a complementary or a substitutive kind? In the first case, the strengthening of institutional trust would lead to a higher degree of interpersonal trust in the economy. In the second case, an increase in institutional trust would lead to a loss of interpersonal trust. The answer to this question seems to lie in a process of institutionalisation of trust that we can observe in all societies. Interpersonal trust is a ubiquitous element of social and economic life. Starting from the elementary forms of social organisation like families and traditional communities, and going on to more complex forms of social organisation in modern, highly differentiated societies, trust is to a greater or lesser extent always present. There is virtually no social transaction where individuals do not invest some trust in one another. At the same time, interpersonal trust develops along the lines which are drawn by social structure (Eisenstadt and Roninger 1984 [1999]). This implies that trust is embedded in the manifold forms of social organisation, such as small or large families, communities, associations, enterprises, social and economic networks, primordial or ‘artificial’ ethnic communities and, even, nations. Above all, all these forms of social organisation produce trust within the respective group. This might have an exclusive effect with regard to nongroup members, that is, outsiders, which is weaker the more an open-minded attitude to non-group members predominates. The degree of exclusivity depends on the group character, its internal structure and the prevailing group ideology. This means that mechanisms which create trust-like group solidarity may be conducive to advancing economic transactions. At the same time, they may be harmful for developing trusting relationships beyond the group or organisation configurations. Interpersonal trust is involved in most economic transactions. However, it seems to be an essential resource especially in more complex, risky actions in which the chances that an economic player receives the economic gain from acting depends on the trusted person’s actions.

TRUST AND INSTITUTION-BUILDING IN TRANSFORMATION ECONOMIES Raiser (1997; 1999) identified a lack of extended trust as a serious structural deficit of transformation economies. At the same time, there was interpersonal trust of a harmful kind which was caused by ‘old comrade networks’. This term describes the weakness of institutions in the first years of the transition process. The old centralistic and bureaucratic communist state had been destroyed by the peaceful revolutions in the Central European countries and

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by the implosion of Soviet power in Russia. However, during the first phase of transition, the new emerging democratic state could not fully replace the old institutions. New laws had to be passed and implemented, and initially they did not function properly. Undoubtedly, there was a considerable degree of anomy, which weighed heavily on the economy and society. The people’s confidence in central institutions, but also in regional and local ones, was rather limited under such circumstances. The situation improved fundamentally in the Central European economies when market institutions were consolidated during the 1990s. These countries made remarkable progress in building up an institutional set of laws, regulations, executive and legal institutions, which are indispensable for a modern market economy. In this way, the framework for entrepreneurial activities has essentially improved during the 1990s, allowing for the creation of start-ups and young dynamic firms, the restructuring of privatised firms, direct investments in technically progressive industrial branches and, finally, a remarkable rate of economic growth after years of economic decline. These efforts were crowned by the early access to the European Union of the eight Central European economies (CEE) in 2004. One might assume that this quick consolidation of market institutions in CEE countries would lead to a higher degree of social trust in these countries. But this assumption is not supported by empirical findings (Inglehart 1998; 1999), which show that there still remains a remarkable gap in the level of measured trust between Central Eastern and Western Europe. Nevertheless, the lower level of social trust in Eastern Europe does not prevent owners of newly founded enterprises and foreign investors from engaging in a vast range of entrepreneurial activities. The marked differences between these transition economies4 of Central East Europe and the western part of Europe are gradually disappearing, which gives rise to the hope that the huge economic gap between old and new European Union (EU) members is closing in the next decades. The flourishing of entrepreneurial activities in the CEE would not be possible without a sound base of interpersonal trust. This assumption is confirmed by the experiences of investors from developed market economies who increasingly find conditions in the economic life of CEE to be very similar to those in Western Europe. The self-reinforcing development of interpersonal trust in the CEE seems to be independent of the rather low level of social trust identified by Inglehart and others. The explanation for these differences between micro-level interpersonal trust and the lack of social trust is the consolidation of market economy institutions. The existence of widely accepted rules in economic life is important for economic players.

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A WIDER LOOK ON TRUST: THE MODERNISATION PROCESS The process we describe here as the ‘institutionalisation of trust’ is not connected with any special type of society, but can in principle be found in all societies starting with primitives ones. To use Luhmann’s (1968) words, trust is a ‘mechanism of the reduction of social complexity’. Nevertheless, the patterns of this institutionalisation become more manifold and diverse with a growing degree of social complexity. In a more complex and differentiated society, social systems, that is, political, economic and religious ones, become independent of each other, and there are more formal and informal organisations which can produce trust among their members and the entire society. But there is one societal process which creates a totally different framework for producing trust: this is the process of modernisation.5 It is certainly true that the concept of modernisation has been discussed very critically during the last decades in social sciences and especially in development sociology. However, today most researchers will agree that there is something like modernisation expressing itself in industrial production techniques, (almost) full literacy and a high degree of social differentiation, that is, a state based on a strong and effective bureaucracy. The social embodiment of modernity is very different and the paths of modernisation are not identical (Eisenstadt 1979; 2000). Nevertheless, different modern societies like the European, the American, Japanese or Chinese societies share some common features. One common characteristic is a high degree of bureaucratisation and the penetration of all spheres of social life by rational reasoning and rational patterns of organisation. Its origin and genesis were analysed by Max Weber as the ‘process of rationalisation’, which all modern societies have experienced during the last centuries and are still experiencing (Weber 1921 [1976], p. 196). Rationalisation is connected with the development of the modern state and the codification of law and, in this context, the creation of commercial law. The latter forms the fundament of economic transaction in modern market economies. It reduces the dependence on former intermediate arrangements concerning good business behaviour. The importance of interpersonal trust for entrepreneurial decisions is drastically reduced and, at the same time, a wide range of new entrepreneurial opportunities based both on economic regulations, which ‘institutionalise’ trust, and interpersonal trust arises. Thus, on the one hand, the arrangements offered by the modern state, for example, formal and informal institutions making economic behaviour predictable, replace interpersonal trust. On the other hand, the emergence of interpersonal trust relations in business life is supported by modern institutions. Institutional trust, or, expressed in another way, confidence in institutions (Luhmann 1968; 1988), and interpersonal trust support one another in a ‘virtuous circle’.

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Does the rise of modern institutions in the Weberian process of societal rationalisation lead to a decline of traditional arrangements which institutionalised trust in pre-modern societies? The answer is, in so far as communitybased structures of the traditional modern society are weakened and the society replaces them (a process analysed by Tönnies 1935 [1979]), formerly well-established forms of collective trust will weaken or disappear. Of course, modern traders and industrialists do not need associations like the Hansa in the regions bordering the Baltic Sea, and there is no place for such associations in modern states. But many forms of formal and informal arrangements between economic players which institutionalise trust on an intermediate level situated between enterprises and the state still survive in modern economies. These institutions generate and guarantee in our terminology ‘collective trust’. They can take on very different forms, comprising enterprise networks, unwritten codes of conduct in industrial branches as well as branch-level or regional associations. Similar to institutional trust, which is related to the modern bureaucratic state, collective trust reduces the importance of interpersonal trust and at the same time opens up new possibilities of developing interpersonal trust. Again, both forms of trust are substitutes within the framework of certain situations and they are complements in other situations. Here, one should have in mind one basic implication of the substitution of interpersonal trust with collective and institutional trust: modern institutions organise business life on a higher, more complex level. The idea that one could renounce modern economic law and replace institutional trust with interpersonal trust is absolutely misleading. Therefore, weakening state-bound formal economic institutions would lead to a decline of institutional trust in economic life. According to Inglehart’s analysis of socio-economic change in the developed world, this part of the world has entered a phase of ‘postmodern’ development. Postmodernisation is characterised by marked changes of value systems and styles of life. The importance of individualistic values such as self-fulfilment and life quality increases. The new, postmodern value system is also marked by a lesser respect for functional rationality (Inglehart 1998, pp. 448–54). The trend towards bureaucratisation, centralisation and governmental engagement in the postmodern economy has reached its limits. Leaving aside the question of whether this analysis of the role of the state in postmodern economies is true, the possible consequences of postmodernity for interpersonal trust are open to discussion. At first glance, one could think that questioning functional rationality might weaken the reliability of formal institutions. In this way, the basis for interpersonal and collective trust could erode. But this consequence does not seem to be inevitable. A more relaxed relationship towards bureaucratic regulation might even strengthen the efficiency of formal institutions. This corresponds to Inglehart’s finding that personal trust

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is stronger among individuals who share post-materialist values. At the same time the diffusion of postmodern values opens the road for strengthening the organisations and institutions of civil society. Institutionalising trust by building up modern institution is by no means an irreversible process. The weakening of modern institutions, which guarantee the normal functioning of business life, would inevitably lead to a loss of economic vitality. There are examples of such vicious circles of institutional and economic decline. One example is the fate of the early Latin American welfare states Uruguay and Argentina in the twentieth century. Another example is the economic development and the breakdown of democracy in Central Europe after the great depression. The institutional deficits created by communist regimes in transition economies provide yet another example illustrating the harmful consequences of a lack of or fundamental weakness in the formal and informal institutions which form the organisational framework of the market economy. There is no chance that interpersonal trust could ever compensate for such deficits. Here, the question arises as to the effects that the decline of social trust in American society diagnosed by Putnam (2001) and other authors could have on the American economy. Above all, this is related to the connection between economically relevant forms of trust and the civil society.

CIVIL SOCIETY AND TRUST There seems to be no better social ground for the development of interpersonal trust relations than among the civil society. This concept was first formed in a political science context. Civil society is formed of civilian associations reaching from local clubs of all kinds to interest groups and to religious and philanthropic enterprises of all sorts. There are at least two broad versions of the concept ‘civil society’ (Foley and Edwards 1996, p. 39). The first puts emphasis on the virtues of associations fostering civilian attitudes and patterns of behaviour of citizens in a democratic polity. Thus, the civil society forms the basis of a democratic state and there is no contradiction, but rather harmony, between civilian associations and (democratic) government. This concept of a ‘civil society’ found its most renowned and authentic expression in Tocqueville’s Democracy in America (1976, esp. pp. 595–9) and was revived in the twentieth century in the political sciences (cf., for instance, Almond and Verba 1963; Gellner 1995). A second and more recent version of the argument for a civil society was formed in relation to the resistance against communist and authoritarian regimes in Eastern Europe, especially Poland, and in Latin America. Here the emphasis is placed on the role of civil society as a counterweight to an authoritarian state.

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In his analysis of the civic traditions of modern Italy, Putnam (1993, pp. 152–62) links the stronger civic traditions of Northern and Central Italian regions to their higher economic performance compared to Southern Italy. His argument is as follows: a higher degree of civic involvement, as measured, for instance, in the strength of mass parties, the incidence of co-operatives and the membership in mutual aid societies, leads to a higher level of social trust, which in turn fosters economic development. For Southern Italy Putnam identifies a fundamental lack of trust, which impedes civil engagement and entrepreneurial activities in the economic field. Putnam’s analysis was criticised for exaggerating the differences among Southern and Northern Italy (Foley and Edwards 1996). Another point of criticism referred to the fact that he did not do justice to the role and importance of political associations like political parties in Italian social life. His recent analysis of the development of civil society in the USA (Putnam 2001) was subjected to even more criticism, which mainly pointed out that he had neglected important and growing parts of the American civil society because of his concentration on certain, more traditional, segments. Although there is no doubt that a thriving civil society has generally had a positive influence on democratic government and may contribute positively to the democratisation of authoritarian regimes, the connection between civil society and democracy seems to be more intricate than admitted by some observers. Ehrenberg (1999, pp. 233–55) points to the complexities of civic institutions, which fulfil different roles under different historical situations and do not always strengthen democratic politics. The question arises whether the same ambivalence can be observed with respect to the economic effects of civil society. In his analysis of the Sicilian Mafia, Gambetta (1988; 1993) demonstrates how a fundamental lack of trust in society leads to the business of ‘private protection’. This lack of ‘social trust’ is due to the weakness of formal and informal institutions which in modern states normally safeguard a wellfunctioning business life. This is reinforced and may be explained historically by the weakness of the civil society. In such a situation, the vacuum created by a weak state is filled by a harmful kind of collective trust, which is ‘perversely’ created within and by clientelistic Mafia networks. In this context, we can observe another, darker side of collective trust.6 Criminal networks and gangs also employ collective informal institutions which regulate interpersonal relations and facilitate the development of interpersonal trust inside these groups. Here, collective trust facilitates the development of interpersonal trust relations which are obviously harmful for social cohesion and economic development. Another weakness of a one-sided perspective on civil society is that the concept has been developed in the cultural context of Western Europe and the USA. The organisations which form civil society are seen and interpreted through Western eyes. The assumption seems to be reasonable that under other

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cultural conditions like those in Asian or Middle Eastern societies civic culture may develop other types of associations and may be generated in a different way. As Van Roy and the contributors to his anthology (Van Roy 1998) show, the attempt to transmit European civic institutions to developing countries has often failed. This happens in those cases where the cultural environment of these countries is not adequately taken into consideration. Indeed, there seems to be a culturally specific component in most concepts of civil society. These concepts can even degenerate to pure ideology if applied to totally different social contexts (for the failure of efforts to establish civil society organisations in sub-Saharan Africa cf. Chabal and Daloz 1999, pp. 22–30). This does not fundamentally question the importance of civic associations for building up democratic states and economic development in developing countries. But it should be taken into consideration if one is trying to develop a civil society in these countries from the outside. As Unger (1998, pp. 168–71) demonstrates with the example of the Thai economy, civic and economic institutions must be well embedded in the culture and society of the corresponding country if they are to exert a positive influence on social cohesion and economic development. The associations of the civil society may positively influence the development of interpersonal trust in the economic sphere. This applies naturally to all groups and associations which are connected with economic activities, like professional associations and trade unions. But at the same time and under certain circumstances these groups can also exert a negative influence on economic activity, as Olson (1982) shows. Their interactions may lead to rigidities on the factor and product markets of the kind which West European economies are now having to confront. It is also worth remembering Adam Smith’s scepticism towards associations of industrialists who join their forces to undermine free competition. Here again, civic institutions have at least two faces: one which fosters social cohesion and strengthens the market economy, and a second which undermines both. So, the merits of civil society should be assessed realistically. It has contributed in a substantial way to the rise in democracy and to the modern market economy. Civil society, which expresses itself in very different forms in various societies, is absolutely necessary for the functioning of modern institutions, but under certain circumstances it may also be the source of burdens for the development of market relations.

BACK TO ECONOMICS: DO WE REALLY NEED INTERPERSONAL TRUST? The previous discussion raises doubts as to whether trust can be dealt with as a homogenous resource. Interpersonal trust is based on an estimation of a

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person’s reliability by the trusting individual. Interpersonal trust may be supported by collective trust, the confidence which is invested by the players into the rules of the group in which they are participating. Finally, interpersonal trust may also be backed up by institutional trust, which means confidence in those institutions of the market economy which have been created and are guaranteed by the state. In all these cases trust is defined in a different way. The sociological literature on trust delivers even more versions of the concept of trust, which have little in common with the economically relevant forms of trust. Civic associations may create, for the people who participate in them, a specific, narrowly limited ‘high-trust milieu’. In most cases, this will not have any influence on the behaviour of people in the economic sphere. Social trust, which is, according to Putnam (2001), apparently shrinking in the USA, only has minor importance for the economy, if at all, at least as long as the institutions guarantee the smooth functioning of the market economy. Interpersonal trust is necessarily involved in all more complicated economic transactions and economic organisations, like firms, that cannot function adequately without trust. But serious doubts arise as to whether interpersonal trust can ever be a sufficient base for more complex economic transactions. Pre-modern societies seem to have invented structural devices to make provisions against opportunistic economic behaviour. So, they render risky transactions possible without relying exclusively on interpersonal trust. By constructing formal and informal institutions they create the basis for ‘collective trust’. In modern societies the state plays a great role in creating a reliable framework for complex economic transactions. Parallel to the state, intermediate institutions at sector and regional level create provisions for a frictionless economic life. Under these circumstances, what do we need interpersonal trust for? In fact, formal institutions in the national economy and the informal institutions of sectors and regions create a framework for economic players in which important economic transactions do not depend merely on interpersonal trust. In other words, institutional and collective trust, or, to use a related term, confidence in formal and informal institutions, replace personal trust. At the same time, new possibilities for the development of interpersonal trust are opened up. The range of realistic economic opportunities is extended and the production possibility curve moves to the right. But one needs to emphasise that here we are talking about very special trust configurations and are not referring to something like a general trust level in society. Thus, on the one hand, the decline of trust in American society, as measured in empirical investigations by Inglehart and Putnam, does not seriously endanger the dynamics and efficiency of the economy. On the other hand, a fall in the reliability and credibility of institutions, which cannot be demonstrated

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with regard to the USA or in the European Union at present, would heavily impair interpersonal trust in the economy on all levels, thus resulting in negative effects on economic dynamics. Here the question arises as to whether trust-building may be enforced by political action. Remember the discussion about ‘good governance’, which was advanced by the World Bank and the International Monetary Fund (IMF) (Schweickert and Thiele 2004; World Bank 2001) some years ago. According to this concept, an essential task of good governance is to lay institutional foundations for an enterprising society in which people can be confident in their institutions and trust the reliability of other economic players who like themselves work in a framework of the order of law. Thus, governments had to create a favourable climate for entrepreneurial activities. As far as formal institutions are concerned, the strong influence of ‘good’ politics may be assumed. This concerns, for instance, the creation of well-functioning legal institutions or the fight against corruption. But in other areas which are connected to the creation of interpersonal trust, the chances of influencing trust-building seem to be rather limited. To reduce this to a simple formula: policy may create a good institutional environment for a high level of interpersonal trust, but it cannot ‘create’ trust.

CONCLUSIONS This contribution discussed the societal dimension of interpersonal trust. The key for a correct understanding of the relations between interpersonal trust and collective and institutional trust is the ‘institutionalisation of trust’. Trust is institutionalised in all societies by creating formal and informal institutions, which make the actions of other human beings calculable and reliable for the individual. In the context of the modernisation process, the modern bureaucratic state takes on a central role in securing a reliable framework for entrepreneurial activities. Complex economic transactions always presuppose interpersonal trust, but they cannot be based on personal trust alone. Stable and well-organised institutions are required in a market economy for a good business life. The relations between the societal and individual dimensions of trust are mainly discussed in the literature with respect to the favourable influence of civil society on trust and the development of institutions in transformation economies. Indeed, there are important interconnections between civil society and trust, but they seem to be more complicated than discussed in the public discourse on civil society. The weakness of formal institutions in transformation economies, at least in the initial phase of transformation, makes interpersonal trust an essential resource for certain risky entrepreneurial actions, but at

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the same time restrains the level of interpersonal trust. From a Weberian developmental perspective, the dominating forms of interpersonal trust depend on setting up modern bureaucratic institutions. In modern economies most economic transactions are based on institutional trust (namely, the stability of and confidence in institutions). They do not require the high level of interpersonal trust which is decisive for economic action in developing societies, thus rendering it a scarce resource in these societies.

NOTES 1. 2.

Cf. also Höhmannn and Malieva (Chapter 1 in this volume). The regional/cultural and sectoral dimensions of trust are dealt with by Welter (Chapter 2 in this volume). 3. Cf. Kautonen and Welter (Chapter 13 in this volume) and Dei Ottati (Chapter 15 in this volume) for the importance of experience and learning processes for the development of interpersonal trust in business networks. 4. The economic and political situation in most parts of the former Soviet Union (for example in countries such as Russia, Belarus and the Ukraine) differs fundamentally from the CEE countries. They still have to go a long way to reach the degree of institutional consolidation of CEE countries. 5. The differences between ‘modern’ and ‘traditional’ should not be overrated. In fact, the ‘traditional’ societies which can be found today are always a mixture of ‘modern’ and ‘traditional’ elements. 6. See Tonoyan (Chapter 3 in this volume), for a more detailed discussion on the ‘dark side of trust’.

REFERENCES Almond, Gabriel A. and Sidney Verba (1963), The Civic Culture: Political Attitudes and Democracy in Five Nations, Boston, MA, and Toronto: Little, Brown & Company. Chabal, Patrich and Jean-Pascal Daloz (1999), Africa Works: Disorder as Political Instrument, Oxford, and Bloomington and Indianapolis, IN: International African Institute in association with James Currey and Indiana University Press. Dasgupta, Partha (1988), ‘Trust as Commodity’, in Diego Gambetta (ed.), Trust: Making and Breaking Cooperative Relations, New York and Oxford: Basil Blackwell, pp. 49–72. Ehrenberg, John (1999), Civil Society: The Critical History of an Idea, New York and London: New York City University Press. Eisenstadt, S.N. (1979), Tradition, Wandel und Modernität, Frankfurt am Main: Suhrkamp. Eisenstadt, S.N. (2000), Die Vielfalt der Moderne, Heidelberger Max-WeberVorlesungen 1997, Weilswist: Velbrück. Eisenstadt, S.N. and L. Roninger (1984), Patrons, Clients and Friends: Interpersonal Relations and the Structure of Trust in Society, Themes in Social Sciences, Digital Reprint 1999, Cambridge: Cambridge University Press.

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Foley, M.W. and B. Edwards (1996), ‘The Paradox of Civil Society’, Journal of Democracy, 7 (3), 37–52. Gambetta, Diego (1988), ‘Can We Trust Trust?’, in Diego Gambetta (ed.), Trust: Making and Breaking Cooperative Relations, New York and Oxford: Basil Blackwell, pp. 213–37. Gambetta, Diego (1993), The Sicilian Mafia: The Business of Private Protection, 3rd edn 1998, Cambridge, MA, and London: Harvard University Press. Gellner, Ernest (1995), Bedingungen der Freiheit: Die Zivilgesellschaft und ihre Rivalen, Stuttgart: Klett-Cotta. Hardin, Russell (1999), ‘Do We Trust in Government?’, in Mark E. Warren (ed.), Democracy and Trust, Cambridge: Cambridge University Press, pp. 22–41. Höhmann, Hans-Hermann and Friederike Welter (2004), Entrepreneurial Strategies and Trust: Structure and Evolution of Entrepreneurial Behavioural Patterns in ‘Low Trust’ and ‘High Trust’ Environments of East and West Europe, Part 1: A Review, Arbeitspapiere und Materialien, 54, Bremen: Forschungsstelle Osteuropa. Inglehart, Robert (1998), Modernisierung und Postmodernisierung. Kultureller, wirtschaftlicher und politischer Wandel in 43 Gesellschaften, Frankfurt am Main and New York: Campus. Inglehart, Robert (1999), ‘Trust, Well-being and Democracy’, in Mark E. Warren (ed.), Democracy and Trust, Cambridge: Cambridge University Press, pp. 121–50. Luhmann, Niklas (1968), Vertrauen: Ein Mechanismus der Reduktion sozialer Komplexität, Stuttgart: Ferdinand Enke. Luhmann, Niklas (1988), ‘Familiarity, Confidence, Trust: Problems and Alternatives’, in Diego Gambetta (ed.), Trust: Making and Breaking Cooperative Relations, New York and Oxford: Basil Blackwell, pp. 94–107. Nooteboom, Bart (2002), Trust: Forms, Foundations, Functions, Failures and Figures, Cheltenham, UK, and Lyme, USA: Edward Elgar. Olson, Mancur (1982), The Rise and Decline of Nations: Economic Growth, Stagflation and Social Rigidities, New Haven, CT, and London: Yale University Press. Putnam, Robert D. (1993), Making Democracy Work: Civic Traditions in Modern Italy, Princeton, NJ: Princeton University Press. Putnam, Robert D. (2001), Bowling Alone: The Collapse and Revival of American Community, New York: Simon & Schuster. Raiser, Martin (1997), ‘Informal Institutions, Social Capital and Economic Transition: Reflections on a Neglected Dimension’, EBRD Working Paper, 25, London: EBRD. Raiser, Martin (1999), ‘Trust in Transition’, EBRD Working Paper, 39, London: EBRD. Schweickert, Rainer and Rainer Thiele (2004), From Washington to Post-Washington?: Consensus Policies and Divergent Developments in Latin America and Asia, Kieler Diskussionsbeiträge 408, Kiel: Institut für Weltwirtschaft. Tocqueville, Alexis de (1976), Über die Demokratie in Amerika [Democracy in America], München: Deutscher Taschenbuchverlag. Tönnies, Ferdinand (1935), Gemeinschaft und Gesellschaft: Grundbegriffe der reinen Soziologie (1979 edition), Darmstadt: Wissenschaftliche Buchgesellschaft. Unger, Danny (1998), Building Social Capital in Thailand: Fibers, Finance, and Infrastructure, Cambridge: Cambridge University Press. Van Roy, Alison (ed.) (1998), Civil Society and the Aid Industry, London: Earthscan. Weber, Max (1921), Wirtschaft und Gesellschaft: Grundriss der verstehenden Soziologie, textbook edition (1976), fifth revised edition edited by Johannes Winckelmann, Tübingen: J.C.B. Mohr (Paul Siebeck).

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Welter, Friederike and Hans-Hermann Höhmann (2004), Vertrauensbeziehungen in KMU: Ergebnisse eines länderübergreifenden Forschungsprojekts, RWI: Materialien 10, Essen: RWI. World Bank (2001), Building Institutions for Markets, World Development Report 2001. Oxford: Oxford University Press. Yamagichi, Toshio and Midori Yamagichi (1994), ‘Trust and Commitment in the United States and Japan’, Motivation and Emotion, 18 (2), 129–66.

6. Measuring trust and trustworthiness Jonathan Leland, Daniel Houser and Jason Shachat1 INTRODUCTION Social scientists have long held the view that trust has a significant influence on the economic prosperity of nations. But researchers have only recently started to find empirical support for this belief. Up to now this empirical research has relied on measures of trust derived from responses to a very simple survey question. These measures are subject to two criticisms. The first concerns the meaning of the responses upon which they are based – what aspects of trust do responses to this question reveal? The second concerns whether the question is interpreted in the same manner across individuals and, more to the point, across cultures. In this chapter we propose that these problems are unavoidable – motivations for exhibiting a behaviour one might interpret as reflecting ‘trust’ can differ depending on the context in which the behavior occurs. We propose that these different motivations underlying trust can be understood and unconfounded using different scenarios drawn from the literature on game theory. We then examine how best to go about measuring trust in these different settings for the purposes of understanding if and how it might contribute to economic well-being. The chapter is developed as follows: first, we review common arguments as to why and how trust might contribute to economic prosperity as well as the literature indicating that trust, as measured by survey responses, does, indeed, have the expected effect. We also review some of the concerns that have been expressed regarding the measures of trust used in these studies. Then we define trust as expectations regarding benevolence of others and, propose a tripartite distinction as to the motives individuals might have for behaving benevolently. We show how situations involving each of these different motivations can be defined and understood in the context of a scenario drawn from game theory. Finally, we discuss how trust as defined in each of these settings might contribute (or undermine) economic well-being and how each might best be measured. 87

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TRUST AND ECONOMIC PERFORMANCE Differences in the prosperity of nations or regions relative to others have proven difficult to explain in terms of differences in standard economic variables like quantities and qualities of labour or capital. During the 1990s, a number of social theorists (for example, Fukuyama 1995; Putnam et al. 1993; Putnam 1995; 2000) argued that these differences could be explained by differences in what is called social capital. Social capital is a composite term reflecting attributes shared within groups that promote co-operative behaviour. Trust is one component of social capital. Civic-mindedness and participation in associational activities are others. Putnam (1993) made the case for the importance of social capital based on an examination of the performance of governments in different regions of Italy all established in the 1970s and all sharing a similar structure. The similarities in structure notwithstanding, there were dramatic differences in the performance of these institutions going forward. Moreover, these differences in performance did not stem from ‘the usual suspects’ – difference in political attitudes, differences in economic endowments, or idiosyncratic changes in demographics owing to things like immigration or out-migration. Instead, performance differences resulted from differences in how civic-minded and trusting the different regional populations were as reflected in things like levels of membership in social and community organisations. In regions where civic-mindedness and trust were high, mostly in Northern Italy, governments performed well. In regions where levels of civic-mindedness and trust were low (for example, Sicily and Calabria), performance was poor. Fukuyama (1995) makes a very similar argument on an international level, suggesting that the superior performance (at least as of the date of the book) of Japan, West Germany and, with caveats, the USA, relative to countries like France, Italy and South Korea was the result of the populations of the former countries being more trusting.2 Claims regarding the economic significance of social capital were initially met with scepticism by some people, particularly, economists. Nobel laureate Robert Solow (1995), for example, argued that it amounted to no more than a ‘buzzword’ with no means of measuring it, but means were developed. Knack and Keefer (1997) wrote a particularly influential article in this regard. In it they examined the contribution of three aspects of social capital – trust, civicmindedness and associational activity – in explaining economic growth rates and investment rates across 29 countries with market economies. To measure trust in each of these countries, they used the percentage of each country’s respondents that answered affirmatively to the following question posed in the 1981 and 1990–91 World Values Survey (WVS):3 ‘Generally speaking, would you say that most people can be trusted, or that you can’t be too careful in dealing with people?’

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Civic-mindedness and associational activity were measured as indices created from respondents’ answers to questions involving whether a person would engage in un-civic actions (for example, avoiding a fare on public transportation, cheating on taxes if given the chance) and whether the person belonged to various groups or organisations (for example, religious or church groups or political parties), respectively. Knack and Keefer then conducted regression analyses examining the impact of these measures on average annual growth in per capita income and investment rates for 1980 to 1992. They found that trust contributes significantly to economic growth, as did civic-mindedness. Contrary to Putnam’s (1993) finding in Italy, associational intensity did not contribute to economic success. Knack and Keefer emphasise the role of trust in reducing the need for monitoring and writing of detailed contracts. Such cost reductions increase the profitability of existing trades and make otherwise unfeasible trades feasible. These cost reductions may also promote productive efficiencies as they allow for greater specialisation and may increase span of control. Dakhli and De Clercq (2002) present evidence that countries with more trusting populations may be more likely to spawn innovations. Specifically, they find that countrylevel innovation as measured by the number of patent applications filed and the percentage of high-technology exports relative to total manufactured exports in different countries are positively related to generalised trust and institutional trust. Huang et al. (2003) find that trust promotes Internet adoption. To the extent this technology enhances productivity, the impact of trust on its adoption positively influences economic prospects. To summarise, studies based on responses to the trust question contained in the WVS suggest that trust contributes to economic prosperity through a variety of mechanisms. In order to understand the true magnitude of the impact trust has on social outcomes (such as economic growth) and, more importantly, to anticipate the effect changing the level of trust will have on such social outcomes, more refined measures of trust are needed. This, in turn, requires we ascertain what people have in mind when they answer the trust question and, as such, what their responses are reflecting – a problem to which we now turn.

TRUST: MEANING, MOTIVES AND GAMES In common usage, the word trust concerns expectations that another person will behave in an honest and benevolent manner.4 People may, however, exhibit benevolent behaviour for different reasons. It may be in a person’s personal self-interest to do so. In this context, laws do a lot to create circumstances

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where honesty and benevolence (or at least not malevolence) is the best policy. So, too, does the prospect of future interaction. Alternatively, a person might choose to be good and/or honest because he or she receives psychic utility from the benefits doing so bestows on others. Yet a third possibility is that people behave honestly and benevolently in the expectation that such behaviour will be reciprocated. Responses to the WVS question do not allow us to discriminate between these different motivations for trust. Doing so, instead, requires much more precise descriptions of the context in which behaviours and preferences will be revealed. To this end, consider the game in Figure 6.1 where, for reasons to become apparent in a moment, the actions available to players are denoted ‘Don’t give’ and ‘Give’. In this game, referred to as the ‘Prisoners’ Dilemma’, players face a knotty problem. To see why, note that for the two players jointly, the best possible outcome would be for both to ‘Give’ as both would then receive a payoff of $10. However, this strategy pair is not an equilibrium, since starting from this point, each player would unilaterally prefer the ‘Don’t give’ option as their payoff would increase to $12. ‘Don’t give’ is a dominating strategy for each player in that it is the best option independent of the other player’s behaviour or strategy. Unfortunately, if both players do so, they wind up at $5, $5. This is the equilibrium outcome for the game in that once this outcome is achieved, neither player has an incentive to change strategies unilaterally. Unfortunately, it is socially ‘deficient’ – both players would prefer if they could have achieved the outcomes associated with ‘Give/Give’. The Prisoners’ Dilemma provides the basic framework for distinguishing between the different motivations people might have for exhibiting honest and/or benevolent behaviour. To begin, note that there are, in essence, three ways to solve the Prisoners’ Dilemma. One, favoured by Thomas Hobbes (1651) and much later by Hardin (1968) and many others, involves converting the dilemma into a non-dilemma though the use of side-payments and sidepenalties. In this approach, it is the role of some central authority (for example, the government) to convert the game – its authority to coerce having been Player 2 Don’t give

Give

Don’t give

$5, $5

$12, $0

Give

$0, $12

$10, $10

Player 1

Figure 6.1

A Prisoners’ Dilemma

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Player 2 Don’t give

Give

$5 – $5, $5 – $5

$12 – $5, $0

($0, $0)

($7, $0)

$0, $12 – $5

$10, $10

($0, $7)

($10, $10)

Don’t give Player 1 Give

Figure 6.2

Solving the Prisoners’ Dilemma

mutually agreed upon by the players. In the context of the game in Figure 6.1, the coercion might involve making ‘Don’t give’ illegal and subject to a $5 fine, the consequences of which are shown in Figure 6.2. Note that now it is a dominating strategy for both individuals to give, good or benevolent behaviour comes about because it is in each player’s self-interest to pursue it. An alternative way of converting the dilemma into a non-dilemma, proposed by Axelrod (1984), involves playing the game many times with the same partner. What Axelrod showed was that with repetition it might pay for purely egoistic players to co-operate with each other as the benefits accrued by doing so would exceed those that would result from defecting even if their partner initially co-operated. For this to occur the future has to be sufficiently important and the date of the last game uncertain, otherwise the incentives to ‘not give’ in the last period would propagate back to imply not giving in the first game. Mutual coercion, mutually agreed upon, and repetition solve the dilemma problem by converting the situation to a non-dilemma in pay-offs. An alternative solution is to convert the matrix to a non-dilemma in players’ satisfaction or utilities. This can come about if people are altruists in that they receive satisfaction or utility from the well-being of others. Alternatively, it may be that they receive satisfaction or utility – a ‘warm glow’ to use Andreoni’s (1989) term – from the act of behaving in a co-operative or altruistic manner. Such a ‘warm glow’ might be taught through appeals to conscience or selfesteem. In either case, the result is the same – the matrix in Figure 6.1, although a dilemma in pay-offs, is a non-dilemma in utilities (that is, it looks like the matrix in Figure 6.2 but with outcomes in utils rather than dollars) and ‘Give’ is the dominant strategy for both players. The Prisoners’ Dilemma provides an ideal framework for representing

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situations in which individual incentives clash with those which would maximise the group outcome. It does not, however, lend itself to understanding the role of expectations of reciprocity in producing benevolent behaviour to the extent that the players’ moves are simultaneous. Berg et al. (1995) propose a sequential, one-sided version of the Prisoners’ Dilemma, termed a ‘trust game’ which does allow us to examine expectations. In this game, Player 1 is told that he and another person with whom he is matched (Player 2) have each been given $100. He is now given an additional $50. He may keep the entire $50 or send some portion of it to the other person. The experimenter triples any amount he chooses to send so, for example, if Player 1 sends $10, Player 2 receives $30. Player 1 respondents are told that Player 2 will have the opportunity to send some portion of the money received back, although they are not required to do so. The Player 1 respondent is then asked how much he would send to Player 2 and, for that amount tripled, Player 2 is asked how much he would send back. Economic theory predicts that a self-interested rational Player 1 will keep the entire amount of money for himself, and if Player 2 does receive any money he will not send any back. In actual play of this game, Player 1s send positive amounts and Player 2s reciprocate by sending money back. Amounts sent are commonly taken as measures of trust – indications that Player 1 expects Player 2 to reciprocate. Likewise, amounts sent back reflect trustworthiness – the extent to which money sent elicits an obligation to reciprocate on the part of Player 2.

TRUST IN ITS VARIOUS CONNOTATIONS: IMPLICATIONS FOR ECONOMIC PERFORMANCE AND METHODS OF MEASUREMENT Having now distinguished between the different motivations people might have for expecting others to be benevolent toward them, we are in a position to identify how trust in each of these different circumstances might contribute or limit economic growth and define precise ways of measuring differences in each across cultures. To begin, note that benevolence resulting from the existence of effective formal and/or informal sanctioning authorities and benevolence as a result of the expectation of repeat interaction are both characteristics of the economic milieu in which individuals interact. Information regarding trust motivated by such incentives should be gleaned though information at the economy level. Predictions regarding the impact of formal and informal sanctioning bodies on economic prosperity will depend on the nature of the body. Clearly governmental sanctioning bodies like the judiciary will promote growth to the extent

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that they protect property rights and enforce contracts. There are a variety of indices available to measure governmental quality in general, and effectiveness of property rights enforcement in particular. Knack and Keefer (1995), for example, constructed an index exemplifying the latter based on commercially provided measures of political risk. They found that this index was significant in predicting differences in economic growth and investment across countries. The implications on economic prosperity resulting from smaller-scale entities enforcing norms are ambiguous. These bodies will expedite exchanges within the relevant group by converting dilemma situations into non-dilemmas. This may produce net economic benefits to the extent that the transactions costs associated with the good or service would simply preclude its provision without some sort of cartel or other form of repeat trade mechanism. The diamond trade – a trade historically dominated by Orthodox Jews and largely closed to entry by others – may illustrate this situation.5 If, on the other hand, limiting exchanges to a small circle of trading partners (implementing the Axelrod solution to dilemmas) exacts economic losses in terms of exchange opportunities forgone that exceed the benefits associated with existing exchanges occurring successfully, the net effect of such groups will be negative. Yamagishi and Yamagishi (1994) argue that the tendency of Japanese businessmen to solve dilemma problems through commitments to repeat play produce just this outcome. Taken together, these observations regarding smallscale or informal sanctioning bodies and networks of mutually committed transactors may explain why evidence regarding the contribution of associational affiliations to growth is so mixed. Altruism and expectations regarding reciprocity are attributes of individuals and, as such, should be measured at the individual level. A number of recent studies have used the trust game described in the prior section to ascertain how trusting people are in terms of their expectations regarding other’s reciprocity as well as how trustworthy those in the position to reciprocate really are. Glaeser et al. (2000) and Danielson and Holm (2002) have used the amounts sent and sent back by participants in experimental trust games to try to identify what responses to the WVS trust question are measuring. Not surprisingly, given the arguments laid out in this chapter, they find little correlation between money sent and answers to the trust question. Fehr et al. (2003) are using games directly as part of a written-response survey to measure trust. Cox (2000) points out the responses to the trust game alone cannot distinguish altruistic motives for sending and sending back money from responses based on expectations or perceived obligations regarding reciprocity. Following Cox (2000), Houser et al. (2003) have formulated questions that have been incorporated in telephone surveys conducted by Indiana University’s Survey Research Center that allow this discrimination. To do so,

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they require survey respondents to decide how they would play two games. In the first, called a dictator game, the respondent is asked to imagine that he or she is matched with another person he or she does not know and will never meet. The respondent is told that both players know that: • each has been given $100 • the respondent has been given an additional $50 • the respondent can choose to keep any portion of the $50 and send the rest to the other player • the experimenter triples any amount sent. The amount the respondent chooses to send is a measure of how altruistic he or she is. The respondent is then asked to imagine a similar situation but one in which, for any amount the respondent sends, the recipient can decide to send some of the tripled amount back. The amount sent by the respondent in this standard trust game, less the amount sent in the dictator game, is a pure measure of trust. In similar fashion, we yoke a dictator game and a game in which the respondent plays the role of Player 2 in a trust game. The dictator game response is a measure of altruism, while the trust game response’s net, that is, the amount sent in the dictator game, is a measure of trustworthiness.

CONCLUSION Trust as measured by survey responses has produced an intriguing array of econometric results regarding the impact of trust on economic prosperity. The faith we put in these results is, however, undermined by questions regarding what the measure of trust derived from survey responses is measuring. The primary message in this chapter is that if we are precise and careful in defining which connotation of trust we have in mind, clear hypotheses regarding implications for economic growth and crisp measurement approaches for exploring these hypotheses follow.

NOTES 1.

Authors are from the National Science Foundation, George Mason University and the National University of Singapore, respectively. Views expressed are those of the authors and do not reflect the opinion or position of the National Science Foundation nor the US government. Annette Leland, Richard Lempert, Robert O’Connor and Friederike Welter provided insightful comments on this paper. Any errors are the responsibility of the authors. 2. These conclusions are not universally embraced. Sobel (2002), for example, criticises Putnam’s thesis regarding the contribution of trust to growth as confusing correlation with causality.

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Both Fukuyama (1995) and Putnam (1995; 2000) attribute a variety of the societal ills experienced by the USA in recent decades to a decline in social capital. 3. For a discussion of the World Values Survey see http://ssdc.ucsd.edu/ssdc/icp02790.html. 4. There are alternative uses of the term trust as, for example, confident in the skill or safety of others. This notion of trust as competence can also be operationalised along the lines outlined in this chapter. 5. For a discussion of this see Richman (2002).

REFERENCES Andreoni, J. (1989), ‘Giving with Impure Altruism: Applications to Charity and Richardian Equivalence’, Journal of Political Economy, 97 (6), 1447–58. Axelrod, R. (1984), The Evolution of Cooperation, New York: Basic Books. Berg J., J. Dickhaut and K. McCabe (1995), ‘Trust, Reciprocity and Social History’, Games and Economic Behavior, 10, 122–42. Cox, J. (2000), ‘Trust and Reciprocity: Implications of Game Triads and Social Context’, University of Arizona, Department of Economics working paper. Dakhli, M. and D. De Clercq (2002), ‘Human Capital, Social Capital and Innovation: A Multi-country Study’, Working Paper, Darla Moore School of Business, Management Department, University of South Carolina. Danielson, A., and H. Holm (2002), ‘Trust in the Tropic? Experimental Evidence from Tanzania’, Lund University, Deptartment of Economics Working Paper, Lund. Fehr, E., U. Fischbacher, B. von Rosenbladt, J. Schupp and G.G. Wagner (2003), ‘A Nation-Wide Laboratory: Examining Trust and Trustworthiness by Integrating Behavioral Experiments into Representative Surveys’, IZA Discussion Papers, 715, Bonn: Institute for the Study of Labor (IZA). Fukuyama, F. (1995), Trust: The Social Virtues and the Creation of Prosperity, New York: New York Free Press. Glaeser, E., D. Laibson, J. Scheinkman and C. Soutter (2000), ‘What is Social Capital? The Determinants of Trust and Trustworthiness’, Quarterly Journal of Economics, 65, 811–46. Hardin, G. (1968), ‘The Tragedy of the Commons’, Science, 162, 1243–8. Hobbes, T. (1651), Leviathan, London: Andrew Crooke. Houser, D., J. Leland and J. Shachat (2003), ‘Game Responses as Survey Instruments: Measuring the Constituents of Social Capital’, research proposal to NSF sponsored Time-Sharing Experiments for the Social Sciences (TESS) research project. Huang, H., C. Keser, J. Leland and J. Shachat (2003), ‘Trust, the Internet and the Digital Divide’, IBM Systems Journal, 42 (3), 507–18. Knack, P. and S. Keefer (1995), ‘Institutions and Economic Performance: CrossCountry Tests using Alternative Institutional Measures’, Economics and Politics, 7, 207–27. Knack, P. and S. Keefer (1997), ‘Does Social Capital Have an Economic Payoff? A Cross-Country Investigation’, Quarterly Journal of Economics, 112, 1251–88. Putnam, R., with R. Leonardi and R.Y. Nanetti (1993), Making Democracy Work, Princeton, NJ: Princeton University Press. Putnam, R. (1995), ‘Bowling Alone: America’s Declining Social Capital,’ Journal of Democracy, 6 (1), 65–78. Putnam, R. (2000), Bowling Alone: The Collapse and Revival of American Community, New York: Simon & Schuster.

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Richman, B. (2002), ‘Community Enforcement of Informal Contracts: Jewish Diamond Merchants in New York’, Harvard Law and Economics Discussion Paper, 384, Cambridge, MA: Harvard University. Sobel, J. (2002), ‘Can We Trust Social Capital’, Journal of Economic Literature, 40, 139–54. Solow, R. (1995), ‘But Verify’, The New Republic, 11 September, p. 36. Yamagishi, R. and M. Yamagishi (1994), ‘Trust and Commitment in the United States and Japan’, Motivation and Emotion, 18 (2), 129–63.

PART TWO

Trust and Entrepreneurial Behaviour in Transition Environments

7. Trust-building in different forms of systemic transition1 Hans van Ees and Reinhard Bachmann INTRODUCTION Institutional factors constitutively contribute to the nature of exchange relationships in various ways. For example, trade associations, legal codes and practices and so on are suggested to determine the quality of relationships within and, particularly, between organisations (for example, Lane and Bachmann 1996; Sorge 1996; Whitley 1999). With regard to exchange relationships, differences also translate into the preferred use of underlying forms and combinations of social co-ordination mechanisms like trust and power (for example, Bachmann 2001). Research indicates that trust and power are elements in exchange relationships in all parts of the world. The forms and the intensity of behavioural dispositions, however, have strong cultural and institutional roots, which can have a considerable impact on the performance potential of business organisations. In general, there are large differences between the institutional environments of transition and (Western) market economies. However, also among transition economies we observe large performance differences as well as large variation in institution-building, which suggests that differences at the national or regional level in terms of routines, culture and institutions contribute to the explanation of a different economic development in these countries. Weak legislative structures and the absence of effective market regulation and property-right enforcement rules prohibit mutually profitable business transactions to various degrees. It can be argued that more efficient governance mechanisms can contribute to more favourable business environments, but this is not to say that this is simply a matter of ‘learning from the West’ (Child and Czeglédy 1996). Much research along this line more or less implicitly assumes that exchanges take place in a market-based context (including market-based agents) and it is unclear to what extent such research will have any bearing on exchanges in transition economies (Peng and Heath 1996). In this chapter, we study the characteristics of underlying exchange 99

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networks in order to say more about the link between institutional and performance differences in transition economies. This approach is motivated in the first place by the observation that in developed market economies as well as in centrally planned and transition economies, economic exchange largely takes place in networks. In the second place, it can be observed that the characteristics of these networks, in particular the role of trust, differ systematically across institutional settings. In our view, network characteristics reflect a wider institutional context (higher-order institutions). From this perspective, economic transition can be conceptualised as the process of destroying the old networks and creating new ones that connect businesses to a market-oriented business environment. Together with the creation of new networks, the parallel development of trust and power has to be stimulated through institutional restructuring. We use the framework developed in Van Ees and Bachmann (2003) to integrate these arguments into a dynamic comparative institutional analysis of the evolution of networks and related trust-building in different forms of systemic transition. For this, we build upon different lines of theory. In the second and third sections, we apply the literature on market-based and centrally planned economic systems, as well as transition economies, to analysing the interplay of institutional arrangement and exchange networks (for example, Raiser et al. 2001). Then we use the literature on trust-building to discuss the role of trust in different institutional configurations. In the fifth section, we build upon recent literature that aims to integrate resource and governance characteristics of networks (for example, Gulati et al. 2000; Toms and Filatotchev 2004). In the following section, we apply this framework to describe different forms of systemic transition. The seventh section concludes the chapter.

THE ORGANISATION OF EXCHANGES IN THE MARKET AND UNDER CENTRAL PLANNING In a market economy, transactions take place in the market. Mainstream economics predicts that market exchange is efficient to the extent that markets are perfect, that is, characterised by a large number of perfectly informed buyers and sellers, and prices that clear the market. The actual organisation of exchange is not an issue. With respect to the ideal-typical exchanges in the centrally planned economy, we can make a similar observation. By analogy to the decentralised exchange in the market economy, central planning builds on centralised complete contracting. Indeed, the central planner is formally equivalent to the Walrasian auctioneer. Paradoxically, the alleged superiority of a market economy is grounded upon an analytical framework in which central planning and market exchanges follow the same logic.

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Notwithstanding the analogy, history has shown that market and centrally planned economies operate very differently from the textbook model. Information is imperfect and distributed asymmetrically. Transaction and coordination costs are inherent to any exchange. In theory, a centrally planned organisation of exchange may allow for more efficient control but the complexity in terms of co-ordination is enormous. Furthermore, central planning destroys private incentives and may foster state-bribery and corruption. Mainstream economics has hardly a contribution to make when it comes to studying the effectiveness of the organisation of exchange. Moreover, we have to abandon the system level. When analysing the actual organisation of exchanges, a continuum of organisational modes exists, ranging from arm’slength relationships, repeated single contracts, strategic alliances, joint ventures and so on, to complete integration (for example, Williamson 1975). Transaction costs economics attempts to explain this variety by referring to the need to reduce the performance and relational risks of the trading partners. The transaction, as the unit of analysis, is considered an isolated event. Trading partners rationally act in their self-interest. The organisation of the transaction is motivated by the desire to optimise control. By contrast, a sociological explanation focuses on the contextual conditions and the dynamics of the transaction relationship (Nooteboom 2002). The transaction is seen as part of an ongoing relationship between the trading partners. Single transactions are regarded as investments in networks of relationships, driven by co-operation rather than competition and the desire to benefit from one another’s knowledge through mutual adjustment. Transaction networks are the rule rather than the exception in developed market economies (Baker 1990). The ongoing globalisation of the economy and the digitisation of technology fuel competitive pressure, which pushes firms to concentrate on those activities that produce the highest quasi-rents (core competencies) (Barkema et al. 2002). Non-core activities are outsourced. The concentration on core competencies, rather than product specialisation, enables a multitude of alternative strategies in very different directions. This also allows for the possibility to apply technology outside firm boundaries in the development and introduction of new products or processes (Milgrom and Roberts 1990). Thus, the capability to share (tacit) knowledge with a large variety of alternative firms emerges as a key to sustainable competitive advantage (Barney 1991). At the same time, firms increasingly rely on trading partners in the global market, which increases their vulnerability. In order to be able to connect with multiple trading partners, governance structures have to be transparent. In order to survive in a global market economy, firms increasingly are driven towards more transparency, which increases vulnerability even more. This is precisely the paradox that is solved

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in modern economies by the establishment of exchange networks, on the one hand, and reliable institutional arrangements between relatively anonymous trading partners, on the other. In addition, under central planning, the actual organisation of exchanges differs substantially from the theoretically predicted organisation. In this respect, Rose’s (1995) metaphor of the ‘hour glass society’ is revealing (see also Raiser et al. 2001). Under communism, individuals organised their transactions along strong mutual ties at the level of family- and friendship-based relationships in order to survive in a hostile environment. This network organisation not only structured transactions ‘at the bottom’, where resources were generally scarce, but also ‘at the top’ of society, where the privileged and powerful made exchanges to maintain the social status quo. Both these networks were inward-looking with little or no interaction between participants of different networks. The entrenchment among network members reflected a survival strategy, which seriously affected individual performance and regional economic development in communist countries (and many other less developed countries). To conclude, as in the market economy, actual exchange under central planning also took place in the context of (local) networks. However, unlike in the market economy, exchange networks in the centrally planned economy emerged as a structure, which was officially not legitimated, and were aimed at survival and maintaining the status quo rather than enabling best practice and sustainable competitive advantage.

THE ORGANISATION OF EXCHANGES IN TRANSITION ECONOMIES The transition from central planning to market economy can be viewed as a process of accelerated institutional change. Economic transition not only requires changing relative prices, but also the entire set of economic, legal and social incentive structures governing economic behaviour. In the process of change, the system of commercial law is not functioning effectively, the enforceability of contracts is limited and competition is regulated inadequately. At the same time, entrepreneurs in these countries cannot hope that these conditions will develop very quickly. For an extended period, transition economies are generally characterised by a weak institutional structure. The weak institutional structure in transition economies unavoidably creates considerable uncertainty and many opportunities for opportunistic behaviour (Van Ees and Garretsen 1994). Hence the question how exchange may actually take place in the context of such a hostile environment. In view

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of the fundamental path dependency of institutional change, it can be argued that, despite the formal restructuring of the centrally planned economy, the actual organisation of exchanges will to a large extent still take place in the context of the existing survival networks. These are, in the first place, (opaque) exchange networks that are built on personal relations among members of new Mafia-like clans. Second are the (opaque) networks of the old communist nomenclature which have survived the transition. These networks are characterised by personal obligations and serious problems of accountability. To some extent, these two forms of social networks represent the sunk investments in relationship capital of individual network members. Economic exchange is facilitated to the extent that informal social capital compensates for weak formal social capital. Both these old networks are characterised by self-sufficiency. Obviously, the opaque networks of the privileged and powerful are more prepared to survive the increased complexity of the business environment of the transition economy. Third, the economic transition may also stimulate the advent of new market-based networks. These new and more transparent entrepreneurial networks of relatively small businesses are, in fact, the drivers of the transition, being based on the allocation of property rights with formal contracts. Generally, the relationships between network members are relatively informal, open to innovation and the exploitation of new business opportunities. However, they are inevitably built upon a relatively small set of resources, which makes these market-oriented networks vulnerable to any form of exploitation and opportunism. In the absence of reliable institutions, investing in potential business partners becomes a highly risky business under ‘transition economy circumstances’. To summarise our argument, we suggest that only developed market economies constitutively build upon a combination of exchange networks and reliable institutional arrangements. To a large extent, transactions are anonymous and trust in the law as well as in other institutions is vital to the existence of market exchanges. By contrast, we argue that transactions in the centrally planned economy are governed by a system of official hierarchy and an unofficial personalised system of network exchanges. In transition economies, although the hierarchy of the centrally planned economy has more or less collapsed, the underlying governance mechanisms are to a large extent still in place. Moreover, in the absence of strong new institutions, exchanges within the contexts of opaque networks are probably the most natural responses to survive the increased uncertainties of the transition economy. As a result, economic development in transition economies does not take off just by itself after the ‘rules of the free market’ have been announced.

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TRUST AS THE UNDERLYING GOVERNANCE MECHANISM IN NETWORKS Trust is important to enhancing the effectiveness of business relationships that depend on co-operation, adding to operational efficiency by reducing transaction costs. Following Luhmann’s (1979) systems theoretical view and Giddens’s (1990) structurationist perspective, we see trust as a means to reduce social complexity. Trust bridges information gaps, thus reducing uncertainty in that a trustor selects one, or a small number of, positive or desirable possibilities as regards the future behaviour of the trustee (Bachmann 2001). Doing so, a trustor – in Luhmann’s terminology – may face a risk but in return the complexity of the decision-making environment is reduced to such an extent that decisions can be made and activities undertaken. With respect to trust-building in exchange networks, it can be concluded that familiarity breeds trust. Localised networks that built upon frequently repeated transactions create strong ties and facilitate norm-sharing and interpersonal trust. Face-to-face contacts and longer-term positive experiences with one another usually foster the creation of trust in such groups of individuals because the risk of misplaced trust tends to be lower where more information about the potential trustee is available and untrustworthy behaviour is sanctioned immediately. The Sicilian Mafia is one of the examples often referred to in this context. In pre-modern times, business communities also tended to be small and predominantly characterised by interpersonal forms of knowledge sharing. These circumstances may still be found where regional or professional networks play an important role. Moreover, as argued in the preceding sections, they are also characteristic for centrally planned and transition economies. Particularly where repeated interaction characterises the business system, social norms such as reciprocity are powerful mechanisms. Trust-building, under these conditions, requires considerable time and effort on the part of and at the expense of the individual actors. However, it can be very intense and effective as a method of protection, as interpersonal trust as a mode of co-ordinating behaviour remains one of the few means to facilitate co-operation in a relatively hostile environment. At the same time, overly strong forms of interpersonal trust support overembeddedness and inward-looking behaviour. Similarly, strong interpersonal trust can feed back on the opaqueness of the exchange networks. Generally, outsiders will not be able to recognise the lines of governance that determine the activities of the individual members of the network. As a result, the inward-looking behaviour of the network participants is supported by the lack of understanding of environment. In the end, entrenchment may result and cause the performance of the network organisations to deteriorate. All this adds to the opaqueness of the actual governance structures. In centrally

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planned economies this development has resulted in a situation where the actual allocation of resources deviates fundamentally from the planned allocation. Many exchanges actually take place in the context of opaque local networks, as prohibitive transaction costs stimulated informal exchange networks based on repeated interaction and familiarity. Thus, a centrally planned economy cannot be denoted as a strongly regulated economy building on institutional-based, that is, ‘extended’, trust. To the contrary, it is largely process-based or characteristic-based trust (Zucker 1986) that governs a major part of economic exchanges in the local networks. In line with this argument, Raiser et al. (2001) report, based on survey data, that the level of ‘extended trust’ is also notoriously low in transition economies. Generally, however, as exit options increase with economic development, large and differentiated socio-economic systems unavoidably also have to utilise other, that is, impersonal and more transparent, ways of governing business relationships. In that case, exchanges reflect formal institution-building and ideology (competition policy, company law, and rules governing financial institutions), which raises the standards for accountability norms. Trust in these exchange networks will generally be more related to formal institutionbuilding and extended trust. Especially, strongly regulated business systems generate a high level of impersonal trust constitutively based on reliable institutional arrangements (Bachmann 2001; Luhmann 1979; Zucker 1986). Economic exchanges in large and differentiated socio-economic systems are not only governed by interpersonal relationships but, particularly, by ‘extended trust’. In other words, the sources of trust can change historically. Furthermore, face-to-face contacts in opaque networks are generally not the way to produce trust in modern socio-economic systems. Here, based on an analysis of the World Value Survey data, Raiser et al. (2001) conclude that the level of semi-personal and impersonal, that is, ‘extended’, trust, is positively correlated with economic growth.

A FRAMEWORK FOR THE ANALYSIS OF TRUSTBUILDING IN DIFFERENT FORMS OF SYSTEMIC TRANSITION As argued in the second section, networks are organisational forms in which transactions are co-ordinated through co-operation in the context of relatively informal relationships between trading partners. Network transactions are built more on trust and reciprocity than on incentives or command. Moreover, we argue that network characteristics reflect the wider institutional setting of the market economy, the centrally planned and the transition economy. Under different institutional arrangements, networks provide a solid and yet flexible

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basis for business transactions and economic development or, alternatively, for survival in the event of weak institutional structures. Networks may also inhibit the growth of firms, industries and regions. Entrenched networks manifest themselves in anti-entrepreneurial and inward-looking behaviour that exhibits a negative impact on economic growth and development. In order to deal in more detail with the moderating impact of network characteristics on the link between performance differences and variation in institution-building in transition economies, we introduce a conceptual framework to analyse network characteristics and dynamics. This framework is inspired by Toms and Filatotchev (2004). According to these authors, network characteristics are driven by the content and context of business activities (see Figure 7.1). The former refers to the ability of organisations to sustain competitive advantage through the exploitation of economies of scale and scope, which is critically dependent on the amount of resources the organisation is able to secure. From a resource-dependency perspective, it can be argued that firms reduce uncertainty through securing resources by participating in different networks. This can easily be combined with a resource-based view, which takes organisation-specific resources as the drivers of corporate performance (Barney 1991; Whittington and Mayer 2000). The wider the resource base of a network (the content), the more the network organisations can rely on selfsufficiency or transactions within the network to cope with the challenges of the environment. In Figure 7.1 (institutional) context refers to explicit and implicit mechanisms that directly or indirectly govern the exchange and exploitation of resources. As already mentioned, the governance of network transactions reflects the wider institutional arrangements. Besides authority and incentive structures, network transactions are governed by reciprocity, commitment, (social) norms and beliefs. Some of these governance mechanisms, such as formal authority and ownership patterns of the organisation’s participating in a network, are explicit and observable to outsiders. Networks in which these mechanisms dominate are transparent. Transparent networks facilitate the exchange of information and knowledge with outsiders, a characteristic that fits the requirements of the market economy. Governance mechanisms such as social norms and reciprocity particularly facilitate interaction within the network and are harder to grasp by outsiders, which may be a favourable characteristic in hostile institutional settings. The downside of opaqueness can be social pressure, for example, the pressure to use or exchange specific resources. To the extent that the more implicit mechanisms underlie exchanges, organisational structures are denoted as opaque (see also Casson 1997). Networks with extensive resources can rely on self-sufficiency to a larger extent, which is expected to have a positive effect on (network) performance.

Content: Available resources

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Network characteristics: • extensive/narrow resources • opaque/transparent

(Institutional) context: Dominant governance mechanisms

Figure 7.1

The drivers of network performance (strategic context and content)

Economic performance and development

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Furthermore, more transparent networks connect more easily with their environment. In general, transparency may have a positive effect on performance because it increases the ability to exchange information and knowledge, and to learn as well as to adapt to changes in the environment of the network organisations. However, transparency also increases vulnerability and complicates the appropriation of rents. Learning and the exchange of information and knowledge inevitably come with a loss of control. In a more hostile environment, for example, one that is characterised by great uncertainties with respect to property rights as in some transition economies, organisations and networks with opaque governance structures have the potential to survive, particularly if this is supported by self-sufficiency. Finally, resources are different with regard to their information and norming characteristics (the dotted line in Figure 7.1). Particularly, the diffusion of technology and knowledge can be opaque in itself as the underlying process of combining assets and resources is complex, tacit and difficult to observe and understand for outsiders. In this situation, the transparency of the underlying governance mechanisms is likewise limited. Combining content and context characteristics, we arrive at the following taxonomy of network characteristics. In Table 7.1 the row distinction is crucial although it can also be observed that the resource base of many organisations in transition economies does not fit the requirements of the market economy. In particular, their resource base can be labelled narrow as necessary managerial resources are lacking (Peng and Heath 1996). Transparent networks are denoted as growth oriented as their governance structure is oriented towards exchanging information, knowledge and other resources with their environments. As mentioned before, this structure facilitates learning and a subsequent growth of their resource base (that is, the development from growth-oriented I to II). Opaque networks, on the other hand, are designed for self-sufficiency, inward-looking behaviour and maintenance of the status quo. Opaque networks may survive successfully in a hostile environment, provided their resource base is extensive enough (the oligarchy or Mafia clan). Poor and powerless networks hardly have the resources to survive through self-sufficiency, whereas their governance structure does not allow them to benefit from Table 7.1 A taxonomy of network characteristics Context: dominant governance mechanism Transparent Opaque Content: available resource base

Extensive Growth-oriented I Narrow Growth-oriented II

Mafia clan Poor and powerless

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the interaction with their environment. In all circumstances, opaqueness decreases network performance as mutually profitable exchanges are foreclosed. In line with our argument in the preceding sections, we conceptualise economic transition as the process of replacing the existing opaque survival networks by newly established transparent growth-oriented networks that connect businesses to a market-oriented environment. Together with the creation of transparent networks, the parallel development of ‘extended trust’ has to be stimulated through property rights’ enforcement, competition policy and trade regulation in order to cut off the roots of the old opaque networks of central planning and to avoid the emergence of new opaque ‘cliques’. However, the process of systemic transition reveals an interesting dilemma. As transition inevitably creates uncertainty, the survival response of business networks is to become more opaque and inward-looking. Increased entrenchment generally does not enhance the ability to adapt to external shocks and the perspective on survival, unless it is combined with a large resource base. Perhaps paradoxically, economic transition thus tends to favour the existing powerful exchange networks, the Russian oligarchies being a good example of the latter. On the other hand, economic growth will generally come from new transactions in the context of new entrepreneurial networks, perhaps of relatively small businesses, which are vulnerable to external opportunism as they are built upon transparency and a relatively narrow resource base. The new networks can only be transparent in a hostile environment if there is support from external political forces, until effective socio-economic institutions and ‘extended trust’ have developed. Low trust in existing institutions decreases the chance to develop trust among members of new transparent networks that are vital for these countries’ transition to a full-fledged market economy. On the one hand, the disintegration of the (old) state is necessary for the emergence of ‘extended trust’ but, on the other hand, this also makes it less likely that sufficient ‘extended trust’ will develop. The challenge of economic transition is, therefore, to create legitimacy for new institutional structures which foster existing and newly created transparent networks that are favourable to strategic restructuring. In this respect, this third party enforcement by credible states or (supra-national) organisations can be regarded as an important condition for successful economic transition.

NETWORKS AND ECONOMIC DEVELOPMENT IN TRANSITION ECONOMIES In the third section we argued that in transition economies the actual organisation of exchanges will to a large extent still take place in the context of

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(opaque) exchange networks built on personal relations, which have survived the transition (that is, new Mafia-like clans, clans of the old communist nomenclature or clans of poor and powerless). These old networks are characterised by self-sufficiency. Eventually, economic transition may stimulate the advent of new and more transparent entrepreneurial networks of relatively small businesses, which are in fact the drivers of the transition and economic development. However, these market-oriented networks are vulnerable to any form of exploitation and opportunism. The actual form of systemic transition in a particular transition economy will depend, among other things, on the historically determined configuration of the three network types. Building upon our network taxonomy, we may distinguish at least three possible configurations. Systemic Transition I: Structural Economic Stagnation The remains of the institutional regulation of the communist regime are destroyed and the opaque networks of the former unofficial economy are invalidated through extreme exposure to market competition. This configuration may characterise the situation in Eastern Germany. In the end, the opaque networks did not survive the transition to the market economy. At the same time, Western organisations took over the market by building up their own subsidiaries. This results in a high level of unemployment and a social climate of distrust. This situation is perhaps best described as structural economic stagnation. The network configuration in this economy is characterised by a vast majority of highly fragile, poor and powerless exchange networks (see Table 7.1). Systemic Transition II: Economic Exploitation This form of transition is characterised by the preservation of the exchange patterns of the transition economies’ old business systems. This situation is favourable to the existing influential networks in the transition economies. In this configuration, economic development will have to come from the privileged and powerful opaque networks. Unless there are strong private incentives, influential opaque networks will not give way to a more growth-oriented economic development, that is, to more transparency. When entering the global arena, some of these opaque networks will take a longterm perspective and survive when the transition will be completed after an extended period. Many of these networks, however, will try to exploit the situation until this is no longer possible. This configuration is characterised by an overrepresentation of Mafia clans. Trust is a matter of personal relationships within the closed circles of obligation-based business clans while

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the development of ‘extended trust’ is hindered by institutionally legitimised corruption and arbitrariness. These forms seem to apply in some parts of the former Soviet Union. Systemic Transition III a and b: Economic Exploration and Development Economic development and growth is channelled through intermediary institutional structures such as trade associations, chambers of commerce, technology transfer institutions and so on. Here, the role of the transition states’ governments is to provide support for economic development in the form of strategic partnerships among Eastern and between Eastern and Western firms. In this configuration, which may be denoted as the growth-oriented scenario, it is supposed that transparent networks are encouraged to build their relationships on trust even when the resource bases of many single firms participating in these networks are narrow. Innovation and learning will be the central focus of these networks. The manifestation of a particular growth-oriented configuration predominantly depends on the content and context of the networks including the sources of trust-building that play a role within and around these networks. Transparent networks drawing on an extensive resource base may offer the best chances for survival in transition economies. Existing opaque networks are to be developed towards more transparency. In many cases, however, transparent networks will have to be developed from scratch, the more so as alternative control structures, in particular ownership, are not yet a focal point in the mind map of Eastern European managers (Steensma and Lyles 2000). From this it can be concluded that firms in transition economies particularly need managerial support in order to be able to meet the challenges of a market economy (Gergs 2002). A narrow resource base re-enforces the need for market orientation, which presumably offers the greatest potential for economic growth. However, this scenario also contains high risks when institutional safeguards are not fully developed (yet). ‘Extended trust’ will have to build on open communication and originate in network relationships, while simultaneously drawing on institutional arrangements in the business environment. Thus, a favourable way of developing innovative networks supports a hybrid form of trust creation. Neither institutions nor interpersonal contacts as such are sufficient to produce an optimal combination of ‘bottom-up’ and ‘top-down’ mechanisms of coordinating expectations and interaction between business partners (Bachmann and van Witteloostuijn 2002). From our point of view, an optimal form of networks presupposes powerful rules rather than powerful actors and a form of trust that allows for long-term orientations and flexibility at the level of interpersonal relationships.

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CONCLUSION Building upon the arguments presented in this chapter, we conclude that economic prosperity will depend upon the extent to and the way in which firms in the transition economies will be able to enter what we call ‘growthoriented innovation networks’. As compared to economic stagnation, on the one hand, and economic exploitation, on the other, the ideal pathway is based on a gradual learning process. Although transparent networks with an extensive resource base may individually have the highest growth potential, at the macro level it may be more efficient to benefit from increased specialisation in networks building on a relative narrow resource base. Moreover, networks with a relatively narrow resource base are forced to be more market oriented, whereas networks with a relatively extensive resource base have a tendency to become more opaque and inward-looking in response to external threats. As the vulnerability of networks with a relatively narrow resource base is considerable, particularly in environments where institutional safeguards are not fully developed, the key to success for a growth-oriented scenario seems to be the parallel development of a reliable macro-institutional framework. All this may increase investor confidence, allowing for rapid diffusion of technology, knowledge and economic growth.

NOTE 1.

A substantially different first draft of this paper was presented at the International Conference on ‘Trust and Entrepreneurship: An East–West Perspective’ in Bremen, Germany, in September 2003. The authors thank the participants of this conference for their comments on the first draft.

REFERENCES Bachmann, R. (2001), ‘Trust, Power and Control in Trans-Organizational Relations’, Organization Studies, 22, 337–65. Bachmann, R. and A. van Witteloostuijn (2002), ‘Institutional and Inter-Personal Forms of Power and Trust as Means of Co-ordinating and Controlling Trans-Organizational Relationships’, paper presented at the 18th Egos Colloquium, Barcelona, July. Baker, W.E. (1990), ‘Market Networks and Corporate Behavior’, American Journal of Sociology, 96, 589–625. Barkema, H., J.A.C. Baum and E.A. Mannix (2002), ‘Management Challenges in a New Time’, Academy of Management Journal, 45 (5), 916–30. Barney, J.B. (1991), ‘Firm Resources and Sustained Competitive Advantage, Journal of Management, 17, 99–120. Casson, M. (1997), Information and Organization: A New Perspective on the Theory of Firm, Oxford: Oxford University Press.

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Child, J. and A.P. Czeglédy (1996), ‘Managerial Learning in the Transformation of Eastern Europe: Some Key Issues’, Organization Studies, 17 (2), 167–79. Gergs, H.-J. (2002), Manager und Märkte. Eine soziologische Untersuchung der Markterschließungslogiken im ostdeutschen Management, München: Rainer Hampp. Giddens, A. (1990), The Consequences of Modernity, Cambridge: Polity. Gulati, R., N. Nohria and A. Zaheer (2000), ‘Strategic Networks’, Strategic Management Journal, 21, 203–15. Lane, C. and R. Bachmann (1996), ‘The Social Constitution of Trust: Supplier Relations in Britain and Germany’, Organization Studies, 17, 365–95. Luhmann, N. (1979), Trust and Power, Chichester: Wiley. Milgrom, P. and J. Roberts (1990), ‘The Nature of Modern Manufacturing: Technology, Strategy and Organization’, American Economic Review, 80 (3), 511–29. Nooteboom, B. (2002), Trust: Forms, Foundations, Functions, Failures and Figures, Cheltenham, UK, and Lyme, USA: Edward Elgar. Peng, M.W. and P.S. Heath (1996), ‘The Growth of the Firm in Planned Economies in Transition: Institutions, Organizations, and Strategic Choice’, Academy of Management Review, 21, 492–528. Raiser, M., C. Haerpfer, T. Nowotny and C. Wallace (2001), ‘Social Capital in Transition: A First Look at the Evidence’, EBRD Working Paper, 61, London: EBRD. Rose, R. (1995), ‘Russia as an Hour-Glass Society: A Constitution without Citizens’, East-European Constitutional Review, 4, 34–42. Sorge, A. (1996), ‘Societal Effects in Cross-national Organization Studies: Conceptualizing Diversity in Actors and Systems’, in R. Whitley and P.H. Kristensen (eds), The Changing European Firm: Limits to Convergence, London: Routledge, pp. 67–86. Steensma, H.K. and M.A. Lyles (2000), ‘Explaining IJV Survival in a Transitional Economy through Social Exchange and Knowledge-Based Perspectives’, Strategic Management Journal, 21, 831–51. Toms, S. and I. Filatotchev (2004), ‘Corporate Governance, Business Strategy and the Dynamics of Networks: A Theoretical Model and Application to the British Cotton Industry, 1830–1980’, Organization Studies, 25 (4), 629–51. Van Ees, H. and R. Bachmann (2003), ‘Transition Economies and Trust Building’, Som Research Report 03G06, Groningen: University of Groningen. Van Ees, H. and H. Garretsen (1994), ‘The Theoretical Foundation of the Reforms in Eastern Europe: Big Bang versus Gradualism and the Limitations of Neo-Classical Theory’, Economic Systems, 18, 1–13. Whitley, R. (1999), Divergent Capitalisms: The Social Structuring and Change of Business Systems, Oxford: Oxford University Press. Whittington, R. and M. Mayer, (2000), The European Corporation, Oxford: Oxford University Press. Williamson, O.E. (1975), Market and Hierarchies: Analysis and Antitrust Implications, New York: Free Press. Zucker, L. (1986), ‘Production of Trust: Institutional Sources of Economic Structure, 1840–1920’, Research in Organizational Behavior, 6, 53–111.

8. Establishing trust in a distrustful society: the case of Russian business1 Vadim Radaev INTRODUCTORY REMARKS Market relations are not confined to free competition and price-making mechanisms. The market is a part of the economy as an instituted process (Polanyi 1992). It is constituted by sets of rules, regulations and other institutional arrangements, including relations of trust. Broadly speaking, we would define trust as a belief that other agents act in a predictable way and fulfil their obligations without special sanctions (Coleman 1988). More specifically, we differentiate between two levels through which trust relationships have to develop. The first level of trust is achieved through the predictability of behaviour of the other actors. The second level of trust is reached through mutual commitment to accepted conventions, which are voluntarily accepted by market actors. We also accept a division between one-sided trust in institutions and reciprocal trust among business actors (Rose-Ackerman 2001a; 2001b). Today Russia demonstrates a prominent example of a distrustful society, with contradictory and unstable formal rules. Formal enforcement is lacking and market actors have to cope with an unpredictable governmental legislative and regulatory policy, both of which produce a high level of uncertainty. As a result, one-sided trust in institutions remains at a low level. One might expect that this deficiency of one-sided trust would be compensated for by reciprocal trust in business partners. However, reciprocal trust in business-to-business relationships is low as well, because honesty often does not pay, which makes the situation even more demanding. Although business actors put the highest value in honesty in business relations, they do not trust each other entirely due to the frequent infringement of business contracts and the non-transparency of business transactions (Radaev 2004b). Taking this into account, the central issues to be investigated in this contribution are the following: 114

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•

How are economic relations established when formal rules are not effectively enforced and both institutions and individuals are not trustworthy? • How does trust emerge and develop in these relationships? • What is the role of the state in the development of one-sided trust in institutions and reciprocal trust among business partners? To study these issues, we borrow conceptual tools from two sources, including the new institutionalist theory (Eggertsson 1990; Fligstein 1996; North 1992) and the literature on trust (Fukuyama 1995; Gambetta 1988; Hardin 2001; Kornai et al. 2004; Rose-Ackerman 2001b; Sztompka 1999). Using these tools, in this chapter we will deal with issues of trust and distrust in Russian business relationships on the empirical level.

DATA SOURCES Our empirical evidence is based on data collected from two projects: a research project on ‘Transaction Costs in Russian Business’, conducted in 1997–98 and funded by the Center for International Private Enterprise (CIPE), and a research project on ‘The Costs of Legalisation’, which was carried out in 2001–02 and funded by Russian business associations RATEC and ACORT. Project 1: Transaction Costs in Russian Business This project included a standardised survey and a set of in-depth interviews conducted with private enterprise managers and entrepreneurs. The standardised survey was conducted between November 1997 and January 1998. Two hundred and twenty-seven questionnaires were collected from the heads of non-state enterprises in 21 regions (mainly in the European part of Russia). All main sectors and business areas were represented. Table 8.1 presents selected basic characteristics of the surveyed enterprises and entrepreneurs. In-depth interviews were carried out from May 1997 to April 1998. In total 96 interviews were recorded. The main focus was on non-state businesses.2 The interviews focus on issues of corruption, contract enforcement, the use of force in business relationships, and problems of market entry for Russian entrepreneurs (for a detailed description of the research outcomes see Radaev 1998; 2001a).

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Table 8.1 Basic characteristics of the sample (227 entrepreneurs) Characteristics

%

Privatised state firms Newly established private firms Small firms Large and medium-size firms Male entrepreneurs Female entrepreneurs Have university degrees Do not have university degrees (One of the) owners of the enterprise Managers of the enterprises Members of business associations Non-members of associations Moscow entrepreneurs Other regions

18 82 79 21 75 25 83 17 79 21 28 72 19 81

Source:

Own survey in 1998.

Project 2: The Costs of Legalisation This project was initiated by two newly established business associations, namely: • the Association of Trade and Production Companies of Electric Durable Goods and Computers (RATEC) which includes companies dealing with wholesale trade and retailing of imported electric durable goods, and some home producers of these goods • the Association of Retailing Companies (ACORT) whose companies develop retailing networks dealing with electronics, food, clothing, footwear, furniture, construction materials and stationery. Thirty-eight in-depth interviews with owners and top managers of Russian companies were conducted in two major series. Fourteen interviews were recorded in 2001 and 24 interviews were recorded in 2002. The main aim of these interviews was the estimation of transaction costs connected with different modes of activity including semi-legal (grey) and illegal (black) business schemes, with a special focus on custom procedures.3 Both studies were devoted to a broad range of institutional issues. For this chapter we draw on the aspects of the studies related to the formation of trust and distrust in business relationships.

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CREATING DISTRUST IN BUSINESS RELATIONSHIPS Conventional wisdom states that the development of the market should be based on legitimate formal rules and a high level of trust. However, in Russia emerging markets mainly develop under conditions where formal rules are contradictory and unstable. The widespread involvement in shadow activities and the non-transparency of Russian business both prevent the formation of trusting relationships, as reflected in the conclusion by one of our respondents: ‘One of the reasons for the low trust is that our market is deep in the shadow and non-transparent. Therefore, everyone is scared to disclose operations’4 (2002, head of a cell-phone selling company). Lack of One-sided Trust The fear of business actors to disclose their activity and join collaborative actions largely originates from common distrust in the state authorities as the main provider of formal rules: ‘Many companies simply did not join us [business association – VR] because they do not trust this state. They do not trust these authorities because they know that there might be a trap. And they would let their folks down’ (2001, head of a wholesale firm in electronics). Let us illustrate this through two examples from our 1998 data, which dealt more specifically with business relationships. First, we asked entrepreneurs what they would do in case of malfeasance from their business partners. It turned out that only 24 per cent of Russian entrepreneurs would turn to the arbitration court when settling disputes. A majority (55 per cent) would try to negotiate and persuade their partners by informal means, whilst another 11 per cent of the entrepreneurs would use force to cover their losses. Thus, a large group of entrepreneurs prefer informal ways of settling disputes. There are several reasons for this. First, the courts of arbitration have proved to be one of the most corrupt institutions which are widely used for asset-stripping and aggressive mergers. Second, these courts are not independent from the direct influence of government officials and business corporations. Moreover, they are frequently used as an instrument for unfair competition in order to push out rivals. Therefore, these courts are not trusted in Russia at present. Third, arbitration procedures are time-consuming and costly. It may cost between 1.5 to 5 per cent of the disputed sum, which makes it especially difficult for small firms. Fourth, due to many gaps in existing legislation, there is no guarantee that justice will be done. Fifth, even if successful in court, this does not necessarily mean that the losses will be recovered, as court executives are few and not very efficient. They often fail to reach a defector. According to the opinion of one of our respondents: ‘it is only worthwhile appealing to the courts of arbitration if you deal with a

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reputable business organisation’ (1998, the head of a trading firm). This quote reflects a certain paradox, namely, that one should trust other business actors as a precondition of taking them to court. Our second example deals with the question of what actions entrepreneurs would most probably take when confronted with the use of force and coercive pressures directed against their firms and them personally. Only 13 per cent claimed that they would call for the police (militia), whilst 23 per cent would appeal to private (either legal or criminal) protection agencies. Thirty-four per cent of the business people would prefer to cope with this problem on their own. Finally, 30 per cent avoided any definite answer (Radaev 1998; 2001b). This suggests that the state has lost a large part of its capacity to impose law and order. This renders reliance on the state protection agencies difficult if formal rules are violated. Entrepreneurs presented one more remarkable argument for avoiding formal court and police procedures, stating that: ‘By appealing to the court you can ruin your relationships . . . It is not a usual way of doing things. There are two categories – “us” and “them”. All state authorities, involving tax inspections and courts of arbitration, are viewed as “them”. It is bad manners to turn to them’ (1998, head of production and trading firm). Thus, apart from the inefficiency of the state authorities and high transaction costs, implicit conventions exist forcing entrepreneurs to resolve delicate issues among themselves without involving a third party. This logic of negative solidarity, which differentiates between ‘us’ (business people) and ‘them’ (authorities), is still influential, whilst formal appeals to the state are judged frequently on moral grounds as attempts to break somebody down. This specific case illustrates how reliance on public institutions could undermine interpersonal trust instead of strengthening it. Lack of Reciprocal Trust When one-sided trust in institutions is low, we would expect that it is compensated by higher reciprocal trust in kin, friends and business contractors. Our evidence demonstrates that business-to-business relationships are not subject to such a simple causation. Widespread distrust is displayed in business relationships. First, this is reflected in the attitude towards newcomers and outsiders. However, even in the case of long-term relationships with regular partners, distrust presents a serious problem. The low level of reciprocal trust is illustrated, for example, by the Business Environment and Enterprise Performance Survey (BEEPS) comparing 26 post-communist economies. Russia scores very highly in terms of prepayment requirements, and lower than average in terms of commodity credit (Raiser et al. 2004).

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One of our respondents expressed the dominant feeling amongst the Russian business community in the following way: ‘I do not entirely trust anyone in business’ (1998, the head of a real estate firm). It is remarkable that this statement refers not only to rule-based trust, but also to affect-based trust founded on personal ties with family and friends (Rose-Ackerman 2001b). Nevertheless, these strong ties are obviously preferred to relationships with strangers. For example, many entrepreneurs started their businesses by setting up teams with their relatives and friends. However, during the 1990s affectbased trust was largely undermined as well, which is illustrated in the following statement: ‘It does not matter if you have very confidential relationships with someone and that someone loves you tenderly. Payment arrears could happen easily’ (1998, the head of a firm selling medical equipment). Are there any differences with regard to relationships with Russian and foreign companies? There is a stereotypical vision that western companies are more transparent and more reliable (which our respondents partially accept). Besides, for many years it was a matter of high prestige for Russians to have business partners from the West. Nevertheless, after accumulating experiences in co-operating with foreign companies, some Russian entrepreneurs became fundamentally frustrated, especially if their initial expectations were high. In the end, there are no fundamental differences in attitudes to domestic and foreign business partners, as the following statements from our interviews illustrate: ‘Unlike five years ago, we now check our western partners more thoroughly than the Russian ones’ (1998, the head of a group of firms); ‘We do not trust western partners because they do not always follow their obligations. We part with them in cases of failures’ (1998, the head of a tourist firm). The main reason for distrust in western companies also emerged in our interviews. In the early years of perestroika, along with reliable business people from the West, swindlers were attracted to the emerging Russian markets as a land of new opportunities. Here, Russian entrepreneurs initially had difficulties in distinguishing between swindlers and reputable business people through checking their credit history and reputation because the respective information channels were not well developed in Russia. Moreover, many Russian entrepreneurs became victims of their initially one-sided trust in the institutions of western business. After having been cheated, Russian entrepreneurs became more cautious and selective in relations with western firms. Infringement of Business Contracts This lack of reciprocal trust is closely connected with opportunistic behaviour in business relationships. What is the source of this opportunism? It originates from the frequent infringement of business contracts, which at present leaves

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large scope for risk and uncertainty in Russian business. To measure the level of this sort of opportunism in relationships among business partners we asked the following questions: • How often are business contracts violated in Russian business in general today? • How often do entrepreneurs face contract infringement in their own business activity? Our data confirm that a high level of opportunism exists. Nearly everyone (92 per cent) admitted that infringements of business contracts happen in Russian business nowadays (Table 8.2). This includes nearly half of the respondents, who consider that contract infringement is frequent, whilst only a negligible group of entrepreneurs do not see a problem here at all. These results were also supported by our previous research findings in a 1996 nationwide survey of entrepreneurs (Radaev 1996, pp. 74–6). As for the personal experience of entrepreneurs, it strongly correlates with their general attitudes. The vast majority of entrepreneurs (82 per cent) reported that they are confronted with this sort of opportunistic behaviour in their own day-to-day business activity (Table 8.2). One-third of them faced it on a frequent basis. There has been a continuous debate among Russian experts on whether the chronic inter-enterprise payment arrears result from the macroeconomic instability and rigid monetarist policies of the Russian government or whether they are largely an outcome of conscious opportunistic strategies of the enterprise managers ‘seeking their self-interest with guile’. In our opinion, both factors might contribute to distortions in the payment systems. In any case, this produces serious institutional effects creating distrust among business partners.

Table 8.2 Infringement of contracts in Russian business Infringement of contracts In Russian business in general In one’s personal experience Notes: Number of interviews: 227. Source:

Own survey in 1998.

Frequent

From time to time

Absent

49% 32%

43% 50%

8% 18%

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Table 8.3 Most important personal features of business partners Features Honesty, trustworthiness Responsibility, liability Professional skills, competence Accuracy, precision Initiative Financial sustainability Gender, ethnicity Work experience and others Note: Source:

79 29 19 12 8 4 1 2

Number of interviews: 227. Own survey in 1998.

Request for Honesty One could ask if the level of trust is an important problem at all. Here, our data give a positive answer. In our 1998 standardised survey we had an open-ended question for the Russian entrepreneurs to find out what they deem the most important personal qualities of potential new business partners. In total, almost 40 characteristics were mentioned. After clustering, they helped to display the most demanding characteristics entrepreneurs require from their (potential) business partners. Nearly everyone points in the same direction, stating that business partners must be honest and trustworthy (Table 8.3). As economic and sociological theory informs us, it is intuition and intellect, creativity and motivation, which are normally attributed to ‘the real entrepreneur’ (Radaev 1997, ch. 6). However, these personal qualities were not frequently mentioned, whilst honesty and trustworthiness were absolute priorities for entrepreneurs. Thus, Russian entrepreneurs are conscious about honesty. Moreover, we would argue that their concern is neither about high moral values nor about generalised trust. In looking for honesty, the entrepreneurs care about very practical rules of business conduct such as payments on time and reliability with regard to payments in general.

CREATING TRUST IN BUSINESS RELATIONS Now let us turn to the main question of our study. How do entrepreneurs cope with a situation in which their business contractors are not entirely reliable and ‘third parties’ responsible for settling disputes are not trusted?

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There is evidence that despite the distrustful character of business relationships, malfeasance in these relations is decreasing over time. This is confirmed by the following insight of our respondent: ‘The problem of reliability of partners . . . always exists in business. However, it becomes less demanding now’ (1998, the head of a stock market board). Does this mean that honesty is starting to pay off? We argue that this is not the case, or at least not the main reason for the decrease in misbehaviour in business relations. The point is that in order to confront opportunism and malfeasance, Russian entrepreneurs had to impose methods of private contract enforcement. This implies, that business people are not becoming more trustful, but rather more cautious when arranging business deals. The following statements confirm this: The number of violations has decreased for the number of business ties has diminished. Before the entrepreneur might give money to somebody who did not pay it back. He was running around saying that he had been cheated. Now the entrepreneur would not lend money to anyone and nobody would let him down. So there is nothing to complain about. The situation is different. (1998, the head of a trading firm) Everyone is now more cautious than before. (1998, the head of a construction firm)

Contractual Forms of Protection Given that Russian entrepreneurs had to exercise control over transactions at their own risk, they take precautionary measures. They start with introducing discriminatory elements into business contracts, with the requirement of prepayments serving as the most prominent example here. In the case of transactions with new partners, prepayments were considered as a compulsory instrument, as is described by one entrepreneur: ‘Partial prepayment is the only real guarantee’ (1998, the head of a trading and production firm). Another precautionary measure includes small test contracts with a new business partner and/or dividing the transfers into several stages to ensure the outcomes. If these test contracts work successfully, business partners increase the volume of delivered goods and services step by step. This is best illustrated by one of our respondents, stating: ‘Initially, when we start working with a new company, we get very bad contract conditions, including 100 per cent prepayment and other things. Over time, normal relationships are established. And conditions change for the better’ (2002, the head of retailing chain stores). In spite of these efforts, no formal contract provides perfect protection from the opportunism of market actors. First, the culture of formal business contracting is not highly developed in Russia so far. Second, formal contracts are not able to cover all necessary issues and anticipate all possible intervening factors.

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Therefore, the parties involved must rely on various sorts of relational contracting (Williamson 1985). Third, having signed a contract, the entrepreneur is still by no means protected from the violation of rules. The contractor could simply grab the money and disappear. This indicates that the status of the firm and the personality of their leaders play an important role as well, as the answers of our respondents show: ‘No doubt it is necessary to sign contracts in any case. But anyway, the implementation of this contract depends on the person’ (1998, the head of a real estate firm); ‘The informal word weighs much more than any signed contract in our market’ (1998, the head of an investment company); and ‘You are not able to put everything on paper . . . And many decisions are taken beyond what is written in the contract . . . There are certain rules which could be more powerful than formal papers’ (2002, the head of retailing chain stores). Checking Business Partners In as far as formal contracting is not sufficient to secure positive outcomes, the entrepreneurs have to develop non-contractual elements of business relationships. First, they start to check their potential partners thoroughly before making business deals: ‘We check every new partner thoroughly and for a long time. And if we start working with him/her we ensure conditions which provide sufficient guarantees for us’ (1998, the head of a group of firms); ‘We do not sign serious contracts before background checks and we do not deal with new partners’ (1998, the head of a holding company). At the beginning of the 1990s, Russian entrepreneurs had to bear the full risk of malfeasance, given the lack of reliable and systematic sources for business information. By the end of the 1990s, opportunities for obtaining data on the financial sustainability and business reputation of market actors had improved considerably. Data on potential business partners are collected from both public and commercial registers and databases. Foreign partners are checked through embassies and the trading offices of the large firms in foreign countries. As one interviewee stated: ‘Now we are dealing with the Ministry of Home Affairs and banks. They can make inquiries about any client for us. This was impossible before’ (1998, the head of an industrial production firm). Firms which misbehave are excluded from business: ‘We have got opportunities for checking firms and their founders. There are already long “black lists” ’ (1998, the head of a stock market board). All in all, large transactions are ensured by prior checks. However, even after getting positive information, the entrepreneurs are still cautious towards newcomers: ‘A sufficient number of partners have been already checked. It is not a problem to find any information you want. A stranger is not able to come to the market from nowhere anymore. Nobody would make a deal with

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him like it was before’ (1998, the head of an investment company). Another entrepreneur said: ‘There are small contracts on 30 thousand and big contracts on 300 thousand [dollars]. No one would make a deal on 300 thousand with a newcomer right away’ (1998, the head of an investment company). We have to add that collecting business data costs both time and money, whilst even a very detailed inspection of potential new partners could not guarantee a positive outcome. What happens is that entrepreneurs close their business relationships to outsiders. Establishing Business Networks Contracts are largely enforced through personal business networks, through which social capital is accumulated (Coleman 1988). Here, a business network is defined as a stable and relatively closed set of interpersonal links between regular business partners. It is based on a combination of formal control and the informal exchange of services. We have grounds to argue that these networks play an increasing part in Russian business. Our respondents describe the situation in the following way: ‘We give goods in credit only to permanent clients. We would never give it to anyone else . . . If you make purchases, you should deal through your own acquaintances. Otherwise, you have no guarantees. They will sell faulty goods to you’ (1998, the head of a wholesale firm); ‘It is vitally important to have permanent partners now. They are valuable not for paying back on time, but for that they in principle pay back’ (1998, the head of a firm selling fuel). Over time, Russian business people have become more selective, especially when dealing with newcomers and outsiders. They reasonably prefer to stay within ‘their own’ exclusive business circles. One of our respondents postulates this very clearly: We are dealing with a smaller and smaller number of people. Some time ago one could disseminate a hundred personal cards just to anybody. Now we do not use cards because we do not meet new people. And even if you are introduced to someone new it is done via those with a high reputation. The circle has not closed down completely, but it is extending very slowly. (1998, the head of a group of firms)

Without doubt, business networks are established to overcome distrust among business partners. What sort of trust is built through these networks? During the initial stages of business creation, many Russian entrepreneurs started their businesses with friends and personal contacts. Our 1993 survey data of 277 Moscow entrepreneurs shows that they started with the following companions: (Radaev 1993, pp. 7–8):

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• • • •

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personal acquaintances: 42 per cent friends and kin: 23 per cent kin members: 17 per cent people unknown before: 11 per cent.

Given the many uncertainties in the business environment, relations were largely built on affect-based trust. During the 1990s, this shifted considerably: initial business teams often were dismantled. Former partners started their own firms. Friendships often became an obstacle to efficient leadership. All in all, business and former friendships started to fall apart. We have several clear statements supporting this: ‘Good acquaintances, as a rule, would let you down in a major portion of the cases’ (1998, the head of a legal firm); ‘It is a fundamental truth in business: those survive who understand that he/she must end friendships at the right moment’ (1998, head of trading firm). This indicates that affect-based trust is being largely replaced by reputation-based trust. Strategic alliances are no longer built exclusively on personal and long-term friendships and familial relationships, but rather increasingly rely more upon the recognition of the professional and managerial skills and business reputations. Firms and their leaders are divided into ‘respectable’ ones (‘they will not let you down’) and unknown ones (‘you should be cautious with them’). In this context, business networks are used to disseminate information on unreliable business agents and to build up reputations, as illustrated in the following statements: ‘Nobody would deal with a man who has cheated once . . . If the sum is not significant he will just be blacklisted as an unreliable partner’ (1998, the head of the marketing department in a firm); ‘Information is transferred instantly. And in case of contract infringement you run a risk of losing all your partners . . . As soon as you have failed to fulfil serious obligations you find yourself cut off from the resources. And your bank closes down. The business community is a really close entity’ (1998, the head of a commercial bank). By and large, whereas honesty may not pay off in free market relationships it is starting to pay off within closed business networks. These networks reduce risks, thus helping to overcome interpersonal distrust and producing a sort of segmented business ethics. Use of networks makes the situation more predictable and creates opportunities for the development of mutual obligations among its members. Building Conventions among Business Actors Established business networks stimulate the process of further institutional change. They present a structural basis for building up new business conventions among market actors. We define these business conventions as shared

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understandings of the market situation and accepted common rules of business conduct. Leading market sellers closely monitor the actions of their contractors and competitors. However, this monitoring is not sufficient in order to cope with market uncertainty, but it generally is supported by face-to-face negotiations. These negotiations are arranged on two interconnected levels. On the political level, leading market actors join the ranks of business associations to work on the strategic rules of the game. On the business level, they arrange informal roundtable meetings to discuss tactical issues. These business meetings can be carried out both within and beyond the walls of business associations. Business-to-business negotiations are not an easy task in as far as their participants could see each other as direct competitors. And naturally the initial level of their mutual trust is limited. Even as members of the same business association, where they exchange information and ideas, they would never be quite open with regard to their market situation and business strategy: There are some unreliable managers. When you start sharing some of your new ideas with them . . . they could somehow go silent and in a while you could see them implementing your own plan. I remember these things . . . As a result, you get reserved when discussing issues. First you would give a small part of the idea and see if the partner is interested. Normally, it becomes a long-term process. (2002, the head of a wholesale company in electronics)

However, our study of the electronic durable goods market in 2001–02 demonstrated that despite obvious constraints, a major part of our respondents believed that successful negotiation is possible and it does take place. What are the requirements for success? In this particular market, many leading sellers have known each other on a personal basis for at least seven or eight years. They meet each other frequently, identifying themselves as members of the same business networks. Reputations have been built within these networks during the 1990s. Above all, personal contacts are encouraged by the fact that business owners and managers dealing with electronic consumer goods have similar profiles in terms of their age and background. Most of them are between 30 and 40 years of age, with engineering/technical university degrees. They have similar histories with regards to their business start-ups and development. All in all, with the usual reservations, this apparently serves as a good foundation for confidential relationships. I think that the level of mutual trust is high enough. We have a unique situation in our business [electronics – VR] . . . Nearly everyone graduated from the same universities and came into business at the same time. Almost all top managers are of a similar age and background. Exceptions are rare. And they understand each other easily. (2002, the head of retailing chain stores)

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Business negotiations and personal contacts are very helpful in raising mutual understanding and the initial level of trust, although no one could expect that the adopted conventions would last for the rest of their lives. The leading actors normally keep agreements within a certain period of time (normally for about a month). Therefore, these conventions need to be maintained and renegotiated on a periodical basis. This is best illustrated by the following example: There are wonderful relations in the market. If folks come to an agreement on a coordinated price policy once in a month they would keep it. Approximately a month later someone starts to defect. The first actor breaks an agreement, and then the second one follows . . . In a month we should meet again to look into the eyes of each other and make another agreement. (2002, the head of a company selling cell phones)

Stigmatisation of Defectors Having established conventions, market actors also have elaborated special instruments in order to classify those who deserve trust and those who are stigmatised as non-trustworthy. Here, our respondents distinguished between three prevalent models of action, namely: • acting by laws • acting by rules • not acting by rules. Acting by laws refers to following the official formal rules (for example, paying the full amount of taxes and duties to the state). In fact, most entrepreneurs are not able to do this consistently with regard to all legal norms in Russia. Large transnational companies with big financial capacities and strict corporate codes can be an exception to this. A major part of the Russian market follows a different code of behaviour, which is defined as acting by rules. These rules (pravila) differ from laws, although they are always related to laws. The existence of this institutional gap does not mean that Russian business is thoroughly criminalised but, rather, that the firms operate in the so-called ‘grey’, or semi-legal, market segments. Empirically, this prevailing model of acting by rules is difficult to define, as entrepreneurs do not convey this clearly during interviews. However, our interviews collected in 2001–02 shed some light on this sophisticated problem. We conclude that acting by rules at least includes the following actions: • avoiding behaviour which ‘damages the market’ (for example, undermining an existing price level by big and spontaneous clearances)

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• avoiding ‘black’ (illegal and extremely risky) business schemes, which could let your contractors down should controlling inspections take place • rejecting ordered checks (zakaznye proverki) for competitors, meaning that state controlling bodies should not be sent to competitors to disrupt their activities as has frequently happened • settlement of disputed issues through negotiations. In this context, leading market sellers try to define themselves as those who act by laws and/or rules, thus distinguishing themselves from defectors who do not comply with these rules. The latter are stigmatised as otmorozki (following no rules) or chernushniki (black dealers), whose actions are damaging for the market. This category of market actors uses dumping prices. Moreover, they evade tax payments, running risk beyond an acceptable point. In addition, they are reluctant to negotiate, not following accepted business conventions. Therefore, they are presented as those who cannot be trusted: ‘We can easily reach an agreement with some companies. And these agreements on the price levels could be kept for months . . . But at the same time there are firms, which follow no rules (otmorozki). It doesn’t make sense to talk to them. They would not understand simple words’ (2001, the head of a company selling cell phones). Leading sellers try to stigmatise defectors and push them out of the market. The state gains importance for the implementation of this policy. Therefore, we need to understand what role the state plays in the formation of trusting and distrusting relationships.

THE STATE AS A SOURCE OF TRUST AND DISTRUST The relationships of market actors with state officials present themselves as a complex mixture of trust and distrust, although distrust dominates. However, in this section we will argue that any conventions among market actors could easily be undermined if they are not backed up by a stable state policy. Expectations of the State The attitudes of market actors towards the Russian state contain some elements of an almost enigmatic character. Let us illustrate this first with two examples, which are beyond the scope of our empirical analysis. The first example is borrowed from the history of Russian financial bubbles in 1994–95. At that time a large amount of private savings was collected and stolen by teams of swindlers arranging so-called ‘financial pyramids’ (for

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details, see Radaev 2000). Strikingly, the victims came to the state to reclaim their money. Formally speaking, one can treat this as a clear manifestation of irrational behaviour because the firms collecting money were privately owned and the state could not have been supposed to take responsibility for their actions, although it was blamed for the losses. The second example comes from the history of the 1998 financial crisis, after which a part of private savings was lost through the bankruptcy of commercial banks. Although the crisis was caused by a default of the state, after the crash there was a massive transfer of private savings to the Sberbank, which was the largest state-run bank. Thus, in spite of the fact that the state was responsible for the ‘market failure’, people brought their money back to the state. Both phenomena could be explained with the help of the concept of moral economy (Polanyi 1992), according to which the state as the most powerful actor must stand behind any public and private economic institution, especially in case of their failure. The state is held responsible for guaranteeing its citizens a minimum level of subsistence irrespective of the reasons for which individuals have lost out. In this context, individuals expect a sort of reciprocity from the state. As a result, one-sided trust in institutions emerges along with expectations of state support. Only those institutions that are explicitly backed up by the state are considered to be reliable. These expectations of state support are often implicit. However, they are quite persistent whatever people would say about their attitudes towards the actual state policy. Turning back to our empirical observations, on a rhetorical level the leading market sellers always emphasise their independence from the state. However, in their actual policy statements they largely seek state intervention rather than its withdrawal (Fligstein 2001). Moreover, their trust in institutions also depends on state policies, whilst they try to use the state in order to implement their own control system. For instance, leading market sellers distinguish between ‘bad firms’ (defined as ‘black firms’ or ‘firms acting by no rules’) and ‘good firms’ as a signal to state authorities. They would prefer ‘bad firms’ to leave the market. However, market leaders are often reluctant to combat defectors directly through blacklisting and other means, which might lead to an open conflict, instead preferring to use the state’s monopoly of legitimate force. By producing these distinctions between ‘good’ and ‘bad’ firms, the leading sellers may also be seeking some privileged treatment for themselves, all of which raises the concerns of the Russian Federation Anti-Trust Ministry. For instance, this Ministry made an unsuccessful attempt to stop the State Custom Committee, which suggested a different system of measuring the custom value for salespersons of large international companies in 2002. The latter did not need to prove the value of their goods when presenting invoices

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from the producer (incidentally, the Anti-Trust Ministry lost the case in the court of arbitration). In this context, both one-sided trust and reciprocal trust strongly depend on the state. Reciprocal trust is largely built upon the predictability of actions of other market actors, as this is the first step towards trust in relations in which distrust still prevails. In as far as the state is the main provider of formal and informal rules, reciprocal trust cannot be established among business actors without predictable state policies. All business-to-business conventions are constructed with a reference to the state regulations. And they would be seriously questioned if there were to be spontaneous changes in the regulatory framework. Therefore, all these conventions are built upon certain expectations which actors have of state actions. When speaking about the state we do not see it as a single entity but, rather, as a set of interrelated administrative bodies represented by public officials with whom market sellers immediately have to establish and maintain contacts in order to decrease uncertainty. Therefore, the success of business associations is frequently measured by the closeness of these contacts. In this context, the next question analyses whether it is easy to build up relationships between leading market sellers and state representatives. Building Conventions with the State There are several fundamental difficulties in the establishment of conventions, or shared understandings, between business and state representatives. First, mutual tensions between business leaders and officials prevent successful negotiations. Entrepreneurs tend to see every official as a bribe-taker, predominantly interested in his or her private gain. At the same time public officials tend to treat every entrepreneur as a smuggler evading tax payments and customs duties. Here are some of the typical complaints: ‘The main problem is . . . how the state treats us. There is an impression that all businessmen are either potential or actual criminals now’ (2001, the head of a wholesale firm of durable consumer goods); ‘The state authorities treat everyone as illegal and as 100 per cent defecting people’ (2001, the head of retailing chain stores). Second, when negotiations between business and the state commence, the main parties normally experience a critical situation with regard to coordinating their activities, as they use different logics to justify their claims and actions (this is called different ‘orders of worth’ in the French economic theory of conventions; cf. Thevenot 2000). Business leaders plan and act according to market logic, aiming at minimising costs and keeping prices attractive for customers. Public officials make use of what we would call an administrative logic. They are mainly concerned about collecting tax payments and custom duties, as well as balancing the interests of all political

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parties involved. This includes opportunities for corrupt public officials to make private gain. Third, parties in negotiations are characterised by asymmetrical power relationships. State officials always have the upper hand in designing policies, playing the role of incumbents and imposing their rules, whilst business agents are viewed rather as challengers to these rules (Fligstein 2001). The authorities can easily turn down all suggestions of business owners and managers without being obliged to explain their behaviour. Therefore, one cannot expect that mutual obligations will be taken seriously and strictly fulfilled. However, at least predictable state policies may seriously contribute to the formation of trust. Fourth, government regulations are often not transparent, which produces uncertainty, thus rendering conventions unstable. At any moment, government officials are able to change formally adopted or informally accepted rules, whilst market actors cannot easily predict these changes. For example, this happened on several occasions in 2001, when the State Custom Committee of the Russian Federation issued an official order, only to cancel it again after a short time, which destabilised the market. A general conclusion regarding the character of relationships between business and state actors is presented in the following statement of our respondent: ‘When considering relations between business and the state authorities I would rather estimate them as “balanced” relations. This means that positive measures taken by the state authorities are followed by their absolutely inadequate and controversial implementation. We have a sort of “equilibrium” here’ (2002, the head of a wholesale firm in electronics). From 2001 to 2002 relationships improved slightly, although the lack of reciprocal trust between company leaders and officials still presents one of the major constraints, limiting the development of both one-sided trust in institutions and reciprocal trust among businesses.

CONCLUSION To conclude, we can describe the general logic for the emergence and development of trust in a distrustful environment as follows: trust emergence starts on the micro level, with informal private ordering and closed business networks, which serve as instruments for creating elements of interpersonal trust. The character of these reciprocal relations also changes over time. Starting with affect-based trust, over time market actors move towards reputation-based trust. Investments in reputation contribute to the development of one-sided trust in non-state institutions such as business associations. In turn, these associations become vehicles for establishing trust in state authorities.

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Finally, a predictable state policy encourages both the development of onesided and reciprocal trust. In this context, the new Russian markets present themselves as a prominent example of a low-trust environment. Formal rules are contradictory and change frequently, whilst government policies often are non-transparent and non-predictable, therefore becoming a major source of institutional instability. This produces uncertainty and undermines one-sided trust in formal institutions. Reciprocal trust in other market actors is also seriously undermined, for honesty often does not pay. Entrepreneurs are confronted with a high level of opportunism and malfeasance in business relationships, which results from the frequent infringement of business contracts. Moreover, there are only limited possibilities of formally enforcing a contract through courts of arbitration and other third parties. Therefore, Russian entrepreneurs mainly have to impose methods of private contract enforcement, including informal ways of settling disputes. Although entrepreneurs do try to protect themselves by introducing discriminatory elements into business contracts, especially in relation to newcomers and outsiders, non-contractual forms play a major role in preventing malfeasance. In order to cope with reciprocal distrust, entrepreneurs collect business information and check potential new business partners. They also build and rely on closed business networks. All these precautionary measures are necessary to create the first level of reciprocal trust, that is, predictable behaviour among other market actors. The second level of trust relationships requires mutual obligations, such as a set of conventions, among market actors. In order to reach a shared understanding and to elaborate common rules of the game, the leading market sellers have to go beyond the mere monitoring of actions of their contractors and competitors, and arrange face-to-face negotiations with them. These negotiations are held on the formal level of business associations and on the informal level of roundtable meetings. Through continuous negotiation market actors (including direct competitors) start to overcome their initial mutual distrust. Leading market sellers also distinguish between trustworthy business partners, being trustworthy because they act within rules, and those who are stigmatised as non-trustworthy because they do not act within rules. Business-to-business conventions would not last long without taking into account state policies, as the state provides the formal rules. No real reciprocal or one-sided trust could be established without state intervention. Although market actors do not trust state authorities, they trust those institutions which are not backed by the state, which is seen as the most powerful source of the legitimisation of rules, even less. The state is supposed to take final responsibility for all market institutions, especially in the case of their failure, whatever the reasons for this may be. Market actors also employ the state controlling bodies in order to produce legitimate force against defectors in the market.

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Thus, all conventions in the market are established with explicit or implicit reference to state policies. In order to reduce uncertainties, market actors have to build up conventions with public officials. It is not easy to reach the second level of trust relationships between business and state representatives, that is, the development of their mutual obligations, because the state always has the upper hand in negotiations and tries to dictate the rules. However, such agreement is necessary in order to achieve state policies which are predictable for the market sellers. To sum up, trust formation in a low-trust society starts at the micro level of interpersonal relations in different market segments. After that, it develops from mutual trust in members of business networks to one-sided trust in institutions dealing with these networks, although this requires predictable state policies and stable market institutions backed by the state. In turn, this stimulates further the development of reciprocal trust, thus creating conditions for a continuous self-enforcement of trust.

NOTES 1.

2.

3.

4.

This chapter is a shorter version of an earlier paper (Radaev 2004a), which was a contribution to the research project ‘Honesty and Trust: Theory and Experience in the Light of PostSocialist Transformation’ (2001–03) convened by Janos Kornai and Susan Rose-Ackerman at the Collegium Budapest. The author and research team of the Centre for Political Technologies (Moscow) (head, Igor Bunin) conducted the surveys. The US Center for International Private Enterprise (CIPE) funded the research. We would like to thank I. Bunin, Rostislav Kapelyushnikov, Alexey Zudin, Natalia Nazarova (Center for Political Technologies) and Vladimir Gubernatorov (Russian Federation Chamber of Commerce and Industry) for valuable support in the implementation of the project. The author and research team of the State University – Higher School of Economics conducted these surveys. We would like to thank the President of RATEC Alexander Plyatsevoy, Executive Director of ACORT Oleg Sazanov, and the President of INP ‘Public Agreement’ Alexander Auzan for facilitating the project. Svetlana Barsukova, Tatiana Kazantseva (first series of interviews) and Vladimir Karacharovsky (second series of interviews) were extremely helpful in the collection and systematisation of important parts of the data. Evgenia Nadezhdina provided technical support. All quotes are translated by the author.

REFERENCES Coleman, James (1988), ‘Social Capital in the Creation of Human Capital’, American Journal of Sociology, 94, Supplement, 95–120. Eggertsson, Thrainn (1990), Economic Behavior and Institutions, Cambridge: Cambridge University Press. Fligstein, Neil (1996), ‘Markets as Politics: A Political-Cultural Approach to Market Institutions’, American Sociological Review, 61 (August), 656–73.

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Fligstein, Neil (2001), Architecture of Markets: An Economic Sociology of TwentyFirst-Century Capitalist Societies, Princeton, NJ: Princeton University Press. Fukuyama, Francis (1995), Trust: The Social Virtues and the Creation of Prosperity, New York: Free Press. Gambetta, Diego (ed.) (1988), Trust: Making and Breaking Cooperative Relations, Oxford: Basil Blackwell. Hardin, Russell (2001), ‘Conceptions and Explanations of Trust’, in Karen Cook (ed.), Trust and Society, New York: Russell Sage Foundation, pp. 3–39. Kornai, Janos, Bo Rothstein and Susan Rose-Ackerman (eds) (2004), Creating Social Trust in Post-Socialist Transition, New York: Palgrave Macmillan. North, Douglass C. (1992), Institutions, Institutional Change and Economic Performance, Cambridge: Cambridge University Press. Polanyi, Karl (1992), ‘The Economy as Instituted Process’, in Mark Granovetter and Richard Swedberg (eds) The Sociology of Economic Life, Boulder, CO: Westview Press, pp. 29–52. Radaev, Vadim (1993), ‘Rossiiskiye predprinimateli, kto oni? (Na primere Moskvy)’ (Who are the Russian entrepreneurs? (An example of Moscow)), Vestnik statistiki, 9, 3–13. Radaev, Vadim (1996), ‘Maly Biznes i Problemy Delovoy Etiki: Nadezhdy i Realnost’ (Small Business and Business Ethics: Hopes and Reality), Voprosy Ekonomiki, 7, 72–82. Radaev, Vadim (1997), Ekonomicheskaya sotsiologiya: Kurs lektsii (Economic Sociology: A Lecture Course), Moscow: Aspect Press. Radaev, Vadim (1998), Formirovaniye novykh rossiiskikh rynkov: transaktsionnye izderzhki, formy kontrolya i delovaya etika (Formation of New Russian Markets: Transaction Costs, Forms of Control and Business Ethics), Moscow: Centre for Political Technologies. Radaev, Vadim (2000), ‘Return of the Crowds and Rationality of Action: A History of Russian “Financial Bubbles” in the mid-1990s’, European Societies, 2 (3), 271–94. Radaev, Vadim (2001a), ‘Entrepreneurial Strategies and the Structure of Transaction Costs in Russian Business’, in Victoria Bonnell and Thomas Gold (eds), The New Entrepreneurs of Europe and Asia: Patterns of Business Development in Russia, Eastern Europe and China, Armonk, NY: M.E. Sharpe, pp. 191–213. Radaev, Vadim (2001b), ‘Entreprise, protection et violence en Russie la fin des annees 1990’, Cultures et Conflits, 42 (Summer), 47–68. Radaev, Vadim (2004a), ‘How Trust is Established in Economic Relationships When Institutions and Individuals Are Not Trustworthy: The Case of Russia’, in Janos Kornai, Bo Rothstein and Susan Rose-Ackerman (eds), Creating Social Trust in Post-Socialist Transition, New York: Palgrave Macmillan, pp. 91–110. Radaev, Vadim (2004b), ‘Coping with Distrust in Emerging Russian Markets’, in Russell Hardin (ed.), Distrust, New York: Russell Sage Foundation, pp. 233–48. Raiser, Martin, Alan Rousso and Franklin Steves (2004), ‘Why and Who Do Firms Trust? Evidence from 26 Transition Economies’, in Janos Kornai, Bo Rothstein and Susan Rose-Ackerman (eds), Creating Social Trust in Post-Socialist Transition, New York: Palgrave Macmillan, pp. 55–70. Rose-Ackerman, Susan (2001a), ‘Trust and Honesty in Post-Socialist Societies’, Kyklos, 54 (2/3), 415–44. Rose-Ackerman, Susan (2001b), ‘Trust, Honesty and Corruption: Reflection on the State-Building Process’, Archives of European Sociology, 3, 526–70.

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Sztompka, Piotr (1999), Trust: A Sociological Theory, Cambridge: Cambridge University Press. Thevenot, Laurent (2000), ‘Organized Complexity: Conventions of Coordination and the Composition of Economic Arrangements’, paper presented at the Conference ‘New Economic Sociology in Europe 2000’, Stockholm University, 2–3 June. Williamson, Oliver E. (1985), The Economic Institutions of Capitalism: Firms, Markets, Relational Contracting, New York: Free Press.

9. Trust-milieus of Russian SMEs: cross-regional comparisons1 Alexander Chepurenko and Elena Malieva INTRODUCTION It is well known that in Russia – a country with complicated transition patterns and a fragile environment – purely economic constraints are overlapped by a degree of high uncertainty concerning the framework of an entrepreneurial activity. Hence, trust – (inter)personal as well as systemic (being divided into collective, based on shared informal norms and values, and institutional, relating to formal social institutions and actors) (Dei Ottati 2002, pp. 27–9; Höhmann and Malieva 2002, pp. 12–15; Smallbone and Lyon 2002, pp. 21–2; Welter 2002, pp. 37–9) – may play a crucial role for the development of any kind of transaction. Entrepreneurs have to build up (and remain embedded in) certain rules and norms which regulate their decision-making in a very flexible and unpredictable environment. This means, they know the people they trust and they trust the people they know (Oleynik 2001, pp. 4–26; Rose 2000). Only gradually, as they develop broader networks as the business matures, do firms move from trust relations based on their family and friends to a wider field of trust ties, grounded on successful reciprocal relations with other economic actors (Shastitko 2002, pp. 36–8). Apparently, a lack of commonly accepted institutions, on which institutional trust could be founded, is due to the high degree of distrust in the state (which can be partly explained by the fact that during a state of transition governing institutions change so rapidly that entrepreneurs cannot have confidence in them, and partly by the emergence and growth in corruption) (Chepurenko 2002, pp. 58–70; Dushazky 1998, pp. 91–4; Savkin 1999, pp. 95–8). Therefore, the commonly based norms and values among different networks may be quite different – that is why a high level of trust in the members of one’s ‘own’ network may be combined with distrust of entrepreneurs and other actors belonging to another network (Oleynik 2001, p. 20). This picture might be true, but it also is too generalised; if one looks at particular cases, the trust-related environments and strategies are much more complicated and very different in different environments, according to sector, 136

Trust-milieus of Russian SMEs

137

locality and so on. Bigger small and medium-size enterprises (SMEs) have more insight into the situation on the market, whereas micro firms much more often rely only on personal ties. Retail traders, who deal with final consumers, have to cope with quite different problems than do, for example, SMEs in business-oriented services, which serve a couple of very big (and therefore very important, but also very influential) clients. Cross-regional differences provide one of the variables. These differences have many origins: (a) the territorial vastness of Russia itself ensures that different natural, climatic and infrastructural conditions affect the socioeconomic situation in several regions in a very different manner; (b) population density plays a significant role (in urbanised territories there is a different entrepreneurial climate to that in rural areas with a small number of inhabitants and so on); (c) the existing industrial structure is a very specific precondition of any kind of entrepreneurial activity and, hence, environment; (d) the policies of local and regional bodies may support or ‘suppress’ business – that is, provide a more helpful framework (with a much higher degree of institutional trust) or force entrepreneurs to act in the ‘shadow economy’ alone, only basing their transactions on informal, personal and collective trust and so on. The survey, which was conducted as part of the above mentioned project, enabled us to find out how great the regional differences in the intensity and constellation of trust are in Russia, and allowed us to draw some conclusions concerning the causes of such differences.

DESCRIPTION OF THE EMPIRICAL SURVEY AND CASE STUDIES An empirical survey of 400 small entrepreneurs in four Russian regions (100 entrepreneurs in each of the regions) was conducted in early summer 2002. The following regions were chosen for the empirical surveys, as a result of our conceptualisation of ‘trust’: Moscow, Nishni Novgorod, Kaluga and Voronesh. According to the ‘Expert-RA’ agency’s (Anonymous 2002, pp. 97–128) regional investment risk rating, the above described regions belonged to the following typical groups: (1A) maximal potential – minimal risk (Moscow was the only region in this group); (2B) medium potential – medium risk (Nishni Novgorod and Voronesh); (3B1) lower potential – moderate risk (Kaluga). Moscow, being the only representative of the group 1A, is, and remains, a special case: about one-quarter of all Russian SMEs and up to 80 per cent of the volume of finance capital are concentrated in the capital city. In order to compare the environmental influence on the attitude of respondents to certain key questions, about one-third of the sample from Nishni

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Novgorod region was taken from entrepreneurs in the second big city of the Oblast, Dzershinsk, (we assumed that there is a difference between Moscow as the capital city, with circa 25 per cent of all Russian SMEs, and the main regional cities, as well as between the latter and local centres and small towns, where the environment is still dominated by informal relations). The total sample included enterprises from the three most developed subsectors of SMEs: the food industry (25.8 per cent), trade (41.0 per cent) and business services (33.3 per cent). However, in Voronesh the number of trade firms was somewhat higher and the share of SMEs from the food industry a little lower (medium-sized and big enterprises dominate this industry in this capital of an agricultural region). The number of newly established firms was especially high in Voronesh (more than 90 per cent), as were privatised ones in Nishni Novgorod and restructured ones in Moscow (19 per cent). This could play an important role in differentiating Voronesh SMEs from those of the other regions with regard to the role of trust towards natives of the region (as this is quite important for young entrepreneurs everywhere). The differences between the entrepreneurs’ background were most evident: whilst most of entrepreneurs belonged to the middle age groups – 30–39 and 40–49 years old – 64 per cent of Moscow entrepreneurs were 20–29 and 30–39 years old. In contrast, respondents from Nishni Novgorod and especially from Kaluga were older than the sample average: in Kaluga, 73 per cent belonged to the age range of 30–39 and 40–49 years. Thus, the small entrepreneurs in the Moscow sample were much younger than in other cities. Having been socialised later, during the transition, the Moscow entrepreneurs had much more often worked as employees in private firms, whereas respondents from other cities more often had experience in state enterprises (Kaluga, Nishni Novgorod) and state institutions (Voronesh) during the Soviet period. Official statistics, as well as the data of several sociological studies, show that Russian small entrepreneurs are well educated (most having received higher education). Secondary school education was overrepresented among entrepreneurs in Nishni Novgorod, as was the share of those with higher education among respondents in Voronesh. Despite their younger age, Moscow entrepreneurs have more often had management experience before starting their own business (67 per cent against an average of 59.5 per cent), whilst in Kaluga and Nishni just over half had such experience. Furthermore, previous managerial experience was much more often in a private firm among Moscow entrepreneurs (42 per cent), whilst in Kaluga and Nishni the share of persons who had such experience in the private sector was significantly lower (26 and 21 per cent respectively). But does this mean that respondents from Moscow have a more adequate understanding of the specifics of business behaviour than their colleagues

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from other regions? This question can hardly be easily answered, as we will see below. In addition, 27 entrepreneurs in Moscow, Kaluga and Nishni Novgorod were interviewed during the period December 2002 to February 2003 to confirm some of the results from the quantitative survey. Many of them were owners of more than one firm: this made it difficult for them to provide some data (often, employees work for more than one firm with the same owner; some of them could not present turnover data for a single firm, having in mind the data for all firms). Nevertheless, some evidence from the interviews was very helpful in explaining the quantitative survey results – especially, with regard to motivation in business transactions, treatment by state institutions and so on.

THE ROLE OF (AND TRUST IN) CUSTOMERS AND SUPPLIERS As regards the respondents’ preferences when establishing new business connections (Table 9.1), it is evident that, first, entrepreneurs in the surveyed regions are relatively open to new deals, although they prefer to make new deals with their already established partners, which is clearly usual everywhere in the world. Second, it seems that these established partners are neither family nor friends – hence, trust in business partners is based purely on economic activities, and not so much on any kind of informal past familiarity Table 9.1 Preferred persons/groups in business transactions*

No preference People of native region People of my ethnicity People of my religion Members of the same business association, chamber Established business partners Friends Family members Other

Moscow

Kaluga

Nishni Voronesh Sample Novgorod total

29.3 5.1 4.0 0.0

3.4 42.4 5.1 0.0

21.2 17.2 1.0 0.0

41.9 8.1 0.0 0.0

25.1 16.0 2.4 0.0

1.0 51.5 6.1 3.0 0.0

0.0 49.2 0.0 0.0 0.0

1.0 47.5 9.1 2.0 1.0

0.0 48.6 1.4 0.0 0.0

0.6 49.2 4.8 1.5 0.3

Notes: *Respondents could give up to three answers in order of priority. This table presents data for the first priority. Source:

Own survey.

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with partners. Third, in contrast to pre-modern societies, neither ethnicity nor religion plays any role in establishing business relations. These identification factors are not relevant in the business strategies of Russian SMEs. Finally, collective trust (in members of the same business association and so on) is very weak – perhaps because SMEs are very seldom members of established business associations, and because the latter have very limited power (to bargain with authorities or reduce administrative barriers for business and so on). There is no reason for entrepreneurs to become members of business associations. The generally accepted practice of ordering transactions is through a contractual regulation; the most frequently used type of contract is a written one (Table 9.2). In this sense, one might say that Russian entrepreneurs are acting in accordance with the old wisdom: trust is good, control is better. On the other hand, in Kaluga and Nishni Novgorod, contracts with both customers and suppliers are much more often regulated orally; in Voronesh up to onethird of deals with customers are not protected by any kind of contract (maybe this is a consequence of the somewhat higher share of retail traders there). As the interviews showed, none of the interviewees would base a business deal on an informal or oral agreement: formal contracts with customers, suppliers and co-operation partners are the rule.2 However, there is little reliance on the law when enforcing contracts. Thus, while written contracts are more or less ‘formal’, it is common business practice to avoid formal sanctions, penalties, arbitrage and the courts (not so much because of a lack of confidence in the result, but because of the long duration of lawsuits and the considerable amount of time consumed by enforcing contracts through the law). However, it is evident that generally relations with suppliers are more often contractually protected than those with customers. This is a sign not so much of an asymmetric contractual power between SMEs and their commercial partners, as of the fact that for many SMEs their clients are private households, whereas their suppliers are firms. Generally, in all surveyed regions, entrepreneurs usually decide to choose a specific type of agreement based on the same group of factors: former experience with the firm, the amount involved in the expected deal and the reputation of the possible contract partner. As the interviews showed, the role of trust is different in different sectors, as well as in different environments: in areas where the number of potential customers/clients is small, the role of trust is less crucial; in sectors with standardised mass products or services, where everyone can change customers/clients very easily (fast-food services, retail trade and so on) trust is an obligatory precondition of stable relations between firms. The criteria usually preferred when choosing the type of agreement are as

Table 9.2 Regulation of customer and supplier relationships Type of agreements 141

No. of agreements Oral agreements Written contract Note: Source:

Customer Moscow Kaluga 25.0 31.0 56.0

13.0 54.0 66.0

Respondents could give several answers. Own survey.

Nishni Novgorod

Voronesh

Sample total

25.0 40.0 53.0

32.0 21.0 60.0

23.8 36.5 58.8

Supplier Moscow

Kaluga

10.0 21.0 76.0

3.0 50.0 83.0

Nishni Voronesh Novgorod 9.0 44.0 59.0

8.0 19.0 78.0

Sample total 7.5 33.5 74.0

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follows (the respondents could reply ‘yes’ or ‘no’): previous experience with the firm; the value of the expected deal; the reputation of the customer/supplier. Looking at the regional groups, it is worth mentioning that previous experience with the firm is much more important for Kaluga SMEs and less important for Voronesh SMEs. The value of the expected deal is of more importance in Kaluga and less important for Nishni Novgorod SMEs. The reputation of the customer/supplier is more important for Nishni Novgorod and Voronesh firms, and less so for SMEs in the food industry. Guarantees with respect to delivery or payment failure are more important for firms from Kaluga, but much less important for companies in Nishni Novgorod. Recommendations from business partners are considerably less important than the four factors mentioned above. However, in Kaluga half of the respondents indicated that this is important for them. But, in general, differences between regions in this area were not very significant. The rise of a client’s market in these Russian cities implies that it is important to have a good reputation in the eyes of a customer’s representative, as this means better conditions of payment and delivery can be achieved or payment may be deferred to a date later than that initially agreed without detriment to the established relations. If, however, relations with the customer did deteriorate, most of the interviewees were able to find new customers very easily. Moreover, trusting clients is much more important, because here the firm itself has to offer sales or consignation: if the client does not pay this can lead to net losses and it will be necessary to find new clients. That is why the role and importance of personal contacts in developing and managing relations and enforcing contracts with clients (safeguards, risk involved, and so on) leads to an orientation towards ‘trust-based’ relations with clients, with the aim of making them ‘friends’ – as everybody is confident that if a contract is broken, the only possible way to avoid losses by diminishing transaction costs is a personal tie to the client. One of the indicators of the level of trust is the preferred terms of payment (Table 9.3). But, despite the fact that the overwhelming majority of entrepreneurs preferred cash on delivery, this can hardly be seen as a definitive sign of low personal trust. Here, the lack of liquid assets could be one of the reasons for this preference, otherwise it would be impossible to explain why, for example, Kaluga, where 97 per cent of the entrepreneurs surveyed choose cash on delivery, contained the largest number of entrepreneurs in the sample, 45 per cent, who were prepared to offer credit to their customers for up to 1 week. Such a unique situation in Kaluga, which is a relatively small city, is perhaps more related to the worse financial situation faced by business there – an SME needs time to sell the goods before it has sufficient money to pay for them. Generally, it is very difficult to ascertain whether the low rate of those

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Table 9.3 Usual payment terms offered to customers

Cash on delivery Bank transfer Credit up to 1 week Credit up to 1 month Credit more than 1 month Other Note: Source:

Moscow

Kaluga

Nishni Novgorod

Voronesh

Sample total

81.0 58.0 18.0 16.0

97.0 63.0 45.0 7.0

81.0 64.0 20.0 15.0

80.0 54.0 14.0 12.0

84.8 59.8 24.3 12.5

10.0 7.0

4.0 0.0

7.0 2.0

4.0 2.0

6.3 2.8

Respondents could give several answers. Own survey.

in the other three cities who offered credit was caused by a low level of trust or by a shortage of finance on the part of customers.

CREDIT TRANSACTIONS AND THE ROLE OF TRUST Credit between commercial counterparts is in general a field of personally based trust, but also involves collective and institutional trust. It is not easy to ascertain which of these factors is more important when taking a decision to grant credit. As Table 9.4 shows, the most common recipients of credit from SMEs in Kaluga, Nishni Novgorod and Voronesh were their employees; only in Moscow did friends feature more frequently. It is a very interesting result Table 9.4 Sources to which money has been lent Recipients of credits Family Friends Employees Customer Supplier Business partners Previous colleagues Other Source:

Own survey.

Moscow

Kaluga

Nishni Novgorod

Voronesh

Sample total

17.0 23.0 7.0 7.0 8.0 18.0 7.0 1.0

31.0 35.0 55.0 27.0 36.0 38.0 5.0 0.0

20.0 33.0 35.0 16.0 20.0 16.0 5.0 0.0

14.0 21.0 38.0 16.0 14.0 30.0 5.0 0.0

20.5 28.0 33.7 16.5 19.5 25.5 5.5 0.2

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when compared with the fact that the level of trust towards employees was relatively low (see below) and that information provided by employees concerning market development in Moscow was very important (we cite the most frequently given answers concerning the importance of different sources of information in making business decisions). As for provincial cities, the practice of lending money to employees could be recognised as a strategy to engage employees in a firm’s activities by paying them low salaries, but always being ready to lend them money. Another result was that in all the regions, the entrepreneurs surveyed ranked family members after business partners and friends as receivers of credit. However, especially in Kaluga, the share of those who had ever lent money to their family was relatively high. Combined with the data on lending money to friends (a much more significant share of entrepreneurs in each of the surveyed regions provided them with cash), one might say that Russian SMEs relatively often supply their relatives and acquaintances with money. It is significant that an entrepreneur often has silent partners among their closest relatives. Usually, such silent partnership is not protected by any form of contract, but only through moral obligations.

INTRA-ORGANISATIONAL RELATIONSHIPS Trust is not only an external, but also an internal factor, influencing relations within the firm. Trust in employees is a core question in intra-firm relations, because, especially in SMEs, effective forms of indirect labour process control are usually impossible and a team spirit and engagement by flexible employees are quite important. At the stage of hiring an employer already has to develop procedures and establish criteria for selection which guarantee a sufficient trust level (Table 9.5). When selecting new employees, personal trust plays a much more important role for SMEs in Moscow. Among the first priorities personal trust is not much lower than professional experience. In contrast, in all the provincial cities in the sample, entrepreneurs first look at the previous professional experience of the hired person – personal acquaintance is still important, but there is a significant ‘gap’ between both criteria. Moreover, recommendations (a form of collective trust) play the second most important role here, whilst personal acquaintance is ranked third. Furthermore, another difference between hiring strategies in Moscow and in the provinces is connected to the motivation of the hired person. In Moscow it still plays a role, whilst in all the other cities sampled it was almost the last among the factors identified as being the most important. Personal acquaintance with future employee is, again, more important in

Table 9.5 Criteria used to select employees* Criteria:

1st priority Moscow Kaluga

145

I know future employees Recommendations Skills level Professional experience Age Gender Motivation Other Note: Source:

28.0 9.0 11.0 37.0 1.0 – 12.0 1.0

9.0 20.0 5.0 44.0 5.0 – 9.0 0.0

Nishni Voronesh Novgorod 18.0 23.0 12.0 40.0 1.0 – 3.0 2.0

*Entrepreneurs could give up to three answers in order of priority. Own survey.

11.0 11.0 14.0 55.0 0.0 – 6.0 1.0

2nd and 3rd priority Sample Moscow Kaluga Nishni Voronesh total Novgorod 16.5 15.8 10.5 44.0 1.8 0.0 7.5 1.0

22.0 36.0 47.0 46.0 12.0 4.0 25.0 2.0

3.0 30.0 40.0 29.0 28.0 5.0 42.0 0.0

19.0 26.0 33.0 39.0 27.0 7.0 33.0 5.0

22.0 45.0 34.0 34.0 12.0 2.0 27.0 2.0

Sample total 16.5 34.3 38.5 37.0 19.8 4.5 31.8 2.3

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Moscow and Voronesh; recommendations, in Voronesh; skills level and professional experience, in Moscow; age, in Kaluga and Nishni Novgorod; and motivation, in Kaluga. The lower level of trust in Moscow is perhaps the ‘dark side’ of the much better labour market situation, where there are wider job opportunities, in contrast to the provinces, where the labour markets are restricted. This is why employees there have less chance to find new work and are better motivated to be more faithful to their employers. Hence, the higher level of trust towards employees in provincial cities not only has personal (in terms of the frequency which credit is offered to employees in these cities), but also an institutional background. Furthermore, as the results of the interviews show, in most cases, entrepreneurs hire employees on the basis of recommendations by persons from the same town or by colleagues; however, nowadays, not only ‘recommendations’, but also concrete knowledge and experience are expected from a potential employee. Moreover, the fact that all the people interviewed mentioned that their labour contracts with employees are a pure formality – real input and salary are governed by unwritten laws, and everybody accepts this – shows that a certain level of collective trust in unwritten laws still exists on both sides.

INSTITUTIONAL AND SOCIAL ENVIRONMENT Generally, the state is regarded as the largest obstacle and danger to entrepreneurial units. The state is, thus, really more of a ‘bandit’ than a regulating body. For this reason it is not state laws and regulations, but rather informal conventions and the ‘common law’ which are the true basis of any entrepreneurial activity in Russia. According to the interviews, the treatment of entrepreneurs by authorities, especially tax agencies and other inspectors (fire, sanitary and so on) is relatively often impolite and high-handed. The most common problems in dealing with these controlling bodies are the low level of competence of their personnel and contradictions in regulations – rules and legislation that can be implemented by the bureaucrats in a very arbitrary manner. Hence, bribes are a solution in order to minimise the transaction costs with regulating bodies. Bribes – often in the form of a gift for a holiday and so on – are usually viewed as a form of symbolic affirmation of ‘trust’ and ‘sympathy’ for a bureaucrat, not as a breach of common law and ethics. In fact, such ‘sympathy’ is rather a way of signalling loyalty to these authorities (combined with an attempt to prove how corrupt the person in question is in order to use his or her ‘services’).

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147

The use of ‘anonymous’ third parties such as tax consultants to deal with the authorities is unusual. More often, there are personal ties or corrupt practices (‘I’ve bought off a person in such-or-such an authority; he or she will inform me of all obstacles and problems I could be confronted with’), which are used to reduce or avoid further contradictions with inspecting bodies. It is a quite well-known fact, confirmed many times in a number of empirical surveys over the last few years in Russia, that entrepreneurs distrust the state authorities and, especially at the level of small businesses, have no confidence in the economic policy of state bodies. The survey results clearly show that this tendency remains dominant as regards different levels of the state and its institutions. Federal bodies are considered to be a constraint more frequently in Kaluga, and less frequently in Voronesh. However, it is worth mentioning that a high share of the sample in Voronesh and Moscow could not give an assessment of the federal bodies. The same picture is characteristic for the attitude to regional bodies. (Here, it can also be added that regional legislatives are judged more negatively the older the firm is.) Generally, Kalugan entrepreneurs seemed to be the most critical of all levels of state and local government. In this context, the intensive personal and collective trust ties, which have been observed a number of times, seem to be a ‘compensation’ for the low level of institutional trust. Courts and courts of arbitration are regarded as more or less ‘neutral’; only in Kaluga, again, and to some extent in Voronesh, were they viewed as a constraint much more frequently than elsewhere. But it is important to mention that the overwhelming majority of respondents have not had any experience with law enforcement institutions, so their opinions are not based on their experience of everyday practice. Relations to the local levels of the state bodies and local authorities are twofold and contradictory. On the one side, there is high distrust towards these bodies as such, which we measured above. On the other side, relations of entrepreneurs to the officers at the lowest level of these bodies were described as being more or less ‘friendly’: entrepreneurs could rely on them (Table 9.6). This is especially true for contacts between entrepreneurs and the local police, labour and environmental inspectors. Thus, despite the fact that the relations to inspections were rather good in all the surveyed regions except Kaluga, this can hardly be regarded as a sign of ‘benevolence’: there are even controlling institutions with which small entrepreneurs meet on a regular basis. So the generally negative attitudes towards state bodies is, indeed, merely a result of the practice of such contacts. These views should instead be seen as an indirect indicator of corrupt practices – especially, with regards to the institutions with which respondents have had the most positive experience. In connection with this, it is not trust, but merely confidence in the behaviour modes of inspecting persons, for example when an inspection takes place. In

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Table 9.6 External relations of entrepreneurs and managers to the representatives of different state authorities Friendly Neutral (neither friendly nor bad) Tax inspector Fire inspector Trade inspector Ecology inspector Local police representative Labour inspector Sanitary inspector Source:

17.5 12.0 7.3 4.0 16.5 4.8 10.8

72.5 59.8 51.0 33.0 44.3 44.5 46.3

Bad

No contacts

Don’t know

7.3 8.8 7.8 1.3 2.8 3.5 11.0

1.5 15.0 27.3 48.8 28.3 33.5 27.3

1.3 4.5 6.8 13.0 8.3 13.8 4.8

Own survey.

a figurative sense, there are genuine relations of ‘calculated risk’ (one calculates whether it would be more risky and more expensive to pay bribes or to undergo the possible public procedures which accompany conflicts between a firm and a state authority – with the consequence that established personal ties to certain corrupt inspectors could be damaged or the person could be removed or changed).

SOURCES OF ASSISTANCE AND ADVICE AND THE ROLE OF TRUST A wide range of trust practices emerges in cases when assistance of any kind is needed. Here, respondents demonstrated different strategies to solve problems occurring in their everyday activities by relying on their social capital (Table 9.7). If SMEs need assistance and advice, they turn first to established business partners or family and friends. The role of business associations and chambers, as well as of consultants and business support agencies (their services are too expensive for many small firms), is rather negligible. However, these practices vary substantially across regions: in Voronesh, entrepreneurs usually only turn to established business partners; when one considers the older age of the firms surveyed in Voronesh, the popularity of the answer ‘no assistance needed’, which was the second most frequently given answer, is quite understandable. Indeed, in Moscow, the answer ‘no assistance needed’ was ranked first; however, it was followed very closely by ‘family and friends’ and ‘established business partners’. In Kaluga, more than half of the

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Table 9.7 Sources of business assistance and advice* Moscow No assistance needed Employees Family and friends Established and regular business partners Consultants, business support agencies Business associations, chambers Contacts in local authorities Other

Kaluga

Nishni Voronesh Sample Novgorod total

30.3 17.2 25.3

10.2 1.7 20.3

18.2 14.1 30.3

41.9 0.0 6.8

25.7 9.7 21.8

19.2

55.9

27.3

45.9

34.1

3.0 0.0 5.1 0.0

6.8 0.0 5.1 0.0

4.0 1.0 5.1 0.0

1.4 2.7 0.0 1.4

3.6 0.9 3.9 0.3

Note: *Up to three answers in order of priority were possible. The share of those who gave definite answers concerning the 2nd and 3rd priorities did not exceed 25–30 per cent in each of the surveyed regions; therefore we excluded this data from the analysis. Source:

Own survey.

respondents rely instead on established business partners, followed, with a big gap, by family and friends. In Nishni Novgorod, family and friends remained the most important source of help, followed by established business partners. However, though these examples may differ, they all show that the protection strategies of small entrepreneurs in Russia are predominantly based on personal trust. Almost none of the interviewees could remember any case of support (information or advice) from ‘anonymous’ organisations – business associations, support agencies or chambers. An important feature of the situation in the cities observed in our case study is that there are apparently two cohorts of entrepreneurs: (a) the few dozens (or hundreds, in the case of Moscow) who are able to exploit membership in public bodies and/or access to the authorities very much in favour of their companies, and (b) the overwhelming majority of entrepreneurs who do not have access to intermediary and public organisations. A reason for this is probably that information in Soviet times was always ‘confidential’; people who had access to certain information could convert this into power and influence. Today, such information (for example, possibilities of financial support, exhibitions) is converted to cash. Only a small proportion of Russian entrepreneurs use the databases (at federal, but also at regional, level) that are being set up and access them via the Internet. This could change with the spread of access to the Internet. On the whole, the creation of various Internet databases and the development of the Internet must be seen as one of the most efficient means to minimise the above mentioned inequality.

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Table 9.8 Help in solving problems during business start

Not applicable No Yes Total Source:

Moscow

Kaluga

Regions Nishni Novgorod

Voronesh

Sample total

2.0 33.0 65.0 100.0

– 44.0 56.0 100.0

2.0 50.0 48.0 100.0

– 53.0 47.0 100.0

1.0 45.0 54.0 100.0

Own survey.

Common relatives and friends (this heading could also cover the so-called private arbiters) have ceased to play, in contrast to the early 1990s, a leading role. Consultants’ and chambers’ services were not used because they can be too expensive for a small firm in Russia. The importance of trust is usually very great before and during the start-up phase: certain resources – such as contacts to possible customers and suppliers – can hardly be obtained by (only) paying money; other resources – cheaper rooms, better qualified employees and so on – can be acquired by paying less money if the start-up entrepreneur has good informal sources of information and knows somebody who could help him or her access such resources. Thus, it is not surprising that more than half of the entrepreneurs interviewed received some support when solving start-up problems. Moscow firms received such assistance more often, and firms in Voronesh and Nishni less so (Table 9.8). The three most used sources of help were business partners (a confusing matter, for at the time of the entrepreneurial start a significant share of start-ups already had some business partners), friends and family.

CONCLUSIONS Most of the persons interviewed did not clearly identify different sides and effects of trust/distrust, but some facts and figures delivered by the survey imply that the role of trust/distrust – at least of personal trust – is not so crucial as it was initially expected to be: • Up to two-thirds of the small entrepreneurs surveyed had no need for trust-based relations during start-up. • Up to half of the turnover of their firms is created in the shadow economy; hence, legal trust related procedures and mechanisms were not helpful in force majeure situations.

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• Personal experience and advance payments play a much more important role than trust when protecting a deal. It might be possible to differentiate regions or sectors according to their ‘level of trust’. The evidence of the qualitative approach and comparison with the survey (which is all the more important, since collective trust especially cannot be studied in a merely quantitative manner) to some extent contradicts our initial assumptions concerning the crucial role of regional differences in the establishment of local trust milieus (Table 9.9). This comparison shows that, first, there are in fact more similarities than differences between SMEs in the surveyed regions. Second, the locally based nature of these differences and disparities is to some extent arbitrary – they may be determined by factors other than location (the samples were too small, the structure of the samples in all four regions was different with regards to sector, age, size and so on). On the other side, similarities between statements made by SMEs in different regions may be the product of some more general trends. These trends, or at least some of them, contradicted our initial assumptions. The trends may be described as follows: 1. If we go beyond some of the verbal statements made by the entrepreneurs interviewed, in which the role of personal trust in relations with business partners, customers and so on or money lending practices was overemphasised, we may see that their actual behaviour is governed by factors other than personal trust. In fact, personal trust plays a much more modest role than we initially assumed, although it is very important in force majeure situations or during start-up. 2. Despite harsh criticism of institutions and a verbally expressed distrust of the state, institutionally based practices are well embedded and accepted (as seen in the preference for written contracts with even established partners, bank transfers, the initialising of prosecution by the courts or courts of arbitration in force majeure cases and so on). Hence, the widespread opinion that institutional trust in Russia is underdeveloped must be corrected. 3. Contrary to our initial assumptions, there are no collective trust milieus to be seen – neither based on any form of local, ethnic or confessional ties, nor on any form of co-operative economic behaviour or membership of business associations and so on. The survey and interviews showed that the times when ‘personal trust’ rested mainly on familial and friendship ties are long gone. People have realised, often thanks to bitter disappointments, that business and private life have to be kept separate. This means that nowadays good personal relationships

Table 9.9 Trust milieus in the surveyed regions: similarities and differences3 Differences between regions

Similarities between regions

Importance of trust in relations with business partners (significantly more important in Kaluga/Voronesh, less important in Nishni Novgorod/Moscow)

Groups – native regions, ethnic, confessional and so on – preferred in business transactions (mainly established business partners + no preferences, except for Kaluga: people from Kaluga were preferred after established business partners; people from native region 2nd were the preference) Types of agreements with customers/clients (only in Voronesh no agreements with customers 2nd ranked, in all other regions – written contracts, oral contracts, no agreements) Payment terms for customers (except Kaluga: high percentage of credit for up to one week, all other regions – mainly cash on delivery and bank transfers)

Criteria for selection of employees (Moscow: experience + personal knowledge, Kaluga/Nishni Novgorod: experience + recommendations, Voronesh: experience + skills) 152

Sources of assistance in complicated situations (in Moscow and Voronesh – no assistance needed + established business partners, in Kaluga and Nishni Novgorod – family and friends + established business partners) Help from any side during start up stage (Moscow/ Kaluga – more often recipients of some forms of help, Nishni Novgorod/Voronesh – mainly no help from any source)

Lending money to third persons (except Moscow where friends and family are ranked first, in all other regions – employees were first) Relations between private firms and authorities (mostly neutral, except Kaluga: more critical approach towards any levels of state and different state institutions) Co-operation areas (minimal role in every possible form) Relations to persons in several inspecting state bodies (everywhere neutral/friendly)

Source:

Analysis of own survey.

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and ‘personal trust’ arise through business relations that have been established spontaneously and been successful for a while, not the other way around, as was common in the early 1990s. This means that the ‘social capital’ of an entrepreneur is not measured by how many business people he or she knows from the old times, but by how skilfully he or she handles marketing and logistics, and whether he or she can use this to create functioning networks. Many admitted that ‘personal trust’ with regards to permanent business partners or even friendships that arise out of business relationships differ from ‘friendship per se’. In the regions investigated, the market today is a customer’s not a supplier’s market. Therefore, business relationships with trustworthy customers, rather than with suppliers, acquire special significance. For this reason, suppliers have to create ties to customers by purely economic means, whereas special emphasis is placed on confidence-building measures when establishing and cultivating permanent relations with clients (birthday presents, help in establishing new business contacts, and so on). Relationships with customers, as well as with new partners, are those zones of entrepreneurial behaviour which are especially trust related. Although contracts are mostly regulated by written agreements, this is to a large extent a consequence of formal fiscal rules, not of the desire to protect oneself from commercial risk. Ethnic, confessional and local ties play next to no role, with one exception: the significantly lower willingness to do business with people of Caucasian ethnic origin. Apparently, both a significant difference in mentality, which is expressed by a disregard for the conventions accepted in Russia (business practices, as one entrepreneur explained, are interpreted completely differently by Caucasians – for example, making minor concessions is not seen as an opportune business practice but rather as ‘weakness’, and therefore does not lead to a service in return, but rather a hardening of one’s own position), as well as chauvinist views exacerbated by the events in the Northern Caucasus and the tragic taking of hostages in the Moscow theatre play a role in this. On the whole, intermediaries are hardly present: associations and unions of entrepreneurs play no role; neither do the ‘out-of-court arbitration procedures’ so popular in the early 1990s, moderated by semi-criminal kryshas (‘roofs’)4 – not mentioned by any of the interviewees. This is probably due to the fact that very short-term business strategies (getting rich quickly by cheating the business partner and then ‘doing a runner’) and the corresponding type of ‘entrepreneur’ are finished. The institutional environment remains uncongenial. This holds true especially for legislation and for the control exercised by various regulatory and administrative state institutions. Institutional trust is either non-existent or close to zero – if one is to believe the entrepreneurs’ statements. However, some facts contradict this, namely,

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the greater role of written contracts, the belief in courts and courts of arbitration (and not in ‘roofs’ as institutions of ‘alternative justice’, as was the case in the early 1990s). It is the unpredictability of the authorities’ policies and legislation that leads to distrust. The respondents attribute this circumstance to the fact that there are no officials capable of understanding business motivation or who are familiar with the capabilities of business ‘from the inside’. The provisional theories on the role of an ‘invisible hand of personal trust’ in the Russian small-scale economy, which were based on certain empirical findings from the early 1990s, should be modified. The same holds true for the overemphasis of the influence of local environments on the structure and character of trust milieus in which Russian SMEs operate. Nowadays, it is not easy to differentiate regions into ‘high’ and ‘low’ trust milieus because of the complexity of trust forms – personal, collective, institutional – and of regional differences in the structure of the latter. A clearly ranked differentiation of regions could be only constructed on the basis of generalised opinions of respondents concerning the role of trust in their everyday practice. The analysis of their answers to more concrete questions shows a much more complicated picture, which could hardly be a product of a strong correlation between, for example, the level of trust and the ‘capital–province’ divide. Trust-related matters are of a more complex nature: age, previous experience in business sector perhaps play a much more significant role than location. And this is a very positive result of the macroeconomic development in Russia in the late 1990s.

NOTES 1.

This chapter is based on the results for Russia within an international project, sponsored by the VW-Foundation and titled ‘Entrepreneurial behaviour and trust. Structure and genesis of economic transactions patterns in “Low-trust” and “High-trust Milieus” in East and West Europe’. 2. This does not contradict the results of the survey, in which many entrepreneurs mentioned that they deal with their partners without any written contract. A common situation – regarded differently by different interviewees – is that in existing business relationships new transactions are initially discussed and agreed upon orally, and only later covered by a formal contract. This is often done not because of a lack of trust, but out of fiscal and accounting necessity. 3. By comparing SMEs from different regions, we describe as similarities such cases when in at least three of the surveyed regions the composition of their responses was more or less the same; differences are cases where the structure of responses was totally different between at least two ‘groups’ of regions. 4. ‘Roofs’ (in Russian: krysha) refer to criminals or bureaucrats who offer ‘protection’ in the form of support and assistance to entrepreneurs regarding problems with business partners, government or other criminals.

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REFERENCES Anonymous (2002), ‘Rejting regionov Rossii (2001)’, Ekspert, 41, 5 November, 97–128. Chepurenko, Alexander (2002), ‘Entrepreneurial Culture in Russia: Does It Develop and What Does It Mean, if It Does?’, in Antonina Bieszcz-Kaiser, Ralph-Elmar Lungwitz, Evelyn Preusche and Erhard Schreiber (eds), Zurück nach Europa oder vorwärts an die Peripherie? Erfolge und Probleme nach einem Jahrzehnt der Umgestaltung in Ostdeutschland und Mittel/Osteuropa, München: Rainer Hampp, pp. 58–70. Dei Ottati, Gabi (2002), ‘Some Thoughts on Entrepreneurial Strategies and Trust’, in Hans-Hermann Höhmann and Friederike Welter (eds), Entrepreneurial Strategies and Trust, Arbeitspapiere und Materialien, 37, Bremen: Forschungsstelle Osteuropa, pp. 27–9. Dushazky, Leonid (1998), ‘Cennostno-motivacionnye dominanty rossiyskikh predprinimateley’, SocIs: Sociologicˇeskije issledovanija, 7, 91–4. Höhmann, Hans-Hermann and Elena Malieva (2002), ‘Trust as a Basic Anthropological Category’, in Hans-Hermann Höhmann and Friederike Welter (eds), Entrepreneurial Strategies and Trust, Arbeitspapiere und Materialien, 37, Bremen: Forschungsstelle Osteuropa, pp. 12–15. Oleynik, Anton (2001), ‘Biznes po ponyatiyam’, Voprosy ekonomiki, 5, 4–26. Rose, Richard (2000), ‘Coping with Organizations: Networks of Russian Social Capital’, working paper, Glasgow: Centre for the Study of Public Policy. Savkin, Vladimir (1999), ‘Predprinimatelskaya sreda v ocenke predprinimateley’, SocIs: Sociologic˘eskije issledovanija, 7, 95–8. Shastitko, A (2002), ‘Mekhanizm obespecheniya sobludeniya pravil (ekonomichesky analiz)’, Voprosy ekonomiki, 1, 36–8. Smallbone, David and Fergus Lyon (2002), ‘A Note on Trust, Networks, Social Capital and Entrepreneurial Behaviour’, in Hans-Hermann Höhmann and Friederike Welter (eds), Entrepreneurial Strategies and Trust, Arbeitspapiere und Materialien, 37, Bremen: Forschungsstelle Osteuropa, pp. 21–2. Welter, Friederike (2002), ‘Trust, Institutions and Entrepreneurial Behaviour’, in HansHermann Höhmann and Friederike Welter (eds), Entrepreneurial Strategies and Trust, Arbeitspapiere und Materialien, 37, Bremen: Forschungsstelle Osteuropa, pp. 37–9.

10. The effect of trust in courts on the performance of Ukrainian SMEs Iryna Akimova and Gerhard Schwödiauer INTRODUCTION Progressive economic development without private property rights, the assignment of asset control rights and return rights to individuals is hardly imaginable. People would not invest if they could not reap the fruits of their investment. Though it has always been recognised by economists that defining and protecting property rights is one of the prime functions of government, the fulfilment of this task has often been taken for granted. The challenge of guiding the transition of the former socialist economies of Central and Eastern Europe to modern market economies, and the debate on policy reform in developing and emerging economies in general, have brought this topic, in particular the indispensable role of government, again to the forefront of economic theory and policy analysis. The transition from plan to market is fundamentally tantamount to the design and support of an adequate property rights structure by the government. Without the government fulfilling its tasks in this respect (‘good governance’), through its legislative, judiciary and executive branches, property rights cannot be effectively established (for example, Olson 2000; Polishchuk and Savvateev 2004) and efficient market institutions cannot emerge. In transition economics the role of property rights in the restructuring of formerly state-owned firms has been intensely discussed, with an emphasis on ownership structure and corporate governance. The question of the enforcement of commercial and credit contracts is closely related to the design and protection of property rights in a narrow sense. It arises if control rights include the right to trade the resources a person owns (alienability rights). Without such contracting rights and the effective enforcement of contracts, individuals would have no incentives to reallocate resources by mutual consent and to mutual advantage, and there would be no markets. Whether the role of government is indispensable for contract enforcement has been the subject of debate. Williamson (1983; 1994), for example, has argued that economic agents rely on a variety of informal institutions (relational contracting, self-enforcement 156

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mechanisms, social networks) which do not depend on a government-provided legal system. The neoclassical theory of contracts (for example, Feinman 1990; North 1990), on the contrary, emphasises the importance of the state for contract enforcement. This sides with Adam Smith’s famous observation (Smith 1776 [1999], p. 510) that Commerce and manufactures can seldom flourish long in any state which does not enjoy a regular administration of justice, in which people do not feel themselves secure in the possession of their property, in which the faith of contracts is not supported by law, and in which the authority of the state is not supposed to be regularly employed in enforcing the payments of debts from all those who are able to pay. Commerce and manufactures, in short, can seldom flourish in any state in which there is not a certain degree of confidence in the justice of government.

The more recent literature on contractual relations in transition economies (for example, Hay and Shleifer 1998; Hendley et al. 1997; Johnson et al. 1999; 2002; Raiser 1999) has provided evidence for the significance of legal institutions such as commercial courts for fostering efficient transactions even in countries with a still insufficiently developed institutional framework. In particular, Johnson et al. (1999; 2002), using survey data for privately owned manufacturing firms in Poland, Slovakia, Romania, Russia and Ukraine from 1997, have found that, while relational contracting and settling disputes without third-party assistance is the basis of most of the transactions, commercial courts matter nevertheless for the firms’ performance. This chapter seeks to contribute to this line of research in two respects. First, using data from a survey of Ukrainian small and medium-sized manufacturing enterprises (SMEs), we focus on one transition country with overall weak legal institutions and show that the firms whose managers report to have trust in courts do significantly better in terms of several standard performance measures. Secondly, we identify some major factors that influence the business people’s perception of the courts’ effectiveness at settling commercial disputes. It turns out that besides experience from using courts, the managers’ perception of the general uncertainty of the business environment, their experience with bribing public officials, and their informal networking relations with representatives of public authorities have a significant impact on whether they express trust in courts or not.

COMMERCIAL COURTS IN UKRAINE In Ukraine, disputes over contracts between legal entities (firms, organisations) are heard by commercial courts, which are called arbitration courts. The functioning of the Ukrainian legal system of contract enforcement has shown

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slow progress compared with the East European transitional countries and even some Commonwealth of Independent States (CIS) neighbours. This shows in the low rank of Ukraine in international evaluations of the legal environment for business conducted by various organisations. The legal indicator survey 2000 of the European Bank for Reconstruction and Development (EBRD), for example, pointed at a gap between the extensiveness and effectiveness of legal reform1 in Ukraine and put it in the group of countries with a serious ‘implementation gap’, which means that relatively comprehensive laws are not being properly implemented (EBRD 2000). By 2001, no significant success in overcoming the ‘implementation’ gap had been registered (EBRD 2001). The ‘implementation gap’ reflects, among other things, a low efficiency of Ukrainian commercial courts. The courts complain of being overloaded with cases, and official time limits for the consideration of the claims brought to court are usually overdrawn. Even if the commercial court eventually rules in favour of the claimant, enforcement of the court’s decision is not easy. The debtor might declare itself insolvent, in which case the State Execution Service, which has the task of executing the decision of the court, initiates the conversion of monetary claims into property claims. However, very often the value of a debtor’s property finally available for sale does not cover the debts. Besides, the order of execution is valid only for three months. If a claimant does not succeed in recouping the debt within this period of time, he or she has to apply to the commercial court for a renewal. Another source of the deficient implementation of legal rules in transitional countries like the Ukraine is the high level of corruption. Widespread corruption makes the actual implementation of legal norms (even if they are well developed) unpredictable and increases the uncertainty of the business environment. Hellman et al. (2000) in their cross-country study have found that about one-quarter of Ukrainian firms consider the selling court decisions in commercial cases a real problem (the respective figure in the case of Poland, for example, was 18 per cent). All the problems associated with the legal enforcement of contracts are reflected in low trust of entrepreneurs in the effectiveness of commercial courts. According to the survey conducted in 1997 by Johnson et al. (1999), only 56 per cent of Ukrainian owners/managers of small firms were willing to use commercial courts in cases of commercial dispute. Our data on the perceived effectiveness of courts are in line with the results of expert evaluations and firm-level surveys mentioned above. We asked entrepreneurs/managers two questions. The first asked whether the courts hypothetically could be used to enforce commercial contracts. Only 47.9 per cent of the respondents said that they could use the courts in case of having a dispute with a trading partner. In the second question the entrepreneurs/ managers were asked whether their firms were involved in a contractual

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dispute with trading partners during the last three years and if they had used the courts for solving the dispute. More than a half of the firms (53 per cent) reported having had a dispute, and among them only one-third used the courts. Why did two-thirds of the firms with commercial disputes not use the courts? The main reasons were the following: ‘Courts cannot enforce the contracts’ (31.5 per cent of the firms), ‘The court procedure takes too much time’ (18.5 per cent), ‘It is better to postpone the payment of the debt than to deal with the debtor’s bankruptcy, since the sale of its assets would not cover the debt’ (30 per cent), ‘Other reasons’ (20 per cent). While the first and the second reasons suggest low efficiency of courts, the last two reasons of the firms’ reluctance to use the courts might also reflect a low level of legal culture and poor quality contracts that make them difficult to enforce. Among the firms that used commercial courts, 43 per cent reported that debts were already repaid by their trading partners (which can be interpreted as a positive experience), 30 per cent were waiting for the positive decision of the court to be implemented and 27 per cent were waiting for the court’s decision. The share of entrepreneurs who trust in courts is significantly larger in the sub-group of the firms which had experience with courts compared with those without such an experience (54.3 vs 25.9 per cent, Chi square = 33.2).

PERCEPTIONS OF COURTS’ EFFECTIVENESS AND THEIR DETERMINANTS The purposeful behaviour of an economic agent is the result of maximising a goal function while taking into account the relevant constraints as the agent perceives them. Strictly speaking it is never the environment itself that impinges on an individual’s behaviour but only the individual’s perception of its environment. Therefore, any theory of economic behaviour has to be based on two fundamental hypotheses: one concerning the individual goal function, the other about the way the individual forms and changes his or her perception of the constraints on its actions (which constraints may be the actions of other identifiable individuals, such as court rulings, or just the aggregate outcome of many other individuals, such as prices). The rational-expectations hypothesis which postulates the mutual consistency of individual perceptions about the environment is clearly an equilibrium hypothesis that makes sense only in a sufficiently stationary environment. These considerations are of direct relevance to the question of whether we should try to capture the effectiveness of courts in enforcing commercial and financial contracts or in settling disputes by some ‘objective’ measures, or should take the ‘subjective’ opinion of business people (expressed, for example, by their answers to the question whether they would use the arbitration

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court in case a customer does not pay his or her debts) as the relevant variable. Objective data on the efficiency of courts in dealing with commercial disputes, as used to explain variations in firms’ performance, for example by Fabbri (2001), reflect the systematic perceptions of firms reasonably well if a country’s or region’s legal institutions are well established and backed by a long and widely recognised tradition of law enforcement. In this case, it is plausible that the entrepreneurs’ perceptions of courts will have converged towards a picture consistent with objective facts, and that the remaining variation across firms will reflect idiosyncrasies of firms and their owner-managers. In countries such as the Ukraine where the reform of commercially important legal institutions is still incomplete and in a flux, the entrepreneurs’ perceptions are of direct relevance for the explanation of their behaviour, even if these perceptions do not yet reflect recent objective improvements in the administration of the law. The essence of their perceptions of the usefulness of courts to enforce contracts is whether the managers believe that they might successfully appeal to the arbitration court in case of a dispute. This is what we mean by ‘trust in courts’. The conceptualisation of ‘trust’ in this context is in accordance with the decision-theoretic approach of Coleman (1990, pp. 91 ff.). Following Johnson et al. (2002) we prefer to operationalise ‘trust in courts’ by directly asking the entrepreneurs the hypothetical question whether they would use the arbitration courts in conflicts with non-complying trading partners, rather than by their actual usage of courts in the past. As Johnson et al. (2002) have shown, firms which display trust in the courts’ contract-enforcing function are more inclined to enter into new contractual relationships with new suppliers and customers. They will to a lesser extent be locked into established networks and engage more actively in process and product innovation. We expect that this will be reflected in the firms’ performance (in terms of an extensive measure, such as profits or sales, or an intensive measure, such as sales per employee). The impact of the entrepreneurs’ perception of the effectiveness of commercial courts as contract enforcers on enterprise performance is the first stage of our analysis. The second stage consists of an inquiry into the factors which shape the entrepreneurs’ trust in courts. This is the more important, as our analysis, in contrast to Johnson et al. (2002), is not a cross-country comparison but deals with the perceptions of a single country’s court system. Why would the perceptions of managers concerning the effectiveness of courts vary within a given country? A manager’s, i’s, trust in the quality of court rulings at time t, Tit, may be conceived of as a function fi of his previous perception Tit–1 and any new relevant information Iit on the basis of which the previously held opinion on the effectiveness of courts is adjusted: Tit = fi (Tit–1, Iit).

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New information may be direct evidence on the current functioning of courts (based on personal experience or on reports deemed reliable) or other, more circumstantial, information thought relevant for the formation of an expectation about the courts’ effectiveness. Within the same country, and therefore, under the same law, both the way in which the information is processed (fi) may vary across individuals and the individual information itself may differ across different court jurisdictions (in the Ukraine there is one arbitration court per region) as well as across different individuals within the same jurisdiction. Variation in fi may be due to unmeasured personal characteristics of managers (like age, education, adaptability to quick changes in the legal environment, personal trustfulness, and so on) or may be purely random. Information based on experience with courts may, as Johnson et al. (2002) have pointed out, differ between firms of different size because of significant fixed costs of using the courts which make it more likely that larger firms go to court more frequently. Experience may also differ due to differences in location, age of the firm or its being a private start-up rather than a privatised former state-owned enterprise (SOE). For such measurable variations we control for the respective regressions. Contrary to Johnson et al. (2002), however, we argue that, even after taking into account these variations among firms, significant differences in their information sets remain that are consequently reflected in their perceptions of the court system’s effectiveness. To some extent these differences are due to the arbitrariness of court decisions as such. The rulings of one and the same court may vary significantly and in an unpredictable way.2 The perception of the quality of a particular institution, for example commercial courts, will be affected not only by experience with this institution but also by the economic agents’ perception of the institutional and business environment as a whole. The quality of one institution is usually related to that of others. Hence, it is a plausible hypothesis that managers who have experienced an improvement in their business environment (regarding regulatory rules, tax legislation, administrative controls and so on) or received respective information are more likely to become more optimistic about the effectiveness of commercial courts, too. A particular characteristic of the weak institutional framework of transition economies is widespread corruption (for example, Shleifer and Vishny 1993). If a multitude of bureaucrats or bureaucratic agencies can independently impose bribe demands on economic agents without providing any assurance of results, the level of corruption-induced uncertainty is high. Again, the perception of the general level of corruption in the society (not just in the commercial courts) affects the perceptions of the firms’ managers concerning the efficiency and reliability of the commercial courts. If

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managers of the firms are required to pay bribes for obtaining various licences and permissions or public services, they would expect corruption in the commercial courts as well and form their perceptions of commercial courts accordingly. Thus, we expect a negative effect of administrative corruption in public institutions other than commercial courts on the managers’ trust in commercial courts. In order to cope with a high level of behavioural uncertainty, firms may use various uncertainty-reducing mechanisms. One of these is the accumulation of social capital via establishing social networks. There is evidence that social networks with resourceful and powerful ties, that is, which contain high-status contacts, produce higher rates of return and better protection from behavioural uncertainty, and result in better performance of firms than the networks with low-status contacts (for example, Lai et al. 1998). In transition economies, where political power has a definite market value (for example, Kryshtanovskaya and White 1996), these high-status contacts typically include connections with powerful bureaucrats who can provide the firm with important business information, state contracts, tax relief and protection from other bureaucrats. This type of social capital we call ‘informal relations’. Informal relations differ from direct administrative corruption (which involves direct payments to government officials for ‘having things done’) in several ways. First, direct bribery does not presuppose a high level of personal trust and is more or less impersonal. Second, contrary to direct bribes, informal relations do not imply immediate delivery of a service. Informal relations are established before the support is provided and are maintained even during the period of time when there is no delivery of any service (otherwise no support can be expected in the future). Finally, informal relations involve non-monetary favours to government officials3 in exchange for their support of the firm. As regards courts, informal relations may be employed to obtain reliable information about the possibility of using commercial courts, thereby reducing the information costs of firms. Informal relations may also help to reduce the waiting time in courts (which in the case of the Ukraine is considerable), and they may serve as an instrument for reducing the arbitrariness of court rulings. Though informal relations are not a substitute for direct administrative corruption and may have no direct impact on the size of the bribes that are paid by the firms, they can reduce corruption-induced uncertainty by helping to assure the expected results of bribing.4 Therefore, we expect a positive impact of the level of informal relations of the firm’s manager with the representatives of various public offices on his or her trust in commercial courts. To summarise, in our contribution, we test the following hypotheses:

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H1 Firms the managers of which trust commercial courts show better performance results than firms whose managers do not trust commercial courts. H2 Managers whose experience with commercial courts is positive are more likely to trust them than the managers without similar experience. H3 The more favourable the managers’ perception of the general quality of the business environment, the more likely they trust commercial courts. H4 Administrative corruption has a negative impact on the managers’ perceptions of courts. H5 The higher the level of informal relations between the managers and the representatives of state authorities other than commercial courts, the more likely managers trust commercial courts.

DATA AND METHODOLOGY For our analysis we use the data from a survey of 285 small and medium Ukrainian business firms (with the number of employees less than 200) involved in manufacturing activity. The sample was generated from the official company registers. Companies were selected according to three criteria: (1) the enterprise should have been established at least two years before the survey; (2) it should be involved in manufacturing activity (which does not exclude conducting trade operations or providing services in addition to the manufacturing activity); and (3) the number of employees in 2000 should be less than 200. The survey was conducted in the late fall of 2000 in the three regions with the highest concentration of SMEs in the Ukraine, namely, Kiev, Kharkov and Donetsk (one-third of the total number of Ukrainian SMEs is located in these regions). The survey was carried out by personal interviews with the managers/owners of the firms. The interviews were conducted on the basis of a prepared questionnaire which covered a broad range of problems, including peculiarities of business environment, participation of SMEs in the shadow economy, their financial and investment decisions, performance results and obstacles to growth. The questionnaire was pre-tested in a pilot study that included 11 personal interviews with owners of SMEs. The descriptive characteristics of the sample are presented in Table 10.1. Our sample is roughly representative by type of ownership and size.5 The sample is not fully representative by industry: compared to the share in total population, the food industry is somewhat overrepresented, while the machine-building and metal-processing industry is underrepresented. However, since all the firms are in manufacturing and the analysis of sub-industry differences is not the aim of the study, we believe that this selection bias will not affect the main conclusions of the study.

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Table 10.1 Descriptive characteristics of the sample Number of the firms (percentage of total sample) Size: 5 years

71 (25.4) 64 (33.7) 150 (40.9)

Distribution by industry: Food industry Metal processing Light industry Construction materials Wood processing Chemical industry Printing industry Other industries Industrial services Regional distribution: Kiev Kharkov Donetsk Source:

94 (33) 43 (15.1) 19 (6.7) 18 (6.4) 17 (6.0) 10 (3.5) 8 (2.8) 51 (17.9) 25 (8.8) 103 (36.1) 85 (29.8) 97 (34.0)

Own survey.

We parameterise and test the hypotheses for the respective determinants of trust in courts and performance in terms of the following logit regression equations: L(Ti) = a + biEi + ciACi + diIRi + eiBEi + ∑n fnXin + εt

(10.1)

The effect of trust in courts on Ukrainian SMEs

L(Pi) = a + giTi + ∑n fnXin + εp

165

(10.2)

Both equations are estimated by maximum likelihood methods. L(Ti) is the logarithm of the probability that firm i expresses trust in courts minus the logarithm of the probability that it does not. Similarly, L(Pi) is the logarithm of the probability that firm i has improved on the respective performance indicator minus the logarithm of the probability that it has not done so. Managers’ perceptions of the effectiveness of courts (Ti) are represented by a dummy variable TRUST which equals 1 if the manager stated that he or she would use the arbitration court to solve a commercial conflict with non-performing trading partners. Equation (10.1) is also estimated with the dummy USEAC, which is 1 if the entrepreneur reported to have actually used the arbitration court during the last three years, as dependent variable. For performance (Pi), we employ two dummy variables SALES and LABPROD which represent the manager’s assessment of the change in the volume of sales and, respectively, labour productivity (defined as sales volume per employee) in 2000 compared to 1999. They are equal to 1 if the manager reported an increase, and 0 otherwise. In addition, we estimate equation (10.2) for performance expectations represented by dummy variables SALESF and LABPRODF which take on the value of 1 if the manager expected an increase in sales or labour productivity, respectively, for 2001. In order to capture past positive experience of the manager with commercial courts (Ei) we use the dummy variable POSEXP which is equal to 1 if the entrepreneur reports that he or she has used an arbitration court in a commercial dispute during the last three years with a favourable result (for example, payment of the debt). Administrative corruption in public institutions other than commercial courts (ACi) is represented by a dummy variable BRIBE which is equal to 1 if the firm reports making extra-legal payments for business registration, licences or protection, and 0 otherwise. The quality of business environment (BEi) is measured by the variable BEINDEX which is an index constructed from subjective ratings of nine obstacles to the successful development of the firm in 1999–2000 given by managers during the in-depth interviews (all on a scale of 1 ‘not important’, to 4 ‘very important’) by using the method of principal components. The index of business environment is a weighted average of the raw measures, where weights are the eigenvectors of the first component. The index is normalised to lie in the interval [0,1], where 1 indicates a ‘bad’ business environment and would be the score of a firm that had rated all nine measures as being a ‘very important obstacle’ to the business success. The mean value for BEINDEX is 0.45 (standard deviation = 0.07) indicating a rather low quality of business environment.

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The level of informal relations between the managers and the representatives of state authorities other than commercial courts (IRi) is measured by an index for implicit corruption IRINDEX. We again use the method of principal components. Our raw measures are the subjective rating of the firms’ managers concerning the importance for the success of the firms of informal relations with the representatives of 10 different state authorities, all on a scale of 1 (not important) to 4 (very important). Again the index of informal relations is a weighted average of the raw measures, where the weights are the eigenvectors of the first principal component. The index is normalised to lie in the interval [0,1], where 1 indicates a high level of informal relations and would be the score of a firm that had rated all 10 measures as being very important for its business success. The mean value for IRINDEX is 0.46 (standard deviation = 0.11), which shows a rather high level of informal relations. As control variables we use three regional dummies (KIEV, KHARKOV, DONETSK), a variable of the firm’s size (SIZE) which is measured by the number of employees in 2000, a variable of the firm’s age (AGE) which is equal to 2000 minus the year when the firm was founded, and a dummy for start-ups (STARTUP) which is equal to 1 if the firm was founded as a private or collective enterprise, and 0 if the firm is a former state enterprise which was privatised. In the performance equation, we also used nine sub-industry dummies. In order to control for the initial performance of a firm we intended to use a dummy INITIAL, which is equal to 1 if the firm has reported to be a profit-maker in 1999, and is 0 otherwise. However, since only three firms from our sample reported to be loss-makers in 1999, for the sake of simplicity we excluded them from the sub-sample used for the estimation of performance equation and, therefore, did not insert INITIAL in the equation. The descriptive statistics for the variables in equations (10.1) and (10.2) is presented in Table 10.2. We have considered the possibility of interdependence between the two equations in the sense that Ti depends on the value of the respective performance measure Pi, in which case Ti and εp would be correlated and the regression estimates would be inconsistent. We tried to insert the term hPi into equation (10.1), which did not yield significant estimates hˆ. In addition, we used the estimated probability of Ti = 1 from (10.1) as an instrumental variable for Ti in (10.2), the difference between the respective estimates of g proved insignificant in the Hausman test. Therefore, we dismiss the possibility of endogeneity with respect to these two variables. The question of endogeneity may also be raised concerning some of the explanatory variables in the above regression models. While experience with commercial courts in the past is without doubt an exogenous variable, this assumption seems more doubtful for the variables for quality of business environment BEINDEX, administrative corruption BRIBE and informal relations IRINDEX. We tried regressions

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Table 10.2 Descriptive statistics for main variables in equations

BEINDEX IRINDEX AGE SIZE

Mean

Standard deviation

0.45 0.46 5.5 25.8

0.07 0.11 5.5 28.8

% of total sample TRUST POSEXP USEAC BRIBE SALES SALESF LABPROD LABPRODF STARTUP Source:

42.1 8.1 18.9 59.3 45.3 43.9 38.2 39.3 78.9

Own survey.

of these variables on the remaining variables on the right-hand side of equation (10.1). The resulting regressions turned out to be insignificant. Hence endogeneity does not seem to be a problem with respect to these variables either.

RESULTS AND THEIR INTERPRETATION Trust in Courts and Business Performance Table 10.3 presents the results of regressions with the short-run performance indicators as dependent variables. The TRUST variable enters the equations for both the retrospective (2000 relative to 1999) and the prospective (2001 relative to 2000) performance indicators with significantly positive coefficients. Industry dummies are never significant. Regional dummies are significantly positive for Kharkov and Kiev, in particular in the prospective performance equations pointing to better growth expectations for these regions compared to Donetsk.

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Table 10.3 Performance equations (standard errors in parentheses) SALES (1) TRUST 0.71** (0.25) STARTUP 0.14 (0.32) AGE –0.02 (0.02) SIZE 0.007 (0.005) Kharkov –0.29 (0.31) Kiev 0.03 (0.34) Industry Y Constant –0.54* (0.38) Percentage correct 68.8 Chi square 14.2** N 277 Note: Source:

LABPROD (2)

SALESF (3)

0.57** (0.26) 0.55** (0.25) 0.48 (0.34) –0.28 (0.32) –0.03 (0.05) –0.04(0.028) 0.006 (0.005) 0.01**(0.005) –0.22 (0.33) 1.0** (0.32) 0.82** (0.30) 0.83**(0.39) Y Y –1.4** (0.39) –0.88(0.40) 73.3 74.2 23.6** 26.5** 277 277

LABPRODF (4) 0.51** (0.25) –0.12 (0.37) –0.06** (0.03) 0.006 (0.005) 0.88**(0.35) 0.96** (0.36) Y –0.38 (0.36) 62.0 16.8** 277

*p < 0.1; **p < 0.05; Y – industrial dummies included. Own survey.

In this contribution we did not intend to separate different efficiencyenhancing effects of trust in courts and determine their relative importance for firm’s performance. We have, however, examined positive bivariate correlations between TRUST and variables that may be behind the positive effect of trust in courts on performance. For instance, we find a significant positive correlation (β = 0.12, p < 0.05) between TRUST and a dummy for changing more than 50 per cent of suppliers during the last three years. The correlation coefficient between the TRUST variable and a dummy for reinvestment of profits during 1998–2000 turns out to be positive but insignificant. It is, however, significant and positive for the correlation with a dummy for expected reinvestment of profits in 2001 (β = 0.18, p < 0.05). These results provide some ground for the conjecture that, presently, trust in courts influences performance of Ukrainian industrial SMEs by encouraging them to switch to more efficient suppliers and increase the level of trade credit with trading partners, while the effect on investment decisions may become more pronounced in the future. The question may be posed concerning how pivotal the variable TRUST is for explaining performance. Instead of explaining performance by ‘trust in courts’ and then in turn ‘trust in courts’ by several other variables, one might try to estimate just one equation for the direct effects of corruption, informal relations, quality of business environment and experience with commercial courts on performance results. Thus, we estimated performance equations in which TRUST was replaced by BRIBE, IRINDEX, BEINDEX and POSEXP

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– the variables which serve as explanatory variables in the trust-in-courts regressions. As dependent variables we used the same four performance dummies, as in Table 10.3. Neither of these regressions has turned out to be significant. We interpret these negative results as evidence that adverse effects of corruption and an unfavourable business environment work mainly indirectly on the performance of Ukrainian SMEs, by increasing the scepticism of entrepreneurs about the ability of the legal system to protect their property rights. Determinants of Trust in Courts In Table 10.4 the first five columns display logit estimates for the trust-incourts equation (10.1). A positive coefficient indicates the extent to which an increase in the level of the respective independent variable increases the probability of a firm to profess trust in commercial courts above the probability of not trusting the courts. Across all specifications the estimated equations are significant and display relatively high explanatory power (with a correctly predicted percentage from 59.0 to 78.0). In column 1 we present the results of the regression where only control variables are included as independents. As can be seen, only SIZE proves to be significant and positive, indicating that larger firms are more likely to trust in courts than smaller ones. In column 2 we add POSEXP. As expected, positive experience with commercial courts has a significant positive impact on managers’ perceptions of the effectiveness of courts. Then we add the indexes for informal relations and bribes (column 3). In column 4 we show the estimates of the trust-in-court regression with the index of business environment instead of the corruption variables. In column 5 the results for all variables entering simultaneously are displayed. These regression results corroborate our main hypotheses H2–H5 about the determinants of trust in courts. The estimates are remarkably robust across the reported regressions in the sense that signs and levels of significance of the main explanatory variables do not change when the latter are inserted in the equation separately (only together with controls) or simultaneously. The inclusion of industry dummies (which themselves are insignificant) has no effect on the level of significance of the main variables. The results are also robust with respect to modification in the sample criteria. Thus, the coefficients of the main explanatory variables remain significant and close to the same magnitudes when the sample is limited to any two out of three regions, to start-ups, or to the group of firms older than five years as well as younger than five years. Column 6 shows the regression with USEAC as a dependent variable and just control variables as independents. There is a significant positive relationship between the size of a firm and its actual usage of commercial courts. When we added, however, the explanatory variables from the TRUST equation, the

Table 10.4 Determinants of trust in courts (standard errors in parentheses)

170

POSEXP

Dependent: TRUST Controls

Dependent: TRUST Past experience

Dependent: TRUST Corruption

Dependent: TRUST Overall business environment

Dependent: TRUST All independents

Dependent: USEAC

1

2

3

4

5

6

2.3** (0.43)

3.0** (0.58)

2.57** (0.52)

3.6** (0.74)

ACLONG ACINEFFEC ACBANKRPT BRIBE IRINDEX BEINDEX

Dependent: TRUST Sub-sample of the firms which had commercial conflict 7

–1.6 (1.4) –3.2** (1.4) –0.68 (1.0) –1.3** (0.50)

–1.2** (0.61)

3.73* (2.0)

6.2** (2.8) –8.1** (3.0)

–15.6** (4.5)

–2.1** (1.0) 14.8** (7.8) –13.1** (7.6)

Controls STARTUP AGE SIZE Kiev 171

Kharkov Constant

0.15 (0.30) 0.03 (0.02) 0.008* (0.005) 0.003 (0.29) –0.10 (0.30) –0.80** (0.36)

Percentage corr. Chi square N Notes: *p < 0.1; **p < 0.05. Source:

Own survey.

57.4 8.7* 277

0.22 (0.46) 0.06 (0.04) –0.002 (0.006) – –0.85*(0.48) –0.32 (0.49) –0.24 (0.58) 71.6 39.8** 189

–0.38 (0.60) –0.21 (0.54) –0.54 (0.67) 0.10* 0.07* 0.13** (0.055) (0.04) (0.06) –0.01 (0.008) –0.004 (0.007) –0.009 (0.008) –0.43 (0.66)

–0.74 (0.54)

0.01 (0.70)

0.23 (0.72) –1.4 (1.2) 78.8 48.8** 189

–0.33 (0.59) 3.2** (1.5) 71.4 39.3** 189

0.69 (0.90) 4.2* (2.2) 77.2 58.8** 189

0.40 (0.46) 0.001 (0.02) 0.01** (0.005) 0.68 (0.37)

–0.52 (0.95) 0.25** (0.12) –0.02 (0.02) 0.42 (1.30)

0.33 (0.54) –1.9** (0.56)

1.8 (1.4) –1.9** (0.56) 69.2 11.5** 277

69.2 11.5** 277

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regression for USEAC turned out to be insignificant (Chi square too low) which indicates that the levels of corruption, informal relations and uncertainty of business environment do not have a significant impact on the actual usage of commercial courts. Finally, in column 7 we present the results of trust-in-courts regressions, in which POSEXP is replaced by three dummy variables. For this regression we used the sub-sample of the firms that had commercial conflicts with their business partners in the last three years. In case they did not use the courts for solving the conflict, the managers were asked to indicate the main reason for this. The three alternative dummy variables represent the reasons of the refusal to use the commercial court: ACLONG stands for ‘procedure is too long’, ACINEFFECT for ‘courts cannot solve commercial conflicts efficiently’ and ACBANKRPT for ‘we do not want to deal with the bankruptcy of our debtor which might prevent implementation of the court’s ruling’. As can be seen from Table 10.4, the inclusion of three new variables does not change the level of significance of the corruption variable and the indexes for informal relations and uncertainty in business environment. Among the three variables, only ACINEFFECT turned out to be significant. Its negative coefficient indicates that in case firms did not use courts in the past because they deemed them ineffective, they also mistrust them presently and are disinclined to use them. Our interpretation of this result ought to be cautious, however. The unfavourable impression of the court system that prevented business people from using it in the past may be not only due to the objectively poor functioning of the court but also to other circumstances, such as the poor quality of contract writing. Anecdotal evidence from transition countries suggests that contracts frequently cannot be enforced by the arbitration courts because of their unprofessional formulation due to a low level of legal culture in general and within the SME sector in particular. In any case, the result implies that the learning mechanism which makes the individual perceptions of the courts’ effectiveness converge to improved objective facts must be expected to work rather slowly.

CONCLUSIONS The successful transformation of the formerly socialist economies of Eastern Europe into well-functioning market economies capable of sustainable growth depends crucially on the effective protection of private property rights by properly designed legal institutions. The formal quality of laws protecting property rights and enforcing contracts is not sufficient for establishing the ‘rule of law’; what matters even more is the quality of implementation of commercial law by an effectively working court system. In particular, for the

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development of small and medium-sized manufacturing firms as the cornerstone of industrial innovation and growth, effective contract enforcement by commercial courts is indispensable. We have argued that entrepreneurial behaviour and the extent to which it is focused on innovative and productive activities instead of pure rent-seeking, is directly influenced by the firms’ perception of the reliability and effectiveness of courts as protectors of property rights and enforcers of contracts – their ‘trust in courts’. We have found that trust in courts has a significantly positive impact on the performance of enterprises as measured by growth in sales and labour productivity. We have identified several determinants of trust in courts in the Ukrainian environment typical of a slow-reforming transition economy. The experience of direct administrative corruption in the form of monetary bribes (to public officials except judges) influences trust in courts negatively, while the business people’s perception of the general reliability of the business environment (in terms of access to and costs of external finance, regulations and taxation) affects their trust in courts positively. Contrary to direct corruption, the form of implicit corruption based on informal relations between business and public officials involving not monetary bribes but reciprocally advantageous deals relying on mutual trust is not detrimental to trust in courts. Here, our analysis confirms that such informal relations, which in a country with weak legal institutions are a means for reducing uncertainty (including directcorruption induced uncertainty), have a positive influence on trust in courts. We have also found a significant learning effect supporting our hypothesis that trust in courts evolves according to an adaptive expectations process: business people who have had some positive experience with commercial courts in the past are significantly more trustful than their ‘inexperienced’ fellow managers. However, those managers whose experience was negative or who so far abstained from using courts are reluctant to trust them. This may mean that even if commercial courts succeeded objectively in improving their record, it might not change the business community’s perception of the quality of the judicial system much for better, or would bring about such a change only rather slowly unless accompanied by a significant improvement in the general business environment and by a reduction in the level of corruption. These findings may be taken as further evidence of the strong complementarity of reform measures in transitional economies. Trust in commercial courts is the channel through which the more objective aspects of the firms’ legal and administrative environment, their actual experience with court disputes, administrative corruption, and so on, impacts on their behaviour and performance. When we tested for the direct effects of corruption, informal relations, quality of business environment and past experience with commercial courts on the performance variables, we did not find any significant quantitative relationship. It is obvious that interpreting this

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result as evidence for the irrelevance of those institutional factors for entrepreneurial behaviour and enterprise performance would be grossly misleading. It just corroborates our basic hypothesis that these factors influence indirectly the performance of SMEs by weakening the entrepreneurs’ belief in the ability of the legal system to protect their property rights.

NOTES 1.

According to the methodology of EBRD Legal Indicator Survey, extensiveness of legal reform measures the extent to which key commercial and financial laws approximate internationally acceptable standards, while effectiveness reflects the degree to which these laws are implemented or enforced (EBRD 2000, p. 33). 2. To quote Hay and Shleifer (1998, p. 398) who refer to Russia but whose observation holds for other CIS countries too: ‘The legal rules are incomplete in crucial areas needed to support existing business activity . . . when legal rules do exist, in many instances judges do not know what they are . . . Even when the law speaks to a particular matter, judges may not have the resources or inclination to verify the relevant facts. And when the facts are available and the legal rules exist, judges may be biased, corrupt, or partial to political sentiment, and hence it is by no means certain how they will rule. Finally, once a judge rules, there are often no institutions to enforce his ruling.’ 3. For example, according to Basu and Li (1998) Chinese government officials provide informal support to SMEs forcing them to hire their relatives. The same evidence comes from Russia and Ukraine. Government officials provide informal support to SMEs which hire their relatives and friends, or friends of other public officials who in turn are able to influence the administrative career of the former or pay back with other favours. 4. In our sample, the coefficient of bivariate correlation between the index of informal relationship and the variable for a level of total bribes as a share of sales is positive but not significant. Both firms that paid bribes (‘payers’) and ‘non-payers’ have reported having informal relations with the representatives of state authorities. This supports our conjecture that informal relations are not a substitute for direct corruption. However, the mean value of the index of informal relations for the sub-sample of the firms that paid bribes is significantly higher than for ‘non-payers’ (0.47 versus 0.44, F = 3.75, sig = 0.05). This might mean that the firms exposed to corruption are trying to use the informal relation mechanism for ensuring the outcome of bribes. 5. The upper employment level for the medium-size firm is considered to be 200 employees. Since there is no official statistics on middle-size firms, when discussing the representativeness of the sample by size we refer only to the statistics on the average level of employment in the small sector.

REFERENCES Basu, Susanto and David D. Li (1998), ‘Corruption in Transition’, Working Paper 161, Ann Arbor, MI: William Davidson Institute, University of Michigan Business School. Coleman, James S. (1990), Foundations of Social Theory, Cambridge, MA and London: Belknap Press of Harvard University Press. European Bank for Reconstruction and Development (EBRD) (2000), Transition Report 2000, London: EBRD.

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European Bank for Reconstruction and Development (EBRD) (2001), Transition Report 2001, London: EBRD. Fabbri, Daniela (2001), ‘Legal Institutions, Corporate Governance and Aggregate Activity: Theory and Evidence’, Working Paper, 72, Salerno: Centre for Studies in Economics and Finance. Feinman, Jay M. (1990), ‘The Significance of Contract Theory’, University of Cincinnati Law Review, 58 (4), 1283–318. Hay, Jonathan R. and Andrei Shleifer (1998), ‘Private Enforcement of Public Laws: A Theory of Legal Reform’, American Economic Review Papers and Proceedings, 88 (2), 398–403. Hellman, Joel S., Geraint Jones and Daniel Kaufmann (2000), ‘Seize the State, Seize the Day: State Capture, Corruption, and Influence in Transition’, Policy Research Working Paper, 2444, Washington, DC: World Bank. Hendley, Kathryn, Barry W. Ickes, Randi Ryterman and Peter Murrell (1997), ‘Observations on the Use of Law by Russian Enterprises’, Post Soviet Affairs, 13, 19–41. Johnson, Simon, John McMillan and Christopher Woodruff (1999), ‘Contract Enforcement in Transition’, Working Paper, 151, Stockholm: Stockholm Institute of Transition Economics. Johnson, Simon, John McMillan and Christopher Woodruff (2002), ‘Courts and Relational Contracts’, Journal of Law, Economics, and Organization, 18, 221–77. Kryshtanovskaya, O. and S. White (1996), ‘From Soviet Nomenklatura to Russian Elite’, Europe-Asia Studies, 48 (5), 711–33. Lai, G., N. Lin and S. Leung (1998), ‘Network Resources, Contact Resources and Status Attainment’, Social Networks, 20, 159–78. North, Douglass C. (1990), Institutions, Institutional Change and Economic Performance, Cambridge: Cambridge University Press. Olson, Mancur (2000), Power and Prosperity, New York: Basic Books. Polishchuk, Leonid and Alexei Savvateev (2004), ‘Spontaneous (non) emergence of property rights’, The Economics of Transition, 12 (1), 103–27. Raiser, Martin (1999), ‘Trust in Transition’, EBRD Working Paper, 39, London: EBRD. Shleifer, Andrei and Robert W. Vishny (1993), ‘Corruption’, Quarterly Journal of Economics, 108 (3), 599–617. Smith, Adam (1776), An Inquiry into the Nature and Causes of the Wealth of Nations, ed. A. Skinner (1999), The Wealth of Nations, Books IV–V, London: Penguin Books. Williamson, Oliver E. (1983), ‘Credible Commitments: Using Hostages to Support Exchange’, American Economic Review, 73 (4), 519–40. Williamson, Oliver E. (1994), ‘The Institutions and Governance of Economic Development and Reform’, in M. Bruno and B. Pleskovic (eds), Proceedings of the World Bank Annual Conference on Development Economics, Washington, DC: World Bank.

11. Emergence of and changes in trust in SMEs in Estonia Urve Venesaar INTRODUCTION Estonia has experienced major changes in both the external and internal environment of enterprises during the period of nearly 15 years since the restoration of national independence, accompanied by a change in people’s attitudes and business ethics (Neivelt 1999; Vetik 2002). This presumes changes in the enterprises’ behaviour and in the mechanisms that influence this behaviour. However, in transition economies the external environment is assessed by authors as one of the dominant features influencing the nature and pace of entrepreneurship (for example, Welter and Smallbone 2003). This has also been confirmed by several empirical studies on Estonia, in which most of the research has been dedicated to the assessment of external political, economic and social influences on enterprise development (for example, Jürgenson et al. 2003; Phare 1998; Smallbone et al. 1997). Today, Estonia has reached a kind of economic and institutional stability. The system of regulation which has been developed should make inter-firm relationships more predictable when compared with the past and promote the development of mutual trust when they co-operate. The institutional environment provides safeguards for the implementation of business deals, thus reducing managers’ risks in decision-making. Notwithstanding the fast systemic change within the country and success in many spheres, one needs to emphasise that the market-oriented reforms are still ongoing, particularly on the micro level. This includes repeated amendments to laws, as well as further institutional changes during implementation in order to adapt regulations and laws. Although society has accepted the general principles of the market economy, the entrepreneurship environment may still be unstable in details, thus promising ongoing institutional developments in the future, as well as changes that may be required by EU accession. Several authors relate trust to knowledge creation or learning (for example, Blois 1999; Humphrey and Schmitz 1998; Nooteboom and Six 2003, p. 12). This also applies to Estonian entrepreneurs who have obtained their knowledge 176

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as a result of long-term learning, adapting to legislative and other institutional changes in the country and finding rational strategies in order to implement their business goals. Here, when analysing the behaviour of small entrepreneurs and their influence in the business environment, both formal and informal institutional relationships are important, and are considered to be mutually dependent and needed for a consistent institutional framework to develop (Welter and Smallbone 2003). In this context, the role of trust is an important informal mechanism in shaping enterprise behaviour. In the initial phase of transition, during the process of creating and improving the formal institutional framework, enterprise behaviour could have been influenced more by informal institutions such as values and norms, which would reflect personal trust. Alongside the development of institutions, the role of institutional trust is increasing. Here, it would be interesting to know which external circumstances encourage the emergence and development of trust in individuals over time. Using institutional theory, especially the concept of formal (rules and organisations related to politics and the economy) and informal (codes of conduct, values and norms) institutions developed by Douglass North (1990), we set out to analyse the impact and mutual dependence of these institutions that appear to influence the behaviour of small entrepreneurs. In this chapter, enterprise strategies are analysed with regard to the effects which three types of trust (personal, collective and institutional) appear to have on the development of various business relations (Welter and Höhmann 2004). Personal trust builds on initial knowledge about the partner. It is also present in bilateral business relationships, which are governed by informal norms and rules. Collective trust is based on the initial knowledge of a person, but it also refers to group behaviour, which is based on shared norms and mutual business conventions, which may occur, for example, in sectors or business associations. Institutional trust refers to the institutional environment, where in a functioning environment small entrepreneurs can enter into transactions with only limited information about partners (that is, anonymity), because legal safeguards and sanctions exist if the relationship fails. We assume that the relationship between these types of trust is changing over time in all types of business relations, including relations with business partners, customers and suppliers or with employees. This is analysed in this chapter, which is based on the empirical results of a survey of enterprises and case studies, as well as on previous research. The institutional developments that have taken place during the period of transition enable us to analyse how changes in the environment might influence enterprise strategies, with particular reference to the role different types of trust play in business relations at different stages of enterprise development. As enterprise strategies develop alongside mutual relations between firms and

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their managers and as reactions to changes in the business environment, we assume that trust also changes dynamically. Therefore, changes in institutional settings have affected the development of trust in individuals over time. Here, changes in enterprises’ behaviour can be understood as the recognition and exploitation of opportunities in a given business environment. This chapter is mainly based on interviews with 105 owners/managers of small Estonian firms in three sectors (food processing, trade and business services), which were carried out in summer 2002, and 10 case studies conducted in early 2003.1 The chapter aims to analyse the development of and changes in trust in inter- and intra-firm relationships, and to evaluate the importance of trust across different enterprise groups and situations in Estonia. First, the chapter starts with a brief overview regarding important trends and changes in the business environment. This is followed by an analysis of the development of business relations, particularly focusing on relations with customers and suppliers, and a description of the support needs in businesses and relations of small entrepreneurs with authorities.

ENTERPRISE DEVELOPMENT AND CHANGES IN THE BUSINESS ENVIRONMENT Since the restoration of independent statehood, Estonian government policy has been characterised by a free market philosophy and commitment to the institutionalisation of private ownership and market reforms. The privatisation model used in Estonia contributed to the creation of competition, the promotion of changes in the economic performance of privatised enterprises, the development of a private enterprise mentality in society and positive changes in entrepreneurship. Private ownership which became dominant in the economy relatively quickly (90 per cent in 1995) as a result of the rapid privatisation process, helped to destroy old business networks, thus creating new business contacts and fostering integration into global networks. As a result of the rapid development of the enterprise sector, according to most indicators of market reform Estonia scores high in comparison with other Central and Eastern European countries and former Soviet republics. For example, the progress in small-scale privatisation and the development of the foreign exchange system was rated as ‘meeting the standards and performance norms of advanced industrial countries’ in 2001 (EBRD 2001. p. 13). Estonia also scores high in the 2003 Index of Economic Freedom, being ranked sixth in the world and classified as a ‘free market economy’. In addition, specific characteristics of Estonia have to be taken into account, such as its small size, the aim of building up a new state and broad support among the population for the reforms, which facilitated a rapid and

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efficient implementation of reform measures, thus contributing to economic growth. However, inefficiencies in implementation and failures also appeared during the reform process, especially when creating the institutional environment for businesses. While the state became the main initiator of the reform process, its high complexity made it difficult to foresee all requirements, as a result of which many processes turned out to be regulated by the market rather than the state. During different phases of the development of the private sector, many factors were (and still are) an obstacle to the performance of enterprises, such as the tax system, licensing regulations or the credit policy of banks. At the same time, an extremely liberal economic policy has been regarded as a lever of fast development of market and competition in the country (Phare 1998). This has inevitably influenced business relations, often requiring strategies which help enterprises to adapt to this specific (changing) external environment. Influenced by the fast changes in the business environment, an example which characterises the early transition period is the tendency of small enterprises to take on multiple and often unrelated business activities and register those in the statutes in order to ensure survival in a fragile and ever-changing business environment. The choice of such, mostly short-term, strategies is caused by the inadequate institutional development across different time periods, as well as the specific conditions connected with the choice of activity, competition, business regulations and other factors. Diversification strategies have been explained as necessary for the realisation of market opportunities, but, more importantly, as a means to overcome short-term financial constraints (Welter and Smallbone, 2003, p. 13). Comparisons of the results of this and many other studies in different periods suggest that recently the business environment has encouraged concentration on one field of activity or the diversification by enterprises into related business fields. Thus, the extent of diversification has decreased, although there are still enterprises that have several different spheres of activity. Along with the stabilisation of the economic situation and institutional development, enterprises have started to pay more attention to long-term plans, strategic management and the elaboration of visions (Teder and Venesaar 2003). This is illustrated by the following analysis of our survey results on the role of trust in different external business relationships over time.

RELATIONSHIPS WITH SUPPLIERS AND CUSTOMERS This section sets out to investigate our empirical data on relationships with suppliers and customers. In particular, we look at the requirements and regulations of these business relationships and their development over time.

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Overall, our empirical evidence suggests that with a politically and economically more stable business environment, the importance of personal trust is diminishing over time while institutional trust is increasing, either substituting and/or supplementing personal trust. A look at the factors influencing the behaviour of small entrepreneurs is interesting with regard to the practices involved in concluding business transactions where already existing business relations are highly valued. Here our survey indicates that, when preparing a new business deal, small entrepreneurs rate the previous experiences of the firm in this kind of deal as the most important criteria when choosing business partners (Table 11.1). This becomes more apparent in small firms with 10–49 employees and older businesses. Criteria such as good business plans and expected profit were estimated to be only slightly less important. The latter were more frequently mentioned by younger and small firms. More than one-third of small entrepreneurs mentioned guarantees for failure of delivery or payment among relevant aspects influencing the preparation of a business deal. Familiarity with a new partner and recommendations from regular commercial partners were also quite frequently mentioned among the criteria. Less important aspects for concluding a business deal in the opinion of small entrepreneurs are the juridical form of the new partner and advance payment, but this is not so in the case of micro enterprises, where, for example, advance payment was the most important criterion for nearly one-quarter of the respondents. Table 11.1

Aspects of decision-making when preparing a new business deal

Relevant aspects

Most important

Experience of your firm in such kind of deals 40.0 Good business plan 38.5 Expected profit 38.1 Guarantees for failure of delivery or payment 37.1 Familiarity with new partner 29.5 Recommendations from your regular commercial partners 24.8 Advance payment 12.4 Juridical form of new partner 7.6 Recommendation from your bank 5.7 Source:

Own survey, reported in Venesaar (2003).

Also important

Not important

54.3 43.3 61.0

5.7 17.3 1.0

59.0 52.4

2.9 18.1

55.2 40.0 30.5 36.2

20.0 47.6 61.9 57.1

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An example of this could be relationships between micro enterprises and large-scale suppliers/producers. And, though all legal forms of enterprises are equal in the country by law, our case study indicates that sometimes sole proprietors may have problems in getting better payment terms. Most of the small entrepreneurs (that is, 84 per cent of entrepreneurs surveyed) also assess existing business relations with customers/suppliers as important or even more important than the business deal itself and its contractual terms. An example of the trust-building process was provided by the manager of a company dealing with food-processing and wholesale activities, who in the initial stage of starting business had difficulties with finding suppliers and clients, and deals with suppliers were small and based on advance payments or short-term credits. Now, as a result of long-term cooperation with suppliers and customers, it is always possible to reach agreements that satisfy both sides. Besides, when the partner (in this case a foreign partner) recommends the company to another supplier, better payment terms can be reached. Entrepreneurs implicitly attach importance to personal trust, which builds on knowledge and individual learning as a result of long-standing relationships between firms. In this example, the small entrepreneur particularly emphasised the importance of mutual acquaintance of partners and the trust-building process, where long-term business relations are established with partners with the same understanding, attitude and trust in business between partners. The relationships established in this way provide a kind of guarantee for the business deals to be a success. The small share of small entrepreneurs who did not regard existing business relations as important were mostly young and micro enterprises. Their activity is subject to more frequent changes and instability, which can be connected with market search and survival efforts. The answers given by small entrepreneurs from the trade sector that the existing business relations between suppliers/ customers are not important may be explained by frequent changes and strong competition (for example, new retail trade chains entering the national market) in this sector. One example reflecting the development of business relations and trust over time refers to changes in relationships with suppliers. For example, new transactions for smaller enterprises normally start with the supplier demanding advance payments. In the case of good and beneficial cooperation over time, suppliers regularly start giving credit to the enterprise and the payment terms may be prolonged, which often concludes with a longterm contract. Such an example was given by an entrepreneur from a small retail trade company, who described the development process of personal trust over time, which led to a regular relationship and was fixed in a longterm contract. In this case, the trade firm’s crediting terms were improved considerably and the concluded contract provided a guarantee for continuing such relations in the future. Over time, enterprises have learned to know and

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trust each other, as they collect information about their mutual business behaviour and fulfilment of payment terms. This example confirms the links between trust and learning (Nooteboom and Six 2003). Business relations with customers/suppliers are characterised by their regulation and agreements, which small entrepreneurs prefer in these relationships. Interviews with small entrepreneurs described the development of the regulation of business relations in the transition period along with changes in legislation and development of relevant institutions (for example, courts), which has considerably improved the entrepreneurship environment. In the choice of the type of agreement, small entrepreneurs are primarily directed by their previous experience and the opportunities offered by improved legislation (Table 11.2). Our survey data indicated that Estonian enterprises generally prefer to use written contracts in business transactions to regulate customer and supplier relationships, which provide small entrepreneurs with a kind of guarantee for obtaining their money in case the other party does not pay. When deciding on the type of agreement, small entrepreneurs consider a number of criteria, among which previous experience was estimated to be very important by almost all enterprises surveyed (Venesaar 2003, p. 33). Therefore, personal trust is highly valued for regulating business deals, which is also confirmed by the importance of some other criteria like recommendations from a business partner. However, collective trust is also very important, which is expressed by another important criterion for the decision-making by entrepreneurs: the reputation of the customer/supplier. Using written contracts, small entrepreneurs rely on institutional trust, which can be considered a kind of safeguard to encourage entrepreneurs in business deals. Though written contracts have some other functions, such as being the basis for accounting or memory aids, this is a necessary document for verifying a business deal in the law courts and for calling in unpaid bills. Sometimes, suppliers are not interested in small firms as customers. This is proved by the relationships of one small shop with large-scale suppliers. For example, the products of large-scale producers who have a good reputation among the population (consumers) are in high demand by final consumers. This results in them putting pressure on smaller customers (that is, small shops) and requiring prepayments as well as setting payment terms which small shops often have to agree with in order not to suffer the loss of their main consumers. Although these small shops may have long-term experience and long-standing relations with their suppliers, in this case sticking to their suppliers obviously is less an indicator of personal trust and more an example of growing competition. Here, contracts can be considered as a safeguard for smaller firms against large-scale suppliers, which in the case mentioned above succeeded as a result of long-term negotiations and good co-operation, and where the good reputation of the shop in the local area played a role. Another

Table 11.2 Criteria for decisions on types of agreements in business relationships (percentage of respondents) Sector

183

Reputation of the customer/supplier Recommendation from business partner Previous experience with this firm Value of the expected deal Guarantees with respect to delivery of payment failure Total number Source:

Food sector

Trade

Business sector

24 80.0% 19 63.3% 29 96.7% 22 73.3% 17 56.7% 30

36 97.3% 27 73.0% 36 97.3% 35 94.6% 32 86.5% 37

38 100.0% 34 89.5% 36 94.7% 37 97.4% 33 86.8% 38

Own survey, reported in Venesaar (2003).

Size (number of employees) 0–9 10–49

5.5

43 89.6 32 66.7 45 93.8 38 79.2 31 64.6 48

41 93.2 30 68.2 42 95.5 40 90.9 33 75.0 44

57 93.4 50 82.0 59 96.7 54 88.5 49 80.3 61

55 96.5 48 84.2 56 98.2 56 98.2 51 89.5 57

Age (in years)

Total

98 93.3% 80 76.2% 101 96.2% 94 89.5% 82 78.1% 105

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example is connected with micro businesses based on non-regular activities, where no contracts exist and supplier–customer relationships are based on informal networks and personal trust. This confirms the belief that informal networks and contacts play a key role in unstable environments (Welter et al. 2003). Empirical evidence also indicates that hand in hand with changes in the enterprise environment there is a shift from informal to more formal relations, which may encourage enterprise managers to co-operate in order to achieve stability in business relations. An example was provided by a small entrepreneur from a wholesale company. She told us that suppliers might need to exchange information with both competitors and officials if customers do not pay on time. Here, small entrepreneurs see the need to share this kind of information with competitors, so that negligent customers cannot cheat on other suppliers. Estonia is a small country and any mistake in business may be costly for everybody. If somebody has cheated once, he or she has great difficulty in restoring their previous status in the market. Moreover, shared experiences between competitors also assist in improving the business environment, which is a common interest for all companies who wish to achieve good results in the long run. In the above case, we can state that personal trust was supplemented by collective trust, the development of which in turn creates preconditions for the whole business environment to become a more trustworthy one. The examples given above illustrate changes in the Estonian enterprise environment as well as changes in the role of trust in business relations with customers and suppliers. As the environment has grown more stable, this has encouraged the development of institutional, and in some cases also collective, trust in business relations.

TRUST IN INTRA-FIRM RELATIONSHIPS Intra-firm relationships between employers and employees are regulated with labour contracts, as required by Estonian law. However, in everyday relationships and decision-making both formal and informal regulations are used, and personal trust plays an important role. This has definitely changed since the beginning of the transition period in the early 1990s. The small entrepreneurs who we interviewed admitted that where earlier they had mainly met decisions themselves, they are now trying to divide their responsibilities in order to delegate them to their employees. A small entrepreneur from a food-processing company confirmed that this improves the economic performance of the firm, as well as helping to control employees. He accepts that workers need to enjoy more rights together with responsibilities and self-control. The survey results also confirmed that intra-firm relationships may also depend on the management experience and style of the manager, the firm’s size, the type of activity

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and the personal characteristics of the employees. For example, one manager from a food-processing company decentralised decision-making, which, in his words, has increased the working motivation of employees. Although the organisational culture in firms has become more democratic, institutional regulations (for example, social and tax policy) have also influenced small entrepreneurs to use some non-formal strategies of behaviour (for example, unreported wages, evasion of taxes). Moreover, the tenuous labour market situation results in excessive efforts on behalf of entrepreneurs and employees in the form of long working days, creating stress, contributing to health problems and resulting in the decline of overall personal satisfaction (Venesaar and Luuk 2004). It is worth emphasising here that the satisfaction of personal goals of the small entrepreneurs surveyed has decreased along with the age of firms, which may be explained by continuous difficulties of solving the problems caused by an unfavourable business environment (for example, the unavailability of finances, rapidly changing legislation, and so on). Personal trust is highly emphasised when small entrepreneurs are searching for new employees. Although according to the law employee searches must be announced publicly, managers try to hire people they know personally (for example, where they have personal knowledge about their competencies or personal characteristics) or who are recommended by colleagues or friends. In rare cases small entrepreneurs turn to the labour offices to find an employee (Venesaar et al. 2004). Such behaviour may result from the current labour protection measures and Acts regulating the dismissal of employees, which stipulate compensations in case of dismissals and terms of notification about dismissal depending on the length of employment with the employer.2 Thus, it is quite costly for enterprises to dismiss employees (Hinnosaar 2003). The Estonian legislation regulating labour relations has been assessed to be similar in severity to the European Union average (Järve et al. 2001). Along with the regulation of the free movement of labour within the European Union, it is assumed that issues of state interference in the labour market may increase (for example, social protection), the role of social dialogue may increase and new requirements for enterprises may also arise in many spheres (for example, working conditions).

SUPPORT NEEDS IN BUSINESSES To which sources do entrepreneurs turn if they need outside help to solve problems? Here our study allows us to compare entrepreneurs’ behaviour in two periods, that is, during the start-up phase of the business and in the year preceding the interview in summer 2002. First, we asked whether the firm had problems when getting started; secondly, whether the entrepreneur used external

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help. Not surprisingly, and in accordance with earlier survey results (Smallbone et al. 1997), two-thirds of the entrepreneurs named among the main problems access to capital/finance as their most pressing problem while starting business, followed by problems of finding skilled labour (39 per cent) and the search for markets and information (30.5 per cent). However, 61 per cent of our interviewees also claimed that they had no problems at all (Venesaar 2003), which in the early transition period can be explained by better market opportunities, easy start-up conditions and the typical attitude of Estonian entrepreneurs, which is to be independent and manage on their own. Nearly 77 per cent of enterprises that mentioned problems in business development when they started (which equals nearly 29 per cent of the respondents) used some form of help for solving the problems mentioned above. To sum up, half of the respondents received assistance from friends and family, the other half the help of persons who were connected with their business such as employees, colleagues, business partners or customers and suppliers (Table 11.3). There were only two cases where enterprises turned to local governments, indicating a lack of support initiatives on the local level during the first years of transition. In all cases, firms applying for external assistance trusted those providing help to act in their interest. The reasons why they trusted are either that no alternatives existed (37 per cent) or that they knew those who were providing help (86 per cent). Thus, with regard to Table 11.3 Sources of assistance during business start and in 2002 (percentage of respondents When business was started

In summer 2002

71.0 14.3 6.7 4.8 2.9 10.5 3.8 0 0 1.9

8.6 35.2 66.7 0 0 64.8 0 43.8 9.5 21.9

No assistance needed Family and friends Employees Customers Suppliers Business partners Previous colleagues Consultants, agencies Business associations Local authorities Note: Source:

Several answers were possible. Own survey, reported in Venesaar (2003).

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the sources of assistance, our analysis showed that small entrepreneurs mainly relied on personal trust arising from personal knowledge. This is even more apparent in small (10–49 employees) and older enterprises. The lack of alternatives may have been a problem for older enterprises that started during the early part of the transition period, when business consultation firms either may not have existed or were not able to help these new and small firms. On the other hand, older enterprises might have had experience and contacts in places where the small entrepreneurs had been working before they established a new enterprise. For younger enterprises the problem might have been a lack of information about consultation opportunities. This is supported by earlier studies (for example, Smallbone et al. 1997; Vensel and Wihlborg 2001), although these also described a greater number of entrepreneurs actively looking for assistance. At the time of our investigation, that is, in summer 2002, small entrepreneurs were asked whom they currently turned to for assistance and advice in business matters. Analysis of our data shows that most of the small entrepreneurs now would ask persons directly connected with business, such as employees, established and regular business partners, followed by business support institutions and local authorities, whilst only one-third of the enterprises would turn to family and friends (Table 11.4). Thus, first, enterprises rely on personal trust in employees and business partners and less on family and friends, which reflects a growing need for more professional assistance Table 11.4 Sources of assistance and advice in the business by membership of business associations Non-members Number % Not applicable No assistance needed Employees Family, friends Established and regular business partners Consultants, business support agencies Business associations, chambers Local authorities Source:

Members Number

%

31 4 45 28

47.7 6.2 69.2 43.1

21 5 25 9

52.5 12.5 62.5 22.5

42

64.6

26

65.0

26

40.0

20

50.0

1 18

1.5 27.7

9 5

22.5 12.5

Own survey, reported in Venesaar (2003).

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during business development than family and friends can provide. This is complemented by institutional trust where small entrepreneurs turn to persons and institutions who they may not know personally, but who might provide the professional help they are looking for. Although the two questions asked are not quite identical, we can still draw some conclusions with regard to changes in the structure of sources of assistance, which indicate both a changing attitude among small entrepreneurs towards external assistance as well as improvements in the business support infrastructure, as new opportunities for enterprises to find consultancy and use other support services have been created during the later period of transition. However, it should be noted that notwithstanding the need to use external assistance, which has been mentioned in other surveys as well,3 the low utilisation of external help in general can be explained by a number of factors: either entrepreneurs are not used to asking for advice, or they are not sure of the benefits of such advice or they have had dissatisfying experiences. On the one hand, the lack of personal experience of business consultants, and along with this the lack of personal trust, may be a reason why entrepreneurs seldom use them. Moreover, many entrepreneurs do not seek advice from entrepreneurship centres, which may be to some extent caused by the shortage of information on the services which they offer, but it may also indicate the low competitiveness of these centres compared with other sources of external assistance. This is also confirmed by the fact that the services offered by entrepreneurship centres are quite narrowly oriented towards certain groups of enterprises (for example, start-ups) (Jürgenson et al. 2003) rather than experienced, operating entrepreneurs who need high-quality professional advice (for example, planning of the product portfolio; market penetration and so on). Based on the above mentioned survey (from the Ministry of Economic Affairs in 2002), nearly two-thirds of the enterprises had at least heard something of consultation possibilities and programmes, but had not used these services themselves (Jürgenson et al. 2003). We also agree that Estonian entrepreneurs are slow to recognise the potential benefits of professional advice and consultancy to the development of their businesses (Smallbone and Venesaar 2004). Going back to our survey and sources of assistance, there are some differences depending on whether small entrepreneurs belong to business associations or whether they co-operate with other enterprises. In this context, our analysis shows that members of business associations tend to use ‘anonymous’ sources of assistance such as consultants and business agencies more frequently (72.5 per cent compared with 41.5 per cent of non-members: see Table 11.4). This is obviously related to contacts arising from their membership, but it might also indicate a better access to business-related information through membership. At the same time, two-thirds of non-members turn first to employees, followed by regular business partners (65 per cent) and family

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and friends (43 per cent). Thus, non-members apparently rely more on personal trust, which, however, could also indicate a lower level of information about existing business services compared to members. Not surprisingly, co-operation also has a direct effect on trust relationships. This is reflected in the fact that co-operating enterprises more frequently used aid from business partners, business associations and their own employees, and less from friends and family, compared with non-co-operating firms. Obviously, participation in co-operation networks increases the knowledge about their business partners, thus contributing to the generation of personal trust between partners. However, co-operation to a certain extent also appears to promote the development of institutional trust, as these enterprises are more open to new business relations and different sources of information such as business associations.

RELATIONS OF ESTONIAN SMES WITH AUTHORITIES Relations with authorities can be influenced by the overall external political and economic environment. The major aspects include regulations of property rights, conditions for market entry and market exit, the availability of financial and labour resources, legal regulations of business activities (for example, contracts, taxation), the nature of relations with authorities (for example, government departments, local bodies, courts) and banks and so on. These relations include both favourable conditions (for example, easy market entry conditions) for entrepreneurship development as well as obstacles (for example, access to finance). In transition countries, traditions also play a kind of role in the relations with authorities, as do the attitudes and behaviour of entrepreneurs and officials inherited from the socialist period. An analysis of enterprises’ behaviour in raising finances indicates that changes in making decisions by small entrepreneurs can be found in cases where they have to find external sources of finance. Many investigations have indicated that the major obstacle in the development of Estonian enterprises so far has been the accessibility of sources of finance, especially for small and medium-sized enterprises. They have had problems with the size of loans (minimum amounts offered by banks are too large), high interest rates, lack of collateral and so on. The survey demonstrated that in the early transition period small entrepreneurs borrowed from their former colleagues, acquaintances and friends and family rather than from banks, because banks did not offer acceptable conditions or enterprises did not want to risk taking out a loan because the manager was not sure of being able to pay it off. Though banking has developed rapidly in Estonia and won the trust of the people, banking policies have been quite conservative with respect to small enterprises, and banks have only

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recently started to offer small loans and other new products to enterprises (for example, leasing). The entrepreneurship support structures have also developed, which offer collateral for loans, starting capital and other services. Although, on the basis of surveys, some increase in the bank loans has been noticed, there is still a high level of dependence on self-financing (Jürgenson et al. 2003). In addition to the conservative policy of the banking sector, this might be due to entrepreneurs’ attitude towards using external sources of finance. However, the accessibility of finances is still a big problem for Estonian small enterprises, indicating that the improvement in the accessibility of finances is one way to promote the development of entrepreneurship in the country. Some efforts have been made in the country in recent years to conduct a number of assessments and studies to more thoroughly analyse the factors of the external environment that limit enterprises’ activity and find new ways of supporting SMEs (for example, Kluth et al. 2004; Zernike Group 2004; Jürgenson et al. 2003). The development of enterprises’ relationships with local governments and other public offices has been relatively slow. In previous surveys, many managers could not assess the potential role of local governments in enterprises’ development, let alone other public offices (for example, Smallbone et al. 1997). If relationships existed at all, they were mainly based on personal connections. Administrative and budget policy presented few opportunities to local governments for corruption and rent-seeking, but officials also lacked experience in fostering and supporting the development of private enterprises. Our survey confirmed that a number of small entrepreneurs consider the relations between official bodies (for example, the courts and federal and local legislatures) and private firms to be helpful. For example, the courts were estimated to be helpful by 80 per cent and regional legislative bodies by twothirds of small entrepreneurs, other official bodies were assessed as being less helpful (Table 11.5). Differences occur across sectors, with regard to their specific needs in dealing with authorities. The firms in business services estimated all relations with authorities, apart from those with regional government, to be better. This can be explained by the special characteristics of some types of firms in business services (for example, design services) which need advice and decisions (building permits, master plans and so on) from official bodies in their everyday work. This is true, for instance, for a local design and consultancy company, which co-ordinates the conditions for construction design with different authorities, and which values highly long-term cooperation with many authorities, as well as with competitors. Local governments are more important for the trade sector, as firms in this sector need licences to be in business. For food-processing enterprises relationships with regional legislative bodies and the courts were assessed as helpful, although in this sector the answer ‘helpful’ was given by a somewhat smaller number of

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Table 11.5 Extent to which entrepreneurs consider the relations between official bodies and private firms as either help or constraint to business success (percentage) Very helpful Federal government Federal legislative Regional government Regional legislative Local bodies Court Arbitrary court Other (please specify) Source:

1.0 1.9

Helpful

Neutral

26.7 42.9 41.9 67.6 28.6 80.0 19.0 1.0

71.4 54.3 57.1 29.5 66.7 15.2 75.2

Constraint

1.0 1.0 3.8

Don’t know 1.9 1.9 1.0 1.9 1.0 3.8 3.8

Own survey, reported in Venesaar (2003).

enterprises than in the other sectors. At the same time, other small entrepreneurs estimated these relations to be neutral (that is, neither helpful nor obstructive) rather than helpful, and only a few answers estimated relations with official bodies to be very helpful or constraining. This can be explained by the facts that the interviewed enterprises have rarely turned to officials for help and that they have had few problems with inspectors. For example, a food-processing company told us that as many technical and sanitary norms relevant for the enterprise are precisely fixed in relevant documents, the enterprise has no need to turn to officials. But it might also indicate that institutional weaknesses with regard to standards, requirements and organisations still exist. When dealing with authorities the main problems mentioned by enterprises were a lack of competence among officials, excessive paperwork and time-consuming procedures (Table 11.6). These problems were estimated to be more acute by enterprises in the business service sector, and by small (10–49 employees) and younger firms. In the business service sector, lack of competence and favouritism were also more often mentioned, which can be explained by the nature of the activities of the business sector. Excessive paperwork was more often mentioned by food-processing, micro and younger enterprises. In the food sector, this may be due to the introduction of EU requirements for sanitary and hygiene conditions. In the case of micro and younger enterprises, registration procedures might be the cause of the problems and, in general, such estimates may be due to their limited resources.

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Table 11.6 Problems in dealing with authorities (percentage of all respondents) Problem exists No Yes

Unfriendly or impolite treatment Excessive paperwork Explicit or implicit requirement to give bribes Time consuming procedures Lack of competence of officials Favouritism Other (please specify) Source:

If problem exists, extent of problem Minor Moderate Major Does not apply

61.0 38.1

39.0 61.9

8.6 11.4

26.7 33.3

3.8 17.1

61.0 38.1

89.5

10.5

4.8

3.8

1.9

89.5

39.0

61.0

39.0

7.6

27.6

25.7

36.2 62.9 97.1

63.8 37.1 2.9

12.4 7.6

29.5 22.9 1.9

21.9 6.7 1.0

36.2 62.9 97.1

Own survey, reported in Venesaar (2003).

Relations with local inspectors are mostly described as being neutral or friendly. The more positive assessments were most frequently for tax inspectors, fire inspectors, police and labour inspectors. Good relationships were appreciated by food-processing firms (fire, trade, police and labour inspectors) and trade firms (the tax inspector), which may have closer contacts with local officials. Relationships with tax collectors are generally close in the case of all enterprises, as they have to submit monthly reports. Enterprises appreciate institutional aspects, namely, the technical arrangement of the tax system, as in recent years accounting has become much simpler and declarations can be submitted via the Internet. Transfer to such online services has required great efforts, co-operation and mutual learning between entrepreneurs and employees of the internal revenue office: thanks to this, a well-functioning system has been created.

CONCLUSIONS Estonia has experienced major changes in entrepreneurship, in people’s attitudes and business relations in connection with the development of market relations since the beginning of the transition period. With the stabilisation of the business environment, trust relations have developed and changed in all

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their forms, while the improvement in formal institutions has started to promote more stable and predictable business relations. The survey results indicated that business relations are based on all three types of trust (that is, personal, collective and institutional), which may play different roles at different stages of enterprise development, and that alongside changes in specific environmental conditions trust changes dynamically in business relations between suppliers and customers. In the early transition period, personal trust prevailed in business relationships. As a result of changes in the business environment and the overall institutional development in the country, the role of institutional trust has increased. For example, our survey demonstrated that nowadays a majority of the firms surveyed use written contracts as agreements, indicating both the necessity to observe government regulations (for example, in accounting) and norms, and the wish to guarantee stable business relations, as entrepreneurs have come to value long-term relations. In this process it is important that as a result of knowledge and individual learning they usually reach agreements that satisfy both sides. In intra-firms relationships, organisational culture has become more democratic. However, institutional regulations (for example, tax policy) have encouraged small entrepreneurs to use some non-formal strategies (for example, unreported wages, evasion of taxes). The relatively low satisfaction of personal goals among small entrepreneurs may be explained by continuous difficulties in solving the problems caused by certain constraints in the business environment (for example, unavailability of finances, changing legislation). The emergence of, and changes in, trust relations depend on the characteristics of the enterprises, such as size, age, sector, involvement of partners, membership and co-operation. An analysis of the behaviour of small enterprises in searching for help to solve problems indicated that, first, during the early stages of business development, enterprises rely on personal trust, which is represented by friends and family, and then later by employees and business partners, as well as persons and institutions whom they need not know personally but who might provide the professional help they are looking for. Changes in the structure of sources of assistance may indicate both a changing attitude of small entrepreneurs towards external assistance as well as improvements in the business support infrastructure, as new opportunities for enterprises to find consultancy and use other support services have been created during the later transition period. The relatively low utilisation of external help in general can be explained either by the fact that entrepreneurs are not used to asking advice, or that they are not sure of the benefits of advice, or that they have had dissatisfying experiences. A considerable share of entrepreneurs does not seek advice from entrepreneurship centres, which may be to some extent caused by the shortage of information on services offered, or the narrow orientation of these services to some

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groups of enterprises (for example, start-ups). Survey evidence also indicates that both membership in business associations and participation in co-operation networks increase the knowledge of entrepreneurs about their business partners, thus contributing to the generation of personal trust between partners. However, co-operation to a certain extent also appears to promote the development of institutional trust, as these enterprises are more open to new business relations and different sources of information such as business associations. A certain degree of development can also be perceived in the relationships of small entrepreneurs with the authorities. On the whole, banking policies have in the past been quite conservative with respect to small enterprises. However, there have been some developments in offering small loans and other new products to small enterprises (for example, leasing, collateral for loans, starting capital) by banks and entrepreneurship support structures, but there is still a high level of dependence on self-financing in enterprises, which has become an obstacle to the growth rate of entrepreneurship. Though relations with local governments and other authorities have been said to be helpful or neutral, with small differences across sectors, and enterprises have had few problems with inspectors, the fact that the interviewed enterprises have rarely turned to officials for help might indicate that institutional weaknesses with regard to standards, requirements and organisations still exist and that there is still room for development in the relations of entrepreneurs with authorities. The analysis of survey results and case studies have helped us to understand conditions in the entrepreneurship environment and processes that support the development of trust in both inter- and intra-firm relations, and in relations with authorities. Estonia’s integration into the EU market, along with continuous development of the institutional structure of the society and the growth of institutional trust, will bring about new changes in business relations and regulations, which in turn will improve the entrepreneurship environment and promote conditions for the growth of entrepreneurship.

NOTES 1.

2. 3.

This chapter is based on the results for Estonia of an international project sponsored by the VW-Foundation and titled ‘Entrepreneurial behaviour and trust. Structure and genesis of economic transactions patterns in “Low-trust”- and “High-trust-Milieus” in East and West Europe’. This research was also supported by the Estonian Science Foundation. Compensation payments may amount to two to four times the average wage, the terms of notification ranges from two to four months if the length of employment is between five and 10 years. This survey was carried out by AS Emor on the basis of telephone interviews with Estonian small and medium-sized enterprises (21 November–20 December 2002).

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REFERENCES Blois, K. (1999), ‘Trust in Business to Business Relationships. An Evaluation of its Status’, Journal of Management Studies, 36 (2), 197–215. European Bank for Reconstruction and Development (EBRD) (2001), Transition Report 2001, London: EBRD. Hinnosaar, M. (2003), ‘Eesti tööturu institutsionaalne raamistik rahvusvahelises võrdluses’, Eesti Panga Toimetised, Working Paper, 7. Humphrey, J. and H. Schmitz (1998), ‘Trust and Inter-firm Relations in the Developing and Transition Economies’, Journal of Development Studies, 34 (4), 32–61. Järve, J., E. Kallaste and R. Eamets (2001), Töösuhted Eestis – Euroopa Liiduga liitumise taustal, Tartu Ülikool, mimeo, Tartu. Jürgenson, A., A. Oks, R. Selliov and K. Värno (2003), ‘Development Problems and State Support Measures of SMEs in Estonia’, Tallinn, http://www.mkm.ee. Kluth, Dresher and Partners (2004), Company Procedures in Estonia: A Comparative Study of the Danish, Estonian and EU Procedures of Company Registration, An FEU project under Danish EU Support Programme to Estonia. Project manager: J.B. Andersen, Denmark. Neivelt, I. (1999), ‘Business Ethics Reflects the State of Economy’, in M. Kooskora and T. Karing (eds), Creating a Sense of Business Ethics in Estonia, Materials of the International Seminar, 25–26 May, Tallinn, Estonian Business School, pp. 8–10. Nooteboom, B. and F. Six (eds) (2003), The Trust Process in Organisations: Empirical Studies of the Determinants and the Process of Trust Development, Cheltenham, UK, and Lyme, USA: Edward Elgar. North, D.C. (1990), Institutions, Institutional Change and Economic Performance, Cambridge: University Press. Phare (1998), The State of Small Business in Estonia: Report, Phare support to SME Development in Estonia, Tallinn: Printing House Pakett. Smallbone, D. and U. Venesaar (2004), ‘The SME Sector in Estonia at the Time of EU Accession’, paper presented at the 13th Nordic Conference on Small Business Research, Tromso, Norway, June 10–12. Smallbone, D., B. Piasecki, A. Rogut, U. Venesaar, L. Rumpis and D. Budreikaite (1997), The Survival, Growth and Support Needs of Manufacturing SMEs in Poland and the Baltic States, Final report of EU Phare ACE Programme (Contract No: P94 0743-R), Middlesex University, London: CEEDR. Teder, J. and U. Venesaar (2003), ‘Growth Management Issues in Estonian Enterprises’, paper presented at RENT Conference in Lodz, November, Poland. Venesaar, U. (2003), ‘Trust and Entrepreneurial Behaviour in Estonia’, in H.-H. Höhmann and F. Welter (eds), Unternehmerisches Handeln und Vertrauen. Struktur und Genese Wirtschaftlicher Transaktionsmuster in ‘Low-trust’ – und ‘High-trustMilieus’ Ost- und Westeuropas, Arbeitspapiere und Materialien, 56, Bremen: Forschungsstelle Osteuropa, pp. 1–72. Venesaar, U. and M. Luuk (2004), ‘The Nature, Impact and Consequences of Longterm Unemployment in Estonia’, in M. Hinnosaar and T. Rõõm (eds), Labour Market Research in Estonia, Papers of the research seminar, 9 May, Tallinn: Bank of Estonia, pp. 143–84. Venesaar, U, M. Hinnosaar, M. Luuk and Ü. Marksoo (2004), Pikaajaline töötus Eestis, EV Sotsiaalministeerium, TTÜ Eesti Majanduse Instituut, Tallinn: Ühiselu. Vensel, V. and C. Wihlborg (eds) (2001), Estonia on the Threshold of the European

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Union: Financial Sector and Enterprise Restructuring in the Changing Economic Environment, collection of papers, Tallinn: Tallinn Technical University. Vetik, R. (2002), ‘Trust in State Institutions in Estonia’, Riigikogu Toimetised, http://www. riigikogu.ee. Welter, F. and H.-H. Höhmann (2004), Vertrauensbeziehungen in KMU: Ergebnisse eines länderübergreifenden Forschungsprojekts, RWI: Materialien, Heft 10, Essen: RWI. Welter, F. and D. Smallbone (2003), ‘Entrepreneurship and Enterprise Strategies in Transition Economies: An Institutional Perspective’, in D. Kirby and A. Watson (eds), Small Firms and Economic Development in Developed and Transition Economies: A Reader, Aldershot: Ashgate, pp. 95–114. Welter F., T. Kautonen, A. Chepurenko, E. Malieva and U. Venesaar (2003), ‘Does Trust Matter? A Cross Cultural View on Entrepreneurship in Different Trust Milieus’, paper to the 2003 Babson College – Kauffman Foundation Entrepreneurship Research Conference, 5–7 June, Babson, USA. Zernike Group (2004), Research on Feasibility and Design of Government Support Scheme to Improve the Access of Enterprises to Venture Financing in Estonia, Final report. Ministry of Economic Affairs and Communications of Republic of Estonia, Tallinn.

12. Trust as a matter of experiences? Findings from the ICT sector of East Germany and Poland Henning Nuissl and Anna Schwarz THE PROBLEM: POST-SOCIALIST TRANSFORMATION, ENTREPRENEURIAL CO-OPERATION AND TRUST The recent transformation of former centrally planned economies has not only brought about an economic environment totally different from what firms and economic agents had been adapted to before, it has also meant that economic links and relationships have deteriorated, the creation of which usually requires several years. On the other hand, however, co-operative entrepreneurial relationships are essential to the economic success of transformation economies. This applies in particular to the regionally embedded SMEs, since they (can) build the fabric of regional economic networks so much hoped for. Hence, in post-socialist economies it is particularly important that both the surviving as well as the recently set up firms seek and find (new) partners. This especially holds for East Germany, where the economic environment has changed even more suddenly and radically than in any other post-socialist country, resulting in a constellation of ‘torn networks’ (Albach 1993). It is a well-known fact that the building of co-operative entrepreneurial relationships first requires some degree of trust between the business partners – anybody who engages in such relationships must generally be aware of the possibility that a respective partner will not stick to previous agreements. There are of course remedies against opportunistic behaviour, mainly contracts. Also, partners can gather information on each other, which enables them better to anticipate the further actions of their counterparts, in other words to predict whether their counterparts will be trustworthy or not. However, no matter how much information one has gathered on a potential partner or what legal devices one has put up, in (economic) life it is generally impossible to definitely exclude the possibility of agreements and arrangements not being followed. Thus, although entrepreneurial co-operation is usually backed up by formal contracts, to a different degree there is always a 197

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remnant of uncertainty that requires (non-substitutable) trust (for example, Arrow 1972). Accordingly, trust between entrepreneurs who are in charge of SMEs has long since been discussed as a crucial resource for economic development (for example, Gambetta 1988). As the development of co-operative relationships is particularly important for post-socialist economies there is an increased need for entrepreneurial trust there. This, however, appears to become something of a problem, because there are certain impediments to the development of trust among entrepreneurs who act on behalf of SMEs in a post-socialist context. The first kind of impediments to the development of trust concerns small firms in general (for example, Hilbert et al. 1991). Engaging in co-operative relationships bears considerable risks for them, because SMEs usually show • increased vulnerability due to a lack of reserves that could be activated if partners did not comply with agreements • a comparably low amount of information on the ‘outside world’, that is, on potential partners, provided within one’s own firm and in connection to this • a lack of access to such information (which increases transaction costs considerably). All in all, as far as business co-operation is concerned, SME entrepreneurs are particularly compelled to rely on trust, since for them there is less of a possibility to substitute trust with anything else (either information or the power to set up rules) as a means to reduce uncertainty about the future action of others. The context of post-socialist transformation further increases the problem for SMEs: scholars have continuously pointed out several peculiarities of postsocialist transformation that impede the emergence of trust severely – such as brutal competition because of an instability of markets, a situation of weak social and law control, political corruption or a general distrust in institutions, let alone a post-revolutionary anomie (cf. Sztompka 1999, pp. 174–5). With the advancement of institutional transformation the relevance of this argument is gradually diminishing. However, since transformation research has shown that the process of post-socialist transformation proves to be more difficult and intricate than was assumed in the beginning, it is still important. Accordingly, some effects of post-socialist transformation still seem to impede the development of trust in countries like Hungary, Poland and, especially, East Germany: local firms are often small, find themselves in a weak market position and are thus hardly able to enter existing networks in any promising position. Their ‘struggle for survival in the market’ absorbs much of the time and energy that would be necessary for the development of broader ideas or strategies regarding the future business (cf. Grabher 1997). Note that the (really or allegedly)

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innovative segments of economy are no exception to this general diagnosis, whilst on the other hand they are particularly dependent on linking their own competences with external assets of technology and knowledge. Many scholars have claimed that the legacy of ‘socialism as it existed in reality’ still also proves to be detrimental to the proclivity of individuals for trusting behaviour for sociocultural reasons. They argue that both the state-managed neglect of elements of civil society and the necessity to organise informal networks of supply arising from an economy of scarcity have led to the emergence of kinship-like groups whose members make a strict difference between ‘ingroup’ and ‘out-group’ people. The lasting orientation according to these dense networks is seen as a severe sociocultural impediment to the development of (new) co-operative relationships. This is a somewhat dramatic diagnosis, given the fact that the sudden transformation of the whole institutional system as well as the general development of the industrialised world, often characterised as an accelerating globalisation, do anything but encourage social cohesion. However, it is also possible to argue that the necessity of relying on informal networks in the everyday life of ‘real socialism’ as well as the legacy of an ideology of solidarity do, in fact, support the development of interpersonal trust (for example, Hradil 1995). Moreover, even the fragmentation of socialist societies into an anonymous, state-dominated public sphere on the one hand and a private sphere, which rests on familiarity, reliability and mutual commitment, on the other, could be interpreted as a resource for trust inasmuch as experiences made in the latter sphere may well enhance the ability to trust others, and under difficult circumstances. Indeed, scholarly observation has led to the discovery that co-operative relationships between East German enterprises often rest on the long-lasting and sometimes ‘resurrected’ acquaintance of their leaders (for example, Koch and Thomas 1997). However, it does not seem appropriate to therefore assume one can directly transfer this empirical evidence to cases of encounters between economic agents who have never met before. In general we assume that the decisive precondition for any kind of cooperative development is the way in which individuals handle the uncertainty inherent in any kind of co-operation, how despite this insecurity they still develop a potential willingness to trust. Thus we are interested in the experiences and observations on this ‘grey area of expectations’ made by people in a transformation context as well as the respective potential for acting ‘in good faith’, which ensues from the specific ways of processing these experiences made in economy and society. More specifically we would like to discover whether entrepreneurs who act on behalf of potentially co-operating firms • perceive the options and opportunities related to collaboration and cooperation

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• overcome anxieties about fraud, deceit or generally opportunistic behaviour, which means that it is necessary to abstain from too precise an (normative) expectation regarding the behaviour of others (as such an expectation is very likely to lead to self-restriction), since both these aspects are basic requirements for the development of cooperative economic relationships. In the following we would like to address these two problems by reporting central findings from two empirical studies on entrepreneurs in East Germany and Poland that were carried out in the information and communications technology (ICT) sector, thus taking the ICT branch as an example.1 It is for three reasons that the ICT sector seems to be particularly suitable for an investigation into the problem of entrepreneurial trust in the context of post-socialist transformation: first, it was and still is regarded as one of the most promising segments of the economy in structurally weak regions; secondly, it is a young branch with mainly young entrepreneurs, which means that its key actors should be most likely to overcome impeding sociocultural legacies of the socialist past; and thirdly, in the ICT branch a joint business is hardly possible without an extensive exchange of knowledge, which in its turn makes the partners highly vulnerable so that trust becomes a matter of utmost importance. Our main argument is that the development of trust among post-socialist entrepreneurs is not necessarily impeded. Nonetheless these entrepreneurs face distinct difficulties when setting about developing mutual trust in an economically weak regional context. We shall develop this argument in four steps. Before presenting our empirical results from East Germany (third section) and Poland (fourth section) we shall render a more precise account of what we actually mean by the notion of trust and how we have tried to get an empirical grip on trust (second section). Finally, the reported findings will be discussed in terms of what conclusions can be drawn regarding the likelihood of post-socialist ICT entrepreneurs engaging in business co-operation (fifth section).

INTERPERSONAL TRUST AMONG ENTREPRENEURS AS A PHENOMENON BASED ON EXPERIENTIAL KNOWLEDGE In everyday language the term ‘trust’ covers a plethora of meanings and is closely related to terms such as hope, confidence or faith (for example, Wilson 2002). But also in the academic literature on trust its definition is (still) far from being undisputed. Generally, however, it could be seen as a kind of expectation nourished in a state of uncertainty with respect to a future event

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(cf. Misztal 1996).2 Since here trust is discussed as a precondition for entrepreneurial co-operation, our interest is focused on trust as an individual entrepreneur’s – optimistic – expectation regarding the future behaviour or action of a potential partner. Also institutional trust – particularly the expectation that the institutions guaranteeing the functioning of the market will work properly – is a precondition for entrepreneurial co-operation, of course. This more general kind of trust, however, could be seen as a condition for the emergence of interpersonal trust; it thus does not pertain to what is to be explained in this chapter (the dependent variable) but must be regarded as a source of explanation for the phenomenon under scrutiny (an independent variable). If (at all) studied empirically, the form of expectation called trust is conceptualised in different ways. Two approaches to the phenomenon of interpersonal trust are predominant, neither of which seems satisfactory with respect to the ‘empirical’ problem of the creation of trust: ‘Trust is often regarded as a generalized personality trait or as a situational variable, whereas it is hardly ever seen as a relationship variable’ (Petermann et al. 1992, p. 210). Seen from a sociological point of view, however, it seems to be indispensable to handle trust as a genuinely social phenomenon. Trust will not simply be the result either of an agent’s individual psychology, for instance a general disposition to trust others (regardless of who these others are and how they behave towards the respective agent), or an isolated decision deduced from the parameters of a specific situation (but unconnected to the decision-maker’s circumstances of action in general and his or her personal experiences in particular). Instead, trust pertains to social relationships from which it cannot be detached – an argument that Granovetter (1985) put forward in his famous seminal work on new economic sociology in order to illustrate the shortcomings of both traditional economic and sociological approaches to economic action. This argument implies that trust evolves by means of mutual interaction (cf. Sabel 1993). Given that trust is necessarily a result of human interaction, the knowledge of individuals interacting potentially in a trust-bearing or trust-maintaining manner can be regarded as the most basic factor in relation to this interaction. First, it is their knowledge that enables individuals to interpret the verbal or non-verbal signals of others. Secondly, and equally important, the knowledge of individuals does not only have a direct impact on the development of trust but also mediates the impact of ‘structural’ conditions: undoubtedly, the context of action is always highly relevant to the emergence of interpersonal trust but this is assumed to be so, not because it directly determines the occurrence of trust, but because its (more or less idiosyncratic) perception by those who are to develop trust has a decisive influence on the objectives, attitudes and assumptions with which these agents engage in the active creation of trust by ‘a mutual process of self-disclosure’ (Giddens 1990, p. 121).

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If trust is regarded as a result of knowledge-based interaction, the former experiences of potentially trusting individuals as a main source of individual knowledge is of extreme importance to the actual emergence of trust (cf. Höhmann and Malieva 2002). The knowledge of individuals is probably more based on experience than on mere observation made from a neutral perspective. Also, individual knowledge is more likely to have an impact on a person’s action if stemming from experience. Thus an entrepreneur’s perception of options and opportunities related to collaboration and co-operation as well as his or her inclination to overcome any fear of fraud, deceit or generally opportunistic behaviour is largely dependent on his or her experiences with business in general and former partners in particular. Hence the presentation of empirical findings will focus on these two kinds of individual experiences as main determinants of the ‘trust potentials’ inherent in a particular societal context. Thus we do not simply limit ‘knowledge’ to information that could be separated from the individual or exchanged at will but, rather, we relate knowledge to its interactive and interpretative genesis. In other words, we do not equate knowledge with the specific information individual agents have about the further action of others; instead, we seek knowledge patterns that help entrepreneurs to understand the world (of economic action) they are living in and to which they have to adapt their own behaviour. In this we specifically focus on experiential knowledge. This means, of course, that we cannot tell what the reality in which economic action takes place is ‘really’ like. Thus our approach to the ‘trust issue’ follows the classical finding of sociology, stating that the perception of reality becomes real in social interaction (cf. Thomas 1981).3

FINDINGS FROM EAST GERMANY The Empirical Design The findings presented below draw on 27 extensive but only weakly structured interviews with ICT entrepreneurs in Brandenburg (the German Land surrounding Berlin) and the eastern part of Berlin. These have been selected for detailed interpretation from a larger sample of around 50 interviews. The interviews were carried out between 1997 and 2000, recorded and transcribed.4 The interpretation of interviews relied on the method of qualitative content analysis (supported by the QDA programme WinMAX) proposed by Mayring (1997), and it aimed at a structured compilation of statements. Eventually it led to a set of more than 500 keywords that reflect the main features of the interviewees’ experiential knowledge concerning – among other things – options and opportunities as well as previous experiences with

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entrepreneurial co-operation. Furthermore, the particular combination of keywords assigned to each interview forms a distinctive profile for each particular ‘case’ (that is, interviewee) that can be compared to the profiles of other ‘cases’. In the following, information will be given on the frequency with which certain aspects were mentioned throughout the whole sample, because this hints at the importance of different aspects – or, to be precise, at the extent to which certain aspects from the interviewees’ point of view seem to be worth mentioning. However, the citation of frequencies must not be misunderstood as an attempt to change the status of the method: a quantification of non-quantifiable data is by no means intended. Experiences of East German Entrepreneurs Concerning the Scope for Economic Action Almost all interviewees experience their position on the ICT market as weak, thus confirming the oft-quoted difficulties of enterprise in a context of postsocialist transformation. This concerns six problems in particular: • The majority of interviewees hint at difficulties in raising money. Banks obviously are rather restrictive in terms of loans for SMEs, especially if SMEs are undercapitalised as is often the case with start-ups in East Germany. • Some interviewees argue that they suffer not only from their own shortage of capital but also from the fact that their (almost solely East German) customers usually do not have any larger financial resources at their disposal either. • Most interviewees see a predominance of ‘exogenous’ actors (for example, Siemens, Alcatel, Deutsche Telekom) on the ICT market, whom they could hardly compete with, especially when it comes to lucrative orders. • Several interviewees mention a stigmatisation of firms from East Germany, which they perceived as a serious restraint to their chances of canvassing for customers. • Many interviewees find the search for partners a particularly difficult task, because in terms of profile they are often very similar to other ICT firms in the respective region. This seems to be mainly due to the impossibility of specialising in (software) development and production without the necessary capital. • Another study has revealed that the entrepreneurs’ negative assessment of the governmental SME policy, including the performance of the regional institutions for the support of local firms, also contributes to their perception of a precarious market position (cf. Blaneck 2003).5

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The weak market position of East German ICT entrepreneurs is also reflected in the heterogeneous profile of the firms represented in the sample. The vast majority of interviewees, in other words their firms at large, were not able to concentrate on a core activity, since soon after 1989 ‘western’ companies occupied the most lucrative segments of the market. So the ‘newcomers from the East’ have had to fill in the remaining niches, which usually means that they have to provide full ICT supply for local demands. Experiences of East German Entrepreneurs Concerning Entrepreneurial Co-operation All entrepreneurs of the sample have gained some experience with cooperative relationships in the past. However, negative experiences with former partners are significantly stated more often than positive ones, and complaints about other entrepreneurs behaving in an opportunist and selfish fashion can frequently be found. This seems to be peculiar to the field under investigation, because under ‘normal’, that is, non-post-socialist, conditions it would be common sense to expect an egoistic approach to interactions in the market sphere. In some of the cases examined East German entrepreneurs justified the negative conclusions they had drawn from experiences of co-operation with the argument that their former partners, in their opinion, had not demonstrated enough public spirit and had not been sufficiently concerned with the welfare of their home region. Hence, they demand a normative understanding of cooperation as a condition for working together in business, which effectively prevents them from gathering positive experiences through cooperation. Even though these findings on co-operative experiences might be slightly biased, because people tend to talk about the disappointment of expectations rather than the ‘normal’ situations in which expectations were met, we can infer that a kind of ‘collective (over-)awareness’ of the risks of co-operation exists, which is anything but conducive to the emergence of a culture of trust and co-operation. However, not all the interviewees’ experiences with external partners are negative, and even fewer are entirely deterrent. Instead, the general bias against co-operative experiences reported by the interviewees in only 13 cases reflects a ‘general disappointment’, whereas in the remaining 14 cases these experiences are mixed and ‘by and large not negative’. So the interviewees could be assigned to two different groups with regard to their former co-operative experience. The same can be applied to the interviewees’ current co-operative engagement: although all interviewees mention at least one existing inter-firm relationship that comprises elements of mutual support, the character of these relationships is very different. For instance, the cooperative commitment of some interviewees is limited to them participating in

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the discussion circles of regional entrepreneurs, whereas others co-ordinate almost all entrepreneurial activities with their partners in order to prepare for a future fusion of the respective firms. Thus it seems to be reasonable to distinguish between ‘strong co-operators’, who get involved in a form of cooperation that bears considerable risk (of broken promises), and ‘weak cooperators’, who only go into loose co-operative relationships. A classification of interviewees according to the two criteria now introduced shows that the first, the quality of former co-operative experience, seems only to have a minor influence on the latter, the actual co-operative involvement (Table 12.1): as one would expect, the number of ‘strong cooperators’ among those entrepreneurs with more positive co-operative experiences is clearly higher than among those with almost only negative cooperative experiences, but also several ‘strong co-operators’ have been more or less entirely disappointed in their experience of co-operation before.6 Although, of course, these ‘qualitative statistics’ do not meet any scientific criterion of significance, they hint at the impossibility of deriving an individual entrepreneur’s propensity to develop trusting relationships primarily from the respective entrepreneur’s experience (whether it concerns the general circumstances of entrepreneurship or a personal involvement in co-operative relationships). Moreover, regardless of their co-operative experience, almost all interviewees claim that they would be happy to further extend their cooperative links to other firms. When the attention is turned to the purposes of co-operation, it becomes obvious that the perception of a difficult economic environment prevents entrepreneurs from recognising the opportunities arising from strategic cooperation. Instead, the majority of interviewees pursue a strategy of both neglecting innovative ambitions and focusing on (mostly local) market niches. Accordingly, these entrepreneurs see co-operation mainly as a means of defending their own market position against bigger companies that are Table 12.1 Four types of entrepreneurs (in the sample) differentiated according to co-operative experience and co-operative involvement (absolute numbers)

Quality of co-operative experience

Co-operative involvement Strong Weak co-operators co-operators

Not entirely negative Negative Source:

Own empirical study (cf. Nuissl et al. 2002, ch. 4).

8 5

5 9

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regarded and dreaded as competition. Only a minority of interviewees state that their further aim of co-operation is an expansion of business. Hence, we can infer that the weak position of market power that East German entrepreneurs consider themselves to be in shapes the general interest they have in each other and, therefore, reduces their inclination to get involved in potentially trust-bearing interaction.

FINDINGS FROM WEST POLAND The Empirical Design In conjunction with the study on the problem of co-operation and trust in the East German ICT branch, Anna Schwarz and Marta Kowalczyk (EuropeUniversity Viadrina) carried out an email survey among ICT entrepreneurs in West Poland (Vojvodships of Wielkopolskie, Lubuskie, Dolnos´ la¸skie, Zachodnio-Pomorskie)7 (cf. Kowalczyk 2001; Nuissl et al. 2002, ch. 7). A questionnaire was emailed to 700 firms, 111 of which responded (16 per cent), which is a fairly good relation, given that there was no personal contact and that in post-socialist Poland there is still a widespread reluctance to participate in any kind of enquiry. Concerning the geographical distribution of firms this sample is fairly representative (Table 12.2). Its representativeness concerning other variables could not be checked, however, and probably it tends towards a form of ‘positive distortion’, since those firms that are open to international contacts are much more likely to answer an email questionnaire from Germany than are others. Table 12.2 Regional distribution of ICT entrepreneurs/firms in West Poland in 2001 Vojvodship

Wielkopolskie Lubuskie Dolnos´ la˛ skie Zachodnio-Pomorskie Total Source:

Number of ICT entrepreneurs/ firms 2946 615 3044 1579 8184

%

Number of ICT entrepreneurs/ firms in the sample

%

36.0 7.5 37.2 19.3 100.0

38 15 35 23 111

34.2 13.5 31.5 20.7 100.0

GUS (Glówny Urza˛ d Statystyczny), calculation by Marta Kowalczyk.

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The responses to the questionnaire have mainly been analysed in terms of frequencies. This has yielded some interesting data that could be compared with the results from the ‘qualitative’ study in East Germany, notwithstanding both the aforementioned ‘positive distortion’ and the fact that the methods employed are, of course, rather different. How Polish Entrepreneurs Perceive their Scope for Economic Action Not only is the structure of the sample of Polish entrepreneurs and enterprises similar to the German study (mainly small enterprises, unspecific profile/little specialisation), but also the Polish entrepreneurs’ experience of their economic environment resembles very much that of their East German ‘colleagues’. In particular they complain about the following drawbacks:8 • a lack of financial resources • a lack of a (continuous) demand for products • an increasing dominance of global players in the market (for example, HP, IBM Polska, Microsoft, Oracle Polska) • an inflexible and inefficient regional policy for economic support.9 In addition, the Polish entrepreneurs mention further problems that obviously are non-existent in the privileged East German case of transformation, that is, intricate and sometimes inconsistent laws. Despite these difficulties, a fairly impressive number of ICT SMEs have established themselves, proving that there has been a highly dynamic development in this segment of the economy. Between 1996 and 1999 alone the growth rate in this segment has almost doubled (Teleinfo 500 2000, p. 56). The ICT branch, which continues to grow rapidly in Poland, mainly profits from the increasing importance of the service sector within the Polish system of employment. As much as 25 per cent of the buyers of ITC products belong to the service sector, and another 30 per cent come from the sector of finance, whereas only 18 per cent work in the field of industry (cf. Bielewicz 2003). Almost a third of all enterprises surveyed intend to invest in co-operation and networking. This proves that, in general, Polish ICT entrepreneurs pay more attention to the opportunities rendered by co-operation than do their East German ‘colleagues’, and they regard investment in these issues as highly relevant for economic success (cf. Teleinfo 500 2000, p. 80). The fact that Polish entrepreneurs stress the importance of co-operation and networking so decidedly is probably due to the fact that their prolific personal networks from socialist times have not been eroded to the same extent as in East Germany, since the restructuring of the economy was, of necessity, based on the structures that already existed: ‘When asked about the secret of their business

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successes, top Polish entrepreneurs almost unanimously indicated the rich personal networks, even before actual capital assets’ (Sztompka 1999, p. 189).10 This continuity of economic relationships presumably concerns even the many young entrepreneurs in the sample in that it shapes economic culture as a whole. Experiences of Polish Entrepreneurs Concerning Entrepreneurial Co-operation There also seems to exist a marked difference between the Polish and the East German ICT business as far as co-operative experiences are concerned. Table 12.3 gives an overview of the experiences the Polish ICT entrepreneurs in the sample made with co-operation. As can be seen, they mention positive cooperative experiences more often than negative ones. This is especially true of those who get involved in co-operation to a comparatively large degree. On the other hand, research-oriented firms hint at a comparatively bad record of co-operative experiences. Even more interesting than the Polish entrepreneurs’ general inclination to engage in co-operation is, in particular, their search for co-operation with international partners, mainly from the ‘West’, whilst they frequently claim that they fear the competition of domestic competitors. Despite the fact that firms with an international orientation are probably overrepresented in the sample, it is still quite amazing that the entrepreneurs taking part in the survey, all in all, intend roughly to double their amount of international co-operation. Table 12.3 Share of Polish ICT entrepreneurs (in the sample) with positive or negative co-operative experiences (percentage) Positive experience

%

Negative experience

%

Transfer of know-how Complementarity of profiles Joint acquisition of orders Joint canvassing Preliminary work (as investment in future co-operation) Development of new product Benefit from reputation Education of employees Honesty concerning strengths and weaknesses Successful subcontracting

84 48 46 44

Taking advantage of information Dishonesty concerning strengths and weaknesses Breaching of agreements Luring away of customers Luring away of employees Making use of reputation

34

Source:

42 38 34 32 17 3

Survey by Kowalczyk (2001) (cf. Nuissl et al. 2002, ch. 7).

30 26 18 16 10

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209

Almost 50 per cent of them want to increase their presence on the German market by working together with German firms. Note, however, that it is definitely not the East German border region that attracts major interest. The international aspirations of the Polish ICT businesses correspond to the optimistic attitude regarding Poland’s EU accession that is prevalent among Polish entrepreneurs (79 per cent according to Rzewuski 2003b). This should even apply to a larger degree to the ICT branch, since the adaptation of Polish administrative structures to EU standards is expected to render a large market for their products and services. However, this is still likely to offer only a limited degree of opportunities to the small, domestic IT firms of Poland.11 As far as the actual reality of co-operation and collaboration is concerned, however, a somewhat different picture emerges. Whereas foreign firms are the co-operators most sought after, actual co-operation almost exclusively takes place with domestic partners. Co-operation with partners from abroad is much rarer – only about a quarter of all firms contained in the sample are actually involved in some kind of cross-border co-operation. Thus one can state that there is a gap between the, mainly domestic, ‘realities’ of co-operation and the co-operative aspirations of Polish ICT entrepreneurs that are strongly focused on the international sphere. However, this is still in stark contrast to the results from East Germany where Poland apparently is hardly perceived as a source of potential partners at all. Corresponding to this finding, Polish entrepreneurs also demonstrate a much more offensive general attitude towards the idea of co-operation. The Polish interviewees’ answers to the question on the tasks of entrepreneurial co-operation reveal a firm will to utilise such business relationships primarily in order to expand one’s own business – for instance, by conquering new markets or increasing one’s know-how.

CONCLUSIONS Concerning the question of how entrepreneurs perceive the options and opportunities related to collaboration and co-operation (which are tantamount to their motives for the creation of trust) the results are hardly ambiguous. Post-socialist entrepreneurs in the SME sector face several distinct difficulties. Moreover, there seems to be a lack of attractive business partners in the region not only from the point of view of the interviewed entrepreneurs, but also as an ‘objective’ fact. The perception of these problems clearly prevents entrepreneurs from trying to develop co-operative, and hence trusting, relationships. However, the findings from Poland show that co-operation can also appear desirable under difficult circumstances. Thus the question arises whether it is possible to explain the differences in the willingness of Polish and German ICT entrepreneurs to develop trusting relationships through the

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different conditions prevalent in these two cases of post-socialist transformation. It will therefore be helpful to render more precisely the context of the conditions for economic action, especially for domestic SMEs. First, the business conditions for East German and Polish entrepreneurship do partially differ from each other. Although most of the economic difficulties mentioned in detail earlier on apply to the East German and Polish case to an equal degree, their contexts represent two opposing economic developments. In Poland a continuous and noticeable drop in the inflation rate (from about 60 per cent to below 10 per cent) was noted between 1991 and 2002, whereas the German inflation rate with only a minor variation at a low level was taken much less notice of by the people. Poland even experienced a drop in the unemployment rate (from 17 per cent to below 10 per cent) between 1994 and 1998, and only since then has unemployment increased again (up to about 19 per cent), in comparison to which the rate of unemployment in Brandenburg rose relatively steadily (from 10 per cent to more than 18 per cent) without any sign of a change in tendency. The greatest difference can be observed in the development of gross domestic product: since 1992 Poland has achieved annual growth rates of between 3 and 8 per cent, which already from the year 1995 onward surpassed the growth rate of Brandenburg, which in its turn has sunk steadily from over 25 per cent in 1992 to below 2 per cent. In short, a noticeable upward trend in the overall economic development of Poland (with the exception of unemployment, which could, however, be interpreted by Polish entrepreneurs as rendering the advantage of cheap and available workers) currently stands directly opposed to a conspicuous and lasting downward trend in Brandenburg (cf. Blaneck 2003).12 Also, in terms of available human capital, Brandenburg is clearly at a disadvantage in comparison to the structurally weak West Polish Vojvodships. Whereas in the former merely 0.53 persons per 1000 inhabitants were occupied in research and development in 2001, the number was two or three times as much, between 0.98 and 1.50 persons per 1000 inhabitants, in the latter (cf. Rosenfeld 2001). Thus, in comparison, the situation in Poland seems more favourable for the opportunity of utilising the potential of innovative entrepreneurs as well as the effects of networking between businesses and research institutions. Business transactions, the willingness to take risks and, when getting involved in a new cooperation, the attempt to open up new market sections can hardly not be influenced by the consideration of such differing circumstances, which, after all, also determine the potential spending power of customers and the chance for new competitors to establish themselves in the market. The second point is the considerable difference in expectations between East German and Polish entrepreneurs at the borderline between West and East Europe regarding their future scope for action. Thus, what people expect of Poland’s EU accession differs very much according to what side of the river

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Oder (forming the border) they live on: the population of the East Brandenburg border region (in summer 2003) mainly expects disadvantages to ensue from the directly imminent EU enlargement, especially a loss of job opportunities (67 per cent) as well as the ruin of workshops (59 per cent) (cf. Schwarz and Jacobs 2004, p. 265). The people living in the West Polish region, on the other hand, regard the near future in quite a different light: many hope to gain clear advantages from their country’s accession to the EU (47 per cent), increased welfare (44 per cent), a rise in the standard of living (46 per cent) and a revival of the spirit of enterprise (70 per cent) (although as many as 21 per cent also fear a rise in unemployment) (cf. CBOS 2003). The willingness to see the EU enlargement in the light of a new opportunity is also much more prevalent in Poland than in East Germany. This, too, is reflected in the popularity of new models for economic liberalism towards which young Polish people are more and more inclined, quite according to the American model. Accordingly, the Polish commentator Adam Krzeminski discovers ‘a spreading of the model of the young, flexible social climber who gets somewhere by virtue of astuteness, hard elbows, experience of the world and permanent further training’ (Krzeminski 2001, p. 687, translated from German). Similarly, other observers have also attributed increasingly (especially) to the (young) Polish such habitual characteristics as flexibility, the capacity to improvise and individualism (Juchler 2003). A more extended study of the context of economic history and in terms of socialisation theory could demonstrate in more detail the fact that certain niches of free-market organisation had already been exploited in Poland under state socialism, that free-market competition was already perceived to be normal, as also rendering new opportunities for oneself (whereas many East Germans feared competition as a threat to their own existence and attempted to avoid it), that socialist ideology and state values fell on much less fertile ground in Poland than in East Germany and, finally, that the destruction of personal networks was much less abrupt and complete in the economic life of Poland than in that of East Germany (where the breaking up and dissolution of enterprises and business co-operations through the Treuhand during the process of privatisation had their own part to play). All these factors together render plausible the fact that conditions in Poland are altogether more favourable for the realisation of new opportunities for action and co-operation. The lesser tendency of East German entrepreneurs to trust can then be explained by the combination of expectations regarding the general economic development with existent subjective patterns of assimilation. Consequently, this sketchy attempt of ours to examine empirically the problem of trust (working with knowledge relevant in connection to trust and produced in as well as affecting processes of interaction and interpretation) basically takes us one analytical step (or more) back to the question of patterns

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of perception and interpretation according to which people, such as entrepreneurs, recognise, interpret and explain their actions and conditions for acting, and condense these into knowledge, thus making it the starting point of a potential rendering of trust. In the spirit of Anthony Giddens, such cognitive patterns (or ways of processing experiences and objective conditions) could be utilised analytically and empirically as the key to understanding the mutual creation of relationships of trust and co-operation under insecure conditions. In short, the title of a future comparative study on the phenomenon of entrepreneurial trust could be this: ‘Trust as a matter of interpretation (of experiences)’.

NOTES 1.

2.

3.

4.

5.

The ICT sector refers to businesses predominantly concerned with information technology and telecommunication, ICT hardware and ICT systems, software, information technology (IT) services and telecommunication services. This follows the definition of the leading German and European trade association in this field (cf. BITKOM 2004). If a more precise definition of trust is needed, it should be useful to resort to the basic commonalties of all the different concepts of trust the academic discourse has put forth, producing ‘a good deal of conceptual confusion regarding the meaning of trust and its place in social life’ (Lewis and Weigert 1985, p. 975). This leads to a definition of trust as an expectation of (a) the (non-) occurrence of a certain event, held by a particular agent, who (b) regards the respective event as meaningful and therefore adapts his or her own action to his or her (trusting) expectation, who (c) has (at best) limited knowledge about the probability of the respective event, who (d) has no control over the respective event and who (e) will be directly affected by the occurrence or non-occurrence of the respective event in so far as he or she could either gain or loose depending on whether it occurs (or not). Beyond this general definition various specifications – regarding the sources, the nature and the (social, psychological, economic) function of trusting expectations – could be made (cf. Nuissl 2002). An approach to the phenomenon of trust that starts off from the knowledge of potentially trusting agents is highly compatible with the way trust is usually dealt with in the economic literature (for example, Ripperger 1998). However, there are at least two important differences: apart from our broader notion of knowledge we distinguish between trust (understood as a form of individual expectation) and actual trusting behaviour (cf. Kee and Knox 1970). The firms represented in the sample were founded between 1990 and 1995, have between one and more than 50 employees and their core competence is without exception varied to a larger or smaller degree. The spectrum ranges from pure trade with computer hardware to advanced forms of software production and includes diverse activities, such as the installing and administration of computer networks, training on computer software or ICT consulting. This predominance of rather small and not highly specialised enterprises is typical for the East German ICT branch (cf. Schwarz 2000). The following quotation by a successful ICT businessman from the Land Brandenburg illustrates well how dissatisfied many East German entrepreneurs are with the work of the institutions for the support of the regional economy: ‘Let me tell you, no institutions for economic support will be of any help . . . quite the reverse. They swallow the little bit of money that is offered by the state. They use it up themselves . . . if financial resources for technology have been made available by the EU for a Bundesland . . . their own administration requires 35 per cent of the money for itself . . . they create projects to ensure their continued existence, and mostly there isn’t much left for others. . . . Go and find out for yourselves, when events take place, there are bound . . . to be less than 20 per cent that are

Trust as a matter of experiences?

6.

7.

8.

9.

10.

11.

12.

213

entrepreneurs there . . . that’s the clearest indication that it’s just a complete form of selfemployment’ (translated from the German, in Blaneck 2003, p. 85 f.). Some of the interviewees who look back on more or less entirely bad co-operative experiences belong clearly to the most successful entrepreneurs of the sample. In a couple of cases this is due to the fact that ‘disappointed’ entrepreneurs extended their activities successfully to markets abroad (in particular to the USA). Hence, no correlation between the ‘quality of former co-operative experience’ and entrepreneurial success could be found. Instead, there is a connection between the date of the foundation of firms and their success. The earlier a firm was established (after 1989) the better were its prospects for the future. One explanation for this observation is in accordance with market theory: the first firms to be founded were the first to stake claims to the evolving markets of Germany’s ‘New’ Länder. A second explanation is more specific: there is some evidence that in the course of the introduction of a market economy the most dynamic and energetic persons (that is, the most ‘gifted’ entrepreneurs) were also the first to endeavour to risk becoming entrepreneurs. As far as the presence of ICT enterprises is concerned, these four West Polish Vojvodships belong to the more weakly developed and marginal regions of Poland. Over 54 per cent of the largest and most profitable Polish IT firms (such as ComputerLand) are based in Mazowiecki, the region surrounding the capital. The largest Polish IT firm at present, ProKom AG, employing over 1420 people, however, is based in Gdansk (cf. ‘Top 200’ 2003). A survey of Polish SMEs that was carried out by the state in the year 2001 revealed the following order of the most important ‘barriers to the development of SMEs in Poland’ from the point of view of entrepreneurs: 91 per cent mentioned the problem of high taxation; insufficient demand was given as a reason by 77 per cent; complicated legal regulations by 76 per cent; difficulties in obtaining credit by 73 per cent; and the state’s disadvantageous SME policy by 69 per cent of those questioned (Polytika 2001, quoted in Kowalczyk 2001, p. 25). Correspondingly a third of all Polish entrepreneurs in a nationwide survey have recently complained about the national economic policy being bad or very bad (Polska Fundacja Promocji i Rozwoju Malych i S´rednich Przedsie˛ biorstw 2000, p. 239). It was only the reorganisation of the local government in 1999 that enabled the establishment of institutions for regional economic support in Poland in the first place. These, however, are highly criticised not only because they are still too unknown (just as in Brandenburg) but also because they reproduce (‘well-tried’) centralist mechanisms of distribution (mainly of EU funds) all over again and, in particular, hardly consider IT firms at all. The significance of more long-term relationships also in modern business transactions is exemplified in a positive as well as negative way by the following quote taken from an interview with a West Polish IT entrepreneur: ‘Well . . . my range of activity is limited to a radius of 100 kilometres, and my experience, my age, one then more or less knows the people, those I can trust, well let’s say, those I can trust 80 per cent, and those I can trust 10 per cent. If I have any doubts, then I prefer not to get involved in a deal like that’ (translated from the Polish, in Blaneck 2003, p. 62). Polish IT firms that are well established expressly welcome the revival of competition through EU membership and emphasise the fact that competition represents a positive factor. This is exemplified in the following statement given by Pawel Przewiezlikowski, deputy chairman of the supervisory board of ComArch: ‘With the enlargement of the EU the barriers to trade and mentality that have limited us so far will disappear. It will become easier to compete in the joint market. We are not afraid of the new competitors, because they already exist in the domestic market, and so far ComArch and the firm have coped well with it’ (cf. Rzewuski 2003a). Note accordingly, results gained from the study of social movements demonstrate that it is not the absolute level of the (possibly precarious) societal situation that plays a part in aggravating conflicts both social and political but, rather, the effect of relative deprivation, that is, the perception of living conditions tending to decline (altogether or within one’s own section of the population as compared to others). In this respect the entire initial economic position of Brandenburg may indeed be clearly assessed to be more positive according to objective criteria than that of (West) Poland; what, however, comes to the fore, influencing people’s

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REFERENCES Albach, Horst (1993), Zerrissene Netze. Eine Netzwerkanalyse des ostdeutschen Transformationsprozesses, Berlin: Edition Sigma. Arrow, K. (1972), ‘Gifts and Exchanges’, Philosophy and Public Affairs, 1 (4), 343–62. Bielewicz, A. (2003), ‘Powoli ale jednak do przodu’, Computerworld (2/2003), website: http://www.computerworld.pl (accessed 3 May 2004). Bundesverband Informationswirtschaft, Telekommunikation und neue Medien e.V. (BITKOM) (2004), Kennzahlen zur ITK-Branchenentwicklung, Spring 2004, website: http://www.bitkom.org/files/documents/ITK-Marktzahlen.pdf (accessed 3 May 2004). Blaneck, Andrea (2003), ‘Netzwerke und Kooperationen an der deutsch-polnischen Grenze. Untersuchungen zum wirtschaftlichen Milieu in grenznahen Gebieten am Beispiel von IuK-Unternehmen und regionalen Wirtschaftsfördereinrichtungen’, diploma thesis, Europe-University Viadrina, Faculty for Cultural Studies, Frankfurt (Oder). Centrum Badania Opinii Spolecnej (CBOS) (2003), ‘Optymizm I pesymizm w mys´ leniu o efektach integracji europejskiej. Komunikat z badan´ ’, Working Paper BS 39/2003, Warsaw, website: http://www.cbos.pl/SPISKOM.POL/2003/ K_039_03.PDF (accessed 3 May 2004). Gambetta, Diego (ed.) (1988), Trust. Making and Breaking Cooperative Relations, Oxford: Basil Blackwell. Giddens, Anthony (1990), Consequences of Modernity, Stanford, CA: Stanford University Press. Grabher, Gernot (1997), ‘Adaptation at the Cost of Adaptability? Restructuring the Eastern German Regional Economy’, in Gernot Grabher and David Stark (eds), Restructuring Networks in Post-Socialism. Legacies, Linkages, and Localities, Oxford: Oxford University Press, pp. 107–34. Granovetter, M. (1985), ‘Economic Action and Social Structure: The Problem of Embeddedness’, American Journal of Sociology, 91 (3), 481–510. Hilbert, Josef, Bernd Widmaier and Stefan Bandemer (1991), ‘Können Konkurrenten Partner werden? Eine Einführung in die Schwierigkeiten und Chancen partnerschaftlicher Kooperation‘, in Josef Hilbert (ed.), Neue Kooperationsformen in der Wirtschaft, Leverkusen-Opladen: Leske + Budrich, pp. 9–22. Höhmann, Hans-Hermann and Elena Malieva (2002), ‘Trust as a Basic Anthropological Category‘, in Hans-Hermann Höhmann and Friederike Welter (eds), Entrepreneurial Strategies and Trust, Arbeitspapiere und Materialien, 37, Bremen: Forschungsstelle Osteuropa, pp. 19–26. Hradil, S. (1995), ‘Die Modernisierung des Denkens. Zukunftspotentiale und “Altlasten” in Ostdeutschland’, Aus Politik und Zeitgeschichte. Beilage zur Wochenzeitung ‘Das Parlament’, (B 20), 3–15.

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Juchler, J. (2003), ‘Zwischen Bangen und Hoffen – Polen vor dem EU-Referendum’, Osteuropa, 53 (4), 502–14. Kee, H.W. and R.E. Knox (1970), ‘Conceptual and Methodological Considerations in the Study of Trust and Suspicion’, Journal of Conflict Resolution, 14 (3), 357–66. Koch, Thomas and Michael Thomas (1997), ‘The Social and Cultural Embeddedness of Entrepreneurs in Eastern Germany’, in Gernot Grabher and David Stark (eds), Restructuring Networks in Post-Socialism: Legacies, Linkages, and Localities, Oxford: Oxford University Press, pp. 242–61. Kowalczyk, M. (2001), ‘Kultur des Misstrauens? Empirische Fallstudie des Kooperationsklimas in einer innovativen Branche in Westpolen’, diploma thesis, Europe-University Viadrina, Faculty for Cultural Studies, Frankfurt (Oder). Krzeminski, A. (2001), ‘Polen auf dem Weg in die Europäische Union – nicht nur eine Innenansicht‘, Informationen zur Raumentwicklung, (11–12), 683–90. Lewis, J.D. and A. Weigert (1985), ‘Trust as a Social Reality’, Social Forces, 63 (4), 967–85. Mayring, Philipp (1997), Qualitative Inhaltsanalyse. Grundlagen und Techniken, 6th edition, Weinheim a.d.B.: Beltz/Deutscher Studienverlag. Misztal, Barbara A. (1996), Trust in Modern Societies: The Search for the Basis of Social Order, Cambridge: Polity Press. Nuissl, H. (2002), ‘Bausteine des Vertrauens – eine Begriffsanalyse’, Berliner Journal für Soziologie, 12 (1), 87–108. Nuissl, Henning, Anna Schwarz and Michael Thomas (2002), Vertrauen – Kooperation – Netzwerkbildung. Unternehmerische Handlungsressourcen in prekären regionalen Kontexten, Wiesbaden: Westdeutscher Verlag. Petermann, F., W. Neubauer and B. Grünheidt (1992), ‘Trust in the Relationship between Superiors and Subordinates: Managers’ Subjective Theories of Trust’, European Review of Applied Psychology, 42 (3), 209–16. Polska Fundacja Promocji i Rozwoju Malych i S´rednich Przedsie˛ biorstw (ed.) (2000), Raport o stanie malych i s´ rednich przedsie˛biorstw w Polsce w latach 1998–1999, Warsaw: Polska Fundacja Promocji i Rozwoju Malych i S´rednich Przedsie˛ biorstw. Ripperger, Tanja (1998), Ökonomik des Vertrauens. Analyse eines Organisationsprinzips, Tübingen: J.C.B. Mohr and Paul Siebeck. Rosenfeld, M.T.W. (2001), ‘Die Wettbewerbsfähigkeit strukturschwacher Regionen in der EU im Vergleich zu ihren Nachbarregionen in den Beitrittsländern‘, Informationen zur Raumentwicklung, (11–12), 781–95. Rzewuski, M. (2003a), ‘Polska informatyka w UE’, PCkurier, (11/2003), website: http://www.pckurier.pl/archiwum/art0.asp?ID=6119 (accessed 3 May 2004). Rzewuski, M. (2003b), ‘UE: bez taryfy ulgowej’, PCkurier (12/2003), website: http://www.pckurier.pl/archiwum/art0.asp?ID=6153 (accessed 3 May 2004). Sabel, Charles F. (1993), ‘Studied Trust. Building New Forms of Cooperation in a Volatile Economy’, in Richard Swedberg (ed.), Explorations in Economic Sociology, New York: Russell Sage Foundation, pp. 104–44. Schwarz, A. (2000), ‘Diverging Patterns of Informalization between Endogenous and Exogenous Economic Actors in the East German Transformation Process – Results from a Case-study in the IT-branch in Berlin-Brandenburg’, Discussion Paper 11/00, European University Viadrina, Frankfurt (Oder): Frankfurt Institute for Transformation Studies. Schwarz, A. and J. Jacobs (2004), ‘Bangen an der Oder: Hoffnungen und Ängste spiegeln sich’, Osteuropa, 54 (5–6), 262–73.

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Sztompka, Piotr (1999), Trust: A Sociological Theory, Cambridge: Cambridge University Press. Teleinfo 500 – Polski Rynek Teleinformatyczny 1999 (2000), vol. I, Warsaw: Migut Media. ‘Top 200’ (2003), Computerworld (2/2003), website: http://www.computerworld.pl/ top200/top35.html (accessed 3 May 2004). Thomas, William I. (1981), Social Behavior and Personality. Contributions of W. I. Thomas to Theory and Social Research (ed. E.H. Volkart), Westport, CT: Greenwood Press. Wilson, J. (2002), ‘The Logic of Faith’, Journal of Beliefs and Values, 23 (2), 133–9.

PART THREE

Trust and Entrepreneurial Behaviour in Mature Market Economies

13. Trust in small-firm business networks in East and West Germany Teemu Kautonen and Friederike Welter INTRODUCTION Research has established that networks play an important role during the establishment, development and growth of small businesses (Greve 1995; Shaw and Conway 2000). This chapter focuses on the governance of smallfirm business networks. Business networks refer to the aggregate of continuous exchange and other co-operative relations that a firm is engaged in with other firms. Therefore, relations within business networks consist of series of transactions possessing a history and a future (Håkansson and Snehota 1995). The governance discussion, on the other hand, addresses the problem of achieving effective co-ordination at minimal transaction costs while accounting for bounded rationality, uncertainty and asset specificity, which give rise to a risk of opportunism (Williamson 1985). The fundamental governance issue is therefore on what basis a firm expects co-operative as opposed to opportunistic behaviour from the partner in a network relation and at what perceived risk. In this context governance mechanisms play a central role. The relation of trust to formal contracts and other forms of formal control has been a central topic in studies of the governance of inter-firm relations and networks (for example, Dyer 1997; Klein Woolthuis et al. 2002; Lorenz 1988). This chapter focuses on the role of trust as a substitute and complement to formal contracts in small-firm business networks. Hence, trust is defined as a broad category that subsumes different forms of informal governance in business networks, that is, those forms that cannot be enforced through the courts. Trust is an expectation of co-operative behaviour from the partner when this behaviour is not subject to a formal contract (cf. Gambetta 1988, p. 217). It is often argued that the advantage of trust is its efficiency in terms of transaction costs compared with the often expensive formal contracts (for example, Cummings and Bromiley 1996; Frambach 2003). Moreover, since contracts are always incomplete (Williamson 1996), trust is needed to ‘fill in the holes’ left by formal contracts, for example, in case of unforeseen contingencies. Trust appears to play a particularly important role for small firms for 219

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several reasons. First, small firms often lack the necessary resources to implement formal contracts (Schumacher and Moyle 2001). Therefore they face the choice between trusting with a high risk and waiving the transaction with its potential benefits more often than large firms do. Both of these choices can have negative consequences on business development. Furthermore, Schumacher and Moyle (2001) add that small firms tend to formalise less because the costs of intricate contracting may be unjustifiable given the often small scale of network transactions and the moderate profit expectations involved. Finally, the absence of contracts may also reflect the general informality and absence of bureaucracy in small firms (Lyons 1994). Despite these benefits, trust is not always the most efficient form of governance. First, trust may be betrayed and thus it is sometimes more prudent to distrust and rely on a formal contract (formalise) (Sztompka 1999). Secondly, trust cannot be established or modified at will. If it is not readily available, building interorganisational trust entails transaction costs which may under certain circumstances exceed those caused by formalisation (Frambach 2003; Nooteboom 2002). This chapter sets out to explore under which circumstances small firms prefer formal contracts and under which conditions they deem it prudent to trust. While most related studies on trust and governance in small-firm networks restrict themselves to analysing trust only on the interpersonal or interorganisational level (for example, Larson 1992; Schumacher and Moyle 2001), this chapter adopts a broader ‘embedded’ perspective (Granovetter 1985; Halinen and Törnroos 1998). It is argued that information used by economic actors to assess the trustworthiness of the partner (‘trust cues’) does not only stem from the network relation as such, but is also derived from the wider socio-economic environment. Trust cues are analysed in terms of three trust categories: personal trust, collective trust and institutional trust. The conceptual part of the analysis concentrates on examining the decision to trust and the properties of the three trust categories. Empirically, the chapter draws on quantitative and qualitative results from Germany.1 The empirical analysis focuses on two issues. The first is the extent to which formal contracts are used to govern network relations, that is, the scope they leave for trust to fill. The second research issue examines the roles of the three different trust categories in filling that scope. The analysis covers both two regional (East and West Germany) as well as three sectoral milieus (food industry, trade and business services), allowing for the comparison of different trust environments.

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TRUST AS A GOVERNANCE MECHANISM The Decision to Trust The decision to trust can be described as a bet with a certain level of risk and certain stakes (Coleman 1990; Sztompka 1999). The stakes reflect the perception of what can be gained or lost by trusting, while risk refers to the assessment of the partner’s trustworthiness, that is, how likely it is that he or she will reciprocate by behaving co-operatively (as opposed to opportunistically). In the governance context a third variable needs to be considered: formalisation resources determine the extent to which the resources needed for the implementation of formal contracts (such as financial resources, legal know-how, time) are available and, thus, to what extent the risk of trusting can be reduced through a formal contract. Although we assume that individuals make rational trust decisions, unlike in neoclassical economics and rational-choice sociology (for example, Coleman 1990), the rationality assumption used here is a ‘weak’ one (Kirchgässner 1998). Besides the limited capacity of the human brain, our decisions are restricted by our subjectively bounded knowledge. When economic actors process information related to a trust situation, they interpret it based on their existing cognitive schemata (Koch 1998; Rizzello 2000). Therefore, a trust decision is made based on the individual’s knowledge and his or her interpretation of all relevant information. Besides comprising conscious decisions based on explicit knowledge, trust may also be habitual behaviour based on routines and tacit knowledge. Routines are rational behaviour as they are based on successful past experiences, enabling individuals to focus their limited capacity on those decisions that are necessary to make (Nelson and Winter 1982; Nooteboom 2002). There is also a danger involved in routine behaviour in the trust context. Even if a routine has proven to be effective for a long time, a ‘golden opportunity’ may appear and increase the pay-off for opportunism for the trustee. In such a case, the assessment of trustworthiness on which the current routine is based may no longer be accurate, and trust may be misplaced. Trust Categories The information regarding the trustworthiness of the partner (trust cues) may be derived from different sources on different levels of embeddedness. The present analysis distinguishes three categories. It should be emphasised that the categories are in no way mutually exclusive, but often trust cues are derived from more than one source, resulting in a ‘pyramid of trust’ (Sztompka 1999).

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Personal trust refers to trust cues related to the business network in general and the network relationship analysed here in particular. Personal trust comprises three subcategories of trust cues. The first subcategory refers to the relation-specific mechanisms of assurance which determine the mutual dependence of the partners. Such mechanisms include specific assets, market power and hostages (cf. Williamson 1985). Asymmetric dependence enhances the trustworthiness of the more dependent partner, while also making it more vulnerable to the actions of the less dependent one. The second subcategory is related to Zucker’s (1986) characteristic-based trust, and concerns the social distance between the partners. Certain characteristics of the partner, such as ethnicity, family ties, age and sex, may communicate trustworthiness. Together with direct experience with the partner, these characteristics may form a basis for ‘personal chemistry’ and empathy in a network relationship. The third subcategory of personal trust is reputation. Reputation can be analytically distinguished as either being past or future oriented. Past-oriented reputation refers to information about the history of the partner. This information may be derived from personal experiences or from the experiences with the partner of directly or indirectly (‘a friend of a friend’) known third parties. Future-oriented reputation is also known as the reputation effect or ‘the shadow of the future’ (Axelrod 1984). It is based on the expectation of higher pay-offs in the future for present co-operative behaviour than for present opportunism. The future pay-offs may stem from dealings with the current partner or other (potential) partners within the reach of the reputation information. Moving beyond the networks of directly and indirectly known actors, the next level of trust cues is called collective trust. This category refers to collective behaviour in groups based on formal and informal codes of conduct. For example, norms and standards in an industrial sector, business conventions in a certain market or in a certain city, as well as rules and norms of civil societal organisations, are sources of collective trust. For collective trust the personal history of the partner or his or her specific characteristics, such as family ties, do not matter, but the essential characteristic is the trustee’s membership of a group with which the trustor associates certain codes of conduct. The trustee’s conformity to the codes of conduct of the group depends on the degree to which these codes have become part of his or her routine behaviour, on the one hand, and the severity and credibility of the sanctions resulting from deviant behaviour, on the other. The reputation effect is the central sanctioning mechanism. It works largely through anonymous channels such as business associations and has a wider reach than the reputation effect in personal trust. The third and the final category is institutional trust. Like collective trust, institutional trust is also based on formal and informal codes of conduct. However, instead of being associated with a specific group, institutional trust

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applies to all groups within a political unit. For example, all industrial sectors within a country are subject to the same legislation, and the actors operating in these sectors are to varying degrees subject to the norms of the national culture. Institutional trust is also a crucial prerequisite for formal contracts. Contracts would not be viable without public and credible enforcement mechanisms such as courts. However, many laws apply in business relations even if they are not referred to in a contract. Institutional trust is a fundamental element in modern market economies because it enables actors to engage in business relations without previous experience or without the partner belonging to a certain perceivably trustworthy group. Method and Sample One of the most difficult issues in empirically researching trust is how to operationalise the concept and how to ask questions about trust. This raises two fundamental problems: the choice of adequate empirical methods and the phrasing of the questions. Although experimental methods have made important contributions to trust research (for example, Glaeser et al. 2000; Yamagishi and Yamagishi 1994), they appear inadequate for researching the trust behaviour of small businesses as embedded in different environments. Our research project used a combination of survey and case study methods, which we considered more appropriate for this purpose. While the quantitative survey focused on describing and analysing the characteristics and structure of trust behaviour in different regional and sectoral environments, the purpose of the case studies was to bring out the embeddedness of trust and its dynamic properties, as well as to allow a ‘peek behind the figures’. The translation of the concepts into concrete questions proved to be difficult. Direct questions asking ‘how much trust do you have in . . .’, would require that individuals were capable of identifying, evaluating and quantifying the level of trust in their actions. Furthermore, direct phrasing would run the risk of receiving socially desirable answers (Nuissl et al. 2002) and it would also neglect the role of tacit knowledge in trusting behaviour. Therefore, we adopted an indirect approach in our study. The main questions concerned the forms of regulation and the criteria by which the forms of regulation are chosen. To account for the whole array of different relations in business networks, we included customer, supplier and other co-operative business relations. The survey sample consists of 197 enterprises in East and West Germany (Greater Dresden and the Ruhr area, respectively; Computer-Aided Telephone Interviews (CATI) interviews), concentrating on owner-managers and key decision-makers in micro and small businesses (micro firms have fewer than 10 employees, small firms have 10–49 employees) in three sectors: the food

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industry, trade and business services. A particularly interesting aspect in the regional comparison is the effect of the socialist legacy on trust milieus in East Germany. The sample is not representative of the small business sector in the respective regions, sizes or sectors, but the choice of key variables and the structure of the sample were chosen in order to allow an investigation of different trust milieus. Before analysing the nature and extent of trust in network relations, it is appropriate to outline some of the basic characteristics of the sample. Most of the firms surveyed are established: the sample contains only five firms that have been founded in the past two and a half years. This reflects the overall decrease in business creation in Germany since 1999, which is mainly due to the unfavourable economic situation. Most West German firms were established between 1946 and 1979 (40 per cent), while most East German enterprises were founded between 1990 and 1994 (62 per cent). Interestingly, 27 per cent of the East German companies were operational during the socialist period. The sample companies generate most of their sales in the local and domestic markets. Although approximately 25 per cent of the firms are active in foreign markets, the share of turnover generated there is usually small. The entrepreneurs surveyed are mainly between 40 and 59 years old, which reflects the overrepresentation of older companies in our sample. Most entrepreneurs had a background in private business before setting up their own venture, while 11 per cent had had previous entrepreneurial experience. The survey data are supplemented by a multiple case study of 15 firms. The case study firms were chosen to allow for cross-regional, cross-sectoral and size-based comparisons. Besides these theoretical replications, also literal replications were catered for through the inclusion of two or more cases in each regional, sectoral and size-based category (Yin 2003).

TRUST IN NETWORK RELATIONS: EMPIRICAL EVIDENCE FROM WEST AND EAST GERMAN SMES Forms of Regulation in Network Relations The first step in analysing the role of trust is to establish the extent to which formal contracts are used and the specific functions that they fulfil. As Klein Woolthuis et al. (2002) point out, contracts are not necessarily safeguards against opportunism, but they may fulfil a range of other functions, some of which are complementary to trust. These include, for example, serving as a memory aid or a sign of commitment. Previous research characterises the German environment as tightly regulated and having a strong institutional

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order, which would imply a high level of institutional trust (Bachmann and Lane 2001). Since institutional trust provides a solid basis for reliance on formal contracts, contracts could be expected to play a central role in business relations in Germany. This is supported by the results of our survey. Table 13.1 summarises the forms of regulation used by our sample firms in customer, supplier and other co-operative network relations. The results indicate that the majority of the firms surveyed regulate their customer and supplier relations with written contracts. In fact, East German firms rely on contracts even more frequently than do West German firms. Schwarz (2000) reports a similar finding, namely, that West German entrepreneurs tended more towards social networks and informal arrangements, whereas the East Germans usually relied on formal arrangements. One explanation could be that this practice is rooted in the socialist past of strongly institutionalised and regulated relations outside one’s social sphere (Nuissl et al. 2002). The difference between micro and small enterprises appears to support the general notion that smaller firms possess fewer resources for formalisation and are overall less formal (Lyons 1994; Schumacher and Moyle 2001). As the case studies also indicate, the sectoral differences are largely caused by the nature of the business and the characteristics of customer base. For example, the firms in the food industry sample (mostly bakeries and butcher’s shops) more often rely on oral agreements because their business mainly involves cash payments and standardised products as well as a large number of one-off customers. On the other hand, companies in the business services sector often have a relatively small number of long-term customer relations involving customised products, and this appears to call for more formalisation. Here, the results appear to indicate an important role for the general nature of business as a determinant of governance, although they do not provide information on the role of sector-specific characteristics such as norms or standards. The central role of the general nature of the business is underlined by the findings concerning other co-operative relations. These are almost as often regulated orally as they are in writing, with little variation across region, sector or the size of the business. The nature of co-operation appears to be the main factor determining the form of regulation. Not surprisingly, more complex forms of co-operation (research and development, personnel, marketing and sales) often go hand in hand with written contracts, whereas more informal cooperation activities such as the exchange of information and support are usually regulated orally. Besides illustrating the importance of the nature of the business relation in question, the results seem to support the general assumption of prudent trust decisions (Sztompka 1999): if the stakes in a relationship grow, the reliance on formal contracts increases. Although the results of the survey indicate an important role for written

Table 13.1 Forms of regulation in inter-firm relationships (percentage) Regions West East Germany Germany

226

Regulation of customer relationships Written contract 48.5 69.9 Oral agreement 29.9 22.6 No regulation 16.5 5.4 Total number (n) 97 93 Regulation of supplier relationships1 Written contract 53.0 68.8 Oral agreement 36.1 21.3 No regulation 8.4 6.3 Total number (n) 83 80 Regulation of other co-operative relationships2 Written contract 48.3 51.2 Oral agreement 43.9 48.8 No regulation 9.8 0.0 Total number (n) 41 41

Size Micro business

Small business

Food industry

Sectors Trade

Business services

Total Percentage Number

49.4 29.9 14.3 77

65.5 23.9 8.8 113

34.4 42.6 21.3 61

58.0 24.0 12.0 50

78.5 15.2 2.5 79

58.9 26.3 11.1

112 50 21 190

55.0 28.3 11.7 60

64.1 29.1 4.9 103

49.2 39.7 9.5 63

63.3 26.5 8.2 49

72.5 17.6 3.9 51

60.7 28.8 7.4

99 47 12 163

48.4 45.2 6.5 31

49.0 47.1 3.9 51

43.8 43.8 12.5 16

52.0 44.0 4.0 25

48.8 48.8 2.4 41

48.8 46.3 4.9

40 38 4 82

Notes: Differences between n and the sample size (197) are due to non-responses. Those few respondents, who did not know or indicated varying regulation practices, are not included. 1. In addition to non-responses 20 business service firms that do not have suppliers at all have been excluded from n. 2. Based on the number of respondents engaged in co-operative relationships other than customer–supplier relations. Source: Own survey.

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contracts, their actual function remains ambiguous. The case studies support the previously cited argument by Klein Woolthuis et al. (2002) that contracts have other roles besides safeguarding against opportunism. They also support Bachmann’s (2001) argument that contracts and trust are not contradictory in the German environment. Three non-safeguarding roles for formal contracts were found in the case studies. One concerns fulfilling the requirements of the institutional environment, such as tax or accounting regulations, which may require written documentation for a business deal. A contract drawn up for this purpose may not have any influence on the level of trust in the actual business relationship. One example is an engineering firm in East Germany, which reported using written contracts, but without the entrepreneur himself being aware of their content. He told us that in his firm contracts are just ‘something for the accountants and administrators’ without any practical relevance for the actual business relations. Another role for contracts is to serve as a memory aid. For example, an East German firm engaged in production consultancy uses simple protocol-type contracts which document the objectives of the project and serve as memory aids when reviewing the final results. However, even if the objectives are not fully met, sanctions are not enforced according to the contract; instead, possible disagreements are settled informally or sanctions follow through the reputation mechanism in the broader business network within the specific area of the firm. A third reason for the use of formal contracts is that this is routine behaviour in business. Several entrepreneurs reported using formal contracts, but could not specify why they do so or what function the contract performs. It appeared to be ‘just the way business is conducted’. Hence, not only trust, but also reliance on formal contracts can be based on routine behaviour. Furthermore, entrepreneurs rarely rely on the safeguard function of formal contracts. Often the contract appears to be the last resort to solve payment or other problems with business partners when other more informal means have failed. Turning to courts is the last resort because of the high expense, long processing times and the uncertain outcome. Several entrepreneurs also said that they prefer informal solutions as part of their business style and some of them claim never to sue business partners or clients. Others complement or even substitute the courts as an enforcement mechanism with other safeguards, which are assurance mechanisms as described in the personal trust category. One example was provided by an East German company engaged in industrial software design. This firm described detailed written contracts being indispensable in the business as a safeguard against ‘excessive additional claims’ by the customer. However, the actual enforcement mechanism of these contracts is not the court, but a safeguard built into the software that allows the firm to remotely disable the product. Here, the contract serves as a memory aid documenting what has been agreed by the

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parties, while the actual safeguard is built into the software. Another example relates to the concepts of trust intermediaries (Coleman 1990) and trilateral governance (Williamson 1985), which in this case are part of the collective trust category. A West German company in the trade sector mainly purchases its supplies from firms that are members of a co-operative society, which acts as an intermediary. The co-operative society pays the suppliers and collects the money from the customers. Decision Criteria for the Form of Regulation Besides analysing the forms of regulation, it is interesting to examine the criteria for selecting a particular form as this adds to our understanding of the roles of the different trust categories. With regards to customer–supplier relations we asked about the general criteria in choosing the type of agreement, while in the case of other co-operative relations we enquired about possible reasons for agreeing to a non-written regulation. Table 13.2 summarises the results. Not surprisingly, almost all respondents mentioned previous experience with the business partner as the main criterion for choosing non-formal agreements in customer–supplier relations. This emphasises the importance of personal trust based on reputation at the inter-firm level and its process-oriented nature (Zucker 1986). Moreover, the broader network level of personal trust and collective trust both appear to play important roles as sources of trust cues, as demonstrated by the high frequency of recommendations and the partner’s general reputation. The amount involved in the expected deal, which refers to the economic stakes involved in the trust decision, is apparently less important in comparison to direct personal trust cues provided by experience and recommendations. Although guarantees, understood as a formal safeguard related to the assurance mechanisms described as a subcategory of personal trust, ranked only fifth in the survey, they were nevertheless mentioned by over 60 per cent of all respondents, meaning that they also play a considerable role for trust decisions. Like the results reported above concerning the forms of regulation, East German and small businesses tend to employ more formal criteria than West German and micro enterprises. The former both rely more frequently on guarantees and they more often name the amount of the deal as a decision criterion. Interestingly, firms in the business services sector rely less on formal cues, but instead emphasise previous experiences with the business partner even more strongly than firms in the other two sectors. This appears to indicate a special role for personal trust at the inter-firm level, which is explained by the distinctive characteristics of this business sector. The number of clients is usually relatively small, customer relations are long-term oriented and the service providers often have access to sensitive client data, all of which obviously result in a special role for personal trust.

Table 13.2 Decision criteria for the form of regulation in inter-firm relationships (percentage) Regions West East Germany Germany

Size Micro business

Small business

229

Customer–supplier relationships: criteria for the type of regulation1 Previous experience with the company 93.8 92.4 90.7 94.7 Recommendation from business partner 78.4 89.1 78.7 86.8 Reputation of the customers/suppliers 68.8 69.6 64.0 71.9 Amount of the expected deal 61.9 67.4 61.3 66.7 Guarantees 59.8 65.2 50.7 70.2 Total number (n) 97 92 75 114 Other co-operative relationships: criteria for a non-written regulation2 Is a friend 33.3 39.0 48.3 29.4 Is a regular customer/ supplier 25.6 36.6 34.5 29.4 Is a member of the same business association 12.8 9.8 17.2 7.8 Was recommended by trusted people 10.3 9.8 10.3 9.8 Only written contracts 38.5 43.9 34.5 45.1 Total number (n) 39 41 29 51

Food industry

Sectors Trade

Business services

Total Percentage Number

90.6

91.7

96.1

93.1

176

84.4

87.5

80.5

83.6

158

62.5

70.8

72.7

68.8

130

65.6 67.2 64

72.9 70.8 48

58.4 53.2 77

64.6 62.4

122 118 189

43.8

28.0

38.5

36.3

29

37.5

12.0

41.0

31.3

25

18.8

12.0

7.7

11.3

9

6.3 31.3 16

4.0 56.0 25

15.4 35.9 39

10.0 41.3

8 33 80

Notes: Multiple answers. 1. Only the most important criteria. The difference between n and the sample size (197) is due to non-responses. 2. Based on the number of respondents engaged in co-operations other than customer–supplier relations (82), excluding two non-responses. Respondents who use non-written agreements could give several answers. Source:

Own survey.

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With regard to other co-operative relations, 41 per cent of all respondents would not accept a non-written agreement under any circumstances, whilst nearly two-thirds would accept this if the business partner was a friend or a regular business partner. In accordance with the previous results, East German and small firms more often insist on written agreements. On the other hand, friendship and the regularity of the business relations played a more important role for East German than for West German enterprises. A possible interpretation would be that since the economic situation in East Germany is poorer, local firms are more inclined to agree to long-term co-operative relations as a means of maintaining current market position (see Nuissl et al. 2002). Therefore, especially strong trust cues directly relating to the inter-firm relations, such as friendship and regularity, would play a particularly important role. Not surprisingly, micro firms rely on personal trust cues directly relating to the inter-firm relationship more often than small enterprises, which tended to insist on written agreements. Also, membership in the same business association, a collective trust cue, was mentioned more frequently by micro firms. This particular category also clearly played a more important role in the food industry than in the other two sectors, which is a result of the craft-based nature of the food firms surveyed (craft businesses have to be members of a chamber of crafts in Germany). Somewhat surprisingly, recommendations from trusted third parties play only a minor role in this context. They are an important selection criterion in the business services sector, where personal trust takes on a special role as discussed above. Again, the case studies tend to attribute the regional and sectoral differences found in the survey to the nature of business rather than to regions or sectors as such. However, they are in line with the results of previous studies on small-firm governance regarding the dynamic properties of trust, indicating that the importance of trust grows as the relationship matures (Larson 1992; Schumacher and Moyle 2001). Two further characteristics related to the level of inter-firm relations in the personal trust category emerged in the interviews. One is that the personality and business philosophy of the entrepreneur influence the trust decision, which reflects the personal influence of the entrepreneur on business in a small-firm context. For example, one East German entrepreneur in the business services sector regulates very informally because he likes to trust people even if his trusting behaviour has almost ruined the company in the past. He also described informality as his personal style of doing business. Another entrepreneur reported that he ‘hated contracts’, preferring an informal business style. Another characteristic is ‘personal chemistry’, which was often mentioned as a trust cue in the interviews (see also Nuissl et al. 2002). For example, a West German chartered accountant said that he attaches a lot of importance to the first meeting with a potential client, during which he determines how he gets along with the client and whether the relationship is worth investing time in.

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The case studies also illustrate examples of collective trust. Some firms preferred to work with local or regional partners, not only because of commercial arguments such as quicker and cheaper deliveries, but also because working with them was perceived to be easier. One example was provided by an East German brewery. This firm prefers working with other East German enterprises because they are perceived as being more flexible and less complicated. This, together with the ‘personal chemistry’ finding, supports Nooteboom’s (2002) notion that the cognitive distance between the partners plays a role in explaining the role of trust in business relations. Another example was provided by a West German firm in the harbour services business, which chooses its co-operation partners either based on recommendations (personal trust) or by selecting potential partners from the member list of a trade association (collective trust).

CONCLUSION This chapter has examined the role of trust in small-firm business networks in East and West Germany. Trust was defined as an expectation of co-operative behaviour from the partner when this behaviour is not subject to a formal contract. Three broad trust categories were defined, indicating where the information used by the actors to determine the trustworthiness of the partner (‘trust cues’) is derived from, namely, personal trust, collective trust and institutional trust. The empirical study focused on different regional and sectoral environments within Germany. However, the governance behaviour of German small firms in general appears to depend more on the general nature of business and the characteristics of customers than on regional or sectoral environments per se. Hence, the main results concern the relative roles of formal contracts and the different trust categories. The first empirical question in determining the role of trust concerned the extent to which formal contracts are used and the function they perform. The results supported the findings of previous studies in two ways. First, written contracts and institutional trust do play an important role in the German business environment as has been suggested by Bachmann (2001). Secondly, contracts are not always primarily safeguards against opportunism; they also fulfil other functions, some of which may be complementary to trust (Klein Woolthuis et al. 2002). Such ‘non-safeguarding’ roles include serving as a memory aid, being a business habit or a requirement of the institutional environment. Moreover, formal contracts are seldom used to enforce an agreement through the courts. Usually, entrepreneurs only turned to courts when all informal methods of solving business conflicts had failed. The common reasons for

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this were – apart from the personal preferences of the entrepreneur – the expense, uncertainty and long processing times associated with law suits. This finding appears to support the results of previous research, indicating that small firms often have fewer resources to formalise business relations and behave, in general, less formally than large firms (Lyons 1994; Schumacher and Moyle 2001). Although further research would be needed in order to specify to what extent formal contracts act as a deterrent rather than as a sanctioning mechanism, it appears that trust in its different forms is the primary governance mechanism in small-firm business networks in Germany. The second research issue concerned the roles of different trust categories. The empirical indicator used was the criteria for selecting the form of regulation in business relationships. As has been suggested by previous studies on trust and governance in the context of small businesses, personal trust, which is based on experience with the partner, appears to play a central role, with its importance increasing as the relationship matures (Larson 1992; Schumacher and Moyle 2001). However, this type of personal trust normally requires time to develop and is not always available in the initial phase of network relationships. Moreover, the broader level of personal trust based on social and business networks seemed to be a common source of trust cues. This was apparent both in the high number of companies relying on recommendations from business and in the role played by the effect of reputation, which seemed to be particularly effective if the number of potential partners was small. Finally, different assurances were used to substitute court proceedings if this was deemed too expensive or time-consuming. Collective trust seems to play a less important role, although in two cases a co-operative society and a business association fulfilled central roles as trust intermediaries. The influence of group-specific norms and standards, however, was not directly evident. Since these are to a large extent tacit knowledge, investigating them in depth might require different research methods than employed in the present study. Several case study interviewees pointed out that they would like to have more organised networking opportunities as a benefit of their obligatory membership of Chambers of Commerce and voluntary membership in business associations. This would imply an indirect role for collective trust in fostering the generation of personal trust. Here, further, especially policy-oriented, research is needed.

NOTE 1.

This chapter is based on the results for Germany of an international project sponsored by the VW-Foundation and titled ‘Entrepreneurial behaviour and trust. Structure and genesis of economic transactions patterns in “Low-trust”- and “High-trust-Milieus” in East and West Europe’.

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Lorenz, Edward H. (1988), ‘Neither Friends nor Strangers: Informal Networks of Subcontracting in French Industry’, in Diego Gambetta (ed.), Trust: Making and Breaking Co-operative Relations, New York and Oxford: Blackwell, pp. 194–210. Lyons, Bruce R. (1994), ‘Contracts and Specific Investment: An Empirical Test of Transaction Cost Theory’, Journal of Economics and Management Strategy, 3 (2), 257–78. Nelson, Richard R. and Sidney G. Winter (1982), An Evolutionary Theory of Economic Change, Cambridge, MA and London: Belknap Press of Harvard University Press. Nooteboom, Bart (2002), Trust: Forms, Foundations, Functions, Failures and Figures, Cheltenham, UK and Lyme, USA: Edward Elgar. Nuissl, Henning, Anna Schwarz and Michael Thomas (2002), Vertrauen – Kooperation – Netzwerkbildung: Unternehmerische Handlungsressourcen in prekären regionalen Kontexten, Wiesbaden: Westdeutscher Verlag. Rizzello, Salvatore (2000), ‘Cognition and Evolution in Economics’, Max PlanckInstitute for Research into Economic Systems Papers on Economics and Evolution, 0008, Jena. Schumacher, Christoph and Brendan Moyle (2001), ‘Small and Medium-sized Enterprises: Trust and Co-operative Agreements’, paper presented at the annual conference 2001 of the New Zealand Association of Economists, Christchurch, 27–29 June. Schwarz, Anna (2000), ‘Diverging Patterns of Informalization between Endogenous and Exogenous Economic Actors in the East German Transformation Process – Results from a Case-study in the IT-branch in Berlin-Brandenburg’, Frankfurter Institut für Transformationsstudien Arbeitsberichte 11/00, Frankfurt/Oder: FIT. Shaw, Eleanor and Stephen Conway (2000), ‘Networking and the Small Firm’, in Sara Carter and Dylan Jones-Evans (eds), Enterprise and Small Business: Principles, Practice and Policy, Harlow: Pearson Education, pp. 367–83. Sztompka, Piotr (1999), Trust: A Sociological Theory, Cambridge: Cambridge University Press. Williamson, Oliver E. (1985), The Economic Institutions of Capitalism, New York: Free Press. Williamson, Oliver E. (1996), The Mechanisms of Governance, Oxford: Oxford University Press. Yamagishi, Toshio and Midori Yamagishi (1994), ‘Trust and Commitment in the United States and Japan’, Motivation and Emotion, 18 (2), 129–66. Yin, Robert K. (2003), Case Study Research: Design and Methods, Thousand Oaks, CA, London and New Delhi: Sage. Zucker, Lynne G. (1986), ‘Production of Trust: Institutional Sources of Economic Structure, 1840–1920’, Research in Organizational Behavior, 8, 53–111.

14. Trust, co-operation and networking in an immigrant business community: the case of Chinese-owned businesses in the UK David Smallbone, Fergus Lyon and Xiao Li INTRODUCTION This chapter is concerned with the role of trust as an influence on business behaviour. The focus is on co-operation and networking activity, since these are types of business behaviour, where there are a priori reasons for believing that trust plays a role. In this context, the chapter focuses specifically on the immigrant Chinese community in the UK, which is appropriate for two reasons: firstly, because there is considerable existing literature that points to the use of social capital by immigrant communities in general, and Chinese immigrants in particular, as a resource for business development purposes; and, secondly, because it suggests that even in a mature market economy, such as the UK, different trust environments may exist for different social groups. This emphasises the need to place entrepreneurship and entrepreneurial behaviour in its social context. The first half of the chapter reviews key literature related to, firstly, trust, sanctions and norms and, secondly, the role of networks and co-operation in relation to immigrant entrepreneurship and ethnic minority business (EMB) development. This is followed by a discussion of empirical evidence related to trust and co-operation in the Chinese minority business community in the UK, drawn from two projects: a large-scale study of access to finance and business support by ethnic minority businesses in the UK; and a series of case studies of Chinese entrepreneurs, which were specifically undertaken in order to gain some process-oriented insights into the nature of co-operation involving Chinese-owned businesses in Britain.

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TRUST, SANCTIONS AND NORMS Trust The concept of trust has been studied in several of the social sciences in differing contexts leading to a mixture of approaches and perspectives (Misztal 1996). A dictionary definition of trust is ‘a firm belief in the reliability, truth or strength of a person; a confident expectation; and a reliance on the truth of a statement without examination’ (Oxford English Dictionary 1995). With respect to entrepreneurship or business behaviour, shared expectation of good or likely behaviour is the central trust issue (Fukuyama 1995; Gambetta 1988; Zucker 1986). Trust operates when there is confidence in other agents, despite uncertainty, risk and the possibility for them to act opportunistically (Gambetta 1988; Misztal 1996). These relations and links are referred to by some as ‘social capital’, which has been defined as ‘features of social organisation, such as networks, norms and trust, that facilitate co-ordination and co-operation for mutual benefit’ (Putnam 1993, p. 167). Much of the debate about social capital has been theoretical and working definitions have been varied, although frequently unquantified and often vague. Within the definitions of social capital, the balance of attention given to networks, trust and norms varies according to the researcher’s viewpoint. In terms of business behaviour, the trust literature makes an important distinction between interpersonal trust and institutional trust. Interpersonal trust is vital in all market transactions when those involved are unwilling to rely on institutional arrangements, or cultural norms alone (Granovetter 1985). An example is the use of informal practices to protect and exploit knowledge in small firms, in preference to the use of formal, legal methods. Based on a study of small firms in four sectors (computer software, design, electronics and mechanical engineering), Kitching and Blackburn (2003) found business owners perceived themselves to be less vulnerable to loss or unauthorised use of knowledge, as a result of high-trust personalised relations they had developed with customers and suppliers, which meant that they perceived formal rights as offering fewer benefits. Zucker (1986) has set out three ‘central modes of trust production’ that are based around selective trust. In addition to institutionally based trust, she also refers to ‘process-based trust’, where trust is tied to past or expected exchange such as in reputation and gift exchange, and ‘characteristic-based trust’, where trust is tied to a person, depending on characteristics such as family background or ethnicity. Business relationships can also be shaped by trust in a third party or intermediary, which in turn are shaped by shared norms and business conventions.

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Institutional- or intermediary-based trust is prevalent when individuals have confidence in the economic, political and social institutions that they have to deal with. These formal institutions refer to issues of contract enforcement, standardisation of measurements and quality, and the provision of information, as well as other areas of the economic system, such as banks or organisations that provide business services. Accountants and solicitors are good examples, because of the need for clients to trust their competence but also their ability to maintain confidentiality over client’s affairs. The basis of institutional or intermediary trust can be subdivided into, firstly, person- or firm-specific attributes such as membership of associations, and, secondly, intermediary mechanisms such as bureaucracy, banks and other formal mechanisms that can be seen to protect the interests of all parties to the exchange. Institutional trust is established when there is a critical mass of individuals trusting in the system. However, to some extent, every enterprise relies on both personalised and institutionalised trust, with one able to replace or complement the other in most circumstances. Personalised trust involves transaction costs to initiate it in terms of building up a relationship. Institutionalised trust incurs transaction costs in terms of ongoing regulation and legal enforcement. Examples of institution or abstract forms of trust are found throughout the world in a range of economic and political contexts, such as the banking and regulatory systems in Western European countries. In terms of business behaviour, trust is based on a perception of the probability that other agents will behave in a way that is expected (Gambetta 1988). In some circumstances, trust may be based on a calculation and assessment of risk, although the means by which individuals make such a calculation will be shaped in part by the social forces affecting them (Lyon 2000; Lyon and Atherton 2001). Individuals will weigh up the perceived risk and act according to their perceptions. They will draw on, and assess the value of, information based on the reputations of other members and may also evaluate the extent to which safeguards and sanctions can be applied. However, trust can also exist without calculation, such as when someone acts out of habit. Habits are drawn on by all of us, in order that we can assume away some risks and make other calculations possible (Hodgson 1988). This is evident in cases where people are asked why they co-operate when there is the risk that the other party may default. A common response is that this is not something that a respondent had explicitly considered previously. Sanctions Sanctions may exist in the form of peer pressure, exclusion from future benefit, or recourse to authority. In certain circumstances, sanctions may involve

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threats of violence. Power relations are a central feature in the formation of inter-firm relationships, which means that one challenge for researchers is to examine power relations within a particular co-operation arrangement and determine how the development of trust is affected by unequal access to resources (for example, by small firm suppliers, on the one hand, and large firm customers, on the other). Power relations have wide implications as they shape the outcomes of all transactions. Differences in bargaining power between businesses result in differing prices and returns. Power relations also have an impact on the extent to which another person may be considered trustworthy. Trust in another person can be based on the knowledge that they can be coerced into co-operation and threatened with sanctions. Much attention has been paid to the structural bases of power, most notably those related to the issues of class and control of capital over the means of production, gender, ethnicity and age. Norms Norms may come in the form of habitual trust where people assume another to be trustworthy or act on the basis of gut feelings. Norms also relate to what is acceptable and unacceptable behaviour in building co-operation, as well as the acceptable and unacceptable sanctions in a particular cultural context. Norms define what actions are deemed to be right or wrong, and include customs of co-operation, reciprocity and interaction with strangers. Furthermore, norms cannot be produced at will and their creation or shaping depends on the cultural background to the relationship, including market exchange contexts. Norms are derived from cultural patterns and habits in society as well as being reinforced by the use of trust. They shape the actions of agents as reciprocity is the basis of personalised relations based on trust. Some norms are consciously applied, relying on social consensus to enforce sanctions, which come in the form of shame and obligations (Scott 1976). Individuals are pressured into keeping to norms by those around them. This can be done by the withdrawal of co-operation, disapproval and attaching social stigma to norm breakers, although this is limited to cases where those involved live in proximity or work closely together.

NETWORKS AND IMMIGRANT ENTREPRENEURS Networks Networks refer to the interpersonal linkages that make up social life, although there are many cases of networks that help to shape economic activities.

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Networks can range from weak ties of acquaintances that can move between groups carrying ideas and information, to the strong ties of families where ingroup solidarity may actually militate against multiple identities and co-operation with outsiders (Granovetter 1973). In a business context, networks have sometimes been seen as a key element of the social resources (or social capital) which small businesses are able to exploit in order to overcome some of their size-related resource constraints and potential institutional barriers (Shaw and Conway 2000; Starr and Macmillan 1990) by providing access to other resources that can be used to develop the business. At the same time, from a business perspective, definitions of networking are not straightforward, particularly in a small business context, where personal- and business-based networks may be difficult to separate. In this context, Curran et al. (1995) pointed out that firms can enter into a wide variety of external relationships with suppliers, customers, accountants, solicitors, banks, trade associations and business support agencies. Some of these relationships are a necessary part of undertaking business activity, whilst others are more voluntary. The definition adopted in this chapter encompasses the conscious exploitation of linkages with other organisations and individuals, including both voluntary and necessary relationships for business development, whether or not such relationships have been expressly formed for such a purpose. It also recognises that links with customers (for example) that are necessary to complete a sale may involve value added aspects if, for instance, the firm receives market information from the customer that goes beyond that necessary to complete an individual transaction. In terms of the contents of network ties, Johannisson (1999) identifies three essentially interdependent forms. These are information networks, which provide intelligence that is of some potential value to the business (and can additionally also provide access to a variety of external resources); exchange networks, which provide operational resources; and influence networks, which also carry information but tend to operate in the main as barriers for potential competitors. Studies which emphasise the role of network relationships in business development tend to be based on the premise that personalised forms of trust between businesses are more effective than other ways of securing trust in a changing competitive environment (for example, Malecki and Tootle 1996). The Immigrant or Ethnic Minority Business Dimension In terms of immigrant entrepreneurship, or ethnic minority owned businesses, one of the factors contributing to their development is said to be the social and economic disadvantage that immigrants often face, which results from a combination of the displacement associated with migration, on the one hand,

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and the discrimination presented by the receiving society, on the other (Aldrich and Waldinger 1990). Given that ethnic minority businesses may face discrimination, such as in accessing formal institutional sources of start-up finance and advice, but also in reaching customers and receiving credit from suppliers (Ram 1994), it might be expected that they would draw on their social resources, in order to compensate for some of their apparent disadvantage. For instance, immigrants may turn to communal resources and family members to provide a potential support mechanism for the groups’ entrepreneurs (Ram and Jones 1998). This backing may come in the form of existing entrepreneurs acting as guarantors for loans for start-ups, preferential patronage by co-ethnic customers, cheap or free labour from kin, in-group networks of trade and information exchange (Ram and Jones 1998). In this regard, studies of ethnic minority and immigrant businesses often highlight the importance of ‘social’ networks, distinguishing between personal networks, which business owners have with specific individuals, and the cultural dimension in which the actors are immersed in (Saker 1992, cited in Ram 1994). In essence, it is the ‘family’ and the ‘community’ that lie at the heart of the social networks of ethnic minority firms (Ram 1994). Although contacts within the networks may not necessarily be continuous for business purposes, such networks are often viewed as a vital element in the development of ethnic minority enterprises in that their closed nature offers members access to resources that may be denied to non-members of that group. Such access is said to give them some operational advantages over their indigenous counterparts, and have been viewed by some authors as an important potential strength of ethnic minority businesses (Waldinger et al. 1990). At the same time, so-called culturalist perspectives, which emphasise the importance of mobilising so-called ethnic resources, have been challenged for overemphasising the role of ethnicity rather than characteristics such as the class of business owners (Mulholland 1997), and an insufficient appreciation of the socio-economic context in which ethnic minority and immigrant businesses operate (Ram and Jones 1998). In this context, although the more recent mixed embeddedness perspective pays close attention to economic and institutional contexts; it does not neglect the importance of social networks to ethnic minority businesses. As Rath (2002, p. 10) points out, ‘networks are instrumental in acquiring knowledge, distributing information, recruiting capital and labour, and establishing strong relations with clients and suppliers’. Moreover, there is no shortage of British studies that highlight the importance of social networks to the viability of ethnic minority businesses (see Ram and Jones 1998, for a review). For example, a recent investigation of the restaurant sector found that the family and wider co-ethnic community were important sources of finance, labour and management for many firms, particularly those from South Asian groups (Ram et al. 2000). Studies of Chinese catering have

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highlighted similar processes at work (Song 1999). This is not altogether surprising in view of the important role of personal contacts as a basis for business dealings in the Chinese community, where personalised relationships with people that can be trusted, and by whom one will be trusted (guanxi), combines elements of instrumentalism with reciprocity. However, in assessing the significance of social networks for ethnic minority business development, a number of factors need to be borne in mind. First, the composition of social networks varies across social groups. In the UK context, this is usually highlighted by contrasting the entrepreneurial fortunes of South Asians, on the one hand, with those of African-Caribbeans, on the other. Adequate explanations of this divergence need to move beyond solely ‘ethnic’ or ‘cultural’ explanations; to incorporate factors such as patterns of migration, unemployment, stereotyping, demographic trends and levels of home ownership (Basu 1991). In addition, as Rath (2002) has argued, excessive reliance on social networks can serve to inhibit the development of the enterprise. The circulation of new information and material resources is limited in tight groups and so, consequently, are the chances of business success, although the extent to which this is the case is likely to depend on the nature and extent of the business experience that exists within these networks. The point has also been made with respect to the role of guanxi in relation to transnational co-operation between Taiwan and the USA in the field of hightechnology industry (Jinn-Yuh and Saxenian 2000), where it was concluded that very close personal ties can sometimes become ‘blind trust’, contributing to firms becoming unconscious of technological breakthroughs or new business opportunities. A guanxi-embedded system, it was suggested, can lead to decisions being taken more on the basis of the strength of a tie than the depth of capability. Finally, social networks should not be confused with exclusively ethnic ties. As Mulholland’s (1997) study of ethnic minority and white-owned family businesses highlighted, successful businesses are marked by their possession of ‘class’ rather than ‘ethnic’ resources; hence business connections, entrepreneurialism, formal education and family ties may be more important, in some cases, than belonging to a particular ethnic group. Social networks may be either formal or informal in nature. The more formal links refer to those built with co-ethnic membership business associations and other organisations, which emphasise ethnic links in their establishment and development. Informal links are primarily personal or community related. Personal networks in this case are mainly developed around friends and the extended families of the business owners, whilst informal community networks operate as an extension of personal links into the wider co-ethnic community, or alternatively through tribal, religious or various sociocultural organisations.

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As a result, family and kinship networks may be viewed as vital building blocks for business development in ethnic minority communities. Furthermore, the willingness to share resources provides the ‘trust’, security and reliability associated with dealing with persons from the same ethnic background. Social network ties are often presented as relying on the trust of its members for their sustenance over time, and such trust is itself a key business resource which can be a source of competitive advantage (Aldrich and Zimmer 1986; Honig 1998; Ram 1994; Smith et al. 2001). The element of trust in such relationships also presupposes that such personal ties will often be informal in nature, which helps to explain why the small business literature has tended to highlight the preference of some ethnic minority businesses for informal network links over formal ones (for example, Fadahunsi et al. 2000).

CHINESE ENTREPRENEURS IN THE UK Before examining evidence of trust-based relations involving Chinese minority owned businesses in the UK, the context for ethnic minority entrepreneurship in the UK is briefly described. Members of ethnic minorities comprise a small but growing proportion of the UK population, from 5.9 per cent in 1991 to 9.7 per cent in 2001 with South Asians, Chinese and African-Caribbeans comprising the main ethnic minority groups (Figure 14.1). However, as Figure 14.1 shows, the Chinese population has shown the largest proportionate increase during the 1990s, to exceed 400 000 by 2001, based on official census returns. It is widely recognised that businesses owned by members of ethnic minorities represent an increasingly significant segment of the small business population in the UK, although the absence of large-scale business databases that include the ethnicity of the owner makes it impossible to paint a completely accurate picture. Nevertheless, members of ethnic minority communities are disproportionately represented among self-employed people, with selfemployment rates higher than for their white counterparts (Figure 14.2). In this regard, Chinese people have the highest propensity to be involved in selfemployment of any group and significantly above that of the white population. Ethnic minority businesses in the UK are concentrated sectorally, with the Chinese population being heavily involved in food and catering businesses (Song 1997). A majority of Chinese-owned businesses in the UK are family run, originally set up by first-generation migrants (Chan 1997). However, there is a growing body of research which suggests that the succession rate in Chinese family businesses is declining as many in the second generation seek out mainstream professional employment outside activities that are viewed as traditional ethnic trades (Chan 1997; Pang 1999). Other drivers can come from

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Ethnic minority population in England and Wales (1991–2001)

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ONS (2001b).

Figure 14.2

Self-employment as a percentage of total employment in Great Britain, by ethnic origin (1999–2000)

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the parents themselves, some of whom may see the capital generated by the family business as offering a mechanism for their children to consider careers other than in catering. Although the Chinese business community in the UK is relatively underresearched in comparison with other minority groups, some insight into the role of network activity in the minority Chinese business community can be obtained from the results of a recent, large-scale study of access to finance and business support by ethnic minority owned firms in the UK, commissioned by the British Bankers Association (BBA), with other key partners (Ram et al. 2002). In interpreting the findings from this study, it might be helpful to describe some of the main characteristics of the Chinese-owned firms surveyed. In sectoral terms, the Chinese sample of 168 firms was fairly evenly divided between restaurants/catering, retailing/wholesaling and professional services.1 The majority of ethnic minority firms included in the study were micro and small enterprises, which were well established with a median age of 10 years, with Chinese-owned firms similar to other EMBs in both respects. In terms of characteristics of business owners, Chinese-owned firms were predominantly owned by first-generation migrants, with by far the lowest reported incidence of owners/managers with management qualifications and/or formal management training of any group. Although this was not reflected in significantly lower levels of reported turnover growth or profitability in the previous financial year, it was associated with a much lower propensity to report a growth objective. One of the main findings of the BBA study, with respect to the Chinese minority community, was their degree of success in accessing finance at startup from the main High Street clearing banks, which was significantly higher than any other ethnic minority group, or indeed of the white control group included in the study. Survey results showed that 49 per cent of Chinese entrepreneurs had been able to access bank finance at start-up compared with 37 per cent of Indian (the second most successful group) and 34 per cent of whiteowned firms. As a result, Chinese-owned firms showed the lowest propensity of any minority group to turn to informal sources of finance (that is, family and friends) when founding their enterprises. Whilst the latter may seem a somewhat surprising result in the light of previous research evidence, it reflects a lower level of need to turn to informal sources because of the degree of success achieved in raising finance from formal sources. These results might be taken as suggestive of the existence of institutional trust-based relations between the minority Chinese community in the UK and mainstream financial institutions. However, more detailed analysis showed that the greater success of Chinese minority owned businesses in dealing with banks at start-up was associated with a significantly higher propensity to take advice from some external

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source: 58 per cent of Chinese-owned businesses, compared with 29 per cent of all ethnic minority firms and 27 per cent of those in the white control group. Moreover, Chinese-owned firms not only had the highest propensity to use some form of external advice at start-up, but they also typically used more than one source, one of which was usually the family (53 per cent of all Chinese-owned businesses, compared with 16 per cent of Bangladeshi and African and Caribbean owned firms, which were the second highest, and just 7 per cent of white owned businesses). At the same time, Chinese minorityowned firms were significantly more likely to turn to a bank or accountant for start-up advice (40 per cent and 23 per cent, respectively, compared with 11 per cent and 7 per cent, respectively, among all EMBs). They were also more likely to source advice through an ethnic business association: 12 per cent compared with just 4 per cent of all EMBs. Public sector agencies were not a major source of start-up advice for businesses in any ethnic minority group. Other research has pointed to the importance of trust-based relations in influencing the choice of business advisers. For example, Bennett and Robson (1999) have demonstrated the role of trust with regard to the choice of business advisers by SME owners, which depends to a great extent on personal relationships and exchanges. Bennett and Robson draw on Zucker’s work (1996) in distinguishing between different trust environments; first, low-trust environments; secondly, those characterised by high personal trust, based on social acquaintances and social relations between clients and suppliers of advice; and, thirdly, environments of high institutional trust, where the client relies on the regulatory structures that exist to govern the behaviour of the supplier. A key finding of the Bennett and Robson study was that the level of trust appeared to explain the levels of use of different sources of advice. For example, accountants, solicitors and banks, which had the highest levels of reported use, draw on institutional trust that is associated with professional self-regulation. By comparison, the use of relatives and business friends as sources of business advice was reported to be associated with high levels of personal trust. Public sector sources all had low levels of trust, depending more on marketing and access to grants to attract clients. Significantly, Bennett and Robson also found that the impact of different sources of advice was strongly related to their degree of specialisation and the level of trust that applied, either institutional or personal. The results reported above for Chinese minority entrepreneurs, drawn from the BBA study, demonstrate that kinship-based networks, based on personal trust, are an important source of business advice, as well as community-based business associations. At the same time, they suggest that the role of different trust environments in explaining the sourcing of business advice is less clearcut than that suggested by Bennett and Robson’s analysis of a large-scale survey of SMEs employing less than 500 people. Case study evidence from

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the BBA study shows that informal networks are used as a basis for finding accountants to act as advisers, who although professionally qualified, are typically members of the Chinese community themselves. These accountants help entrepreneurs to prepare their applications for finance, as well as introducing clients to banks in some cases. This suggests that these Chinese minority entrepreneurs recognise the value of professional assistance to help them to access bank finance, although their selection of advisers is based more on personalised trust than on trust in accountants as an institution. Unlike the owners of mainstream SMEs in the Bennett and Robson study, Chinese entrepreneurs rely on personal trust through their informal networks to find these professionals, who mediate between businesses and other organisations, such as banks, drawing on institutional-based trust. Some Case Study Evidence Additional insights into the nature of co-operation involving Chinese minority owned enterprises in the UK, and the trust that is implicit in the process, may be gained from a series of 10 case studies, undertaken in the period July–September 2003, based on face-to-face interviews with owners and managers, and conducted by a Chinese interviewer. These businesses included six restaurants of different types, three businesses involved in herbal medicine and acupuncture, and an estate agent. All business owners originated either from Fujian province in the People’s Republic of China or from Hong Kong. As well as collecting profile data on the businesses and their owners, the interviews sought to identify the nature and extent of any business-related cooperation or networking that the entrepreneurs were involved in, together with an attempt to identify the role of trust in the process. Key areas emerging in this regard are related to labour recruitment, the selection of accountants and, to a lesser extent, to finding suppliers. In eight out of the 10 cases where the interviews were conducted with business owners (rather than with employed managers), personal networks, focused on personal acquaintances, were mentioned as a means of recruiting labour. In the other two cases, respondents were unable to discuss these aspects in detail, because of a lack of knowledge on their part. However, the use of personal networks for labour recruitment does not mean that personal recommendation is a substitute for the level of competence expected, because in all cases the recruit, supplier or accountant needed to demonstrate their competence in the role, which in the case of new recruits could involve a trial period. On the one hand, the role of the personal network is to build a bridge between demand and supply sides in terms of exchange information. On the other hand, the role of the personal network is to provide

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an initial filter through recommendation, with an implied element of trust in the judgement of a friend or business associate, on the part of the entrepreneur. There was some variation between the cases in the nature of the personal networks, although they were all ethnic based. In some cases, they were based on the geographical area of origin (particularly those from Fujian), who were all first-generation migrants, but in other cases they were profession or sector based, such as in the case of practitioners of herbal medicine or acupuncture. In the case of the owner of one of the larger restaurants in the study, his personal networks consisted of ‘people who had previously worked for him, plus other restaurant owners’. The tendency for ethnic minority businesses to recruit mainly co-ethnic labour is a frequently reported research finding (for example, Ram and Jones 1998). This was a consistent feature of the Chinese minority owned businesses in this study, which typically relied on introductions from members of their personal networks to hire new recruits, although some form of trial period was common. Ethnic minority owned firms are not unique in relying on informal recruitment methods, since this process is typical of most micro enterprises and many small firms. At the same time, the consistent recruitment of coethnic labour is a distinctive feature of ethnic minority firms. However, the personal trust element in this case seems to be mainly evident with respect to the judgement of those recommending potential recruits, because they are from the same ethnic group, rather than with the recruits themselves, since a degree of control appears to be a more common feature with regards to employer–employee relations. This is because in a small immigrant community, employees need to guard their reputations or they may find it difficult to obtain alternative employment, as one of the herbal medicine practitioners emphasised. In addition, there were some cases where the control exerted by employer over employees was extreme, such as where the latter was said to have entered the country illegally, which was reported to lead to long working hours with low pay. In such cases the relationship is more reliant on sanctions and demonstrates that trust can be based on control as well as reputations and ‘good will’. With respect to the choice of accountants, the results from the case studies confirm those described above for the BBA study. In only one case was a nonChinese accountant reported being used, and the most common method for finding a suitable accountant was to ask friends and associates for recommendations. The accountants used were professionally qualified, trusted for their competence as well as for their ability to treat the affairs of their clients as confidential. As in the case of labour recruitment, the role of the personal network is to reduce decision-making risk and to increase confidence in the relationship developing into a successful one. Finding suppliers was another role for the personal network, which included finding reliable builders and

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decorators in the case of two of the restaurant owners, as well as suppliers of food ingredients and herbal medicines, more generally. Trust in business relations is something that needs to be earned, which may be illustrated with reference to the credit terms set by suppliers. In case study firms, credit terms varied from one or two weeks, to cases where two respondents complained about the failure of long-term suppliers to collect what was owed to them, which after three to four months could amount to several thousand pounds. The length of time that two entrepreneurs had been working together appeared to be the main factor influencing credit terms. Such examples reflect a high level of trust in the relationship from the supplier side, which includes confidence in the ongoing viability of its customer and thus their ability to pay. At the same time, a strong element of inertia is common in many types of business–business relationship, reflected in the statement of one of the restaurateurs who said that ‘I don’t like to change the firms we collaborate with, because we get used to them’. This may include learning to trust them, although it may simply reflect a desire to restrict change to situations where it becomes a necessity. The study generated other examples where trust played a role in business development processes. These include an emphasis, by the owner of one of the larger restaurants in the study, on the necessity of trusting others if a business were to grow, because of the need to delegate some decision-making authority to others. This can be a particular issue in the case of restaurant and catering businesses when it becomes necessary to move to multi-site operation, although successful delegation has often been identified as a constraint on successful small business growth (for example, Smallbone et al. 1995). However, as predominantly family-owned enterprises, the personal trust implicit in many kinship-based relationships was a common way of dealing with this issue. Another example concerned the importance of building reputational trust of a business in order to build its customer base, such as in Chinese herbal medicine. Interestingly, one of the Chinese business owners compared Indian with white English customers in this respect, with the latter harder to penetrate, because of what she described as cultural factors associated with less willingness to discuss matters of personal health with friends and associates.

CONCLUSIONS The empirical investigation of the use of networking by Chinese minority owned businesses in the UK emphasises the role of social networks involving family, friends and acquaintances. The most consistent theme emerging from the Chinese minority owned case studies focused on the role of the personal

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network as a source of reliable and trusted information to guide entrepreneur’s decisions, with respect to the recruitment of labour, the choice of accountants and finding appropriate suppliers. As Szarka (1990) has emphasised, social networks are influenced by the personal networks of relations between an entrepreneur and specific individuals, and/or business activities to which they are attached, as well as to the wider cultural dimension, which transfers values, attitudes and behaviours that shape the nature of the relationships which are formed. As Perry (1999) has pointed out, although all small businesses make use of personal and family ties to some degree, Chinese and ethnic minority business networks are prime examples, with a number of distinctive characteristics. One of the strengths of these networks is the trust and commitment shown by their members, which can involve different forms of mutual support and resource sharing. Networking can generate contacts, but as the owner of the estate agent business stressed: ‘One cannot rely on networking to do business; there is also a need to build a good reputation.’ However, the extent to which this applies may be affected by the extent of the growth ambitions of the entrepreneur, together with the extent to which the target market is a co-ethnic one. The limitations of an overreliance on personalised networking are illustrated by the owner of an estate agent business when he said: ‘Doing business in the UK is different from in China. We don’t need to spend money and time building networks with individuals and businesses. Business circumstances are fairer here than in China. Furthermore networks are very limited because a person only knows a limited number of people.’ In other words, breaking out of an ethnic market niche to become established in mainstream markets cannot rely solely on ethnic minority based networks. As Birley (1985) has previously pointed out, whilst a close personal network is often a source of strength for entrepreneurship and small business development, a reliance on it can become a weakness. The informal methods demonstrated by Chinese minority business owners in recruiting labour, are not unique to this particular group, since informality in management practices and business relations is a recurrent characteristic of small business behaviour. However, the distinctively Chinese element is associated with the patterns of social activity reported by a number of entrepreneurs, such as ‘meeting friends once or twice per week for dinner and to play cards’. Although there was some variation in the precise nature of the personal networks that were used for business purposes by individual entrepreneurs, they were all ethnic based. As far as trust is concerned, the study shows the difficulties of convincingly demonstrating the precise nature and extent of the role of trust as an influence on business behaviour. Researchers can observe and analyse behaviour and seek participants’ explanations for it but, because trust is such an abstract

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concept, its precise influence on specific actions taken can be difficult to isolate. In trusting the judgement of their friends and personal acquaintances, the Chinese case-study entrepreneurs were relying on the truth of the statements of these people without examination, thereby meeting the dictionary definition of what constitutes trust (Oxford English Dictionary 1995). However, in accepting recommendations for potential recruits, suppliers and business advisers, the entrepreneurs were not exposing themselves to great risk, beyond an initial trial period. The role of networking, and the trust implicit in it, was not used as a substitute for judgement and decision-making by managers, but rather as a resource to assist it. The research also shows that trust can be based on personalised relationship and institutions. However, relationships may be based on both personal trust and institutional trust at the same time, such as the relationship between accountants and businesses. The findings from the BBA study, and from the case studies, with respect to the use of accountants by Chinese entrepreneurs are broadly similar and potentially significant. It is clearly demonstrated that advice which is sourced through informal networks can nevertheless be supplied by professionally qualified advisers. This is important because there has been some discussion in policy circles about the relative merits of ‘support’ from formal and informal sources, which are typically characterised as ‘family, friends and associates’, because of possible differences in the quality of what is provided. This is a policy issue because of the traditionally low levels of use of advisers in public agencies by ethnic minority businesses in the UK (Ram and Smallbone 2003). However, the results presented here from the Chinese minority business community suggest the quality issue may be more complex than many recognise, because of the need to distinguish between the process of identifying a potential supplier of advice or assistance, on the one hand, and the individual or organisation that supplies it, on the other. In other words, advice sourced through the use of informal methods may be provided by a ‘formal’ adviser. There is a principle implicit in this from which mainstream public sector agencies might learn, namely, the potential value of working with informal and community-based networks in order to increase their engagement with ethnic minority business owners. This might be seen as part of a strategy of building the trust-based relationships that are essential if business advice and support is to be effectively delivered.

NOTE 1.

This reflected a sampling decision to include both traditional and emerging sectors of activities for each ethnic minority group.

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REFERENCES Aldrich, H.E. and R. Waldinger (1990), ‘Ethnicity and Entrepreneurship’, Annual Review of Sociology, 16, 111–35. Aldrich, H.E. and C. Zimmer (1986), ‘Entrepreneurship through Social Networks’, in D.L. Sexton and R.W. Smilor (eds), The Art and Science of Entrepreneurship, Cambridge: Ballinger, pp. 3–24. Basu, D. (1991), ‘Afro-Caribbean Businesses in Great Britain: Factors Affecting Business Success and Marginality’, PhD thesis, Manchester Business School. Bennett, R. and P.J.A. Robson (1999), ‘The Use of External Business Advice by SMEs in Britain’, Entrepreneurship and Regional Development, 11 (2), 155–80. Birley, S. (1985), ‘The Role of Networks in the Entrepreneurial Process’, Journal of Business Venturing, 1, 107–17. Chan, E. (1997), ‘Migration, Cultural Identity and Assimilation Effects on Entrepreneurship for the Overseas Chinese in Britain’, Asia Pacific Business Review, 3 (4), 211–22. Curran, J., R.A. Blackburn and J. Kitching (1995), ‘Small Businesses, Networking and Networks: A Literature Review, Policy Survey and Research Agenda’, Small Business Research Centre, Kingston University, Kingston upon Thames: SBRC. Fadahunsi, A., D. Smallbone and S. Supri (2000), ‘Networking and Ethnic Minority Enterprise Development: Insights from a North London Study’, Journal of Small Business and Enterprise Development, 7 (3), 228–40. Fukuyama, F. (1995), Trust: The Social Virtues and the Creation of Prosperity. London: Hamish Hamilton. Gambetta, D. (1988), ‘Can We Trust Trust?’, in D. Gambetta (ed.), Trust: Making and Breaking Co-operative Relations, Oxford: Blackwell, pp. 213–37. Granovetter, M. (1973), ‘The Strength of Weak Ties’, American Journal of Sociology, 78 (1), 360–80. Granovetter, M. (1985), ‘Economic Action and Social Structure: The Problem of Embeddedness’, American Journal of Sociology, 91 (3), 481–509. Hodgson, G.M. (1988), Economics and Institutions: A Manifesto for a Modern Institutional Economics, Cambridge: Polity Press. Honig, B. (1998), ‘What Determines Success? Examining the Human, Financial and Social Capital of Jamaican Microentrepreneurs’, Journal of Business Venturing, 13 (5), 371–94. Jinn-Yuh, Hsu and A. Saxenian (2000), ‘The Limits of Guanxi Capitalism: Transnational collaboration between Taiwan and USA’, Environment and Planning A, 32 (11), 1991–2005. Johannisson, B. (1999), ‘Networking and Entrepreneurial Growth’, in D.L. Sexton and H. Landström (eds), The Blackwell Handbook of Entrepreneurship, Oxford: Blackwell, pp. 368–86. Kitching J. and R. Blackburn (2003), ‘Innovation, Intellectual Property and Informality’, in R. Blackburn (ed.), Intellectual Property and Innovation Management in Small Firms, London and New York: Routledge, pp. 16–34. Lyon, F. (2000), ‘Trust, Networks and Norms: The Creation of Social Capital in Agricultural Economies in Ghana’, World Development, 28 (4), 663–82. Lyon, F. and A. Atherton (2001), ‘Collaboration and Innovation in the Knowledge Economy: An Examination of Clustering Processes of Firms in the North East of England’, paper presented at Regional Studies Association Annual Conference, London, 21 November.

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Malecki, E. and D. Tootle (1996), ‘The Role of Networks in Small Firms’ Competitiveness’, International Journal of Technology Management, 11, 43–57. Misztal, B.A. (1996), Trust in Modern Societies, Cambridge: Polity Press. Mulholland, K. (1997), ‘The Family Enterprise and Business Strategies’, Work, Employment and Society, 11 (4), 685–711. ONS (2001a), Social Trends 31, London, Office for National Statistics. ONS (2001b), Labour Force Survey (LFS), Historical Quarterly Supplement, Table 10, London: Office for National Statistics. Oxford English Dictionary (1995), Concise Oxford Dictionary of Current English, 9th edn, Oxford: Oxford University Press. Pang, M. (1999), ‘The Employment Situation of Young Chinese Adults in the British Labour Market’, Personnel Review, 28 (1–2), 41–57. Perry, M. (1999), Small Firms and Network Economies, London and New York: Routledge. Putnam, R. (1993), Making Democracy Work: Civil Traditions in Modern Italy, Princeton, NJ: Princeton University Press. Ram, M. (1994), ‘Unravelling Social Networks in Ethnic Minority Firms’, International Small Business Journal, 12 (3), 42–63. Ram, M. and T. Jones (1998), Ethnic Minorities in Business, Milton Keynes: Small Business Research Trust. Ram, M. and D. Smallbone (2003), ‘Policies to Support Ethnic Minority Enterprise: the English Experience’, Entrepreneurship and Regional Development, 15 (2), 151–66. Ram, M., B. Sanghera, T. Abbas, G. Barlow and T. Jones (2000), ‘Ethnic Minority Business in Comparative Perspective: The Case of the Independent Restaurant Sector’, Journal of Ethnic and Migration Studies, 26, 495–510. Ram, M., D. Smallbone and D. Deakins (2002), Ethnic Minority Businesses in the UK: Access to Finance and Business Support, London: British Bankers Association. Rath, J. (2002), ‘Needle Games: Mixed Embeddedness of Immigrant Entrepreneurs’, in J. Rath (ed.), Unravelling the Rag Trade: Immigrant Entrepreneurship in Seven World Cities, Oxford: Berg. Saker, J.M. (1992), ‘Ethnic Minority Entrepreneurship and the Role of Social Networks’, paper presented at the 22nd European Small Business Seminar, Amsterdam. Scott, J.C. (1976), The Moral Economy of the Peasant, New Haven, CT: Yale University Press. Shaw, E. and S. Conway (2000), ‘Networking and the Small Firm’, in S. Carter and D. Jones-Evans (eds), Enterprise and Small Business: Principles, Practice and Policy, Harlow: Pearson Education, pp. 367–83. Smallbone, D., R. Leigh and D. North (1995), ‘The Characteristics and Strategies of High Growth SMEs,’ International Journal of Entrepreneurial Behaviour and Research, 1 (3), 44–62. Smith, D., E. Wistrich and A. Haynes (2001), ‘Ethnic Minority Business and Social Capital: Contributions to Regeneration’, Middlesex University Occasional Paper, London. Song, M. (1997), ‘Children’s Labour in Ethnic Family Business: The Case of Chinese Take-Away Business in Britain’, Ethnic and Racial Studies, 20 (1), 690–716. Song, M. (1999), Helping Out, Philadelphia, PA: Temple University Press. Starr, J.R. and I.C. Macmillan (1990), ‘Resource Co-optation via Social Contracting: Resource Acquisition Strategies for New Ventures’, Strategic Management Journal, 11, 97–102.

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Szarka, J. (1990), ‘Networking and Small Firms’, International Small Business Journal, 8 (2), 10–22. Waldinger, R., H. Aldrich and R. Ward (1990), Ethnic Entrepreneurs, London: Sage. Zucker, L.G. (1986), ‘The Production of Trust: Institutional Sources of Economic Structure, 1840–1920’, Research in Organisational Behaviour, 8, 53–111.

15. Global competition and entrepreneurial behaviour in industrial districts: trust relations in an Italian industrial district1 Gabi Dei Ottati The whole mechanism of society rests on confidence: it permeates all life, like the air we breathe, and its services are apt to be taken for granted and ignored like those of fresh air, until attention is forcibly attracted by their failure. (Marshall 1923, p. 165)

INTRODUCTION This contribution considers the role played by trust in the functioning and reproduction of the industrial district as a dynamic local system. Various theoretical papers on the subject exist (for example, Becattini 1990; Brusco 1995; Dei Ottati 1994a; Lorenz 1992). However, there is hardly any record of empirical research on this theme.2 This chapter tries to fill this gap in part by presenting the results of a survey aimed at analysing the current relationships of trust between entrepreneurs in the industrial district of Prato, which, like the other local systems, for some time now has had to face the challenges of the so-called globalisation. The contribution is laid out as follows. The next section summarises the model of the industrial district and the role that trust plays in it. The third section outlines the essential features of Prato’s textile district and of the empirical survey carried out there. In the following two sections the results of this survey are analysed, referring respectively to the subcontracting relations and to the role of institutions (formal and informal) in promoting an environment characterised by widespread trust. The sixth section outlines an interpretation for the data gathered. The contribution concludes with some considerations of a more general nature on possible local responses to global pressure.

255

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THE COMPETITIVE ADVANTAGE OF INDUSTRIAL DISTRICTS AND TRUST One of the main findings of the research on industrial districts is that there are some features at the basis of their dynamism that are peculiar to their social and institutional milieux. Brusco (1995, p. 55) summarised these features in three points: 1.

The relationships among businesses are characterised by a close interweaving of competition and co-operation. 2. The relationships between entrepreneurs and their employees – both at the micro level within the business concern and at the macro level in industrial relations – present at any one time elements of conflict and elements of participation. 3. The productive and, more generally, the social structures are rich in knowledge closely connected with productive activity, technology, marketing and often with financial administration and management. In fact, those features allow district firms to enjoy a bonus of entrepreneurship, flexibility and creativity, in comparison to other models of economic organisation, largely in the form of economies that are external to the single firms but internal to the local system. In turn, those localised external economies are mainly the outcome of the smooth working of three processes, essential for the reproduction of the above features and, hence, also to the district’s competitive advantage. The principal vital district processes are: • the process of the localised social division of labour • the process of its flexible integration • the process of localised learning and innovation. For their smooth working, all three vital district processes need widespread trust among individuals and organisations. Since the concept of trust is very complex and can be analysed from different perspectives, it is useful to start with a definition of what we mean by trusting behaviour in economic relations. Trust is the expectation that the other party in a relationship will not exploit the vulnerability inherent in cooperation. The reasons for such an expectation are varied, but among them it is helpful to distinguish between membership of the same community, on the one hand, and therefore the sharing of the same value system, attitudes and codes of behaviour, and, on the other hand, acquaintance with the other party, usually acquired step by step over repeated direct interaction. Since, in the first

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case, trust depends on the observance of common explicit and implicit rules that benefit everyone in the local system, we can think of it as collective capital. In the second case, trust derives, at least in part, from rational behaviour, in the sense of taking account of the future benefits to be gained from establishing a good personal reputation. In this case, therefore, we can think of trust as a form of personal capital (Dei Ottati 1994a).3 Normally, trust both as collective and as personal capital is widespread in industrial districts, the one reinforcing the other, even if only trust as collective capital is distinctive of this organisational form. This is due, on the one hand, to a shared set of common rules of behaviour and business routines, accompanied by economic and social sanctions and rewards, and, on the other hand, to the prospects of future gains derived from the building up of a reputation for skill and goodwill trustworthiness in an environment characterised by an extensive social division of labour, where information circulates easily. Trust both as collective and as personal capital is necessary to fuel the three vital processes mentioned above. A sustainable process of social division of labour in the local system constantly requires that there should be many people who are willing to start a new business and who are also in a position to do so. Because of the way production is organised in districts,4 the main starting capital to set up a business is often the reputation for skill and goodwill trustworthiness. Many firms in districts are set up by individuals aiming for personal improvement and possessing specialised knowledge in any one of the activities in which the production process of the local industry is subdivided. Such people are frequently short of financial capital, but thanks to their personal reputation, gained in previous business relations, they can obtain the advance necessary to start up on their own. In other words, they are able to use trust in the form of personal capital as security, instead of collateral. In these ways trust (both competence and goodwill trust) fuels the localised division of labour which is the main engine of the district’s social and economic evolution.5 It is well known that the division of labour increases productivity if (and only if) it is possible to integrate the resulting specialised activities in an effective way and at a low cost. Usually, the integration of the division of labour is obtained by either the market or by the firm. It is also recognised that the market, with the price system, cannot co-ordinate closely complementary activities (Richardson 1972), as occurring in industrial districts. Therefore, the normal mechanism to co-ordinate the localised division of labour in districts is a hybrid form called ‘community market’ (Dei Ottati 1991). This is a combination of prices formed through local market competition and reciprocal co-operation, based on the respect for implicit rules of fair behaviour. Again, this illustrates the crucial importance trust as collective capital has for the very existence of an industrial district, as trust permits flexible integration

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(Becattini 2003, pp. 10–11) of the localised social division of labour. This form of integration is more flexible than vertical integration within firms. Thanks to the plexus of local markets for specialised inputs, district firms can rearrange in different ways the various activities, thus facilitating the adaptation to the requirements of a changing and differentiated demand. Economists often only recognise newly codified knowledge as innovation, which is the outcome of large investment in research and development. However, incremental innovation, which is the result of widespread knowhow and contextual knowledge (Becattini and Rullani 1996), is usually overlooked, in spite of its growing value in markets with increasingly variable demand and ever more customised products. Industrial districts are characterised by a milieu that favours the learning of production knowledge and stimulates creativity and incremental innovation.6 Indeed, the strengthening of relations in the same locality among a great number of people and firms, specialised in activities that are partly similar and partly complementary, creates a very rich environment for a variety of skills which are different but interconnected, referring mainly to the same industry or to activities subsidiary to it. However, such an abundant pool of a variety of skills is necessary but not sufficient to activate widespread learning and creativity. In order for different firms and individuals to truly exchange knowledge, they need to share standards of communication and behaviour as well. The fact that they are involved in activities, which are linked to the same sector (similar technology and market conditions), facilitates reciprocal understanding. But only the sharing of a common code of conduct ensures that there is reciprocal trust, needed whenever the exchange involves knowledge and innovation. Consequently, the competitiveness derived from the capacity of district firms to constantly introduce new variations into the process and the product ultimately also depends on trust, which is especially based on respecting the implicit rules of fair competition. In order to highlight the possible effects of globalisation on trust relations in industrial districts and, hence, on the reproduction of the competitive advantage of district firms, we decided to research this crucial issue empirically in a well-known Italian industrial district, that is, the textile district of Prato.

THE PRATO DISTRICT AND THE SURVEY The province of Prato can be seen as broadly superimposed on a local system, which has the socio-economic characteristics of an industrial district. In fact, the textile area extends over municipalities beyond the province of Prato, towards both Florence and Pistoia, covering a territory of about 700 square kilometres and counting a population of 300 000 inhabitants.

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Table 15.1 Textile establishments and employment in the Prato district Years

Establishments

Employment

1951 1961 1971 1981

830 7 601 10 695 14 689

21 572 41 590 49 969 61 119

Source:

ISTAT (1951, 1961, 1971, 1981).

Ever since 1200, wool manufacturing has continued to characterise Prato’s economy. However, its fame as the ‘rag capital’, which represented the image of the local industry up until the 1970s, goes back to the second half of the nineteenth century, when the process of wool regeneration was introduced. Even so, the birth of Prato as an industrial district dates from immediately after the Second World War, following first the recovery of the textile industry and then the crisis and disintegration of the major wool mills that had previously dominated the local economy.7 Thanks to the high productivity and flexibility owing to the new division of labour among local firms, from the 1950s the Prato district entered a period of about 30 years of extraordinary growth, partly favoured also by the increase in the international demand for textiles (Table 15.1).8 In the 1980s, however, the persistent drop in demand for carded cloth (a typical local product) caused prolonged stagnation and a process of restructuring within the district. Many firms responded to the crisis by upgrading and differentiating their offer of textile products. In addition to the traditional carded wool fabric, there were new (for Prato) types of cloth, in linen, cotton, silk, viscose and so on, even as far as including non-woven fabric and imitation furs (Dei Ottati 1996). Despite a marked reduction in establishments (over 40 per cent less) and workers (25 per cent less) compared with the early 1980s, the textile industry today still remains the fundamental engine of the local system. According to the 1996 census of industries and services, there were about 50 000 workers employed in textiles and clothing in the Prato district and there were about 9000 establishments in the same industries. The local Industrialist Association estimated that the value of the district textile production in 2001 reached about 5500 million euros. Therefore, in terms of production and employment, the Prato local system is second in Tuscany (after the Florence area) and one of the foremost in central Italy. Moreover, the restructuring carried out in response to the difficulties of the 1980s brought about many changes, but it did not alter the organisation of the local industry, which today is still based on an extensive division of labour among firms.

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Starting from the theoretical observations summarised in the previous section and from our knowledge of the Prato district evolution ever since the postSecond World War years, we tried to investigate trust relations in the district empirically. In particular our research was focused on subcontracting relations, and on the role of informal institutions (such as business customs) and formal institutions (such as trade associations) in promoting a high-trust environment. The empirical study took place in summer 2002, comprising in-depth interviews with some key experts in the Prato district, that is, officers and entrepreneurs engaged in the local artisan and industrialist associations, and with the president of the local service centre. The study then proceeded with a specific survey using two questionnaires (one designed for final firms and the other for phase firms9) for interviewing 45 entrepreneurs: 18 were owners of final firms and 27 were owners of phase firms.10 The final and phase firms included in the survey are independent and not linked to one another by subcontracting relations. The enterprises selected for the survey were drawn from lists of firms obtained by the local trade associations from among their members who were willing to participate in our project. The interviews were conducted, either personally by the author of this chapter or by trained interviewers, from November 2002 to January 2003, at a time of extreme market uncertainty and low demand, with the war in Iraq drawing near. This contingency must be taken into account in interpreting the survey results, because of its influence on the local climate of trust.

SUBCONTRACTING RELATIONS AND TRUST Because of the localised division of labour among firms, subcontracting is a structural feature of the industrial district organisation: 83 per cent of our final firms subcontract to specialised phase firms all (or nearly all) of the manufacturing activities and often also several business services. Owing precisely to that division of labour, district firms tend to be small,11 consolidating themselves by building their own ‘external organisation’ (Marshall 1961, p. 377), which is a network of more or less wide and stable business relations with other firms, most of which are specialised in complementary activities.12 The results of our survey confirm that both final and phase firms have an extensive network of, respectively, subcontractors and customers, mostly located in the Prato district and with whom business relations are habitual (Table 15.2). From a structural point of view, the evidence gathered confirms substantial interdependence among district enterprises. Moreover, the exchange of nonsimultaneous obligations, such as information and the provision of technical assistance or, in some cases, even of credit to subcontractors, is rather consistent: 94 per cent of our final firm entrepreneurs provide information to their

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Table 15.2 Number of subcontractors or ordering firms respectively of the responding final and phase firm entrepreneurs Number From 1 to 5 From 6 to 10 From 11 to 20 From 21 to 50 Over 50 Total Source:

Subcontractors of final firms

Ordering firms of phase firms

17.7 5.9 23.5 29.4 23.5 100.0

34.8 26.1 17.4 13.0 8.7 100.0

Own survey.

habitual subcontractors and 67 per cent also give them technical assistance and other forms of support. These findings seem to show the relational character of subcontracting, illustrating that trust is still an important lubricant in interfirm relations within the district. In order to better explore the kind and diffusion of trust in the present subcontracting relations of the Prato enterprises, we applied the same method used by Sako to measure trust in subcontracting in the automotive industry in various countries (Sako 1998, p. 94). We asked our interviewees to evaluate the following statements on a five-point Likert scale where ‘five’ is equal to ‘strongly agree’ and ‘one’ is equal to ‘strongly disagree’: 1.

‘The information we receive from our subcontractors (or customers) is useful to our firm.’ 2. ‘Our habitual subcontractors (or ordering firms) will help us even if not foreseen by the agreement.’ 3. ‘Given the chance, our subcontractors (or ordering firms) might try to take unfair advantage of our business.’ The first statement measures competence trust13 in the other party, while the responses to the second and third statements reveal the degree of goodwill trust14 and the perception of the risk of falling victim to opportunistic behaviour respectively. The results are summarised in Table 15.3, which shows the percentage of interviewees who agree or strongly agree with each of the above statements. They show a clear asymmetry between final firms and phase firms in the level of trust held in the other party in subcontracting. Whilst most of our final firm entrepreneurs agree or strongly agree with both the first and the second statement, the

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Table 15.3 Trust and opportunism in subcontracting relations of the Prato firms

1. Competence trust 2. Goodwill trust 3. Opportunism Source:

Relations with subcontractors

Relations with ordering firms

83.8 88.9 5.5

59.2 37.0 59.2

Own survey.

figures for phase firm entrepreneurs are considerably lower. Moreover, the low diffusion of trust, especially goodwill trust, that our phase firm entrepreneurs have in their customers (mainly Prato final firms) is confirmed by the responses to the third statement, where the majority of phase firm entrepreneurs think that, given the chance, their customers might behave opportunistically, but only 5 per cent of our final firm entrepreneurs fear the same from their subcontractors.

LOCAL INSTITUTIONS AND TRUST Considering the crucial role that trust (and particularly trust based on a shared common code of fair behaviour) plays in the reproduction of industrial districts as dynamic local systems, we believed it worth examining empirically whether the Prato entrepreneurs were conscious of the existence of such a local code and, if so, whether they knew these rules. Here, we were guided by the findings of Brusco (1999), who tried to identify the principal rules of the game in industrial districts. He divided them into three different groups: cautions, interaction rules and sanctions. Examples of these rules are: • ‘It is a good thing to trust those who deserve it, even though prudent attitudes are legitimate and allowed. These attitudes . . . represent cautions, typical of any careful entrepreneur’ (Brusco 1999, p. 21). • ‘Two agents who work together on a continuous basis will never fully take advantage of the market power that is available to them, owing to their reciprocal interdependence . . . Each of them will take into consideration the survival needs and the success opportunities of the other’ (Brusco 1999, p. 22) • ‘It is wrong and shameful for a client, a consultant, a subcontractor or an employee to use information, knowledge, or a network of relationships

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for personal gains to the detriment of the firm that has involved them in specific initiatives with good faith’ (Brusco 1999, p. 24). In our survey, we tried to verify the validity of those implicit rules also in the existing subcontracting relations in the Prato district. First, we asked our entrepreneurs whether they thought that customs had been established in the district with regard to economic relations and to subcontracting in particular. Eighty-seven per cent of all interviewees agreed, thus confirming the awareness of the existence of a local code of business conduct. By applying the subdivision introduced by Brusco (1999), we were able to verify that Prato entrepreneurs were trustful, but with caution. Before passing or receiving an order to or from a new firm, they sought information from other colleagues. Moreover, orders were usually small at the beginning of the relationship and, in any case, the order (or the working capacity) was divided among several firms. The rules of interaction were also confirmed, as 59 per cent of our final firm entrepreneurs stated that, in negotiating subcontracting terms, they took the survival needs of the subcontractors into consideration, and an appreciable percentage of our interviewees also asserted that they followed the convention of treating any information obtained in a work relationship with reserve and fairness (Table 15.4). Respecting the rules of fair competition clearly depends on the effectiveness of the sanctions imposed on those who contravene. In answering the question regarding the sanctions against anyone not respecting the implicit rules of the district, more than half of our interviewees (final and phase firm entrepreneurs) affirmed that the offender would lose any chances of future collaboration with the damaged party. About 40 per cent added that the sanction would also involve a loss of reputation in the local business community, which implied future difficulty in finding any of its members willing to collaborate, but there Table 15.4 Interaction rules in subcontracting relations* Implicit rules In fixing contract terms the survival needs of the other party are considered Information is not used opportunistically Note: Source:

*Several answers were possible. Own survey.

% final firms

% phase firms

58.8

50.0

35.3

50.0

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were even some who answered that, at present, there were no adequate sanctions against firms violating the implicit rules typical of the district. Overall, our evidence confirms that the Prato entrepreneurs are conscious of the existence of a local code of fair conduct. However, the answers referring to sanctions show that there also is some difficulty (at least contingent) in achieving full observance of those norms that are at the basis of trust as collective capital within the district. The in-depth study of Prato’s industrial district from its formation until the present time (Becattini 2001; Dei Ottati 2003b) has shown clearly that it is not just implicit rules which are important, but also formal institutions such as local government, trade associations and trade unions, which are instrumental in promoting, sustaining and reproducing the climate of high trust and social cohesion necessary for the district to be renewed over time as a dynamic local system. In his famous essay on social capital and development in the various regions of Italy, Putnam (1993) identified the ‘civic community’ – that is, patterns of civic involvement and social solidarity – as a key factor explaining the better economic performance of the regions of North and Central Italy compared with those in the South. An important element of ‘civic community’ is civil associations. Our empirical study did not aim at measuring the ‘civic community’ of Prato, however, it demonstrates that voluntary associations are widespread in the district. All firms included in our survey were members of one or more local associations. In particular, all belonged to an industrial or artisan trade association. The literature on industrial districts (Brusco and Pezzini 1990; Dei Ottati 2003a; Trigilia 1990)15 often emphasises the role of political parties, trade unions and trade associations in promoting communication and collaboration not just among their own members, but also between different groups and categories in the local system. In this context, the results of our survey show that the Prato trade associations offer services and carry out other activities which produce localised external economies, both in the area of production knowledge and in that of the rules of conduct.16 As far as production knowledge is concerned, the services most used by our entrepreneurs are those related to vocational training (84 per cent of all interviewees),17 and to the organisation of trade fairs (53 per cent). On the other hand, regarding the policing of the observance of the implicit rules of the district, entrepreneurs mainly use the following services: settlement of disputes in relations between firms and between management and workers, the definition of standards for business relations and the reporting of unfair conduct. The set of services and activities just mentioned shows that local trade associations can play an important role in reproducing trust as collective capital. Indeed, they can help the reputation mechanism to function properly, as through participating in

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member activities, local entrepreneurs can be quickly informed of the conduct of anyone in the district business community. And this re-enforces the negative and positive effects of person’s/firm’s reputation which, as we have seen, is fundamental to ensuring respect for the rules of reciprocity.

INTERPRETING THE SURVEY RESULTS The main results of our survey are in accordance with the theoretical literature on industrial districts. The enterprises are specialised and small in size. Subcontracting is a structural feature and both final and phase firms have an extensive network of mainly local subcontractors or customers (depending on the respective firm) with whom they have been working regularly for several years. Moreover, the non-simultaneous exchange of obligations (such as information, technical assistance and other forms of help) and the use of voluntary associations are widespread. We also found confirmation that entrepreneurs are aware of the existence of local customs of fair competition. On the whole, these findings suggest that Prato retains the economic, social and institutional features of an industrial district. However, our survey also shows that the trust of subcontractors in their local ordering firms currently is rather low. Furthermore, there appear to be difficulties with regard to the ability adequately to sanction people or concerns violating the implicit rules of fair behaviour. How, then, does one explain these signals of unease? It is very important to understand their origins in order to intervene properly and restore a climate of high trust among district firms and among all local individual and collective actors, as the competitive advantage of district firms is based on trust. Our empirical research, even though not focused on external links, has highlighted that current relations between Prato final firms and their clients scattered throughout the world are more conflicting than collaborative. This is partly due to the prolonged international recession. But it also seems partly related to the broad process of globalisation, which, among other changes,18 has brought about reorganisation and concentration in the clothing and distribution sectors. On the one hand, this has reduced the total number of buyers of textile products and, on the other hand, it has increased the size of those who have remained. This has strengthened the market power of those who demand textile products over those who offer them. Moreover, clothing companies, the direct clients of Prato final firms, in their turn often receive orders from big distributing chains, which unilaterally establish the method of purchase, the time and place of delivery, as well as the prices of the goods purchased. Additionally, multinational fashion groups ever more frequently buy textiles directly from developing countries, where they have outsourced

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the production of a growing quantity of garments, marketed under their own brands. These external changes, combined with the international slump, seem to have reduced the market power of many district final firms to the point of triggering a cut-throat competition among them. Considering the way in which production in the district is organised, all this has resulted in a progressive reduction in the rates paid to local subcontractors, an extension of terms of payment and an increase in objections made by external clients to the Prato final firms, and from the latter to local subcontractors. Not surprisingly, therefore, this situation tends to erode trust between Prato firms, in particular the subcontractors’ trust in their buyer firms, and above all, the trust based on respect for the local code of fair competition, which is distinctive of the district form of organisation.

CONCLUSIONS: CONSCIOUS LOCAL GOVERNANCE AS RESPONSE TO GLOBAL PRESSURE One of the most important trends in the world economy in recent years has been the globalisation of economic activity. World trade, direct foreign investment and foreign portfolio investments, for example, have all grown significantly, as have distant labour migrations. The globalisation of production and trade has been accompanied by the decentralisation of multinational firms, which have found it advantageous to outsource (especially in developing countries) an increasing share of their non-core activities. To some (for example, Amin 1994), globalisation is essentially threatening local development and industrial districts. Actually, if rationally and properly managed, globalisation may also be turned into an opportunity for the renewed economic and social growth of established industrial districts and for local development in general. This is so because the competitive advantage of districts depends crucially on factors that the very process of globalisation has made more rather than less important. As highlighted by Alfred Marshall, those factors are to a large extent the outcome of the ‘industrial atmosphere’, that is, of the collective capital of skills, trust and institutions, which, being embedded in the local fabric of social and economic relations, is substantially immobile (Marshall 1923, pp. 283–7). Therefore, such an atmosphere is much more valuable now than in the past, precisely because globalisation and progress in transport and information technologies have drastically reduced any advantage linked to the possession of easy transferable factors.19 Moreover, the heightened market uncertainty and the increased demand for product variation and innovation in many sectors have made the capacity for quick adaptation and continuous

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differentiation, characteristic of dynamic industrial districts, ever more critical for competitiveness. In spite of that, the findings of our survey on trust in the Prato district are not entirely reassuring. The asymmetry in trust relations between final firms and phase firms is, together with some signals of difficulties in enforcing compliance with district rules of reciprocal co-operation, somewhat troubling.20 Those signals might simply be the effect of a prolonged slump. But this may not be the case, if, let us suppose, the cut-throat competition in district markets is mainly due to structural changes in the external world linked to the general process of globalisation. In the latter case, global pressure will not cease with the international recovery of demand but, on the contrary, will continue, eroding local profits (both of phase and final firms) and wages, and ultimately it will also destroy belief in the benefits of mutual co-operation. All that would lead to the breakdown of trust and, consequently, to the decline of the district as a dynamic socio-economic system,21 unless local people intervene with a conscious collective action aimed at reproducing competitiveness in the new conditions. In order to regenerate over time an ‘industrial atmosphere’ (and trust which is a crucial part of it), the ‘semi-automatic’ mechanisms of adjustment characteristic of the district (that is, competition combined with customs of co-operation in local markets, see Dei Ottati 1991) are not sufficient in the face of important external challenges, but conscious local governance is needed. By conscious local governance we mean, first, the capacity to imagine a new feasible path of local development and, secondly, the ability to organise a consensus between the various local actors: the principal categories in the district (both phase and final entrepreneurs and workers), as well as trade associations, trade unions, local government, and other relevant bodies (public and private). In a recent paper (Dei Ottati 2003a), we called this sort of governance ‘extraordinary concertation’, in order to distinguish it from ‘normal concertation’, which is mainly concerned with the regulation of local industrial relations in a broad sense, that is, including both employment and supplier relationships. While ‘normal concertation’ has the function of maintaining a climate of co-operation within the district during a period of regular change, and hence of semi-automatic adaptation, ‘extraordinary concertation’, or conscious collective action, is a device to face up to major external challenges, which require deliberate intervention in order for the local system to be able to adjust effectively. As a matter of fact, in the latter case, incremental innovation in products and processes, deriving from the semi-automatic adaptation typical of district firms, may not be enough to restore the competitiveness of the local system, as demonstrated by the Sinos Valley (Brazil) case cited by Schmitz (2001).22 We repeat that what is needed, in order to have the chance to turn globalisation into an opportunity for more

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general growth and well-being, is a deliberate collective action devised to reach a new common vision of the future development of the district as a whole, and not just of a part of it.23 This, of course, requires a new social pact and it often involves institutional innovation, making political action necessary, particularly in mediating local conflicts, so that, together with new localised external economies, a sense of common identity and purpose can be promoted or re-created.24 Finally, in our view, conscious local governance is not simply a means of reproducing the districts’ competitive advantage in response to major challenges. On the contrary, it is seen as a possible starting point towards the difficult but necessary goal of attaining a more conscious global co-ordination, as we think that the future of humankind cannot be left exclusively to the powerful, but short-sighted, forces of the global market competition.25

NOTES 1.

2. 3. 4. 5. 6. 7. 8. 9.

10.

11.

In this contribution I use the results of the Italian research within an international project sponsored by the Volkswagen Foundation, titled ‘Entrepreneurial strategies and trust. Structure and evolution of entrepreneurial behavioural patterns in “low trust” and “high trust” environments of East and West Europe’. I wish to thank all the participants in the project for the discussions we had during the various meetings and the participants at the final international conference held at the University of Bremen on 26 and 27 September 2003. A previous version of this paper also was presented to the international conference in honour of Professor Sebastiano Brusco on ‘Clusters, industrial districts and firms: the challenge of globalization’ held at the University of Modena on the 12 and 13 September 2003. I am also grateful to Luigi Burroni, Colin Crouch and Giovanni Solinas for reading and commenting on a first draft of the paper. I alone am responsible for any remaining error. Exceptions are Belussi and Caldari (2003) and Pendenza (2000). Our distinction between trust as collective and as personal capital is similar to that introduced by Lyons and Mehta (1997) between socially oriented trust and self-interested trust. The production process of a localised industry is subdivided into phases and more generally into specialised activities carried out by formally independent firms that are, actually, economically interdependent. See Becattini (1990, pp. 40–41). On the process of subdivision of labour in industrial districts, see Becattini (2003, pp. 4–5). On industrial districts as creative milieux, see Becattini (1991). On the events that gave rise to the Prato industrial district, see Dei Ottati (1994b). On the evolution of the Prato district from the 1950s to the 1980s, see Becattini (2001), Dei Ottati (2003b). Because of the division of labour among local firms, it is useful to distinguish between district final firms and district phase firms. Final firms are those specialised in the design and marketing of district products, while phase firms are specialised in one or more phases of the production process typical of the district. The final entrepreneurs we interviewed included eight producers of fabrics, six producers of yarns and knitwear, three producers of special textiles and one producer of clothing. The phase entrepreneurs we interviewed included 13 weavers, five spinners, five specialised in either winding and reeling or in warping, and four specialised in finishing and dyeing. In our survey 70 per cent of phase firms and 39 per cent of final firms employ less than 20 workers.

Global competition and entrepreneurial behaviour in industrial districts 12. 13. 14. 15. 16. 17.

18.

19. 20. 21.

22.

23.

24. 25.

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On the tendency of district firms to grow externally by networking and building teams of enterprises, see Becattini (2001) and Dei Ottati (2003a). Competence trust can be defined as the expectation that the other party should possess the competence necessary to adequately fulfil the job required. Goodwill trust is the presumption that, given the chance, the other party will not take unfair advantage. It therefore goes beyond the expectation of mere respect of the formal agreement. On the role of intermediate institutions in local development, see Arrighetti and Seravalli (1999). On Marshallian external economies, see Bellandi (2003). Vocational training courses offered by the Industrialists’Association of Prato include several fields: from the analysis of budgets to the study of textile processes, from marketing to management, from finances to client relations and from new information technologies to the study of foreign languages. On recent changes in several Italian industrial districts (large-scale immigration from culturally distant countries, relocation of manufacturing activities, emergence of larger firms), which appear to be more or less induced by globalisation, and on the consequences of those changes for local governance, see Mistri (2002). On the increased importance of localised factors such as trust and tacit skills for competitiveness in a globalised economy, see Maskell (2000). See also Benko and Pecqueur (2003). On the role that informal rules have in creating the conditions for trust relations in industrial districts, and how changes in the relative power of the local firms may weaken trust, see Farrell and Knight (2003). On the decline of the Midlands hosiery industry due to unbridled price competition in the local system which had destructive consequences, such as the lowering of product quality, the de-skilling of labour and the stagnation of technical progress and innovation, see Wilkinson and You (1993). Under the pressure of global competition the footwear firms of the Sinos Valley cluster were able to increase the inter-firm co-operation necessary to upgrade products. However, the lack of an adequate political mediation caused the failure of the so called ‘Shoes from Brazil Programme’. This was a project of intervention aimed at repositioning the cluster internationally, by the creation of a recognisable image and the shift from production to design and marketing. See Schmitz (2001). On the necessity for deliberate collective action from local bodies to reproduce the competitive advantage of industrial districts and local systems of small and medium-sized enterprises in general, see Dei Ottati (2003a), Schmitz (2001). Henton (2001), for example, shows how the Silicon Valley has been able to maintain the competitiveness of its enterprises over decades, thanks to the capacity of finding ever new ways to organise collective action. In particular, to tackle the new and more complex problems of the twenty-first century, a work group made up of leaders from businesses, local administrations and experts has been instituted. This group has drawn up a general programme of what Silicon Valley should be in 2010. In order to carry out this programme, the Silicon Valley Civic Action Network has been created, with the specific task of promoting civic engagement around the economic, social and territorial goals of the Silicon Valley Programme 2010. On a case in which political action and specifically a territorial pact has promoted a common vision of local development and trust relations among local actors in Central Italy, see Burroni, Chapter 16 in this volume. On the governance of globalisation, see The World Commission on the Social Dimension of Globalization (2004).

REFERENCES Amin, Ash (1994), ‘Holding Down the Global’, in Ash Amin and N. Thrift (eds), Globalization, Institutions and Regional Development in Europe, Oxford: Oxford University Press, pp. 257–61.

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Arrighetti, Alessandro and Gilberto Seravalli (eds) (1999), Istituzioni intermedie e sviluppo locale, Roma: Donzelli Editore. Becattini, Giacomo (1990), ‘The Marshallian Industrial District as a Socio-economic Notion’, in Frank Pyke, Giacomo Becattini and Werner Sengenberger (eds), Industrial Districts and Inter-firm Co-operation in Italy, Geneva: International Institute for Labour Studies, pp. 37–51. Becattini, Giacomo (1991), ‘The Industrial District as a Creative Milieu’, in Georges Benko and Mick Dunford (eds), Industrial Change and Regional Development, the Transformation of New Industrial Spaces, London: Belhaven Press, pp. 102–14. Becattini, Giacomo (2001), The Caterpillar and the Butterfly. Prato in a Changing World 1954–1993, Firenze: Le Monnier. Becattini, Giacomo (2003), ‘From the Industrial District to the Districtualisation of Production Activity: Some Considerations’, in Fiorenza Belussi, Giorgio Gottardi and Enzo Rullani (eds), The Technological Evolution of Industrial Districts, Boston, MA: Kluwer Academic, pp. 3–17. Becattini, Giacomo and Enzo Rullani (1996), ‘Local Systems and Global Connections: the Role of Knowledge’, in Francesco Cossentino, Frank Pyke and Werner Sengenberger (eds), Local and Regional Response to Global Pressure: The Case of Italy and its Industrial Districts, Geneva: International Institute for Labour Studies, pp. 159–74. Bellandi, Marco (2003), ‘Some Remarks on Marshallian External Economies and Industrial Tendencies’, in Richard Arena and Michel Quéré (eds), The Economics of Alfred Marshall. Revisiting Marshall’s Legacy, Basingstoke: Palgrave Macmillan, pp. 240–53. Belussi, F. and K. Caldari (2003), ‘Fiducia cooperazione nei processi di distrettualizzazione’, Sviluppo locale, 10 (23–4), 52–81. Benko, Georges and Bernard Pecqueur (2003), ‘Sous la globalisation, le poids des territoires’, Sciences Humaines, numéro spécial (2), 120–23. Brusco, Sebastiano (1995), ‘Local Productive Systems and New Industrial Policy in Italy’, in Arnaldo Bagnasco and Charles Sabel (eds), Small and Medium-size Enterprises, London: Pinter, pp. 51–68. Brusco, Sebastiano (1999), ‘The Rules of the Game in Industrial Districts’, in Anna Grandori (ed.), Inter-firm Networks Organization and Industrial Competitiveness, London: Routledge, pp. 17–40. Brusco, Sebastiano and Mario Pezzini (1990), ‘Small-scale Enterprise in the Ideology of the Italian Left’, in Frank Pyke, Giacomo Becattini and Werner Sengenberger (eds), Industrial Districts and Inter-firm Co-operation in Italy, Geneva: International Institute for Labour Studies, pp. 142–59. Burroni, Luigi (2005), ‘Local Policies and Trust Relations: The Case of the Vato Territorial Pact’, Chapter 16 in this volume. Dei Ottati, Gabi (1991), ‘The Economic Bases of Diffuse Industrialisation’, International Studies of Management and Organisation, 2 (1), 53–74. Republished in G. Becattini, M. Bellandi, G. Dei Ottati and F. Sforzi (eds) (2003), From Industrial Districts to Local Development: An Itinerary of Research, Cheltenham, UK, and Lyme, USA: Edward Elgar, pp. 73–94. Dei Ottati, Gabi (1994a), ‘Trust, Interlinking Transactions and Credit in the Industrial District’, Cambridge Journal of Economics, 18 (6), 529–46. Dei Ottati, Gabi (1994b), ‘Prato and its Evolution in a European Context’, in Robert Leonardi and Raffaella Y. Nanetti (eds), Regional Development in a Modern European Economy: The Case of Tuscany, London: Pinter, pp. 116–44.

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Dei Ottati, Gabi (1996), ‘The Economic Changes in the District of Prato in the 1980s: Towards a More Conscious and Organised Industrial District’, European Planning Studies, 4 (1), 35–52. Dei Ottati, Gabi (2003a), ‘Local Governance and Industrial Districts’ Competitive Advantage’, in Giacomo Becattini, Marco Bellandi, Gabi Dei Ottati and Fabio Sforzi (eds), From Industrial Districts to Local Development: An Itinerary of Research, Cheltenham, UK, and Lyme, USA: Edward Elgar, pp. 184–209. Dei Ottati, Gabi (2003b), ‘Exit, Voice and the Evolution of Industrial Districts: The Case of the Post-World War II Economic Development of Prato’, Cambridge Journal of Economics, 27, 501–22. Farrell, G. and J. Knight (2003), ‘Trust, Institutions, and Institutional Change: Industrial Districts and the Social Capital Hypothesis’, Politics and Society, 31 (4), 537–66. Henton, Douglas (2001), ‘Lessons from Silicon Valley: Governance in a Global Cityregion’, in Allen J. Scott (ed.), Global City-regions: Trends, Theory, Policy, Oxford: Oxford University Press, pp. 391–400. Istituto Nazionale di Statistica (ISTAT), Census of Industries and Services, 1951, 1961, 1971, 1981, Rome: ISTAT. Lorenz, Edward H. (1992), ‘Trust, Community and Cooperation: Toward a Theory of Industrial Districts’, in Michael Storper and Allen J. Scott (eds), Pathways to Industrialization and Regional Development, London: Routledge, pp. 195–204. Lyons, B. and J. Mehta (1997), ‘Contracts, Opportunism and Trust: Selfinterest and Social Orientation’, Cambridge Journal of Economics, 24, 239–57. Marshall, Alfred (1923), Industry and Trade, 4th edition, 2 vols, London: Macmillan. Marshall, Alfred (1961), Principles of Economics, 9th edition, 2 vols, London: Macmillan. Maskell, Peter (2000), ‘Social Capital, Innovation, and Competitiveness’, in Stephen Baron, John Field and Tom Schuller (eds), Social Capital: Critical Perspectives, Oxford: Oxford University Press, pp. 111–23. Mistri, Maurizio (2002), ‘Globalizzazione e processi di governance nei distretti industriali’, Argomenti, 4, 5–25. Pendenza, Massimo (2000), Cooperazione, fiducia e capitale sociale. Elementi per una teoria del mutamento sociale, Napoli: Liguori Editore. Putnam, Robert D. (1993), Making Democracy Work: Civic Traditions in Modern Italy, Princeton, NJ: Princeton University Press. Richardson, G. (1972), ‘The Organisation of Industry’, Economic Journal, 82, 883–96. Sako, Mari (1998), ‘Does Trust Improve Business Performance?’, in Christel Lane and Reinhard Bachmann (eds), Trust Within and Between Organisations, Oxford: Oxford University Press, pp. 88–117. Schmitz, Hubert (2001), ‘Local Governance and Conflict Management: Reflections on a Brazilian Cluster’, in Allen J. Scott (ed.), Global City-regions: Trends, Theory, Policy, Oxford: Oxford University Press, pp. 401–16. The World Commission on the Social Dimension of Globalization (2004), A Fair Globalization: Creating Opportunities for All, Geneva: International Labour Office. Trigilia, Carlo (1990), ‘Work and Politics in the Third Italy’s Industrial Districts’, in Frank Pyke, Giacomo Becattini and Werner Sengenberger (eds), Industrial Districts and Inter-firm Co-operation in Italy, Geneva: International Institute for Labour Studies, pp. 160–84. Wilkinson, Frank and J. You (1993), ‘A History of Destructive Competition and Aborted Cooperation: The Midlands Hosiery Industry’, manuscript.

16. Local policies and trust relations: the case of the Vato territorial pact1 Luigi Burroni NEW POLICIES FOR LOCAL DEVELOPMENT AND TRUST IN A ‘GREEN FIELD’ CONTEXT Since the mid-1970s, a growing body of research in the social sciences has highlighted the importance of processes of local development and the dynamism of industrial districts. As many researchers have demonstrated, the reasons behind the good performance of these peripheral areas can be found in a constellation of resources that had not been eroded by the Fordist model, which triggered a sort of ‘local reinterpretation’ of the process of industrialisation (Bagnasco 1977; Becattini 1987; Sabel and Zeitlin 1997; Trigilia 1986). These include, among other things, widely diffused trust, locally rooted knowhow, and a general diffusion of entrepreneurial values (Dei Ottati 1995). Furthermore, these areas were characterised by a tightly woven network of local institutional actors, including local governments, unions and employers’ associations that promoted the development of what has recently been defined as local collective competition goods (Crouch et al. 2001; 2004). The importance of these goods has increased further since the beginning of the 1990s, when the paradox related to the local roots of economic development began clearly to take shape. While globalisation increases the territorial mobility of firms, it also renders them more dependent on their immediate external context. This paradox implies that the competitiveness of the single firm and of local and regional economic systems increasingly depends on how effective local actors are – whether individual, collective, private or public – in creating co-operative agreements that not only deliver price benefits, but also boost external economies and create clear location advantages (Amin and Thrift 1995; Cooke and Morgan 1998; Porter 1998). By extension, competitiveness is also linked to the ability of local, national and European-level institutions (and policies) to promote and produce these local collective competition goods, so that there has been a sort of re-territorialising of economic, political and governmental activities (Keating 1997). Following these changes, a different kind of policy for the promotion of 272

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local socio-economic development has recently emerged in many European countries. It is based on social negotiation practices and on contractual policies, and it aims at producing the above mentioned ‘local collective competition goods’. The rise of these new policy instruments was also favoured by the recent changes promoted by the EU in many policy fields (Trubek and Zeitlin 2003). In Italy this process has led to a new season of policies, called programmazione negoziata (negotiated planning), characterised by a set of new instruments among which we find the Patti territoriali (territorial pacts), a policy instrument introduced in 1994 to promote development and create infrastructures in the backward areas of Southern Italy.2 They are local agreements between public and private partners to design and implement plans of action within industry, agro-industry, services, tourism and in local infrastructures, aiming at promoting local socio-economic development at a sub-regional level through ‘innovative forms of decentralized social dialogue, or of concertation and the joint and consensual planning of local initiatives for economic and occupational development’ (Regalia 2003). Thus, there are two main goals of these policy initiatives: on the one hand, they act in terms of labour market improvement and employment creation and, on the other hand, they promote the creation of partnerships and the achievement of ‘improved trust, coordination, understanding, influence and common purpose’ (ECOTEC Research and Consulting 2002). This is why it is important to look at the outcome of these policy instruments if we want to understand the relationship between local policies and trust creation better. Analysing a territorial pact for employment, the so-called Vato pact, carried out in the Valdichiana-Trasimeno-Amiata-Orvietano area, across Tuscany and Umbria, I investigate the capability of this policy to promote social capital and trust relations among local firms and institutions.3 After a brief description of the main characteristics of this pact, I focus on the situation prior to the territorial pact analysed here. Before the pact, the level of relational social capital as well as trust relations among local institutions of the Vato area was very low:4 local governments, in fact, ruled different local administrative units without having any kind of mutual contact. Thus, it becomes interesting to analyse briefly how and why this experiment of inter-institutional cooperation emerged. In the second part, I focus on the effect of this pact, confirming that trust and social capital have been the outcome and not the precondition of this policy. At the same time, I show that this process of trust promotion had a different impact in the institutional and economic arena. The planning and implementation of the pact supported and improved the relations – and the capabilities – of local administrations, collective organizations, and so on, promoting inter-institutional co-operative networks, while trust and cooperation among firms emerged with some difficulties. These results underline that co-operation can also emerge in the absence of

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social capital and trust. This does not confirm the hypothesis of those who suggest that trust and social capital are strongly affected by path dependency. This particular empirical case, in fact, illustrates that it is not possible to exclude the fact that previous relational assets influence trust and social capital, but at the same time co-operative networks can emerge in a greenfield context.

THE RISE OF INTER-INSTITUTIONAL CO-OPERATION The Vato territorial pact was created at the end of the 1990s on the border area between Tuscany and Umbria, in Central Italy. It includes four main areas (Valdichiana, Amiata, Trasimeno and Orvietano – Vato) that had distinct local administrations and collective organisations. The Vato pact was the first experiment of politica di area vasta (policy with a large territorial frame of reference) for this area. It is one of the largest of the Italian territorial pacts: even though there are only 210 000 inhabitants of this area, the pact covers an area of about 3000 square kilometres. According to an inclusive logic, almost all the most important local institutions participated in this pact, that is, the two regional administrations (Tuscany and Umbria), three provincial administrations (Siena, Perugia and Terni), four comunità montane5 (Amiata, Cetone, Monte Peglia and Selva di Meana, Monti del Trasimeno), 39 Municipal administrations and many other local institutions (trade unions, employers’ associations, and so on). More than 100 firms applied successfully to the first call for a total of about 630 new employees. These firms specialised mainly in tourist activities (45 per cent of the total number of firms) and in manufacturing (about 35 per cent). Furthermore, this pact included the implementation of 30 different infrastructures, with an expected increase in employment of 400 new employees. The management of this pact was delegated to a società consortile a responsabilità limitata (public/private limited liability company) – Società Patto 2000 – which runs, organises and supervises all the activities of the pacts. This company has 95 partners and a capital stock of 390 500 euros. As mentioned above, the Vato territorial pact contributed to establishing a new territorial frame of reference for local policies; the four areas involved in the pact are different administrative territorial units, with their respective local government, trade unions and employers associations. Before the pact, examples of co-operation among the actors of these four areas could be found only on minor issues (such as road and tourist signs), as an interviewee affirmed: ‘Before this experience, many of the actors who played a leading role in the implementation of this pact did not know each other.’ Thus, it is particularly interesting to note that this kind of policy, based on co-operation

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and co-ordination among public and private actors, emerged in a local context that experienced neither significant previous forms of co-operation nor substantial kinds of inter-institutional trust relations. The hypothesis developed here is that two main kinds of variables triggered the above mentioned forms of co-operation. The first is given by a set of exogenous variables that formed the precondition for the creation of the pact. The first and obvious variable is given by the introduction of new kinds of policies that allowed adoption of new territorial frames of reference. At the same time, these new policy initiatives fitted particularly well with the needs that were perceived as crucial in the Vato area, that is, promoting entrepreneurship in both more traditional and modern sectors, supporting the creation of new physical infrastructures strongly connected to local firms and activities, and promoting intangible collective competition goods such as professional training. In other words, the strand of policies of the programmazione negoziata created new room for manoeuvres of local actors and offered new opportunities for local governments and associations. These opportunities were perceived as particularly interesting by local actors of the Vato area, who started to consider the territorial pact as an instrument able to promote all the kinds of local collective competition goods that the Vato area needed. This view was also supported by the national – and European – debate around these policy initiatives. Starting from the mid-1990s, there was a growing consensus around policies based on the idea of multi-stakeholder and bottom-up partnerships at local level and on social negotiation practices, which were perceived as particularly well targeted to confront the promotion of local economic development. According to all the people interviewed in this research, this widespread consensus at national and European levels strongly influenced the point of view of many local actors, reinforcing the perception of the territorial pact as ‘the’ great opportunity to enhance the local development process of this area. Finally, it should be noted that during this period several national laws and reforms were implemented that reinforced the role played by some local governments, such as the provinces, which previously played a weak role in comparison to other local administrations. In some cases, the territorial pact became a great chance for provincial administrations to reinforce their role in the local governance set-up and to acquire major visibility. For this reason, the provinces often supported the planning and implementation of territorial pacts, playing a major role in the organisation and mobilisation of local actors. This also happened in the Vato area, where the three Provincial administrations (Siena, Perugia and Terni) played a key role in planning and implementing the Vato pact. Therefore, the growing attention and consensus on policies for local development, the experiment of negotiated planning policies and the process of

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decentralisation towards some local administrations represented three exogenous conditions that favoured the implementation of the territorial pact in the Vato area. Nevertheless, these exogenous elements tell us only part of this story. If we want to understand how this form of greenfield co-operation emerged, it is necessary to focus our attention also on local endogenous variables. The first feature that should be noted is the high degree of socio-economic and political homogeneity that characterised this area. As for the socioeconomic sphere, the large Vato area is not characterised by radical internal differentiation. Thus, even if slight differences exist, it is not possible to identify a polarisation of needs and interests among the different areas of the Vato region. At the same time, it is possible to identify a high level of homogeneity on the political side, with many of the major administrations ruled by centreleft coalitions. This socio-economic and political homogeneity favoured co-operation in a twofold process. On the one hand, it brought about the emergence of positive sum games, promoting a widely legitimised, shared and well-defined set of priorities, and lowering conflict among local actors; this favoured mobilisation around a specific policy agenda, promoting co-operation instead of conflict. On the other hand, this homogeneity favoured the rise of a new policy community, that is, a new group of actors involved in the policy process for the Vato area that played a very important role in the planning of the pact. The rise of this policy community was also favoured by a common mood that was very widespread in the area, reflected in the dominant idea that the Vato area was of marginal interest to national and regional policy-makers. In the local actors’ view, the territorial pact could modify this situation by giving major visibility to this area. Therefore, the mobilisation around the pact became the way to claim attention and funds from regional and national administrations, and this priority contributed to smoothing the path towards the avoidance of possible conflicts. Last but not least, the important role played by some local political entrepreneurs should be considered, especially some representatives of the provincial administrations, trade unions and the comunità montane: they were actors with different professional backgrounds but who immediately perceived the pact as a great opportunity to produce a radical shift towards a local governance model able to combine all the needs of this area. These actors favoured the co-operation and the creation of the pact, mobilising all the local institutions and firms that might be interested in joining the pact. In this sense they had a key role in the promotion of the above mentioned new policy community, thus becoming the pillars of this community. Summing up, exogenous and endogenous variables also favoured the rise of co-operation in a context in which trust relations among institutions were

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almost absent. What is particularly interesting is that in this case study, trust relations and inter-institutional co-operation emerged during the process of planning and implementing this policy initiative, so that it seems possible to affirm that trust and social capital have been more the result of the process of co-operation than a prerequisite. Nevertheless, it is necessary to draw a clear distinction among the different kinds of trust promoted by this policy experiment, analysing in more detail its impact and distinguishing between the effects on local institutions and on local firms.

THE IMPACT OF THE VATO TERRITORIAL PACT Many of the policies set up under the Programmazione negoziata umbrella aim at reinforcing the local economy through the improvement of the capability of local authorities to promote local development. Thus, any evaluation of these experiences has to take into account their impact on the local governance architecture. For this reason, I start with the institutional impact of the pact, showing that the planning and implementing phases of this pact directly influenced the process of change introduced in the previous paragraph. After that, I focus on the economic impact of this policy. In this way a sort of a paradox will emerge: the pact improved the ability of local governments and collective organisations to promote local development, it promoted trust relations between public and private administrations, and fostered the emergence of institutional learning. But, at the same time, it has partly failed to foster a radical shift in local productive organisation, being unable to modify profoundly either the productive or the relational features of local firms. This twofold analysis will allow the development of some hypotheses on the advantages and shortcomings of this kind of policy. The first outcome that should be noted is related to the mobilisation of a large group of local actors around a shared project of local development. In the previous paragraph we saw that some local leaders contributed to starting the pact in the Vato area. The consequent activity of planning and implementing the pact contributed to reinforcing the ties among these political entrepreneurs creating a group and, at the same time, this group started to incorporate new actors, so that a new local policy network emerged. Actors from this network increasingly focused their attention upon the territorial rather than the sectorial dimension of local policies, confirming the rise of a new territorial policy community (Keating and Loughlin 2002): actors and organisations that previously had little chance to co-operate started to reflect on the opportunities and constraints of the Vato area. This discursive process strengthened the common vision that constituted one of the main pillars of the new local territorial community, with an effect also clearly perceived by the local actors (common

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vision – Figure 16.1). Together with this new policy community a new territorial unit of analysis for local policies (the Vato area) emerged, radically modifying the territorial frame of reference of local economic policies. In a certain sense, it is possible to affirm that the pact promoted a new coalition for a new territory, according to a path that has been common to other similar experiences, as has been stressed by the report on the evaluation of European territorial pacts (ECOTEC Research and Consulting 2002). The rise of polycentric co-operative relations provides a second important outcome of this pact. During the pact, actors who were part of the above mentioned policy community, established purpose-oriented coalitions pursuing

commonvision capablocadm trustcollectiveorg trustpublicpriv qualityprod trustamfirms innofirms cooperationamfir 3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

Note: Innofirms: capability of firms to innovate; qualityprod: capability of firms to produce high-quality products; cooperationamfir: degree of co-operation among firms; trustamfirms: trust relations among firms; capablocadm: capability of local governments to promote local development; trustcollectiveorg: trust relations among collective organisations (bilateral bodies, employers association for small and medium firms, employers association for large firms, and so on); trustpublicpriv: trust relations between public and private actors; commonvision: emerging of a common vision of the needs, constraints and opportunities for local development. Source: data collected with a feeling thermometer (scaled 1–10: 1 absolutely negative – 10 very positive) given to all the interviewed at the end of the open-ended interview.

Figure 16.1

The impact of the Vato territorial pact

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specific objectives outside the framework of the pact. This is shown well by the President of the Comunità Montana dell’Amiata: Before the experience of the territorial pact I didn’t know the Presidents of the others three comunità montane of this area. The territorial pact – and the related activities of social negotiation – created strong links among us, which also helped us to act ‘outside’ the Pact, as is shown by the fact that all four comunità montane are now carrying out a wide series of projects funded by the European Commission and by the Ministry of the Environment. On the one hand these social relations (also underpinned by trust and friendship) were fostered by the territorial pact and on the other hand they contributed to reinforcing the network of actors related to the pact.

Thus, the pact fostered the rise of flexible and purpose-oriented ties among actors and organisations devoted to carrying out specific purposes such as preparing an application for some EU line of funding, creating a specific physical infrastructure and producing some kinds of local collective competition goods, and so on. Thus, it seems possible to affirm that a positive sum game in terms of trust creation emerged with the pact. The third important outcome of this pact is related to the promotion of institutional learning and to the improvement of the capability to plan and coordinate economic policies (Sabel 1994). Many actors underlined that in planning and implementing the pact, they learnt to create integrated policies for local development. The experience of the pact forced us to plan and implement a project for local development, in a long term perspective and with high integration between public and private investments. Thanks to this experience, many of us acquired new skills and changed our outlook on how to sustain local economic development

said a local government official. This learning process improved the capability of local governments supporting the introduction of relevant innovations. One such example is given by the setting up of specific procedures in order to simplify local public administration (such as the so-called sportello unico per le imprese). Another example refers to the setting up of offices dedicated to the promotion of local development in municipal and provincial administrations, with a subsequent programme of recruitment and training of highly skilled human resources. But the most important change is related to the improvement in the capability to plan and implement tangible and intangible public infrastructures closely related to private investments: ‘With the experience of the pact we learnt to integrate and co-ordinate public investments and to link them to the needs of the firms,’ said one interviewee. These and other innovations contributed to the capability of local administrations, as many interviewees perceived a strong improvement in the effectiveness of local administrations in fostering local economic development (Figure 16.1 – capablocadm).

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Trust and entrepreneurial behaviour in mature market economies

Related to the above mentioned change, many local actors also perceived a general growth of trust among local government and private actors (trustpublicpriv) and among collective organisations (trustcollectiveorg). At the same time, they noticed significant improvements in the relationships among local government, private actors and trade unions (relwithunions). Summing up, it is possible to affirm that the carrying out of the pact fostered a further change in the local governance model. A new territorial frame of reference for local economic policies emerged, new coalitions of local actors started to play a major role, a new vision of the world surfaced among local policy-makers, and trust relations among public and private actors were consolidated, and so on. This picture resembles that proposed by the optimistic strand in the literature that emphasises the importance of discursive policies, the effectiveness of experiments in local deliberative democracy and the competitiveness of an associational economy model. However, looking at the economic impact of the pact, both light and shadows emerge. The first thing that should be noted is that this territorial pact triggered new private entrepreneurship in several sectors. The data in Table 16.1 highlight the kind of private initiatives promoted by the pact. As can be seen, a large amount of private initiatives were approved in tourism and the majority of these promoted the creation of new plant; these projects were medium to large, as is shown by the amount of public contribution (tourism accounts for 45 per cent of total initiatives and for 55 per cent of the total Table 16.1 Private initiatives funded by the territorial pact (September 2002)

Alimentary and agro-industrial production Industry and manufacturing Services Tourism and agriturismo Total Source:

Number of projects of private firms

New plants

% of projects per sector

% of new plant of the total per sector

% of public funds per sector

14

9

12.8

64.3

22.0

39 7

21 3

35.8 6.4

53.8 42.9

17.0 6.0

49 109

30 63

45.0 100.0

61.2 57.8

55.0 100.0

Data processed from the Patto2000 archive.

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public contribution). As for manufacturing activities, this sector represents about one-third of the total number of private initiatives, with SMEs and new plants that played an important role. These positive results have been associated with the effectiveness of the pact in sustaining both tangible and intangible positive externalities. As for the former, the integration between public and private investments should be noted. Most of the public infrastructure of this pact (70 per cent) resulted in being strictly related to the investments of private firms, and this integration is greater with regard to the tourist sector. The setting up of public infrastructure directly targeted to the demands of the local economy had an obvious and direct positive impact on the local economy, reinforcing the competitive advantage of local firms. At the same time, it also had an indirect positive cognitive impact on local economic actors, as it reinforced the idea that local institutions believed in the project of local development carried out with the pact, which in turn contributed to the mobilisation of local entrepreneurial resources, favouring the birth of new firms. As for the latter, some entrepreneurs underlined that the pact had a positive effect not only because it contributed to private firms’ investment, but also because it brought about some important intangible external economies such as trust and local reliability. As one local entrepreneur said: ‘Being part of the pact represented a sort of guarantee, a reliability certified by local institutions, and this is a good competitive advantage for a firm.’ Nevertheless, even if the pact enabled some positive externalities, a significant number of private initiatives failed: as we can see in Table 16.2, 42 private projects failed and only 38 projects out of 109 were completed or were in their final phase in September 2002. However, only a small part of the public infrastructure failed definitively, even if a large number of them were delayed. Furthermore, the experience of the pact was not able to promote the rise of new networks and ties between local firms. Table 16.2 State of the art of private and public initiatives (September 2002) Firms Number of Public initiatives contribution €000s Number of projects Projects cancelled Projects in the final phase Completed projects Deferred projects Non-deferred projects Source:

109 42 24 14 16 13

32 600 14 700 4 700 4 550 7 280 1 333

Data processed from the Patto2000 archive.

Infrastructures Number of Public funds initiatives €000s 30 3 2 5 18 2

139 169 186 1 264 10 433 372

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Trust and entrepreneurial behaviour in mature market economies

Thus, any evaluation of the economic impact of the Vato pact requires a high degree of caution. While it promoted the rise of new private initiatives and entrepreneurship in a region that was not characterised by high economic dynamism, some of these initiatives failed and others seem to have faced significant delays in being created. The paradox given by the positive effects on the local governance system and the ambiguous impact on the local economic scene remains to be explained. Here I try to identify some elements and processes that can help to explain this paradoxical path. The first is related to the temporal decoupling between external economies produced by the pact and the needs of the new small firms promoted by this policy. Public investment devoted to producing local collective competition goods had relevant delays in their creation so that private entrepreneurship, especially in small-scale companies, has been unable to benefit from the external economies promoted by the pact. At the same time, many of the positive externalities produced by the pact (promotion of trust relations, learning processes, and so on) emerged during the pact. This means that they started to produce positive outcomes when it was probably too late for some SMEs. This decoupling can also explain why some large firms had better results: they had larger autonomous resources so that they could fill the time lag between the beginning of the pact and the availability of positive externalities. A second element is strictly related to the first, as it concerns the structure of the Società Patto 2000 that managed the pact. This organisation, in fact, only had very limited financial and human capital resources (two people plus the president). Considering the fact that the administrative management of the Italian territorial pact is quite complicated, the structure of the Società Patto 2000 was too weak to set up a regular – and important – service of support for newly founded firms and to create services for local development. A third factor is related to the rise of organisational inertia. The new governance architecture based on a new territorial frame of reference was challenged by the organisational structure of local public and private organisations. They have a large number of functions that continue to be organised based on the previous administrative territorial unit of reference. This obviously contrasts with the logic of the new territorial frame of reference promoted by the pact, thus introducing a sort of institutional inertia that hindered a definitive reshaping of local governance according to the direction promoted by the Vato pact. This tendency, common to many Italian territorial pacts, was particularly important in the Vato area, which is characterised by a large number of local administrations and organisations. Fourth, at the end of the 1990s there was an important turn in the above mentioned national debate on territorial pacts at national level: after an initial period of a-critical consensus around this policy initiative, the mobilisation around these policies strongly declined and many underlined that the so-called

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programmazione negoziata should have been replaced by direct incentives for firms. This process had a negative influence on the implementation of many Italian territorial pacts (Magnatti et al. 2003), creating a sense of ‘being abandoned’ by the higher levels of regulation. At the same time, recent developments in regional policies in Italy have supported the so-called progetti integrati territoriali and the devolution of the organisation of local policies to the regional administration. This could have significant effects on a pact that comprises two different regional administrations, radically changing its structure and aims. Thus, the weak institutionalisation of this area as a territorial unit of policy together with the rising critique of the programmazione negoziata could give rise to uncertainty about the future of the pact, weakening this policy initiative and its effect on the local economy.

CONCLUSIONS Summing up, the experience of the Vato territorial pact offers two lessons that are useful in understanding trust relations and the rise of co-operative networks. The first is that co-operation and effective partnership among public and private actors can also emerge in the absence of trust and social capital. A similar process has been shown by a recent evaluation of European employment pacts (Ecotec Research and Consulting 2002, p. III): In areas with a multitude of pre-existing partnerships and other agencies involved in employment policies at local level, Pacts had little to offer in terms of institutionbuilding. In areas that lacked a tradition of partnership-oriented co-operation in the field of labour-market interventions, the creation of the Pacts had the potential of contributing substantially to the development of partnership abilities.

Thus, the promotion of trust can be supported by policy initiatives such as territorial pacts that promote co-operation practices based on bottom-up and broad partnership, able to support various processes of learning. This seems to be particularly true under certain conditions that can help this process. In particular, I have distinguished between exogenous and endogenous variables. In the Vato case, the presence of common understanding widespread in the four local areas involved in the pact, the presence of a local policy community and of a small group of local political entrepreneurs favoured the rise of inter-institutional co-operation based on trust relations. This policy experience represented a major change in the policy paradigm for this area, with a shift from local government models (based on the isolated action of local public institutions) to local governance models (based on a partnership approach) and with the emergence of a new territorial frame of reference for local policies.

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However, it should be noted that this pact also has some weaknesses. Looking at the economic arena, we have already mentioned that the pact has had a weak impact on the promotion of trust relations and networks among local firms. At the same time, even if better results have been achieved in the institutional sphere, in this case too some problems need to be solved. First, it is not very clear what the role of the new territorial frame of reference will be after the experience of the Vato pact. Second, local actors do not seem to have a common position on how trust relations and social capital will be promoted in the absence of the Territorial pact line of funding. Third, it is not clear what mechanisms will replace the co-ordination and mobilisation previously activated by local individual political entrepreneurs. Therefore, it seems possible to affirm that if support for local development is still one of the priorities for this territorial area, and if it is easier to destroy rather than promote trust relations, solving the above mentioned points of weakness acquires major relevance for the Vato area.

NOTES 1.

The author of this contribution has used data coming from a larger project funded by the Italian Ministry of Treasury – Department for Development Policies. He thanks the Department for the support obtained during the research. This project has been co-ordinated by Piera Magnatti, Francesco Ramella, Carlo Trigilia and Gianfranco Viesti, and its main results can be found in the report ‘La lezione dei patti territoriali per la progettazione integrata nel Mezzogiorno’, downloadable at www.dps.tesoro.it. The author benefited also from presenting a draft of this chapter at a seminar organised at the European University Institute, where Fabrizio Cafaggi, Colin Crouch, Donatella Della Porta, Bob Hancke and Adrienne Heritier gave particularly useful suggestions. 2. On the Italian territorial pacts see Barbera (2001), Cersosimo (2000), Cersosimo and Wolleb (2001), Freschi (2001), Trigilia (2001a) and Magnatti et al. (2003). 3. The results presented here are obtained with the analysis of secondary data from different sources, 19 open-ended interviews and one focus group. 4. On the relation between trust, social capital and local development see Trigilia (2001b) and Farrell and Knight (2003). 5. The comunità montana is a territorial administrative unit that gathers a variable number of municipalities.

REFERENCES Amin, A. and N. Thrift (1995), ‘Globalisation, Institutional Thickness and the Local Economy’, in P. Healey, S. Cameron, S. Davoudi, S. Graham and A. Mandani-Pour (eds), Managing Cities: The New Urban Context, Chichester: John Wiley, pp. 92–108. Bagnasco, A. (1977), Tre Italie. La problematica territoriale dello sviluppo italiano, Bologna: il Mulino. Barbera, F. (2001), ‘Le politiche della fiducia. Incentivi e risorse sociali nei Patti territoriali’, Stato e Mercato, 3, 413–49.

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Becattini, G. (ed.) (1987), Mercato e forze locali: il distretto industriale, Bologna: il Mulino. Cersosimo, D. (2000), ‘I Patti territoriali’, in D. Cersosimo and C. Donzelli (eds), Mezzo Giorno. Realtà, rappresentazioni e tendenze del cambiamento meridionale, Rome: Donzelli, pp. 209–50. Cersosimo, D. and G. Wolleb (2001), ‘Politiche pubbliche e contesti istituzionali. Una ricerca sui Patti territoriali’, Stato e Mercato, 3, 369–412. Cooke, P. and K. Morgan (1998), The Associational Economy, Oxford: Oxford University Press. Crouch, C., P. Le Galès, C. Trigilia and H. Voelzkow (eds) (2001), Local Production Systems in Europe: Rise or Demise? Oxford: Oxford University Press. Crouch, C., P. Le Galès, C. Trigilia and H. Voelzkow (eds) (2004), Changing Governance of Local Economies: Responses of European Local Production Systems, Oxford: Oxford University Press. Dei Ottati, G. (1995), Tra mercato e comunità: aspetti concettuali e ricerche empiriche sul distretto industriale, Milan: FrancoAngeli. ECOTEC Research and Consulting (2002), ‘Thematic Evaluation of the Territorial Employment Pacts’, website: http://www.europa.eu.int/comm/regional_policy/ sources/docgener/evaluation/doc/tep_report1.pdf. Farrell, H. and J. Knight (2003), ‘Trust, Institutions and Institutional Change: Industrial Districts and the Social Capital Hypothesis’, Politics and Society, 4, 537–66. Freschi, A.C. (2001), ‘Capitale sociale, politica e sviluppo locale. L’esperienza dei Patti in Toscana’, Stato e Mercato, 3, 451–86. Keating, M. (1997), ‘The Invention of Regions: Political Restructuring and Territorial Government in Western Europe’, Environment and Planning C: Government and Policy, 15, 383–98. Keating, M. and J. Loughlin (2002), ‘Territorial Policy Communities and Devolution in the United Kingdom’, EUI Working Papers, SPS no. 2002/1, Florence: EUI. Magnatti, P., F. Ramella, C. Trigilia and G. Viesti (2003), ‘La lezione dei Patti territoriali per la progettazione integrata territoriale nel Mezzogiorno’, website: http://www.dps.tesoro.it. Porter, M. (1998), On Competition, Boston, MA: Harvard Business School Press. Regalia, I. (2003), ‘Decentralizing Employment Protection in Europe: Territorial Pacts and Beyond’, in D.M. Trubek and J. Zeitlin (eds), Governing Work and Welfare in a New Economy: European and American Experiments, Oxford: Oxford University Press, pp. 158–87. Sabel, C.F. (1994), ‘Learning by Monitoring: The Institutions of Economic Development’, in N.J. Smelser and R. Swedberg (eds), The Handbook of Economic Sociology, Princeton, NJ, Princeton University Press, pp. 137–65. Sabel, C.F. and J. Zeitlin (1997), World of Possibilities: Flexible and Mass Production in Western Industrialisation, Cambridge: Cambridge University Press. Trigilia, C. (1986), Grandi partiti e piccole imprese, Bologna: il Mulino. Trigilia, C. (2001a), ‘Patti per lo sviluppo locale: un esperimento da valutare con cura’, Stato e Mercato, 63, 359–67. Trigilia, C. (2001b), ‘Social Capital and Local Development’, European Journal of Social Theory, 4, 427–42. Trubek, D.M. and J. Zeitlin (eds) (2003), Governing Work and Welfare in a New Economy: European and American Experiments, Oxford: Oxford University Press.

Index ACORT (Association of Retailing Companies) 115–16 Albach, Horst 197 Aldrich, H.E. 240, 242 Alesina, A. 7 Almond, Gabriel A. 79 alternatives to trust 17 Amin, Ash 266, 272 Anderson, A. 44 Andreoni, J. 91 Arrighetti, Alessandro 269 Arrow, K. 198 Association of Retailing Companies (ACORT) 115–16 Association of Trade and Production Companies of Electric Durable Goods and Computers (RATEC) 115–16 associational activity, measuring 89 Atherton, A. 237 Axelrod, Robert 59, 91, 222 Bachmann, Reinhard 99, 100, 104, 105, 111, 225, 227, 231 Bagnasco, A. 272 Baker, W.E. 101 Barber, Bernard 12 Barbera, F. 284 Bardhan, P. 39 Barkema, H. 101 Barney, J.B. 101, 106 Basu, D. 241 Basu, Susanto 174 Baumol, W. 35 BBA (British Bankers Association) study 245–8, 251 Becattini, Giacomo 255, 258, 264, 268, 269, 272 Becker, G.S. 41, 44 BEEPS (Business Environment and Enterprise Performance Survey) 118

Belgium, GDP levels 66 Bellandi, Marco 269 Belussi, F. 268 Benko, G. 269 Bennett, R. 246 Berg, J. 92 Beugelsdijk, S. 67 Bielewicz, A. 207 Birley, S. 250 Bjørnskov, C. 39, 41, 55, 61, 62 Blackburn, R. 236 Blaneck, Andrea 203, 210, 213 Blois, K. 176 Bohnet, I. 32 bonding networks, trust in 43–4 Boyd, R. 27 bribees, honest 53–4, 56 bribery 146; see also corruption; informal relations bridging networks 43 Bromiley, Philip 219 Brusco, Sebastiano 255, 256, 262, 263, 264 Busenitz, L.W. 27 business conditions, for East German vs Polish entrepreneurship 210 Business Environment and Enterprise Performance Survey (BEEPS) 118 business finance Chinese entrepreneurs in UK 245 in Estonia 189–90 business support, see help sources preferences Caldari, K. 268 Canada levels of general trust 64 voluntary organisation density 66 Casson, M. 106 Caucasians, as viewed in Russia 153 CEE (Central Eastern Europe) 76; see also transition economies 287

288 Center for International Private Enterprise (CIPE) 115 Central and Eastern Europe causes of absence of trust 18–19 see also transition economies Cersosimo, D. 284 Chabal, Patrich 81 Chan, E. 242 Chang, L.-C. 26 characteristic-based trust 236 Chepurenko, Alexander 136 Child, J. 99 Chinese entrepreneurs in UK access to finance 245 case study evidence 247–9 characteristics of firms surveyed 245 population 242 use of advisers 245–7 see also immigrant entrepreneurs CIPE (Center for International Private Enterprise) 115 civic society and corruption 53 cultural component 81 see also civil society civic-mindedness, measuring 89 civil society definitions 79 and trust 79–81 trust in 42–3, 55 Coase, R.H. 60 Coleman, James S. 12, 13, 17, 40, 44, 59, 60, 114, 124, 160, 221, 228 collective trust commonalities with institutional trust 16 definitions 15, 73–4, 222 and modernisation 78 commercial courts Ukraine 157–9 commercial courts, trust in analysis data 163–7 results 167–72 theory 160–63 and business performance 167–9 determinants 169–72 see also courts, trust in; legal framework, trust in

Index communism, and trust 18–19 competence trust 261 conference, Bremen (2003) 1 confidence 74; see also institutional (one-sided) trust contract infringement 119–21; see also commercial courts, trust in; reciprocal trust contractual protections 122–3; see also sanctions Conway, Stephen 219, 239 Cooke, P. 272 Cornelssen, Inse 19 corruption and civic society 53 and GDP 45, 53 generalised trust 41–3, 55 generalised vs particularised trust 40, 50–53, 55–6 honest bribees 53–4, 56 particularised trust 43–5, 55–6 research data and methods 45–50 Russian view of bribery 146 and trust 62–3 Ukraine 158 see also informal relations Costs of Legalisation, The 115 countries, problems of classifying trust levels 33–4 courts, trust in definitions 159–60 in Russia 147 in Ukraine 172–4 see also commercial courts, trust in; legal framework, trust in Cox, J. 93 Crouch, C. 272 culture definitions 25–6 and institutional theory 26–8 as resource for trust 20 role of trust 28–9 sectoral 30–32 Cummings, L.L. 219 Curran, J. 239 Czeglédy, A.P. 99 Dakhli, M. 89 Dallago, B. 27 Daloz, Jean-Pascal 81

Index Danielson, A. 93 dark side of trust 54–6 Dasgupta, Partha 74 De Clercq, D. 89 De Soto, H. 39 deciding to trust 221 degrees of trust 16–17 Dei Ottati, Gabi 136, 255, 257, 259, 264, 267, 268, 269, 272 democracy, see participatory democracy, and corruption Denzau, A.T. 27 dictator game 94 DiMaggio, Paul 20 disembedding 9 disembedding mechanisms 9, 15 distrust methods of countering 121–8 origins of 117–21 Djankov, S. 39 Dushazky, Leonid 136 Dyer, Jeffrey H. 219 East Germany business conditions 210 entrepreneurial co-operation 204–6 entrepreneurs’ perceptions 203–4, 210–12 Eastern Europe data reliability 67 social capital comparison with the West 64–7 transition, and research into trust 8 see also Central and Eastern Europe economic performance, and trust 88–9, 92–4 Edwards, B. 79, 80 Eggertsson, Thrainn 115 Ehrenberg, John 80 Eisenstadt, S.N. 75, 77 EMBs (ethnic minority businesses), see Chinese entrepreneurs in UK; immigrant entrepreneurs employee selection Chinese entrepreneurs in UK 247–8 Russia 144–6 employees lending money to 143–4 relations with employers 184–5 trust in 144–6

289

Endreß, Martin 8 entrepreneurial behaviour, and culture 35–6 entrepreneurial co-operation East Germany 204–6 West Poland 208–9 entrepreneurial perceptions East Germany 203–4, 210–12 West Poland 207–8, 210–12 entrepreneurs backgrounds 138–9 as potential bribe-payers 39–40 Erikson, Erik H. 11 Estonia entrepreneurship environment 176–7, 192–4 help sources preferred 185–9 market reform 178–9 reliance on personal trust 34 SME relationships with authorities 189–92 SME relationships with business counterparties 179–84 SME relationships with employees 184–5 voluntary organisation density 66 ethnic minorities, see immigrant entrepreneurs exchange networks in centrally planned economies 100–102 definitions 239 role of trust 104–5 in Russia 124–5 taxonomy of 108–9 in transition economies 102–3, 109–11 transparency vs opaqueness 106–9 expectation, definition 12 experience, as source of trust 20–21 expert systems, as disembedding mechanism 9 Fabbri, Daniela 160 face-to-face interaction 59–60 Fadahunsi, A. 242 family networks, see kinship networks Farrell, G. 269 Farrell, H. 284 Fehr, E. 93

290 Feinman, Jay M. 157 Filatotchev, I. 100, 106 finance, see business finance Fisman, Raymond 62 Fligstein, Neil 115, 129, 131 Foley, M.W. 79, 80 foreign business partners, Russian view 119 formal institutions, need for 60 Forschungsstelle Osteuropa an der Universität Bremen, conference (2003) 1 Frambach, Hans 11, 219, 220 France, levels of general trust 64 Freschi, A.C. 284 Frey, B. 66 Frick, S. 25 Fuchs, S. 17 Fukuyama, F. 7, 33, 63, 88, 95, 115, 236 future, trust in the 14 Gambetta, Diego 11, 44, 80, 115, 198, 219, 236, 237 game theory, and motives of trust 89–92 Ganesan, Shankar 7 Garretsen, H. 102 Gatti, Roberta 62 GDP, and corruption 45, 53 Gellner, Ernest 79 generalised trust and corruption 41–3, 55 levels of 64–6 measurement of 63 vs particularised trust 40, 50–53, 55–6 Gergs, H.-J. 111 Giddens, Anthony 9, 15, 16, 17, 104, 201 Glaeser, Edward L. 93, 223 globalisation local development and industrial districts 266–8, 272 Prato industrial district, Italy 265–6 and research into trust 8 and sectoral cultures 31 goodwill trust 261–2 Grabher, Gernot 198

Index Granovetter, M. 28, 201, 220, 236, 239 Greif, A. 30, 31, 36 Greve, Arent 219 guanxi 44, 241 Gulati, R. 100 Håkansson, Håkan 219 Halinen, Aino 220 Hardin, G. 90 Hardin, Russell 44, 73, 115 Hay, Jonathan R. 157, 174 Heath, P.S. 99, 108 Hellman, J.S. 39, 158 Hells Angels problem 61 help sources preferences Estonia 185–9 Russia 148–50 Hendley, Kathryn 157 Henton, Douglas 269 Hess, R. 7 high-trust milieus 17–18, 41; see also low-trust milieus Hilbert, Josef 198 Hinnosaar, M. 185 historical memory 20–21 Hobbes, Thomas 90 Hodgson, G.M. 237 Höhmann, Hans-Hermann 7, 8, 15, 18, 19, 20, 29, 34, 73, 136, 177, 202 Holm, H. 93 honest bribees 53–4, 56 Honig, B. 242 hour glass society 102 Houser, D. 93 Hradil, S. 199 Huang, H. 89 Huck, S. 32 Humphrey, J. 176 ICT sector, entrepreneurs’ experiences 202–6, 206–9 immigrant entrepreneurs and social networks 239–42, 249–51 see also Chinese entrepreneurs in UK implementation gap, of legal reform in Ukraine 158 incremental innovation 258 industrial districts models 256–8 see also Prato

Index influence networks 239 informal institutions Prato, Italy 262–4 sanctions 15, 263–4 trust acting as 28–9 informal relations 162; see also corruption information networks 239 informing authority, trust in 14 Inglehart, R. 63, 64, 65, 76, 78 institutional (one-sided) trust definitions 15, 16, 74, 201, 222–3, 237 and interpersonal trust 74–5 lack of, in Russia 117–18, 153–4 and modernisation 77–9 institutionalisation of trust 74–5, 83–4 institutions and culture 26–8 definitions 59–60 and personal trust 75–6 intermediary-based trust, see institutional (one-sided) trust Internet adoption 89 interpersonal (social) trust as based on experimental knowledge 200–202 definitions 13–14, 73–4, 236 economic impact 81–3 and institutional trust 74–5 and modernisation 77 societal dimension 83–4 see also personal trust Jacobs, J. 211 Järve, J. 185 Jinn-Yuh, Hsu 241 Johannisson, B. 239 Johnson, Simon 157, 158, 160, 161 Jones, T. 240, 248 Juchler, J. 211 Jürgenson, A. 176, 188, 190 Kahle, E. 29 Kaluga credit/payment terms anomaly 142 employee selection 144–6 entrepreneurs 138–9 help sources preferred 148–50

views of state bodies 147 see also Russia Kaufmann, D. 39 Keating, M. 272, 277 Kee, H.W. 212 Keefer, P. 67 Keefer, S. 88, 93 kin, trust in and bonding networks 43–4 lack of 119 lower than employees 144 Russian SMEs 139–40 kinship networks 242 Kirchgässner, Gebhard 221 Kisfalvi, V. 35 Kitching, J. 236 Klein Woolthuis, Rosalinde 219, 224, 227, 231 Knack, P. 88, 93 Knack, S. 67 Knight, J. 269, 284 knowledge 12–13, 202 Knox, R.E. 212 Koch, Lambert T. 221 Koch, Thomas 199 Kornai, Janos 115 Kowalczyk, M. 206, 208, 213 Krampen, Günter 13, 14 kryshas 153 Kryshtanovskaya, O. 162 Krzeminski, A. 211 La Ferrara, E. 7 Lageman, Bernhard 18 Lai, G. 162 Lambsdorff, J.G. 44, 56 Lane, C. 99 Lane, Christel 225 Larson, Andrea 220, 230, 232 Ledeneva, A.V. 29, 56 legal framework, trust in 41–2, 55 legal reform, implementation gap in Ukraine 158 legalisation, costs of 116–17 Leipold, H. 29 Lewis, J.D. 212 Li, David D. 174 local development and globalisation 266–8, 272 policies for promoting 272–4 see also Vato territorial pact

291

292

Index

local institutions, Prato, Italy 262–5 Lorenz, Edward H. 219, 255 Loughlin, J. 277 low-trust milieus 17–19, 56; see also high-trust milieus Luhmann, Niklas 7, 10, 14, 16, 74, 77, 104, 105 Luuk, M. 185 Lyles, M.A. 111 Lyon, Fergus 28, 136, 237 Lyons, Bruce R. 220, 225, 232, 268 Macmillan, I.C. 239 Mafia 44, 80, 104 Maghribi traders coalitions 30–32 Magnatti, P. 283, 284 Malecki, E. 239 Malieva, Elena 29, 34, 136, 202 Manolova, T.S. 34 market exchange organization, see exchange networks Marshall, Alfred 255, 260, 266 Maskell, Peter 269 Mayer, M. 106 Mayring, Philipp 202 measures of trust payment terms as indicator 142 problems with 87 see also associational activity, measuring; countries, problems of classifying trust levels medieval European trade relations 30–32 Mehta, J. 268 memory, see historical memory Milgrom, P. 101 Mistri, M. 269 Misztal, Barbara A. 11, 201, 236 modernisation, and trust 77–9 modernity, and research into trust 7–9 money, trust in 14; see also business finance Morgan, K. 272 Moscow employee selection 144–6 entrepreneurs 138–9 help sources preferred 148–50 see also Russia motives for trust 89–92 Moyle, Brendan 220, 225, 230, 232

Mulholland, K. 240, 241 Neivelt, I. 176 Nelson, Richard R. 221 Netherlands levels of general trust 64 voluntary organisation density 66 networks 238–9; see also exchange networks; small-firm business networks Nishni Novgorod employee selection 144–6 entrepreneurs 138–9 help sources preferred 148–50 see also Russia Nooteboom, Bart 74, 101, 176, 182, 220, 221, 231 normative institutions 31–2 norms 238 Norris, Pippa 43 North, Douglass C. 19, 27, 28, 115, 157, 177 Nuissl, Henning 205, 206, 208, 212, 223, 225, 230 Offe, C. 17 Oleynik, Anton 136 Olson, Mancur 63, 81, 156 one-sided trust, see institutional (one-sided) trust others, trust in, see interpersonal (social) trust Paldam, M. 39, 41, 55, 59, 62, 63, 64, 67 Pang, M. 242 Panther, S. 7, 20, 33 Parsons, Talcott 40 participatory democracy, and corruption 55 particularised trust and corruption 43–5, 55–6 vs generalised trust 40, 50–53, 55–6 Patti territoriali 273; see also Vato territorial pact payment terms, as indicator of level of trust 142 Pecqueur, B. 269 Pendenza, Massimo 268 Peng, M.W. 34, 99, 108

Index people, trust in 41; see also kin, trust in Perry, M. 250 personal trust and business association membership 188–9 defined 15–16, 73, 222 in entrepreneurship 33, 125 in Estonia 34, 185 in Russia 34, 150–53 in transition economies 75–6 Petermann, F. 201 Pezzini, Mario 264 Pleines, Heiko 7 Poland, GDP levels 67 Polanyi, Karl 114, 129 police, trust in 55; see also legal framework, trust in Polishchuk, Leonid 156 political action, and trust-building 83 political power, trust in 14 Porter, M. 272 Portugal GDP levels 66 levels of general trust 64 postmodernisation, definitions 78–9 power centralisation, and social capital 61–3, 69 Prato (Italy) empirical study details 260 features of textile district 258–60 globalisation 265–6 local institutions and trust 262–5 subcontracting relations and trust 260–62 pravila 127–8 Preisendörfer, Peter 14 Prisoners’ Dilemma and motive for trust 90–92 one-sided version 92 process-based trust 236 programmazione negoziata 273; see also Vato territorial pact property rights, and transition economies 156–7 Putnam Instrument proxy 66 Putnam, Robert D. 17, 43, 62, 64, 79, 80, 82, 88, 89, 95, 236, 264 Radaev, Vadim 114, 115, 118, 120, 121, 124, 129, 133

293

Raiser, Martin 28, 29, 42, 75, 100, 102, 105, 118, 157 Ram, M. 240, 242, 245, 248, 251 RATEC (Association of Trade and Production Companies of Electric Durable Goods and Computers) 115–16 Rath, J. 240, 241 rationalisation, definitions 77 rationality, and trust 15–16 reciprocal trust and corruption 44–5 lack of, in Russia 118–19 see also contract infringement reciprocity 11–12 Regalia, I. 273 religious belief 12 Research Centre for East European Studies, Bremen, conference (2003) 1 research methods 223–4 Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Essen, conference (2003) 1 Rhine-Westphalia Institute of Economic Research, Essen, conference (2003) 1 Richardson, G. 257 Richerson, P.J. 27 Richman, B. 95 Ripperger, Tanja 212 Rizzello, Salvatore 221 Roberts, J. 101 Robson, P.J.A. 246 Romania GDP levels 67 voluntary organisation density 66 Roninger, L. 75 Rose, Richard 41, 102, 136 Rose-Ackerman, Susan 29, 45, 114, 115, 119 Rosenfeld, M.T.W. 210 Rothstein, B. 41, 55, 60, 61, 62, 63 Rotter, Julian B. 12 Rullani, Enzo 258 Russia Caucasian business counterparties 153 contract infringement in 119–21 contract types 140–42, 146

294 Russia (cont.): data sources for 115–17 as distrustful society 114–15 employee selection 144–6 entrepreneurs 138–9 foreign business partners 119 future growth 68–9 GDP levels 66 giving of credit 143–4 help sources preferred 148–50 institutional change 34–5 levels of general trust 66 levels of trust 19 new business counterparty preferences 139–40 origins of distrust 117–21 payment terms 142–3 regional diversity 137, 151–2 reliance on personal trust 34, 119 SMEs 137–8 the state and trust 128–31, 146–8 trust creation 121–8 Ryterman, R. 41 Rzewuski, M. 209, 213 Sabel, C.F. 201, 272, 279 Saker, J.M. 240 Sako, Mari 261 sanctions definitions 237–8 Prato, Italy 263–4 Savkin, Vladimir 136 Savvateev, Alexei 156 Saxenian, A. 241 Schäfer, Mike Steffen 8 Schjødt, E.B. 60, 61, 62 Schmid, Wilhelm 20 Schmitz, H. 176 Schmitz, Hubert 267, 269 Schrader, H. 34 Schramm, M. 44 Schuknecht, L. 42 Schumacher, Christoph 220, 225, 230, 232 Schwarz, Anna 211, 212, 225 Schweickert, Rainer 83 Scott, J.C. 238 Scott, R.W. 31, 32 sectors, and trust 30–32 self-confidence

Index as foundation of all trust 13 requiring two-way interaction 11–12 Seligman, Adam 7 Seravalli, Gilberto 269 Shastitko, A. 136 Shaw, Eleanor 219, 239 Shleifer, Andrei 157, 174 Simmel, Georg 11, 12, 16 Six, F. 176, 182 small-firm business networks decision criteria for form of regulation 228–31 forms of regulation 224–31 role of trust 219–20, 231–2 trust as governance mechanism 221–4 Smallbone, D. 18, 28, 29, 33, 34, 136, 176, 177, 179, 186, 187, 188, 190, 249, 251 Smith, Adam 59, 60, 157 Smith, D. 242 Snehota, Ivan 219 Sobel, J. 94 social capital benefits 60–61, 89 definitions 59, 60 Eastern Europe compared with the West 64–7 and growth 67–9, 88–9 measurement of 63–7 modelling social capital and growth 61–3 and power centralisation 61–3, 69 social capital theory, and institutional economics 61–2 social networks, and immigrant businesses 240–42, 249–51 social trust, see interpersonal (social) trust socialism, legacy of 197–200 Società Patto 2000 274, 282; see also Vato territorial pact Solow, R. 88 Song, M. 241, 242 Sorge, A. 99 sources of trust 19–21 Starr, J.R. 239 state, Russian and establishing conventions 130–31 expectations of 128–30 SME views of 146–8

Index state institutions, trust in 42, 55 Steensma, H.K. 111 Stolle, D. 41 strength of trust, see degrees of trust Stutzer, A. 66 super presidentialism 63 Svendsen, G.L.H. 60, 61, 67 Svendsen, G.T. 59, 60, 61, 62, 63, 64, 67, 69 Sweden, levels of general trust 64 Switzerland GDP levels 66 voluntary organisation density 66 symbolic tokens 9 system trust 14 Szarka, J. 250 Sztompka, Piotr 8, 11, 13, 17, 18, 19, 115, 198, 208, 220, 221, 225 Tanzi, V. 42, 62 Taube, M. 44 technology, trust in 14–15 Teder, J. 179 Thevenot, Laurent 130 Thiele, Rainer 83 Thomas, Michael 199 Thomas, William I. 202 Thrift, N. 272 Tocqueville, Alexis de 79 Toms, S. 100, 106 Tönnies, Ferdinand 78 Tootle, D. 239 Törnroos, Jan-Åke 220 trade relations, in medieval Europe 30–32 transaction costs, Russian business data 115 transaction networks, see exchange networks transition, challenges of 109, 197–200 transition economies exchange networks in 102–3, 109–11 importance of culture 26 importance of property rights 156–7 trust replacing institutional deficiencies 29 transparency, in exchange networks 106–9 Treisman, D. 39, 45 triad of trust 13–14

295

Trigilia, Carlo 264, 272, 284 Trubek, D.M. 273 trust acting as an informal institution 28–9 characteristics commonly agreed 9–13 ‘dark side’ 54–6 definitions 13–14, 114, 200–201, 219, 236, 256–7 early research 8 institutional trust 15 and modernity 7–9 personal trust 15–16 psychologist’s definitions 13–14 and self-interest 89–92 sociological definitions 14 trust-building enforcing by political action 83 among entrepreneurs 32–3 framework for analysis of 105–9 by local co-operation 277 trust games 92, 94 UK, ethnic minority population 242 Ukraine, commercial courts 157–9 Unger, Danny 81 University of Bremen, conference (2003) 1 USA GDP levels 66 levels of general trust 64 voluntary organisation density 66 Uslaner, E. 41 Van Ees, H. 100, 102 Van Roy, Alison 81 van Witteloostuijn, Arjen 111 Vato territorial pact creation of 274 economic impact 280–83, 284 institutional impact 277–80, 283 and inter-institutional co-operation 274–7 Venesaar, U. 179, 180, 182, 183, 185, 186, 187, 188, 191, 192 Vensel, V. 187 venture creation, personal trust 33 Verba, Sidney 79 Veselov, Y. 34

296

Index

Vetik, R. 176 Volkov, V. 41 voluntary co-operation 59–60; see also social capital voluntary organisation density 64, 66–7 Voronesh employee selection 144–6 entrepreneurs 138 help sources preferred 148–50 views of state bodies 147 see also Russia Wade-Benzoni, K.A. 27 Waldinger, R. 240 Warren, M.E. 7 Weber, Max 14, 77 Weggel, O. 25 Wei, S.-J. 39 Weigert, A. 212 Welter, F. 13, 15, 18, 29, 33, 34, 73, 136, 176, 177, 179, 184 West Poland business conditions 210 entrepreneurial co-operation 208–9 entrepreneurial perceptions 207–8, 210–12 White, S. 162 Whiteley, P.F. 67 Whitley, R. 99 Whittington, R. 106 Wihlborg, C. 187

Wilkinson, Frank 269 Williamson, O.E. 29, 101, 123, 156, 219, 222, 228 Wilson, J. 200 Winter, Sidney G. 221 Witteloostuijn, Arjen van 111 Wolleb, G. 284 Woodruff, C. 28 World Business Environment Survey 50, 53–4 World Values Survey (WVS) questions used 63–4, 66, 88 use as corruption research data 45–6 written contracts Estonia 182 Germany 33, 225, 227, 230–31 non-safeguarding roles 227 Russia 151 WVS, see World Values Survey Yamagishi, Midori 73, 93, 223 Yamagishi, Toshio 73, 93, 223 Yan, A. 34 Yin, Robert K. 224 You, J. 269 Zafirovski, M. 27 Zak, P.J. 67 Zeitlin, J. 272, 273 Zimmer, C. 242 Zucker, Lynne G. 105, 222, 228, 236, 246