Trust and Regulation: Addressing a Cultural Bias

46 Pages Posted: 16 Dec 2009

See all articles by Paolo Pinotti

Paolo Pinotti

Bocconi University - BAFFI Center on International Markets, Money, and Regulation

Date Written: September 14, 2009

Abstract

Cultural traits shape both the scope and the consequences of government intervention. Failing to account for cultural differences may therefore bias the estimated effects of regulation. This paper investigates the direction and the magnitude of this bias, from both a theoretical and an empirical point of view. It presents a simple model in which agents differ in terms of trust and trustworthiness, and average trust predicts average trustworthiness across countries. Entrepreneurial activity by the untrustworthy imposes negative externalities on the whole economy and burdensome entry regulations may lower these externalities at the cost of limiting economic activity by all agents. The model delivers two main predictions: within each country, preferences for regulations depend negatively on individual trust; across countries, lower trustworthiness drives higher levels of unofficial activity, negative externalities and government regulation, thus inducing a positive spurious correlation between all these variables. Evidence from individual level and cross-country data is consistent with these implications of the model. In particular, it suggests that a large part of the previously estimated negative effects of regulation can be attributed to omitted variation in cultural traits.

Keywords: trust, regulations, unofficial economy, externalities

JEL Classification: L51, Z10, D02, K42

Suggested Citation

Pinotti, Paolo, Trust and Regulation: Addressing a Cultural Bias (September 14, 2009). Bank of Italy Temi di Discussione (Working Paper) No. 721, Available at SSRN: https://ssrn.com/abstract=1523626 or http://dx.doi.org/10.2139/ssrn.1523626

Paolo Pinotti (Contact Author)

Bocconi University - BAFFI Center on International Markets, Money, and Regulation ( email )

Milano, 20136
Italy

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