01/11/2015
Should you wish to join Mara Salvatrucha (MS-13), a Los Angeles gang, you must voluntarily submit to a violent beating from existing members. An example of this rite of passage is even captured on a YouTube video. This strange behaviour has something to do with the way we human beings deal with forming relationships when formal law is unavailable. We rely on social norms, sometimes including rites of self-harm, to become trustworthy.
There is a structural similarity between forming a pact with criminal partners to rob a bank and entering into a business contract in India’s relatively weak institutional environment. When you form a criminal pact, and your partner “defects”, the very nature of the activity disables you from approaching a court of law. What do you say to the judge in a court? Do you tell her that your partner ran away with your share of the stolen loot? Similarly, when your business partner breaches a promise, your chances of legal redress within a reasonable time are low.
However, despite the weakness of formal institutions, both criminal pacts and market-based transactions are thriving. Undaunted by the fear of breach in inherently high-stakes games, Mumbai gangs continue to recruit members, diamond traders in Surat continue to trade in millions of dollars, and lovers continue to get married. How do social norms build trust that institutions don’t provide?
First, social norms can be invoked for punishment when a partner reneges on a promise. Underground gangs can punish defectors informally in dark alleys. Gangs can also inflict collateral damage on a defector’s family members. Similarly, a trading community can exclude a trader failing to deliver goods he has promised. The community can even exclude the defecting trader from social goods available within the community. The “shadow of the future” is salient both underground as well as aboveground in much the same way that the “shadow of the law” is supposed to be.
But what if it is not possible to trace a criminal partner after he defects? India is a big country, and it is easy to vanish into the anonymity of the masses. What if the person that you entrusted with your stolen goods, or with the diamonds that he promised to examine before a purchase, has vanished? What if the pay-offs of defection are much higher than all future cash flows of remaining in the community of criminals, or business co-ethnics? Social scientists have discovered that trust comes to the rescue even when behaviour cannot be monitored. Trust is the glue that holds relationships together every time a trader from Kerala transacts with a trader from Gujarat or a joint venture partner from overseas transacts with an IT firm in Bengaluru.
What is trust? Evolutionary game theorists specify that trustworthiness is a state of affairs when the “all-in” pay-offs of an agent are different from his “raw” pay-offs. This simply means that when an agent experiences intrinsic psychic costs, possibly due to guilt or ethical considerations, which in turn make his total pay-offs of defection negative, he becomes trustworthy. When an observer recognizes this hidden state in another person, either from that person’s revealed preferences or from his behavioural cues, he starts trusting the person.
Cooperative behaviour involving trust can emerge due to repeat transactions between parties. Repeat transactions help mitigate uncertainty by increasing knowledge about others’ behaviours. Having several drinks with business partners over the years can do the trick. Co-ethnicity may also help, not merely by leveraging informal norms to punish defectors, but also by helping reduce informational asymmetries between parties.
But what happens when people do not have opportunities for repeat transactions? What does an overseas businessman visiting for a short duration, without opportunities for repeat transactions, do?
There are two natural mechanisms that can rescue relationships formed with limited opportunities for repeat transactions. The first is costly signalling, discovered by evolutionary biologists. Agents endowed with an abundance of latent traits can incur costs, or can engage in self harm, better than those who are less endowed. Peacocks displaying brightly coloured plumes that are costly from an evolutionary point of view (because of greater vulnerability to predators) are better able to signal that they are of a “high-quality type” to their mates than peacocks that cannot afford this display. Committed entrants into gangs like MS-13 can better afford to withstand the hazing than those without the commitment. Manufacturers producing superior goods can better afford to give costly warranties than manufacturers producing inferior goods.
The second mechanism of building trust involves commitment devices that reduce exit options. A commitment device helps a person avoid straying from a previously chosen path, thereby demonstrating to a potential partner that he is trustworthy. When I set a wake-up call at bedtime, I bind myself to preferences that may otherwise change by morning.
A specially designed, Internet-enabled alarm clock (Dan Ariely talks of one) that can transfer money from my savings account to a political party that I hate every time I hit snooze can be a commitment device. Potential entrants to gangs undertake crimes to “burn bridges” with aboveground society to signal commitment. When businesses increase their asset specificity by manufacturing parts particular to a specific partner, they demonstrate greater trustworthiness.
Although I teach a course on law at a management school, I realize that what I teach may be incomplete for my students. Legal remedies are expensive and time consuming. Management curricula should teach students how to build sustainable relationships in institutional vacuum. It is not far-fetched to say that my students should learn something from the honour among thieves before they enter the world of business. A common thread runs between the underground and the business world—and that thread is the production of trust to overcome institutional failures.
Pavan Mamidi’s areas of research interest cover signalling theory, trust, social norms, contracting, behavioural ethics, negotiation and experimental methods.
