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Chapter 9 The Role of Trust in the Long-Run Development of French Financial Markets PHILIP T. HOFFMAN, GILLES POSTEL-VINAY, AND JEAN-LAURENT ROSENTHAL U SING HISTORICAL DATA, we test whether social capital generates trust in past financial markets and whether the effects of trust persist across time. The evidence for the tests comes from 108 credit markets in France over nearly two centuries. We find that social capital had no significant effect on trust in these credit markets and that this trust must have changed over time. The implication is that trust in financial markets is an intermediate variable that evolves rather quickly so long as societies are not pathological. Trust, it has long been argued, can facilitate economic transactions that make people better off and thereby have an enormous impact on economic growth (Arrow 1972). Trust ought to have such an effect, if it means that people can invest without spending a great deal to keep from being defrauded. And its consequences should be particularly important in financial markets, for investors inevitably put their money in other people’s hands. There is some evidence that trust does work this way. A measure of trust taken from questionnaires is correlated with more rapid economic growth (Knack and Keefer 1997). It also seems to explain individuals’ willingness to invest in financial markets that cannot be traced back to differences in their wealth or their attitudes toward risk and ambiguity (Guiso, Sapienza, and Zingales 2005). But what in turn determines trust? It is usually presumed to reflect some form of social capital, such as norms 249 that discourage abuses of trust or social networks that facilitate punishment of untrustworthy behavior. The usual (though not universal) assumption is that this social capital will change very slowly, if at all, in a given society, but it will vary a great deal from place to place.1 The same will therefore be true of trust. And there is considerable evidence from surveys and experiments that social capital and trust do in fact vary across societies and even within regions of a single country (Putnam, Leonardi, and Nanetti 1993; Henrich et al., 2004; Guiso, Sapienza, and Zingales 2004, 2006). There is also evidence that the two are linked in financial markets (Guiso, Sapienza, and Zingales 2004, 2005). If trust is generated by social capital and if it does in turn significantly affect financial markets, then its effects should be visible both today and in the past. More social capital, be it stronger norms to discourage fraud or more effective networks to punish deviants, will mean more trust and hence—if other things are equal—more lending and investment, no matter what the year. And if social capital changes slowly, then so will trust, and the effects of trust on lending or investment will remain the same over long periods. As yet, no one has subjected this argument to a thorough statistical test.2 In particular, no one has verified—at least quantitatively—that the relationship between trust and social capital holds in the past or that the effects of trust persist over time. The statistical evidence usually advanced in favor of trust mattering and of its being generated by enduring social capital simply cannot speak to this issue, because it all comes from current day observations—experiments, modern surveys, and cross-sectional regressions—and thus cannot answer questions about the past or about change over time. Historical evidence would be an obvious way to see whether the relationships observed today bear up over long periods, but no one has ever subjected them to the right sort of statistical scrutiny. The omission is hardly a matter of mere antiquarian interest, because it raises fundamental questions about trust, social capital, and even about policy. If the sort of relationship between social capital and financial development that we see today were to end up disappearing in the past, we would in fact have to rethink what trust in financial markets might be. We would have either to admit that in the long run trust does not matter in financial markets, or to conclude that it is not generated by fixed or slowly changing social capital. It would have to come from some other source, at least in financial markets. Historical evidence is critical here. Without it, we cannot tell how durable the effects of trust are, a matter that is essential for policy. Simply knowing that trust and lending are linked at one moment...

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