Institutional trust and economic policy Lessons from the history of the Euro : Lessons from the history of the Euro

Chapter 7. The Relevance of Trust for Economic Outcomes

CHAPTER 7 The Relevance of Trust for Economic Outcomes In the previous chapters, I have examined how institutional trust matters in economic policymaking in the EU-15 and the CEE-10 within the context of euro-zone accession. The experiences of various members during the subprime crisis represent an important test for the sustainability of policies. As we could observe, while most countries fared according to expectations, there were also important exceptions that call for a modification of the original theoretical framework. The aim of this closing chapter is to integrate the findings into a coherent narrative and answer the original question of the project: how and when does trust matter in economic policymaking? Understanding the conditions under which trust can exert its influence gives policymakers a proper perspective on when its significance is either underestimated or overestimated by the presence of prominent examples for either position. The chapter proceeds as follows. First, I will briefly summarize the main findings of individual chapters then provide a comparative assessment of the role of trust in the old and new member states of the EU. Afterwards , I will revisit the hypotheses from Chapter 3 on the expected paths of economic development in high- and low-trust environments. In the following section, I will summarize the main factors, which are responsible for deviation from the hypotheses. In the closing part of the chapter, I will discuss some of the policy implications of the research. 7.1. Summary of findings While it has been recognized that trust matters for economic outcomes, the problem of causality has remained underexplored. This book has attempted to contribute to filling this gap through focusing on the role of institutional trust in influencing economic policy. By narrowing the ques- 178 Institutional Trust and Economic Policy tion to policies associated with the euro, I also aim at contributing to the ongoing debates about the future of the common currency. In order to provide a theoretical framework for assessing how trust might matter to economic policies, in Chapter 2 I situated the subject in the broadly understood institutionalist school of economics, which is able to handle both rational and non-rational motives in human decision making . Through integrating insights from Post-Keynesian, Austrian, and new institutional economics, as well as modern political philosophy, it has been proposed that the presence or absence of institutional trust creates virtuous and vicious cycles in law-abidance, which critically influence the possibility for economic agents to have realistic long-term plans. In a lowtrust environment the uncertainty surrounding the functioning of institutions results in a tendency towards having a short-term focus in decision making. The major question of Chapter 3 was to assess how and when a prevailing tendency among economic actors towards short-term decision making affects the decisions of policymakers. Within the context of the creation of the euro-zone it has been suggested that while trust does not necessarily affect unique decisions, in repeated situations without clear external pressures the presence or absence of institutional trust clearly has a role in policymaking. Several hypotheses were proposed on how lack of trust might matter in decisions over economic policy, including populist fiscal measures, suboptimal strategies for consolidation, as well as the postponement of structural reforms. As a consequence of such policies, it was hypothesized that low-trust countries are likely to fare poorly in and outside of the euro-zone, while high-trust countries were expected to fare well regardless of their decision over the euro. In order to assess the hypotheses empirically, first fiscal policies prior and after the creation of the euro-zone were examined in the EU-15. In Chapter 4, it was found that in spite of the motive for consolidation due to the Maastricht criteria, the EU had a clear influence on fiscal policy in only five countries out of the 15. In contrast, institutional trust—as approximated by the World Governance Indicators—proved to be a good predictor of what type of fiscal consolidation was implemented. In hightrust countries consolidation focused primarily on the expenditure side, while in low-trust countries tax increases and savings from debt service contributed the most to the improvement of the fiscal balance. Through the divergent cases of Sweden and Portugal, the mechanisms behind this outcome were also shown—while in Sweden a nationwide cooperation on optimal fiscal policy measures could be achieved, in Portugal, consolida- The Relevance of...