The trust game and wealth creation

There’s a fascinating article discussing game theory and wealth creation over at financial-planning.com titled Winning the Trust Game

The article is a quick read and I highly suggest checking it out. Here are a few points that I found interesting:

The Trust Game

The article opens with a discussion of the trust game. This is a two player game with the following setup. One player, an investor, is given money at the start. The investor can take the money and end the game, or he can give all or part of it to the other player, the trustee. Whatever money is offered is tripled before the trustee gets it. In turn, the trustee can either take the money or send part or all of it back to the investor.

How might this game play out? In a world without trust, the solution is mutually destructive. The investor could reason that the trustee would be selfish and simply take all the money, leaving the investor out to dry with nothing. Hence, the investor would never offer money–he would take all the money at the beginning. The game terminates before wealth creation could take place and lots of money is left on the table.

Gladly, this is not how people actually play the game. Repeated experiments have shown people play with trust. The investor player almost always offers some portion of the money to the trustee, like $4 out of an original $10. The trust is generally warranted as the player in the trustee role usually gives back more than the investor sent.

But sometimes the trustee simply takes all the money and runs. It’s a reminder that trust means vulnerability and risk of being exploited. But more often than not people are willing to take that chance for the potential gain.

Trust is important for an economy

The trust game has many analogies in business, whether it be a bank loaning money or an individual buying company stock. Investors need trust to get the economy going, and trustees have to maintain some level of integrity to keep faith in the system.

Trust is thus vital for economic growth, and interestingly there is some empirical work to back up the relation between trust and wealth. From the article:

Economists Paul Zak and Stephen Knack found that trust (that is, being trusting) is among the strongest predictors of a nation’s wealth. For example, when asked, “Do you think most people can be trusted?” fewer than 10% of respondents from Brazil, the Philippines and Uganda said yes. Contrast that with the much wealthier countries of Denmark and Norway, where more than 60% of those surveyed answered yes to the question. Admittedly, the question is vague. Yet it’s the same question asked all over the world, with starkly different results.

Incidentally, I think this study is something we should teach all of our school kids. I especially want to teach it to the kids who stole the entire bowl of candy during Halloween that I set out when I had to run a few errands. I failed to chase them down, but if I did, I might have informed them how they were ruining the fabric of society, or something like that.

Good intentions aren’t good enough

The end of the article is my favorite part and it discusses some of the practical issues with trust. It’s a reminder that even the best of intentions can go wrong and it’s important to be vigilant.

For instance, suppose you are a waiter and you provide impeccable service to a table. You are trusting that your service will be rewarded with a generous tip. But that’s not always going to cut it. Say a well-intentioned patron does wish to reward you but is bad at math and hurried. He might leave a mediocre or modest tip. It might be an accident, but the bottom-line is the same whether the patron wished to be cheap or made an honest mistake.

While it would be unwise to distrust all customers, it would equally be foolish to remain completely trustworthy. A small cue like a suggested tip on the receipt could help the situation and at least help clarify the patron’s intent.

The take-away lesson is that trust evaluation requires diligence and a sophisticated approach. One answer is to adopt a probabilistic outlook to events. Rather than expect all customers to tip appropriately, a server might put a belief of 70 percent that a well-intentioned patron would tip generously. Disappointments can be handled as expected realizations and this is a constructive approach.

For more details on the topic, do read the entire article: Winning the Trust Game

Closing tangent

I consider myself a trusting person, but for the record, I would never do one of those “trust falls” as seen here.

Link to Youtube video – Trust fall