Markkula Center of Applied Ethics

How Trust is Achieved in Free Markets

Voluntary institutions can assure quality and safety without resorting to governmental restrictions.

By Daniel B. Klein

Suppose the muffler drops off your car in the middle of Iowa. You pull off the interstate in search of a repair shop. You find Joe's Auto Repair.

But the mechanics at Joe's see that you are from out of state. They know, regardless of how fairly they treat you, you will not be returning and will not be speaking to other customers. Perhaps they will deal with you honestly, but caution is advised.

[Middleman Illustration]

The middleman creates a bridge
of trust between two traders.
Illustration by Dug Waggoner

Then you notice a Meineke shop down the road. You will never return to that Meineke shop either; but for some reason, you have more trust in Meineke and you take the car there.

Why are you more trusting of Meineke? Although you will never return to that particular Meineke shop, you might reach a judgment about Meineke in general on the basis of your experience. The franchisee at that shop doesn't care whether you ever go to another Meineke shop, but the parent company does care and takes steps to make that happen. The company employs "mystery shoppers" who pose as ordinary consumers with broken cars. Also, it receives and remedies customer complaints.

Consumers may not be consciously aware of such trust-building practices, but they rightly intuit that some assurance lies in familiarity. The company name is a bit like a friend, and the serviceperson wearing the company logo is like the friend of a friend.

Voluntary Action Works
As we all know from our personal experience, consumers seek trust. What is less obvious is that entrepreneurs supply it. Meineke is at the interstate exit precisely because there is a trust problem to be solved and profit to be had in solving it.

The franchise relationship is just one example of a general pattern of trust-making practices. Consumers demand trustworthiness, and entrepreneurs profit from supplying what consumers demand.

When people bemoan the imperfections of the current business climate, they often take for granted the degree of comfort, safety, and trust they have become accustomed to. They forget these things have been achieved by a process that arose to meet the problems of the day and will rise again to meet new challenges.

Perfection is never reached because imperfection is constantly reinvented in our own minds. Regardless of the absolute level of living conditions, human beings will find things to improve. Free, voluntary action addresses whatever problems individuals currently perceive, and remedying these problems itself creates profit opportunities.

That humans, interacting voluntarily, tend to overcome obstacles and organize themselves to better their condition may seem too obvious for comment. But in the case of product quality and safety, Americans now endure a large number of governmental restrictions that are justified precisely on the grounds that free, voluntary practices are not able to overcome adequately the problems of low quality or unsafe products and services.

The Food and Drug Administration restricts freedom of choice in pharmaceuticals, the Occupational Safety and Health Administration restricts freedom of contract in employment, occupational licensing restricts the freedom to enter a trade, and so on.

Economists have shown these restrictions impose heavy costs on society. The FDA causes thousands of premature deaths every year, and occupational licensing significantly aggravates the hardships of the poor. These costs should be redeemed by concomitant benefits; but since voluntary institutions would have achieved such benefits anyway, there really is no justification for the injuries.

Trusters and Promisors
How do voluntary institutions create safety and quality? Voluntary transactions generally involve at least two parties; we might call them trusters and promisors.

The truster (referred to here by feminine pronouns) may be the customer of a doctor, an auto mechanic, an accountant, a lawyer, or a securities broker. But she may also be a landlord, a creditor, an employee at a potentially hazardous manufacturing plant, or an employer enrolling her workforce in a health-care organization.

She must decide whether to entrust her resources to the promisor (referred to by masculine pronouns). Does the promisor have the incentive or inclination to honor her trust?

Promisors build and protect their reputations for trustworthiness, sensing the truth in the saying, Time wounds all heels. Over time, an individual truster who has frequent positive dealings with a promisor has some grounds for trust and will probably become a loyal customer. On the other hand, the truster may learn that a treatment was inappropriate, and the wrongdoer may lose her business.

But a heelish promisor must fear that time will wound him even when dealing with an infrequent truster. Trusters share their experience with family, friends, neighbors, and co-workers. When someone has a problem and is unsure about how to proceed, usually that person seeks advice from someone familiar: "Do you think I should see a lawyer for this? How should I choose a lawyer?" In this manner, a negative experience—even if infrequent—takes on extended life.

When someone with experience advises us on the trustworthiness of a promisor, he or she functions as a knower for us. But whether our experience is personal or mediated by a knower, we feel most comfortable in extended dealings; thick and richly diversified extended dealings in trade may, in fact, merge seamlessly with friendship and community.

Reputational Nexus and the Middleman
In every area of life—the family, the church, the social club, the neighborhood, the workplace, the marketplace—we are embedded in a constellation of extended dealings, or a reputational nexus. Our social linkages, including all our chatting, create a variety of nexuses that hang together to form one vast netting.

Trust depends on the thickness and the pattern of the links. In the marketplace, providing reputational links as a basis for trust is a service businesspeople can make a profit from. One function of the middleman is to create a bridge of trust between two traders.

The Meineke franchisor provides a reputational bridge between the motorist and the franchisee, who meet only in passing. Franchised motels, restaurants, and convenience stores also capitalize on trust in infrequent dealings.

The role of the reputational bridge is also demonstrated by the retailer who, a hundred times daily, serves as the link between a consumer and a producer. Many matches between consumers and producers are irregular—as in the case of a consumer purchasing a washing machine or an ulcer medication—but the consumer has extended dealings with the retailer, who in turn has extended dealings with the producer. By carrying the appropriate array of products, middlemen can make a profit by creating trust for the consumer with an irregular need of a specialized commodity.

Brand names are another way of creating trust in a free market. In the late 19th century, as transportation systems and mass production created a national market in America, consumers confronted "a profusion of unstandardized packaged goods...[and] unfamiliar selling and processing techniques," making it hard for them to judge such things as "the freshness of food or the durability of clothing," according to consumer historian Norman Silber. In Test and Protest, Silber tells how the market responded:

To ease the minds of customers about problems of quality, reliability, and safety, manufacturers and advertisers appealed to consumers to buy according to brand names. National Biscuit, Heinz Soup, Armour Meat, Standard Oil, and other companies placed one banner on many different products. The consumer who found one product of a brand to be satisfactory, those companies suggested, could assume that all other products also would be suitable.

Ways of Apprehending Untrustworthiness
But can these promisors be trusted? Promisors often mislead and deceive trusters, but trusters know their vulnerability and look for solid evidence. Consequently, promisors who can evidence trustworthiness are rewarded in business traffic.

They might offer such evidence as praise or honors from an independent knower, someone who can evaluate the product but who does not reap gains from its success. If the word is favorable, the promisor will spread it far and wide.

It is good fortune to win an award or to be praised by the critics. But sometimes promisors do not wait around for fortune to find them. They simply hire a knower to make an evaluation. The knower is remunerated for generating the information, and, if the word is favorable, the promisor invests in conveying it to trusters.

For example, electronics manufacturers hire Underwriters' Laboratories to test and inspect their products and grant a UL mark upon approval. Companies and governments hire Moody's to rate their securities, and the rating is then used in marketing the securities.

[Daniel Klein]

Daniel Klein
Photo by Charles Barry

Trustworthy promisors have every incentive to self-disclose, and they employ a wide variety of means to do so. What about the untrustworthy? They do not strive to self-disclose; in fact, they have a special incentive to deceive. How do trusters apprehend the untrustworthy?

One way is to make inferences from the accolades, coveted seals of approval, and glowing endorsements that are not. When we view a curriculum vitae, a meagerness of distinctions will be evident and lead us to doubt outstanding talent.

Similarly, trusters remain wary when they do not hear any of the wide variety of horns that trustworthy promisors blow in self-disclosing. It is precisely that the horns are denied to untrustworthy promisors that makes these endorsements effective signals of quality.

Another way to apprehend untrustworthiness is, of course, represented by knower services that trusters pay for. Hired inspectors, Consumer Reports, Dun & Bradstreet, TRW, and movie critics such as Siskel and Ebert all report on the trustworthy and untrustworthy alike.

Competitive Expose
Another way of apprehending untrustworthiness is forged by competitors.

Promisors expose the poor characteristics of competitors' products, if only by insinuation, in advertisements, sales demonstrations, and marketing literature. Pauline Ippolito, a leading student of quality information policy, has remarked on the vigor of low-tar-and-nicotine-cigarette sellers in distinguishing themselves from the higher tar brands (going far beyond the mandated disclosures in advertisements).

Before the 1971 imposition of restrictions on cigarette advertising, advertisements for low-tar brands sometimes pictured rivals and listed the tar content beside each. Many researchers think that the restrictions have inhibited the market for low-tar cigarettes.

In general, competitive advertising is a great service to trusters as it helps them discover product differences and the validity of product claims.

Another way for promisors to apply pressure on their rivals is to challenge the truth of their advertising. Of the 65 advertising challenges resolved by the Better Business BureauÕs National Advertising Division in 1992, almost all of which dealt with the truth and accuracy of advertising claims, 72 percent were brought by competitors.

Trust Without Regulation
So, should you trust Mr. Dealer? To help you decide, you can get to know him, look into his credentials and seals of approval, try out his service on a trial basis, ask for a warranty, ask a neighbor about him, get a second opinion, consult an information bureau or a rating organization, find out what his competitors are saying about him, or have someone that you trust arrange your dealings with him.

If, after all, you cannot come to trust Mr. Dealer, then don't! Look for someone else who gives better grounds for trust.

A failure to foster trust opens opportunities for individuals and firms to profit by providing what is lacking. In the realm of voluntary affairs, bad outcomes breed their own remedies.

The only rascal in the laissez-faire story is the untrustworthy promisor. A vote for coercive government measures to control him must rest on the belief that this rascal cannot be adequately foiled by voluntary institutions.

But the open-ended, voluntary processes generated by resourceful middlemen, qualified knowers, trustworthy promisors, and wary consumers have been every bit as successful as government restrictions in providing quality and safety assurance.

This article draws on "Trust for Hire: Voluntary Remedies for Quality and Safety," a chapter in Reputation: Studies in the Voluntary Elicitation of Good Conduct (Ann Arbor: University of Michigan Press, 1997), edited by Daniel B. Klein. This chapter can be accessed on the Ethics Connection ( Klein is an associate professor of economics at Santa Clara University.

Response by William K. Black

Further Reading

McCloskey, Donald N. "Bourgeois Virtue." The American Scholar, Spring 1994.

Wildavsky, Aaron. Searching for Safety. New Brunswick, N.J.: Transaction Publishers, 1988.