Assurance and Trust

Many transactions involve promises of quality and safety that cannot be fully verified before the fact. In these situations, one party decides whether to trust the other to deliver what is promised. A consumer decides whether to trust the grocer, pharmacist, or mechanic to deliver a good or service of a certain quality. A bank decides whether to trust a prospective borrower. A landlord decides whether to trust a possible tenant.

Both the promiser and the person relying on him gain when the promiser keeps his promise (in the same way as prisoners gain by cooperating in the prisoner’s dilemma). Society flourishes when people can trust each other. But those who act on the promises of others must have grounds for their trust. They value not only the quality and safety of a good or service, but, in the first instance, the assurance of quality and safety. Trust depends on assurance.

Many public policies are predicated on the belief that the free enterprise system (including a functioning tort system) cannot adequately provide quality and safety assurance. Numerous federal regulatory bodies, among them the Food and Drug Administration, the Consumer Product Safety Commission, the Securities and Exchange Commission, the Occupational Safety and Health Administration, and the National Highway Traffic Safety Administration, in addition to state and local licensing and housing bodies, all issue restrictions on citizens’ freedom of contract in the name of ensuring quality and safety (popularly described as consumer protection). Research establishes that these restrictions bring significant social losses. If they do not achieve quality and safety assurance beyond what would be achieved by the free enterprise system, they are unredeemed.

The free enterprise system provides numerous ways of extending assurance. It may be impossible to verify the quality of the upcoming transaction, but one can often verify those of past transactions. Assurances of one kind or another circulate in various forms—as informal gossip or as carefully monitored databanks—which provide information regarding the reputation of the promiser. Reputation may be defined as the relevant current opinion of the promiser’s trustworthiness.

Promisers gain by providing assurance, so they seek to build, expand, and project their good reputations. They create and display brand names, which serve as umbrellas under which their transactions are grouped in the minds of those who need to rely on them. Promisers manage the extent and scope of their products and services to generate the repetition and pattern of dealings that give their name and reputation cogency. Once established, a good reputation can be extended to other lines of service where trust had previously been limited. A promiser’s failings or misdeeds, in contrast, damage his reputation and induce others to shun him.

With respect to services such as medical therapies, those who are dependent on the promises of others and those who extend promises interact infrequently and the possibility of repeat dealings is small. In these cases, the demand for assurance creates opportunities for the emergence of middlemen to serve as a bridge of trust between the participants. Consumers do not buy pharmaceuticals directly from Pfizer or Merck, but rather from established retail stores. The consumer’s local drug store, which acts as a middleman, has extensive dealings with both the consumer and the manufacturer. In addition, the middleman often shares some of the expertise of the promiser and serves as an agent of those who, of necessity, rely on these promises. A nexus of reputation then links the parties. To the consumer, the manufacturer is like a friend of a friend. One of the important functions of all retailers, hospitals, clinics, dealers, brokers, and firms is to generate the reputational nexus that brings assurance to parties who would otherwise meet only infrequently or in isolation.

All promisers put on their best face and tend to conceal their failings. Again this problem creates opportunities for its own remedy. A parallel industry of third-​party record keeping, evaluation, and certification will likely emerge to deal with these contingencies. Practitioners range from the amateur expert to industry inspectors to professional product raters to medical schools. These agents, in any of their varieties, may be called knowledge possessors.

Sometimes it is those who must rely on others that pay knowledge possessors for supplying information on promisers. Consumers pay the Consumers Union for its ratings, patients pay doctors to recommend drugs, employers pay agencies to screen prospective employees, home hunters pay agents and inspectors to evaluate properties, and creditors, landlords, employers, and insurers pay credit bureaus for credit reports.

Sometimes it is the promisers who pay knowledge possessors. Electronics manufacturers pay Underwriters’ Laboratories to evaluate the safety of their products, corporations and governments pay Moody’s or Standard & Poor’s to evaluate the securities they issue, corporations pay accounting firms to conduct an audit of their financial statements, kosher food manufacturers pay rabbinical authorities to certify their preparations, and students pay universities, institutes, and training programs to certify their abilities. In all such cases, promisers apply to the knowledge possessor in the hope that they receive a seal of approval that can be shared with prospective consumers of their good or service. These consumers (or their agents) recognize such seals of approval and are thus assured by the trustworthiness of the promiser. After a fashion, the knowledge possessors rent out their own good reputation to promisers and have strong incentives to do so responsibly. (The principle of specialization or division of labor applies even to reputation.)

In addition to these practices, five other paths to assurance exist:

1. Promisers demonstrate quality and safety and make the content of promises clear and publicly understood by such means as advertisements, displays, sales assistance, labeling, packaging, and try-​out periods.
2. Traders ensure the quality of their good or service by such means as warranties, guarantees, return policies, security deposits, and withheld payment.
3. Those who trust and their agents test and monitor promisers and third-​party knowledge possessors using unannounced inspections, decoys, undercover operatives, and second opinions.
4. Promisers’ failures are exposed by rival promisers in competitive advertising, product comparisons, and contests.
5. By making visible investments that would be profitable only for a high-​quality product, promisers signal quality by advertising, obtaining accreditation, and making long-​term investments in design, facilities, and so on.

The Internet is vastly expanding all forms of information exchange and reputation building. As soon as critics find some fault in e-​commerce (such as doubts about privacy, security, or trust), entrepreneurs invent an e-​solution, which usually takes the form of a service provided by middlemen or knowledge possessors.

The supply of assurance (or grounds for trust) takes myriad forms. Although regulators sometimes suggest that government restrictions are necessary to protect consumers, such suggestions never seem to seriously consider how resourceful middlemen, expert knowledge possessors, trustworthy promisers, and wary consumers function to achieve trust.

Further Readings

Beales, Howard, and Steven Salop. “Selling Consumer Information.” Advances in Consumer Research 7 (1980): 238–241.

Calkins, Earnest Elmo. Business the Civilizer. Boston: Little, Brown, 1928.

Klein, Daniel B. Assurance and Trust in a Great Society. Irvingtonon-​Hudson, NY: Foundation for Economic Education, 2000.

———, ed. Reputation: Studies in the Voluntary Elicitation of Good Conduct. Ann Arbor: University of Michigan Press, 1997.

O’Driscoll, Gerald P. “The American Express Case: Public Good or Monopoly?” Journal of Law and Economics 19 (1976): 163–175.

Scherman, Harry. The Promises Men Live By: A New Approach to Economics. New York: Random House, 1938.

Smith, Adam. “On the Influence of Commerce on Manners.” Lectures on Jurisprudence. R. L. Meek, D. D. Raphael, and P. G. Stein, eds. New York: Oxford University Press.