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Kenneth Arrow: trust’s central role

Posted: 11/07/2012 - 05:49

We know that trust, ethical behaviour and collaboration go hand-in-hand in our personal and social relationships. But how widespread are those things in our business and outsourcing relationships? Obviously they should be!

This is why I have chosen to feature Kenneth Arrow, an American economist and the recipient of the Nobel Prize in Economics with John Hicks in 1972. It think it’s time to rewind and want to share some of Arrow’s valuable insights on the nature and value of trust and ethics in economic interactions.

Trust is not only a nice thing to have and foster; it has, as Arrow said back in 1974, a very important pragmatic value.

“Trust is an important lubricant of a social system,” he noted in a widely-disseminated quote (cited for instance in Trust by Francis Fukuyama). “It is extremely efficient; it saves a lot of trouble to have a fair degree of reliance upon other people’s word.”

Unfortunately trust is not an easily purchased commodity: “If you have to buy it, you already have some doubts about what you’ve bought.” Arrow says that trust and similar values such as loyalty and truth-telling are what an economist refers to as “externalities.” They have practical economic value and they increase the value of the system, “by for example enabling you produce more goods or create more value for services.”

But the problem as I see it and as Arrow alludes to is that these externalities are not commodities in the traditional sense of open market trading. The confluence of markets and ethics needs special handling and consideration.

“The market has deficiencies of a kind for which ethics is a remedy,” Arrow wrote in a 2006 article, ‘The Economy of Trust’. For example, he says the world is “filled with private information. There is inside information on products and in contracts. In these situations, there is a very strong possibility of one person using this information to take advantage of the other. If this happens frequently, a market may not exist at all because the buyers know that they don’t know certain things, and that the sellers can exploit them.”

“To get markets that work,” he continues, “you have to keep the other person from trying to cheat you at every moment. So morality is closely related to the workings of the market.” Not only is morality closely related, he adds, it “plays a functional role in the operation of the economic system.”

Arrow asks some pertinent (and uncomfortable) questions: “Could it be argued that a certain amount of virtue of a basic kind – being honest, honoring contracts, providing accurate information – is required for a market to work? Is it a danger that prosperity can sometimes weaken those virtues? To become prosperous you need to be virtuous, but then does prosperity erode the foundations of virtue? I don’t know if it’s so much prosperity as the prospect of prosperity that’s dangerous.”

These are difficult questions to answer and terms that are difficult to define, which could be a reason why as Arrow says, “psychology is invading the whole field of behavioural economics. I believe that sociology should play more of a role in economics than it does.”

Very true. When was the last time you thought about the value of morals and ethics in the marketplace? Got you there, didn’t I? Yes, they should play a functional role in our business relationships. I believe there is a shift occurring to this way of thinking, and the Vested collaborative approach to business partnerships, based on social norms of trust, integrity, honesty, transparency and reciprocity puts businesses on this more righteous path.

So how do you put all this “trust” and “ethics” in a contact? The Vested Outsourcing Manual calls for companies to create a joint Statement of Intent that includes an agreement on the behaviours that buyers and suppliers will mutually seek. This goes right into the front of the contract!

Bottom line: I agree with Arrow – how could one not agree with a Nobel laureate? You’ve got to start with ethics and trust as the foundational lubrication in order to have a successful collaborative business deal.

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About The Author

Kate Vitasek's picture

Kate Vitasek is an international authority for her award-winning research and Vested® business model for highly collaborative relationships.   Vitasek, a Faculty member at the University of Tennessee, has been lauded by World Trade Magazine as one of the “Fabulous 50+1” most influential people impacting global commerce.    Her work has led to 6 books, including: Vested Outsourcing: Five Rules That Will Transform Outsourcing, Vested: How P&G, McDonald’s and Microsoft Are Redefining Winning in Business Relationships and Getting to We: Negotiating Agreements for Highly Collaborative Relationships.

Vitasek is known for her practical and research-based advice for driving transformation and innovation through highly-collaborative and strategic partnerships.   She has been appeared on CNN International, Bloomberg, NPR, and on Fox Business News.  Her work has been featured in over 300 articles in publications like Forbes, Chief Executive Magazine, CIO Magazine, The Wall Street Journal, Journal of Commerce, World Trade Magazine and Outsource Magazine.