Building Social Capital

Introduction

The concept of ‘social capital’ describes the quality of the social context in which exchange and teamwork take place: does the social context promote efficiency and coordination, or is it an impediment to trade and a source of distrust? In this chapter we answer the following questions: What is social capital? How is social capital created? What are the determinants of social capital and how are they measured? What is the relation of social capital to the performance of firms? We also endeavour to relate the concept of social capital to that of mutuality.

Social Capital as a Mechanism for Trust and Cooperation

As noted by the sociologist Mark Granovetter (1985) and others, economic exchange does not take place in a vacuum: it happens within a social context. This is because exchange involves interpersonal interactions and triggers a wide range of human emotions, from satisfaction at having reached a good deal or outsmarted a competitor, to the guilt of having betrayed a business acquaintance, or outrage at having been cheated by a trading partner. Even if trade is conducted in an impersonal manner, the human mind is quick to realize or imagine that another person is involved, thereby triggering the emotions associated with promises and betrayal.

Social interactions also activate various cognitive processes—such as inferring someone’s type or motives. Unfortunately, however, most people are poor at drawing inferences: they jump to conclusions based on limited evidence (e.g. Kahneman 2011); they misjudge the precision given by small and large samples (e.g. Rabin 2002, Griffin and Tversky 1992); and they underestimate echo-chamber effects in rumours and gossip (e.g. Jackson 2009). Furthermore, expectations about the future behaviour of others are often shaped by shared norms and identity, meaning that people can misinterpret the actions of those from a different culture or background. As a result of all these processes, people often have erroneous beliefs, a feature that, combined with statistical discrimination, leads to prejudice and distrust.

Taken together, these biases and the emotions associated with them form the social context in which human exchange takes place. They affect how economic agents interact with each other—for example, in transactions with clients, workers, and suppliers—and in teamwork within firms and other hierarchical organizations. When people do not trust each other, trade and cooperation are impeded. Because information is by nature imperfectly distributed and unforeseen shocks occur constantly, opportunities abound for things to go wrong in economic transactions and within teams. And when something goes wrong, misperformance may be interpreted as a sign of incompetence or mischief. This creates distrust, and distrust makes trade difficult and renders organizations dysfunctional. Hence in the absence of a mechanism to alleviate or mitigate naturally arising distrust, economic exchange within and across organizations is bound to be inefficient.

Laws and courts are often seen to provide the required mechanism. While they are clearly important, there are many aspects of human behaviour that they cannot affect, such as when stakes are small, or when taking legal action would be futile or too costly. Formal institutions must be supplemented by informal mechanisms for trust and cooperation. Social capital is one such mechanism, loosely defined as a combination of interpersonal links, shared beliefs and identities, and norms that together reduce the incidence of distrust in economic exchange and teamwork. Creating social capital to reduce distrust and support mutually beneficial exchange is at the core of the idea of mutuality, which aims to promote a mutuality of service and benefits between a company, its employees and shareholders, and its consumers, suppliers, and other commercial partners.

Creating Social Capital

Trust is essentially an expectation of behaviour: trusting means expecting someone to behave in a predictable and beneficial way. This expectation comes partly from our understanding of that person’s private interest. But in trade or teamwork situations, private interests are typically opposed: theoretically the client prefers to avoid paying; the supplier can save money by delivering bad quality; and the team member would benefit from free-riding. People can be encouraged to act against their private interest by the social penalties involved in not doing so: non-paying clients are blacklisted; unreliable suppliers are dropped; and shirking workers are laid off. These kinds of penalties are stronger when interpersonal links are hard to replace, serve many functions, and are part of someone’s identity or group membership. Groups that are cohesive and have a strong identity are better able to discipline members for violating norms of cooperative behaviour. When this social capital is used to support market exchange and firm performance, it can enhance efficiency. But it can also be used to pervert exchange—for example, by favouring kith and kin—and to undermine organizations, perhaps by diverting time and resources away from the goals of the organization.

One way of creating social capital is thus to form a group identity that supports the economic goals of an organization or market. Because group identities are typically persistent, they are not necessarily amenable to rapid change—and can even become a force against change. Creating this type of group identity requires leaders able either to generate it from scratch or to channel an existing identity to serve a new purpose. Many firms and organizations rely on devices such as team sports or happy hour drinks to create a sense of conviviality that hopefully fosters group cooperation. Some business organizations engage in similar types of group bonding activities, with the view of encouraging more ethical and group-minded business practices. In other cases, the leadership comes from existing group structures that are repurposed for an organizational or market-support role.

Another approach to social capital consists of cultivating norms of individual behaviour that support the good operations of markets and organizations. The human mind comes equipped with a moral sense, and there are many human emotions associated with the respect and violation of norms, such as conformism, pride, guilt, shame, moral outrage, and self-righteousness. Norms associated with pro-sociality, redistribution, and fairness generate their own set of additional emotions, including altruism, envy, ambition, and competition. All these emotions are strong motivators of human behaviour, suggesting that deliberately cultivated social norms can be harnessed to support trustworthy behaviour in markets and firms.

Social norms can also evolve following the introduction of new legislation or through interventions directly intended to change social norms, such as educational campaigns and other awareness-raising activities. Firms too can influence social norms, particularly by setting standards of fairness in the way they deal with clients, suppliers, and workers. Early efforts in that direction include ‘paternalistic’ employers who vow to treat their employees as they would treat relatives. More recent expressions of this approach include corporate social responsibility initiatives and mutuality, which is arguably its most evolved and satisfying manifestation.

By identifying the key dimensions of social capital, the above discussion helps us identify the levers upon which to act in order to create it. But it does not clarify how this is done in practice. What distinguishes mutuality from other forms of social capital formation is the determination to construct social capital through mutual investment by the parties involved. This approach resonates with the observations we made at the start of this chapter: economic relationships take place in a social context, and this context triggers a wide range of human emotions that can either support or hinder exchange. Mutuality relies on what is essentially a modern version of reciprocal exchange1 to trigger a virtuous cycle of reinforcing trust between economic partners. Reciprocal gift exchange has long been an effective way of building strong human ties between strangers, as it triggers a wide range of emotions conducive to trust and empathy. Mutuality borrows from this timeless wisdom.

Measuring Trust and Trustworthy Behaviour

Now that we have a better understanding of what social capital is and of the factors that determine it, how can we measure it? More precisely, how can we assess the extent to which the social context is conducive to market efficiency and to cooperation in large organizations and firms?

The most direct measure of social capital is its key output: the expectation of trustworthy behaviour. This expectation can be measured with respect to an unspecified stranger, or towards a member of a specific group to which the respondent does or does not belong—for example, in a caste-based society, towards a member of the same caste or a member of a different caste. Expectations can also be measured differentially towards trust in market transactions versus trust in teams of co-workers. It is possible also to ascertain the extent of trust: for example, would you entrust this person with amount of money X for a friend?

Trust may be misguided, however, and if destroyed can undermine performance and pull people apart. Hence measures of trust should be complemented by measures of trustworthiness. One way of achieving this is through an experiment in which respondents are entrusted with money and asked to forward it to a specified stranger. By varying the amount of money and the type of stranger, it is possible to ascertain the extent and directed nature of trustworthiness in a population. If respondents are equally trustworthy irrespective of stranger type, we can talk of generalized morality: people can be trusted to act reliably with all strangers. In contrast, if they treat strangers differently according to their type, this indicates in-group bias.

More can be learned by assessing trustworthiness in different types of market interaction (for example, as client, supplier, employee, or borrower) and towards different contractual parties: towards a corporate seller or a street vendor; towards a co-worker or manager; or towards a bank or MFI. People from different cultures or backgrounds may have different views of what constitutes acceptable behaviour in market transactions and in employer–employee relations.

Next the researcher may want to know whether the social capital is based on group membership or social norms. In order to measure this, questions should be asked about the respondent’s different identities (gender, ethnicity, religion, caste where relevant, and place of origin) and about membership and engagement in associations and other relevant social groupings. The purpose is to examine whether in-group bias in trust and trustworthiness correlates with group identity or membership. If it does, this suggests social capital based on group membership. This type of social capital may reflect strong within-group bonds, but may be insufficient to support efficient exchange and collaboration between members of different groups or identities; it could even be counter-productive. It may also be useful to examine the extent to which respondents participate in group activities organized by economic agents (e.g. firms) compared to those organized by non-economic ones (e.g. churches, extended family, sporting groups).

If engagement with mutual investment activities correlates with trustworthy behaviour towards co-workers and managers, this constitutes suggestive evidence that mutuality can create social capital. A similar observation applies to engagement in mutual investments between the firm and its clients, suppliers, and investors. The question is whether a firm can compensate fractured identities and group membership by creating a corporate culture of mutuality that fosters trustworthiness and cooperation within the firm. This leaves open the question of whether the social capital created by one firm would benefit or hurt other firms. Ultimately, however, truly convincing evidence that firms can create social capital requires experimenting with various corporate culture interventions—including mutuality—and submitting the observed outcomes to rigorous statistical analysis, preferably based on the randomization of treatment across plants or establishments. (See Chapter 15 for a description of a randomized controlled trial of a reciprocal investment intervention involving a Mars company and its distributors in Kenya.)

Social norms are another important source of social capital. In some societies, for example, it is acceptable to display distrust towards strangers—perhaps refusing to talk to them, or to eat with them. In Western societies, we are supposed to be polite and courteous even with strangers, and we are not expected to cheat strangers just because they are strangers. In other words, being trusting or trustworthy can simply be ‘the right thing to do’. Information about norms can be collected by eliciting respondents’ attitudes towards normative statements, such as ‘it is acceptable not to pay a supplier in order to take a child to the clinic’ or ‘it is acceptable for an employer to dismiss a worker for unjustified absence’, with responses following a Likert scale (i.e. on a continuum from ‘strongly disagree’ to ‘strongly agree’). While normative questions are informative, though, they may capture what respondents believe others expect them to say. Stronger evidence can be obtained using incentivized methods, such as experimentally putting the respondent in a specific situation and observing their actual behaviour. By comparing behaviour with responses to normative statements, it is possible to gain a sense of how strongly people adhere to specific norms. For instance, people may deviate from the norms they hold in response to behaviours perceived as insulting or disrespectful.

Norms are delicate determinants of human behaviour and should be approached as such. One particular issue that affects firms is how individuals respond to incentives. Economists are strong believers in the usefulness and legitimacy of material incentives—so much so that they often cannot imagine others might think differently.

However, fostering a culture of unconditional cooperation may succeed better than hard incentives if conditional cooperation is perceived as illegitimate. For instance, in countries where people face many problems at home, dismissing a worker for missing work is often seen as unacceptably harsh. Instead of reducing absenteeism, applying this punishment to a worker as an example for others may create a backlash: seen as inherently unfair, the employer loses the moral high ground and employer loyalty suffers, triggering a loss of morale and an increase in turnover and, possibly, pilferage. Seen in this light, mutuality may better serve the long-term interest of the firm than a policy of harsh conditional penalties.

The appeal of the social capital approach is that it covers many of the ways in which social context affects markets and organizations within a single framework. It also brings to the fore both the bright and dark aspects of social capital: while it enhances group cohesion and boosts trust, it can also turn parochial, as when members of a particular ethnic group or gender discriminate against outsiders, or when loyalty towards a commercial enterprise fosters potentially destructive competition (so-called corporate warfare).

Social Capital and Firm Performance

What lessons can we learn from this rapid overview regarding the relationship between social capital and firm performance? Social capital can benefit or hurt firm performance depending on the types of group loyalties and social norms that are activated by it. If economic partners of the firm—i.e. workers, investors, suppliers, clients—identify with the firm and share similar norms of behaviour, strong social capital among these partners should help the firm perform better. On the other hand, if the main allegiance of economic partners is to groups outside the firm and/or shared social norms that are contrary to those of the firms, then strong social capital among them will hurt the firm. For instance, corruption is often associated with collusion among employees (and some managers) to work against the interests of the organization. The ability to collude successfully is helped by strong social capital among workers. Similarly, investors, suppliers, and clients can collude, either explicitly or implicitly, to discriminate against the firm. The stronger the ties they have between them, the easier collusion is.

To counteract these forces, the firm needs to be informed about relevant social groupings and prevalent social norms among its main economic partners. Failure to do so can lead to a loss of performance— especially when the firm operates cross-culturally (e.g. Chu et al. 2018). The next step is for the firm to identify the most problematic rifts and to experiment with ways of creating unifying social capital—for example, by emphasizing a shared identity and a commonality of interests, by creating opportunities for enjoyable and memorable social contact across divisions, and by gradually shifting norms of behaviour. The latter requires the firm to understand precisely which penalties and reward systems are seen as morally and socially acceptable. I have offered ideas above on how to collect the necessary information.

Conclusion

Mutuality can be seen as promoting a humanist approach to business, one in which the firm seeks to create a sense of common purpose and values with its economic partners, rather than adopting an exploitative approach or pandering to local norms and allegiances. Based on analysis, the ability to pursue this strategy effectively depends on the absence of local social capital operating against the firm’s mutuality principles. It is nonetheless important to recognize that fostering mutual investment in reciprocal relationships has been practiced by human societies since time immemorial to build social capital and achieve mutually beneficial exchange. The difference is that the approach is applied to the market realm, which is known to be such a powerful mobilizer of human dynamism and ingenuity. It is this combination of old and new that makes mutuality such a promising avenue to joint prosperity.

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Note

1. Also called gift exchange in the anthropological and sociological literature (e.g. Polanyi 1944, Platteau 1994a, b).

Marcel Fafchamps is a senior fellow at the Freeman Spogli Institute for International Studies and a professor (by courtesy) for the Department of Economics at Stanford University. Prior to joining FSI, Fafchamps served as professor of development economics for the Department of Economics at Oxford University. He also served as deputy director and then co-director of the Center for the Study of African Economies. His research interests include economic development, market institutions, and social networks. His current research focuses on entrepreneurship, factor markets, and the efficiency of social networks in Africa and South Asia.

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