Originally posted on BehavioralEconomics.com in July 2016
Trust, The Sharing Economy and Behavioral Economics
4 Lessons from Behavioral Economics for the Sharing Economy
By D’Arcy Coolican & Lucas Coffman
Getting trust right is critical to commerce and economic growth. Evidence from behavioral economics can help guide the way.
Trust and the Rise of the Sharing Economy
Trust. It’s a complex, tricky, hard to explain, harder to define concept, but it’s crucial for so many things.
As Adam Smith pointed out, a base level of trust in society is necessary for specialization and the economic growth that accompanies it. If we didn’t trust the butcher to give us quality meat without having to inspect the cow every time — or worse yet, if we needed to litigate after every grocery run — the whole system would come to a screeching halt.
This concept is even more critical in the sharing economy — which is often, quite appropriately, referred to as the trust economy.
The sharing economy requires an incredibly high degree of trust, often based off little more than a profile picture and rudimentary reputation system. One needs only a few examples to realize how much trust is actually involved.
Think about the faith required to get into the backseat of a random person’s car late at night? Seemed like a leap, until Uber made it ubiquitous.
Or consider letting a complete stranger staying your guest bedroom? Even visionary investors thought it was a dangerous idea … until AirBnB proved that it wasn’t.
Maybe it’s a trust in the platform (i.e., I trust Uber to screen and monitor drivers) or just trust in people (i.e., that AirBnB host looks legit), but either way it requires a tremendous amount of trust.
These successes in the sharing economy startled more than a few cynics who assumed that this reliance on trust, reputation and goodwill would quickly become a giant scam or worse.
The Subsequent Fall of the Sharing Economy
But a concept that began with such promise is already going through some tough growing pains.
In many ways, the sharing economy seems to be coming apart at the seams. Whether it’s Uber drivers attacking their passengers, or Lending Club defrauding users, these recent problems — and big problems they are — have re-emboldened the original pessimists who doubted the idea of a trust economy in the first place.
Given that trust that is so crucial to the sharing economy — and that many Silicon Valley darlings seem to be getting it wrong — we thought it was time to go through the important lessons from behavioral economics on how trust (and trustworthiness) actually works, and the important consequences for the sharing economy companies.
Lessons from Behavioral Economics for the Sharing Economy
Lesson 1: Trust begets trustworthiness
One of our favorite concepts in behavioral economics is the idea that signaling that you trust someone, is a strong way to get that person to act in a more trustworthy manner towards you.
Armin Falk and Michael Kosfeld provided the first evidence of this hypothesis in their seminal paper: “The Hidden Costs of Control”. We give details on the experiment here, but the takeaway was that when Person A chooses to control or limit Person B’s options, Person B acts in a less trustworthy way towards Person A.
Put another way: If you show you trust the person, they’ll act more trustworthy towards you. Trust is self-fulfilling.
In many ways this explanation can help us understand the initial success of the trust economy.
This positive — and counter-intuitive — outcome helps show that people are more trusting than skeptics usually assume, especially when someone else goes out on that limb first.
This idea — and the resulting spike in trust-based activity — helped fuel much of the early optimism of a utopian trust economy where we could all operate on a system of goodwill toward mankind.
Lesson 2: Trust and reciprocity are limited in time
The TED talk types are often inclined to focus on these surprisingly positive elements of trust, but they often ignore the limitations that are just as important. While trust and reciprocity are very real phenomena, they also have very real limitations.
Most importantly, trust and reciprocity decline quickly with the passage of time.
As Uri Gneezy and John List show in their wonderful paper on gift exchange, the warm glow and good feeling of a generous and trustworthy act begins to disappear very quickly and after a few hours there is no difference in outcomes.
As one gets farther from the moment when trust was shown, the less likely one is to act in a trustworthy way.
How does this concept affect the sharing economy?
Maybe that AirBnB guest will be conscientious on the first night, but after 10 days in your apartment, they might spilling things on the couch and leaving a mess in the bathroom.
Or that 36 month loan on Lending Club or Vouch will look very different in month 32 than it does in month 2.
Many of the challenges the sharing economy has seen recently can be traced back to the evidence documenting this very real limitation on trust and collaboration: timing matters.
Lesson 3: Trust and reciprocity are limited in scope
Just as time can work to diminish trust and goodwill, so too can it diminish with decreased social proximity.
As Arun Chandrasekar from Stanford, Cynthia Kinnan from Northwestern, and Horacio Larreguy from Harvard show in their paper on Social Networks as Contract Enforcement, people are much more likely to act appropriately (even without a contract) when they share many close social connections with the person on the other side of the table. As these common social ties decrease, the degree of cooperation declines significantly.
So what does this mean for the sharing economy?
One might be more conscientious of refilling the gas for the car sharing service they use by their apartment that they know their friends also use, but maybe not the car they use when they’re visiting a different city.
Or (more controversially) an AirBnB user might be more likely to rent a room to someone that looks and sounds like they do.
Again, this evidence doesn’t mean the sharing economy doesn’t work, but we need to be aware of what the behavioral evidence says we should expect to ensure the systems that are built are fair and durable.
Lesson 4: Don’t lose trust, because it’s really hard to get back
One of the most under-appreciated concepts in the world of sharing economy start-ups is the idea that once trust is lost, it can be extremely hard to get back. “Move fast and break things” might work for a social media company like Facebook, but it can destroy an industry that relies on sharing, trust and cooperation.
For an example of this we need to look no farther than the heartbreaking history of the Tuskegee Study.
The Tuskegee Study was an experiment that started in the 1930’s that aimed to study certain diseases in poor black sharecroppers. The horrifying part was that after a cure for the disease was discovered, doctors withheld treatment in order to continue studying the effects on their patients. Revealed to the public in 1972, it goes down as one of the darkest moments in US history.
In a new paper, Marcela Alsan from Stanford and Marianne Wanamaker from the University of Tennessee, showed that this helped create a post-1972 distrust between black males and the medical community that has persisted. Over the last 50 years this distrust has led to black males underutilizing doctors and dying almost 1.4 years younger.
As the post-2009 finance community can attest, re-gaining the public’s trust after it has been lost can be an extraordinarily difficult task.
So for every sharing economy start-up that fails to foster or reward the trust of their users, the entire industry suffers. One does wonder how the sharing economy as a whole suffers for every one of these Uber driver issues or bad Lending Club loans.
The behavioral research would suggest that the price will be high.
What does it all mean?
The sharing economy was born with an incredible amount of promise. It was going to leverage trust to help create a more cooperative and efficient world. But if it’s going to actually fulfill this promise, its leaders need to begin to acknowledge and design around the limits on trust and cooperation that behavioral economists have already been helping us understand.
It doesn’t mean we should declare the entire industry dead and move on to the “next big thing”. It just means we need to be more thoughtful about where it will work and what design mechanisms can give it the best chance for success.
Not every exchange is ripe for the sharing economy. For example, a platform that relies on a reciprocal action years after the initial action might be too disconnected to actually work. This is probably just a no-go.
Some platforms might not be as big as Uber. For some, the limitation on scope means the actual circle of trust is necessarily small. I might be willing to lend my lawnmower to 100 people around me but my car to only 25 people around me. This might be smaller that venture capitalists ideally want, but at the end of the day I’m sure they’d prefer a platform that works to one that doesn’t.
Commitment mechanisms are critical where time is a factor. For example Frank is a P2P lending platform that allows people to borrow money from friends and family in a safe way. In Frank the reciprocal action usually happens months after the initial action, but because the platform asks borrowers to set up the repayment schedule immediately it captures that sense of trust and reciprocity at its peak. (Full disclosure: the authors of this article helped design and create Frank.)
Repetition is important where trust can dissipate. Every interaction can help build and re-enforce trust. Taking an Uber everyday can help me trust the system. Or getting an email from Frank with every successful payment can help restore the feeling of trust and reciprocity.
Technology can make the world feel smaller. Online communities — whether a Reddit board, an AirBnb reviewer, or a Facebook group — can make people who were previously distant feel “proximate” and increase that trust factor.
Start-up failure rates are unacceptable for the social economy. The majority of start-ups end up failing, it’s just how that system works. And it’s fine if the platforms fail, but for every user that feels a breakdown of trust, the rest of the industry suffers. Everyone needs to be cognizant of that.
I believe in the sharing economy. I believe it has the power to create economic opportunities for a part of country that is often left behind. I believe it can make the world more efficient and reduce the power of middle-men.
But until that industry begins to understand the well documented behavioral and psychology constraints of it, it will fail to meet the lofty expectations that it sparked.
Read full post at Behavioraleconomics.com
