Bryan Caplan  

Trust, Diversity, Credit Cards, and E-Commerce

Eugene Fama, Extreme Libertari... Extended Adolescence: A Possib...
Modern social scientists are in love with trust.  Economists, sociologists, and political scientists all eagerly explain that high-trust societies work, and low-trust societies don't.  Trust is so beloved that many leftist social scientists have started to sound like social conservatives.  The most famous example is Robert Putnam, who reluctantly reports a clear trade-off between trust and diversity.  From the standpoint of trust, monocultural societies like Japan seem far superior to multicultural societies like the United States.

Strangely, though, this academic conversation has barely acknowledged an enormous social development: the rise of e-commerce.  At first glance, it seems like an enormous triumph of trust.  You go to a website and buy something sight unseen from a total stranger.  A few days later, you usually get what you ordered.  Quality is high.  Indeed, you're usually happier with your internet purchase than you would have been if you'd driven down to the local shopping center or mall.

Given research on trust and diversity, you might expect e-commerce to flourish only in high-trust societies and/or sub-cultures.  But that's not what we see.  Internet commerce is everywhere.  Firms neither know nor care if a customer comes from a high-trust culture.  If you want to buy, there's only one question they really care about: What's your credit card number?

The reason is pretty obvious: Credit card companies provide something far superior to mere faith in your fellow man.  Namely: ironclad reputation.  Credit card companies have spent decades vetting and disciplining both vendors and card-holders.  As long as you play by the company's rules, its ironclad reputation stands behind you.  Otherwise, you're in big trouble.  A vendor that cheats customers gets kicked out of the network.  A customer who doesn't pay his debts loses his account and his credit rating.  If you have no credit rating to lose, the system lets you buy your way in with a pre-paid credit card.

How important have credit cards been for e-commerce?  Well, consider these two scenarios:

1. The whole world has Danish levels of trust, but credit cards don't exist.

2. The whole world has American levels of trust, but credit cards do exist.

In which scenario would e-commerce be more likely to flourish?  Americans have already witnessed internet commerce explode in a scenario very similar to scenario #2.  Can anyone imagine e-commerce taking off in #1?  (Danish comments are especially welcome ).

Thomas Jefferson famously remarked, "Were it left to me to decide whether we should have a government without newspapers, or newspapers without a government, I should not hesitate a moment to prefer the latter."  Reflecting on e-commerce makes me want to add: "Were it left to me to decide whether we should have trust without credit cards, or credit cards without trust, I should not hesitate a moment to prefer the latter."  When intermediaries are supremely trustworthy, you don't need to cross your fingers and hope your fellow man chooses to treat you right.  You don't need to know if you and the vendor have a culture in common.  As long as VISA vouches for both sides, it's all good.

COMMENTS (21 to date)
Pajser writes:

The construction is circular. Those who do not believe to credit cards do not surf e-commerce sites. For any conclusion, one should know how many people believe to credit cards; about 70% in USA.

Bedarz Iliaci writes:

America has high level of trust. If you want a low-trust society, goto North India outside of Delhi where the credit card companies do not even issue credit cards.

The low-trust level implies a non-functioning justice system where it can be perilous for ordinary people to even approach police to report crime or fraud.

LemmusLemmus writes:

I don't know about Denmark, but I have anecdotal evidence about Germany (though no proper data). I'll guess that about half of e-commerce transactions are conducted without credit card companies as intermediaries, for the simple reason that many people don't have credit cards. A variety of pay models is available, including prepayment and allowing the seller to withdraw money from your account. In the latter case, the authorization can easily be revoked by the customer and hence requires the seller's trust in the customer and/or the legal system.

John Jenkins writes:

All you are doing is substituting whom the parties trust. Both buyer and seller trust the cc company to police the transaction, so they are willing to enter into the deal. If either side doesn't trust the intermediary (Paypal is an alternative example, as is eBay itself), then the transaction would not occur (or they would find another intermediary whom they trust, like an escrow agent, which would increase the transaction costs). Trust is still present and necessary to the transaction.

BJ Terry writes:

This doesn't only apply to credit card companies but also to other financial intermediaries. Consider futures markets. Despite market participants taking on potentially massive amounts of leverage all the time, the clearinghouse that sits at the center of the market guarantees all the transactions, allowing a tremendous volume of activity.

Even more mundane financial intermediaries implicitly engage in trust brokering, as when investment banks sell IPOs to their clients, but have to carefully price them to on average provide profits compared to where the IPOed shares will trade on the exchange.

It doesn't seem like this is necessarily a prerequisite to e-commerce, though. Silk Road, early eBay, and Craigslist were/are still markets based on reputation metrics for the first two and relying on society's inherent trust-level for the last. It seems like you could build an e-commerce system only on individual reputation metrics rather than a financial guarantee, assuming there was some other convenient means of financial transfer. This could possibly be based on some sort of web-of-trust model which would make it uncentralized even in the reputation manager.

Jody writes:

A trusted middleman definitely enhances trade, but the effect is not unique to credit cards. And I would say the reputation value of ccs is actually slight, contra Bryan, as there are more significant risks to a transaction than if the transaction completes as requested.

In general, observed repeated interactions allow for reputation effects to be established without a middleman - this was the idea behind rating sellers (and buyers!!) on eBay and other sites.

A similar service is offered by the BBB, Emily's list, Consumer Reports (trust in quality) and the like.

Personally, I won't use credit cards with vendors I do not trust - simply the knowledge that they accept ccs is insufficient. And even then, I use a low limit card online to reduce my exposure.

As evidence of the value of determining trust by vendor and not by the cc company, consider that 10% of Americans have experienced credit card fraud. (

8 writes:

There needs to be a certain base level of trust. If the underlying society is losing trust in its government, institutions and currency, eventually there may be a critical failure that causes trust to collapse. If the banking system collapsed and electronic payments were halted, you will hope to God you are living in an area of high trust.

Great post, Bryan!

Shane L writes:

I enjoyed that and think it makes sense. I guess social trust has importance when there is no intermediary, however.

And apart from economics, it's nice, isn't it? Feels nice to be somewhere that you feel you can trust strangers so if you need help someone has your back.

Sam Hardwick writes:

Most e-commerce internal to Finland is done using direct deposits via banks' websites. When the payment is confirmed, the vendor ships. If the vendor screws the customer over, I don't think there's any way to just cancel the payment, you'd probably have to take the vendor to court. I've never heard of that happening to anyone dealing with a business (as opposed to an individual).

Roger Sweeny writes:

Internally, Visa has to be a pretty high-trust society. Visa's business model doesn't work if a company that cheats its customers stays in the network because of a bribe or because it's owned by someone's brother-in-law.

ajb writes:

I'm not sure I understand this post. In most societies with credit cards but low trust there is MUCH more limited ecommerce than the United States. Ebay is a very good example where the kinds of guarantees that Paypal and Visa/MC provide are simply unavailable in most of the world. Moreover, even in places in those countries where one can order online and use credit cards, the number and types of stores that successfully use ecommerce and can convince people to give their credit cards is quite small as a fraction of the total number of stores in that nation. I suggest Bryan investigate Russia, China, India, and South America to see how differently ecommerce functions in those countries and how often even credit card backed transactions involve high transactions costs, low quality outcomes, and all sorts of ways in which sellers can slightly shaft you at the margins without your being able to get your money back in a convenient fashion.

Andrew writes:

Yes, social trust is more important to an economy/society than most people think.

With that said, my "trust" of e-commerce has nothing to do with my credit card anymore than when I use my credit card in person.

I would posit that people trust e-commerce because they can pretend the person they are trading with can be whomever they desire he/she to be.

This is why people get so upset when they call customer service and a "non-american" answers the phone.

Insight writes:

"If you want to buy, there's only one question they really care about: What's your credit card number?"

This is totally wrong, at least at the extremes (not necessarily wrong between USA and Denmark).

A friend who used to be involved with a an online e-commerce site told me that orders from many countries (mostly eastern europe but also a few others) were generally rejected, including many valid ones, since they turned out to be high fraud risks (paid by merchant on card-not-present transactions). A low margins the seller just can't take the risk.

At a low enough level of trust, e-commerce does break down.

gwern writes:

The focus on credit cards and web commerce strikes me as very strange. Caplan seems to be hugely impressed by them - but why? Historically, they're nothing new, and such distant transactions vastly predate websites. Consider the famous Sears mail catalogue, where you could (and millions did) buy everything you needed for your farmhouse, including the farmhouse itself: (Sears would even finance the houses, until the Great Depression hit, although they continued their “No Money Down” financing for smaller purchases indefinitely, and segued easily into credit cards when those came into existence.)

One could justly write of the Sears mail catalogue that "At first glance, it seems like an enormous triumph of trust. You go to a catalogue and buy something sight unseen from a total stranger. A few weeks later on the train, you usually get what you ordered. Quality is high. Indeed, you're usually happier with your mail-order purchase than you would have been if you'd driven down to the local general goods store or distant town." And just like a web retailer such as Amazon, Sears guaranteed satisfaction “or your money back”.

Now, in 1888 when the first Sears catalogue went out, which did America possess more of: social trust & homogeneity, or digital credit cards & computers & Internet?

Anthony Deluca writes:

I have sold thousands of dollars of items on various forums. This is technically illegal but it is common practice on many forums for people to send payment as a gift. If you do this there is no recourse if someone defrauds you.

I also sent almost everything without insurance and often without delivery confirmation. Had someone said the stuff was lost in the mail they probably would not even have lost much reputation on the forums.

I was scammed exactly 0 times. If there are even slight reputational effects I really trust the average member of a community.

However in all these cases the people I sold to were on the same forum as me. So in some sense they were not total strangers. I do not know if I would sell like this to truly random people.

MingoV writes:

Trust isn't that important for purchases of goods. Your credit card company or facilitating guarantor (such as e-Bay) can greatly reduce the likelihood of getting ripped-off.

Trust is a big issue when you are paying for services. Many service providers (such as home repair contractors) do not accept credit cards. Many require at least 50% up front to cover materials. You are trusting the provider to do good work and to do it on time. That trust is undeserved all too often, and it is almost impossible to get the provider to correct the bad work at no extra charge. The Better Business Bureau can help if the provider is a member, but many service providers are not. Informal networks exist for customers to rate and comment on service providers, but I've only seen this for clinicians. This approach could work for all types of services, in theory, but many customers would have to report their experiences to achieve reliable assessments.

Jeff writes:

I am pleased to see Bryan addressing an issue that critics of his open borders absolutism have raised on a number of occasions, and in quite an insightful fashion at that. Kudos are in order.

Brad writes:

"Indeed, you're usually happier with your internet purchase than you would have been if you'd driven down to the local shopping center or mall."

Why so? My utility isn't higher for online purchases than for brick-n-mortar purchases - at least I don't think it is. In fact, my inner child likes the instance gratification I receive when I shop at the mall or store. Buying online has its advantages, but not satisfying my "must have it now" attitude.

rr writes:

I don't know Denmark but I can talk about another high-trust society: Switzerland.

There you may not need to pay on the spot even if you bought on-line. You can get a bill in the mail a few days later. No need of credit card.

A farmer buys a cow from another farmer with a shake of hands, nothing written down.

That said, for those few who do not pay there is a registry maintained by the authorities.

kr writes:

In Poland where I live, e-commerce (our local version of e-bay, large part of it is trading between individuals) is quite big and yet we:

(a) are not an especially trustful society (see @Insight above)

(b) do not use credit cards to pay individual sellers (we might use them to pay in a regular shop, but paypal and such are not big here, so there is no simple way to pay by credit card for something you buy from an individual)

Usually we use bank transfers which leave us at the mercy of the seller, but for some strange reason everything still goes all right 99.9% of the time.

Frankly I don't know how to explain it. I'm not very fond of putting "trust" everywhere but explaining e-commerce with credit cards (institutionalized trust) doesn't seem to be a viable explanation either.

It might be that "buying online" is a different thing altogether in a high-trust, mid-trust and low-trust society - in the sense that we spend more time judging if the seller, and his offer are trustworthy. I know that I would pay more for a product from a seller that I thought I could trust (based on previous comments, how much information on the product is provided, the general look&feel of the offer, even geographical distance). Maybe, we "pay" more in spent time for the same transaction that elsewhere is finalized without much thought about those things.

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