The objective of this paper is to analyse the relationship between institutional economics of cooperation and the political economy of trust. In recent years, a great amount of scholarly attention has been devoted to the political, social, and economic consequences of cooperation. A central question in interdisciplinary literature is the relationship between cooperation and trust. Some researchers (Cook 2000; Kramer and Tyler 1996; Ostrom 1998) have already considered the role of trust in facilitating cooperation. If trust facilitates cooperative behaviour, it is possible that there is a link between the attitude of trust and behavioural outcomes. Previous research (Scholz and Lubell 1998a, 1998b) has already provided some evidence of a link between trust and cooperation. Research on collective action assumes trust increases the likelihood of cooperation.

A new instrument for value production in the global economy is the cooperative mode of organisation characterised as interdependent, long-term relations among autonomous organisations. Productive and creative cooperation is considered a potential incentive-related coordination in many spheres and activities among governments and their agencies, firms of the industrial and commercial sectors, cooperation and conflict between firms, between workers and management, and between firms and functions that must contribute to a major economic project.

Institutions have an important influence on individuals’ expectations of the future, locking in the system to a stable long-run structure. Cooperative structures can emerge as an ‘institution’ defined as an observed regularity in the behaviour and/or actions of individuals or groups when they encounter a similar set of circumstances (Witt 1987, 87). Social institutions are sets of rules that structure social interactions in particular ways. These rules provide information about how people are expected to act in particular situations, can be recognized by those who are members of the relevant group as the rules to which others conform in these situations, and structure the strategic choices of actors in such a way as to produce equilibrium outcomes (Knight [1968] 1982, 54).

The self-organisational perspective sustains that institutionalisation of competitive or cooperative behaviours results from micro-macro interactions more than coordination costs and asset specificity. New organisational economics explains theoretically the different modes of vertical relations between firms, suppliers and customers.

Trust may be sustained by appropriate institutions (Levi 1998, 77-101; Hardin forthcoming). Trust facilitates co–operative exchanges between actors to make commitments to behave without the monitoring and enforcement of an external agent reducing the transaction costs of cooperation (Coleman 1990; Putnam 1993; Granovetter 1985; Kreps 1990). An institutional account of trust is made by Farrell and Knight (2003). Institutions may exert an independent effect on trustworthiness. The evolution of institutions may be expected to have an impact on trustworthiness and cooperation among individuals.

Transaction costs, principal-agent theory, market power, increasing returns theory, strategic management (competitive forces, resource-based view (RBV), organisational knowledge and learning), strategy choice theory and resource dependency theory, offer complementary explanations of cooperative arrangements. Transaction cost theory focuses on cost minimisation; relationship marketing on providing superior customer value; organisational learning on knowledge; strategic behaviour theory on profit maximisation; and resource dependency theory on obtaining resources (Figure 1).

Farrell and Knight (2003, 8) define trust as “a set of expectations held by one party that another party or parties will behave in an appropriate manner with regard to a specific issue”.

Promoting trust and cooperation between firms, institutions and local government can achieve economic gains. “What is needed is sufficient trust to initiate cooperation and a sufficiently successful outcome to reinforce trusting attitudes and underpin more substantial, and risky, collaborative behavior. (…) Virtuous spirals of trust and effective collaboration need to be established.” (Webb 1991, 237).

Harmonious relationships between firms, communities and government are built upon trust and mutuality. “Social trust in complex modern settings can arise from two related sources — norms of reciprocity and networks of civic engagement.” (Putnam 2003, 171). The reciprocity characteristic of networks enhances cooperation because: (1) it increases the costs of defection, (2) it fosters robust norms of reciprocity, (3) it facilitates communication and improves information flows, and (4) it embodies past success at collaboration and provides a blueprint for future cooperation (Putnam 2003, 172). Empirical studies on the evolution of cooperative network relationships that focus on inter-organisational relationships include Human and Provan (2000).

Economic cooperation is impacted by trust. Trust is a key element and decisive factor in the cooperation relationship, which allows real commitment and confidence among the partners to develop a vision for the long-run. A seriously flawed cooperative working relationship will doom any agreement to failure, although a flawed written agreement can always be modified. Interdependent decisions to cooperate are influenced by the degree of cooperation already present in the organisations and may lead to an equilibrium in which cooperative alliances prevail.

In the more socialised version of trust, it has been observed that norms of fairness may enter into transactions between parties and firms. Often in relational contracting, norms of conflict resolution within the relation develop (Macneil 1978). Trust is an interdependent action of social cooperation for mutual benefit (Coleman 1990, 306-10).

Rational choice theory explains that trust is a factor in social interactions characterised by risk, as Coleman (1990, 91) puts it: “They are situations in which the risk one takes depends on the performance of the other actor.” There is a positive relationship between trust and social capital, on the one hand, and political and economic success. Researchers attempt to document the various ways in which trust and social capital can improve the performance of political and economic systems. Putnam (1993, 2000) intends to demonstrate that the political and economic success of large social communities is linked to generalised trust and cooperation, though.

Luhmann (2000) distinguishes between person- and system-trust according to the recipient of trust. Person-trust is aimed at individuals and system-trust refers to the trust in abstract systems of relationships (Krause 1996) such as organisations. Thus, trust can exist towards the representative and at the same time towards the partner organisation.

Rational choice theory of institutions explains why individual actors come to trust each other, sets out different forms of cooperation and helps one understand the differences between them. The “encapsulated interest” account of trust combined with institutional theory provides the basis for comparative analysis of trust in explaining cooperation (Farell 2000). The “encapsulated interest” account of trust specifies the relationship between institutions and trust predicated as trustworthiness in a three-party relationship (Hardin, forthcoming), with people's own self-interest involved.

Farrell and Knight specify this relationship between trust and social institutions, in a middle ground between Hardin (forthcoming) and the broader conception of social trust (Putnam 1993). According to Farrell and Knight's account (2003, 8), “the existence of institutions in common social settings can affect the trustworthiness of the actors in those situations in such a way as to create ongoing relationships of trust among those actors.” The authors suggest a model of the relationship between institutions and trust among actors. Institutions give actors an incentive to behave in a trustworthy or untrustworthy manner and/or affect social beliefs about the trustworthiness or untrustworthiness of actors through their dissemination of information about the expected behaviour of others.

Trust and trustworthiness become relevant when the social cooperation cannot be reduced to simple institutional compliance. Cooperation inherent in institutional compliance is different from cooperation through the use of the concepts of trust and trustworthiness. Thus, in any relationship among institutions, trust and social cooperation are relevant. “Cooperation through compliance with institutional rules in particular social settings affects an actor's beliefs about the propensity of others to cooperate (their level of trustworthiness) in similar settings which affects that actor's willingness to cooperate at some subsequent point in time in that same social setting.” (Farrell and Knight 2003, 10-11.) Changes in trustworthiness and in trust between actors lead to changes in the extent and form of cooperation. The model the authors set out specifies a set of causal relationships, which may plausibly affect trust and cooperation between actors (Farrell and Knight 2003, 15).

The model of trust, trustworthiness and cooperation appears “to provide a good account both of cooperation between actors, and the evolution of this cooperation over time, in relations between economic actors” (Farrell and Knight 2003, 38). A model of trust, trustworthiness and cooperation is shown in Figure 14.

Trust and confidence in the partner can rise unrealistically during the partner search and selection stages, only to drop as difficulties arise (Doz 1996). A simple contracting scheme in order to differentiate transactions and corresponding governance structures can be shown by using the classification of transaction types of Williamson's contracting scheme (Figure 15).

Hirsch and Meyer (2005) explain the scheme in the following terms: a good or service can be supplied either (1) by a general-purpose technology or (2) by a special purpose technology. The latter has the advantage that it is more efficient for servicing steady-state demands (e.g., for a cooperation partner), but it requires greater investments in transaction-specific durable assets.

The variable k is used to measure the extent of transaction-specific assets. An investment in the general-purpose technology can be described by k=0 and, respectively, k>0 when there have been transaction-specific investments. According to Williamson (1989; 1999, 62-63), classical market contracting suffices for the first kind, while for the latter type, unassisted market governance poses hazards. The question is whether individuals should trust each other. The authors call this the trust problem in cooperation. Game theory, and more specifically, the prisoner's dilemma, models this kind of trust decisions as shown in Figure 16.

The trust engendered in the partner will result in behaviour of benefit to the firm in the alliance. The political economy of trust in clusters of small firms geographically concentrated relies on cooperation to prosper.

Power has distribution aspects (Knight 1992). Power affects cooperation based on trustworthiness as a relational concept. Any agreement puts in place relationships of power and prescribes roles of action to the partners. Relationships of partnership include the distribution of power and may not be based on equality and equity. In the case of indigenous groups, real partnership must involve equitable cooperation. Power over relevant decisions can be shared but not necessarily equal power. There is not always a consensus on decisions and the degree of influence exerted by partners may not be equal. Thus, any asymmetries in power affect the trusting relationship of cooperation. There is a widespread perception of alliances as “weapons of power”, instead of being “tools of management” (Schroeder 1976).

Firms frequently exercise their power over other firms to solicit compliance. Schroeder (1976) argues that alliances work, to a certain extent, as pacta de contrahendo, constraining and controlling the actions of the allies. To achieve a genuine relationship based on trust it is necessary to establish an appropriate culture linked to reputation sanctions (Kreps 1990) or to subject behaviours to external organisational forms or institutions that provide actors with a technology limiting their ability to use power (Levi 1998). Cultural and legal backgrounds of partners give rise to communication and coordination information asymmetry.

Explaining the relationship between trust, distrust and power in subcontracting relations among firms, Farrell and Knight (2003), Farrell (2005; 2004) have suggested that asymmetries of power are incompatible with trust up to a certain level, and even when trust and its outcomes are asymmetric, trust may be possible. Disparities of power prevent trust from arising and distrust is the likely outcome. Firms may prefer to exploit their power instead of nurturing complex relationships of cooperation (Helper 1993).

The level of confidence required by a partner is not static. Increasing the level of trust does not necessarily lead to a reduction in the control exerted by partners: “the trust level and the control level jointly and independently contribute to the level of confidence in partner cooperation” (Das and Teng 1998, 496). These authors deny any relationship between trust and control, suggesting that high levels both of control and of trust are necessary in international joint ventures compared with other forms of inter-organisational cooperation. In a joint venture, a new corporate entity is formed. Thus, trust and control seem to be independent, but other contingencies should be included in the analyses of the relationship between trust and control in different forms of inter-organisational cooperation, such as the impact that cultural factors have on these variables.

As a means of both enhancing cooperative behaviour and mitigating competitive conflicts, relational capital based on mutual trust and interaction at the individual level between alliance partners creates a basis for learning and know-how transfer across the exchange interfaces (Kale, Singh and Perlmutter 2000). Canadian companies currently in Mexico concur and overwhelmingly view establishing trust as very important to doing business with Mexicans (Dennis and Beamish 1993).

There is a causal relationship between institutional economics of cooperation and the political economy of trust. Increasing the number of cooperative relationships and activities between agents increases the probability of cooperation, as they develop trust by working together over time. I argue that institutional cooperative arrangements should be considered in relation to economic gains for the parties and agents involved. These cooperative arrangements are the result of relationships of trust that aim to develop economies of scale, economies of scope and to internalize externalities, but also of the economic and political interests of agents and the institutional context in which cooperation takes place.

The political economy of trust plays a major role in the development and ultimate success of cooperative relationships between political and economic agents. Lack of opportunism in cooperative relations between economic agents and political actors is the result of trustworthiness of some kind between them. Cooperative practices are affected by changes in trust and by the bargaining weight of actors affected by the existing institutions. However, it has been almost impossible to completely isolate the effects of trust from other incentives adequately calculated about the relevant benefits and transaction costs of cooperation specific to different types of actors. Asymmetrical forms of cooperation seem to be likely when the existing institutional rules do not provide the required trust for bargaining between economic agents. A political economy model of trust, trustworthiness and cooperation provides a cooperative equilibrium between economic actors over time.