Externalities and Distrust

Gianmarco Daniele, Andrea Martinangeli, Francesco Passarelli, Willem Sas and Lisa Windsteiger

No 21462, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Why do advanced democracies struggle to maintain high levels of trust? We present a theory grounded in everyday interaction among individuals. Governments rely on regulation to foster cooperation and mitigate externalities. Individuals, however, hold heterogeneous perceptions of the externality problem. As a result, regulation generates distrust toward the government, but for different reasons. Those who are more concerned about the externality blame the government for adopting rules they view as too lenient. Those who are less concerned object to being required to comply with rules they perceive as unnecessary. Regulation also shapes interpersonal trust. Once in place, rules define standards of civic behavior and become reference points for evaluating others’ actions. Interpersonal trust erodes when non-compliance is observed. The theory predicts asymmetric patterns of trust polarization, with “disobedient†groups primarily distrusting political institutions and “civic†groups mostly distrusting non-compliant individuals. It also predicts a joint decline in interpersonal and institutional trust as regulation tightens or beliefs become more dispersed. Evidence from a large survey experiment conducted in the aftermath of the Covid-19 pandemic supports these predictions.

Keywords: Regulation; Externality; Covid-19 (search for similar items in EconPapers)
JEL-codes: D70 D72 H3 O52 (search for similar items in EconPapers)
Date: 2026-05
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