“I have always wondered about a question.. How do we verify credibility data in a free market?? I mean in case of investor trusts to invest in some bonds..”

A former student of mine posed this question to me because (I guess) I keep saying “free market good – government bad”. I also guess that he is a person seriously intrigued by my insistence on this point and who is bothered by this question. I further guess that the reason he asked this question is that he is not convinced that something like a reasonable guarantee of a person’s or an agency’s credibility is possible in a free market or at least not more certain than under a system where government enforces certain norms.

Understanding credibility

What is credibility? It is simply the answer to the question “How certain can I be that this person I am dealing with will deliver as he is promising to?” In simple terms, a man’s credibility is a measure of the trust that others are willing to place on him. When an individual is highly trusted, he is said to have a high credibility and when he is not, he is said to have a low credibility.

Second, what is the realm of credibility? It is the set of all situations where an individual promises to behave in a particular manner or deliver a particular outcome. Based on the promise, the recipient of the promise agrees to behave in a certain corresponding manner or deliver a certain outcome. For instance, an employer promises an employee a certain wage to be paid on a certain date of the month. In exchange for this promise, the employee agrees to apply his labour (mental and physical) on tasks as designated by the employer (directly or through his representatives).  In this circumstance, each party, i.e., the employer as well as the employee, trusts the other to act as promised.

If one of them (say A) fails to act as promised, the trust of the other party (say B) gets dented. B is now less willing to trust A.  The more frequently A reneges or even fails to deliver (even though the intent may be to deliver), the less willing B would be to trust him. A is then said to have lost credibility (in the eyes of B). If A engages in such behaviour with many individuals (C, D, E, etc.), then his credibility would become low with C, D, E, etc. If other individuals (P, Q, R, etc.) come to know of A’s behaviour pattern through B, C, D, E, etc., they would tend to have a lower level of trust in A’s promises and A may be said to have low credibility with P, Q, R, etc., as well.

On the other hand, if A were to keep his promises, B, C, D, E, etc., would have a greater level of trust in A and A may be said to have a high credibility. Other individuals P, Q, R, etc., who learn about A’s behaviour pattern from B, C, D, E, etc., would now also repose a higher level of trust in A and A may be said to have a higher level of credibility.

What happens when an individual changes his behaviour pattern? Over a period of time, his credibility changes. If a hitherto credible individual starts reneging on his promises, his credibility falls depending on how quickly the information spreads to other individuals. The faster information spreads, the faster his credibility falls. Rebuilding credibility after it falls very low is, however, likely to be a much slower process because people would in general be once bitten twice shy. However, it is indeed possible for a person to rebuild his lost credibility by working hard at keeping up his promises.

We thus learn something very important about the concept “credibility”. The extent of credibility an individual possesses depends on his behaviour pattern and in particular on his attitude to the promises he makes to other individuals.

Why is credibility an important issue?

Credibility is important because in many of our interactions and exchanges with people, we are placed in a position where we need to trust them. When we visit a doctor, we trust that the doctor knows what he is doing and that following his advice is likely to heal us. When we lend money to someone against a promise to repay the loan as per agreed upon terms, we trust the other person to repay as agreed. Even personal relationships rest on trust. The wife trusts her husband’s fidelity and the parent trusts that his child does indeed behave well when he is not watching her. Entire civilized societies exist because people trust others to behave in a particular manner.

In fact, with the exception of cash-and-carry and barter transactions, all exchanges that people have with each other rest on a foundation of trust. One can even say that without trust, the entire fabric of civilization would come crashing down.

At an individual level, a person’s credibility is a reflection of the trust that he is able to inspire in others. If A has a low credibility with B, C, D, etc., then the latter are very unlikely to have exchanges with him, at least in the areas of low credibility.

Credibility takes even more importance when we are dealing with people we do not know too well.  Before we place our trust in an individual, we would like to verify that the individual is indeed worthy of our trust, i.e., if he has a high level of credibility. Before entrusting our health to a particular doctor or our money to a particular investment firm we would like to check their credibility with others who have had an opportunity to experience that doctor’s or investment firm’s past behaviour, especially with regard to keeping up his/its promises.

How the free market would deal with credibility

If the explanation of credibility given above is reasonably valid, then we see that credibility is a “good” of value to a whole host of people. In fact, one can even say that credibility is a good of value to everyone though the only issue might be whose credibility and in what areas. A doctor’s credibility in the area of repaying loans he has taken is of no consequence to patients who seek his treatment.

If credibility is a good of value, it is clearly possible to have a “market in credibility”. What this means is that it then becomes economically worthwhile for some people (A, B, C, etc.) to specialize in the area of gathering information about the behaviour and performance of other people (P, Q, R, etc.) working in various areas of activity. The information thus gathered may be analysed to identify behaviour patterns that will help yet other individuals (X, Y, Z, etc.) understand the credibility of P, Q, R, etc.

X, Y, Z, etc., thus become potential customers of A, B, C, etc., who provide the former an insight into the credibility of individuals P, Q, R, etc., with whom X, Y, Z, etc., plan to have transactions, be they of a personal or commercial nature. Conversely, P, Q, R, etc., may also thus become potential customers of A, B, C, etc., if it is in their interest that potential customers X, Y, Z, etc., get reliable information about their past behaviour and thus get a good assessment of their credibility.

Like for every other good, price of information related to credibility would be arrived through the operation of the forces of supply and demand. Which areas of information the market would cater to would in turn depend on the customers’ valuation of the information. If people in general regard certain types of information as more valuable, they would be willing to offer more for it. Conversely, people would be willing to offer less for information that they consider less valuable.

Summarising the explanation

Credibility is a good of value to all individuals, to each in areas relevant to him/her. As a good of value, it can be produced and exchanged in the free market of voluntary exchange. The free market, where anyone is free to produce and exchange any good, would therefore witness the provision of “credibility verification/validation services” just as it would witness the provision of cars, toothpastes, televisions, healthcare services, education and a whole host of other products that we are used to seeing produced and exchanged. There is therefore no need for anyone to worry about how a free market would be able to deal with issues of credibility.