Annotation. The paper reviews the role of social capital and trust in ensuring productive performance of individual firms. The study suggests that the impact of trust on economic outcomes is materialized via a number of routes. First, trust promoting joint problem solving and enhancing relationships between partners stimulates investments in innovation. Second, trust reduces transaction costs, mitigates opportunistic behavior and thus ensures specific investments and the best governance structures.Thus, for developing countries and countries in transition, like Georgia, creation of trust-generating institutions is a crucial task, which in turn will ensure innovative and productive performance of individual firms.

Keywords: social capital, trust, transaction costs, innovation, firm’s performance

Recent period, academic literature has greatly emphasized the relationship between social capital and firms’ economic performance. Knack and Keefer (1997) in their pioneering empirical study of the economic consequences of social capital find that trust and civic cooperation as dimensions of the social capital are characterized by significant and positive contribution to nation’s economic growth. They argue that higher levels of social capital lead to better allocation of resources stimulating thus economic agents to reallocate their resource form protective to productive activities.

The key element of social capital is the trust. The concept of trust that underlies relational contractual arrangements is based on social norms and personal relations (Lewis, 1985). Heide and John (1992) show that norms play a very important role in structuring economically efficient relationships between independent firms. They argue that supportive norms have significant economic value when specific assets need to be safeguarded. Mitigating possibility for opportunistic behavior and reducing uncertainty, trust reduces pressure toward vertical integration (Granovetter, 1985). Macaulay (Macaulay, 1963) in his preliminary study of non-contractual relations in business found that the norms of keeping commitments impose obligations on parties to transactions at the cost of damaging personal relationships. Arrow emphasizing the role of trust as a control mechanism defines it as "…an important lubricant of a social system" (Arrow, 1974; p. 23). The role of informal trust-based institutions takes on special significance for firms operating in transition economies. Such institutions allow firms to cope with the issues of high transaction costs, uncertainty and scarce information in dealing with their partners and thus facilitate smooth functioning of the economies in transition.

Generally, academic literature distinguishes a number of routes via which social capital and trust can influence firm’s performance. Below we review these mechanisms in more detail.

Trust and Innovation. A growing body of recent empirical studies stresses the role of trust in stimulating investments in R&D and innovation (Akcomak and ter Weel, 2009; Doh and Acs, 2010; Landry, Amara and Lamari, 2002; Akçomak and Muller-Zick, 2013; Camps and Marques, 2014). Akcomak and ter Weel (2009) consider an innovation as an important mechanism that mediates the link between social capital and economic outcomes across European regions. The study applies historical institutions as instruments for the social capital and utilizes 3SLS strategy to estimate the casual effects of historical institutions and investments on the current social capital, the impact of social capital on innovation, and the influence of innovation on current income growth. The results of the empirical investigation of the interrelation between social capital, innovation and per capita income shows that social capital affects per capita income growth only indirectly by promoting innovation.  Doh and Acs  (2010), explore the effects of social capital on innovation at the national level. The study utilizes general measure of social capital indicator comprising of generalized and institutional trust, associational activities and civic norms. The main finding of this paper is that when R&D expenditure and human capital are controlled, social capital has a positive impact on innovation and that social capital interacts with entrepreneurship.  Using survey data of manufacturing firms in Canada, Landry, Amara and Lamari (2002) explore the impact of different forms of social capital on innovation. In this paper the innovation process is modeled as a two-stage decision-making process, where at the first stage, the firms decide to whether to innovate or not whereas, at the next stage, the firms make a decision about the degree of radicalness of the innovative activity. Moreover, Landry et al. create a number of indexes to capture a structural social capital (business network assets, information network assets, research network assets, participation assets, relational assets) and cognitive social capital (reciprocal trust) constructs. The study results suggest that social capital is an important determinant of both the firm’s decision to innovate and the radicalness of its innovative activity. In particular, the paper finds that social capital measured by participation assets and relational assets increase the likelihood of innovation of firms, while social capital taking the form of research network assets contributes significantly to the radicalness of innovation. Akçomak and Muller-Zick (2013) based on the data from a number of European countries, investigate the impact of trust on innovation. Applying instrumental variable approach the authors set up a causal relationship between trust and innovation. As a proxy for trust the authors use generalized trust and a range of trust-related variables. The findings of the study suggest that trust (in particular generalized trust and non-egoistic fairness) have robust and significant impact on innovation even after controlling for causal, spatial and non-linear forces.  Dakhli and de Clercq (2004) examine the effect of human and social capital on innovation at the country level. In this paper the three dimensions of social capital is conceptualized as follows: trust, associational activity and norms of civic behavior. Based on the analysis of data from World Development Report and World Values Survey across 59 countries, the authors find support for the positive relationship between human capital and innovation and partial support of the positive impact of trust on innovation. Camps and Marques (2014) use a qualitative methodology within a single-case study to explore the influence of various dimensions of social capital on the multiple types of innovation capabilities. The study reveals the mediating role of a set of general innovative capabilities – enablers - that add to innovative activity. The paper discusses how various dimensions of social capital contribute to the development of different types of innovation, that is product, process, marketing, strategic and behavioral innovation.

On the other hand, the relationship between innovation and firm’s performance, is well documented in economic literature. A growing body of recent research acknowledges that firm’s productivity growth is driven by its innovative and R&D capabilities (Griliches, 1979; Pakes and Griliches,1980; Crepon, Duguet, and Mairesse, 1998; Loof et al., 2003; Mairesse et al., 2005; Griffith et al., 2006). A number of recent studies emphasize the importance of innovation for firm’s performance for transition economies (EBRD 2014; Papava, 2017; Berulava and Gogokhia, 2016a; Berulava and Gogokhia, 2016b).

To summarize, trust promoting joint problem solving and enhancing relationships between partners stimulates investments in innovation and thus ensures productivity growth of firms.

Trust, Transaction Costs, Specific Investments, Productivity. Another way that trust can influence economic outcomes is through reducing of transaction costs. Arrow states that "…In the absence of trust, it would become very costly to arrange for alternative sanctions and guarantees, and many opportunities deriving from mutually beneficial cooperation would have to be forgone." (Arrow, 1969; p. 62). Zak and Knack (2001) using principal-agents theoretical model show that trust between economic agents solves moral hazard problems, and thus makes well-being more inclusive and improves investment and growth. Berulava and Lezhava (2008), in their study of the relationships between manufacturers and their distributors in Georgia, find that higher level of trust existing between partners leads to less complete contracts and lower prepayment requirements, reducing thus transaction cost and facilitating economic exchange. A number of empirical studies provide evidence on the role of trust in reducing of transaction costs and ensuring better interfirm relationship and economic performance (Helper and Sako,1995; Dyer and Wujin Chu, 2003).

According to Sako (2002), trust-based relationship allows for reducing of transaction costs and thus it ensures the most efficient governance structure. Moreover, she argues that trust stimulates investments in specific assets, which in turn guarantees future returns and productivity growth. Similarly Granovetter (1985) suggests that mitigating possibility for opportunistic behavior and reducing uncertainty, trust reduces pressure toward vertical integration. Thus, trust can influence economic performance (e.g. productivity) not only through stimulating investments in R&D and innovation. Providing safeguard from opportunistic behavior and reducing transaction cost, trust promotes specialization and thus contributes to productivity growth. There is some empirical evidence of the impact of trust on productivity. Bjørnskov and Méon (2010) using a three-stage least-squares procedure find a strong evidence of a causal effect of trust on the level and growth of TFP. According to the authors this effect of trust on TFP is due to property-rights institutions rather than political institutions. Berulava (2013) in his study of the impact of trust-based relations on firm’s performance in transition economies, reveals that trade credits, used as a proxy for trust, provide incentives for more intensive innovation activities and ensure higher labor productivity rates.

Summary. The above review suggests that trust and social capital are among those key factors that have substantive influence on the performance of individual firms. This influence can be materialized by means of several transmission mechanisms. First, trust stimulates R&D and innovations through inducing joint problem solving and enhancing relationships between partners. In turn, via promoting R&D and innovations, trust positively effects productivity. The same time, social capital and trust can contribute to productivity growth via mechanisms other than R&D and innovations. In particular, trust reduces transaction costs, mitigates opportunistic behavior and thus ensures specific investments and the best governance structures. To summarize, Western countries prosper because they provide institutional environment, comprised from both formal and informal institutions, that ensure high level of social capital and trust. Only under such conditions economic agents receive the possibility and stimuli for innovation, thus creating preconditions for steady economic growth. Thus, for developing countries and countries in transition, like Georgia, creation of trust-generating institutions is a crucial task, which in turn will ensure innovative and productive performance of individual firms.

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