Trust is mutual

How to to restore trust in the economy, society, and with your AI-powered financial planner

Photo by krakenimages on Unsplash

Hello,

Welcome to Known Unknowns, a newsletter that trusts you to trust yourself.

Restoring Trust

I contributed to Bloomberg’s series on declining trust in society. We don't trust our fellow citizens (especially if they vote a certain way), and we also have less trust in our institutions: government, courts, public health, the media, and businesses. Pretty much everything, except Amazon and the military, has seen a decline in trust. This erosion can undermine economic prosperity. Trust is essential for transactions, the protection of property, the enforcement of contracts, and confidence in the accuracy of information. Trust is as crucial for growth as innovation, capital, and labor.

As with many problems, I believe the solutions for restoring trust can be found in financial markets. The financial industry constantly loses trust, yet people still entrust their life savings to markets. I take a Mertonian approach. Bob Merton argues that to trust a counterparty, we must believe they are competent and lack nefarious motives. However, in a large economy, we rarely know either of these things directly, so we must infer trust through other means. One approach is transparency—knowing everything about the transaction, such as reading the specs when buying a dishwasher. Another is verification, which is often more practical since transparency isn’t always possible, either because we're not expert enough to make sense of the data, or there’s just too much of it. Verification can come from third parties, like comparing returns to a benchmark, reading Amazon star-reviews, or consulting Consumer Reports.

Regulation can also play a role in enhancing trust by ensuring transparency (through disclosure rules) or verification (through accreditation). However, many regulations don't achieve these aims and can even contribute to mistrust. Good regulation sets up the right incentives rather than just telling us what to do.

As we aim to restore trust, providing transparency or credible verification should be the goals of all institutions. In a world rife with disinformation, this is a challenge, but trust is a two-way street. Institutions have lost trust in large part because they didn’t trust the people they serve. Public health lost trust by not being transparent about what was known and unknown during the pandemic. The media lost trust by not just reporting the news but telling us what to think. For all its problems, financial markets still function because we are trusted to make sense of the data and act in our own best interests. Amazon is trusted because its review system appears unbiased.

Yes, there are bad actors and flawed data, and some curation is necessary. But we should strive for something closer to Amazon’s review system—processing data in an unbiased way and relying on the wisdom of crowds—rather than Google’s Gemini model, which manipulates data to shape our opinions. We need regulation that encourages more fee-only advisors, rather than a poorly defined fiduciary standard.

Our AI Future

John Cochrane wrote an excellent essay on the future of AI and how it won’t replace all our jobs. I also wrote about two examples of how AI can expand the market rather than take jobs.

The Industrial Revolution transformed the market for consumer goods. Power looms replaced bespoke artisans, but they also created a whole new market. Suddenly, quality cloth was affordable for everyone. Wealthy consumers still patronized high-skill artisans for bespoke luxury goods, and they still do today. While fewer artisans were in demand, those who remained had to offer something machines couldn't. But in the end, the market grew, and enough people found work.

Tech and AI will probably do the same for service jobs. I use a personal trainer through an app, which is cheaper than in-person training because it allows him to scale up what was once a time-consuming, face-to-face service. I get the benefits of a top-tier trainer five days a week all month for the price of a single in-person session. I get what I need from a trainer: guidance, motivation, and accountability.

The financial advice market is likely to see even more profound changes. Good, fee-only advisors tend to focus on high-net-worth clients, but everyone needs good advice. In fact, those with less money arguably need better advice, as they have less margin for error. With AI and current robo-advisors, everyone can get pretty good portfolio construction, arguably as good as from a high-end advisor. But portfolio construction is only part of an advisor’s job. Advisors also act as therapists, having difficult conversations—like telling you that you can’t afford to keep subsidizing your 40-year-old son’s music career, helping with end-of-life financial decisions, or guiding you when your spouse dies, and you have to manage household finances for the first time.

Like my trainer, technology will allow advisors to scale their business and focus more on relationships. The market will also become more segmented. If you have $5 million, you’ll get the advisor equivalent of a Birkin bag: lots of personal attention. If you have less, you might get just an annual or life-changing conversation, with AI handling your portfolio and sending standard updates. If you have even less, you may only get a machine, but that’s better than nothing. I don’t care how good AI gets, these are not conversations I’d want to have with a bot.

In any case, good advisors will still have a job, and because they can scale, they’ll serve new markets they never did before.

Inequality and the Election Outlook

Last week, I was part of a panel for the World Economic Forum on the upcoming election. It was an update from my fiery panel in January (though I didn’t bring the heat that time—I just laughed awkwardly as I talked about tariffs). I brought up what has been remarkable over the past four years: inequality has finally declined. This should be a big deal because we were told inequality was the greatest economic challenge of our time. It was blamed for everything, from slower growth to the election of Donald Trump.

But inequality fell because lower-income people saw real wage increases, while everyone else experienced wage declines in real terms. So, inequality narrowed, but it came at the cost of most Americans becoming worse off. And despite lower inequality, many Americans are unhappy with the state of the economy. I guess it wasn't just about inequality after all and there are actually trade-offs to different policy goals. Or maybe how inequality is reduced is what really matters.

Until next time, Pension Geeks!

Allison