How Trust Develops in Developing Economies — And Why It Matters for Capital

Capital does not flow to opportunity. Capital flows to legibility. In markets where formal institutions are strong, credible, and consistently enforced, investors can extend trust to strangers — to founders they have never met, in sectors they have never operated, across borders they have never crossed. In markets where those institutions are absent or unreliable, investors fall back on the only trust that is cheap: the trust they already have in people they know. The result is a structural misallocation of capital that no amount of pitch-deck polish can fix — unless the underlying information problem is solved.

Why trust is an economic variable, not a cultural one

The canonical treatment of trust in economics begins with Knack and Keefer’s 1997 cross-country study in the Quarterly Journal of Economics, which used World Values Survey data across 29 market economies to demonstrate that social capital — measured by trust and civic norms — has a statistically significant positive effect on economic growth.¹ The mechanism is straightforward: trust reduces transaction costs. When counterparties expect honesty and reliable follow-through, they spend less on monitoring, contracting, and enforcement. That freed-up resource compounds into output.

The more precise formulation, however, distinguishes between two analytically separate phenomena that are often conflated. Interpersonal trust — what researchers call generalised or horizontal trust — is the willingness of individuals to cooperate based on mutual expectations of honesty with people they encounter in everyday interactions.² Institutional trust — sometimes called vertical trust — is confidence in formal systems: courts, regulators, registries, and the rule of law that governs them.³ These two forms of trust operate at different levels: interpersonal trust reflects relational environments; institutional trust reflects broader systemic conditions.⁴ They tend to be positively correlated, but they are not the same thing, and their economic functions diverge sharply in developing markets.

The World Bank has documented a positive association between institutional trust and a range of development indicators, including economic growth, social cohesion, and the ability of a political system to sustain policy reforms.⁵ In Morocco, the Bank estimated that a decline in trust constrained the country’s growth by $2.21 billion between 2005 and 2014 — against an initial nominal GDP of $59.52 billion.⁶ That is not a rounding error. It is a structural drag, and it is replicated across dozens of markets where institutional quality is low and improving slowly.

What happens to capital when institutional trust is absent?

In low-income and emerging-market contexts, interpersonal trust often serves as the primary economic lubricant. Informal networks and community-based collaborations enable local trade and microenterprises to function.⁷ But the absence of institutional trust impedes scalability.⁸ This is the core structural problem: interpersonal trust is bounded by the radius of a network. It cannot be extended to strangers at scale without an institutional scaffold to make that extension credible.

Knack and Keefer conjectured that higher trust could reduce reliance on formal credit institutions and improve the quality of economic policies — but the inverse is equally true.⁹ Where trust is low, lenders and investors compensate with relationship proximity. They lend to people they know, in geographies they can monitor, through intermediaries they have worked with before. The result is a capital market structured around networks rather than merit.

The OECD’s 2025 Africa Capital Markets Report makes this concrete. Family and friends remain a significant source of credit across the region, arising from structural features in financial markets but also from cultural mores that emphasise local and relationship-based lending.¹⁰ Meanwhile, collateral requirements and financial history checks disproportionately exclude micro, small, and medium enterprises from formal credit systems — a critical gap given that MSMEs account for roughly 80% of employment across the continent.¹¹ The SME financing gap in sub-Saharan Africa alone is estimated at $331 billion, and it continues to expand despite significant efforts from public and private capital providers.¹²

This is not an African problem. It is a low-institutional-trust problem that manifests wherever formal systems are weak. The same dynamic operates in parts of Latin America, South and Southeast Asia, and Eastern Europe: capital concentrates in relationship networks, and founders outside those networks pay a structural premium — or go unfunded entirely. The World Values Survey records generalised trust scores below 10% in many Latin American and sub-Saharan African nations, compared with above 60% in Nordic countries.¹³ That gap is not a cultural curiosity; it is a price signal embedded in every cost-of-capital calculation in those markets.

How information asymmetry functions as a tax on founders

The institutional-economics framing is useful here. Following Douglass North’s framework, transaction costs are the costs of information processing in the broadest sense — the costs of search, verification, contracting, monitoring, and enforcement.¹⁴ Weak property rights and unreliable legal systems generate high transaction costs by making it expensive to verify claims and enforce agreements.¹⁵ In capital markets, this manifests as information asymmetry between founders and investors: the founder knows their business; the investor cannot cheaply verify what they are told.

Stiglitz and Weiss’s classic 1981 analysis of credit rationing showed how asymmetric information between lenders and borrowers leads to suboptimal credit allocation — not because capital is scarce, but because verification is expensive.¹⁶ In high-institutional-trust environments, formal systems — audited accounts, credit bureaux, land registries, court-enforced contracts — do the verification work at low marginal cost. In low-institutional-trust environments, that verification must be done relationally, through networks, at high marginal cost. The investor who cannot cheaply verify a founder’s claims either demands a higher return to compensate for the risk, or declines to invest at all. Both outcomes are suboptimal.

The BIS has noted that more information and greater transparency tend to increase trust, enabling providers and users of funds to work with a wider range of counterparties — and that with enough transparency between users of finance and providers of funds, intermediation itself may not be necessary.¹⁷ That is a precise statement of the opportunity: if verification infrastructure can make evidence legible to strangers at low cost, it can substitute for the institutional trust that formal systems normally provide.

Where verification infrastructure substitutes for institutional trust

This is where the structural argument becomes operational. The problem in low-trust institutional environments is not that founders are untrustworthy. It is that trustworthiness is expensive to demonstrate to strangers. The solution is not to wait for institutions to improve — a generational project — but to build the verification layer that institutions normally provide.

Research on fintech in emerging markets and developing economies has shown that perceived capital market failures create an institutional vacuum that requires filling by proto-institutional structures.¹⁸ Fintech provides intermediation by combining technological capabilities with platform trust transference, incorporating efficiencies otherwise absent within the existing physical financial infrastructure.¹⁹ The mechanism is not magic: it is the systematic reduction of information asymmetry through auditable, machine-readable evidence.

Consider what verification infrastructure actually does. A founder who can demonstrate — through cryptographically signed financial records, independently verified operational data, or standardised disclosure against a recognised framework — that their reported metrics are accurate has effectively produced institutional trust from first principles. They have made their claims legible to a stranger without requiring that stranger to rely on a shared network, a shared regulator, or a shared legal system. The cryptographic proof layer is not a compliance exercise; it is a trust-production technology.

The OECD’s G20 Principles of Corporate Governance make the same point at the market level: sound corporate governance frameworks promote trust in capital markets through fair, transparent, and predictable market practices that support investor confidence, making it easier and cheaper for companies to access capital markets.²⁰ The same logic applies at the firm level. A founder who builds internal governance and disclosure infrastructure before it is legally required is compressing the risk premium that external capital charges for uncertainty. That is a direct financial return on what looks, superficially, like administrative overhead.

The use of alternative credit data — mobile money transaction histories, supplier payment records, utility payment patterns — follows the same logic. These data streams make previously opaque creditworthiness legible to lenders who have no prior relationship with the borrower. They substitute for the credit bureau infrastructure that high-institutional-trust economies built over decades. The substitution is imperfect, but it is directionally correct: it lowers the cost of verification, which lowers the cost of extending trust to strangers, which lowers the cost of capital.

The compounding logic of trust infrastructure

There is a compounding dynamic here that founders and operators in low-trust institutional environments consistently underestimate. Trust infrastructure — verifiable records, auditable systems, standardised disclosure — does not merely lower the cost of a single transaction. It accumulates into a track record that lowers the cost of every subsequent transaction. The founder who builds verifiable systems early is not just solving today’s capital problem; they are building the institutional equivalent of a credit history that compounds over time.

This is the insight that separates operators who build systems from those who manage relationships. Relationship-based trust is non-transferable and non-scalable: it must be rebuilt with every new counterparty. Verification-based trust is transferable and scalable: evidence produced once can be shared with many counterparties at near-zero marginal cost. The mechanics of how a deal closes in a low-trust environment almost always come down to this distinction — whether the founder can produce evidence that a stranger can verify, or whether they are asking the investor to extend personal trust they have not earned.

The research on institutional quality and economic growth across developing Asian economies, sub-Saharan Africa, Latin America, and Eastern Europe consistently finds that institutional quality positively influences economic growth — and that the impact varies across regions precisely because the baseline institutional environment varies.²¹ The implication for founders is direct: in markets where the institutional baseline is low, the founder who builds their own verification infrastructure is not just differentiating themselves from peers. They are creating a private institutional scaffold that the market has not yet provided.

The African Development Bank’s Capital Markets Development Trust Fund, which has mobilised $15 million to implement 13 projects reshaping capital markets across 15 countries, frames its mandate explicitly around developing liquid, deep, and resilient capital markets to nurture reliable sources of long-term finance.²² The regulatory and governance infrastructure that fund supports is, at its core, a trust-production programme — an attempt to build the institutional layer that makes impersonal capital allocation possible. Founders who build the firm-level equivalent of that infrastructure are not waiting for the market to develop. They are building ahead of it.

The AI-verified diligence layer emerging across global capital markets is the most recent iteration of this substitution logic. Machine-readable evidence, verified by systems that do not require personal relationships to function, is the technological expression of what institutional trust does in mature markets: it makes claims legible to strangers at low cost. Founders who understand this are not building compliance infrastructure. They are building trust infrastructure — and trust, in capital markets, is the cheapest form of leverage available.

What this means

The long arc of institutional economics points in one direction: as verification becomes cheaper, the radius of trust expands, and capital can flow further from its origin. The founders who understand this are not waiting for their markets to develop mature institutions. They are building the verification layer themselves — one auditable record, one standardised disclosure, one cryptographically signed data point at a time. That is not compliance. That is compounding. And in markets where institutional trust is expensive, it is the most durable competitive advantage available.

For a structured framework on building the credibility infrastructure that makes verification possible, the FounderWise Brief covers the operational systems that compound founder agency across markets.