Recent empirical work has shown that trust plays an important role in economic development. In this paper, we delve deeper into the mechanism behind that relationship. Specifically, we investigate the effect of trust on human and physical capital while controlling for the fact that the two types of capital are simultaneously determined. In a sample of 50 countries from 1976 to 2005, we show that trust has a positive and significant effect on human capital and a non-linear effect on physical capital. Increasing trust in a low-trust country has a greater impact on the accumulation of physical capital than an identical increase in trust in a high-trust country. We go on to investigate the interaction between institutions and trust and find that institutional reform is less effective at promoting investment in countries with high levels of trust.
- Human capital
- Physical capital