Trade, Trust and Transaction Costs

Abstract

Transaction costs are a major reason why internatio nal trade flows are much smaller than traditional trade theory would suggest. Trust between trading partners lowers transaction costs and may therefore enhance trade. The empirical analysis of this paper shows that more trust leads to more trade so that part of the “mystery of missing trade” can be attributed to the lack of trust betwe en trading partners, e.g. because of cultural differences and habits, or because of insu fficient information on product quality and reliability. Our gravity equation estim ates for 25 countries show that measures of both formal and of informal trust contr ibute to the explanation of bilateral trade flows.