Bilateral trust and trade: Evidence from China

Abstract

AbstractBy changing transaction costs, trust can be a determinant of interregional economic exchange. Based on data sets of bilateral trust and trade at provincial level in China, this study investigates the trust–trade relationship empirically. As a channel of affecting bilateral trade, bilateral trust is incorporated into gravity models. By controlling for institutional quality, labour migration and other economic indicators, the baseline results show that the bilateral trust is positively correlated with the bilateral trade significantly. The sensitivity tests using an alternative estimation of interprovincial trade in China also confirm this positive trust–trade relationship. In addition, we use an instrumental‐variable estimation to control for the endogeneity of bilateral trust, and find that the trust–trade relationship is robust. This relationship seems to reveal that improving bilateral trust can be a new channel of boosting bilateral trade.