1. INTRODUCTIONThis paper examines the effect of trust on economic development. There is a growing literature that argues that trust is one of the main determinants of current economic development. According to these studies, a prerequisite for the success of market economies is to depart from closed group interactions and to expand transactions to anonymous others. In this context, trust facilitates the extension of anonymous exchange. Trust is also likely to improve the functioning of institutions as it minimizes the need for external enforcement of contractual agreements. This decreases the cost of transactions. On the other hand, lack of trust is associated with suspicion and fear of fraud. This increases the cost of transactions. Thus, generalized trust and trustworthiness are considered essential for successful economic performance. Accordingly, trust is expected to have a positive association with economic development.Nevertheless, the literature cannot determine easily the causal effect of trust on economic development. The key difficulty in estimating a causal effect of trust, as a component of culture, is that it is endogenous to economic development. Some studies, such as Inglehart and Baker (2000), argue that the modernization theory stresses that economic development has predictable effects on culture and social life. Other studies argue that industrialization produces pervasive social and cultural consequences. Therefore, to identify a causal effect from a cultural variable such as trust to economic development, we have to find some exogenous source of variation in trust. In other words, when we estimate the effect of trust on economic development, we have to use instrumental variables.The purpose of this paper is to identify new instruments for trust. The instruments used are the geographic characteristics pertinent to the topography of the terrain in a country. Specifically, the mean elevation and the terrain ruggedness are used as instrumental variables for trust. Elevation and terrain ruggedness reflect natural barriers that impede different groups of people from communicating and interacting with each other. These inconsistent landscapes can hinder the feeling of trust and possibly exacerbate a sense of alienation and suspicion towards others who are kept at a distance by the uneven topographic features of the terrain. Rugged terrain also hinders trade between communities. This does not allow the members of these communities an opportunity for interaction and communication that permits trust to flourish. Rugged terrains are also costly to traverse, which does not facilitate mobility and travel from one area to another. This serves as an impediment to communication between different groups of people who are separated from each other by the irregular features of the terrain.There are several studies that investigated the effect of trust on economic development and long run economic growth. For instance, Knack and Keefer (1997) investigate whether social capital has an economic payoff by exploring the relationship between interpersonal trust and economic performance. In their empirical analysis, they focus on the role of trust as the most important indicator of social capital. The results show a statistically significant effect of trust on growth. Zak and Knack (2001) extend their analysis by adding other countries to the sample. The authors also conclude that trust has a significant effect on aggregate economic activity. Guiso et al. (2009) address the question of whether cultural biases affect economic exchange using data on bilateral trust between European countries. The authors attempt to explain why the perception of trustworthiness differs so greatly across Europe, and explore the economic consequences of these perceptions on trade, foreign direct investment, and foreign portfolio investment. The authors find that trust is affected by cultural aspects of the trusting and the trusted country, such as their history of conflict, and religious, genetic and somatic similarities. …