Social Trust, Rule of Law, and Economic Exchange: Evidence from China and Its Major Trading Partners

ABSTRACT

Using cross-country panel data and employing the instrumental variable generalized method of moments (GMM) method, this article examines the effect of social trust on economic exchange between China and its major trading partners over the period 2005–2013. Social trust significantly increases bilateral trade and foreign direct investment (FDI) between China and its partners, and this effect is much stronger in nonmember countries of the Organization for Economic Cooperation and Development (OECD) than OECD member countries. Further exploration suggests that the heterogeneity could be explained by the substitution relationship between social trust and the rule of law: social trust matters more in countries where the rule of law is weaker. We also .find that the impact of trust on trade and FDI is weaker in countries that have greater language similarity to China, are adjacent to China, or are common-law-origin countries. Based on these results, in implementing the Belt and Road Initiative, the Chinese government and companies should not only focus on each country’s legal norms but also attach importance to the role of social capital in international economic exchange.

KEY WORDS:

• China
• FDI
• international trade
• law
• social trust

JEL:

• A14
• F14
• F21
• K10
• Z13

Supplementary material

Supplemental data for this article can be accessed here.

Notes

1. Ideally, it is better to use social trust of country i in China. However, the WVS indicates only the general social trust of a country. Thus, this article mainly investigates the role of general trust of other countries in economic exchange with China.

2. GDP_China is omitted in the regression, because it only has variations along the time dimension and would be collinear with year dummies. Stata can report a coefficient of GDP_China if it was added in the model, and meanwhile the coefficient on one of year dummies would be omitted. But this coefficient estimate does not make much sense.

3. Strictly speaking, the control variables that influence international trade and FDI are not completely the same. For example, free trade agreements mainly influence international trade while bilateral investment agreements mainly influence investment. We discuss this in detail in the robustness tests.

4. See Table S3 (available online).

5. The full sample is obtained by keeping those observations used in the regressions of Table 3.

6. Although the correlation between the rule of law and political stability is high, the variable inflation factor (VIF) of each variable is small and less than 10 (see Table S2, available online), so collinearity is not a serious problem. To further eliminate collinearity concerns, we use stepwise regression, and the comparative results (regression with and without the rule of law) show that our empirical results do not change significantly. To save space, these tables are not presented here and can be provided upon request.

Additional information

Funding

Changyun Wang acknowledges the financial support from the National Natural Science Foundation of China [Grant Number: 71874194]. Teng Zhong thanks the National Natural Science Foundation of China [Grant Number: 71703018] for financial support.