To identify the effect of social capital on financial development, we exploit social capital differences within Italy. In high-social-capital areas, households are more likely to use checks, invest less in cash and more in stock, have higher access to institutional credit, and make less use of informal credit. The effect of social capital is stronger where legal enforcement is weaker and among less educated people. These results are not driven by omitted environmental variables, since we show that the behavior of movers is still affected by the level of social capital of the province where they were born.

Until recently, economists have been reluctant to rely on culture as a possible determinant of economic phenomena. Much of this reluctance stems from the very notion of culture: it is so broad and the channels through which it can enter the economic discourse so ubiquitous (and vague) that it is difficult to design testable, refutable hypotheses. In recent years, however, better techniques and more data have made it possible to identify systematic differences in people's preferences and beliefs and to relate them to various measures of cultural legacy. These developments suggest an approach to introducing culturally-based explanations into economics that can be tested and may substantially enrich our understanding of economic phenomena. This paper summarizes this approach and its achievements so far, and outlines directions for future research.

How much do cultural biases affect economic exchange? We try to answer this question by using data on bilateral trust between European countries. We document that this trust is affected not only by the characteristics of the country being trusted, but also by cultural aspects of the match between trusting country and trusted country, such as religion, history of conflicts, and genetic and somatic similarities. We then find that lower bilateral trust leads to less trade between two countries, less portfolio investment, and less direct investment, even after controlling for the characteristics of the two countries. This effect is stronger for goods that are more trust intensive. Our results suggest that perceptions rooted in culture are important (and generally omitted) determinants of economic exchange.

We thank Roc Armenter for excellent research assistantship, Chiara Corti and Adam Cartabiano for their help in inputting the tables, Jason Hwang for his great help with the WVS coding, and Louise Kelley and participants to the 2002 Carnegie Rochester series for comments. Luigi Guiso also thanks MURST and the EEC and Luigi Zingales the Stigler Center at the University of Chicago for financial support. The views expressed herein are those of the authors and not necessarily those of the National Bureau of Economic Research.