Social capital vs institutions in the growth process

Is social capital a substitute or a complement to formal institutions for achieving economic growth? A number of recent micro studies suggest that interpersonal trust has its greatest impact on economic performance when court institutions are relatively weak. The conventional wisdom from most macro studies, however, is that social capital is unconditionally good for growth. On the basis of the micro evidence, we outline an invest-ment game between a producer and a lender in an incomplete-contracts setting. A key insight is that social capital will have the greatest e¤ect on the total surplus from the game at lower levels of institutional strength and that the e¤ect of social capital vanishes when institutions are very strong. When we bring this prediction to an empirical cross-country growth re-gression, it is shown that the marginal e¤ect of social capital (in the form of interpersonal trust) decreases with institutional strength. Our results imply that a one standard deviation rise in social capital in weakly insti-tutionalized Nigeria should increase economic growth by 1.8 percentage points, whereas the same increase in social capital only increases growth by 0.3 percentage points in strongly institutionalized Canada.