The destruction of New York's World Trade Center by religious fanatics on September 11, 2001 led many commentators to question whether religion and globalization are compatible. The relationship is complicated by its theoretical ambiguity: religion can both enhance and suppress economic activity in general, and its potential network effect can both create and divert trade. There have been few empirical studies to shed light on the matter, however. This paper fills this void by examining the empirical relationship between religion and international trade.
AN INTRODUCTION TO THE AMBIGUOUS ECONOMIC EFFECTS OF RELIGION
Religion is an institution that guides general economic behavior, and it therefore also affects the important economic activity of international trade. Religions often promote "economically-friendly" behavior, such as honesty, diligence, and the provision of public goods. But, because religions focus on
spiritual issues rather than the "pursuit of happiness," they may also suppress people's motivation to engage in welfare-enhancing economic transactions. Religion's overall influence on trade-enhancing institutions is, therefore, ambiguous. (Iannaconne, 1998) observes in his survey of the literature on religion and economic activity that "religion seems to matter, but its impact is far from uniform." lannaccone's survey also reveals how sparse the research on this issue is. How religion influences the institutions that directly affect international trade has not been systematically examined by economists.
Religion may also have a network effect that facilitates complex economic transactions among people in different countries. Religion's role in creating international trade networks has been investigated by (Greif, 1989; Grief, 1994; Rauch, 1999; Rauch, 2001; Rauch & Trindade, 1999). The sharing of religious beliefs can mitigate problems such as adverse selection, moral hazard, and default. Therefore, religion can facilitate complex economic transactions among people in different countries. These network effects of religion are not necessarily favorable to increased international trade, however. Networks can divert trade as well as create trade. Furthermore, networks may hinder the long-run growth of trade by limiting the entry of new participants and the inclusion of new products. Recent works by (Mokyr, 1990; Holmes & Schmit/, 1995; Parente & Frescott, 2000) showed that vested interests often obstruct competition and economic change, suggesting that networks may serve to protect certain participants from competition from those outside their network.
TESTING THE RELATIONSHIP BETWEEN RELIGION AND TRADE USING THE GRAVITY MODEL
These ambiguous theoretical results signal the need for an empirical study of religion's effects on international trade. In order to test the institutional and network effects of religion on trade, an augmented gravity model is applied. The gravity model normally explains 70 percent or more of the cross section variation in world trade volumes, and it has proven useful for examining the importance of potential influences on trade. The model is theoretically attractive because it can be derived from a number of traditional trade models; see (Linnemann, 1966; Learner & Stern, 1970; Anderson, 1979; Deardorff, 1998).
ADDING RELIGION VARIABLES TO THE GRAVITY EQUATION
For religion to substantially influence a country's institutions, it must be a dominant religion. Minor religions adhered to by a few people are unlikely to have much effect on a country's overall economic institutions and, hence, its aggregate level of international trade. A dominant religion can be defined as one that is followed by at least 75 percent of the country's population. Religion's network effect depends on whether people in different countries share the same religion. Therefore, to distinguish between religion's influence on trade through the institutional channel and the network channel, three dummy variables are introduced into the augmented gravity equation: DOM for each pair of countries in which one trade partner has a dominant religion, DIFDOM when trade partners both have dominant, but different, religions, and SAMEDOM for country pairs in which both countries have the same dominant religion. …