Economists typically use physical capital and labor as inputs in the description of production processes as it is believed that these inputs are essential to production. The same reasoning could be applied to other inputs. In particular, anybody involved in purchases and sales activities knows that contacts and relationships are also essential inputs for a firm's survival. However, while the importance of this “social” capital has long been recognized in other social sciences (see, for example, Granovetter 1985, 1995; Coleman 1988; Putnam 1993; Helliwell and Putnam 1995), this view has only recently received attention in the economics literature (Narayan and Pritchett 1997; Barr 1998; Fafchamps 1998; Fafchamps and Lund 1998; Grootaert 1999).

The definition of social capital in different economic and social studies has not been uniform. Some researchers have defined it in terms of trust and norms of civic cooperation (Knack and Keefer 1997; Temple and Johnson 1998) or in terms of cultural values, such as degrees of compassion, altruism, and tolerance (Fukuyama 1995). Others have emphasized institutions and the quality and quantity of “associational” life (Coleman 1988; Putnam 1993; Narayan and Pritchett 1997; Grootaert 1999). While those definitions share common elements, their exact meaning is imprecise and thus difficult to measure. The vagueness of the concept may be one reason why economists have been wary of using it.

Social capital in its broadest sense can influence economic exchange in two ways.