The Political Economy of Trust: Institutions and the Sources of Inter-firm Cooperation Henry Farrell Cooperation between small firms in “industrial districts,” where the production process may be radically disintegrated, poses an important challenge to current political science theories of trust and cooperation. Neither the conventional Williamsonian transaction cost approach, nor political culture arguments about the importance of diffuse interpersonal trust, seem capable of explaining them. In this paper, I suggest that the problems posed by these districts – the existence of apparently “irrational” forms of trust in the political economy, and of “high trust” forms of cooperation in societies with low levels of interpersonal trust – may be explained if one adopts a more sophisticated institutional approach. By combining the recent arguments of Russell Hardin and others about trust as “encapsulated interests” with recent rational choice work on institutions and cooperation, I show how institutions may affect trust between economic actors, and thus cooperation. I apply these arguments to two case studies of “industrial districts,” mechanical engineering in Bologna in Italy, and Stuttgart in Germany, and show that empirical evidence supports the hypothesis that trust may depend on institutions, and vary with institutional context.