I think people don't trust each others to "give back", and that's the reason people rely on guanxi, instead of trusting normal social contract and normal civil relationship between strangers. They want to have extra fixed|irremovable elements embedded (such as born in the same county, having blood relationships, etc, etc.), so they can have a bit protection in social|business transactions, to accomplish anything in China's trust-less environment.

In the past Chinese have lived in small villages. Even though the land is vast, people rarely moved to other places due to lack of means and the atrocious government policies. So ordinary people dealt with relatives and village folks in their entire lives. Trust was based on the threat that you would be practically dead if you behaved badly and were shunned by the village.

Now coming into the 20th century, people started moving into cities to interact with strangers. It's a new and somewhat shocking experience, because most of them only knew the way of life which you just obey the orders from parents/senior family members, follow the old rituals. Unlike the western countries which went through centuries of Enlightenment, the new Chinese cities are almost void of social and civil code, void of sensible law and law enforcement. That's what China has been through in the last century. Quite a few, now escaped from the watchful eyes of folks back in the villages, use the newly gained freedom to conduct unlawful activities, from fabricating their credentials, to using dirty recycled oil to prepare food, all the way to bribing and accepting bribes to drive people away from their home in order to build a shopping mall. So imho ordinary Chinese do not trust each other that much. They seek insurance(strong guanxi is a form of it) in all daily interactions, and hope others would behave.

"For thousands of years Chinese have lived in small villages." that's not specific to China.

"instead of trusting normal social contract and normal civil relationship between strangers". What's "normal" to you? Western way of life?

"unlawful activities": because there's no such thing in the West? It is actually the opposite: Chinese people are less prone to do criminal activities, so much that I'd let my 10 yo daughter walk at night almost anywhere in China, while even a male adult wouldn't walk unaccompanied in many places in the West. I do not say that it is because of some special essence of Chinese people, to me it is simply because of a better education.

There is a lack of trust in China's rule of law and beaurucratic systems, which is quite justified. Given that you can't expect the system to work well on its own, the next step is to intervene through the use of family, professional, and personal connections.

Foreigners are definitely included in these circles, it is just that their use is very limited (what good is an English teacher in your network, or a software engineer). Also, the FCPA makes participation dangerous for us Americans, at least. Even giving a doctor a red envelope at a state hospital is in violation.