Italy's 'trust no one' culture holding back growth

The local bike shop’s proprietor, a rather cantankerous old man, greeted me with a suspicious eye and deafening silence. After I made clear my intention to purchase a bike, he snapped that he had only one to sell me, and I could take it or leave it.

“You run over a nail, I am not responsible,” he proclaimed. “You ride the main cobblestone streets and damage the wheel, I am not responsible. You break the chain, I am not responsible.” He went on and on.

Then I realised what had just happened. He wasn’t trying to shoo me away. Rather, he was vetting me as a customer. He didn’t know me, which meant he couldn’t immediately assess the riskiness of entering into a simple transaction for a used bike.

Just like things have always been.

Underlying Italy’s old-timey feel is a dearth of one of the most basic building blocks of contemporary market economies: impersonal trust.

This is in stark contrast to the rest of the developed world, and explains in large part Italian businesses’ problems in obtaining access to capital. Italian banks have long been stingy in their business lending, especially so now, in the current rough economic climate.

Tight access to capital plays a part in keeping businesses in Italy small. In fact, Italy has the highest proportion of employment in firms with fewer than 10 employees in Europe. Many prefer to stay small, keeping their customer and supplier bases within a close network of friends, family, and regular customers.

At its core, this lack of societal trust is a symptom of Italy’s lack of an efficient mechanism for enforcing contracts. In fact, it ranks last among developed countries in that regard, according to the World Bank. And that leads to some major problems.

Let’s say you manufacture farm equipment and sign a contract to deliver several new tractors. You gin up production to meet the delivery date.

But then the customer backs out of the sale, leaving you stuck with a bunch of new tractors and no buyer. In most countries, a business in such a situation would go to court to seek redress. But not in Italy, where resolving these kinds of disputes takes years and umpteen procedural hurdles.

So, firms pull back. They carefully vet their suppliers and customers because they don’t want to be stuck with a multi-year lawsuit and a bunch of costly goods. Those outside established networks have a hard time getting in.

The genius of the market is that it obviates the need for building rapport in everyday transactions.

Security of contract allows individuals to implicitly trust others, with the understanding that any violation can be resolved legally in a swift manner. Impersonal trust frees businesses to grow by reducing the transaction costs in taking on new clientele.

How can Italy break free of its pervasive culture of distrust?

Prime Minister Matteo Renzi has made lots of noise about judicial reform since taking office, but he has his work cut out. Raising court fees - presently among Europe’s lowest - could help discourage Italy’s disproportionately large number of frivolous lawsuits.

Reducing the number of procedural steps to resolve a suit (Italy has the most in all of Europe) would lessen the possibility of additional smaller suits at each step.

But taking on Italy’s entrenched special interests, of which lawyers are among the most powerful, is easier said than done. The past four prime ministers tried, and failed.

Lawyers benefit greatly from low-cost lawsuits and the judicial system’s complexity, so it’s no wonder that Italy has more lawyers per capita than most European countries. And they will fight tooth and nail to preserve the status quo.

Renzi entered office with more political capital than recent prime ministers. He ought to use it in shaking Italy out of its low-trust rut. And that begins with reform of Italy’s courts.

The writer is is an adjunct fellow at the Competitive Enterprise Institute in Washington DC