The Chronicles of a Capitalist Lawyer

Religion and Economics Rationality

2012-02-29T11:36:00.002+07:00

A couple of days ago, a notorious organization disrupted a health charity event, demanding the event be stopped on the basis that it might be related to the spreading of a certain religion. Their claim was simple, if the event was made to spread religious beliefs, it will cause social unrest within the nearby community.

I find such arguments to be completely unreasonable. It not only shows that the organization does not understand the basic concept of spreading of religion, it also interferes with events that might increase the welfare of society and therefore are beneficial from a legal and economic perspective.

Under Islamic law, one of the valid recipients of "zakat" is "muallaf." These are the people who have just converted to Islam and therefore need to be given more incentives to maintain their faith. In other words, Islam publicly recognizes and validates the use of economic incentives to gain more followers.

The fact that Islam allows the use of economic incentives means that other religions should also be permitted to do the same, and in case Muslims are concerned with the spreading of other religions via economic means, they should also fight back using the same measures. It would be very beneficial to people who are in need if religious organizations compete among themselves to increase their charity spending in order to gain new followers.

Interestingly, people often want to separate economics from religion, fearing that combining them will taint the religion’s sanctity and that it will look very bad in front of God. Again, that is nonsense. In reality, every religion always plays with incentives. And I am quite confident that the general concept of religion is compatible with the notion that humans are rational and will always try to maximize their self-interests, even though they might not be very good in assessing the costs and benefits of their actions and in assessing future risks.

Let us first begin with the concept of heaven and hell. All major religions have such a concept in their teachings. If you always act good or at least the amount of your good deeds outweighs your bad deeds, you will go to heaven with all of its benefits. Meanwhile, if you end up doing more bad deeds, you will go to hell with all of its scary tortures. Like it or not, heaven and hell are the perfect examples of how religions use economic incentives to shape people preferences.

There is a follow-up question though: if people are really rational, how could they still do bad deeds? I have discussed this issue in my previous article, “On Why Religiosity Has not Translated Into Better Legal Compliance,” so I will not discuss it here. But you don’t need to worry, it won’t change my analysis in this article.

Some religious followers believe that the highest level of piety is to act not because of the promise of benefits and punishment by God, but simply because they love God and they want to receive the grace of God. However, it does not necessarily mean that such courses of action are free from economic realities.

These people realize that doing the above will increase their level of religiousness in front of God. Furthermore, the satisfaction that they receive from reaching such a level also maximizes their value. In short, to the extent the benefits outweigh the costs (since it is not easy to reach this level), it is absolutely rational for religious people to chase the grace of God.

Sufi followers desperately train themselves to get rid of individualism by doing religious activities. Yet, I have not uncovered any successful incidents of cleansing our minds of the idea of getting maximum rewards for pleasing God. Deep in our minds, we realize that if we can please God, it will be beneficial to us, even if we don’t expect heaven. We are still bound by our interest in maximizing our rewards.

And there are many good examples of economic incentives and the notion of individuality in religion. Helping other people is not mandatory, it is encouraged unless you are talking about people that are legally dependent on you. Islamic law also recognizes the concept of "fardu kifayah" for more urgent issues that need collective action. This means that the responsibilities of the faithful of a religion are collective. Once one person satisfies the required obligation, the others will be released from any liability of sin.

Having said that, I think religious people should embrace economic realities in their lives and start to contribute to the betterment of society. It is the original goal of religion anyway and would produce the best result for all of us.

The Right of Illegitimate Child - An Overview of the Latest Constitutional Court Decision

2012-02-20T11:11:00.001+07:00

A couple of days ago, the Constitutional Court decided that Article 43(1) of Law No. 1/1974 on Marriage is deemed conditionally unconstitutional. You may read the complete decision here. This is indeed an interesting development. For many years, most legal scholars agree that a child born outside a legitimate marriage will only have legal relationship with his/her mother and not with the father. In other words, the Constitutional Court decision revolutionizes the entire concept of illegitimate child. The big question is, is it a good thing?

I must say that I am disappointed that the decision is poorly reasoned. From a total of 45 pages, the majority opinion only consists of 3.5 pages. It is true that you can't assess the quality of a legal opinion merely from its length, but still, I think that the majority should further elaborate their thoughts before making such a revolution, especially when they claim that: (i) marriage registration is only an administrative requirement of marriage instead of a validity requirement, and (ii) that sexual intercourse that produces child imposes a legal obligation to the parties involved.

The discussion will be divided into 3 sections. First, we will discuss the claim made by the majority opinion that marriage registration is only an administrative requirement. Second, we will discuss whether Constitutional Court has the power to change the concept of father's obligation toward illegitimate child. Third, we will discuss the economic analysis of this major change and how it will affect the incentives of Indonesian people.

A. Marriage Registration is not and should not be an Administrative Requirement

I do not understand how the Constitutional Court can say that registration of marriage should only be an administrative requirement when in fact Religious Court usually, if not all the time, does not recognize a marriage which has not been properly registered even though such marriage has satisfied the so called "religious" requirements. While this is only a reasoning and is not a part of the decision itself, it still gives an ammunition to the proponents of unregistered marriage who believe that they can validly marry without having to register the marriage, seriously jeopardizing the rights of the parents (either the mother and/or the father) and the children in case they don't have any supporting evidence in the court.

There is a good reason why we want marriage to be registered and as far as I can see from the majority opinion, they too reach the same understanding, i.e. that it will be more efficient for court and administrative process if the marriage status of citizens is clear. Maybe the majority think that since an illegitimate child will have legal relationship with his/her father after this case, it will not be harmful to say that marriage registration is not a requirement for marriage validity. If this is true, then the majority has made a big mistake.

Under the rational choice theory, we could safely assume that rational people who choose the path of marriage would love to have their marriage properly validated. This means that they will do all the necessary requirements to ensure that there is nothing wrong the legal status of their marriage, including their marriage registration. And it is also rare to find a modern day case where these rational people fail to register their marriage properly only because they don't know about such requirement.

This indicates that marriage registration can be considered as an effective way to screen those who want to have a valid marriage and those who want to find a loop hole within their marriage. As such, we can infer that unless there is a strong evidence of good faith negligence, people who do not register their marriage must have a bad faith intention. After all, it would be highly questionable if a couple would let go all of their marriage benefits by fail to register their marriage, unless they have other goals to pursue.

Right now, there are some ambiguities in the law on the legal status of marriage registration. While legal ambiguities are usually bad, there are situations where ambiguities are helpful, such as in this case. We can screen the bad faith couple and since there is a risk that the marriage is invalid, parties will have the correct incentives to make their own decision for the marriage. However, by saying that marriage registration is only an administrative requirement, we destroy the protection given to the good faith couple and also the effectiveness of the screening mechanism.

Remember, marriage cases can be complicated and it does not have to include child issues. It could be that a male want to avoid responsibility, it could also be the husband want to have another wife, it could be that a woman want to steal another woman's husband, etc. In any case, priority of protection should always be given to those who have a valid marriage. First, the costs to assess the validity would be cheaper. Second, it also gives incentives to good faith spouse to question his/her spouse on why they don't register the marriage. That would not happen if we say that registration is only an administrative thing, meaning that the marriage would still be valid even without any registration. How could an average person (without any legal knowledge) effectively screen his/her spouse if he/she can convince her that registration does not affect their marriage?

If Constitutional Court wants to talk about the right of illegitimate child, they should focus on the relevant article, instead giving a poorly reasoned analysis like this. It does not help the already problematic marriage case and it will reduce the costs of being unfaithful.

B. Constitutional Court Authority for Making Such Decision

Can we say that the Constitutional Court breached its authority by saying that an illegitimate child also has a legal relationship with his/her father? Not necessarily. Legally speaking, declaring that the provision of Article 43(1) of Law No. 1/1974 which says that an illegitimate child only has a relationship with his/her mother is unconstitutional can only mean one thing, that an illegitimate child should also have a legal relationship with his/her father. This is an a contrario method of interpretation and is acceptable among legal scholars.

The fact that the Constitutional Court must add the requirements for having a scientific test in order to prove the blood lineage is something that we can't avoid. If the Constitutional Court does not say anything about such problem, it would be problematic for district and religious courts in determining the status of their child since currently there are no clear standards for such proceeding. As such, I believe that the decision, poorly reasoned as it may be, did not breach the scope of Constitutional Court's authority.

C. The Economic Effect of the Decision

The economic effect of this decision would be interesting. On the one hand, people who want to avoid marriage responsibility by refusing to register the marriage will have less incentives to produce child, while those who want to steal other people spouses will try their best to produce an illegitimate child. For the illegitimate children, this might be a good decision, at least if they are unwanted, the parents will have less incentives to give birth to them. However, I still have some concerns, especially with the Court's reasoning on marriage registration and also the right of legitimate child.

To the extent the couple can successfully prevent the birth of a child in unregistered marriages, I doubt that we can reduce the rate of unregistered marriage if we say that it is only an administrative requirement. And this will be bad for people who don't know how to protect their right under a valid marriage. It seems the Constitutional Court forgot that a child is only one actor within a marriage and that we should also consider the right of the husband and wife.

Furthermore, granting legal relationship to illegitimate children would not be a problem to the extent it is applied to a father who only have one spouse. It would be problematic if the illegitimate child was produced with his mistress, since it means that the grant of such relationship is made on the expenses of the person's wife and legitimate child. This is something that should also be considered. It might be that this decision will give more incentives to wives to increase their supervision on their husbands, ensuring that they will not cheat outside and thus increases the costs of their marriage. But it could also be used by a husband to subdue his wife to follow his intention of having another marriage since no matter what, once he produces an illegitimate child, such child will still have legal relationship with him, and the legitimate wife and child will not be able to do anything.

From these scenarios, we can see that the problem is not that simple. Personally, I believe that it would be more efficient if the Court clearly says that the marriage without any registration is invalid, after all, all of these problems would not happen if not for the registration issue. This would give better clarity and give incentives to people to avoid unregistered marriage so that guys cannot trick women into that kind of marriage and vice versa. Nevertheless, the decision has been made and we will need to abide by it. I could only hope that it will not produce the wrong incentives to Indonesian couples.

The Market for Gem and the Problem of Being an Expert

2012-02-08T13:38:00.000+07:00

Today, I attended a very interesting Law and Economics Workshop at the University of Chicago Law School on Market for Gem. In his paper, the author argued that the Market for Gem is an reversal of the Market for Lemon. Market for Lemon is a market where, due to information asymmetry between buyers and sellers where sellers have better information than the buyer, the high quality products will be driven out from the market, leaving the market only with low quality products. A good example of this type of market is the market for used cars.

On the other hand, according to the author, the Market for Gem can be described as a market where, due to information asymmetry between buyers and sellers where buyers have better information than the seller, the low quality products will be driven out from the market, leaving the market only with high quality products. At a glance, this seems odd, won't an efficient market produce the same thing, i.e. low quality products will be kicked out from the competition by better products? Apparently not. The Market for Gem is applicable to a situation where low price products that can actually be purchased by certain type of buyers are not being sold because the seller does not know the quality of his own products and therefore he does not have incentives to sell the good products.

The author provides a nice model to show his argument. But that would be too complicated to be described in a blog, so instead, let me show you a simple example. Suppose you have three bracelets, one from pure gold, and two are fake golds. Let us assume that each of them is crafted masterfully so that unless you are an expert, you are completely unable to differentiate the bracelets. Suppose that the market price of the pure gold bracelet is US$5,000, while the fake gold bracelet is US$50. What would be your selling strategy?

You can sell each of the bracelets by using the average price, i.e. US$1,700. But once you disclose the fact to the buyer that two of the bracelets are fake, inexperienced buyers who wish only to buy the fake bracelet will refuse to buy since they only expect to pay around US$50. Meanwhile, experienced buyers will choose to buy only the pure gold bracelet since the price is lower than the market price. But in that case, you will lose money, since you sell a US$5,000 product with a price of US$1,700 and you will be left with the fake bracelets.

In the end, you will only have two strategies, either you sell the bracelets as a bundle, meaning that the buyers must buy all of the bracelets (denying the chance of buyers of fake gold bracelets to buy the cheaper products). Or you will price each of the bracelets using the price of the pure gold bracelet, hoping that an expert buyer will come and buy it. According to the author, there is a social loss in this case, since people are being deprived from their rights to buy the products with the lower price.

The author then provides some ideas on how the law can help to solve this issue, such as by imposing a mandatory disclosure rule for buyers who have the expertise on matters related to the products so that the seller can make an informed decision. Unfortunately, I believe this become the downfall of the paper. The basic problem of this paper is because the author tried so hard in his model to show that Market of Gem is truly an inverse version of the Market for Lemon. While it is true that the basic problem in both markets is same, i.e. information asymmetry, the causes are completely different.

The information asymmetry in the Market for Lemon is mainly caused by usage of the products, while the information asymmetry in the Market for Gem is caused by difference of level of expertise, meaning that buyers in such market are having an informational advantage because of their own expertise gained from investment of their own time and money. To the extent that the buyers gain such expertise without any illegal measures, requiring them to disclose their advantages would be similar to punish people for their own good efforts. This would give bad incentives for people who have worked hard for acquiring such expertise.

A good example would be insider trading cases in capital market transaction where buyers of shares would only be punished if it can be proven that they gained their insider information through illegal measures, e.g. breach of confidentiality duty, abuse of power/authorities, etc. But for buyers who gained their material information from their own research and perseverance, there would be no reason to punish them if they fail to disclose such information to the seller and gain a considerable amount of profit that can be enjoyed by the seller if only the seller knew the existence of such information.

Furthermore, in the Market for Lemon, we do not want people who know that there are defects in their good to sell their products without disclosing such information to the buyer because it would not be efficient if people are being asked to accept bad products without having any recourse to the sellers. In simple mathematical formula, the buyer values the products in P, the seller knew exactly that the value is actually P - x. Of course it would not be fair for the buyer to pay P for a product whose value is less than P.

Meanwhile, in the Market for Gem, the Seller's valuation of the product is P, and the Buyer's valuation is P + x. From any point of view, it is an efficient transaction. In fact in any case, buyers only buy a product from the sellers because the buyer value the products more than the seller. If not, there would be no transaction in the first place. The actual problem with the Market for Gem is that we have to admit now that there should be an objective valuation outside the valuation of sellers and buyers over an asset in order to help the seller in making the right decision. I think this is ridiculous.

I would be very careful in using legal solution in solving the problem of the Market for Gem. After all, we encourage people to do their own research in order to reduce the information asymmetry and therefore we hope that a better and more efficient market can be created. If the problem is on the level of expertise, rather than asking the buyer to inform their knowledge to the seller, why don’t we instead give incentives to the seller to gain the necessary expertise? Returning to the basic principle that we desire good quality products in the market, if the seller does not even know the quality of his own product, he should not try to sell his products in the first place.

Moreover, we also need to assess the actual damages caused by the existence of Market for Gem to the welfare of the society. If the products involved within such market are trivial, maybe we don't need any new duty or obligation. In fact, basic contract law have already provided a solution for this problem. While the buyer does not have any legal obligation to disclose what he really knows about the relevant product, the seller can always ask the buyer to give a representation that he does not know at all about the product. If it turns out that the buyer lied, the seller can simply bringing a suit for breach of representation by the buyer. If the buyer refuses to give the representation, that can be used as a signal by the seller that the buyer really knows something that the seller doesn't know. In any way, it is still a very interesting paper and hopefully we can see the updated version of this idea soon.

Desperately Seeking Legal Certainty

2012-01-26T07:57:00.001+07:00

The title of this post reflects my curiosity with lawyers (by lawyers I mean all people who have received formal legal education) who desperately seek legal certainty. Their usual argument is: legal uncertainties will lead to unfairness and arbitrariness within the society, which obviously is bad. However, I must say that there is a fundamental flaw in this argument since legal certainty too can also produce unfair and arbitrary result. Most of the time, law is a political product rather than an absolute principle, and thus there is no guarantee that the process is clean from any competing interests, where one group would be the winner on the expense of others. In other words, both legal certainty and uncertainty are neutral concepts, they can be good and bad at the same times depending on how we view its purpose and effect to the society.

Maybe the problem lies with the definition of legal certainty itself. Does this mean that the law should be predictable? Or does it mean that the law should be formal and rigid, that there is a general standard applicable for every cases and that it should be enforced without any exception? Answering this issue is indeed a herculean task but I'll try to describe my basic points in this post to start the discussion.

First, we should move to a famous Antitrust Case in the Supreme Court of the United States, Leegin Creative Leather Product, Inc. v. PSKS, Inc. This was a case for vertical price fixing, where Leegin, a leather goods and accessories manufacturer imposed a minimum fixed price for its products that must be complied by its retailers. One of its retailers, PSKS, refused to comply with such minimum price and as result, Leegin ceased to sell its products to PSKS imposing a huge amount of losses to PSKS. PSKS then argued that Leegin has entered into an agreement with his retailers, including PSKS, that restrained trade or commerce (basically restricting competition) and therefore it should be deemed violating the Sherman Act (the Antitrust Law of the United States).

For more than 100 years, the precedent in the United States concerning vertical price fixing is that it is a per se illegal agreement, meaning whatever the reasoning for entering into such agreement, such agreement will be deemed as anti competitive and therefore illegal. However the majority opinion in the Supreme Court reverse such long standing precedent as instead declare the rule as a rule of reason, meaning that such agreement will only be illegal if there is a solid evidence that such agreement is unreasonable and causes anti competitive behavior which adversely affect the welfare of the society.

This is a very interesting case for many reasons. First, the decision was full with economic analysis (something that is quite rare on the Supreme Court level). Two, the decision rejected the application of per se rule for this type of case (which is the usual formalistic way of legal reasoning) on the basis that while such per se rule lowers the administrative costs for future cases (i.e. since every similar contract should be deemed illegal, it can be expected that all courts in the United States will give similar treatment without having to go to a lengthy process caused by the use of rule of reason), it can also produce inefficient results since in the view of the majority, the existence of vertical price fixing can also produce pro-competitive results in certain conditions (such as promoting competition between manufacturers while maintaining price in the level of retailers).

The dissenting itself argued that while there might be certain positive economics effects of vertical price fixing, this is not something unknown back in 1911. If the past justices believed that such positive elements can not justify the legality of the arrangement, how could the current justices defy such reasoning? If there is no significant change in the conditions related to the case, the stare decisis rule (i.e. that a court precedent should be binding against future cases which have similar conditions and elements) should still be applicable and therefore the court should not reverse the precedent. This will ultimately jeopardize legal certainty created by stare decisis rule. As you can see, both groups of justices provide interesting points with respect to legal certainty versus legal flexibility (which is supported by economic reasoning).

Another experience that I had with my Judicial Decision Making course is also interesting to be shared here. As justices in the Supreme Court of Delaware, we handle various cases related to mergers and takeovers of publicly listed corporations. The issues are complex, ranging from shareholders rights for appraisal for their shares in a merger transaction, conflict of interests between shareholders and directors, and fiduciary duty of directors toward corporations. We work on the basis of clean slate doctrine (so we can build our own business law doctrine) and we also build our own set of precedents to be used for future cases.

Only in three weeks and 6 cases, I could easily see how difficult it is to build a consistent approach to the various issues that we face. When we think we have already considered everything, the next new cases show that the principle that we used in the previous case cannot be applied consistently or it will bring a perverse result, either to the corporation or to the shareholders, etc. To certain extent, we need to revise the precedent that we have established previously in order to accommodate the cases.

Take as a case, the doctrine of business judgment, that directors should not be liable to the shareholders in case they can show that they have done their job with good faith and with a reasonable care. Seems easy to translate in practice, but in reality it is not. When can we say that the directors have acted to the best extent of their capabilities? Who can evaluate the performance of the directors? The court? But the court is not a business expert, and putting too much standard might not be a good solution if the ones who create such standard do not have sufficient capacity. So again I face a dilemma, picking certainty versus uncertainty.

If only all legal issues are white and black, maybe seeking legal certainty would not be a desperate issue. But in reality, we live in a gray world. Forcing certainty to everything tends not to solve the problem. On the other hand, having an exact rule will reduce administrative costs (as stated in Leegin case), but on the other hand, it does not mean that it is clean from other type of costs, in fact it can also produce inefficient results. The key question is, how can we strive for a balance?

One of the interesting point of the US legal system is how they divide their laws into two major groups. The common law and the statutory law. The statutory law resembles the civil legal system that we use in our country where everything is regulated by statutes and we tend to answer any legal issues on the basis of the provisions of such statutes. Meanwhile, the common law also use statutes as the basis (other than using judge made law), however statutory provisions that fall under the common law group tend to be more general and somewhat ambiguous, which most or the time are further elaborated by the judges in the court. The US Antitrust Law and the Securities Laws are two good examples of this common law type where the provisions are simple and open to many interpretations by the court.

Obviously the level of certainty in this type of common law statutes is lower than the statutes in the statutory law group. I can confirm this at least from my experience dealing with US securities laws and antitrust law issues. You can make various arguments with the issues such as what constitutes securities, what constitutes public offering, what constitutes a rule of reason case, etc. Compared this with Indonesian securities laws and antitrust laws where it is more certain in terms of definition and concepts. Even for the Delaware General Corporate Law which is quite exhaustive, we can have a heated debate concerning what provisions should be considered as a default rule (i.e. can be waived by parties through a contract like in Indonesian contract law) and what provisions should be considered as a mandatory rule absent express provisions in the body of the law.

Maybe this is a good time to evaluate to what extent we should have certainty in our legal system, whether everything should be regulated precisely so that there is no room for flexibility for the sake of securing certainty. We should also see to what extent the court can be a more productive asset in our legal system by giving them bigger flexibility in solving certain type of cases (such as in corporate and securities laws).

Furthermore, instead of trying to regulate everything within the provisions of a law, maybe it would be a good idea to instead create a more flexible regulation accompanied with a governing value that should be used whenever we want to interpret and enforce the provisions of such regulation. One good example is the normative principle of law and economics where law should be designed to promote efficiency and maximize the welfare of the society (though other people might also have different values). I believe that answering this issue would contribute significantly to the development of our legal scholarship and I would be interested to elaborate more my ideas on this subject in a more formal way.

Outsourcing vs Firm Integration - The Case of Boeing

2012-01-24T10:23:00.000+07:00

The failure of Boeing's outsourcing business plan by farming out most of its work to other overseas firms might be a good example of the danger of outsourcing when it is used without proper calculation. The original idea itself seems good. By outsourcing the work to other firms instead of doing it by itself, Boeing hoped to save costs. First, Boeing can choose firms which have better economies of scale (meaning that such firm have better comparative advantage compared to Boeing and therefore can produce the required products on a cheaper basis). Second, Boeing can focus its works on things that it could do more efficiently (again the idea of economies of scale). Third, by separating the works to many firms, Boeing expected that each of those firms will have less bargaining power against Boeing, lowering the chance of hold up problem for Boeing in the future (see my discussion on Hold Up problem here).

Unfortunately, this seemingly perfect plan did not work in practice. As you can see in my link above, Boeing is already three years late from the original schedule and has spent billions dollars over the budget. It is a business disaster. But why such system does not work? Before I provide my analysis, I would like to share a deal that I once did for one of my major clients.

The client wanted to build a new huge factory in order to expand its business to a new level. In the past, the client usually appointed only one single contractor to do all the work (design, procurement, and construction). However, for this particular project, the client came with a new idea. Instead of using single contractor, it first divided the works into procurement (including design) and construction. Then it further divided the procurement parts into 4 separate parts with 4 different suppliers. It was a good idea. Although the contracts became very complex, the client can save a lot of money by lowering the contract price and reduce the bargaining power of the suppliers (effectively preventing them from forcing their own terms and conditions which would usually happen when there is only one contractor/supplier).

It is interesting why my client structure could effectively work while Boeing's plan turned out to be a failure. Several factors that must be considered are among others: (i) the number of parties involved in the deal which is related to the costs for coordination, (ii) the costs for enforcing the contracts which is correlated with the degree of interdependence between the parties, and (iii) the level of technology involved in the process.

One of the most interesting examples provided by Milton Friedman on the power of free market is the story of pencil. No one knows exactly how pencils could be made, there are so many parties involved in the process and yet, firms make pencil with ease without having to be coordinated nor integrated in the process. It is the perfect example of the invisible hand, how market could work without the need of central coordination among market participants. But issues always come when we try to generalize everything. The case of Boeing can be a good example when failure occurred because lack of coordination.

In my client's case, it took a lot of effort and months of negotiation in order to coordinate 4 suppliers. Yes, there are only 4 suppliers involved in the deal, but the contract drafting process took a long time to ensure that proper risk allocation was made for each contract since even when all of the suppliers were different, each supplier's action can have a significant impact to other supplier's work. A delay in part 1 could impose delay on part 2 and so forth. In other word, coordination really matters. What happened with Boeing is that it seems that Boeing used too many different suppliers located in various parts of the world (I would assume that Italy suppliers would be totally different from Chinese suppliers). This choice of action increased the costs of coordination significantly.

This bring us to the second issue, the costs for enforcing the contract. Since people respond to incentives, if breaching the contract is more efficient than actually satisfying the contract's provisions, we could safely assume that people will choose to breach the contract. In Boeing case, it seems that it's suppliers farm out their work to another sub contractors, increasing again the costs of coordination. Surely it is standard to have contracts where subcontractors are not permitted to sub contract their job to third parties without prior approval from the work giver or that while work can be sub contracted, the liability stays with the supplier. But that kind of contract would work effectively only when the costs of enforcement is not high. If the enforcement cost is high, there would be less incentives for the work giver to enforce the contract. Even worse, since the contract value has been divided into so many suppliers, the value of each contract might be too small for each supplier, to the extent that they do not fear of any liabilities, even when they are deemed fully liable (since usually a supplier will limit its liabilities only to the value of the contract and not the whole project).

In other words, this is a reverse issue of hold up. In hold up problem, a party can increase its bargaining power excessively due to certain specific conditions or advantages that such party has against its counterpart. But in this case, the party has no incentive to work for the best interest of its counterpart because it's stake of interest is low. Even if its counterpart is in impeding doom, that would not affect its position significantly and thus it is meaningless whether the business relationship should be maintained or not.

Finally, the issue of technology is also dominant in Boeing case. What they are trying to build is a new airplane. In case you don't know, airplane can be considered as the most advance technological product in earth. It is very hard to build a plane that could work properly. That's why Boeing case cannot be compared with the success story of the car industry in terms of outsourcing their job overseas. There is a huge discrepancy between the technology needed to build a plane and the one needed to build a car. This would surely affect the amount of coordination needed between the parties. We can say that it would be better in Boeing case if they simply have more integrated coordination and conduct the work by themselves.

At this point, we reach the most fundamental question posed by the Theory of the Firm. Why people choose firm to conduct its business activities, instead of using the market? The primary answer would be the need for coordination. To the extent the costs of integrating the market process (production, manpower and capital) in a single business platform is cheaper than the costs of doing all of that via the market, rational men should choose to use the firm structure. It is a natural thing to do. Too bad that people often polarize the issue of market vs the firm into a debate of uncoordinated economy against coordinated economy as if only one is superior. A productive debate should discuss what type of economic system would work best in accordance with the situation and condition. The pencil case shows the strength of the market while the Boeing case shows that uncoordinated market process could produce inefficient result. In the end, always pick the most efficient system if we really care about the welfare of the society.

The Fatal Accident and the Case for Intentional Murder

2012-01-23T13:06:00.003+07:00

Just recently, an Indonesian woman drove her car against several pedestrians, killing at least 8 of them and injure 4 people (or maybe more). Several news reports said that the woman had consumed narcotic drugs prior to the accident, adding the number of crimes that she might end up with in the court. Obviously, this type of case will fall under the definition of either unintentional murder or reckless acts which cause death. But what I would like to explore more is the possibility of imposing intentional murder provision against the defendant.

Once there was a case in Indonesia where a bus driver drove his bus and dozens of his passengers to oblivion by throwing the bus directly into a river. The driver was driving so recklessly and in such a high speed that he lose control of the bus and end up flying from the bridge. He survived, but unfortunately most of his passengers were not as lucky as him. The state attorney who filed the suit against him felt so disgusted that he claimed that the driver has conducted an intentional murder. He absolutely knew that his action was very dangerous toward himself and his passengers, yet he failed to drive properly. Even worse, some witnesses testified that they have warned the driver how dangerous is his driving and he simply ignored the warning. The end result was a disaster.

I forgot how the case ended up, if I am not mistaken, the state attorney won the case. It is true that the Indonesian legal system does not recognize precedent system where a final and binding court decision can also bind future decisions. Still, it is a good case and can be used to inspire other cases, possibly including this case. But before we move to this case, I would like to discuss first whether it is correct to consider this kind of "recklessness" as an intentional action.

Standard law and economics analysis says that a person should be liable for damages to his victim due to an unlawful act in case the costs of him for avoiding such act is lower than the costs imposed to his victim multiplied with the probability of such action to occur. The mathematical formula would be as follow: B < PL where B is the cost for avoidance, P is the probability of the act's occurrence, and L is the losses incurred by the victim. The higher the intention of the defendant, the higher the probability would be. In certain cases, the value of P could be maximized into 1 or 100% chance that the action will occur and the victim will absolutely incur losses. Take as an example a person who intentionally hit other person without any reason.

The bigger the P is and to the extent such amount of P is increased due to the contributory action of the defendant, the higher the liability of the defendant should be. Why? Again, standard law and economics analysis will say that when the increase in P is caused by the defendant action, the sanctions to be imposed to him must also be increased in order to increase his costs of doing unlawful action. The problem with this analysis is that it ignores the subjective intention of the defendant, something that is still perceived as an absolute thing in classic criminal law, i.e. the Mens Rea element.

There is a good reason that intention should not be seen merely from the subjective point of view. When you drive in a high speed under the influence of drugs and on a busy road in a city, you ought to, no you must absolutely know that your action is really, really dangerous. To say that it is a reckless driving merely on the basis that you don't intent to kill anyone seems absurd and does not make any sense. That is why I would prefer the objective standard of reasoning used by law and economics to establish an intention to do criminal activity. This is a case where the amount of P would most likely reach 1 (or 100%), it would be miracle if a driver in such state would not produce any accident whatsoever.

At this stage, we do not know the entire facts, so I can't judge the end result. But if it is true that the driver drove within the influence of drugs and in such a reckless way, it is suffice to say that she should be deemed of doing an intentional murder. Note this, the punishment of intentional murder is 15 years while the punishment for reckless act which causes death is only 5 years, so there is a huge discrepancy which is determined by how we perceive recklessness and intent to do crime. Furthermore, I would say that further investigation should also be done against the passengers of the car. Just to ensure whether they know that the driver did have problems and still let her to drive or whether they have acted properly and reminded the driver. This kind of act should not be left unpunished and proper sanctions should be given to ensure that we are giving the correct incentives to the society.

Neoliberalism and the Fallacy of the Shock Doctrine

2012-01-23T11:41:00.000+07:00

Since I call myself the Capitalist Lawyer, it's hard for me to resist the temptation of enrolling in one of my law school's courses: Law and Political Thought - Neoliberalism and Its Critiques. After all, I always believe that you can't properly learn a thought if you don't learn its critiques. One of the required readings in this course is Naomi Klein's book, the Shock Doctrine. The basic idea of her book is that the globalization of neoliberalism is primarily caused by the shock doctrine, where neoliberalism supporters use a crisis in a particular place in the world to spread their ideology in an effective way, ensuring that the changes can be made in a massive scale and that such changes would be almost irreversible once they are established as governmental policies.

To add the spices, the book also shows how the shock therapy is administered to various part of the world such as Chile (Auguste Pinochet case), Iraq (the oil companies saga), Asia tigers (the 1997 crisis where Indonesia was part of the victims), China (Deng Xiaoping reformation and the Tiananmen Square) and also England's liberalization (under Margaret Thatcher rule). Furthermore, she also believe that all of these disasters were caused by the idea of Milton Friedman, the famous economist from the University of Chicago. Milton Friedman who was very famous for his teaching on the power of freedom, free market and limited government was blamed as the prime perpetrator of neoliberalism. He was also quoted as the guy who first started the idea of using crisis as a way of spreading ideology.

I must say that reading her book, I am not convinced that there is a strong relationship between the idea of Milton Friedman and the administration of the shock doctrine. It seems that most, if not all, of her critiques and evidence used in the book are precisely not a part of Milton Friedman teachings, nor should they be considered as a part of the original idea of neoliberalism. I would say that she has mixed neoliberalism with corporatism and/or crony capitalism which should be rejected from any point of view.

First of all, using crisis as a starting point of spreading your idea is totally legitimate. Through out the history, we have seen numerous times how crisis change how people perceive the world. If it is not because of the Great Depression in the 1930s, Keynesianism would never had the chance to spread. No one would believe that the solution for depression is additional government consumption. And if it is not for the 2008 crisis, no one would write books on Keynes revivalism. I think the reason why crisis is so effective to spread new ideas is simply because during crisis, people are shocked, their previous believe is shaken, they are vulnerable and would easily see any other new alternatives as the solution. This is what we call as hindsight bias.

Unlike her idea, that shock therapy is a bad idea, I believe that crisis is neutral. Any person can use a crisis for his own advantage, including spreading his ideas. Whether such idea is good or not is a separate matter and history will usually determine the longevity of an idea, whether it will survive for a long time or not. The same thing also happened in Indonesia during the 1966s. When Sukarno fell from his throne and Indonesia was consumed by more than 600% rate of inflation, it was also the right time to dethrone the socialism ideology and replace it with a balanced government intervention-free market economic system. In reality it was a success until Indonesia was turned into a state of crony capitalism and ended badly in the 1997 crisis. If we don't have such crisis, who knows where will our beloved country actually end. Maybe worse than now.

Second, her stories show how dictators use their power to force the free market idea into the society and how corrupt governmental officials cooperate with corporate officers for the sake of their own profits and interests (business lobbying is a serious problem, even in the United States). While that might be true, I don't think that represents the vision of Milton Friedman on capitalism and freedom. The capitalism that I know and believe as the best economic system for the welfare of society does not support dictatorism nor does it support crony capitalism. The capitalism that I know also does not support absolute freedom where business firms can do everything without any liabilities whatsoever. That does not make any sense. Economics teaches us that there are externalities that can be produced by a party against the welfare of the society and that in order to enable the market to work efficiently, such party must be held liable and internalize the costs that it has imposed to the society.

This is where I think Naomi Klein miscalculated her own idea. She work really hard to show how evil Milton Friedman is and how bad neoliberalism is, where government is being stripped from their power and the state assets are sold to several oligopolists who then control the market for their own benefits. Yet in reality, none of these represent neoliberalism thought. Minimum government should not be translated into: "you can do whatever you want". It means that the government should not try to be too big and then used by various interest group for their own purposes. We know that government consists of people, and we also know that they are not angels. To believe that government would always consist of good people would be as naive as believing that the market would always full with good people.

Ronald Coase in his famous Theory of the Firm has shown that firms, coordinated and integrated business units where capital, management, and employee meet and work together, exist within the market. Some empirical researches also show that 50% of the businesses conducted in the market are being run by firms. In short, this means that coordinated effort is necessary and also useful to the extent that the costs of doing so is cheaper than doing transactions via the market. So naturally, there is a balance between coordinated economy and uncoordinated economy where the invisible hand will work.

So in the end, what is neoliberalism? I am still looking for the answer during the course. But I don't believe that it should be placed in the same place with dictatorism and crony capitalism. The idea to promote the welfare of the society by maximizing the freedom of the people and limiting the role of the government in order to make it focus on its essential duties should never be used to justify greed and crimes. It is stupid if you think everything should not be regulated, but that's just the same with the idea of regulating everything. I'll update this issue once I finish the course.

Does Legislative Intent Exist?

2012-01-17T08:30:00.046+07:00

Two of the interesting notions in the world of legal interpretation are the existence of legislative intent (maksud pembuat undang-undang) and that such intent is eligible to be used in interpreting ambiguous laws. I too must admit that I once agreed with those notions during my undergraduate days, but later on I changed my position and my encounter with Public Choice theory strengthened my conviction. First of all, legislators (in our case, DPR) are not a single entity. As famously termed by Kenneth Shepsle, a Professor of Government from Harvard University, "congress is a they, not an it". There is a deep insight in that statement with some serious implications.

Some legal scholars believe that legislators have certain intentions when they promulgate a law. Thus, whenever there are ambiguities in the law, judges should try to interpret the text of the law in accordance with the governing legislative intention. But of course, this is far from the truth. Try reading a law and see the elucidation section. Some have explanations, but most of the time, we only see the words: cukup jelas (clear enough). And I can confirm with huge confidence that the term "clear enough" is simply overrated, meaning that what those legislators thought as clear is not clear at all. After all, no language can perfectly express the intention of a single person, what do you expect then from our language in expressing the intentions of 560 people?

The fact that our DPR consists of hundreds of members shows that it is impossible to determine their intention as a whole. There would never be a single unified intention from these people. Each faction has its own interest, and each member of such faction might also have different interests and preferences. The final product, i.e. the law along with its elucidation, does not necessarily reflect the intention of the overall legislators, it is simply the result of various political compromises with all of its flaws and errors. There might be the winning coalition and losing coalition and the law may only reflect the view of the winning coalition. Not to mention that there are also possibilities of interest groups' involvements in law making process which might jeopardize the interest of many for the needs of the few.

So what is the biggest implication of the above insight? We must understand that since the legislators do not have an unified intention, trying to interpret the laws in accordance with their intention might not really work in practice. A good example is the Constitutional Court decision in the judicial review of Broadcasting Law (Law No. 32/2002), specifically on the authority of the Indonesian Broadcasting Commission (KPI) to issue broadcasting licenses for private broadcasting companies. In such decision the Constitutional Court declared that what the legislators intend to say does not mean anything if it is not expressed in the law itself.

As a background, the law says that the authority to issue broadcasting license resides with the Ministry of Communication and Informatics (KOMINFO). However, KPI argues that the legislators actually intend to give such authority jointly to KOMINFO and KPI in its capacity as the representative of the people. After all, KPI has the authority to conduct the preliminary selection process and provide recommendation to KOMINFO. Why then the licensing authority should solely fall into KOMINFO? But as stated by the Constitutional Court, it doesn't matter what the legislators thought about what KPI authorities should be. If they don't put it in the law, they can't say it as a law.

I tend to agree with the Constitutional Court, but I would not stop only on the texts of the law. Even when we refuse to acknowledge the existence of legislative intent, we still need to be practical. In my view, interpretation of the law must consider three main factors: (i) the texts of the law, (ii) the context of such texts in view of the overall provisions of the relevant law, and (iii), the possible consequences of using such context in practice. The law is a product of men and thus cannot and should never be separated from a reality check. Furthermore, with respect to my third point, as I've always stated in my posts, the law should be directed to reach the most efficient result, meaning satisfying the welfare of the society as much as possible with the lowest costs possible.

Using this method of interpretation, the text of the law would still be the primary source of the law, but we will also be less formalistic in interpreting the texts. Instead, judges decision will be guided by how their judgment can achieve the best results for the society welfare by calculating the costs and benefits of the immediate and long term effect of their judgment. No wonder Oliver Wendell Holmes, in his most famous law review article written in 1897, The Path of the Law, argued as follow: "For the rational study of the law the black letter man may be the man of the present, but the man of the future is the man of statistics and the master of economics."

Of course, it is not easy to use this method of interpretation in practice. We tend to narrow this method to simply judging based on the society's sense of justice which is not helpful at all since we really don't have a standard of what could be exactly considered as the society's sense of justice. No wonder judges choose to use legislative intent as a solution when plain meaning method does not work to solve the case.

Right now, I am taking a class on Judicial Decision Making, focusing on corporate law issues, where I act as a justice of the supreme court in the State of Delaware, United States of America. I believe this would be a very good opportunity for myself to test how I will decide the cases using my own legal interpretation method (since we start with a clean doctrinal state) and whether I can consistently apply what I've said in this post. Once I've completed the whole course (it will take around 2 months period), I will update again my view on this issue in a separate posts.

On Why Lawyers Should Never be Required to Report Their Own Clients

2012-01-13T08:51:00.001+07:00

It's been a month since the last time I wrote in this blog. I guess vacation time is really over. Anyway, yesterday I read a interesting news from Kompas. Apparently, one of the former chiefs of the Commission of Corruption Eradication (KPK) had an idea that lawyers of corruption case suspects must report the payment for their service that they received from their client to the anti money laundering authorities. The reason for this policy? Because they believe that there is a good indication that the money is coming from corruption and therefore the lawyers must report it.

Although I am always sympathetic with anti corruption movement and would love to hear new innovations, I can't believe that a former lawyer could actually voice this perverse idea. Sure, having this kind of mandatory reporting could be a good screening mechanism. Those who report would probably have no case at all, while for those who refuse to report, we can expect that there is something fishy is going around. Would not that produce an efficient way of legal enforcement?

The answer is no. There is a good reason why lawyers are sworn not to provide any information to third parties that might jeopardize the interest of their clients. A good analogy to this issue is the market for health insurance. One of the main problems of health insurance industry is the fact that there is a huge information asymmetry between the insurance companies and the policy holders. Insurance companies get money from this business by pooling the money from their clients and hoping that the amount of the pooled money will exceed the total money that they will pay for the claimants. Of course, the pooled money are just a fraction of the total expected health costs of the policy holders depending on the probability of paying the insurance claims in the future.

As you can see, there is a huge incentive for people with high health risks to buy insurance policy while people who know that they are quite healthy will most likely refuse to purchase an insurance policy (unless they are risk averse or the price is acceptable to them). In case the numbers of high risk people beat the numbers of low risk people significantly, a market of lemon will soon be created where insurance companies will be flooded with high risk policy holders and the insurance premium will be increased to cover the higher probability of insurance claims payment. In one instance, the premium can reach a level where those who actually really need the insurance cannot afford the price and those who are previously interested to buy the insurance policy refuse to do so. A solution for this problem is to require all people to buy mandatory health insurance policy in order to reduce the premium amount (see as an example, automatic insurance for employees).

Similar thing would also happen once lawyers have the obligation to report anything fishy related to their clients (I mean, if you do this for corruption cases, we should also do the same for all criminal cases, from thievery to murder and rape crimes, why bother making the differentiation?). Being a lawyer myself, I could assure you that lawyers are the master of covering their own liabilities. Rather than being a victim, the lawyers will eventually report the client to the related authorities. There would be no incentives for lawyers to protect the interest of their client. Once they know that their clients are most probably guilty, they will stop representing their client since they are being required to report things that may jeopardize their clients' interest. Why bother having state attorneys if that's the practice?

And clients are not stupid, some will refuse to use lawyers services because of fear of being betrayed, in which we can assume that they are indeed guilty. But that is a very dangerous assumption. One of the basic principles in criminal law is that we cannot punish someone based only on assumptions. That's why we have the "beyond the reasonable doubt" rule. Punishing the wrong people or giving a punishment which is not in accordance with the severity of the criminal activities is not efficient since it lowers the costs of doing criminal activities (the lower the probability of getting punished, the lower the costs of crime). Thus, we invest in creating a rule that can produce the most correct result (or at least we hope to).

Creating a system where lawyers can turn out to be their clients own enemy once they deem that the clients are most likely guilty is not helpful at all. Those who are really in need of legal assistance will be excluded from the legal service. We need to understand that law is not an easy subject for most of the common people and they might not always understand whether they have done something wrong or not. That's why we create a system where lawyers act as their assistant in understanding the legal issues that they will face in the court and that the lawyers will protect the confidentiality of any information that they receive from the client. This is the essence of presumption of innocence. To ensure that the system will work, there must be a relationship of trust between the lawyers and the clients.

This bring us to the second reason. If people don't use the service of lawyers if they don't believe their own lawyers, the number of clients will decrease. Depending on the situation, there can be two possibilities. One, the end of lawyers business. Second, an increase in the fee of lawyers and a new business focusing on the clients who solely conduct validly legal activities. I am certain that this is not the intention of having lawyers in our legal system. It might be hard to accept, but the only way for the whole system to work is to let lawyers represent all the people regardless of the fact whether they are really guilty or not.

In any way, I am happy that the idea has been rejected by the legislators. At least now I can find something that I could agree with them after all these years.

Is The Right to Die Justifiable?

2011-12-13T13:49:00.000+07:00

The latest case of an Indonesian law student who burned himself to death in front of the Presidential Palace is indeed an interesting one. At first, I want to disregard the student's motive but then I realize that the question of motive is the essential part in the analysis which will affect our final thoughts in perceiving his decision. So, let's start with the question: do people have the right to die?

It's a tricky question which triggers a lot of debates involving significant different views. The comments on the above case can be a good example. Some people consider the action as a foolish one without any benefit to the society, that people will soon forget it and it is harmful to the student's parents and close family members. Other people consider it as a heroic action, that it demonstrated a resistance to a corrupt government, and that the student should be honored because not a lot of people will have the bravery to burn themselves as a form of protest.

What interest me the most is the fact that the discrepancies in views were ultimately caused by the motive of the student in burning himself. Why the motive should be considered at all? Are we saying that the right to die should be honored in certain conditions in accordance with the motive? We condemn ordinary suicide (in case the student burned himself out of desperation with his own life) but we approve the action if it is done out of desperation of other people's life? How come? More importantly, why should we bother with the right to die? The dead guy would have no interest with what we will say on his right to die simply because he is already dead.

The main problem here is because if we agree that people have the right to die, it indicates that people should also have the basic right to freely do whatever they want with their own body (well at least some people believe that people should be free to do so). I mean, if we agree that people has the right to kill themselves (which is the ultimate action that a man can do with his body), they should also have the freedom to, say, hurt themselves or conduct activities that may be harmful to their body as long as they give their full consent for doing such action (meaning no fraud or coercion or misappropriation of condition by third parties).

Applied consistently, there should be no paternalistic regulation on how people should behave, and there should be no "protective" regulations intended to protect the public from doing dangerous activities as long as they agree to do such action. In other words, those "protective" regulations should be optional instead of mandatory. Yet we know that the this is not the case in real life. Safety regulations in factories and mining sites, and even mandatory safety belt in cars can be a good example of those kind of regulations.

It is weird if we assess the validity of a right only based on a motive. Suppose, a company is conducting a risky business. Installing a safety device would cost them a lot of money, say, US$20 million which will reduce the accident rate into 1%. If the Company chooses this option, they will pay 5 workers, each with a fixed salary of US$20,000 a year. Another possible way of doing this business is to employ those 5 people without any safety device, where each will receive an upfront payment of US$1,7 million, but the risk of deadly accident will increase to around 85%. From economics point of view, it is possible that the second option would be optimum for the welfare of the society. The company can reduce its costs, allowing them to sell cheaper products, and they compensate the employee generously for the additional risk taking.

Now imagine that one of those 5 employees is a father to three children. Thinking about the future of his family, he decides to take that risky job with a full understanding of the high probability of death. He believe that the payment justifies his increase of risk that even in the case that he dies, the overall compensation is enough to ensure the survival of his family in the future. Should he be prohibited from doing so? Should the company be deemed liable when an accident happen and the father dies? If we care about motives in deciding whether an act is good or not, can't we consider this as an heroic action? A father who chooses to increase his probability of death for the sake of his family?

I bet that most of you will consider this idea as a perverse one, but if we choose to assess the right to die simply from the motives, this is the consequence. It's easy to create similar cases and yet people preferences can vary significantly. It is almost impossible to find consistency of opinion in this matter. Here Law and Economics tries to provide the answer from welfare maximization issue. It might be easier to have a standardized safety regulation because not all people have the same perception of risks. Some will agree to take the risks, some will not. Creating a standard regulation could effectively solve the collective action problem among the employees. Granted there are costs associated with safety regulations, but the costs should be calculated in a way that promotes overall efficiency to the society (increase safety might increase productivity and might induce people not to participate in too risky business which may turn out to be bad for the welfare of the society).

If we agree with the above welfare maximization analysis, the right to die should also be viewed in such instance. Thus motive is irrelevant, instead, we should ask, what's the costs and benefit for granting people with the right to die? Should we give incentives for people to die? Might be in war with other countries for the sake of gaining victory or in case of patients with terminal ill where prolonging life would be too costly and too painful for him. But in cases where there is no perceive benefit of killing yourself and even worse, where the action imposes certain costs to third parties (imagine the costs imposed to the family left behind due to the suicide), I would say that we need to give incentives for people to avoid such action.

How can we give the incentives if the person is already dead? Well, we can do that by condemning certain type of suicidal activities that we view as wasting a precious life for nothing or where the benefits do not justify the costs of losing the life. Might not be effective for people who have lost their hope with their life, but for those who believe that their suicide can be meaningful, it could be a good deterrent mechanism. By informing them that their action would be useless and meaningless, we impose a huge costs to them for doing their action. What is the use of killing yourself in such case if people will simply disregard it?

Another way is to impose liability to anyone who knows a person's plan to kill himself but fail to prevent such death. Again, might not work for suicide for private reasons. But if it is for the so called "public cause", there is a high probability that some people will know about the plan in advance and therefore should be imposed with an obligation to refrain the soon-to-be-dead guy from his planned suicide. This is primarily based on the least cost avoider principle. It is not cleat though whether our current law is in line with the above approach. While there is no legal sanction for a failed suicide (no court will punish you if you fail to perform your suicidal action successfully), any people who assist you in your suicide attempt can be penalized with a prison sanction of at least 4 years. The text of the law indicates active assistance, while my proposed solution is to impose liability for passive assistance.

To close this post, I admit finding a right answer on the right to die is problematic. I am certain that some people will disagree with the notion that killing yourself could be justified as long as the perceived benefits exceed the costs. But we do have some examples on this issue, such as in war (imagine suicide mission) or in euthanasia (interesting to note that some Islamic legal scholars prohibit active euthanasia but not the passive one). It might be that there is no right answer for this problem and in the end, it's all about preferences. If that's the case, the voice of the majority will eventually determine whether a right to die should ever be granted.

Assessing Death Penalty - Law and Economics Style

2011-12-09T11:40:00.000+07:00

Imposing a death penalty or capital punishment for certain type of criminal activities would always be a controversial issue. Some people believe that the imposition of death penalty is important to create an effective deterrent effect toward criminal activities. Others believe that death penalty is against one of the basic human rights, i.e. the right to live. Before I provide my arguments below, I will have to inform you all that I am a supporter of death penalty, albeit with certain conditions.

First of all, in normative Law and Economics, welfare maximization and efficiency are the two key terms that must be prioritized in assessing the quality of a law, including the imposition of any criminal sanctions. Why? Because in Law and Economics terms, a law would be deemed useful for the society if it can maximize the overall welfare of the people without imposing too much costs on them. The perfect law would be pareto efficient, where all people will be better off without having any losers in the society. While that might be nice, in practice it is almost impossible to satisfy the Pareto criterion, and therefore Law and Economics usually end up with Kaldor-Hicks efficiency, i.e. a law will be considered efficient if it can maximize the overall welfare of the society (so that in general, there is a surplus for the society) and open the possibility of compensating the losers, even though the compensations have not yet been materialized.

I understand though that welfare maximization is not the sole value that can be adhered in a society. What about, say, fairness? However, as argued by Steven Shavell and Louis Kaplow, two prominent economists and law professors from Harvard Law School, in their book, Fairness vs Welfare, welfare should always be prioritized whenever there is any conflict between welfare and fairness principles, simply because fairness is an element of welfare maximization while welfare itself is not necessarily a part of fairness maximization. The duo provide some very interesting arguments in the book but I will discuss that in another occasion. For now, I only like to introduce the basic concept of welfare maximization in Law and Economics.

Having said that, the next question would be: can we justify the existence of death penalty in a legal system from Law and Economics perspective? The quick answer is: it depends. The three main factors that should be considered are: (i) the costs and benefits of imposing the death penalty compared to alternative sanctions, (ii) the administration costs for death penalty, and (iii) the net effect of death penalty to the society.

Costs of Imposing Death Penalty in Comparison with Alternative Sanctions

With respect of the costs of imposing death penalty, suffice to say that death penalty is cheaper than prison. Killing one person is definitely easier than maintaining a person's life in the prison for certain period of time. But it would be wrong if the comparison is made only to prison. The fact that the costs of death penalty are cheaper does not necessarily means that it is superior to other type of sanctions. In fact, from economics perspective, death penalty might be inferior compared to the sanctions in the form of fines because death penalty does not produce any direct additional wealth or at least create a transfer of wealth. The only way we can say that death penalty produces wealth (indirectly) is if there is a good evidence that death penalty effectively deters crimes and therefore reduces the overall costs of criminal activities to the society and save the people's money for costs of legal enforcement.

Administrative Costs for Imposing Death Penalty

Another important issue is the costs for administration of death penalty. Since death penalty is irrevocable, in the sense that you can't raise the dead once the sanction has been administered, the administrative costs for getting the right decision tends to be higher in order to avoid costs of wrong decisions (such as longer waiting period for the execution of the penalty, additional costs for producing evidence, etc). Why we need to avoid these wrong decisions and why people should pay for the costs? Other than fairness related argument, Law and Economics believe that wrong judgment reduces the probability of allocating the criminal sanctions to the intended target, i.e. the real criminals. For each wrong judgment, we impose unnecessary costs to the innocent person and let the criminals free from the sanctions which means that the costs for them to do their criminal activities are reduced, inducing them to do more criminal activities.

In other words, wrong judgment is a factor that may increase the probability of doing crimes simply because the criminals know that the probability of them getting caught and being sanctioned is reduced. So, letting too many wrong judgments will be inefficient for the society. But the same inefficiency could also happen when we spend too much money in trying to reduce the error costs of judgments. A good example would be cases where it is very difficult to proof that the defendant is guilty, such as in rape case. I have argued in my working paper here, that imposing death penalty for rape cases might be counterproductive because the process of evidence is difficult and the administrative costs for getting the right decision would be too huge. As a result, imposing alternative sanctions which are revocable in the future might be the best option for rape cases.

The Net Effect of Death Penalty

The most controversial aspect of death penalty is the claim that it can effectively deter crimes rate. Obviously, this is something that needs further empirical research, especially in Indonesia. I note from one of my professors that some empirical researches in the US found that high death rates in the prison can effectively deter the rate of crime. We can categorize this as an indirect death penalty sentence since you can be easily sentenced to a prison (and therefore less administrative costs for the entire process) but there is no guarantee that you will survive the prison. Apparently, having no life guaranty in the prison is scarier than having a direct death penalty where the process is longer and the possibility to avoid such sanction is higher.

As I said above, to the extent that death penalty can be an effective deterrent mechanism, such penalty might be an efficient solution for reducing criminal activities. How can we assess the efficiency of death penalty? In simple mathematical formula, death penalty would be deemed efficient when P > (C + AC + WC), where P is the amount saved by the society from reduced criminal activities, C is the costs of imposing death penalty, AC is the administrative costs of death penalty and WC is the costs for irrevocable wrong conviction. To be more consistent, we can also add the utility function of the criminals who receive such death penalty, since in a way, we impose costs to him by taking his life.

Based on the above super simplified model, I could tell that the basic problem with death penalty is that there is no calculation for the utility function of the victim, in fact the imposition of death penalty will never calculate the interest of the victims because they are simply out from the equation. Granted, the victim might receive some utilities from the retribution effect of death penalty, but I am not sure whether that will be enough. Again, as I said above, while death penalty might be more efficient than prisons, fines might actually be more superior than death penalty in welfare maximization and the use of death penalty should be really limited to certain type of criminal activities.

Conclusion

If I have more spare time, I would love to write more on the Law and Economics analysis of death penalty just like when I write about Economic Analysis of Rape Crimes. My support for death penalty is basically conditioned upon the satisfaction of the above model. If the overall costs of death penalty are bigger than the expected reduction in criminal activities, then supporting death penalty would be useless as it is the same with reducing the welfare of the overall society. Personally, I will give more support to any sanctions that can compensate the victims while still giving deterrent effect to criminal activities, such as a significant amount of fine and/or forced labor.

My another thought would be that death penalty should only be imposed to criminals whose activities are considered very dangerous to the societies and therefore letting them return to society without effective way of preventing them from doing the same thing would be too costly, such as serial murderers. But this can lead to another debate on what type of dangerous activities that should be sanctioned with death penalty. On that matter, I will reserve it for another time.

School Discrimination, Availability Heuristic, and Positive Exclusionary Vibe

2011-12-02T10:15:00.000+07:00

Yesterday, another interesting case occurred in Indonesia. Apparently, a private school required a child with HIV positive father, who has been previously admitted to such school, to undergo a HIV test. If the result is negative, the child is permitted to enroll, but if she is positive with HIV, then her admission will be cancelled by the school. In short, the parent refused to give the result and the school later on informed them that because the other parents in the school refuse the presence of the child having a potential of HIV positive, the admission for the school is cancelled. The main question from law and economics perspective, can this action be considered as a discrimination? Can the school, as a private party, refuses the admission of a child because of the risks brought by that child to other children, whatever the probability is? What would be the solution?

I look first at Law No. 23/2002 on Protection of Children and I find in Article 13 of that Law that a child, while under the care of parents,guardians, or any other parties responsible for the custody,is entitled to protection from any form of discrimination. If we consider the above action as a discrimination, judging from the text of the Law, I doubt that the school can be blamed, since the text seems to be intended to protect children from discrimination by their own parents or guardians. A school might be considered as a guardian of a child during the school time, but if the child never enrolled in the first place, there would be no legal obligation to protect the child from any discrimination. And based on that notion, I can see why the school chose to instead cancel the admission rather than accept the kid, if the kid is already in the school, the school will be obliged to protect her from any kind of discrimination.

So what would be the answer to this problem? Let's take a look at the reasoning used by the school to cancel the admission, i.e., they say that other parents disagree having a child with a potential HIV in the school. If this is true and these parents are the majority faction in the school, I can see why the school ended up with their decision. I bet they know that in the modern interconnected world like we are having now, this case will cause public controversies, there will be uproar, and to certain extent their name will be tainted. But, as long as their legal risks are low and most parents whose child go to their school support such policy, their benefits are still higher and there will be less incentives to change such policy.

Should we change the law then? Should we impose liability to the school for cancelling the admission? Should we force them to accept a child whatever his/her sickness is and whatever the probability of that sickness in infecting other kids is? I admit, these are very hard questions, and before we can answer those questions, we should analyze first the economics of preventing risk of infectious diseases. The State of Illinois can be a good example where it requires all international students to have immunization from certain diseases. Failure to do so within a certain time frame will cause the students to be rejected from registering for the remaining quarters in an academic year. Can we call this as a discrimination to immigrants or visitors? Might be, but voters love a state that seems to protect their citizens interest and the state can always say that it has the obligation to protect its citizens from any unwanted casualties.

This is precisely the problem faced by the above school. On one hand, the risks of accepting a kid with HIV positive might be very small to the other kids enrolled in such school, after all, HIV is not a disease that can be easily transmitted to other person. But on the other hand, even though the risks are small, the majority have different perception, which, I suspect, is caused by availability heuristic, i.e., since HIV is such a famous disease with significant adverse effect to a person's health, people tend to think that the risks of having such sickness is also high and therefore they reject any possibility of having a kid with HIV positive around their kids.

If my prediction is correct, imposing liability to the school will make no sense. You can't expect them to solve the problem that is out of their control (you can't control the preference of all the people in this world and it would be even harder if these people are already becoming your stakeholders), and it is likely that even when the kid is finally admitted, she will receive more discrimination from other kids and their respective parents (because we know that even when the kid is not admitted yet, some parents have already voiced their concerns and rejections). It's a bad game for the poor kid. Of course, this should not be the end of the world for the kid.

Other schools might actually take this opportunity as a marketing tool. But to achieve that, they must state their policy from the beginning. As an example, they should say that their school is opened to any kids with HIV positive and that they will provide a safe environment for everyone when they open their school registration. Stating this from the beginning will have the effect of screening parents that might not agree to have their kids sharing a class room with a positive HIV kid and therefore, we can expect less rejection from other parents. Only parents who support such idea who will send their kids to the school and this will allow the creation of a better environment for the HIV positive kid.

Borrowing the term from one of my Professors, Lior Strahilevitz, we can call this strategy as an exclusionary vibe. You effectively screen people who disagree with your policy and discourage them from getting into your community without having to say that you reject them. It's a double edge sword, it can be used to discriminate people, but it can also be used positively, as in creating a healthier environment for kids development. Furthermore, can this be a good business? I would think so, there are still many people who buy the idea that having a non-discriminatory school is good for the education of their children. And when these schools can attract many students, other schools will soon follow.

To close this post, in dealing with hard cases like this, sometimes, imposing liability would only increase the costs for each parties involved and might not be beneficial for the kids. Using strategy to raise public awareness is good, but I would suggest not to continue with a legal fight unless we can ensure that the problem lies within the school itself and not the parents. Because if the other parents are the problem, punishing the school will only add more fire to these parents, and the end result might be backfired. Remember, you can't control people preferences, it would be more effective to screen these people out and build a different business. If it is profitable, and my guess is: it is, the problem can be solved quicker than we thought.

On Why Religiosity is not Translated Into Better Legal Compliance

2011-11-29T11:38:00.001+07:00

Today's news indicates that the Department of Religion is considered as the worse governmental department in terms of corruption level. That's not so surprising, considering the fact that similar problem has occurred numerous times in the past. As an example, see this news from 2002. Our main question for today's post is: why religiosity is not translated into better legal compliance? Shouldn't religion help a person to be a better person and therefore religion can assist us in creating a community that has better legal compliance? I will argue that religiosity per se does not help in pursuing higher rate of legal compliance. In fact, the case is universal even for a person who denies the validity of any religion and instead claims that he is a moralist.

As I have argued in one of my previous posts, Knowing the Law vs Complying With The Law, people respond to incentives. You cannot expect that people will comply with the law simply because they know the law. To the extent that the benefit of doing a crime is higher than the costs, it is most likely that a criminal will conduct his crime. Thus, in law and economics view, we need legal enforcement to impose sanctions to criminals with a hope that such sanctions will increase the costs of doing criminal activities and can induce the criminals to reduce their negative activities.

Based on the above insight, no wonder that religion, standing alone, cannot be expected to significantly reduce the level of criminal activities simply because religion does not impose any sanction in the current life. You may be aware that certain religions offer a terrible afterlife sanctions for whoever dare to violate religion rules. While we can always debate on what constitutes religions rules, the issue is clear, although the sanctions are so vicious (burned alive and might be for an eternity too) that they cannot be comprehended by any ordinary human beings, they will only happen in the after life.

Some behavioral law and economic researches show that in general, people tend to discount the occurrence of bad things in the future even though they know that their current actions can increase the likelihood of those bad things. Good example: we know that overeating and less body exercise can be translated into higher probability of various nasty sickness, including heart attack, stroke, and diabetes. Yet, most people tend to discount that probability by staying with their unhealthy lifestyle (shamefully, I am also in the same category). It is also usual that significant changes in behavior will only occur after these people experience the problem by themselves. As an example, rate of doing healthy lifestyle activities will increase for people who have experienced heart attack and survive. That kind of experience will most likely leave a scar (or in economic terms, huge costs) in their life and they will have strong incentives to alter their behavior.

Returning to religiosity, not only that afterlife sanctions will be hugely discounted in considering them as a cost of doing criminal activities, there are several concepts in religion that can significantly reduce the value of such afterlife sanctions. Consider the concept of repentance of sins (taubat) that exist in any type of religion. This concept allows all believers to be forgiven by God from all of their sins to the extent they faithfully stop all of their previous heinous activities and do many good things as a repayment to the society. You can say from law and economics perspective that this is in line with the principle that criminals should compensate the society for the costs that these criminals impose to the society due to their criminal activities. That's true, but you must also consider the fact that the concept of repentance is not as effective as you think would be.

First, there is an issue on when should a person commit repentance? Since this can be done in any time before he dies and if we assume that people also discount the possibility of them dying at a time nearby, you can bet that most criminals will choose to repent far far away in the future. Even worse, since there is no minimum standard repayment for repentance, there is a possibility that such repayment activities are not suffice to cover the costs of their previous criminal activities. Obviously, that is not efficient for crime preventing. We are happy that religion provides an incentive for criminals to repay their sins in this world but without any clear enforcement mechanism, the repayment can be too late or not enough at all.

Second, since there is a possibility for multiple offenses and also multiple repentance, there are no strong incentives for religious people to comply with the law. They can always say that they are weak, that God is forgiven and all is well. Yes, we can argue that God might not agree with these people in relation to the faithfulness and intensity of their repentance, but no ones know what God really thinks. Uncertainties in this type of case increase the discount of afterlife sanctions, rendering their effectiveness into a new low level.

Having said that, the case is also similar for any moralists out there. We learn from one of US founding fathers, James Madison, that people are not angels. According to him, if people are angels, we do not need government, but since we know that they are not, we need a government to supervise them, and we also need further mechanism to check and balance the government since they consist of people too. You can claim that righteousness can come from many different ways, but you are just an ordinary human, and not all human can resist temptations.

Let me give you a simple example on insider trading cases. In the US, it is not unusual to find lawyers who still conduct insider trading cases even though they know the law and the severe punishment that will be imposed to them for doing such activities. Yet, some lawyers fall under insider trading cases. How could that be? Because the temptation is very high, we are talking about millions and millions of dollars here! And it is so easy to do insider trading that unless you can find a good way to remind yourself of the risks, you will most likely do it. And when they actually do it, you should ask why? Because again, they discount the probability of them getting caught because they know the law and they feel that they can avoid liability through their legal skills. Try to compare this with the fact that the Department of Religion handles an excessive amount of money from the government for hajj purposes. Do you think they are mentally strong enough to fight their temptations?

As you can see, even in the case of clear and severe punishments, some people cannot resist the temptations and end up doing their criminal activities. They might have already calculated the costs and benefits of their actions, where higher risks are translated into higher return. So, what can you expect from severe sanctions that will only occur in the future, the possibilities of them happening are pretty much uncertain, and there are many ways to avoid those sanctions with low costs(i.e. repentance)? The end result is clear, religion or morality, standing alone, is not effective to prevent people from doing criminal activities.

To close this post, I disagree that people are using this fact to blame religion as a source of evil. While religion and morality are not effective when they are standing alone, they can become a nice addition for strong legal enforcement. In his book, Predictably Irrational, Dan Ariely, a famous behavioral economist, shows that religion and morality can be useful tools in increasing the commitment of people to walk in the right path (especially by repeating such moment of commitments every day), i.e. as a method to increase their awareness that what they are doing is bad. But remember, they are only additional psychological tools, and effective strong legal enforcement would always be mandatory and necessary if we want to effectively reduce the rate of criminal activities.

Blackberry Queuing and Screening Mechanism

2011-11-26T11:14:00.003+07:00

Indonesia always provides us with interesting cases from economic perspective. The latest one is the new Blackberry product launching where the seller gave a 50% discount to 1,000 first purchasers. It was a major event as people rushed to Pacific Place mall to buy the product. Unfortunately there are some casualties, as there is an excessive amount of buyers and the mall is not big enough for all of them. While we can ask why didn't the seller stop the visitors as soon as they reach 1,000 to avoid unnecessary casualties, one may ask why did the seller choose this marketing strategy? Cafe Salemba economists provide their answers in these two nice articles: Economics of Queuing and More on Buying Frenzies. Meanwhile, I'll analyze the case from the Seller's perspective.

There are a lot of different types of buyers. Some are very conscious about the price of a product, so if the price is too high for them, they won't buy it. In the recent Blackberry case, we can argue that the seller used this understanding to actually screen its potential buyers and therefore they can get more buyers. The Blackberry's price is around 4,5 million rupiah. By all means, it is not a cheap gadget, but we know that such price is higher than the price in the United States and there is a theory that the price of the Blackberry in Indonesia is being inflated while the demand is still high in average. In short, it could be a very good business.

Now, by imposing a 50% discount to the price, there are two benefits that the seller can get. First, it can get those buyers who previously thought that Blackberry is overrated and therefore don't value Blackberry that high or people who want to have Blackberry but doesn't have enough money. Giving a 50% discount is still a good way to induce people to buy products. To the extent that this people don't highly value their time (they don't have better thing to do, or the utility of getting the Blackberry is higher from standing in the hellish queue, etc), these people will definitely enter the queue.

Second, the process can effectively screen the buyers who value their time more than their cash and get them to also buy the Blackberry with the inflated price. By giving such a hellish condition in the queue, the seller can know the people who will choose to skip the queue by paying more. No wonder that at the same time, the seller also conducted an exclusive sale using the original price. That's smart.

Now, we know that the seller imposed a restriction that the buyers in the queue cannot be represented by other people. Why do you think so? If there is no such restriction, the people who value time more than their cash will be induced to pay other people to stand in the queue for them, and that will disturb the screening mechanism. The seller definitely doesn't want to subsidize the people who value their time more. However, as we understand, the costs for supervision is also high. Therefore, they didn't conduct a full supervision, instead, they just let people rush in. Why?

There is an elementary game theory involved here. The seller knew that the costs for supervising the entire process would be high, managing thousands of people is not easy. But the buyers didn't know that information. Some will predict that the seller will be strict with the rules, some will predict that the seller will be lenient, and there will be chaos. Whatever the end result is, it is still a good way to screen the people who are not really sure with the value of their money versus their time but nevertheless have some interests to buy the Blackberry. If these people are risk averse, or prone to risks, they will probably not go to the queue and they will buy the product later on. For those who really want the Blackberry but don't have enough money, they will stay. For the people who value their time more and put their jockeys in the queue, they put a bet, if they get it, it would be nice, if not, they buy it later on and risk some money for the jockeys. Again, risk aversion matters, not all people want to risk their money for nothing and so they may decide not to do it.

Overall speaking, from the seller's perspective, there is a probability that the discounted products will be purchased by its unintended targets, i.e. the people who value their money less than their time. But it should not be many, and the seller can still effectively increase the demand of its products and reap more profits. So instead of being a sign of irrationality, it might be a good indication for good strategy for getting more buyers. Unless there are other additional high costs to the sellers for these kind of activities (i.e. death, riot, etc), we can expect more sellers to pursue the same strategy. So, two suggestions to improve the end result for consumers, next time it would be better to give a time limit for coming to the place and also limit the people who can stay in the location when they reach 1,000 or whatever the intended maximum amount of buyers is.

Hold Up Problem and Chicken Game - Why Cooperation Matters

2011-11-22T14:02:00.001+07:00

Imagine that your are a property developer who wishes to build a new amusement park in certain city. The business prospect is good, and the city is also happy with the project since it will increase the city's tax revenues and improve the city's economic growth. But before you can start your dream project, you must first buy the necessary land from several owners. Here is when the problem starts. If you tell these owners that you are trying to build an amusement park above their land, each rational seller who maximizes his/her own interest might hold up the sale of his land, hoping that they can increase the value of their land as the number of sellers decrease. The smaller the number of sellers, the higher the gain that they can get from holding up their land. Of course this is detrimental to your project since it is effectively similar to a monopoly by the sellers and it increases the difficulties of settling the negotiation.

True, the sellers realize that the increase value of their lands owes to your proposed project. If they are being too greedy and you choose to abandon the project, they will gain nothing. So there is a possibility that they will give up and sell their land with the maximum value that they think they can reap from you without making you cancel your plan. However, there would always be a possibility that one seller remains unwavering. Seeing that other people have already sold their lands, he understand that now his land has the biggest value of all and he knows that you don't have any choice other than buying his land in order to continue with your project. He also knows that you have already incurred a lot of money for purchasing the lands and you will need to start the project in order to recoup your initial investment costs. Effectively, you become a hostage of the final seller due to an increase of his bargaining power. This is what we call as the Hold Up Problem.

Hold Up Problem is a serious matter. If we don't find a good solution, Hold Up Problem can end up discouraging any form of investment that may benefit the society. Why? Because obviously, you don't want to waste your money for initial investment if in the end you will be ripped off by whoever holds the final trump card. The costs of investment will be too high and any rational person will eventually choose not to put the investment in the first place. As you can see, both parties and the society can be better off if only the parties cooperate, but because they can't trust each other, they fail to do so.

The case does not stop there. A Hold Up Problem can easily turned into a Chicken Game. Ever heard about this game? A good example is the famous scene in old US movies where two stupid kids are driving against each other on a collision course. If both of them stay in the path, they will die. But if one of them chooses to swerve from the path, both will survive, although the one who swerves first will be called as a coward chicken, hence why we call this as Chicken Game. Let us try to apply the basic principle of this game into our case above.

Once initial investments to purchase the lands have been made by you and there is only one seller remaining, you only have two choices. You can "swerve" by accepting the ridiculous demand from the seller and continue with the project (of course, you're being a loser here), or you can stay in the path and continue with the project even though you have not secure the land from the last seller. If you choose the latter, it is a disaster for both of you. Once the project has been started, the value of the seller's land will drop to virtually nothing. Who wants to buy a land in the middle of an amusement park that cannot be used for anything? For you it is also a problem since you will spend a considerable amount of costs to alter your project and ensure that it can be build around the remaining land. Both parties can be better off in this case if they cooperate and again, my analysis shows that they can end up with unnecessary losses.

So how can we solve the issue? Some people argue that Hold Up Problem can be solved through takeover or merger (it works on certain type of contracts), but we know for sure that in our case, the problem is the takeover itself, so we can skip that solution. I would think of two solutions. First of all, you can purchase the lands from the sellers without having to disclose your future plan for the land. As far as I know, there is no legal obligation to disclose the reasons for doing a transaction and this solution may work in case you can design a system that will not cause the sellers to suspect you of doing anything fishy.

Second, you can disclose your plan and then offer to buy the land of the sellers as a single package (everyone must sell their lands at the same time or the deal is off). By doing this, you prevent the possibility of having a Hold Up Problem in the future as the sellers will be required to act as an unity. Again, the solution might not guarantee that you can do your project but at least you won't be a hostage to certain sellers. Furthermore, in case the majority want to sell their land for a nice fortune, asking the sellers to sell their lands as a bundle will induce them to cooperate to reach the best conclusion for everyone and there would be pressures to sellers who refuse to sell without a good reason.

As you can see from the above, cooperation matters where there is an inherent collective action problem. The issue is to give the correct incentives that can promote cooperation among parties that might have different interests. In this case information matters. How we disclose the information in the first place will affect the strategy that we will choose to close the deal. Here I agree with the current legal regime that allows people to transact without having any obligation to disclose their purpose in doing such transaction. Requiring such obligation might be inefficient in case the information can be used for Hold Up purposes.

If you can propose other solutions that may be implemented to the above problem, feel free to give your comments. Who knows, we might end up finding a solution worth a Nobel Prize :)

Why I Disagree with Legalization of Prostitution

2011-11-19T11:18:00.000+07:00

I guess I have not fully elaborated my points on my previous post on prostitution and inequality, as I might need to address some concerns from those who are in favor of legalizing prostitution. You can read some of their main arguments here. Their arguments can be summarized as follows: by regulating the industry, the government can give incentives to the industry players to treat the women better, create a safer environment, and by doing so, helping the women for a better life. Furthermore, if it's truly a voluntary transaction, people should be free to do so. As good as they may be, I disagree with these lines of arguments, and I am not even talking about morality issues.

First of all, I doubt that regulating prostitution will be more efficient than making it illegal. We know that people respond to incentives. In other words, the government may require people to comply with certain regulations, but if there are no legal enforcements, it is most likely that they will not comply. The case is similar to prostitution. So when the government actually regulates prostitution, there would also be enforcement costs to ensure that the entire industry comply with the rule. Can the defenders of legalization show that the costs will be cheaper rather than enforcing law against prostitution. Because if the net effect is same, why bother legalizing it?

Second, I'm surprised if there is any free market defenders who support the notion that the government should regulate prostitution in order to protect the women. Most free market defenders despise government intervention in the market. The market works best when there is no intervention as usually, people will only enter into a voluntary transaction if that transaction benefits the relevant parties. So I find it amusing that some people ask the government to interfere with the prostitution market. Not only it shows that the business is inherently bad that we need government help to deal with it, it also shows that they tend to forget that intervention by regulation does not always end up well, which will lead us to my third point.

The major question is, what type of regulation that will be needed for an industry like prostitution? To what extent will we allow people to freely sell their body? Can we say that in line with the rising of the price, the consumers are allowed to demand more extreme sex actions? Should we allow consumers to sue the women in case their performance is not satisfying? Should we allow wives to sue the men and the prostitutes in case the wives found out the act in accordance with the principle that each party should be liable for the externalities that they cause to third parties and therefore are obliged to compensate such third parties? Or, in accordance with the Chicago style, when transaction costs is low, resources will be allocated efficiently, meaning that the prostitute and the husband will "pay" the wife for the right of having an affair.

I mean if we agree that people are free to do everything as long as they "voluntarily" agree to do so, why bother making safety regulation? This is precisely in line with the case of whether there should be a mandatory safety regulation in a construction project if the employer has offered bigger payment for those who want to take higher safety risks. The main issue is what would be the correct price where additional risk taking is justified. If those who agree with legalization of prostitution can accept this notion, I will rest my case. But if we are still talking about protecting the right of the prostitutes, the legalization does not have a strong case other than whether the costs of enforcing the protection are cheaper than making it illegal.

But let us stop this debate for a while. What are we trying to achieve here? The better protection of the women? Or finding what idea should win between the freedom of women with her own body and the compliance with moral values? The first is important and pragmatic, the latter is simply meaningless in practice. If we agree that the whole debate is made to find the most efficient and effective way to protect women from abusive treatment, then we are in the same track.

Let us remember that prostitution consists of 2 type of worker, i.e., those who might enjoy the profession and receive good benefits (the lucky ones), and those who are not lucky, which will stay in poverty, who are prone to high risk of death and terrible sickness. Those who have already enjoy a good position surely want to regulate the profession. It gives them better protection. But the case is not the same for the unlucky ones, which sadly, can be in the majority.

Now, for the unlucky ones, I disagree with legalization. The fact that they are in that state shows why we should not trust that the pimps and customers will treat them better without strong enforcement action from the government. As I said in my previous post, rather than spending costs for enforcement of regulation, why not spend the money to actually reap the profits of the pimps and the money of the customers to compensate the prostitutes? What do you think is the main incentive for pimps to send women to prostitutes? Money! If such incentive is taken, would they still do it? If they are being required to give their entire profits and capital from the business and then the funds are distributed to the women, wouldn't that be better? Of course the sanction will not work if the fine does not reflect the entire benefit of the business. This is standard economic analysis, if the benefits of doing criminal activities are higher than the costs, the criminal will most likely do it.

So if the defender of legalization says that the fine is not effective, most probably because the fines do not reflect the whole economic benefit of prostitution and the prostitutes do not receive any compensation, which of course will induce them to return to their usual life. Remember, in my proposed solution, prostitutes should not be sanctioned. The target should be the pimps and customers, which will effectively increase the costs of doing prostitution and hopefully reduce the level of prostitution itself. I can imagine a sanction where not only the customers will need to pay a huge fine (which will be distributed to the prostitutes), his name will be also publicly announced. This business can survive for so long, partly due to anonymity, destroying such advantage will impose a significant costs to the customers and I expect that their behavior will be pretty much affected.

Another thing about legalization, is there any guarantee that legalization of prostitution will effectively erase all illegal prostitution? If the legalization is made on the basis that we need to protect the women, is there any guarantee that customers will comply with all the safety standard regulation? Isn't there a possibility of a black market where all of those earthly desires, which reject all notion of limitation, still exist? And in such case, legalization does not have an effective purpose other than dividing the customers into two types, the nice ones who go to the legalized brothel, and the bad ones who go to the illegal brothel. Of course, further empirical research is needed to support this argument. But this is something that must be considered by the proponent of prostitution legalization in case the probabilities are huge.

MacKinnon, Prostitution, Inequality, and a bit of Economic Analysis

2011-11-15T12:15:00.001+07:00

Today, I attended a public lecture by Catherine A. MacKinnon, a world-known feminist and also a professor of law from University of Michigan, on Trafficking, Prostitution, and Inequality. I consider this lecture as a very important event as it gave us a clear understanding on the negative effect of trafficking and prostitution. I'll first summarize MacKinnon's arguments and then I'll provide a Law and Economic style of analysis to support her arguments.

MacKinnon Arguments Against Prostitution

MacKinnon opened her argument by saying that there is an inconsistent way of thinking within the public regarding trafficking and prostitution. All people agree that trafficking, i.e. selling human beings to other humans by force, is bad in any way. However, the opinions are divided when we discuss about prostitution. Some people believe that prostitution is inherently bad, either from morality or gender equality points of view. While some other people believe that prostitution is a symbol of freedom and entrepreneurship of women, after all, it's about the freedom of women to use their body as they may like and prostitution is just another form of profession, hence, the term commercial sex worker.

For her, the term commercial sex worker is utterly ridiculous and she asked how could people consider prostitution as just another type of profession? Based on her own and several other empirical researches, prostitution is definitely not a decent profession, if not at all. A recent polling from several prostitutes showed that more than 89% of them wish to be able to leave the job. Most of prostitutes end up in prostitution not because of free will, but because of coercion (usually from trafficking) and bad financial condition.

Basically, these prostitutes enter the job because they don't have any better options. The working condition is harsh (in India, an average prostitute can handle around 8,000 men in a year! Not to mention that they are being required to satisfy all the needs of their customer, whatever that is, as long as the customer pays), they are prone to various sexual transmitted diseases and psychological trauma (MacKinnon found that the level of trauma within prostitutes is similar to those who have experienced war!), and they are also prone to harmful activities that may result in their death (various customers have different taste of sexual activities and it is not unusual to have customers who love violence for the sake of enjoying their sex). In short, it's not a good life. In fact, MacKinnon asked everyone in the room, would they ever consider to take that kind of job if they have a better option?

MacKinnon further argued that prostitution pretty much relates to gender inequality. Surely there are male prostitutes, but compared to female prostitutes, their numbers are miniscule. Moreover researches show that it is far easier for the male prostitutes to opt out from their profession compared to their female counterparts. Female prostitutes are usually treated as goods, objects. The inequality is even clearer when we see how society treats the customers very well, simply from the fact that they are called as customers, in other word, they are just simple buyer who wish to purchase sex with women as an object of satisfaction. No wonder MacKinnon refused to use the word customer, she named these group of guys as John.

MacKinnon also argued that it is absurd to consider that female prostitutes entered into the business of prostitution because they have already given their "consent" and therefore people should leave them alone and let the market does the job, i.e. voluntary transaction among the people. In reality, their consent is not real, their consent was given due to weak conditions and because of the payment that they receive from the Johns (and they don't even receive the payment in full, most of the payment will go to the pimp). Based on that understanding, MacKinnon stated that having sex with prostitutes is essentially a rape in another form.

So what's the solution for this problem? MacKinnon offered the Sweden System, where prostitution is being criminalized, but not for the female prostitutes, rather, the pimps and the customers. Various empirical researches showed that the result of this policy is quite effective, the prostitution rate is going down and more women can be released from the hell that they experience in the world of prostitution. The reason for adopting this policy is because there is already an inequality between the female prostitutes and the male customers and pimps. Imposing the same sanctions to the prostitutes increases the inequalities and misses the real villains who are responsible for the existence of prostitution.

MacKinnon also rejected the legalization of prostitution as a solution to fight the bad treatment that prostitutes receive in her job. In one of her researches, she found that even when there are legal prostitution center, some people still prefer to use the illegal prostitutes because they refuse to have their sexual activities and tastes being regulated. In the Dutch, one pimp complains that the regulation of having pillow in the room (which apparently is required in order to increase the level of comfortness of the customers) is bad, because some prostitutes were being killed by pillow. It's a weapon of murder. In other words, the Government is not a good law maker when dealing with prostitution because they don't understand the nature of this business.

An Economic Analysis of Prostitution

Simply speaking, I support MacKinnon arguments, and I will try to show that not only prostitution is bad from the perspective of morality and gender equality, but also from economics point of view. The standard economic analysis usually says that whenever there is a voluntary transaction between two parties, the government should not interfere since it is assumed that these people would never enter into the transaction if both are not better off as a result of the transaction. I agree with this notion. The problem is, some people assume that prostitutes sell their body voluntarily to other people and therefore the government should just leave them alone or even better, legalize the profession. They argue that legalization and calling these prostitutes as commercial sex worker will reduce the degradation that they receive, improve their quality of life and everyone will be better off.

Seems correct? Absolutely not. First, you can't assume voluntary transactions exist just because people agree to sell their bodies for money. MacKinnon empirical data show that this is an illusion. The consent is not given properly, meaning that standard economic analysis cannot be applied. Instead, we must assume that without consent, we are imposing costs to the prostitutes by forcing them to do something that they don't prefer in the first place. We further know that the payment that they receive does not reflect the costs and risks that are being imposed to them and on top of that, they don't even have the flexibility to leave the job. It is clear then that in terms of causality, the pimps and the customers are harming the prostitutes. From tort law perspective, this should entitle the prostitutes to claim compensation from their customers and pimps.

In this case, the above reasoning is in line with MacKinnon's Sweden System. If the ones who inflict harm are the customers and the pimps, it does not make any sense at all if the prostitutes are being penalized. In fact, it would be even better that not only the pimps and customers are being criminalized, they must also be required to compensate the prostitutes for the harm that they inflict. In this case, the result will be efficient. First, there will be less incentive for pimps and customers to conduct their bad activities. Second, possibility of women being released from the brothel is increased and the fact that they can receive proper compensation is also a good way to provide them a fresh start for their life.

Now, some people argue that enforcing sanctions is costly, while legalizing action is profitable since the government can tax such action. In a sense that's true, but again economic is not a rigid science, it is flexible depending on the situation. And I can say that legalizing prostitution is simply a stupid idea. Yes, the government can tax the activities, but it means that the government strategically chooses to abandon their own citizens, i.e. the prostitutes, to live in misery, which of course is not efficient.

There is a better way, i.e. criminalizing the activities and target the pimps and the customers. The government doesn't need to always send these guys to prison. It can fine them to pay a huge amount of money to the government, where some are used to pay the legal enforcement costs and some are used to compensate the prostitutes in order to start a new life. This could be a cheaper solution and we know that pimps and customers have quite a lot of money. If not, pimps will not maintain prostitution business and guys will not choose to pay for sex if they can somehow get it for a cheaper price through other means.

To close this post, I would like to give an interesting definition of prostitution from Namibia (courtesy of MacKinnon of course), i.e. prostitution is any type of sexual activities that are being traded with commodities other than sex. This is deeply insightful, i.e. that sex should only be traded for the joy of sexual activities itself. Let us hope that someday we will be able to banish all type of prostitution in this world.

An Economic Analysis of Rape Crimes (Working Paper)

2011-11-12T13:00:00.000+07:00

Pursuant to my post here, I manage to elaborate my arguments into a decent working paper. I'm planning to submit this paper to an Indonesian law journal, but I would like to hear first some useful comments from my readers that I can use to improve the paper. So if you have any comments, please don't hesitate to contact me, I would be grateful for that.

Two Major Issues on Same Sex Marriage

2011-11-09T09:28:00.002+07:00

The legalization of same sex marriage will always be a controversial issue to be discussed as it encompasses many fundamental aspects of human life, including religion, morality, law and economics. In this post, I will focus on two issues that in my opinion are worthy to be discussed before we can consider the incorporation and legalization of same sex marriage into our law, i.e. (i) the problem of equal position in traditional heterosexual marriage, and (ii) the legal complexity that same sex marriage will impose to ordinary family law.

A. The Problem of Equal Position in Heterosexual Marriage

As you may be aware, even in the most developed nations, there is still a tendency for distribution of domestic tasks between the husband and wife. In general, the husband will be most likely responsible for providing the main family income while the wife will be responsible for maintaining the household chores, which usually includes the additional task of grooming and raising the children. I don't know whether this task distribution is incorporated into a law in other jurisdictions, but in Indonesia, the incorporation is pretty much clear. Under Law No. 1 of 1974 on Marriage, the husband is responsible for providing the living needs of the wife to the best of his ability (in his capacity as the head of family) and the wife is responsible for maintaining the household (in her capacity as the house wife).

Though seems simple, in reality, the effect of the above arrangement is significant and I dare to argue that such arrangement has already turned out into a baseline (see my discussion on baseline here). In countries and communities where economic activities are dominated by men, women position is generally weak and it affects their bargaining power within the marriage. It is true that by imposing the legal obligation on the husband to provide the main financial support for the family, it seems that the regulator is protecting the interest of the wife on the assumption that the wife is the weaker party. However, there is an inherent problem that might have been overlooked.

Logically, if you are financially dependent to a person, you will need to comply with such person's demand to the extent that it is necessary to maintain the benefit that you receive. Even when the law says that husband and wife have the same rights, it is nothing more than dead letters in front of economic reality, i.e. those who have better economic power within a marriage tends to control the relationship within such marriage (and in worst cases, the control issue can turn the marriage into an abusive relationship).

In my opinion, imposing a legal distribution of domestic tasks might create the wrong incentive (though in the case of Indonesia, I would say that our culture and religion hold the bigger portion).First, it forces the husband to always become the family's financial backbone even though in some cases he does not have enough capability. Second, it creates an impression to the wife that working outside the family household is a bad thing, forcing them to believe that stay at home housewife is the best option for them. Would not it be better if a couple can determine by themselves how they will regulate their family relationship, including on getting family income, maintaining assets and raising children? Further research will be needed to answer this problem.

Unfortunately, the notion of distribution of job has been deeply embedded into our subconscious, making a considerably slow progress in creating equal position within a marriage. Even nowadays when women position has already getting better in marriage due to their higher involvement in the job market, it is not uncommon to find women who will trade their economic power for the sake of raising the children in the family.

So what's the connection between the issue of equal position and same sex marriage? To answer that question, we need to understand first whether the traditional distribution of task is also applicable in same sex marriage. Since this is a marriage between same sexes, there are no husband and wife, no head of family and housewife, and therefore, I would assume that the distribution of role within such family will need to be agreed between the couple themselves instead of relying on any particular standard. In other words, to accept same sex marriage in our law is to revolutionize the entire concept of equal position in a marriage.

The grand question is: can we accept same sex marriage if we have not even reached the state of equal position in heterosexual marriage? It would be questionable to legalize same sex marriage without even reforming laws on ordinary heterosexual marriage and redefining the position of husband and wife in such marriage. In the end it's a whole package.

B. Family Law Complexity

Another major issue that is sometimes overlooked when dealing with same sex marriage is the complexity that it will create toward traditional family law. Legalizing such marriage does not mean that we can just simply give the right to marry to same sex couple and everyone would have a happy ending, further revisions must also be done the the overall body of family law which may include: child status, inheritance, divorce requirements, and joint assets (which may also cover tax issues). And revising those provisions would be a major challenge.

1. Child Status

Child status will be the first to be caught under the complexity. The problem is clear, same sex couple cannot produce children without the help of other sexes. So what would be the status of the children produced from the offspring of unmarried biological parents? Should it go to the father or the mother or to the ones who have established a family, i.e. the same sex couple? The current default rule is that a child produced by unmarried couple can only be claimed by the mother. In short, it is impossible to authorize same sex marriage, without revolutionize the concept of a legitimate child.

Imagine also when each of the couple want to produce a child. If successful, it would mean that a same sex family might have two completely separated by blood children, and these kids are not prohibited from marrying each other since they don't have any blood relationship anyway. So that would be an interesting form of family. I won't give a moral assessment for this kind of family, but I am quite certain that it would be more complicated. Thus, I would say that for same sex couple, adopting an unrelated child might be easier than having a child from their own flesh and blood.

2. Inheritance

Further, the complexities caused by the child status will directly affect inheritance. One thing for sure, by default, only one person in the same sex marriage will have family relationship with the child (in case they choose to use their own offspring). Assuming that they have two separate children, one will inherit based on blood relationship, the other one will only be able to inherit through a testament in case one of the parents died. Again, another complexity.

It would also be interesting to learn about how the couple in same sex marriage will inherit each other assets especially in a regime where there are differences of inheritance portion for husband and wife (such as in Islamic law). Or should the law create a different set of inheritance system for same sex marriage? What would be the efficient inheritance system?

3. Divorce and Child Care

The process of divorce in same sex marriage will need to be amended in case there are differences in the procedures for husband and wife. Furthermore, in such divorce, who will be responsible for the child custody? Can we sue for a husband alimony payment as in the usual heterosexual marriage? Although I doubt that can happen if there is no distinction. Should alimony be imposed upon the party having better financial conditions? Or if there is no blood relationship with the child, can we actually impose alimony payment?

4. Joint Assets and Tax Problems

Revising the concept of joint assets for same sex couple would be easy to the extent that we only need to change the definition of marriage. But there might be some problems from tax perspective, especially for the tax relief usually given to married couple. Is that something that the tax department will ever give? Of course if the amount is not that big, the same sex married couple might renounce such right for the sake of legalization (there is always a trade off). But if the amount is high, would these couple agree or will they claim that there is a discrimination? That would be an interesting case. I heard though in the US that same sex couple are fighting for this kind of tax equalization. One thing for sure, even getting a tax equalization for a booming industry in the biggest muslim populated country such as Islamic finance is very difficult, so I wonder whether that kind of equalization will be granted to a controversial arrangement like same sex marriage.

5. Conclusion

Like I said in the first portion of this post, accepting same sex marriage means that some radical changes must also be done toward heterosexual marriages main concepts. The same is also applicable to the laws surrounding the marriage. Again, it's a single package. An additional thought, with all of these complexities, would it be better for same sex couple to govern their relationship purely through agreement/contract instead of waiting the government to regulate the structure of same sex marriage?

Now, I will not offer any solution here nor any endorsement on what would be the best concept of marriage, the analysis within this post is purely positive, not normative. However, if you are interested to read further on this issue, you may download this paper from Harvard Journal of Law and Public Policy, titled: "What is Marriage?" Happy reading!

Should We Ever Impose a Good Samaritan Liability?

2011-11-07T14:20:00.001+07:00

Good Samaritan liability basically means imposing a legal obligation to a bystander (to the extent he has the capacity to help) to save a person in need of help. Thus, in case the bystander fails to save the person in need, and such person is harmed, the bystander will be liable. This is one of the interesting issues discussed in law and economics of torts. The case that inspires me is the Chinese toddler case (you can read the details here), where a Chinese toddler was being struck by a car, and no one helped her for quite a long time until a second car hit her again. When someone actually helped her, it was already too late, and she died in the hospital. If only the bystanders around the toddler helped her immediately, she might be saved and the story will be a happy ending one. Unfortunately, that's not the case here.

I asked some of my LLM Chinese friends in University of Chicago about this case and they confirmed that there was a case in the Supreme Court of China where a person is being penalized for helping an old woman from an accident. The facts of the case were never clear and people make their own conclusions, one of them is that helping other people may cause problem to you, especially when you don't know whether the people are really in need or they are just trying to put a scam on you (apparently, there are also cases where some swindlers trick people by pretending as accident victims and then blame anyone who nice enough to help them).

This is a serious matter, especially under the basic principle that people respond to incentives. If people can't determine whether their altruism as bystanders would be beneficial to all parties or at least don't cause them into any unwarranted trouble, their best rational choice is actually not to help anyone. And that is really bad to the society because it imposes a huge social costs to people in need. They can be helped with small costs, but because people fear that they will be in trouble if they try to help, these people in need end up with nothing or even bigger losses.

Now I remember that one of the comments that I see in Twitter is why not imposing a Good Samaritan liability? We impose liability to bystanders to help those in need in case those bystanders have the capacity to do so and the costs for doing such action would be low and lesser than the losses imposed to the victim due to the inflicted harm. Example: you're trying to cross the street and suddenly a car in full speed is about to hit you. I can easily save you by holding your hand and thus prevent you from being hit by the car. Doing that will not cause any additional risks to me (the car will not hit me) and if I don't do that minor action you'll die or at least be significantly injured.

Some people argue that liability should be imposed to me in this case based on the least cost avoider principle under the famous Hand's Formula (if you want to know more about Judge Learned Hand, see here). The principle basically says that a person should only be liable for torts in case the costs to avoid such harm (taking precautions) is lower than the loss imposed to the victim multiplied by the probability of the occurrence of such losses. Using standard economic approach, it's difficult to resist the strength of this argument, after all, the costs are lower than the benefits, surely, we should impose such duty to give the correct incentive for people to help other people.

However, I find this kind of approach as simply perverse. Not from morality point of view, but from an advance economic analysis. First of all, there is a problem of causation. It's easier to pinpoint a causation effect from an action rather from omission (as a caveat, I would like to emphasize that it's easier not easy). The standard of proof would be very expensive to prove causation in a case of omission. There is no solid evidence that even when I hold your hand, I can save you from a significant injury, after all it's an "ïf only"case. If you can't impose causation, how can you hold responsibility in economic terms? An easier solution for my hypothetical case is to impose liability to the car driver, because he is the one who hits you. In reality, if you survive, you will most likely sue him. If not, your family will sue him. And that would be easier for all parties.

Second, if we apply the notion that we are legally obliged to help other people whenever we are the least cost avoider (and there will be sanctions for failure to do so), it would be a disaster. Let us use an extreme case, imagine that there is a hungry child in front of you (you don't know him at all). Without food, he will not survive. You don't help him even though you are able to do so and he died shortly. Should you be liable in this case? My answer is no and it's for good reason. It will impose an enormous costs to everyone to always be aware whether there are people in need around them. Furthermore, the costs for enforcement will also be humongous. People will start to sue other people if they don't get help in case they think that they can be helped by bystanders. It can turn out to be a lucrative business for lawyers, but for great expenses to the society.

One solution to this, which has already been incorporated in our penal code, is to impose liability only to specific people who have clear legal duties to take care of such people in need. Example: duty of care by parents to their child. This can be an efficient rule if the duty is strictly imposed to people who have control over the people in need and therefore are in a better position to understand the need of such people.

Another solution is to protect bystanders from any liability in case they try to help. You don't need to give additional benefits to altruists, after all for these guys, helping other people has already increased their utility. But you may want to protect them from liability imposed by their good intentional action. The problem with this rule is again standard of proof in causation. Like I said above, in case of omission, it is harder to perceive the causation. But once an action has been done, that action can be placed in the causation analysis.

A no liability rule for all helpers might not be efficient in cases where bystanders don't actually help and instead cause additional problems. So another set of rule can be added, i.e. the no liability rule will only be applicable for bystanders who can show good faith in his actions and have the minimum reasonable skills to help. In this case, hopefully, people having no capabilities to help will stay away from helping other people in need and therefore they can avoid unnecessary problems. It's not a perfect system, some people who think that they are reasonably well to help other people may end up liable for reckless help but it is better than creating a system where everyone is not liable and thus there are less incentives to be careful in helping other people.

Birthday of The Capitalist Lawyer - 2nd Edition: Some Reflections on Legal Thoughts

2011-10-26T10:00:00.007+07:00

Today is my 28th birthday and I guess it would be nice to start a-once-in-a-year reflection in my blog (started it in 2009, but completely forgot to follow up in 2010, typical). I will not make any reflection about my life (nothing to reflect, it's a damn good life anyway), so for this year, I'll reflect the development of my own legal thoughts.

I started my formal legal education in 2001 without knowing a thing about the law, I didn't know whether I will be interested with it or what I will do after I graduated. My primary reasons at that time? Just following my intuition plus chasing my dream of being admitted at the University of Indonesia (my second choice was UI's Political Science, don't ask me why I picked that, cause I can't answer that even until today). So yes, it's more about getting into UI rather than picking a subject that I really like. Fortunately, I was lucky. By the second semester I knew for sure that I love this subject!

At first, my primary choice of specialization was constitutional law. 2001 was the time where many constitutional law professors secured high positions within Indonesian government. It was a transition era in the Republic and constitutional scholars were needed to guide the process. However, a fated encounter with a really weird lecturer caused me to change my mind entirely. It was so bad that I said to myself, "all the good professors are in the government now and we're stuck with these buffoons. Like hell I will take constitutional laws." So I decided to specialize in other fields: procedural and business laws. Again, I am a lucky guy. Turns out it's a correct decision, as now I work as a corporate lawyer, a profession that I literally enjoy not only professionally, but also academically.

But those things only affect my professional skills. What really affects and shapes my legal thoughts is a whole different subject of law that I accidentally learned during my law school days, i.e. Islamic legal theory. It started with a challenge from my best friend, saying that I will never master Islamic law, because I can't differentiate the type of waters that you could use to purify yourself (wudhu). Of course, knowing how predictable I am, I took that challenge and soon I regularly went to UI's mosque's library. Although I planned to start with the library's classical Islamic law books collection, I ended up with Islamic legal theories first. And I was impressed, by the 9th century, Islamic legal scholars have already developed a concise legal theory that will put common law and civil law scholars at that time to shame.

Granted, the current development of Islamic legal theory is pretty much gloomy (no new development), but I learned something from my personal study, the existence of a theory called Istislah or Maslahah Mursalah, which basically states that legal scholars, in the absence of clear legal rules, should take the welfare maximization of the society as a prime concern in deciding cases. The concept is simple, but the insight is very deep. Such insight helped me to think for the first time about what constitutes a good law.

During my early years, I got an impression that my faculty only taught its students to become technical masters of law. We know the laws, we can easily apply them into concrete cases, and we are proud with that. The famous motto in my faculty, "If you're a law student, always talk with a legal basis." It's nice, but something is missing here. Being a technical master means that you are only acting as a spokesman of the law. You don't care whether it's good or not, heck, that's not even important. This is what I call as an abuse to Hans Kelsen's Pure Theory of Law (See my discussion on Kelsen at here, here, and here).

So for me, this is non sense. This kind of education reduces the profession of lawyers into simple craftsmanship. Lawyers should be able to do more than that, they should be able to work as policy makers, they should analyze the quality of laws and propose a better version if they think that the current ones suck. Istislah theory helped me to see that error earlier and I am thankful for that.

Now, when we're eventually getting into the question of what constitutes a good law, there are various methods to determine the standards. I started with the believe that a good law should reflect the society's sense of justice, local wisdom. But that belief didn't last long. Why? I come to realize that there is no standard for reflecting the society's sense of justice. In the end, it will always be a matter of preference. Suppose the society deems honor killing as a part of their justice system, would we still agree to enforce it in the name of local wisdom?

Logically, I move forward to a standard which seems to be universal and applicable in every situation and condition. So I turned out to legal principles established by religious belief, i.e. Islamic law. Yet, it didn't satisfy me. Years of researches show that other than the agreement among Islamic scholars on the mandatory prayer, fasting, zakat and hajj, there is no unity of opinion in Islamic laws. Cultures or 'urf have a great impact on how scholars interpret the laws and there is a never ending debate on what standards that are deemed applicable for eternity and that are subject to changes. As a result, there isn't any production of worthy new ideas within Islamic law, it's just a repetition of the old ideas and debates that ended in the 15th century. Thus, I concluded that similar to the notion of society's sense of justice, Islamic law is not that reliable for providing a clear standard on what constitutes a good law. FYI, the use of Istislah itself is still controversial within Islamic legal scholars, so that could explain why its development has been halted for a very long time.

Finally, I end up with the law and economics movement. It's ideas of welfare maximization and promotion of efficiency as guidelines for determining a good law really captivate me. First, I see law and economics as the modern interpretation of Istislah theory, its spiritual successor. Second, since it is a combination with economics, it is easier to assess the standards to determine whether they really work or not (empirical research is very encouraged in this field and I think it is very helpful). Furthermore, economics is a science that can be applied to almost every aspect of human life, so applying such science into legal conceptions prove to be an eye opening of things that we have already taken as granted. The notion that incentives matters still amaze me on how we can use different incentives to structure a law that will work efficiently and to explain the behavior of the people in facing the law and legal enforcement.

When I choose law and economics as my primary tool for assessing the quality of laws, I don't close the opportunity of using other helpful methods. No tool is perfect, and maybe in the future, we will develop an even better method for analyzing the law. But until that day comes, I'll stick for a while with law and economics.

Why I Favor Votes as Commodities rather than Duties

2011-10-24T13:42:00.000+07:00

A couple of days ago, I received an interesting comment from @tirtasusilo on my latest post. His question is: "How would you persuade someone who is against vote buying because he/she considers voting a duty, not a commodity?" First of all, a rational person should not consider voting as merely a duty as I argue here. But surely, giving that kind of answer would be cheap. So I'll try to answer that question through this post.

What would a person think about his vote if he considers it as a duty? My assumption: he takes voting as a way to do the right thing. He votes because he believes that he does something for the betterment of society. Consequently, voting should never be traded. You don't trade what is right only for money. While his notion might be tempting for a lot of people, I'm afraid I have to say that it is this notion that persuades political parties to use vote buying to get what they want.

First of all, we cannot effectively prevent people from picking their own preferences, whether they want to protect the integrity of their votes or they think that voting is a crap mechanism which means nothing, or that voting is a valuable item that can be traded for a good price, etc. The fact that there are many preferences means that sly politicians can use different methods of persuasion for getting as many support as possible from the voters, including building an image as good politicians in front the media to get votes from the duty oriented guys and using tricky methods (including money and political promises) to gain additional votes from the commodity oriented guys. In this case, we are not maximizing the utility of the duty oriented guys, we're maximizing the utility of politicians and commodity oriented guys.

Now, if duty oriented guys really want to maximize their interest, i.e. preventing politicians from vote buying, they should agree with the system that I proposed, i.e. legalizing vote buying with certain conditions. The reason is simple, such system is created for the sole purpose of reducing vote buying, it is created not to let people trade their votes like crazy but to keep people from buying and selling their votes. Think it as a more efficient solution that basically satisfies the interest of the voters (for getting a better election in term of fairness and quality) and imposes significant additional burden to politicians who dare to use money in getting their support.

Sure, we can always resort to the old school style, such as making vote buying as an illegal act and enforcing heavy punishments against violators of vote buying restriction. The question is: will that be efficient in Indonesia case? How much money do you think that we have spent for the entire national and regional election? These costs include campaign costs, the "hidden" vote buying costs, candidates disputes costs, enforcement costs, etc. Not only that these costs are damn expensive, we still end up with buffoons as our leaders. And being rational, these buffoons will most likely try to do anything to recoup all of their costs during the election. After all, no sane people will go and spend most of his fortunes for securing a position if he don't expect some benefits from getting that position. What could be even worse than that?

So, considering the above argument, if these duty oriented guys really care about doing the right thing, would they pick the "right" method that will produce the "not right" results, or would they pick the seemingly "not right" method that will produce the "right" results?

Once Again, In Defense of Vote Buying

2011-10-21T14:04:00.001+07:00

A week ago, I wrote about using vote buying mechanism to prevent political parties from buying our votes. You can see the article here. Furthermore, there is also an article from Greg Mankiw and Michael Sandel in 2007 on why vote buying should not be allowed. Before I update my proposal, I'll give some comments to Mankiw and Sandel's ideas.

The Inherent Problem of Mankiw and Sandel Cases

The main argument of Mankiw is that vote buying can produce externalities to third parties. I guess there's a grain of truth in his idea, but unfortunately, his example does not make any sense at all. I reproduce his case here for ease or reference:

"Suppose three voters are deciding whether to provide a public good that costs $9, which would be financed by a $3 tax on each voter. Andy values the public good at $8, while Ben and Carl do not value it at all. Under majority voting, Ben and Carl vote against, and the public good does not get provided, which is the efficient outcome.

Suppose, however, that Andy could buy Ben's vote for $4. He could then ensure the project gets passed. Andy is better off by $1 (the $8 benefit minus the $3 tax and the $4 price of the vote), Ben is better off by $1 (the $4 price of the vote minus the $3 tax), and Carl is worse off by $3 (the $3 tax). The Andy-Ben vote deal has negative externalities on Carl."

What's the main problem of his case above that can be answered by public choice theory? His case stops at the fact that Carl is worse off by $3. If Carl is a rational person, what would he do? He can also offer to purchase Ben's votes for $2, after all, losing $2 dollar is better than losing $3 and for Ben, receiving $2 is surely more attractive than receiving a net benefit of $1 from Andy.

Then what will Andy do? He can choose to increase his offer to $5 for Ben's vote and therefore receives no benefit from the policy. At this point, Andy's marginal cost equals his marginal benefit, it's the point where he should stop because any further increase on the price of Ben's vote will cause losses to him. What would be the proper response of Carl? He can stop, or he can also choose to offer $3 dollar for Ben's vote. It's the same for him both ways, if he stops, he will lose $3 anyway, so he still has the incentive to offer such $3 (marginal cost equals marginal benefit). Now, if Andy is rational, he will stop, because he knows that proceeding with the vote buying battle will only end up with further losses. How about Carl, should he pay Ben? No, because his offer is basically only valid when Andy still wants to buy Ben's vote. There is no need for him to pay Ben if in the end Carl cancels his plan. Of course you can say that under this circumstance, Andy will come again to offer Ben to sell his votes. True, but then Carl can also do the same and a problem of cycling will be created.

Sandel's argument is more persuasive, he shows that it is possible for Andy to actually persuade Ben to establish a value for the proposal and therefore he will vote in favor of Andy's proposal without having Andy to buy Ben's vote. In this case, Sandel argues that the end result will be the same for both cases (involving vote buying or not), there will be some costs imposed to Carl. However, even in this case, Carl can always offer to buy Ben's vote for a price.

Sandel says that suppose Ben values the proposal for $4 after hearing Andy's persuasion, meaning that he will reap a benefit of $1 if he vote for the proposal. What can Carl do? Of course, he will offer Ben $2. What will then Andy do? He can offer a price of $5 to buy Ben's vote and then Carl will offer Ben a price of $3, and Andy will face the same problem again. Another cycling will be made in Sandel's case.

The simple problems created by Mankiw and Sandel actually resemble the real political life. It's a case of battle between interest groups where benefits will be spread to the majority by imposing costs to a group (wide spread benefit vs narrow cost). Of course, the group will not just sit and wait for the impeding doom. They will fight for their right and if they have to lose something, they will make sure that at least it shouldn't exceed their total expected costs should the problematic policy is promulgated. I'll deal with this issue in another post. Now, let's return to my further elaborated proposal.

The Elaborated Proposal for Vote Buying

Since I'm still in favor of vote buying for Indonesia, I'll try to elaborate more my original proposal in this post. Further comments and questions will be much appreciated.

The basic principle is that in a general election, voting is the commodity, people are the sellers, and political parties are buyers. Now, what's the main reason for political parties to buy our votes? Assuming that these guys are rational, I would say that they buy our votes on the basis that the expected benefits that they will reap after they secure a position are still bigger than the total expected costs that they will incur during the election. The costs can include campaign costs and any penal sanctions that may be imposed to them if they're caught (vote buying is still illegal in Indonesia).

However, as I've said numerous times, you can't separate law from the legal enforcement. In our country, it is safe to assume that the probability of being caught and sentenced for vote buying is quite slim, meaning the costs of getting caught is not that big and therefore there is less incentive for complying with the law. In this case my proposal would be: vote buying should be legalized, any political parties are allowed to actually come to us and offer a price for our vote. This is the basic proposal, but to ensure that it can work, I'll add some additional rules.

1. Minimum Price Cap

There should be a minimum price cap for our votes which reflects the expected benefits of the political parties should they win the election. I would say though that since the number of Indonesian citizens are very huge, increasing a little bit of the price of our votes would have significant financial impact to our political parties in case we can't assess their expected benefits (so at least we impose higher costs to them). Say that the current market price of our vote is around Rp50,000 per vote and then we increase that to Rp55,000 per vote. Assuming that there will be at least 100 million voters, an increase of Rp5,000 per vote is equal to an additional total costs of Rp500,000,000,000 or around US$55,000,000.

2. Bidding System

We can choose two systems to sell our votes. The first is by using the rule of Tullock Auction (Gordon Tullock is a famous public choice theorist), where all political parties can bid for our votes and the highest bidder will win all of our votes, however, the ones who lose the bid will also be required to actually pay the amount that they have offered during the bid process to us.

Second, we can use a system where each political party can bid for our votes by paying us directly, but: (i) they are required to disclose the amount publicly (or we can ask the media to do that), (ii) they are required to deposit a non-refundable minimum amount to us for their offering (say 10-15% of the offer price); (iii) there would be no legal guarantee that the voter will vote in accordance with the bid winner, meaning, the winning political party can't go to the court to enforce their right to be voted by us, and (iv) the political parties can always change their offering to us until the date we walk to the election booth and set our vote.

You may say that the above system is crazy, no one would like to enter into this kind of arrangement where the seller position is absolute. But that is precisely why we need to adapt this kind of system. In the current system, it is very hard to proof that political parties are involved in money politics. Have you ever considered the costs imposed to us for all of these hidden money politics and also the total costs of the national and general elections (all of those disputes in the Constitutional Court and the re-elections)? Not only it's a waste of tax payers money, it also does not provide us with the best candidates to lead our country.

Under my proposed system, there would be less incentives for political parties to buy our votes. Why? First, we eliminate small parties by this system, leaving all the major parties in a competition to rule us all. Second, unless there is a super political party with infinite source of funds, no one will ever win the vote bidding.

Let me tell you how this will work in practice by using an assumption that there are 3 parties, A, B, and C and that each party has more or less the same financial condition. Each of A, B, and C would have the incentives to win the election because they know that they can win the election by money and that the losing party will most likely lose everything. Since they all know the other party prices, they will continuously try to outbid the other party until they exhaust all of their money, creating a cycling problem. Of course in this case, A can make a coalition with B to defeat C in the vote bidding, but C can also offer B to instead cooperate with it and defeat A. Another infinite cycling will also be created here.

Furthermore, since there is no guarantee that people will vote for they who pay the most, there are incentives for these parties to offer things other than money to induce people to vote them and I'm quite certain that there would be no case where we end up with an absolute winner after the vote bidding fight just because it pay the most.

Their only solution is to actually agree to stop using money and induce voters to vote them for other reasons. True that under this regime, there would always be an incentive to betray such agreement, but since it will create another cycling problem, they will be forced to comply. Suppose A, B and C agree that they will not use money to buy our votes. Then, B realizes since it is still legal to buy our votes, they can try to buy our votes behind A and C. A and C, fearing something might happen behind their back, will start to have the same incentives and will also return to money politics. You see where this is going? So the conclusion is clear: stop using money to buy our votes or end up being caught in an infinite vicious cycle.

Of course this is not a bullet proof mechanism, if A, B, and C have a very stable coalition, we would be in big trouble. But I guess that would not happen in Indonesia, after all , no groups of robbers will ever have a stable coalition since each of them would try to maximize their own benefits on the expense of others. For further readings, try searching in Google for Arrow's Impossibility Theorem.

You Think Our Legislators Suck? There's a Good Explanation For That!

2011-10-14T13:16:00.000+07:00

If there is only one thing that I can be confident about Indonesia, that must be the notion that most Indonesian citizens hate their legislators. How couldn't we? We rarely (read: never) hear any good news about them, and we oftenly (read: all the time) hear about how irresponsible they are with their job. Remember how they lavishly spend the state budget for their ridiculous comparative study in foreign countries? How they plan to build a new potentially (read: absolutely) useless new building? How they can't meet their yearly target for issuing new laws? (though considering their capabilities, this might be a bless is disguise)

Before you're planning for a bloody revolution, try to think about it again. Aren't these legislators the product of our beloved democracy? After all, it's the people who vote them as our representatives. But why do they betray their own constituents? It seems as if they only think about themselves or the interest of certain minority groups who have the means and funds to purchase these legislators voices in the house of representative. In reality, these interest groups don't have enough voices to put the legislators in their current position. Yet, it's clear that these groups have more control over the legislators compared to the majority of the people, i.e. us. How could that be? Should we say that democracy is a total failure? Will we have a better chance under the rule of a benevolent dictator?

The Problem of Collective Action

Public Choice theory has a very good answer for this problem (by the way, public choice theory is basically the application of economic analysis into political theory). In short, we are facing the problem of collective action, which can be further elaborated into three main issues: (i) high transaction costs, making coordination within a large group almost impossible, (ii) free rider issue within uncoordinated group, keeping people from working together (creating a vicious cycle along the way), and (iii) internalization of the interest groups' costs among a lot of people tends to lower the average costs that must be borne by each individual, giving less incentive for the people to fight back. Let's discuss this one by one.

In general, we, the people, are pretty much diversified. There are too many scattered interests and the costs for coordinating us into a single systematic group where each person knows perfectly other people needs, would be too expensive. Unfortunately, the case is different with interest groups. Because they are smaller in numbers, it is easier for them to coordinate among themselves, meaning less transaction costs to work together in order to satisfy their interests. This might seem obvious and logical but most people tend to underestimate this important factor. Why do you think we embrace the idea of decentralization?

Without any effective mechanism for coordination, surely it would be very difficult for the majority to fight back. Here is where the free rider issue arises. Suppose you really want to fight back the legislators and the interest groups, you want to show them that the people are not toys to play with. To do this, you plan to invest your money in making an awareness campaign, letting people know that their legislators suck and that we can't let that happen anymore in the next election. But just when you're about to cash your check, you start to think, "wait, if I'm putting my money now, will many people agree with me and support my effort, or will they just enjoy the fruit of my efforts by doing nothing?" Unless you're a saint or you have your own interest group, you'll probably reconsider your decision and then you will wait for other people to start the effort. See the vicious cycle here?

Finally, there is a major issue of cost internalization. When interest groups and our legislators are making policies that benefit themselves, they impose additional social costs to the rest of the people. Imagine the wasted tax money that they use for unnecessary spending, or imagine the additional burden that consumers will need to pay when interest groups, say in the form of pollutants, can induce the legislators to let them free from being responsible for the externalities caused by them to the society. Yet, since these additional costs are imposed upon a diversified group, most of the people only bear a fraction of the costs. Not to mention that these costs can also be internalized for a long term, lowering the burden to the each individuals. The end result? Less incentives for the majority to fight back since they don't feel the impact as a whole. If they do, they would have done something to prevent the interest groups and the legislators from doing whatever they want. The above things may explain why we had a "successful" reformation (read: revolution) in 1998, but not nowadays.

One Crazy Solution: Why Don't We Sell Our Votes?

So what can we do? Firstly, we need to understand how the majority of Indonesian people view the voting process and how interest groups and legislators perceive the benefit of their position. Do Indonesian people take voting as an important matter or they consider it as a commodity that they can sell for certain price? Furthermore, how do the majority of our legislators perceive their position? For the greater good of the society or for their own benefit (calculating the benefits of having the position minus the costs of getting appointed).

If the latter is correct, the solution would be to impose an excessive price for people's votes. My main idea is: rather than imposing a sanction for political parties which try to manipulate the vote by using money, give the freedom to them to use their money as they like. Why? In a country where the price of a vote is cheap and the legal authorities are weak, there is no way for a clean political party to win against those who use money in their campaign (money is real, talk is cheap). Having said that, why don't we say to the people that they should vote for whoever can purchase their votes for the highest price (of course there should be a minimum cap for such price reflecting as close as possible the benefit that the legislators might receive from getting the position, e.g payment from interest groups).

The more expensive the vote is, the better. The expected results are: (i) interest groups and political parties will be forced to exhaust their own resources for wasteful acts, i.e. spending a lot of money though there will be only one winner, and (ii) along with the increase in costs of buying votes, less interest groups will join the game since the expected benefits are going down to almost nothing. Through this solution, we're imposing a collective action problem to the political parties. They might work well as a single group, but if we put them in a situation where the most optimal way to reduce their costs is to not paying anyone, they will also face the same problem that larger groups face.

Let's see how my solution work. If parties continue to pay for getting their votes, some of the smaller parties will soon realize that it is not worth it and stop playing. At this stage, it is safe to assume that the remaining players are the major ones. You may think, now we're doomed, we have major players controlling the game and no one can fight it. Not necessarily! These major players have two options: (i) they can continue to compete in spending a lot of money for getting votes or (ii) they can reach a mutual consensus that no one will use money in their campaign. Of course since none of them can trust each other (collective action problem), they will continue to spend their money to the extent that they will have no more resources to spend. In the end, when they have exhausted all of their resources, they will be forced not to use money anymore in their campaign or they will face the risk of having a vicious cycle of unnecessary money spending.

Suggestions and comments are welcomed.

Knowing the Law vs Complying with the Law

2011-10-13T09:56:00.002+07:00

Yesterday morning, I had a nice discussion with one of my juniors in the Faculty of Law, University of Indonesia, @najmulaila, concerning the concept of legal awareness. The basic case is quite simple, she's complaining about the law students' attitude who make a right turn within the faculty, despite knowing that it is clearly prohibited. She further argued that it's useless to talk about legal compliance in Indonesia if these students don't follow the rules themselves. After all, according to her, what's the purpose of knowing the laws, if you don't comply with them? Suffice to say, she is a proponent of legal awareness campaign, i.e. having more awareness of the law should be translated into an increase in legal compliance.

Here where I quickly have a different opinion. Knowing the law does not necessarily mean that you will comply with such law. The reason is simple and can be traced back to the basic assumption of Law and Economics, people are rational being and they respond to incentives. From the fact that most students violate the no-turning-right rule, I can conclude that the Faculty has not imposed any sanctions to the violators. No sanctions means no costs to these students to violate the rule. Hence, what are the incentives for them to comply? Surely we can't assume that these young students are those "righteous people" who will follow the law simply because it is the right thing to do as depicted in legal philosophy course. Plato always dreams of having a philosopher as the king because he exactly knows that it is impossible to have such king in the real world.

Of course, being a diligent law student, she didn't immediately agree with me and instead offered another argument: my line of thinking is the same with corruptors! They corrupt because they know that the benefit of corruption is bigger than the costs (such as going to the prison). I almost shouted "EUREKA" when she actually said that because it is precisely what I have argued before in some of my posts (here and here). This is how Law and Economics explains the behavior of criminals, they calculate the costs and benefits of their criminal acts and whenever they decide that the benefits exceed the costs, they will most likely conduct the crime.

If we think it through, assuming that knowing the law will increase legal compliance is a dangerous assumption, because it is a highly misguided assessment of human behavior, and there are many consequences to such assumption. Take the law students case as an example. You can always say to them how humiliating their act is, but unless the Faculty takes a real action toward the violators or unless making a right turn will cause the students to be involved in a serious accident, I bet that the rate of violations will never decrease significantly. What do you expect? Are these students hypocrites? I don't think so. They are mere human.

Another example: it is possible that the people who understand the law can find a leeway and use such understanding for their own benefits which of course is not in line with our hope that increasing their awareness will induce them to comply with the law. So what should we do? The answer is better legal enforcement! Legal enforcement should never be separated from the law itself.

You can make the best law in the world, but if you have no one to enforce it, such law would be meaningless. This is especially true when you are trying to regulate people's behavior. Oliver Wendell Holmes correctly pointed out that people are only interested with what judges will do with the law. In other words, people are more interested to know what legal authorities will decide against them in certain cases and not only what the law say.

By this, I'm not talking only about criminal law, this is applicable for any subject of law. Suppose there is a law saying that certain contracts are prohibited and will be deemed void by operation of law if people entered into such contracts. If people know that the judges will declare these contracts null and void whenever the parties bring them to the court, they will most likely not sign these contracts in the first place.

So there we have it, a short discussion on how we should take a look at the law. One important thing that I learn from Law and Economics: some of the concepts are so obvious that people tend to disregard them entirely. At least that's the experience of Ronald Coase and his concept of Transaction Cost. The concept was made when he's still in his 20s and yet, he received his Nobel Prize in his 80s. It took 60 years for people to realize a concept that is so obvious to everyone if they think it through. Ain't that crazy?