Wednesday, October 26, 2011

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

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.

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Monday, October 24, 2011

Why I Favor Votes as Commodities rather than Duties

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?

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Friday, October 21, 2011

Once Again, In Defense of Vote Buying

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 prove 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.

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Friday, October 14, 2011

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

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 in 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.

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Thursday, October 13, 2011

Knowing the Law vs Complying with the Law

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?

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Wednesday, October 12, 2011

The Future of Law and Economics (Collection of Essays)

This is too important to be not posted in my blog, a series of important essays by law professors of the University of Chicago Law School on the future of law and economics program. Enjoy!

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Thursday, October 06, 2011

The Tale of the Evil Car Company (Part 2 - Proposed Policy)

I have received several comments for my previous post, and I thank all of the commentators for the effort. I must say though, if only I set a prize for giving these comments, I would definitely give such prize to my brother, Prasetya Dwicahya, for his excellent comments (no family bias involved here). So if you have not read his comments, you better check it out before going further with this post.

Anyway, most of what I will say has already been covered by Prasetya's comments. Thus, I'll focus instead in analyzing his proposed policy to find out whether such policy can be the best option to be pursued by the government. Prasetya's proposed policy is something that we call as the freedom of choice policy which is in line with the concept of free market and pareto efficiency (a condition where as a result of the policy, some individuals are made "better off" without making any individual to be "worse off"). People is free to choose whether they want to use the car without the safety device or bear an additional costs in order to install the safety device. The company is free to produce its products (even if there is a defect) provided that it discloses all material information to the public so that people can make an informed decision and the company can reduce its marginal costs. And the Government has the role to enforce the law to ensure that the company will pay the expected compensation to any victim of the car due to the unavailability of the safety device .

Theoretically, this can be a win-win solution that promotes efficiency to the maximum. With this kind of policy, the costs of legal enforcement by the government would not be too expensive (assuming that the rate of accident is low in accordance with the probability that has been set out by the company), the company will not be burdened with huge additional costs, and the people will have many options to choose in order to maximize their utility and preference (i.e. getting an absolutely safe car or playing with the laws of probabilities for a huge jackpot). But it seems this is too good to be true. Or isn't it?  Or do you think this idea disgusts you, that it is a morally reprehensible choice? I mean, how do you even sure about letting people take a bet with their life in the line, even though the probability is very small?

In practice, we let people take this kind of risk all the time. We know smoking is dangerous, yet we are not able to prohibit people from doing it. And suppose you say that there is a huge interest group behind smoking activities, there is even a better example which is more similar to the above car case. We know overeating and poor exercise are a good recipe for health problems and they also increase the probability of getting caught by various diseases, including heart attack. Yet, I bet that the government will not issue any law that prohibits people from overeating and force them to exercise routinely. My main question, if we care about our people (like in the case of the automobile company), why don't we just choose the path of regulating people's daily life? There are many answers to that: the enforcement costs will be too big, it's an invasion to people's privacy, it's another form of "big brother"/dictatorship, etc. Now, if we can give those lines of arguments to the overeating problem, shouldn't we take the same position for the problematic car?            

What I would further argue is this, the above proposed policy that respects the element of freedom can potentially be the best option for the automobile case in any possible way. Let us tweak the case a little bit. Suppose now the probability of having an accident due to the unavailability of safety device is 80%, meaning that from 2,500,000 cars, 2,000,000 cars will go haywire. Will our proposed policy save the problem? Or should the government forces the automobile company to install the device? I would say there is no need for the government to do that. Using a simple costs and benefit analysis, the company will definitely realize that the costs of not having such safety device will be too big to be borne by the company. In this case, their best option is to install the safety device.

Now, another tweak. Suppose the costs of installing the safety device is not US$10 per car, but US$100,000 dollar. Will our proposed policy work? I bet yes. In this case, the marginal costs of producing the car (i.e. the costs of producing an additional unit of the car) will defeat its marginal benefits. Simply saying, the automobile company will never produce the car in the first place.

Having said the above, I need to put a caveat. Our world is very complex and a solution for a problem may not work for another problem. What I want to show here is how economics can be used as a handy tool in formulating our laws and policy. I'll continue to use this theme for my next articles and hopefully we can try to apply it in different cases with different policies. One thing for sure, this exercise should be fun.

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Monday, October 03, 2011

The Tale of the Evil Car Company (Part 1 - Question of Policy)

Suppose one day a major automobile publicly listed company announces that it is selling a new cheap product that will allow people to have car more easily (for the sake of discussion, we will not discuss the externalities that people will face with more cars in the road).  The car is a huge success for the company, generating a huge profit, and the stocks' value of the company has also increased several times in a year. But then, an accident happens, a gruesome one. Further independent investigation shows that while the probability of the accident is very low, around 1:100,000 per year, it can be avoided if only the company install a safety device.   

Facing this result, the company announces to the public that to cut the costs of the car, it did not install the safety device required for preventing such accident. Why? Apparently, the cost for installing the safety device is around US$10 per car and since they produce 2,500,000 car a year, the total additional costs that the company will bear for a year is US$25,000,000. Meanwhile, by attaching a value of at least US$100,000 per person as a compensation for each accident and with the assumption that the car will be purchased entirely, the company estimates that the total costs of the accident per year wouldn't be more than US$2,500,000. So, by a simple cost and benefit analysis, the best option of the company would be not to install such safety device.

Soon this controversial information fills all the major newspapers. The enraged citizens are calling this company as an evil car company, and politicians demand the company to be responsible for such matter. Assuming that you are a policy maker, what will you do with this case? What kind of policy that you will formulate against the fact that the company has chosen not to install such safety device?

This is the first part of my post that deals with the basic question. I'll post my proposed policy but I would like to see first how my readers will respond to this kind of question. Your comments will be much appreciated.

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Saturday, October 01, 2011

On Why Ignorance of the Law Can't Be a Good Defense or Should It be?

All first year law students in any part of the world should know this principle: ignorantia legis neminem excusat or simply saying, you will not be able to defense your illegal act in front of the court on the basis that you don't know the law. This might be a simple principle, but there is a deep meaning here and I had a very nice discussion with Prof. Anup Malani this morning regarding this matter.

Try to consider this. Suppose you're attending a class of a "killer" professor. Most of the time, he only mumblings aimlessly. Then, on the final examination day, you suddenly realize that the questions presented do not contain a single thing that has been taught in the class. It's completely different and you stare blankly at the exam paper. What do you feel? That it isn't fair? That it seems like the professor is cheating the student? Well if you think so, I would completely agree. This is not fair at all. In fact, if I were you, I will definitely report the professor to the higher ups and ask him to be removed since this is so unprofessional.

But if you think it through, wouldn't you find the similarities between the case above and the legal principle that we are now discussing? With so many regulations issued each year, in reality we've already drowned in regulations (and the parliament is still thinking about issuing new regulations each year?). No human being, even the best lawyer in the world, can know and fully understand the entire law in a single country. And yet, with all of these facts, there would be no excuses for all citizens to say that since they don't know the law, they should be exempted  from legal liabilities in case they mistakenly violate a law. How can that even be possible?

Apparently, there is a good economic reasoning for this certain principle and that is the fact that the cost of faking your ignorance of the law is so cheap (as easy as I say: "I don't know") that opening the possibilities of exempting people out of ignorance would be a major disaster for legal enforcement. Of course, this is not a perfect solution. When the laws aren't as many as nowadays and when the laws are usually still in line with basic common sense, adhering the non ignorance principle would be a good choice. But the case would be different with the current development in legal system.

One of the issues that was discussed today is the fact that there are a lot of new laws in the United States that criminalize acts without any mens rea element. Mens rea basically means the intent to violate the law or the "guilty mind". In other words, you can be criminalized for doing certain acts even when you do not have any intention to conduct such act. Let us take an example, suppose that there is a local law that restricts people to put their cars on the road sideways in certain hours. Say that the regional parliament members have their own reasoning and it is common for the people there to put their car on the road sideways. Wouldn't you be surprised when one day you are being fined for putting your car in the sideways without any warning whatsoever and you can't defense yourself on the basis that you don't know about that law?

What was considered as a good legal principle can be turned into a giant mess. Try the regional regulations in Indonesia. It's very hard to access any information about these laws, there are plenty of them, and each person, including companies, are expected to comply with all of the requirements set out under these regional laws. It does not work that way and a legal system that works like that is no different than legalized burglary.

Having said that, I have to admit that finding the right balance is difficult. On one side, we do not want to provide huge incentives to people to violate the law. On the other hand, we can't let government officials do as they please without proper restriction or we will end up with high cost economy in many part of our lives. Some suggestions would be: (i) with respect to criminalization, the government should be careful in not creating too many new criminal acts, it sends the wrong signal and it increases inefficiency in state management; (ii) even if we need to criminalize, adding the element of mens rea would be helpful in reducing unnecessary violation; and (iii) socialization of new laws is imperative and it would be better if the Government can introduce those kind of laws gradually. Remember the introduction of seat belt rule?                    


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