Wednesday, February 29, 2012

Religion and Economics Rationality

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.

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Monday, February 20, 2012

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

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.

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Wednesday, February 08, 2012

The Market for Gem and the Problem of Being an Expert

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.

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