The Chronicles of a Capitalist Lawyer

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?

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!

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.

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.

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?