• 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.
  • 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.
  • 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.
  • Desperately Seeking Legal Certainty

    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

    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

    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

    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?

    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

    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.

  • The Protection of Criminal Suspects in Law and Economics Perspective

    Forthcoming in Jurnal Teropong Edisi RUU KUHAP 2015 | 23 Pages | Posted: 10 May 2015 | Date Written: April 28, 2015

    Public Choice Theory and its Application in Indonesian Legislation System

    24 Pages | Posted: 8 Oct 2012 | Last revised: 8 Nov 2014 | Date Written: October 8, 2012

    Special Purpose Vehicle in Law and Economics Perspective

    Forthcoming in Journal of Indonesia Corruption Watch, 'Pemberantasan Kejahatan Korupsi dan Pencucian Uang yang Dilakukan Korporasi di Sektor Kehutanan', 2013 | 15 Pages | Posted: 22 Aug 2013 | Date Written: August 18, 2013

    Legal Positivism and Law and Economics -- A Defense

    Third Indonesian National Conference of Legal Philosophy, 27-28 August 2013 | 17 Pages | Posted: 22 Aug 2013 | Last revised: 3 Sep 2013 | Date Written: August 22, 2013

    Economic Analysis of Rape Crime: An Introduction

    Jurnal Hukum Jentera Vol 22, No 7 (2012) Januari-April | 14 Pages | Posted: 12 Nov 2011 | Last revised: 8 Oct 2012 | Date Written: May 7, 2012


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