The Chronicles of a Capitalist Lawyer

Today is a sad day indeed for Indonesia as one of its greatest economists, Prof. Widjojo Nitisatro, passed away this morning. What a great loss! Although I have never met him in person, I know him through his splendid articles and books about him, especially the Kesan dan Pesan Sahabat-Sahabat Widjojo Nitisastro. Two of my favorite articles of him deal with the economic analysis for national development and the economic analysis of Article 33 of the 1945 Constitution (which discuss the correct economic structure for Indonesia). I consider those articles as the classical example of economic analysis of law in Indonesia and they have significant impact on inducing me to pursue the art of Law and Economics.

While I have been writing about law and economics for many times in my blog, I have never formally written about an introductory article on economic analysis of law itself. I guess this is the right time to do so as a tribute to the late Prof. Widjojo Nitisastro. You will surely be missed and may you rest in peace. God bless you.

Economic analysis of law or law and economics is a school of thought primarily developed in the United States that uses the powerful tool of economics to analyze various legal issues. It discusses three primary questions: (i) What is law? (ii) Why law exists in the society and can have binding power? (iii) What can be considered as a good law? Two prominent scholars can be considered as the early developers of law and economics, Gary Becker, a prominent economist who won Nobel prize in 1992, and Richard Posner, a prolific legal academician who is also considered as one of the best judges in the United States. Both teach at the University of Chicago and contribute significantly to the development of law and economics.

Why economics can be a useful tool in analyzing the law? The primary notion used in this school of thought is that men act rationally. Not in the sense that they can always make perfect calculation at all times but in the sense that they respond to incentives and pay attention to the costs and benefits of their actions, even when they are subject to various limitations in doing so. This is the basis of positive law and economics which deals with descriptive analysis on the law and how it will affect human behavior.

The second notion in law and economics is the pursuit of efficiency and welfare maximization of society. This is used by normative law and economics which believes that law should be designed to maximize the welfare of the society, whereas to reach that goal, law must be designed as efficient as possible. The more efficient the better, since it means that we can save costs while produce the biggest benefits to the society.

Interestingly, despite the fact that law and economics has reached a very strong position in the United States, dominating the legal thought there, it is relatively unknown in Indonesia which sadly, still focuses its law teaching with classical legal thought. I guess this should be changed if we really want to improve our Indonesian legal system.

Why law and economics is helpful for developing our legal system? I have three main reasons. First, by paying attention to how the law can shape the incentives of the people, we can shape our law to effectively affect the behavior of the people. As an example, I once argued on limiting the use of prison as a sanction for corruptors and instead using the sanction of assets confiscation. Assets and money are the bloodline of corruptors, the ones that significantly induce them to do the crime in the first place. If we only send them to prison but fail to secure the assets back, that will allow the criminal defendant to use the money to buy his way through the legal system (remember the case of luxury prison).

Second, by paying attention to the notion of efficiency, we will also pay attention to the costs and benefits of having regulation. Only regulate if the costs of doing so are lower than the benefits. Do not try to regulate everything because we cannot have an effective regulation without effective enforcement. And enforcement can be costly, the bigger the scope of the enforcement, the bigger the costs. Classical legal thoughts believe that law should be obeyed because it is promulgated by the relevant authorities. This is completely wrong. It is obeyed either because we find a mechanism to enforce it or the general society believe unanimously that such law is useful. Hence, the need of enforcement.

One good example of this would be laws that deal primarily with regulating private behaviors that do not produce clear harms such as how to dress publicly. On the one hand, regulating those kind of things will be costly, imagine the price for enforcement and the potential social unrest that it will create since it will give legitimation to people to violate other people on the basis of dress. On the other hand, there is no clear benefit of regulating such behavior in the first place other than to serve the idea of several people about morality. We've seen a lot of these absurd laws, such as laws that try to regulate how to name your child. I wonder how these laws could even exist if not only for the purpose of political maneuver.

Finally, by putting the goal that laws should always aim to maximize the welfare of the society, we will have a good guide in developing laws that will be useful for the society. And there are a lot of things that we can discuss here. Some good examples that I have once discussed: how to efficiently regulate liability of people in tort cases (such as whether we need to establish good samaritan liability), whether we should maintain death penalty (do the benefits justify the costs?), how to prevent rape crimes effectively, the extent to which we can limit foreign investment in Indonesia, how to share the legal risks of infrastructure development in order to induce more investors to come to Indonesia, how to reduce courts burden by cutting unnecessary costs for judging petty crimes (the latest Supreme Court regulation is a nice example of this), and many more.

I believe that it is important for law makers and legal enforcers to always strive for welfare maximization in rendering and interpreting the law. You do not enforce the law for the sake of the law itself. Law is not holy, it is not untouchable, it is not derived from the sky, rather it is made to serve men and should be made in view of men needs. Prof. Widjojo Nitisastro has started the idea of using economic analysis in shaping our national development and making sound economic policy long time ago. It was a great contribution, something that we, youngsters, must also strive to achieve. The least thing that I could do is to introduce law and economics to Indonesia and contribute in offering good public policy for our nation.

Recently, I saw an interesting question on Twitter: Are lawyers allowed to receive payments from corruption money? My answer is yes, and there is a good reason for that.

Based on my personal observation, it seems that there is a belief by the public that lawyers should not represent suspects of corruption cases, and should therefore not receive their money, since it might be tainted with the corruption itself.

I find this argument to be ridiculous. First of all, under the prevailing laws, if you conduct a transaction with a third party, provided that you act in good faith, there is no need for you to know where the money is coming from.

From an economics point of view, it is an efficient rule. Imagine the costs to society if we need to know the source of income of all parties that transact with us. This kind of know-your-customer rule is generally applicable only for banking and securities transactions, where the potential of money laundering is high; but this rule should not be applied to the general public transactions.

Second, every criminal suspect has the right to be represented by a lawyer, whatever his criminal activities are, be it murder, rape, thievery, or corruption. Hating corruptors does not mean that lawyers cannot represent them or receive their money for payment of their service.

In one of my previous articles, I argued that lawyers have an absolute duty of confidentiality in assisting their clients. This means that the lawyer is prohibited from ever betraying his client, or jeopardizing the interest of his clients in any way. It is the only way to ensure that all criminal suspects will have the same position in front of the law to prevent abuse of power by legal enforcers.

By imposing such duty, even when the lawyer knows that his client is guilty, it does not mean that he can suddenly report his client to the relevant authorities. Once he represents the client, the duty must be applied at all times. It also means that when the lawyer receives the money and knows it’s coming from corruption, the lawyer should not be required to report the source of such payment to any authority, simply because that will defeat the entire purpose of client-attorney confidentiality.

At this point, readers might voice their protest over the above rule. How could we let corruption suspects use their money lavishly for paying their lawyers, which can also be used as a cheap tactic for money laundering. Don’t give up hope yet. There are many things that we can do to prevent such a thing from happening.

While the lawyers are not required to report the source of their payments, the authorities can always require them to report the amount of their fee. Doing so will allow the authorities to determine whether the payment is reasonable or whether it is being used for something suspicious. If it is used for a money laundering purposes, we can expect that the amount will be excessive. Furthermore, in the end, such money will still need to be returned to the corruption suspects. Of course, the authorities may interfere during the process of returning the money.

It is true that the lawyers are entitled to receive payment for their services, but it does not mean that they may assist their clients in another type of crime. At that point, we can impose liabilities upon the lawyers for abetting money laundering. This will provide less incentives for them to assist their clients in doing so, and the clients will also have less incentives to use the lawyers service for money laundering purposes.

As a result, we can expect that the payment made by the corruption suspects will only represent the lawyers fee. After all, if the lawyers cannot find a way to transfer the money back, the corruption suspects will never transfer an excessive amount of money to their lawyers in the first place.

I think this is a win-win solution for all parties to ensure that lawyers can represent their clients properly and protect the integrity of the criminal justice system, while also preventing abuse of the lawyer’s position to help the corruption suspects in securing their corruption assets.

In law and economics terms, we call this as a pareto efficient rule where we can maximize the welfare of the society without having to impose costs to other parties. And in my opinion, we should always strive for achieving that efficiency if we really care about society.

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.

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.

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.

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.

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.