The Chronicles of a Capitalist Lawyer

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 latest case of an Indonesian law student who burned himself to death in front of the Presidential Palace is indeed an interesting one. At first, I want to disregard the student's motive but then I realize that the question of motive is the essential part in the analysis which will affect our final thoughts in perceiving his decision. So, let's start with the question: do people have the right to die?

It's a tricky question which triggers a lot of debates involving significant different views. The comments on the above case can be a good example. Some people consider the action as a foolish one without any benefit to the society, that people will soon forget it and it is harmful to the student's parents and close family members. Other people consider it as a heroic action, that it demonstrated a resistance to a corrupt government, and that the student should be honored because not a lot of people will have the bravery to burn themselves as a form of protest.

What interest me the most is the fact that the discrepancies in views were ultimately caused by the motive of the student in burning himself. Why the motive should be considered at all? Are we saying that the right to die should be honored in certain conditions in accordance with the motive? We condemn ordinary suicide (in case the student burned himself out of desperation with his own life) but we approve the action if it is done out of desperation of other people's life? How come? More importantly, why should we bother with the right to die? The dead guy would have no interest with what we will say on his right to die simply because he is already dead.

The main problem here is because if we agree that people have the right to die, it indicates that people should also have the basic right to freely do whatever they want with their own body (well at least some people believe that people should be free to do so). I mean, if we agree that people has the right to kill themselves (which is the ultimate action that a man can do with his body), they should also have the freedom to, say, hurt themselves or conduct activities that may be harmful to their body as long as they give their full consent for doing such action (meaning no fraud or coercion or misappropriation of condition by third parties).

Applied consistently, there should be no paternalistic regulation on how people should behave, and there should be no "protective" regulations intended to protect the public from doing dangerous activities as long as they agree to do such action. In other words, those "protective" regulations should be optional instead of mandatory. Yet we know that the this is not the case in real life. Safety regulations in factories and mining sites, and even mandatory safety belt in cars can be a good example of those kind of regulations.

It is weird if we assess the validity of a right only based on a motive. Suppose, a company is conducting a risky business. Installing a safety device would cost them a lot of money, say, US$20 million which will reduce the accident rate into 1%. If the Company chooses this option, they will pay 5 workers, each with a fixed salary of US$20,000 a year. Another possible way of doing this business is to employ those 5 people without any safety device, where each will receive an upfront payment of US$1,7 million, but the risk of deadly accident will increase to around 85%. From economics point of view, it is possible that the second option would be optimum for the welfare of the society. The company can reduce its costs, allowing them to sell cheaper products, and they compensate the employee generously for the additional risk taking.

Now imagine that one of those 5 employees is a father to three children. Thinking about the future of his family, he decides to take that risky job with a full understanding of the high probability of death. He believe that the payment justifies his increase of risk that even in the case that he dies, the overall compensation is enough to ensure the survival of his family in the future. Should he be prohibited from doing so? Should the company be deemed liable when an accident happen and the father dies? If we care about motives in deciding whether an act is good or not, can't we consider this as an heroic action? A father who chooses to increase his probability of death for the sake of his family?

I bet that most of you will consider this idea as a perverse one, but if we choose to assess the right to die simply from the motives, this is the consequence. It's easy to create similar cases and yet people preferences can vary significantly. It is almost impossible to find consistency of opinion in this matter. Here Law and Economics tries to provide the answer from welfare maximization issue. It might be easier to have a standardized safety regulation because not all people have the same perception of risks. Some will agree to take the risks, some will not. Creating a standard regulation could effectively solve the collective action problem among the employees. Granted there are costs associated with safety regulations, but the costs should be calculated in a way that promotes overall efficiency to the society (increase safety might increase productivity and might induce people not to participate in too risky business which may turn out to be bad for the welfare of the society).

If we agree with the above welfare maximization analysis, the right to die should also be viewed in such instance. Thus motive is irrelevant, instead, we should ask, what's the costs and benefit for granting people with the right to die? Should we give incentives for people to die? Might be in war with other countries for the sake of gaining victory or in case of patients with terminal ill where prolonging life would be too costly and too painful for him. But in cases where there is no perceive benefit of killing yourself and even worse, where the action imposes certain costs to third parties (imagine the costs imposed to the family left behind due to the suicide), I would say that we need to give incentives for people to avoid such action.

How can we give the incentives if the person is already dead? Well, we can do that by condemning certain type of suicidal activities that we view as wasting a precious life for nothing or where the benefits do not justify the costs of losing the life. Might not be effective for people who have lost their hope with their life, but for those who believe that their suicide can be meaningful, it could be a good deterrent mechanism. By informing them that their action would be useless and meaningless, we impose a huge costs to them for doing their action. What is the use of killing yourself in such case if people will simply disregard it?

Another way is to impose liability to anyone who knows a person's plan to kill himself but fail to prevent such death. Again, might not work for suicide for private reasons. But if it is for the so called "public cause", there is a high probability that some people will know about the plan in advance and therefore should be imposed with an obligation to refrain the soon-to-be-dead guy from his planned suicide. This is primarily based on the least cost avoider principle. It is not cleat though whether our current law is in line with the above approach. While there is no legal sanction for a failed suicide (no court will punish you if you fail to perform your suicidal action successfully), any people who assist you in your suicide attempt can be penalized with a prison sanction of at least 4 years. The text of the law indicates active assistance, while my proposed solution is to impose liability for passive assistance.

To close this post, I admit finding a right answer on the right to die is problematic. I am certain that some people will disagree with the notion that killing yourself could be justified as long as the perceived benefits exceed the costs. But we do have some examples on this issue, such as in war (imagine suicide mission) or in euthanasia (interesting to note that some Islamic legal scholars prohibit active euthanasia but not the passive one). It might be that there is no right answer for this problem and in the end, it's all about preferences. If that's the case, the voice of the majority will eventually determine whether a right to die should ever be granted.

Imposing a death penalty or capital punishment for certain type of criminal activities would always be a controversial issue. Some people believe that the imposition of death penalty is important to create an effective deterrent effect toward criminal activities. Others believe that death penalty is against one of the basic human rights, i.e. the right to live. Before I provide my arguments below, I will have to inform you all that I am a supporter of death penalty, albeit with certain conditions.

First of all, in normative Law and Economics, welfare maximization and efficiency are the two key terms that must be prioritized in assessing the quality of a law, including the imposition of any criminal sanctions. Why? Because in Law and Economics terms, a law would be deemed useful for the society if it can maximize the overall welfare of the people without imposing too much costs on them. The perfect law would be pareto efficient, where all people will be better off without having any losers in the society. While that might be nice, in practice it is almost impossible to satisfy the Pareto criterion, and therefore Law and Economics usually end up with Kaldor-Hicks efficiency, i.e. a law will be considered efficient if it can maximize the overall welfare of the society (so that in general, there is a surplus for the society) and open the possibility of compensating the losers, even though the compensations have not yet been materialized.

I understand though that welfare maximization is not the sole value that can be adhered in a society. What about, say, fairness? However, as argued by Steven Shavell and Louis Kaplow, two prominent economists and law professors from Harvard Law School, in their book, Fairness vs Welfare, welfare should always be prioritized whenever there is any conflict between welfare and fairness principles, simply because fairness is an element of welfare maximization while welfare itself is not necessarily a part of fairness maximization. The duo provide some very interesting arguments in the book but I will discuss that in another occasion. For now, I only like to introduce the basic concept of welfare maximization in Law and Economics.

Having said that, the next question would be: can we justify the existence of death penalty in a legal system from Law and Economics perspective? The quick answer is: it depends. The three main factors that should be considered are: (i) the costs and benefits of imposing the death penalty compared to alternative sanctions, (ii) the administration costs for death penalty, and (iii) the net effect of death penalty to the society.

Costs of Imposing Death Penalty in Comparison with Alternative Sanctions

With respect of the costs of imposing death penalty, suffice to say that death penalty is cheaper than prison. Killing one person is definitely easier than maintaining a person's life in the prison for certain period of time. But it would be wrong if the comparison is made only to prison. The fact that the costs of death penalty are cheaper does not necessarily means that it is superior to other type of sanctions. In fact, from economics perspective, death penalty might be inferior compared to the sanctions in the form of fines because death penalty does not produce any direct additional wealth or at least create a transfer of wealth. The only way we can say that death penalty produces wealth (indirectly) is if there is a good evidence that death penalty effectively deters crimes and therefore reduces the overall costs of criminal activities to the society and save the people's money for costs of legal enforcement.

Administrative Costs for Imposing Death Penalty

Another important issue is the costs for administration of death penalty. Since death penalty is irrevocable, in the sense that you can't raise the dead once the sanction has been administered, the administrative costs for getting the right decision tends to be higher in order to avoid costs of wrong decisions (such as longer waiting period for the execution of the penalty, additional costs for producing evidence, etc). Why we need to avoid these wrong decisions and why people should pay for the costs? Other than fairness related argument, Law and Economics believe that wrong judgment reduces the probability of allocating the criminal sanctions to the intended target, i.e. the real criminals. For each wrong judgment, we impose unnecessary costs to the innocent person and let the criminals free from the sanctions which means that the costs for them to do their criminal activities are reduced, inducing them to do more criminal activities.

In other words, wrong judgment is a factor that may increase the probability of doing crimes simply because the criminals know that the probability of them getting caught and being sanctioned is reduced. So, letting too many wrong judgments will be inefficient for the society. But the same inefficiency could also happen when we spend too much money in trying to reduce the error costs of judgments. A good example would be cases where it is very difficult to proof that the defendant is guilty, such as in rape case. I have argued in my working paper here, that imposing death penalty for rape cases might be counterproductive because the process of evidence is difficult and the administrative costs for getting the right decision would be too huge. As a result, imposing alternative sanctions which are revocable in the future might be the best option for rape cases.

The Net Effect of Death Penalty

The most controversial aspect of death penalty is the claim that it can effectively deter crimes rate. Obviously, this is something that needs further empirical research, especially in Indonesia. I note from one of my professors that some empirical researches in the US found that high death rates in the prison can effectively deter the rate of crime. We can categorize this as an indirect death penalty sentence since you can be easily sentenced to a prison (and therefore less administrative costs for the entire process) but there is no guarantee that you will survive the prison. Apparently, having no life guaranty in the prison is scarier than having a direct death penalty where the process is longer and the possibility to avoid such sanction is higher.

As I said above, to the extent that death penalty can be an effective deterrent mechanism, such penalty might be an efficient solution for reducing criminal activities. How can we assess the efficiency of death penalty? In simple mathematical formula, death penalty would be deemed efficient when P > (C + AC + WC), where P is the amount saved by the society from reduced criminal activities, C is the costs of imposing death penalty, AC is the administrative costs of death penalty and WC is the costs for irrevocable wrong conviction. To be more consistent, we can also add the utility function of the criminals who receive such death penalty, since in a way, we impose costs to him by taking his life.

Based on the above super simplified model, I could tell that the basic problem with death penalty is that there is no calculation for the utility function of the victim, in fact the imposition of death penalty will never calculate the interest of the victims because they are simply out from the equation. Granted, the victim might receive some utilities from the retribution effect of death penalty, but I am not sure whether that will be enough. Again, as I said above, while death penalty might be more efficient than prisons, fines might actually be more superior than death penalty in welfare maximization and the use of death penalty should be really limited to certain type of criminal activities.

Conclusion

If I have more spare time, I would love to write more on the Law and Economics analysis of death penalty just like when I write about Economic Analysis of Rape Crimes. My support for death penalty is basically conditioned upon the satisfaction of the above model. If the overall costs of death penalty are bigger than the expected reduction in criminal activities, then supporting death penalty would be useless as it is the same with reducing the welfare of the overall society. Personally, I will give more support to any sanctions that can compensate the victims while still giving deterrent effect to criminal activities, such as a significant amount of fine and/or forced labor.

My another thought would be that death penalty should only be imposed to criminals whose activities are considered very dangerous to the societies and therefore letting them return to society without effective way of preventing them from doing the same thing would be too costly, such as serial murderers. But this can lead to another debate on what type of dangerous activities that should be sanctioned with death penalty. On that matter, I will reserve it for another time.

Yesterday, another interesting case occurred in Indonesia. Apparently, a private school required a child with HIV positive father, who has been previously admitted to such school, to undergo a HIV test. If the result is negative, the child is permitted to enroll, but if she is positive with HIV, then her admission will be cancelled by the school. In short, the parent refused to give the result and the school later on informed them that because the other parents in the school refuse the presence of the child having a potential of HIV positive, the admission for the school is cancelled. The main question from law and economics perspective, can this action be considered as a discrimination? Can the school, as a private party, refuses the admission of a child because of the risks brought by that child to other children, whatever the probability is? What would be the solution?

I look first at Law No. 23/2002 on Protection of Children and I find in Article 13 of that Law that a child, while under the care of parents,guardians, or any other parties responsible for the custody,is entitled to protection from any form of discrimination. If we consider the above action as a discrimination, judging from the text of the Law, I doubt that the school can be blamed, since the text seems to be intended to protect children from discrimination by their own parents or guardians. A school might be considered as a guardian of a child during the school time, but if the child never enrolled in the first place, there would be no legal obligation to protect the child from any discrimination. And based on that notion, I can see why the school chose to instead cancel the admission rather than accept the kid, if the kid is already in the school, the school will be obliged to protect her from any kind of discrimination.

So what would be the answer to this problem? Let's take a look at the reasoning used by the school to cancel the admission, i.e., they say that other parents disagree having a child with a potential HIV in the school. If this is true and these parents are the majority faction in the school, I can see why the school ended up with their decision. I bet they know that in the modern interconnected world like we are having now, this case will cause public controversies, there will be uproar, and to certain extent their name will be tainted. But, as long as their legal risks are low and most parents whose child go to their school support such policy, their benefits are still higher and there will be less incentives to change such policy.

Should we change the law then? Should we impose liability to the school for cancelling the admission? Should we force them to accept a child whatever his/her sickness is and whatever the probability of that sickness in infecting other kids is? I admit, these are very hard questions, and before we can answer those questions, we should analyze first the economics of preventing risk of infectious diseases. The State of Illinois can be a good example where it requires all international students to have immunization from certain diseases. Failure to do so within a certain time frame will cause the students to be rejected from registering for the remaining quarters in an academic year. Can we call this as a discrimination to immigrants or visitors? Might be, but voters love a state that seems to protect their citizens interest and the state can always say that it has the obligation to protect its citizens from any unwanted casualties.

This is precisely the problem faced by the above school. On one hand, the risks of accepting a kid with HIV positive might be very small to the other kids enrolled in such school, after all, HIV is not a disease that can be easily transmitted to other person. But on the other hand, even though the risks are small, the majority have different perception, which, I suspect, is caused by availability heuristic, i.e., since HIV is such a famous disease with significant adverse effect to a person's health, people tend to think that the risks of having such sickness is also high and therefore they reject any possibility of having a kid with HIV positive around their kids.

If my prediction is correct, imposing liability to the school will make no sense. You can't expect them to solve the problem that is out of their control (you can't control the preference of all the people in this world and it would be even harder if these people are already becoming your stakeholders), and it is likely that even when the kid is finally admitted, she will receive more discrimination from other kids and their respective parents (because we know that even when the kid is not admitted yet, some parents have already voiced their concerns and rejections). It's a bad game for the poor kid. Of course, this should not be the end of the world for the kid.

Other schools might actually take this opportunity as a marketing tool. But to achieve that, they must state their policy from the beginning. As an example, they should say that their school is opened to any kids with HIV positive and that they will provide a safe environment for everyone when they open their school registration. Stating this from the beginning will have the effect of screening parents that might not agree to have their kids sharing a class room with a positive HIV kid and therefore, we can expect less rejection from other parents. Only parents who support such idea who will send their kids to the school and this will allow the creation of a better environment for the HIV positive kid.

Borrowing the term from one of my Professors, Lior Strahilevitz, we can call this strategy as an exclusionary vibe. You effectively screen people who disagree with your policy and discourage them from getting into your community without having to say that you reject them. It's a double edge sword, it can be used to discriminate people, but it can also be used positively, as in creating a healthier environment for kids development. Furthermore, can this be a good business? I would think so, there are still many people who buy the idea that having a non-discriminatory school is good for the education of their children. And when these schools can attract many students, other schools will soon follow.

To close this post, in dealing with hard cases like this, sometimes, imposing liability would only increase the costs for each parties involved and might not be beneficial for the kids. Using strategy to raise public awareness is good, but I would suggest not to continue with a legal fight unless we can ensure that the problem lies within the school itself and not the parents. Because if the other parents are the problem, punishing the school will only add more fire to these parents, and the end result might be backfired. Remember, you can't control people preferences, it would be more effective to screen these people out and build a different business. If it is profitable, and my guess is: it is, the problem can be solved quicker than we thought.

Today's news indicates that the Department of Religion is considered as the worse governmental department in terms of corruption level. That's not so surprising, considering the fact that similar problem has occurred numerous times in the past. As an example, see this news from 2002. Our main question for today's post is: why religiosity is not translated into better legal compliance? Shouldn't religion help a person to be a better person and therefore religion can assist us in creating a community that has better legal compliance? I will argue that religiosity per se does not help in pursuing higher rate of legal compliance. In fact, the case is universal even for a person who denies the validity of any religion and instead claims that he is a moralist.

As I have argued in one of my previous posts, Knowing the Law vs Complying With The Law, people respond to incentives. You cannot expect that people will comply with the law simply because they know the law. To the extent that the benefit of doing a crime is higher than the costs, it is most likely that a criminal will conduct his crime. Thus, in law and economics view, we need legal enforcement to impose sanctions to criminals with a hope that such sanctions will increase the costs of doing criminal activities and can induce the criminals to reduce their negative activities.

Based on the above insight, no wonder that religion, standing alone, cannot be expected to significantly reduce the level of criminal activities simply because religion does not impose any sanction in the current life. You may be aware that certain religions offer a terrible afterlife sanctions for whoever dare to violate religion rules. While we can always debate on what constitutes religions rules, the issue is clear, although the sanctions are so vicious (burned alive and might be for an eternity too) that they cannot be comprehended by any ordinary human beings, they will only happen in the after life.

Some behavioral law and economic researches show that in general, people tend to discount the occurrence of bad things in the future even though they know that their current actions can increase the likelihood of those bad things. Good example: we know that overeating and less body exercise can be translated into higher probability of various nasty sickness, including heart attack, stroke, and diabetes. Yet, most people tend to discount that probability by staying with their unhealthy lifestyle (shamefully, I am also in the same category). It is also usual that significant changes in behavior will only occur after these people experience the problem by themselves. As an example, rate of doing healthy lifestyle activities will increase for people who have experienced heart attack and survive. That kind of experience will most likely leave a scar (or in economic terms, huge costs) in their life and they will have strong incentives to alter their behavior.

Returning to religiosity, not only that afterlife sanctions will be hugely discounted in considering them as a cost of doing criminal activities, there are several concepts in religion that can significantly reduce the value of such afterlife sanctions. Consider the concept of repentance of sins (taubat) that exist in any type of religion. This concept allows all believers to be forgiven by God from all of their sins to the extent they faithfully stop all of their previous heinous activities and do many good things as a repayment to the society. You can say from law and economics perspective that this is in line with the principle that criminals should compensate the society for the costs that these criminals impose to the society due to their criminal activities. That's true, but you must also consider the fact that the concept of repentance is not as effective as you think would be.

First, there is an issue on when should a person commit repentance? Since this can be done in any time before he dies and if we assume that people also discount the possibility of them dying at a time nearby, you can bet that most criminals will choose to repent far far away in the future. Even worse, since there is no minimum standard repayment for repentance, there is a possibility that such repayment activities are not suffice to cover the costs of their previous criminal activities. Obviously, that is not efficient for crime preventing. We are happy that religion provides an incentive for criminals to repay their sins in this world but without any clear enforcement mechanism, the repayment can be too late or not enough at all.

Second, since there is a possibility for multiple offenses and also multiple repentance, there are no strong incentives for religious people to comply with the law. They can always say that they are weak, that God is forgiven and all is well. Yes, we can argue that God might not agree with these people in relation to the faithfulness and intensity of their repentance, but no ones know what God really thinks. Uncertainties in this type of case increase the discount of afterlife sanctions, rendering their effectiveness into a new low level.

Having said that, the case is also similar for any moralists out there. We learn from one of US founding fathers, James Madison, that people are not angels. According to him, if people are angels, we do not need government, but since we know that they are not, we need a government to supervise them, and we also need further mechanism to check and balance the government since they consist of people too. You can claim that righteousness can come from many different ways, but you are just an ordinary human, and not all human can resist temptations.

Let me give you a simple example on insider trading cases. In the US, it is not unusual to find lawyers who still conduct insider trading cases even though they know the law and the severe punishment that will be imposed to them for doing such activities. Yet, some lawyers fall under insider trading cases. How could that be? Because the temptation is very high, we are talking about millions and millions of dollars here! And it is so easy to do insider trading that unless you can find a good way to remind yourself of the risks, you will most likely do it. And when they actually do it, you should ask why? Because again, they discount the probability of them getting caught because they know the law and they feel that they can avoid liability through their legal skills. Try to compare this with the fact that the Department of Religion handles an excessive amount of money from the government for hajj purposes. Do you think they are mentally strong enough to fight their temptations?

As you can see, even in the case of clear and severe punishments, some people cannot resist the temptations and end up doing their criminal activities. They might have already calculated the costs and benefits of their actions, where higher risks are translated into higher return. So, what can you expect from severe sanctions that will only occur in the future, the possibilities of them happening are pretty much uncertain, and there are many ways to avoid those sanctions with low costs(i.e. repentance)? The end result is clear, religion or morality, standing alone, is not effective to prevent people from doing criminal activities.

To close this post, I disagree that people are using this fact to blame religion as a source of evil. While religion and morality are not effective when they are standing alone, they can become a nice addition for strong legal enforcement. In his book, Predictably Irrational, Dan Ariely, a famous behavioral economist, shows that religion and morality can be useful tools in increasing the commitment of people to walk in the right path (especially by repeating such moment of commitments every day), i.e. as a method to increase their awareness that what they are doing is bad. But remember, they are only additional psychological tools, and effective strong legal enforcement would always be mandatory and necessary if we want to effectively reduce the rate of criminal activities.

Indonesia always provides us with interesting cases from economic perspective. The latest one is the new Blackberry product launching where the seller gave a 50% discount to 1,000 first purchasers. It was a major event as people rushed to Pacific Place mall to buy the product. Unfortunately there are some casualties, as there is an excessive amount of buyers and the mall is not big enough for all of them. While we can ask why didn't the seller stop the visitors as soon as they reach 1,000 to avoid unnecessary casualties, one may ask why did the seller choose this marketing strategy? Cafe Salemba economists provide their answers in these two nice articles: Economics of Queuing and More on Buying Frenzies. Meanwhile, I'll analyze the case from the Seller's perspective.

There are a lot of different types of buyers. Some are very conscious about the price of a product, so if the price is too high for them, they won't buy it. In the recent Blackberry case, we can argue that the seller used this understanding to actually screen its potential buyers and therefore they can get more buyers. The Blackberry's price is around 4,5 million rupiah. By all means, it is not a cheap gadget, but we know that such price is higher than the price in the United States and there is a theory that the price of the Blackberry in Indonesia is being inflated while the demand is still high in average. In short, it could be a very good business.

Now, by imposing a 50% discount to the price, there are two benefits that the seller can get. First, it can get those buyers who previously thought that Blackberry is overrated and therefore don't value Blackberry that high or people who want to have Blackberry but doesn't have enough money. Giving a 50% discount is still a good way to induce people to buy products. To the extent that this people don't highly value their time (they don't have better thing to do, or the utility of getting the Blackberry is higher from standing in the hellish queue, etc), these people will definitely enter the queue.

Second, the process can effectively screen the buyers who value their time more than their cash and get them to also buy the Blackberry with the inflated price. By giving such a hellish condition in the queue, the seller can know the people who will choose to skip the queue by paying more. No wonder that at the same time, the seller also conducted an exclusive sale using the original price. That's smart.

Now, we know that the seller imposed a restriction that the buyers in the queue cannot be represented by other people. Why do you think so? If there is no such restriction, the people who value time more than their cash will be induced to pay other people to stand in the queue for them, and that will disturb the screening mechanism. The seller definitely doesn't want to subsidize the people who value their time more. However, as we understand, the costs for supervision is also high. Therefore, they didn't conduct a full supervision, instead, they just let people rush in. Why?

There is an elementary game theory involved here. The seller knew that the costs for supervising the entire process would be high, managing thousands of people is not easy. But the buyers didn't know that information. Some will predict that the seller will be strict with the rules, some will predict that the seller will be lenient, and there will be chaos. Whatever the end result is, it is still a good way to screen the people who are not really sure with the value of their money versus their time but nevertheless have some interests to buy the Blackberry. If these people are risk averse, or prone to risks, they will probably not go to the queue and they will buy the product later on. For those who really want the Blackberry but don't have enough money, they will stay. For the people who value their time more and put their jockeys in the queue, they put a bet, if they get it, it would be nice, if not, they buy it later on and risk some money for the jockeys. Again, risk aversion matters, not all people want to risk their money for nothing and so they may decide not to do it.

Overall speaking, from the seller's perspective, there is a probability that the discounted products will be purchased by its unintended targets, i.e. the people who value their money less than their time. But it should not be many, and the seller can still effectively increase the demand of its products and reap more profits. So instead of being a sign of irrationality, it might be a good indication for good strategy for getting more buyers. Unless there are other additional high costs to the sellers for these kind of activities (i.e. death, riot, etc), we can expect more sellers to pursue the same strategy. So, two suggestions to improve the end result for consumers, next time it would be better to give a time limit for coming to the place and also limit the people who can stay in the location when they reach 1,000 or whatever the intended maximum amount of buyers is.

Imagine that your are a property developer who wishes to build a new amusement park in certain city. The business prospect is good, and the city is also happy with the project since it will increase the city's tax revenues and improve the city's economic growth. But before you can start your dream project, you must first buy the necessary land from several owners. Here is when the problem starts. If you tell these owners that you are trying to build an amusement park above their land, each rational seller who maximizes his/her own interest might hold up the sale of his land, hoping that they can increase the value of their land as the number of sellers decrease. The smaller the number of sellers, the higher the gain that they can get from holding up their land. Of course this is detrimental to your project since it is effectively similar to a monopoly by the sellers and it increases the difficulties of settling the negotiation.

True, the sellers realize that the increase value of their lands owes to your proposed project. If they are being too greedy and you choose to abandon the project, they will gain nothing. So there is a possibility that they will give up and sell their land with the maximum value that they think they can reap from you without making you cancel your plan. However, there would always be a possibility that one seller remains unwavering. Seeing that other people have already sold their lands, he understand that now his land has the biggest value of all and he knows that you don't have any choice other than buying his land in order to continue with your project. He also knows that you have already incurred a lot of money for purchasing the lands and you will need to start the project in order to recoup your initial investment costs. Effectively, you become a hostage of the final seller due to an increase of his bargaining power. This is what we call as the Hold Up Problem.

Hold Up Problem is a serious matter. If we don't find a good solution, Hold Up Problem can end up discouraging any form of investment that may benefit the society. Why? Because obviously, you don't want to waste your money for initial investment if in the end you will be ripped off by whoever holds the final trump card. The costs of investment will be too high and any rational person will eventually choose not to put the investment in the first place. As you can see, both parties and the society can be better off if only the parties cooperate, but because they can't trust each other, they fail to do so.

The case does not stop there. A Hold Up Problem can easily turned into a Chicken Game. Ever heard about this game? A good example is the famous scene in old US movies where two stupid kids are driving against each other on a collision course. If both of them stay in the path, they will die. But if one of them chooses to swerve from the path, both will survive, although the one who swerves first will be called as a coward chicken, hence why we call this as Chicken Game. Let us try to apply the basic principle of this game into our case above.

Once initial investments to purchase the lands have been made by you and there is only one seller remaining, you only have two choices. You can "swerve" by accepting the ridiculous demand from the seller and continue with the project (of course, you're being a loser here), or you can stay in the path and continue with the project even though you have not secure the land from the last seller. If you choose the latter, it is a disaster for both of you. Once the project has been started, the value of the seller's land will drop to virtually nothing. Who wants to buy a land in the middle of an amusement park that cannot be used for anything? For you it is also a problem since you will spend a considerable amount of costs to alter your project and ensure that it can be build around the remaining land. Both parties can be better off in this case if they cooperate and again, my analysis shows that they can end up with unnecessary losses.

So how can we solve the issue? Some people argue that Hold Up Problem can be solved through takeover or merger (it works on certain type of contracts), but we know for sure that in our case, the problem is the takeover itself, so we can skip that solution. I would think of two solutions. First of all, you can purchase the lands from the sellers without having to disclose your future plan for the land. As far as I know, there is no legal obligation to disclose the reasons for doing a transaction and this solution may work in case you can design a system that will not cause the sellers to suspect you of doing anything fishy.

Second, you can disclose your plan and then offer to buy the land of the sellers as a single package (everyone must sell their lands at the same time or the deal is off). By doing this, you prevent the possibility of having a Hold Up Problem in the future as the sellers will be required to act as an unity. Again, the solution might not guarantee that you can do your project but at least you won't be a hostage to certain sellers. Furthermore, in case the majority want to sell their land for a nice fortune, asking the sellers to sell their lands as a bundle will induce them to cooperate to reach the best conclusion for everyone and there would be pressures to sellers who refuse to sell without a good reason.

As you can see from the above, cooperation matters where there is an inherent collective action problem. The issue is to give the correct incentives that can promote cooperation among parties that might have different interests. In this case information matters. How we disclose the information in the first place will affect the strategy that we will choose to close the deal. Here I agree with the current legal regime that allows people to transact without having any obligation to disclose their purpose in doing such transaction. Requiring such obligation might be inefficient in case the information can be used for Hold Up purposes.

If you can propose other solutions that may be implemented to the above problem, feel free to give your comments. Who knows, we might end up finding a solution worth a Nobel Prize :)