4.16.2011

Even pirates need contracts

My advisor, Bentley MacLeod, has successfully convinced me that incomplete contracts are a central problem in both environment and development economics.  In both situations, there are a large number of complex phenomena that are difficult to specify in advance. This makes it difficult to write contracts describing future contingencies, leading to incomplete contracts and market failures.


I came across this story by NPR, a nice example of how important complete contracts are: Somali pirates are writing increasingly complex contracts with one another. Here are the highlights:
Ransoms now average between $4 million and $5 million, and researchers estimate as many as 2,000 pirates operate from Somalia's shores. 
Law enforcement sources say the larger pirate syndicates are becoming increasingly sophisticated and professional. Last year, the coast guard in the Seychelles, an island nation in the Indian Ocean, found an 11-page, handwritten piracy contract in a seized skiff. Like many business ventures, the contract outlined everything from division of profits to an employee code of conduct. 
I would love to know the rate of return for lending capital to pirates:
Wayne Miller, a former police officer from Australia, spent last year teaching the Seychelles' police how to interrogate pirates. Miller has seen the contract and said it divided ransom money into shares based on investors' contributions to the operation. 
"If they provided AK-47s or RPGs [rocket-propelled grenade launchers] or fuel, even the skiffs and mother ship, they were given a certain share that was quite high, and that ensured that whatever was made, the bulk would come back to them," Miller said.
 And don't forget your risk premium:
Miller said ransom shares for pirate workers were divided between those who did the more dangerous jobs — hijacking on the sea — and those who did the safer tasks on land. 
"Shares on land would relate to taking care of hostages once they were taken ashore," Miller said in an interview in Somaliland, an autonomous region of Somalia. "We noticed that the biggest share went to one particular person, and my assumption is that would be the negotiator." 
... or some basic institutions to ensure the rest of the rules are followed...
The contract even outlined a pirate code of conduct. Pirates could not fight and had to obey the captain's orders. If they broke the code, they forfeited shares. But the contract was not all stick. 
"What was striking were bonuses for being first on board another ship," said Miller.In fact, piracy researchers say the first on board can sometimes win a Toyota Land Cruiser.

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