Tyler Cowen invokes Klein and Leffler (1981) to explain the the apparently high price of paid by Client #9 for sex, arguing that high price in combination with the repeat purchase mechanism were part of a self-enforcement mechanism designed to assure performance (in this case, presumably, sex and secrecy). That the $4,300 represents a substantial premium over the competitive price in order to assure such performance is plausible, but there is another possible story. Self-enforcement requires a premium stream sufficient to facilitate performance, not more. The premium must be greater than the possible gains from non-performance. What are those gains from providing sex but not secrecy in this case? One could tell a story that the shirking gains are not incredibly high, and therefore the required premium stream would be low since any expected gains from shirking must be offset by the expected costs associated with the prostitute incriminating herself. Plus, how large could the private benefits be for disclosing this information?Â Further, wouldn’t there necessarily be some private sanction from the employer for disclosure?Â We are talking about the world of illegal economic activity and non-legal sanctions.Â Â In other words, one might expect that an efficient self-enforcement mechanism might involve the employer’s commitment to supplement additional enforcement capital.
If this story were correct, there would not be a huge premium stream required to assure performance and we would be left with the inference that $4,300 is the competitive market price for the services of an upscale prostitute. I find that argument plausible as well.Â But this interpretation tends to overlook or discount the gains from potential extortion or media attention for the prostitute and overestimates the expected costs of the criminal penalties. Under this second interpretation, where extortion is a significant component of the gains to shirking and those gains are large (for example, some fraction of the customer’s wealth), one might reasonably argue that the premium stream embodied by the $4,300 is far too low to assure performance!Â However, I do agree with Cowen that it doesn’t make sense to design a self-enforcement mechanism and then incriminate oneself as appears to have occurred here.
Poor self-enforcement mechanisms are what got Gov. Spitzer into trouble in the first place, it seems.