A Rogue Economist Explores the Hidden Side of Everything
Steven D. Levitt and Stephen J. Dubner
Chapter one of Freakonomics begins with a brief discourse on incentives. Levitt believes that most incentives do not arise organically. Instead, someone had to invent them with some goal in mind.
“An incentive is a bullet, a key: an often tiny object with astonishing power to change a situation”― Steven D. Levitt #Freakonomics
The Hidden Side Of Everything
For Levitt, morality represents the way people would like the world to work. Economics represents how the world actually works. So first, the book offers five fundamental insights using economics.
- Incentives are the cornerstone of modern life. understanding them is the key to solving any riddle of human behavior or event.
- The conventional wisdom is often wrong. While we often accept explanations and theories from experts as fact, these are often not scientific at all. For example, drinking eight glasses of water a day has never been proven to do a thing for your health.
- Dramatic effects or events, often have distant, even subtle, causes. For example, the drop in the crime rate was not caused by any recent efforts at policing but by the abortion law passed two decades earlier.
- Experts use their informational advantage to serve their own agenda. From real estate agents to scientists, most experts have their own biases in favor of self-interest. This means they don’t always put your best interest first.
- Knowing what to measure and how to measure it makes a complicated world much less so. This means that, despite the chaos and seeming unpredictability of the modern world, it is understandable if we learn to look at the data in the right way.
“The conventional wisdom is often wrong.”― Steven D. Levitt #Freakonomics
Incentives Are the Cornerstone of Modern Life
An incentive is simply a means of urging people to do more of a good thing and less of a bad thing. From childhood, we all learn to respond to incentives, positive or negative. If you get good grades in school, you get a new bike.
Economics at its root is the study of incentives. How people get what they want or need, especially when other people want or need the same thing.
There are three basic flavors of incentives:
Very often an incentive scheme will have all three varieties.
“Morality, it could be argued, represents the way that people would like the world to work, wheareas economics represents how it actually does work.”
For example, the anti-smoking campaign imposed a $3 syntax as an economic incentive against buying cigarettes. In addition, smoking was banned in restaurants and other public places. This was a social incentive.
At the same time, the government asserted that terrorists raised money by selling black market cigarettes, which was a moral incentive against smoking.
He also gives an example of a daycare center faced with a problem that some parents were late in picking up their children. The center decided to levy a small fine each time a child was picked up late. The result that you would expect would be that late pickups would decrease, but surprisingly the result was that parental tardiness increased.
Apparently, parents balanced a small fine against their own inconvenience in being on time and decided that the cost was worth it. The fine may also have converted a social or moral issue into an economic one. How much will it cost if I’m not on time?
“When people don’t pay the true cost of something, they tend to consume it inefficiently.”
Levitt stresses that types of incentives, economic, social and moral often playoff or replace one another.
“Don’t listen to what people say; watch what they do.”― Steven D. Levitt #Freakonomics
Cheating on Standardized Tests
In a study of the Chicago public school system, Levitt found that a significant percentage of teachers helped their students pass the annual standardized tests. Why? Because the system provides incentives to schools and teachers whose students get high scores.
Under the No Child Left Behind policy in American education, schoolchildren who get low scores on the standardized tests get held back a year. In addition, a school that gets low scores can get its funding cut or face closure, and a schoolteacher whose students get low scores can get demoted or fired.
Conversely, schools that do well on the tests get more funding while teachers whose students get good scores can get promoted or receive cash bonuses.
The Question of Cheating
One of the questions I love to ask is who cheats and why? Well, his studies show that even those who seem most honorable or who seem to have the least opportunity to do so often cheat because of incentives.
Sumo wrestling is another field that is found to be prone to cheating. Sumo is the premier sport in Japan, one that is considered to be sacred and honorable. But the incentives scheme in sumo makes it highly prone to cheating. Each sumo wrestler needs to maintain a ranking that affects how much he earns, what privileges and reputation he enjoys. To maintain his ranking, he needs to win at least 8 victories out of 17 every year.
On the final day of the tournament, some wrestlers will have 7-7 cards, meaning they have 7 wins and 7 losses and need to win their final bout to maintain their ranking. However, if one looks at the win-loss percentage of the same wrestlers the next time they fight, the data shows that the 7-7 wrestlers win only 40% of the time against the same opponents. The most logical explanation is that some quid pro quo had been reached between the players, something like: you let me win today, and I’ll let you win the next time
He describes how the KU Klux Klan was weakened considerably when its secrets were made public and how the clan relied on its credible threat of violence, rather than actual violence.
Levitt Uses real estate brokers to illustrate the value of information and people’s interests in revealing it. Finding that brokers make much better deals when negotiating for their own properties rather than for the properties of their clients.
“Information is a beacon, a cudgel, an olive branch, a deterrent–all depending on who wields it and how.”― Steven D. Levitt #Freakonomics
Using and Abusing the Information
The Ku Klux Klan and real estate agents have one thing in common: both use the information to gain power over others.
The Klan was founded just after the Civil War to promote white supremacy, first against blacks, then later against blacks, Jews and other races. It grew in the first decade of the 20th century, then declined during the First World War, when national unity became a stronger motivation than segregation.
The Klan thrived after the War when fear of war was replaced by uncertainty about the economy. What finally caused the downfall of the Klan? Information. The Klan, fundamentally, derived its power and appeal from being a secret society. It had secret passwords, secret handshakes, and members who were only known to each other. While a lot of people spoke against the Klan, they knew very little about
Chapter 3 of Freakonomics examines the economy of crime, specifically incentives facing American street gangs, dealing in crack cocaine. The few gang members at the top made a very good living, but the vast majority could not live on what they earn and stayed in the business only in the hope of rising to the top.
The discussion raises the vital issue of increased crime rates, which accompanied the introduction of crack cocaine.
Conventional Wisdom Is Often Wrong
People often lament that there is so much crime in modern society and say it was more peaceful in the “good old days.” But this is far from true if you take the long view.
Statistics show that, compared to the 18th and 19th centuries, or even the 1900s-1950s, crime is considerably lower today. And again, this is because of incentives compared to earlier times. We have more moral, social and economic incentives today against committing the crime. We have economic incentives, social incentives, and moral incentives.
We already learned that one major reason behind the crime drop was the law legalizing abortion. Another example of a distant cause that is causing a dramatic effect is the invention of crack cocaine in the 1970s.
Before then, the civil rights movement in America had made great progress in making life better for black Americans, in terms of healthcare, education, job opportunities, etc. But when crack cocaine, cheaper form of cocaine, was invented, the job of distributing it to the masses feels the black street gangs.
Crack cocaine setback blacks progress in America by about 10 years and send mortality against sword after declining for years. On a national scale, crack cocaine contributed to a rise of a nationwide crime wave at America
In 1939, Dupont introduced nylon stockings for women. Until then, there were only silk stockings available, which were expensive and hard to come by, making them inaccessible for most women. Nylon stockings made it possible for women to wear stockings all the time. It was the same with crack cocaine.
In the 1970s, cocaine was the classiest drug. But it was also the most expensive so few drug users could afford it. Then crack cocaine was invented, which was simply mixing small quantities of cocaine with baking soda and water and then cooking off the liquid.
The invention of crack cocaine coincided with a cocaine glut in Colombia. And an enterprising Nicaraguan, Oscar Danilo Blandon, figured out how to make use of the two to make money. He brought in large volumes of cocaine and distributed it to predominantly black street gangs to turn into crack cocaine and sell on the streets. Overnight, crack cocaine became the most popular drug in America. It was cheap, provided a powerful high that didn’t last long, so always sent the customer back to buy some more.
Drugs and the Setback in the Black Movement
Until crack cocaine entered the scene, Blacks as a group in America were gaining great strides in terms of civil rights, health, opportunities, and economic power. But crack cocaine’s destructive effect was felt hardest by blacks.
When crack cocaine infiltrated black neighborhoods, infant mortality and crime soared in these communities. On a larger scale, crack cocaine contributed to the larger crime wave that started building in America until the mid-1990s until it was stopped by another unexpected cause – the abortion law.
“Most of us want to fix or change the world in some fashion. But to change the world, you first have to understand it.”― Steven D. Levitt #Freakonomics
Chapter 4 of Freakonomics discusses various theories proposed in hindsight and levered finds that some had met it, but most did not.
His surprising answer and the most controversial of his research results discussed in the book is that crime rates fell as a result of the 1973 Supreme court decision which legalized abortion.
His theory, which he backs up the data, is that pregnant women tended to live in conditions associated with later criminality of their children, including low levels of education, single parenthood, and poverty. Thus abortion rights more than any other factor prevented criminals from being born.
Levitt states clearly that proposing abortion as a means of future crime prevention would have huge moral implications. His intent is merely to provide data and thereby illustrate the unintended consequences of a change in public policy.
In the past few decades, parenting has become its own science. There are “parenting experts” who publish books on the proper way to raise a child. Countless sociological and psychological studies are being conducted about the proper way to breastfeed, the proper way for children to sleep, the proper way to punish children, etc.
Like most so-called experts, parenting experts are good at sounding sure of themselves, even if their information is questionable. And like all experts, parenting experts are adept at inspiring fear in their audiences of parents—the fear of raising bad children.
One reason that parents are so easily convinced by parenting experts is that parents—and, in fact, all human beings—are bad at assessing risk. There are certain risks that scare people into changing their behavior—but these changes in behavior are often out of proportion with the risk itself.
For example, one case of mad-cow disease in New Jersey prompted huge numbers of Americans to stop eating beef altogether. On average, people are far more frightened of planes than cars, even though cars are responsible for many more fatalities than planes. If one accounts for the likelihood of death in a car versus the likelihood of death in a plane, assuming equal time spent in both vehicles, then the overall likelihood of death is about the same.
Why are people frightened? One persuasive theory about fear is that people tend to be frightened of things that pose an immediate threat, rather than a far-off danger.
For example, Congress is more likely to pass a bill fighting terrorism than a bill fighting heart disease, even though heart disease kills far more people every year than terrorism. Heart disease is a far-off problem; terrorism, according to the authors, is “happening now.”
The authors return to the question of parenting. When parents try to make their children safer, it usually involves buying some new product—a product which won’t necessarily protect the child at all.
For example, the car seat is often touted as a vital way to protect children in car crashes. In reality, though, the real benefit of putting a child in a car seat is that the child sits in the back seat of the car, rather than riding shotgun; the car seat itself doesn’t do much to save the child’s life.
“Solving a problem is hard enough; it gets that much harder if you’ve decided beforehand it can’t be done.”― Steven D. Levitt #Freakonomics
Which is More Dangerous: A Gun or a Swimming Pool?
Most parents would not keep a gun in the house for fear that it can cause harm to their children. Few parents, however, would think there is nothing wrong with having a swimming pool at home.
Data shows, however, that there is one drowning of a child for every 11,000 residential pools in America. In a country with 6 million pools, this means that roughly 550 children under the age of ten die of drowning every year.
Meanwhile, there is a child killed by a gun for every 1million guns. In a country with an estimated 200 million guns, this means roughly 175 children under ten die from guns each year.
This shows that the risks that scare people are very different from the risks that actually kill people. In simple terms, some risks are more frightening than others.
A terrorist attack, for example, is more frightening, than heart disease, even though more people die of the latter. And a swimming pool is less scary than a gun. In other words, risk is viewed by people as: Risk = Hazard + Outrage. If the hazard is high but the outrage is low, people tend not to react too much, such as in the case of heart disease. But if the hazard is low and the outrage is high, such as for terrorist attacks, then people tend to overreact.
“If you both own a gun and a swimming pool in your backyard, the swimming pool is about 100 times more likely to kill a child than the gun is.”― Steven D. Levitt #Freakonomics
Chapter six takes the question of perfect parenting. To an amusing extreme by examining the names parents gift of the children, and questioning whether those names predicted the children’s later life outcomes.
Parents want to believe that they make a big difference in the kind of people their children turn out to be. We can see this in the first “official act” a parent performs—naming the child. In recent years, there have been hundreds of books written about the importance of naming one’s child. Parents sense that their child’s name can somehow “predict” the child’s success in life.
In 1958, a man named Robert Lane had two children. He named one child Winner, and the other, Loser. Strangely, Loser Lane went on to be a pretty successful man: he went to prep school on a scholarship, and eventually became a detective sergeant for the NYPD.
His colleagues call him Lou. Winner Lane, on the other hand, became a career criminal and has spent most of his adult life behind bars. We might ask—what effect does a child’s name have on its development? Does the name really matter?
To begin studying this issue, we can return to the ideas of Roland Fryer, whom we encountered in the last chapter.
Fryer has studied the segregation of black and white culture: black and white people watch different TV, smoke different cigarettes, buy different brands, etc. Did fryer wonder: was the distinctive black culture in America a cause or just a reflection of the economic disparity between white and black people?
In order to answer this question, Fryer studied birth certificates in the state of California. One interesting point he came across was that black and white families give their children strikingly different kinds of names. Other minorities, such as Asian-Americans and, to a lesser degree, Hispanic-Americans, tend to give their babies names that are somewhat similar to the names for white babies. There is, one could say, a “black-white naming gap.” This gap is a recent phenomenon—before the 1970s, there was a great overlap between white and black names.
For example, the typical black baby born before 1970 was likely to receive a name that was twice as common among blacks as it was among whites. After 1980, the figure had shot up to twenty times as common.
Statistically speaking, there are some distinctively black names. For example, of the 454 people named Precious in the 1990s, 431 were black. By contrast, the vast majority of people named Wyatt, Tanner, Claire, and Molly are white.
What kinds of mothers are likely to give their children distinctly black names? The statistics indicate that these mothers are usually low-income, unmarried, and uneducated, often still in their teens. Fryer hypothesizes that giving a child a distinctly black name is a sign of solidarity with the black community. Giving a black baby a “white name,” such as Emily, Katie, or Amy, could be condemned as a sign of “acting white.”
What Makes the Perfect Parent?
Many books and studies have been written and disseminated on what parenting would be best for children. There is no single answer but Levitt found interesting correlations between how a child’s school performance (as seen in test scores) and his family environment
In a nutshell, children’s test scores were strongly correlated or affected (positively or negatively) by eight other factors in their family life:
– The child has highly-educated parents (Positive)
– The child’s parents have a high socioeconomic status. (Positive)
– The child’s mother was thirty or older at the time of her first child’s birth. (Positive)
– The child had low birth weight (Negative)
– The child’s parents speak English at home. (Positive)
– The child is adopted. (Negative – because parents who give up their babies for adoption tend to have lower IQs)
– The child’s parents are involved in the PTA. (Positive)
– The child has many books at home. (Positive)
Other factors that do not correlate at all with good test scores, which seem to indicate that they do not matter or affect a child’s school performance, are:
– The child’s family is intact
– The child’s parents recently moved into a better neighborhood
– The child’s mother didn’t work between birth and kindergarten.
– The child attended Head Start.
– The child’s parents regularly take him to museums.
– The child is regularly spanked.
– The child frequently watches television
– The child’s parents read to him/her nearly every day.
“The key to learning is feedback. It is nearly impossible to learn anything without it.”― Steven D. Levitt #Freakonomics
A summary of “Freakonomics” by Steven D. Levitt and Stephen J. Dubner. Check out Make Me Read for summary of the best business books.