The Wise Curve

Understanding Freakonomics

Freakonomics is a well known, hot selling book authored by Steven D. Levitt and Stephen J. Dubner. I wish to do a book review on it, but not in a normal way, as I wish my readers to see it from a different perspective. Some readers of Freakonomics may feel blur after reading the book, not realizing what the book is really about, other than recalling a few stuffs like sumo wrestler, druggies and child’s name. That is a pity because the essence of the book is not really being absorbed by the readers. Today’s post is here to dig up the essence of this book so that readers can better understand and apply some principles behind Freakonomics.

Freakonomics is about applying some economics principles, the driving mechanism behind most of the things in our life, to analyse various issues such as crime and education. The issues mentioned in the book are quite controversial and “freaky” (it talks a lot about crime) but the truth behind the issues is related to economy. Look at the cover of the book. It shows a green apple with the flesh of lemon. The apple resembles the issues we see from outside based on conventional wisdom, and the lemon flesh is the causes of the issues, which might not be something we expect. This book does a very good job in telling us that conventional wisdom may not be true, and we should study the research data behind the issues to make accurate conclusion.

Here are the chapters of Freakonomics:

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1. What do Schoolteachers and sumo wrestlers have in common

This chapter mainly talks about incentive. People respond to incentives, both positive and negative. Positive incentive, such as reward, prize and toys, can serve as encouragement for people to do something; Negative incentive, such as punishment, high cost and beating, can act as deterrent to prevent people from doing something. If I sell nice laptops for only 50 bucks with free gifts, many people will rush to buy them from me, because the low price and free gifts are attractive incentives and people respond to it positively. Harsh punishment for certain criminal acts will “scare” most people away from committing them (unless they are risk takers) as people respond negatively to such negative incentive.

The Authors of Freakonomics use this principle to show that schoolteachers and sumo wrestlers cheat as they are responding to positive incentive (reward). Teachers cheat by making their students’ grade looks better so that they can get reward for “improving school performance”. Likewise, sumo wrestlers cheat by making complot with other wrestlers as the reward for the winners is very great. The same “incentive principle” can also be applied to explain why people go to the extend of breaking laws, such as politicians going corrupt, companies lying to the public and people avoiding taxes.

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2. How is the Ku Klux Klan like a group of real-estate agents

This chapter highlights the power of information, and how information is abused to benefit certain people. When there is an imbalance of information (which is known as information asymmetry), one side of two parties will gain an upper hand over the other. We depend on the service of experts, as they know more than us in certain field, but how do we know if they over charge us for their expertise? Are they doing their job properly? We can’t know for sure as we are lacking the information that they have.

The authors point out that some real-estate agents abuse such knowledge imbalance. The way they sell the clients’ houses is different from how they sell their own houses. There is no incentive for them to try to sell the clients’ houses with higher price since they don’t get much profit from doing so. In fact they try to persuade us to lower our price. That’s not really a good service but such information imbalance enables them to cheat.

The authors also show that Ku Klux Klan (a group of conservative white Christian extremists) benefits from information asymmetry. They have their secret rituals, which are not known to the public. Their overall secrecy creates public fear, which give them power over common folks. When someone openly exposed KKK’s secret rituals (on radio), KKK suddenly lost their influence as their aura of mystery vanished. Similarly, internet enables information transfer so that people can know more stuff that was once held by “experts”. Such “exposure” of information reduces the information imbalance, and causes the prices of experts’ service to collapse.

Information is power, and power corrupts.

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3. Why do drug dealers still live with their moms

This chapter has two gems.

The first one is that many organizations have pyramid like structure of monetary status. Only the top person, such as the gang leader or big boss, will get a lot of incentives (huge pay), while those low ranking foot soldiers who lurk at the base of the pyramid get very little. That is why many low ranking drug dealers have to live with their moms, because they have no choice, they can’t get their own home because their earning is so low, even though drug business is highly profitable. Most of the money is channelled to the ones on top.

This is the same as in other industries. Big bosses are overpaid, grade-A actors live a luxury life and so on. The people at the top are given so much incentive because such inequality lures people to the pyramid and stay there as people are eying at the top people. These bottom people have big dreams of climbing the ladder to reach the top, for money or for fame, even if that means enduring harsh condition and low pay. Not bad for a motivational strategy, but pity those not so well known actors, office workers, unknown bloggers and drug dealers, their chance of becoming the top guy is very slim, and they will continue to lurk at the bottom thanks to such inequality of incentive, which sucks people into this rat race like a black hole.

The second gem is about further application of incentive. Drug dealers risk their lives (gang shooting, violence etc.) on the street to sell drugs because the business brings a lot of profit (positive incentive), and they think the incentive is worth such risk. However, when crack (a kind of cocaine drug) price falls due to cheaper production, the profit drops and drug dealers think the danger of selling drugs outweighs the profit. This leads to a drop in drug selling activities, so is the violence related to them. This shows that a change of incentive can change people’s behaviour and crime rate.

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4. Where have all the criminals gone

This chapter is about analysing issues based on data and correlations. Tossing opinions on what causes a problem without verification of data is useless and misleading. Conventional wisdom may be based on logic to analyse an issue but data might show conventional wisdom to be untrue. In this chapter, the authors reveal a shocking truth (to the pro-life zealots of course) that there is a strong correlation between legalizing abortion and a steep drop in crime rate. Well, that’s what data shows, which matters more than conventional wisdom and political correctness.

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5. What makes a perfect parent

Again, this chapter uses data to analyse “good parenting”. It lists out many possible factors that influence a child’s school performance, such as “the child has highly educated parents”; “the child is regularly spanked” and so on. One by one, the authors analyse the factors based on data. Some factors cause the child to do well in school; some factors are correlated to the child’s performance, but might not be the cause (correlation does not mean causation, it might just be an indicator); some factors are not correlated to school performance at all, but they are what conventional wisdom believe in helping children’s schooling. Finally, the overall data show that what the parents are is more important than what the parents do, in determining the child’s performance. For example, the parent’s level of education is more important than how often the parent spank the children. That’s a big hit at conventional wisdom.

This chapter also highlights the importance of making decision based on statistics. Parents fear that the child might die from gun accident, but more relax when come to swimming pool drowning, although statistics shows that there are far more children who die from drowning each year than gun accident. We fear the death of gun accident more than drowning because of “outrage” factor, where the sight of a child being shot by a gun is gruesome and horrifying, making us irrational and not taking proper statistic into consideration. It seems like fear kicks away our rationality pretty easily.

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6. Perfect parenting, Part II; or: would a Roshanda by any other name smell as sweet?

The last chapter is about the trend of naming children. Data reveal that how a child is named does not very much influence his future success, and it shows more about the parents. For example, some children with stupid names like “temptress” and “shithead” got their names from (stupid) parents with low level of education. Parents with higher level of education (who are also richer) name their children differently from low-educated parents. The data also show how the naming trend changes in decades, where “richer” names tend to become “poorer” names when less educated parents name their children after popular “rich” children’s name.

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I hope my summary of Freakonomics will help readers to better understand the knowledge behind this book so that we can apply it in our daily life. I think Freakonomics is very practical, only when we understand it well. The good news is that there will be a sequel to Freakonomics called Superfreakonomics and I think we can have a lot of fun reading it. Let us end this post with a word of wisdom from Steven Levitt, the co-author of this book:

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