Reading Journal: Freakonomics

books
Published: 10 Aug 2022
10 mins read

“Freakonomics” is a book about human psychology, sociology, and the role incentives play in our lives and society at large. It is filled to the brim with delightful examples and anecdotes that defies your expectations again and again; at the very least, it will have you think “huh! That was clever.”

Steven D. Levitt is a young economist at the University of Chicago. He explores unorthodox topics such as:

  • Which is more dangerous, a gun or a swimming pool?
  • Do real-estate agents really have their client’s best interest?
  • Is online-voting for elections a good idea?
  • If drug dealers make so much money, why do they still often live with their mother?
  • What caused the crime rate to plummet in the 1990s?

The modern world, despite a surfeit of obfuscation, complication, and downright deceit, is not impenetrable, is not unknowable, and - if the right questions are asked - is even more intriguing than we think. All it takes is a new way of looking.

Flavors of Incentives

Day Care Late Fee

At a day-care center in Israel, children are supposed to be picked-up at 4 PM sharp. Despite the time limit, there are always tardy parents who fail to meet the timeline, forcing teachers to wait around until everyone’s been picked up.

  • In an attempt to reduce the number of tardy visits, the center declared a fine of $3 per child per incident. It would stand to reason that the number of late pickups should drop after the fine is enacted.

But unexpectedly, the number of late pickups went up! In order to understand why, we need to first explore incentives. Economics, at its root, is a study of incentives. There are three types:

  • Economic Incentive - Monetary rewards or fines. This one should be easy to understand. We prefer to make more money and not lose money.
  • Moral Incentive - People don’t want to do anything they consider wrong or shameful
  • Social Incentive - People don’t want to do anything seen by others as wrong or shameful

Returning to our original question of why the number of late pickups went up, well as it turns out, the economic incentive of a $3 punishment isn’t enough to offset the reduced moral incentive. For just a few dollars each day, parents could buy off the guilt. They might even see it as just additional fee for taking care of their kids longer.

Real Estate Agents

Another interesting factoid that demonstrates the importance of incentives is related to real estate agents:

  • Suppose you are trying to sell your house, It stands to reason that your real estate agents should have your best interest in mind. Right? After all, they earn a commission based on the price they sell your home for. You both earn more money on a higher offer. Seems like a win-win situation at first glance.
  • However, publicly available data suggest that real estate agents tend to list their home on average 10-days longer, and sells at a price 3% higher. This seems to suggest that real estate agents don’t try their hardest when selling your house, but does try their hardest when selling theirs. It’ll all make sense once we dive into the numbers:
  • For a $300,000 offer (6% commission):
    • Agents receive $18,000. Seller receives $282,000
    • Commission is split between buyer’s and seller’s agent: $ 9,000
    • Commission is split between agent and agency: $4,500
  • For a $310,000 offer (6% commission):
    • Agents receive $18,600. Seller receives $291,400
    • Commission is split between buyer’s and seller’s agent: $ 9,300
    • Commission is split between agent and agency: $4,650
  • $291,400 - $282,000 = $+9,400, $4,650 - $4,500 = $+150
  • Therefore, for the substantially increased effort of getting an offer $10,000 higher, you receive +$9,400 while the agents receive +$150… Seems like the incentives aren’t fully aligned after all.

In conclusion, when selling their own house, real estate agents hold out longer for the best possible deal. On the other hand, when they are trying to sell your house, their incentive is to get the first decent offer that comes along. They want to make deals and make them fast.

Why Online Voting is A Terrible Idea

Have you ever asked yourself the question: “What is the point of voting?”. Pragmatically speaking, unless you live in a swing state, your vote is of relatively little importance. Furthermore, voting exacts a cost in terms of time, effort, lost productivity with the only discernible payoff being a vague sense of “civic duty”.

In order to minimize the cost of time and effort in voting, Switzerland experimented with an online voting system that is both quick and convenient! Never again would any Swiss voter have to stand in line during a rainstorm to cast a ballot!

  • After the online voting system is instated, the voter turnout actually dropped! In other words, making voting easier actually led to less participation. If the cost of voting is lower, by the law of supply and demand, shouldn’t the voting turnout increase!?
  • Again, by looking at the incentives, we realize that social and moral incentive plays the dominant role in voting. Economic incentive - whether the act of voting is a waste of time and money - is of relatively minor importance.
  • The social norm in a democratic society is to be a good citizen and fulfill your civic duty at the polls. As such, the primary motivator is not “how much time and money this will cost me”, but rather to be seen by others as being a good citizen.

Why Do People Cheat?

“If you are not cheating, you are not trying hard enough” - Mark Grace

Who cheats? Well just about anyone if the stake is right.

Some might insist that they don’t cheat, that they would never stoop so low. It would be a debasement of their virtues! But the reality is we all cheat to some degree. While some forms of cheating are relatively harmless, others are more scandalous. Perhaps you’ve downloaded pirated movies, music, software, or you’ve Googled homework solutions during a stressful week before finals, or you’ve claimed some tax credit that you know you don’t necessarily qualify for. Cheating at its core is a economic act: getting more for less.

Take the intriguing anecdote of the disappearance of 7 million children in the US:

  • In 1987, seven million American children sudden disappeared. It was not some organized kidnapping. As it turns out, for that tax year, tax filers were now required to provide social security number for each children they list as dependent.
  • Phantom children who previously only existed as a means to obtain tax deduction on previous year’s 1040 forms, vanished! Seven million children represents one in ten dependent children in the US!

“How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortunate of others, and render their happiness necessary to him, though he derives nothing form it, except the pleasure of seeing it.” - Adam Smith in The Theory of Moral Sentiments

Experts and Information Asymmetry

In any economic transaction, there is usually one party that has better information than the other. Economists call this phenomenon information asymmetry. In fact, it is in the best interest of the experts to keep the asymmetry as wide as possible.

Experts depend on the fact that you don’t have the information they do. Or that you are so befuddled by the complexity of their operation that you wouldn’t know what to do with the information if you had it. Or that you are so in awe of their expertise that you wouldn’t dare challenge them.

The internet has greatly shrunk the gap between experts and the public. For example, in the 1990s, price of life insurance fell drastically. Many websites became widely accessible for customers where they can compare, within seconds, the price of insurance sold by various companies.

With the advent of the internet, it is now easier than ever to make more informed purchases. Be on the lookout for abuse of information asymmetry and do your research!

Mystery of The Dropping Crime Rate in The 1990s

Figure: Crime Rate Projections From Levitt’s Paper

In the 1990s, crime rate fell so suddenly and so sharply that it baffled everyone. Many analysts cite the drop in crime rate as a result of things such as innovative policing strategies, changes to the drug market, aging population, stronger economy, and many other factors.

Levitt spends 20 pages of the book dispelling each of these explanations as either completely irrelevant, or having relatively minor effect. By looking at the data, Levitt came to the an unexpected conclusion. The drop in crime-rate is actually a result of Roe v. Wade

What sort of woman was most likely to take advantage of Roe. v. Wade? Very often she was unmarried or in her teens or poor, and sometimes all three. What sort of future might her child have had?

It turns out children who grew up in a dysfunctional family are at the greatest risk for becoming criminals. In fact, the two factors that are the best predictor for future criminal activities in children are: childhood poverty, and single-parent household. Both of which are drastically reduced by a woman’s right to legalized abortion.

In the 1990s, just as the first cohort of children from the post Roe v. Wade era was hitting their late teen years - the years during which young men enter their criminal prime - the rate of crime began to fall. Furthermore, the data seems to indicate that the states which had legalized abortion earlier (e.g. California, New York, Washington, etc.) saw a correspondingly earlier drop in crime rate.

History of Abortion Rights

  • In the early days of the nation, abortion was permissible before “quickening”, which refers to the first movement of the fetus that usually occurs about 16 to 18 weeks into the pregnancy. Abortion was expensive and dangerous back then, which meant the average women had a lot more babies.
  • In 1828, abortion was made illegal in New York. By the 1900s, abortion had been made illegal throughout the country
  • In the 1960s, several states began allowing abortion under extreme circumstances (e.g. California, Washington, Hawaii, etc.)
  • On January 22, 1973, legalized abortion was suddenly extended throughout the nation with the US Supreme Court ruling of Roe v. Wade. To quote part of the ruling:

The detriment that the State would impose upon the pregnant woman by denying this choice altogether is apparent… Maternity, or additional offspring, may force upon the woman a distressful life and future. Psychological harm may be imminent. Mental and physical health may be taxed by child care. There is also the distress, for all concerned, associated with the unwanted child, and there is the probability of bringing a child into a family already unable, psychologically and otherwise, to care for it.

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