Freakonomics
A Rogue Economist Explores the Hidden Side of Everything
by Steven D. Levitt and Stephen J. Dubner

In the summer of 2003, The New York Times sent Stephen Dubner, a financial journalist, to write a profile of Steven D. Levitt, a heralded young economist at the University of Chicago. Dubner, who was researching a book about the psychology of money, had previously interviewed dozens of economists and found that they tended to speak English as if it were "their fourth or fifth language." But Steven Levitt turned out to be a very different kind of animal.

The journalist was dazzled by the breadth and inventiveness of Levitt’s work, and by his knack for explaining it in simple terms. Despite Levitt's Ivy League credentials, he tended to approach economics in a highly unorthodox and accessible way.

"I honestly don't know very much about the field of economics," he told Dubner at one point during the interview. "I'm not great at math, I don't know a lot of econometrics, and I also don't know how to do theory. If you ask me about whether the stock market's going to go up or down, if you ask me whether the economy's going to grow or shrink, if you ask me whether deflation's good or bad, if you ask me about taxes — I know nothing about any of those things."

What interested Levitt instead was the stuff and riddles of everyday life. For years, his quasi-scientific investigations into these subjects were a feast for anyone wanting to know how the world really works. Consequently, while in New York City, his friends in the publishing industry were telling Levitt that he should write a book.

"Write a book?" he said. "I don't want to write a book." Levitt felt he already had a million more riddles to solve and didn’t see himself as much of a writer. So he said that no, he wasn't interested. "Unless," he proposed, "maybe Stephen Dubner and I could do it together." And thus Freakonomics was born.

In the introductory chapter, we learn that the title of the book came from Levitt's sister, and it stuck because it signals that the book isn't your typical economics book. When others have questioned him about it further, Levitt has always been quick to insist that he's not very freaky himself.

"I think one of the differences between me and most other academics is I'm just like everyone else," he writes on his Web site Freakonomics.com. "I like to eat at McDonald's. I like to listen to popular music. The kinds of questions that attract me are the kind of questions everyday people would ask."

For these and other reasons, some people — including many of his peers — refuse to recognize Levitt’s work as economics at all. Of course, Levitt challenges this, arguing that he is merely distilling economic theory down to its most primal aim: explaining how people get what they want, or need.

Unlike most academics, Levitt is not afraid to use personal observations and anecdotes to reinforce a point he’s trying to make. He trusts his intuition. He sifts through a pile of data to find a story that no one else had found. He devises a way to measure an effect that veteran economists had declared un-measurable.

Indeed, the entire purpose of Freakonomics is to challenge conventional wisdom by revealing counterintuitive, and often unsettling, truths. Through all of this, Levitt aims to show the world how it really is — warts at all — not how we wish it would be.

And although he insists the opposite is true, Levitt appears to enjoy a little controversy. His overriding academic interests — though he says he has never trafficked in them himself — are cheating, corruption and crime. While these are undoubtedly controversial subjects, they’re not the only reason Levitt is attracted to them. As it turns out, liars and cheaters are a gold mine for a curious economist like Levitt because of all the data they unwittingly leave behind. "Some cheating leaves barely a shadow of evidence," writes Levitt. "But in many cases, the evidence is massive. You just have to know where to look."

For instance, Levitt invites us to consider what happened one spring evening at midnight in 1987. It was the night when seven million American children suddenly disappeared. He asks us rhetorically: "Was it the worst kidnapping wave in history?" Hardly. It was the night of April 15, and the IRS had just changed a tax rule. Instead of merely listing each dependent child, now tax filers were required to provide a Social Security number for each child. With that simple rule change, seven million "phantom" children vanished overnight, representing about 1 in 10 of all dependent children in the United States.

In this case, the incentive for all those cheating taxpayers was quite clear. There’s no great mystery to unravel. But what can we predict about the behavior of other people in our society — our friends, our co-workers, even our children’s public school teachers? Do most people have strong incentives to cheat? And if so, how would they do it? In Freakonomics, Levitt and Dubner offer one set of possible explanations.

Who Cheats?

The first half of Freakonomics deals with virtually every type of cheating you could think of — from schoolrooms to rigged sumo wresting competitions. And it’s immediately clear that Levitt takes particular delight in catching wrongdoers.

In the chapter on cheating schoolteachers, Levitt discusses a set of algorithms he used to identify which teachers in the Chicago public-school system were lying about students’ test scores — i.e. they were purposely inflating students’ scores so as not to suffer reprimands from the principal, and/or to receive undeserved performance bonuses.

Fortunately, a cheating public school teacher is no match for a well-trained economist!

After analyzing piles of anonymous test-score data from the Chicago schools that had long been available to other researchers, Levitt soon discovered that "cheating classrooms systematically differ from other classrooms along a number of dimensions." For instance, students in cheating classrooms are likely to experience unusually large test-score gains in the year of the cheating, followed by unusually small gains, or even declines, in the following year. After observing actual testing procedures, Levitt also discovered there are a number of ways a teacher could easily cheat. For instance, if a teacher was particularly brazen, she might simply give her students the correct answers. Or, after the test, she might actually erase students' wrong answers and fill in correct ones. A sophisticated cheater would also avoid conspicuous blocks of identical answers.

"The first step in analyzing suspicious strings is to estimate the probability each child would give a particular answer on each question," explains Levitt. "This is done by using past test scores, demographics and socioeconomic factors as explanatory variables." By measuring these and other factors, Levitt was easily able to identify which teachers he thought were cheating. (And, perhaps just as valuable, he was also able to identify the good teachers.) The Chicago school system, rather than disputing Levitt's findings, invited him into the schools for retesting. As a result, the cheating teachers were discovered and fired.

Who Else Cheats?

Levitt clearly has a knack for unmasking cheats. Next he targets real estate agents.

After dealing with a couple of real estate agents in a personal capacity, Levitt started to suspect that these particular agents were maximizing their commissions by selling Levitt’s houses too quickly, and for too low a price. As an economist, this didn’t surprise him at all.

Levitt reasoned that it might not be worth the agents’ effort, from a purely economic perspective, to maximize the value of each and every sale based on this common type of commission structure. That is to say, there’s little incentive for a broker to play hardball and hold out for an extra $10,000 when he or she would only stand to make a few additional commission dollars on that amount. So how did he prove his theory? Levitt simply contrasted average sale price data for agents’ clients’ houses with similar data for the same agents’ own houses. It then became apparent that many agents consciously take more time to sell, and consistently get a higher price, when their own cash is on the line.

Why Do People Cheat?

"For every well-meaning person who goes to the trouble of creating an incentive scheme," writes Levitt, "there is an army of people — from schoolteachers to real estate agents — who will inevitably spend even more time trying to beat it."

Levitt thinks of cheating as one of the most basic economic acts — the act of getting more for less. So that means it isn't just substance-abusing athletes and perk-abusing politicians who cheat. It’s also the waitress who pockets her tips instead of pooling them. Or the department store payroll manager who goes into the computer and shaves time off his employees' hours to make his own performance look better. And it’s the innocent-looking third grader who blatantly copies test answers from the kid sitting next to him.

So if waitresses, store managers, elementary school students, and even schoolteachers all cheat, are we to assume that mankind is innately and morally corrupt? Levitt argues it’s not as bad as it seems, since the social stigma costs of cheating keep people generally well behaved. In other words, Levitt says there’s a direct relationship between people’s good behavior and the type of harm that would come from getting caught. Some types of cheating, like cutting in a line, involve a high chance of getting caught, but the actual punishment received is usually negligible. However the cheater feels like a schmuck, and it’s this social stigma — or shame — that keeps people honest. So, because of the moral pain involved, people tend to avoid cheating even when the benefit of cheating far outweighs the apparent costs. When society tells us that something is wrong, most of us internalize that lesson, and we feel guilty when we break the rules.

One important Freakonomics rule about moral pain is that it’s related to being able to identify a victim. When you steal from a friend or co-worker, the victim is obvious. But when you steal from a big corporation, it feels more like a victimless crime because the victim cannot be easily identified.

Levitt illustrates this point with an anecdote about a man who sells bagels in large office buildings using the honor system. Every morning, he puts out the bagels and a collection box where people are supposed to pay for what they eat. What he found was that, on average, about 87% of the people pay each day.

What’s particularly interesting is that the data showed that smaller offices are more honest than big offices. An office with a few dozen employees is generally 3 to 5 percent more honest than a larger office. He reasons that small offices are more honest because there’s greater "shame" in being dishonest at a small office; people there are more likely to know you.

In common economic parlance, a person’s net benefit from cheating is equal to the benefit he gets from cheating, minus the opportunity costs, minus the perceived probability of being caught times the punishment, minus the social stigma, minus the moral pain. A person will cheat if the net benefit exceeds zero. Got it? Good.

Why Do Drug Dealers Still Live With Their Moms?

In the second half of the book, Levitt leaves behind his exploration of lying and cheating as perfectly rational economic behavior to pursue other similarly freaky lines of inquiry.

For instance, in the chapter entitled: "Why Do Drug Dealers Still Live With Their Moms?" Levitt explains that life on the streets is essentially a tournament, and that common drug dealers are understandably willing to incur unfathomable risks for the distant possibility of being a drug kingpin.

In his research, Levitt discovered a crack gang works just like any other type of capitalist enterprise: you have to be near the top of the pyramid to make a big wage. Notwithstanding the gang leader’s rhetoric about the family nature of his business, the gang's wages are about as skewed as wages in corporate America. A crack gang foot soldier has plenty in common with a McDonald's burger flipper or a Wal-Mart shelf stocker — long hours and low pay. Hence the apparent need for so many low-level drug dealers to live at home with their parents (or more typically, with their single moms) well into their late 20s.

The leader of a crack gang once told one of Levitt’s researchers that he could easily afford to pay his foot soldiers more, but it wouldn't be prudent. "You got all these guys below you who want your job, you dig?" said the gang leader. "So, you know, you try to take care of them, but you know, you also have to show them who’s the boss. You always have to get yours first, or else you really ain't no leader. If you start taking losses, they see you as weak ..."

The fact that drug dealers live with their moms is freaky but it’s just part of what they do for their shot at the brass ring.

The Economics of Baby Names

In another weird and wonderful chapter, Levitt explains how he once used publicly available birth certificate information on every child born in California for the past 40 years to show how lesser known, and in some cases unique, baby names favored by high-income, high-education parents — think of names like "Madison" and "Alexander" — tend to work their way down the economic ladder over time.

Levitt’s research showed that, once parents on the middle and lower end of the economic scale embrace upscale baby names, the affluent parents drop them. By using this model, Levitt is therefore able to predict that little-known baby names currently favored by upscale parents in some areas of California (e.g. "Phoebe" and "Clementine") will be commonplace throughout the State in about 10 years.

As a sub-set of this same research, Levitt also looked at whether first names associated with African-Americans have an effect on a child's future success. His conclusion? Although, on average, someone with a distinctively black first name may not fare as well in terms of education and wealth, it's not the name's fault. Rather, the name is simply a passive indicator of the kinds of social and economic obstacles a child from that particular background may face in his or her life.

The Infamous "Crime and Abortion" Chapter

As interesting as subjects like cheating teachers and baby names may be, Freakonomics is best known for its controversial chapter dealing with the purported link between the decline in violent crime and new abortion rights for women. It goes something like this:

During the early 1990s, many experts forecast that America would soon be engulfed in a torrent of violent crime. Happily, by 2005, this doomsday prophecy has proved itself to be wildly off base — violent crime rates are falling. Naturally, those same experts then began scrambling to find plausible explanations as to why they were so utterly wrong.

"To paraphrase an old saying," writes Levitt, "failure is an orphan but success begets a thousand experts vying for the credit." In this case, there are several seemingly plausible explanations for the non-explosion of crime. Some experts have credited Rudolph Giuliani's innovative "broken window" policies. (The idea is if you don't let people get away with petty crimes such as breaking windows they will be much less likely to perpetrate more serious crimes.) Others point to tougher gun laws. Still others have suggested that more policemen, or capital punishment deserve all the credit.

While it’s tempting to believe that Rudi Giuliani’s leadership, or some other easily implemented policy decision saved our society from a wave of criminality, Levitt’s explanation for the drop in violent crime is far more controversial. He argues — quite convincingly — that the drop in crime of the late 1990s is due to the Roe v. Wade decision.

Here is Levitt's theory boiled down to its essence: "Decades of study have shown that a child born into an adverse family environment is far more likely than other children to become a criminal. And the millions of women most likely to have an abortion in the wake of Roe v. Wade (i.e. poor, unmarried, and teenage mothers for whom illegal abortions had been too hard to get), were often models of adversity ... Just as these unborn children would have entered their criminal primes, the rate of crime began to plummet." This suggests that Roe v. Wade allowed women to abort many of the children that would have otherwise grown to become criminals. Levitt then goes on to support his assertion with reams of statistical analysis.

Cognizant of the knee-jerk reaction this final chapter would be sure to generate, Levitt is very careful to stress here that he is just describing the world as it is, and not making value judgments. "Freakonomics-style thinking doesn't traffic in morality," says Levitt. "If morality represents an ideal world, then economics represents the actual world."

Conclusion

As we jump back and forth between stories of cheating schoolteachers, shady real-estate agents, and wild theories on crime and abortion, Freakonomics — at first glance anyway — might appear to be missing a grand, unifying theme. But let’s take a closer look.

What could be said to unite all of Levitt’s seemingly disparate stories and anecdotes is a belief that the modern world — despite an oversupply of obfuscation, complication, and downright deceit — is by no means unknowable. On the contrary, if the right questions are asked, perhaps the world today makes far more sense than we may first think. All it takes is a new way of looking at things ... A "Freakonomics" way of looking at things.

In recent memory, there has not been an economics text that has gripped the popular consciousness like this highly original offering from Steven Levitt and Stephen Dubner. But then again, there have not been many books in the genre that have tried to explore "the hidden side" of quite so many ordinary things. Perhaps that’s why Freakonomics is so much more entertaining and provocative than any book about economics has a right to be. At the very least, you’re now armed with enough riddles and stories to last a thousand cocktail parties. But Freakonomics might do more for you than that. It might just re-kindle your thirst for understanding the real world.

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