Freakonomics - Part 1

FREAKONOMICS - Part 1

by Steven D. Levitt & Stephen J. Dubner

Starting from the general premise that there is often a hidden side to things, authors Steven D. Levitt and Stephen J. Dubner explore in their highly successful book Freakonomics 5 concepts:

          1. Incentives are the cornerstone of modern life.  

          2. Conventional wisdom is often wrong.

          3. Dramatic effects often have distant, subtle causes.

          4. Experts often use to their advantage the information only they have gathered and analyzed.

          5. The modern world becomes easier to understand when one knows what and how to measure 

              it. (12)

Chapter 1 of Freakonomics has an intriguing title - What Do Schoolteachers and Sumo Wrestlers Have in Common?  The answer to this question is, for the authors, evidence of Concepts 1 and 5. Analysis of data regarding teachers in the Chicago Public School system and professional sumo wrestlers reveals both the "power" (30) and the "dark side" (20) of incentives.

After the Chicago Public School system introduced high-stakes testing in 1996, teachers found themselves under enormous pressure to ensure that the vast majority of their students passed these tests.  While there were rewards such as praise, promotion, and job security for teachers whose classes performed well on the standardized tests, teachers whose classes did poorly could face the negative consequences of censure, being passed over for promotions, and even termination.  Hence, the incentives associated with teachers cheating when it came to high-stakes testing were tantalizing. On this point, the authors quote comedian W. C. Fields: "A thing worth having is a thing worth cheating for." (21)  The cheating by Chicago district teachers would likely have gone unnoticed if not for the sophisticated analysis of the multiple-choice test score data.  Identifaction of algorithms such as suspicious answer strings revealed that many teachers had either given correct answers to their students or simply changed their students answers themselves.  For instance, one teacher had 15 students in her/his class all give the same 6 consecutive correct answers.

According to the authors, examination of data also showed that many sumo wrestlers in Japan were cheating due to incentives - ironically though, not by winning matches but by deliberately losing them!  The data analysis was extensive.  From examining the results of 32,000 tournament matches between 1989 and 2000, suspicious patterns emerged.  Most notably was that close to 80% of matches between sumo wrestlers with 7 and 7 win-loss records and 8 and 6 win-loss records resulted in the generally lower-favoured 7-7 wrestler somehow winning the match.  The incentives for winning a majority of tournament matches are enormous, icluding a huge increase in both income and prestige.  Thus, the authors speculate that big bribes were offered by wrestlers with 7 and 7 records to those with 8 and 6 records to throw matches.  Wrestlers with 8 wins and 6 losses had nothing to lose by throwing such matches since they were already guaranteed a majority of wins and the incentives associated with that feat.  

Teachers and sumo wrestlers - Strange bedfellows!

In Chapter 2, Levitt and Dubner again show how a similarity between two very different groups provides evidence for their concepts. In this instance, it's that both the infamous Klu Klux Klan and real-estate agents are motivated by incentives (Concept 1) and have gained advantage from information hording. (Concept 4)

As a secret society, the Klan struck fear in the hearts of its opponents and enemies through its violent, scourge of God image while also appealing to uneducated whites by claiming to be a righteous, not-for-profit association.  However, after a journalist named Stetson Kennedy fed information he obtained from inside sources in the Klan to radio personality Drew Pearson, the Klan was revealed to the American radio audience to be a far less powerful group and its so-called righteous leaders little more than racist profiteers.  The authors conclude,  "[Pearson] turned the Klan's secrecy against itself by making its private information public; he converted heretofore precious knowledge into ammunition for mockery." (61)

With respect to real-estate agents, Levitt and Dubner explain that, like most people, they are motivated by incentives.  The realtor's incentive is the quick and tidy commission he/she can earn by persuading "...the homeowner to sell for less than he would like while at the same time letting potential buyers know that a house can be bought for less than its listing price." (70)  This sleight of hand is accomplished by the realtor's withholding from the homeowner expert information on the housing market, such as recent sales trends and inventories of similar houses.  The real-estate agent uses his/her "informational advantage" (what economists call imformation asymmetry) to befuddle the homeowner and "...make [him/her] feel stupid or rushed or cheap or ignoble." (65)

Concept 2, Conventional wisdom is often wrong, is the theme of Chapter 3 "Why Do Drug Dealers Still Live With Their Moms?"   During the 1990s, the illegal crack cocaine industry exploded in America.  The image portrayed by the media was of millionaire crack dealers engaging in "one of the most profitable jobs in America." (89)  This image, however, couldn't have been farther from the truth.  The reality was that the vast majority of crack dealers operated in impoverished urban neighbours and were, indeed, earning so little they could only afford to live at home.  Sudhir Venkatesh's analysis of a Chicago gang which controlled the crack cocaine market around a housing project on the south shore of Lake Michigan revealed that gangs operated like American corporations: Gangs were hierarchical with a small group of central leaders at the top of the pyramid, followed by local leaders then a small group of officers who reported to the leaders.  Towards the bottom were many foot soldiers who actually sold crack in the steets, and underneath them were scads of rank and file members.  While the leaders enjoyed large profits, foot soldiers in the gang Venkatesh investigated earned less than minimum wage!   So then one might ask, why would foot soldiers peddle crack cocaine?    

            Well, for the same reason that a pretty Wisconsin farm girl moves to Hollywood.
            For the same reason that a high-school quarterback wakes up at 5 a.m. to lift
            weights.  They all want to succeed in an extremely competitive field in which, if
            you reach the top, you are paid a fortune (to say nothing of the attendant glory
            and power. (102)

The answer is, simply put, that "...criminals, like everyone else, respond to incentives." (103)

           

       

The Third Wave Part 2

The Third Wave 

An Entrepreneur's Vision of The Future

(Part 2)

In Chapter 7, "The Rise of The Rest", Steve Case begins by noting that, since the First Wave of the Internet, venture capital money has been mainly limited to 3 states - California, New York, and Massachusetts. However, with the dawning of the Third Wave, a new distribution, which the author terms the rise of the rest, is occurring.   Whereas during the First Wave hugely successful start-ups were mainly the creation of "twenty-something coders" in places such as Silicon Valley, during the Third Wave, entrepreneurs with multi-billion dollar new companies are "...more likely to be thirty-something farmers, teachers, doctors, chefs, and artisits - people who saw a problem in their own spheres of expertise, then leveraged the skills of others [in their own backyards] to build great companies." (109)  

One of the many benefits that Case attributes to the rise of the rest, is the injection of new investment in dozens of cities and regions throughout America and the positive impact such investment is having on local and the national economies.  As well, the author predicts that the rise of the rest will bring much needed diversity - "...both of people and ideas" (115) to an Internet-driven world of commerce that has, hitherto, been dominated by the cultural majority.  Writes Case, "...Facebook reported that only 4 percent of its employees in the United States were Hispanic in 2015, while only 2 percent were black.  At Google, the numbers are similar, and have been for years." (115) 

Impact investing is another phenomenon of the Third Wave.  The author defines it as "...a bridge between traditional business and philanthropy - and between financial return and social good." (120)  In other words, it is not enough in this day and age for corporations, if they want to attract ethically-minded young workers, to "do well" (attrack investment and make profits); they must also "do good". (122)  

Steve Case recounts, in Chapter 9, the story of the unsuccessful merger of AOL with Time Warner in January 2000 and the subsequent decline of AOL, and his departure from the company he co-founded.  The reason for the merger had to do with the replacement in the late 90s of dial-up (phone lines) internet access with broadband (cable lines) internet connectivity.  Unable to partner with a cable company, AOL bought Time Warner instead. 

Although both internal and external problems led to AOL's demise, Case belives the biggest factor in its failure was cultural incompatibility between AOL and Time Warner and a related lack of trust.  The merger got off to a rocky start when, as a condition of the merger, $1 billion in cost cuts were made, resulting in layoffs of people and cutting of projects.  Writes the author, "That bred an immediate and spiraling resentment among senior executives and severly undercut our ability to build trust." (141)  He also notes that there was "...a fundamental disconnect" between administrators at AOL and Time Warner about the Internet's potential. (142)  The Third Wave lesson to be learned from the decline of AOL is "...how important the people factor is.  It doesn't really matter what the plan is if you can't get your people aligned around achieving the same objectives." (153) Concludes the author on the failure of the merger: "I even noted that the two sides seemed to be speaking different languages and speaking past each other. And while some of the differences related to different world views and strategic perspectives, I think much of it, sadly, related to personal mistrust and lingering resentments." (154)  

  

 The main point the author makes in Chapter 10 is as follows: "Government is going to play an important role in the Third Wave." (159)  To support this theory, he illustrates the essential role government played in the First Wave of the internet.  For one thing, he notes that most innovations from the late 80s through the first decade of the new millenium were only made possible by federal support.  He also emphasizes that "We would not have had the Internet itself if not for government." (163)  Indeed, it was the Advanced Research Projects Agency of the United States Department of Defence that was responsible for creating the first host-to-host connection between computers in different locations which eventually gave birth to an internetworking system, or "internet" for short. According to Case, governments will have a dual role in the Third Wave - "as a regulator and as a customer". (164)   He believes governments need to regulate the storage and use of personal data so as to balance privacy and security needs against the commercial uses of data for profit.    

In "America Disrupted" (Chapter 11), Steve Case identifies 6 areas on which he believes the U. S. government should focus in order to attract Third Wave start-up companies.  Among these areas of focus are greater investment in reserach and development and making it easier for startups to raise money through measures such as tax incentives like reduced rates on capital gains earned from startup investments.  It is, however, his advice on how to make it easier to hire top talent that is most significant.  Case recommends a more flexible immigration system through measures like Canada's Startup Visa program.  He maintains that a more immigrant-friendly attitude is needed in America if the country is to continue to thrive during the Third Wave: "The United States can remain the most innovative and entrepreneurial nation, but only if we are a magnet for the world's best and brightest. Immigration is not just a problem to solve; it's an opportunity to seize. (192) 

In Chapter 12, Case offers some tidbits of Third Wave advice for entrepreneurs, corporate leaders, and government:

• For Entrepreneurs - Worry less about your net worth and more about your net impact
• For Corporate Leaders - "Keep your finger on the pulse of technology ... Empower your team to ask questions [and] Allow more crazy ideas to bubble up...." (206)
• For Government: Reduce regulatory restrictions currently on entrepreneurs.

The author then concludes his book with a 7-part plan for reinvigorating American entrepreneurship  which he calls RESTART:

• Reform how government works with startups - Government should provide them with incentives to reinvest their profits so that subsequent innovations occur and more jobs are created;
• Educate for the Third Wave - that is, teach entrepreneurial skills such as curiosity and collaboration;
• Source goods and service from startups;
• Provide Tax incentives to regional investors who are "...capable of funding startups in their own backyards." (221)
• Attract and retain talent, including immigrants.
• Rethink capitalism and entrepeneurialism replacing businesses-for-profit with "profit-plus-pupose businesses. (226)
• Transform local ecosystems making cities "more interconnected, more inclusive, and more impactful." (226)