… And other puzzlers. Maverick economist Steven Levitt explains why a lot of the things you thought you knew about money are wrong.
By Etelka Lehoczky
With their reams of data and tendency to speak in jargon, economists often seem to dwell in a parallel universe–one where the trials and tribulations of our daily financial lives barely register a blip. Not so Steven Levitt, 37, a University of Chicago professor who has been named the best economist in the country under age 40 by the American Economic Association. Levitt’s stock in trade is taking a fresh look at everyday topics through an economic lens. In his new book, Freakonomics: A Rogue Economist Explores the Hidden Side of Everything, written with Stephen Dubner, Levitt offers insights and advice on a variety of topics, from dealing with real estate agents to raising successful kids.
Q. You spend much of your book dissing experts who supposedly help consumers. What do you have against them?
A. We’re raised to trust experts, to think that by virtue of being experts they’re looking out for our interests. But experts are people. You’ve got to believe that given the opportunity to do a lot better for themselves while taking a little bit from you, some will do it. And my research supports that. We already hold a healthy distrust of some experts, like car mechanics, politicians and maybe lawyers. But with others–for instance, real estate agents and funeral-home directors–we generally don’t distrust enough.
Q. So how does this play out–with real estate agents, for example?
A. If you’re selling your house, you’re counting on the real estate agent’s knowledge of the market to get you a great price. Otherwise you’d save the commission and sell the house yourself. But the way that real estate incentives are structured, it’s not in an agent’s short-term interest to hold out for the best deal. Once you take out the other realtor’s commission and the agency’s cut, the agent earns only 1.5% of the sale price. So getting a price that’s $10,000 higher for a house is worth only $150 more to a realtor. Do you really expect the agent to work hard to show your house for a few more weeks just to collect an extra $150?
Q. Do you have any proof?
A. The best way to prove whether a real estate agent is abusing his position is to measure how he treats you vs. how he would perform the same service for himself. So we looked at data from the sales of 100,000 homes in Chicago, including 3,000 owned by the agents themselves, controlling for variables like the location and quality of the house. We found that an agent keeps her own home on the market an average of 10 days longer and sells it for an extra 3% or more–that’s $9,000 on a $300,000 home–partly because she uses more of the right buzzwords in her ads [for more about these words, see “The Secret Language of Real Estate Ads” on the next page]. When a realtor sells her own home, she holds out for the best offer; when she sells yours, she pushes you to take the first decent offer you get.
Q. What do you suggest sellers do?
A. If you’re comfortable with researching the value of your house (and there are plenty of websites, like Domania.com, that can help you do that), you can bypass the agent, save the commission and market the house yourself, using a discount service that will list the sale on the multiple-listing service for $500 to $750. If you’re too busy or intimidated to sell the house yourself, try to use an agent who is a friend or who has ties to your social network. She has an incentive to forgo her short-term interests and try to get you the best deal because she’s concerned about her long-term interests: She wants repeat business or she doesn’t want to lose your friendship.
Q. Are there times when an expert’s incentive structure works in your favor?
A. I’ve come across at least one: A study of auto mechanics in California found that they often let cars pass that should have failed emissions inspections, even though that meant they wouldn’t earn anything for the repairs. Their incentive was that lenient mechanics tend to get rewarded with repeat business. Whether it’s right for them to let cars continue to pollute is a different question entirely.
Q. You poke a lot of holes in conventional wisdom about the things parents do to give their children a leg up in life–for instance, sending their kids to the best schools. You say it’s not worth it. Why?
A. We based our findings on a study of the Chicago school system, which is the third largest in the country and offers families a lot of school choice. We found that your child may actually be worse off attending a better school. It turns out that academically, it may be better to be a big fish in a small pond. Kids seem to benefit from the special attention that comes with being a very good student in a not-so-good school. Going from being the best kid in a terrible school to a mediocre kid in a great school is a bad trade, judging by graduation rates and academic performance.
Q. Does that mean private schools are a waste of money?
A. What my research suggests, albeit indirectly, is that the biggest payoff of private schools is not academic. The benefits have more to do with the kind of kids your child will hang out with. We found that attending schools that were better academically did benefit kids socially, and it kept them out of trouble. So private schools aren’t necessarily a waste of money. You just need to understand what benefit you’re buying.
Q. You also take issue with recent studies that have suggested the names that parents choose for their children will affect how successful those kids will be.
A. A number of studies have found, for example, that résumés that have names associated with black families elicit fewer callbacks than résumés that have traditional “white” names. But when we looked at long-run life outcomes, and controlled for other factors, we found that the name you are given has absolutely no impact on any kind of economic or social variable that you can measure. Your name just does not affect the kind of life you’re going to lead. And that was true of many common beliefs about how to improve a child’s odds of success in life. It didn’t matter if the child was trotted off to museums, read to frequently or watched a lot of TV, or even whether his mom worked or the family was intact.
Q. Are you saying that what parents do for their kids doesn’t matter?
A. The research shows that what matters most is factors like your education and your income–and it probably doesn’t hurt to be hard working, loving and curious about the world. In other words, what you do as a parent, in the end, matters less than who you are.
Money magazine, 2005
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