Freakonomics Chapter 3: Summary
In chapter 3 of Freakonomics, Steven Levitt and Stephen Dubner ask an interesting question: Why do drug dealers still live with their mothers? Conventional wisdom would have us believe that drug dealers should be making bank. After all, who is going to go through the trouble and the risk of selling drugs for minimum wage? The answer to this question is deeply rooted in incentives. And it turns out that drug operations are very similar to real-world enterprises such as McDonalds. People on the top take the largest cut. People on the bottom are trying to become those people.
Anything for The Right Incentive
Economics tends to assume people think rationally. Rationality can be loosely defined, however. A rational decision in any given situation can change based on the information an individual has. For instance, if you believe you will be compensated appropriately for a job, you will decide to take it. Now say for that same job, you are led to believe that pursuing it will lead to a greater company position in the future. In this scenario, you may be inclined to accept a lower salary with the promise that one day you will be making more, even if this information is entirely false. Incentives guide everyone’s decisions no matter what that incentive may be. This is important to understanding why someone may make an “irrational” decision. We as outsiders simply have more information to help make better decisions.
Face-to-Face With The Drug Den
In 1989, Sudhir Venkatesh, an Indian Graduate of the University of California was working on his PHD. His graduate professor sent him into the field to survey the poorest black neighborhoods in Chicago and have them rate their quality of life. This survey was not designed very well, and as one could imagine, within a short amount of time Venkatesh found himself in a particularly grim situation.
The first people Venkatesh happened upon were teenage crack dealers, and unbeknownst to him, they were in the middle of a drug war. He was detained by the teenagers as they decided what to do with him. His unassuming looks granted him a certain level of leniency with the crack dealers that afforded Venkatesh the opportunity to speak with them, and at some point, he ended up meeting the gang’s leader. Venkatesh and the gang’s members talked deep into the night until after 24 hours, they let him go.
Venkatesh was fascinated by this encounter, and against his better judgment decided to head back with an express purpose. He wanted to study, observe, and record the day-to-day operations of the gang. And after a long discussion with the gang’s leader was given the opportunity.
Throughout his time in the midst of the drug operation, Venkatesh witnessed many things, including a turf war that would end in a federal indictment for much of the gang’s management. Before Venkatesh left, however, he was given a group of ledgers that contained all of the recorded financials for the gang over a four-year period. What he found was that the gang didn’t operate much differently than a Mcdonald's.
The Financials of The Drug Den
The gang that Venkatesh discovered was a part of a much larger operation, an organization that ran over 100 branches of gangs. At the top of it all was the “Board of Directors”, who each gang leader reported to and paid almost 20% of their revenue. The rest of the money was spread among the members of the gang. The leader saw a tax-free $100,000 a year, not including money accrued through other means. On the other hand, the total revenue spent per month on wages for the rest of the gang was only $9,500 dollars. The top officers in the game each made about $7 an hour. Foot soldiers made only $3.30, less than minimum wage.
So why then do people work for a gang that pays them less than a fast-food job would and with the added risk of getting killed at a rate as high as 1-in-4? The foot soldiers did it because it was the best opportunity they were aware of. In these neighborhoods, there are few college graduates or those with high-paying jobs of the corporate world. There are no success stories other than the leaders of these gangs that make enough to live large, and everyone wants their job. Foot soldiers are willing to work for cheap if it means distinguishing themselves and ending up on top, even if the odds of their success are particularly low.
Freakonomics Chapter 3: Key Takeaways
Gang operations work very similarly to corporate enterprises, where lots of people on the bottom are working for a few well-paying positions on the top. This ties into how incentives work in general. If the right carrot is dangled in front of someone, they’ll make seemingly irrational choices to get it since they aren’t made aware of the high odds necessary to reach said carrot. Furthermore, they aren’t aware of other often tastier carrots that lie not in front of them, but in places still within reach.
My Review of Freakonomics Chapter 3
This chapter is an excellent example of taking an interesting concept, in this case, drug dealers and tying it into a wider economic concept. Furthermore, the authors are able to use this chapter to once again subvert reader expectations and build upon the theme of looking past “Conventional Truths” to see the reality within every situation. Ultimately, I find that this chapter ties up very nicely by staying focused on one concept and building that concept to a logical conclusion that deals with the role of incentives on the economy, as well as the effect of unintended consequences which it goes on to explore in the next chapter.