Freakonomics 2 – Information and Common Sense


Today’s post is our second visit to a classic book – Freakonomics by Steven D. Levitt and Stephen J. Dubner.

The Ku Klux Klan

Chapter 2 of the book is about the power of information, as demonstrated by the story of the Ku Klux Klan.

  • The Klan was formed by former Confederate soldiers after the American Civil War.

Soon the Klan evolved into a multistate terrorist organization designed to frighten and kill emancipated slaves. The early Klan did its work through pamphleteering, lynching, shooting, burning, castrating, pistol-whipping, and a thousand forms of intimidation.

Although Washington forced the Klan underground, so-called Jim Crow legislation effectively enforced many of its aims.

The DW Griffith film The Birth of a Nation rejuvenated the Klan, and by the 1920s there were 8M members.

  • But then the nation united in World War 2 and the Klan declined again.

After the war, the Klan restarted, with Atlanta, Georgia as its HQ.

A local journalist – Stetson Kennedy – decided to expose the workings of the Klan, as did “John Brown” a former Klan member.

  • Kennedy later wrote a book about both of their exploits.

Brown divulged what he was learning at the weekly Klan meetings: the identities of the Klan’s local and regional leaders; their upcoming plans; the Klan’s current rituals, passwords, and language. It was Klan custom, for instance, to append a Kl to many words. (Thus would two Klansmen hold a Klonversation in the local Klavern.)

There was a secret handshake, and some coded statements to identify brethren in a strange town.


The authors point out that there were few actual lynchings after the war (though obviously all murders are terrible).

  • Even in the 1920s, 20K black children were dying in infancy each year, compared to 28 adults who were lynched.

There was also no correlation between lynchings and Klan membership, which suggests that Klan members probably didn’t carry out the majority of lynchings.

The most compelling explanation is that all those early lynchings worked. White racists – whether or not they belonged to the Ku Klux Klan – had through their actions and their rhetoric developed a strong incentive scheme.

The Klan that Stetson Kennedy wrote about was in fact a sorry fraternity of men, most of them poorly educated and with poor prospects, who needed a place to vent.


The Klan also worked (like many religions and quasi-religions) as a multi-level marketing operation.

  • Dues, protection money and the proceeds from large rallies and insurance schemes rippled up to the top of the triangle.

Kennedy tried to get the Klan’s charter revoked on the grounds that it clearly wasn’t a non-profit, but failed.

Spy games

[Kennedy] had noticed one day a group of young boys playing some kind of spy game in which they exchanged silly secret passwords. It reminded him of the Klan. Wouldn’t it be nice, he thought, to get the Klan’s passwords and the rest of its secrets into the hands of kids all across the country?

He started to feed information to the the producers of the Adventures of Superman show, watched by millions.

During the war, the Adventures of Superman program had portrayed its hero fighting Hitler and Mussolini and Hirohito. But now he was in need of fresh villains. The Klan was a perfect target, and Superman turned his powers against them.

Radio journalised Drew Pearson also included the updates in his Washington Merry-Go-Round show.

  • And Klan membership began to fall.

[Kennedy] turned the Klan’s secrecy against itself by making its private information public; he converted heretofore precious knowledge into ammunition for mockery.

Lemons and funerals

The day that a car is driven off the lot is the worst day in its life, for it instantly loses as much as a quarter of its value. Because the only person who might logically want to resell a brand- new car is someone who found the car to be a lemon. So even if the car isn’t a lemon, a potential buyer assumes that it is.

This is information asymmetry in reverse – the potential buyer assumes that the seller has information, even though he may not.

The seller would do well to wait a year to sell it. By then, the suspicion of lemonness will have faded; by then, some people will be selling their perfectly good year-old cars.

The internet has solved a lot of information asymmetry problems.

The Internet is brilliantly efficient at shifting information from the hands of those who have it into the hands of those who do not.

The authors use price-comparison sites as an example.

The Internet has proven particularly fruitful for situations in which a face-to-face encounter with an expert might actually exacerbate the problem of asymmetrical information – situations in which an expert uses his informational advantage to make us feel stupid or rushed or cheap or ignoble.

Funeral directors pushing an expensive casket are a good example.

  • Meanwhile, doctors pushing expensive treatments, plus Enron, insider trading scandals and glowing analyst reports of junk companies are evidence that we have further to go.
Real estate terms

We came across reaL estate agents in the previous article.

Aside from the fact that selling a house is typically the largest financial transaction in your life, there are at least two pressing fears: that you will sell the house for far less than it is worth and that you will not be able to sell it at all.

Which comes down to not setting the price too high or too low.

  • And the agent is the one with the relevant information about the local market.
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But the agent is not your friend – she wants the commission.

An agent keeps her own house on the market an average ten extra days, waiting for a better offer, and sells it for over 3 percent more than your house–or $10,000 on the sale of a $300,000 house.

This is an incentive problem.

The agent only stands to personally gain an additional $150 by selling your house for $10,000 more. So her job is to convince you that a $300,000 offer is in fact a very good offer, even a generous one.

A big part of a real-estate agent’s job is to persuade 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.

Which is where codewords come in. Here are words linked to higher sale prices:

  • Granite
  • State-of-the-Art
  • Corian
  • Maple
  • Gourmet

And here are five linked to lower prices:

  • Fantastic
  • Spacious
  • !
  • Charming
  • Great Neighborhood

Good words are specific, objective characteristics of the property.

  • Bad words are subjective, hyperbolic or related to the neighbourhood.

Guess which ones agents use to sell their own homes.

But like the funeral director and the car salesman and the life-insurance company, the real-estate agent has also seen her advantage eroded by the Internet.

The Weakest Link

Might there be a way to test for discrimination in a public setting?

It turns out there is.

  • The Weakest Link involves contestants ganging up on each other to vote one of them out after each round of questions.

In the first several rounds, it makes sense to eliminate bad players since the jackpot grows only when correct answers are given. In later rounds [this] is outweighed by each contestant’s desire to win the jackpot. It’s easier to do that if you eliminate the other good players.

So we need to work out a player’s ability (from the answers in early rounds) and compare that effect with race, gender, and age.

  • Good players eliminated early are discriminated against.
  • Bad players who hang around have been favoured.

Black and female players are treated fairly.

Neither of these findings is so surprising. Two of the most potent social campaigns of the past half-century were the civil rights movement and the feminist movement.

But discrimination hasn’t disappeared, it’s just that certain types have become unfashionable.

How might you determine whether the lack of discrimination against blacks and women represents a true absence or just a charade? The answer can be found by looking at other groups that society doesn’t protect as well.

So instead, Latinos and the elderly are treated badly (on the show, at least).

There are two leading theories of discrimination.

The two types are “taste” (I don’t like you) and “information” (I think you have poor skills).

Latinos suffer information-based discrimination. Elderly players, meanwhile, are victims of taste-based discrimination. Other contestants – this is a show on which the average age is thirty-four – simply don’t want the older players around.

Internet dating

According to a study by Dan Ariely and others:

[Internet daters are] a lot richer, taller, skinnier, and better-looking than average. That, at least, is what they wrote about themselves.

The women were also a lot blonder than the real population.

The worst mistake to make in online dating is not to use a photo.

There are plenty of reasons someone might not post a photo – he’s technically challenged or is ashamed of being spotted by friends or is just plain unattractive – but as in the case of a brand-new car with a For Sale sign, prospective customers will assume he’s got something seriously wrong under the hood.

56% of men and 21% of women received no replies.

  • And the most popular traits are the stereotypical ones.

Men need to be rich (from a profession or a job with a uniform), tall with straight and not ginger hair, and looking for a long-term relationship.

  • Women need to be good looking, blond and not fat, with a middling income.

Men and women on the dating site listed their race. They were also asked to indicate a preference regarding the race of their potential dates – “the same as mine” or “it doesn’t matter.”

80% of white men and 50% of white women said that race didn’t matter.

  • But these men sent 90% of responses to white women.
  • And the women sent 97% of responses to white men.

A clear case of virtue-signalling.

  • There is similar data around US mayoral elections where one candidate is black and the other white, and in polls where one option is painted as “evil” by the media (Brexit, Trump and the UK’s “shy Tory” phenomenon).
Drug dealers

Chapter 3 is about the limitations of conventional wisdom – common sense if you prefer.

  • It deals with a study of Chicago drug dealers by Sudhir Venkatesh.

He befriended a gang leader (JT, of the Black Disciples – a business major in college) and got to understand the economics of drug dealing.

It turns out that drug gangs are quite like the Klan and other quasi-religions, or MLMs in general.

  • The authors prefer to compare the gang to US business, and in particular to Mcdonalds.

The gang was one of about a hundred branches – franchises, really – of a larger Black Disciples organization. JT reported to a central leadership of about twenty men – the board of directors. JT paid the board of directors nearly 20% of his revenues for the right to sell crack in a designated twelve-square-block area. The rest of the money was his to distribute as he saw fit.

Three officers reported directly to JT: an enforcer, a treasurer, and a runner (who transported large quantities of drugs and money to and from the supplier). Beneath the officers were the street-level salesmen known as foot soldiers. The goal of a foot soldier was to someday become an officer. J T had anywhere from twenty-five to seventy-five foot soldiers.

At the very bottom of J. T.’s organization were as many as two hundred members known as the rank and file. They were not employees at all. They did, however, pay dues to the gang, some for protection,others for the chance to eventually earn a job as a foot soldier.

During the four years covered by the ledgers that Sudhir had access to, monthly revenues increased from $18.5K to $68.4K.

  • In year 3, average revenues were $32K.
  • Expenses were $14K ($5K on drugs, $5K to the board, $1.3K on mercenaries, and $2.7K on weapons and miscellaneous expenses)
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That left $18K, of which $8.5K went to JT.

  • He was making $100K pa, and the board members were on $500K.

But JT’s three officers made only $700 per month ($7 an hour).

  • And the foot soldiers made less than minimum wage.

So the answer to the [authors’] original question – if drug dealers make so much money, why are they still living with their mothers? – is that, except for the top cats, they don’t make much money. In other words, a crack gang works pretty much like the standard capitalist enterprise: you have to be near the top of the pyramid to make a big wage.

Most of J. T.’s foot soldiers also held minimum-wage jobs in the legitimate sector to supplement their skimpy illicit earnings. During the years that Venkatesh lived with J. T.’s gang, foot soldiers often asked his help in landing what they called “a good job”: working as a janitor at the University of Chicago.

As well as the bad pay, over the four years, a foot soldier faced a 1-in-4 chance of being killed.

Compare these odds with those for a timber cutter, which the Bureau of Labor Statistics calls the most dangerous job in the United States. Over four years’ time, a timber cutter would stand only a 1-in-200 chance of being killed.

Or compare the crack dealer’s odds to those of a death-row inmate. In 2003, Texas put to death twenty-four inmates – or just 5 percent of the nearly 500 inmates on its death row during that time. Which means that you stand a greater chance of dying while dealing crack in a Chicago housing project than you do while sitting on death row in Texas.

Why on earth would anyone take such a job? 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).

These budding drug lords bumped up against an immutable law of labor: when there are a lot of people willing and able to do a job, that job generally doesn’t pay well. This is one of four meaningful factors that determine a wage. The others are the specialized skills a job requires, the unpleasantness of a job, and the demand for services that the job fulfills.

This is why prostitutes earn more than architects.

Little girls don’t grow up dreaming of becoming prostitutes, so the supply of potential prostitutes is relatively small. Let’s just say that an architect is more likely to hire a prostitute than vice versa.

An editorial assistant earning $22,000 at a Manhattan publishing house, an unpaid high-school quarterback, and a teenage crack dealer earning $3.30 an hour are all playing the same game, a game that is best viewed as a tournament.

You must start at the bottom to have a shot at the top. You must be willing to work long and hard at substandard wages. In order to advance in the tournament, you must prove yourself not merely above average but spectacular.

And once you come to the sad realization that you will never make it to the top, you will quit the tournament.


The rest of Chapter 3 is taken up with the story of crack cocaine, which is much cheaper and more addictive than the powder and transformed the drug from a white middle-class indulgence into a black street drug.

By the time crack came to Chicago, the black gangsters had made the connections to buy their cocaine directly from Colombian dealers. Black Americans were hurt more by crack cocaine than by any other single cause since Jim Crow. Within a five-year period, the homicide rate among young urban blacks quadrupled.

This lead to apocalyptic predictions of the bloodbath to come.

The bloodbath did not materialize. The crime rate in fact began to fall.

We’ll find out why in Chapter 4.

  • Until next time.

Mike is the owner of 7 Circles, and a private investor living in London. He has been managing his own money for 40 years, with some success.

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Freakonomics 2 – Information and Common Sense

by Mike Rawson time to read: 9 min