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Freakonomics or Amateur Sociology?

By Arnold Kling - July 5, 2005 12:00 AM

"In some quarters of our profession, the level of discussion has sunk to the level of a New Yorker article: coffee-table articles about 'cute' topics, papers using 'clever' instruments. The authors of these papers are usually unclear about the economic questions they address, the data used to support their conclusions and the econometrics used to justify their estimates. This is a sad development that I hope is a passing fad."
-- James Heckman, economist, University of Chicago

 

Freakonomics may or may not have been the target of James Heckman's ire. But I think that the criticism is applicable to the surprising best-seller by acclaimed economist Steven D. Levitt and journalist Stephen J. Dubner. If readers come away from this book thinking that they have discovered how economics ought to be done, I would indeed consider it a "sad development." The book is most notable for its willingness to pass off speculative and tentative findings as though they were well-vetted, settled facts.

 

Robert Solow argued that in order to address some knotty problems in economics -- such as the failure of wage adjustments to eliminate unemployment or the failure of underdeveloped countries to achieve economic growth -- an economist might resort to what he termed amateur sociology. However, he implied that this should be done with reluctance, not enthusiasm. Where Solow said that economists might occasionally dip their toes, Levitt and Dubner dive in head first.

 

(I might point out that Heckman and Solow are Nobel laureates. Levitt is a winner of the John Bates Clark medal, which is for the best work by an American economist under the age of 40, and which may carry more prestige within the profession than the Nobel. Suffice to say, I am not on any of their level.)

 

Buyers are Liars

 

One topic Levitt studied was real estate agents. He says that real estate agents, rather than helping you get the best price for your house, actually talk you into underpricing your house so that they can earn their commissions with little effort.

 

Levitt looked at 100,000 homes sold in the Chicago area, and he compared the way agents sold their own homes with the way that they sold clients homes. On page 9 of Freakonomics, the authors write, "it turns out that a real-estate agent keeps her own home on the market an average of ten days longer and sells it for an extra 3-plus percent, or $10,000 on a $300,000 house." Gotcha!

 

I share the general resentment of real estate commissions. I believe that the transaction costs involved in buying and selling houses are ridiculously high. Nonetheless, I think that Levitt has not invested enough time in understanding how the housing market works. One thing that economics teaches you is that there are many ways for high incomes to be competed away -- unless they are earned.

 

A decade ago, I met with a housing data expert whose wife is a real estate agent. At the time, I thought that the Internet would soon make real estate agents obsolete. The expert disagreed, and he told me that the key to the housing market is this phrase: Buyers are Liars

What "buyers are liars" means for you as a seller is that the family that spends a lot of time dickering may never end up making a written offer. Even worse, the written offer may fall through. Experienced real estate agents filter out the liars.

 

Suppose that you are vacating on September 1st in order to take a job in a different city. In July, Smith offers to buy your home for $300,000 and Jones offers to buy it for $292,000. Smith's offer is contingent on selling his own home first, and Jones' offer is not. Which offer should you take?

 

If you rejected Smith's offer because of the contingency, you missed out. It turns out that he was making a good-faith effort to sell his house at a fair price, and he succeeded. You could have had the higher price.

 

Jones, meanwhile, also needed to sell his house in order to buy yours. But in order to get you to accept his offer, he did not make a contingency bid. Too bad you didn't know that he was a liar. When he had to back out of the deal you made with him, he forfeited a good-faith deposit of $1000.

 

When buyers back out of deals, sellers can collect out of the good-faith deposits. Some of the money. Sometimes. I have never heard of a seller who felt like the money was sufficient to compensate for the hassle.

 

I am not saying that you should not go FSBO (for sale by owner) or let your house be sold by Aunt Millie, who just got her license last month. But if you want to measure the benefit of using an experienced real estate agent, don't just look at transaction prices. Compare the number of deals that fall through.

 

As for Levitt's findings comparing real estate agents' home sales to those of their clients, consider this. A typical client may or may not be "under the gun" to sell because of a relocation, change in family status, or what have you. Real estate agents on average are more likely to be moving for "trade-up" reasons. When you are trading up, your focus is on getting the highest price. When you are "under the gun," your focus is on selling as quickly as possible. Perhaps that is what accounts for Levitt's results.

 

Law of Proportionate Belief

 

Perhaps I should welcome Levitt as a breath of fresh air in the profession. My friends Bryan Caplan and Alex Tabarrok clearly see him that way. Alex wrote, "I'm freaky, too! Well, let me make that a bit less personal. Economists today are examining a wider range of issues than ever before, not just in law, political science and history but now also in anthropology, sociology, philosophy and more."

 

That's fine. I certainly think that in economics a new paradigm could be an improvement over the mathematical straitjacket of mainstream theory. But we should proceed with a fair amount of caution and humility.

 

I felt that Freakonomics jumped from topic to topic, like a whirlwind 10-day European tour, never pausing to allow the reader to get a real feel for the surroundings. You are not in one place long enough to stretch and think.

 

I am not saying that Steve Levitt is necessarily wrong about real estate agents, or about other claims that he makes. But rather than go public and pass judgment, he ought to point out that more study needs to be done. Other economists may find different ways to test his hypotheses -- and they may get different results.

 

Reading Freakonomics, what I kept seeing was evidence and analysis that by my standards seemed tenuous. Yet it was presented as the "surprising truth." In that way, it violated what for me is the precious Law of Proportionate Belief.

 

For someone steeped in the social sciences, Freakonomics can be a fun and useful read. But if you read just one economics book this year, make it something else.

 

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