steven levitt.keynote address.2nd annual private wealth conference.bermuda

Levitt: It’s wonderful to be here. It’s my first trip to Bermuda. I must say that I can’t remember when I felt both so welcomed and learned so much over dinner last night from such an intelligent group of people, so it’s really a pleasure to be here.

That was the trailer to the FREAKONOMICS movie. And if I ever thought something was unlikely to occur, it was that my book would be turned into a movie. If you’ve read the book, it doesn’t exactly scream out cinematic to me. And a crazy guy came to us and said, “I want to turn this into a movie.” And he said, “I’ll give you $10,000 for the rights.” And I thought, That’s the best free $10,000 I’ll ever get, because there’s no way this thing will ever get turned into a movie. And he ended up turning it into a movie, and it was the biggest box office flop in history. They put it out there, and nobody went to it. I mean, literally, nobody went to it; it was gone within two weeks. And I must say I was happy, because the last thing I wanted was to be a movie star. My calling’s definitely not being a movie star.

The closest thing I had to being a movie star, maybe, was that Indiana Jones quote that Ian said. And after the Wall Street Journal dubbed me the Indiana Jones of economics, I was at a cocktail party with my wife just a couple weeks later. I don’t think she knew that I was within earshot; she was talking to one of the other women. And this other woman was quite impressed at my newfound celebrity, and she said to my wife, “What does it feel like to be married to the Indiana Jones of economics?” And my wife said, “Indiana Jones? I think Jim Jones would be a better comparison.”(laughter)

Levitt: So let me tell you a story about a guy named John Szilagyi. John Szilagyi is a sort of gentleman that any business owner would want working at his or her company. He worked for the same organization for 40 years. He showed up at work on time; he did his job well. And, on top of that, he had one special thing: he actually had an idea. Now, one idea doesn’t sound like much, in 40 years. But if your idea’s a good idea, one idea is plenty. And John Szilagyi’s idea turned out to be very, very good.

So who is John Szilagyi? He actually worked for the U.S. government, the IRS, and he was a tax auditor. He sat in the basement of some building in Washington, DC, and he poured over his tax returns, looking for incongruities in the taxes. And he also had a fetish of sorts: There was one thing that drove John Szilagyi crazy, and that was when parents gave ridiculous names to their children. And the one that put him over the top was a family that had a daughter named Fluffy. And he said, “That’s just not right; parents shouldn’t be naming their children Fluffy.”

And he went to his bosses, and he said, “I’ve been looking at the 1040 tax forms that Americans fill out, and right next to the place where you list the name of all of your dependents, there’s some white space. Why don’t we ask for the social security number, the identification number of the dependents, as well. Well, his bosses said, “You know, we’re doing great the way we are. Why do we want to rock the boat? It’s so much trouble to change the tax forms. Let’s just keep on doing what we’re doing.”

2nd Annual Private Wealth Conference

Presentation Transcripts

Steven LevittCo-Author of bestselling business books Freakonomics & Super Freakonomics

Keynote Address

- 2 - 2nd Annual Private Wealth Conference

Steven Levitt

So nothing happened. And three or four years passed, and it turned out that this was in the early ‘80s, and then things got a little worse, and the demands just became louder and louder for the IRS to raise more revenue. And they asked around, “Does anyone have any ideas?” And John Szilagyi came forward again and he said, “Well, I had this old idea about the social security numbers on the tax form.” He had a new set of bosses. They were more ambitious; the times were tougher. And they went ahead and they went through the trouble to redo the tax forms, to hold the public hearings that were necessary in order to make those changes.

Now, on April 16, 1987, something truly amazing happened in the United States. It turned out that overnight, 7 million children vanished from the face of the earth. They disappeared without a trace. And it wasn’t the biggest kidnapping spree in history; it was one man and one man alone. And that was John Szilagyi, because it turns out that about 1 in 10 of all the children reported to the IRS by Americans were fabricated — were just made up in order to get the $250 deduction that you get in the United States per dependent off of your tax bill.

John Szilagyi’s incredibly simple idea ended up being worth something like $3 billion, $2 or $3 billion a year to the U.S. Treasury. And it wasn’t just once; it was really a perpetuity. These children disappeared forever. So, in present discounted value, this was a $20 billion idea.

Now, when I started looking into this, it just didn’t seem quite right. Was it really possible that Americans were so morally bankrupt that they were fabricating children? I mean, not just a few; we’re talking about 7 million children being fabricated. And I happened to be talking to my parents on the phone, explaining my latest research. And when my father confided to me that I myself had lost both a brother and a sister on that fateful night in 1987, I realized perhaps I was onto something.

Now, I’d like to talk about the John Szilagyi story, for two reasons: One is that, to an economist like myself, everything is about incentives. Any problem you face, it makes sense to start by thinking about the incentives of the people involved, and this is a good example. So you’ve got the incentives of people like my father, right? When the IRS has very low audit rates, and the punishments are low, then if you don’t have a strong moral compass, you might very well fabricate children on your tax form — completely predictable.

You’ve got the incentives of people like John Szilagyi’s bosses. They suffered from what an economist would call the “principal agent problem” — that if that $20 billion would go into their pockets, I’m sure they would have been much more aggressive, much quicker, to make the change and to put the social security numbers on the tax forms. But, because the money was going into the Treasury’s coffers, it wasn’t really that big a deal to them, and it was too much trouble; missing a few soccer games at home wasn’t worth the trouble of creating that money for the government.

It’s a huge problem in businesses. And, really, the fundamental problem, I think, in business is how you get people — employees — to behave in a way that’s consistent with what is in the best interest of the organization, as opposed to in their own private interest. People, in general, pursue their private interest — a very difficult problem to solve.

I didn’t really tell you the whole story about John Szilagyi. You might imagine that he would become a hero at the IRS, having had such a great idea. Certainly, he must have gotten a large bonus. It turns out, indeed, that he was turned down for a bonus that year at the IRS. You needed to maybe have a $200 billion idea, not a $20 billion idea, in order to get a bonus at the IRS.

When I talked to him after he retired, he was incredibly disgruntled and disappointed, because he didn’t care so much about the money, but what he expected — now, I don’t know what he expected — but he expected that when he would walk into the lunchroom at the IRS, people would stand up and clap for him and say what a great idea he’d had. And they didn’t do that. Nobody cared; he was completely anonymous.

And it really angered him, which I think is another interesting case of how, when people do great things, and we don’t recognize them right away, it often can backfire. But, certainly, within the IRS, it sends a strong message that innovation is not going to be an important part of your job, because the person who has the single-best idea they’ve had at the IRS in 50 years didn’t get rewarded.

The other thing about the Szilagyi story, which I think is even more important, is that it’s about an idea. And not a complex idea. I


Steven Levitt

think when people talk about ideas, they think about fancy things, like the theory of relativity or of gravity; ideas that people like you and I are never going to have. But those aren’t the most powerful ideas. To me, the very best ideas are the ones which are completely and utterly obvious, once someone raises them. And I think that’s a good example. When I say that he had the idea of putting social security numbers on the tax form, I imagine the response is, “Well, of course, you’d want to do that; it’s so obvious.” But, at the same time, there were 10,000, 20,000 people like John Szilagyi who looked at the same set of information, and it never occurred to them to have the same insight. It really was an insight.

But those are the hardest ones to find are those insights that are right there. I think the financial crisis is a great example. In the U.S., I cannot have a conversation without someone telling me how obvious it is that real estate prices were going to collapse; the whole housing market was going to collapse. And yet, nobody did anything about it; nobody saw it coming.

Oh, sure, it was obvious. And yet, somehow, all those signs — even look in the data — the signs were there, but nobody saw it coming. And it’s one of those things where, somehow, conventional wisdom is so blinding that we’re all busy and caught up in other things, and the world has become so complex, there’s so many things to think about, that we really just have, I think, become slaves — I know with me personally, there are things my mother told me, and my basic rule of thumb is if my mother told it to me, it must be true. And that’s in spite of the fact that every single piece of data I’ve ever gathered is that my mother just fabricated things right and left; they were completely wrong. And yet, somehow, deep in my soul, I go back to that as being the truth. And I think that’s a natural human inclination — to follow experts and to believe things rather than to think.

One of the great virtues of being an academic economist is that I have a job that has virtually no responsibilities. I teach at the University of Chicago, but my teaching obligation turns out to be 60 hours a year. It’s crazy. The American education system is completely crazy that they give me a job that requires 60 hours a year. And yet, the rest of the time, I’m free to do whatever I want. I come to Bermuda and play golf sometimes.

A lot of times, though, I do research. And the base of my research is thinking — simple ideas. And I probably spend — unlike the typical person — you know, I’d say the typical person spends something like maybe 5 to 10 minutes a week really thinking about ideas. And I don’t know whether you would be typical or atypical, but for me, I probably spend 10 to 20 times as much of my time trying to come up with ideas, and I’m not that good at it. As much time as I spend thinking, I have about 1 to 2 good ideas a year, I’d say. It’s a terrible return, in terms of — I’m sure many of you would be much more productive than me in idea generation, but I have the luxury of doing it. But the funny thing is, if you only have 1 or 2 good ideas a year, but you piled them up over a decade, well, it turns into a best-selling book. And that’s not a bad return on your investment, if you think about doing it.

Now, you can see from the trailer, and if you know my work at all, you know I study ridiculous things: cheating, sumo wrestlers. And I caught a bunch of Chicago public school teachers who were taking the forms of their students, the test forms, and they were erasing the answers and replacing them with the right ones, or in some cases, the wrong ones, depending on how good the teachers were, to try to not get into trouble for not teaching well. I’ve studied a crack cocaine-selling gang in Chicago and showed that, all in all, if you compare the crack gang and McDonald’s, they look a whole lot like one another. I’ve looked at how real estate agents rip off their clients in the United States by telling them to do the wrong thing, because their incentives, the incentives of the agents, are very different than the incentives of the clients.

Now, no youngster has as their dream to be the kind of economist I turned out to be. Not many have a dream to be an economist in general. But there are a few who dream of being — and I was one of them. I always wanted to be an economist. But I wanted to be a real economist. My idol, growing up, was Alan Greenspan. I wanted to be the kind of economist who, when I made a terrible mistake, markets were thrown into convulsions, and the world got turned upside down. But it turned out that reality sometimes intercedes, and you don’t end up being able to do what you want to do.

So how did I turn out be the economist that I was? Well, I wanted to be that real economist. But the most important thing to being an economist, it turns out, is being good at math. It’s a crazy thing. You might think that knowing something about the economy would be important. But they asked my colleagues — they did a survey — and only 2% of the academic economists said that knowing anything about the economy was important to success. And 70% said proficiency at math; that’s what you needed. Now, I knew


Steven Levitt

nothing about that when I went to be an economist.

And math proficiency is never something I’ve been accused of. It started in high school. I was in an honors calculus class. I still remember to this day, and vividly, because my teacher was one of these sadistic sorts of teachers, who when a student didn’t know the answer, instead of just letting it go, would just bully you and embarrass you over and over, trying to elicit the answer when there was no answer that was ever going to come. I’m scarred by this experience to the point where I still have nightmares of being bullied by this guy.

It’s not often that you get the chance to actually get back at sadistic people like that. In my case, I happily had the opportunity. It happened at my 20-year high school reunion. I’m not sure why, but this guy, Mr. Drexel, the teacher, he actually showed up to my reunion. He was not a young man; he had been in his ‘60s when he taught me, which put him in his ‘80s at the time of this reunion. And I thought, What can I do to get back at this guy?

Eventually, after cycling through various unsavory options that certainly would not have ended well, I decided I would do to him what my own students do so painfully to me. What my students do is- I’ll be at a restaurant or in the grocery store, and a former student will come up to me and will say, “Professor Levitt!” And a big smile on their face. And I’ll look at them, and as far as I can tell, I have never seen them before in my life. And I’ll say, “Oh, hi!” And it’s very awkward, and eventually, they understand that I have no idea who they are, but they’re pretty good sports about it, usually.

Eventually, we’re able to do some sort of fancy dance whereby I sort of half-pretend to know who they are, and they half-pretend to not be offended, and then we part ways. So I thought, I’m going to do that exact same thing to Mr. Drexel, except I’m just not going to let him off the hook at all. So I strolled up to him, and I said, “Mr. Drexel!” He looked at me completely blankly, just as I was sure he would. I was going to stand there as long as it took and just let him hang there. After two or three seconds, he started to smirk. I thought, Wait, what is he smirking about? This is not a smirking kind of occasion. And then he spoke, and he said, “Wait a second. Did you get a 2 on the Calculus AP exam?” And I said, “As a matter of fact, I did get a 2 on the Calculus AP exam.” He said, “That is the single-lowest score of any student I ever taught in my 45-year career at the school. I remember you!” And the memory of just how bad I was at calculus came flooding back to him.Well, I proved that 2 — which is really quite a low score — was no fluke when I showed up at Harvard as a freshman. They did a battery of tests to determine what classes you should take. The class that I was assigned to in mathematics was called Math 1A — the single-lowest class they offered at the university. And it’s the last math class I ever took. I was able to get an economics degree without doing any math. I went and worked in business for two or three, four years. And then one day I had this epiphany that I should go and be an academic economist. Now, I didn’t know what it meant to be an academic economist, clearly, but I applied to schools. And, for reasons I still don’t fully comprehend, I was admitted to MIT’s Ph.D. program in economics, probably the most technically rigorous economics Ph.D. in the world.

I’ve always believed in markets, and I had a lot of faith. I figured, if the people at MIT think I can do the job, I can do the job. I didn’t realize how completely and utterly wrong I was. And I showed up optimistic about this new career I was following. And that optimism might have lasted two or three minutes into the first lecture, as the professor scribbled these equations up on the board. And it had been, what, eight or nine years since I had been in a math class. But I did remember enough to know that when you saw a d in a math equation, that stood for a derivative.

The thing that was unsettling to me is that in these equations, there were regular d’s, and then there seemed to be these sort of script d’s. I had never seen a scripted d in a math equation before, so I just assumed it was bad penmanship, that the professor just had bad handwriting. So, in my notes, I just wrote down d, d, d, and I didn’t worry what kind of d it was. But the longer this lecture went on, the more nervous I got, because these regular d’s were always one on top the other, and this other d was always one on top the other. Finally, as hard as it was, and as much as I regretted having to do it, I broke down, and I turned to the guy next to me, and I said to him, “Hey, is there a difference between the straight d and the curly d?” And he turned back to me, and he simply said, “You are in so much trouble.”(laughter)

Levitt: And he was right; I was in so much trouble, because it turned out this curly d thing is what’s called a partial derivative.


Steven Levitt

Never heard of it; didn’t know such a thing existed. But if there’s any one thing that is central to economics, it is a partial derivative. And every other kid in the class knew exactly what it was; it’s second nature to them. I just didn’t even know what it was. And not just that, but day after day, every lecture, some new math concept I’d never heard of; I was just completely in over my head. It was obvious to me, to my peers, to the professors that I was in the wrong place at the wrong time.

Now, the thing that saved me were incentives, because it turns out, at MIT, because of the difficulties that they’ve had with — a lot of people do very poorly at MIT. As a consequence, compared to other places, they’ve made it very difficult to flunk students out. In order to flunk a student out, it requires a professor to spend an enormous amount of time documenting just how terrible this student is and pushing him across. But the thing is, economists aren’t self-interested. Every one of my professors, knowing they should have thrown me out of the program, instead took the easy way out and said, “I’m going to give him a terrible grade, give him a C-minus or a D-plus. I’m going to throw him over the wall to the next guy, and hopefully, the next guy won’t be as lazy as me, and he’ll kick him out.

So that’s how I managed my way to winter break at MIT. When I went home and pondered my fate, it was just clear I should be doing something different. But I really hated being a management consultant, and that’s what I did. I didn’t want to go back with my tail between my legs and do that again. So I came to my parents, and I said to my parents, “I’m in a real quandary. Do you have any advice?” And, interestingly, my father gave me the one and only inspirational speech that he’s ever given me, because my father was much more of the “cheat on your taxes” kind of father than the inspirational teaching kind of father.(laughter)

You’re not going to believe this story, but I promise you it is a true story. He says to me, “I faced the exact same kind of crossroads when I was your age.” So my dad’s a doctor; he’s a medical researcher. And after he had done his residency and his internship, he got invited to a very prestigious research fellowship in Boston, at one of the big Boston hospitals. And he showed up there, and about two months into it, this big shot in the field of medicine — this guy would eventually be the editor of the New England Journal of Medicine, which is one of the most prestigious jobs you can have in all of medicine — So his mentor calls my dad into his office, sits him down, and he says, “Levitt, I’m sorry to say, but you have no talent for medical research.” My father, of course, was horrified, but what is he going to do? The guy goes on then. He says, “But there’s one area of science which is so devoid of knowledge that I believe even someone with your severe limitation may be able to make a contribution.” And my father says, “Well, what area of medicine is that?” And the guy says, “Intestinal gas.”(laughter)

Levitt: Now, my father takes those words to heart. You’re not going to believe, but my father devotes his entire professional career to researching intestinal gas. He becomes the world’s foremost medical expert on the topic. And you think I’m joking, but when I was in high school, GQ — you know, the magazine — GQ actually did a two-page spread on my father. Big picture, and the headline reads, “The King of Farts.”(laughter)

Levitt: So here’s what my father says to me: He says, “Look, I had no talent. You have no talent. If you want to succeed in a profession for what you have no talent, the only hope you have is to take on a set of questions which are so embarrassing and degrading that no self-respecting member of the profession would want to have anything to do with it.”

And I thought about it, and I realized my dad was probably right. If I had any hope of success in economics, it was going to be by taking on the kinds of ridiculous and embarrassing questions that no real economist would want to do. The shocking thing is that I did that. I don’t know what is more embarrassing: that I had to follow a career like that or that you’re willing to sit in the audience and listen to the economy.(laughter)

Levitt: So, having made a career doing ridiculous things, I probably fell prey to the same kind of mistake as everybody — which is when you’re good at one thing, you start to think you’re good at everything. So, having done that, I thought, maybe I could use the


Steven Levitt

same sets of tools that allowed me to break the sumo wrestling cheating ring to answer real problems. And, I must say, the example that I’m going to talk about now — I’ve done a lot of things that people find offensive, and if you look at my books, you know what I’m talking about. I don’t want to sully the sponsors by mentioning some of the things I’ve done that will perhaps sully their reputation if people know the sorts of things I write about.

But the one issue where I really felt like I might have something to say, it turns out, maybe surprisingly, maybe wrongly, it was global warming. And global warming is such an important issue, and there’s so much uncertainty around exactly what’s happening and what the long-term implications will be. And that’s exactly why it’s such an important problem, because 50 years from now, the effects may be absolutely devastating, or they might not. And that kind of uncertainty is what makes it a question that I think is a good one.

The more I looked into — I’m not a climate scientist; don’t pretend to be a climate scientist — the more I looked into the issues, the more it became clear to me that climate science is kind of a strange thing in that it’s about half science and it’s half religion. The climate scientists get offended when you say that, but it really is a big part of religion, because it’s based a lot on faith and on a view of the world that humans have a place in the world, and they’re not doing the right thing.

And I don’t disagree. What I’ve tried to say is, Well, let me approach this differently. When I approach a problem it’s as an economist. Economists, essentially, don’t put a moral spin on things. But with climate science, we really do put a moral on it — we’re doing the wrong thing; we’re doing the wrong thing for our children. What I tried to do was say, what if I approach this problem looking at the science. I’m only a consumer of science; I never will produce any kind of knowledge about climates, right? Put that together with economics. Now, to put this into perspective, I was doing this research right before the Copenhagen meetings, which were going to be the momentous occasion in which the entire world came together and collectively changed the way we behave to reduce carbon emissions to save the world.

Being an economist, there were three things that struck me as being quite strange about the focus of climate scientists on reducing the amount of greenhouse gases that are emitted. The first thing is that it’s incredibly expensive. So the path that the climate scientists are advocating is reducing greenhouse gases. The estimates run about a trillion dollars a year, from now, every year in perpetuity. An incredibly expensive solution; a trillion dollars is a lot of money, and somebody’s got to pay for that, and it was never clear who was going to pay for it.

The second problem — that even the climate scientists will tell you; I mean, this is not like me making it up — the climate scientists will say that, even if we were to radically reduce our emission of greenhouse gases today, the temperature of the earth will continue to rise for about 50 years, because the half-life of carbon dioxide in the atmosphere is about a hundred years. We could do all the right things today, and the globe will continue to warm for 50 years, which doesn’t seem to me like a great solution, if your solution is trying to avoid global warming.

The third piece, which is the most obvious piece to an economist, is that there’s no way in the world — and I was saying this even in advance of Copenhagen — that you’re going to bring together governments and people and have them say, “Yes, we’re going to make tremendous sacrifices for the sake of the greater good, for the future generations.” It sounds wonderful, but I challenge you to look at any problem over the last 200 years that has been solved by humanity coming together and doing the right thing. I think that’s where the logic, where religion and climate science comes together; it’s a belief that if you tell the people the message, they will do the right thing. Especially in situations like this, where I’m one person out of 6 or 7 billion, it doesn’t really matter what I do; that’s not going to affect the problem. I pay all the costs of austerity, of doing the right thing, but I don’t get the benefit. It’s even worse if you think about the people of Bangladesh who are burning dung to survive. How persuasive is it going to be to them to say, “Look, we need you to burn less dung, so the Americans can feel good about the fact that global warming” — it’s just not going to happen.

And, just as one would predict, absolutely nothing came out of those meetings. Now, for two years, there has been no measureable impact at all to global warming. Everything that’s pushing towards global warming has gone unabated; despite many efforts, there seems to be nothing happening.


Steven Levitt

So is there another approach? The climate scientists at the time would say, “No. The only way we could do it is by reducing emissions.” But that was just part of the religion, because religion, they needed unity; they wanted everyone to believe that was the only answer, because they thought that’s the only way to make this happen. But, looking at the history of mankind in problem-solving, almost every problem we’ve solved, whether it’s a medical problem or — I’ll give you an example. If you go back to the end of the 1800s, in the United States and around the world — the problem is true in Bermuda as well — there was an incredibly pressing problem which was threatening to be the undoing of cities, of urban life. And it turns out that that problem, which nobody could see the answer to — there were international conferences being held, where they brought in all the experts and said, “How can we solve this problem, which will make it impossible for cities to exist?”

Well, it turned out the problem was horse manure, that horses were used extensively in cities. In cities like New York, the horse manure was piled up one to two feet deep. In fact, if you’ve been to New York City, the brownstones, the entrances to the brownstones are on the second floor, usually. That’s because there was so much horse manure that they wanted to enter on the second floor to get away from it. And people thought, if we project this out, growing cities and dead horse carcasses and whatnot, there’s just no way — the disease — it’s just terrible. Then, overnight, the problem disappeared, because someone invented cars. Once the car came along, the horse became unnecessary. And believe it or not, the car at that time was an amazing environmental improvement. Now cars are part of the problem that we’re trying to solve. But almost every problem we’ve ever faced in humanity has been solved by technology.

Polio is another example. There was a report put out by the U.S. government in the 1930s or ‘40s that projected that polio would consume up to 30 percent of the U.S. health budget in 40 years and that we were going to — basically, that was going to be the biggest and most important we faced in terms of healthcare. Well, it turned out that Salk and Sabin invented a vaccine, which now, for maybe 50 cents a person, eradicates polio, essentially. That innovation turned it from the thing that was going to absorb 30 percent of our health bill to something which was completely trivial. Those are just a few examples.

So the question is: With global warming, could technology, as opposed to behavior change — making humans alter the way they live their lives — could that be the answer? And it turns out that there are at least three — probably more — but at least three proposals on the table that real, highly respected scientists are almost certain could work to radically change the path of global warming, if we were willing to try that.

Now, this is where environmentalists go crazy, so if you’re an environmentalist, just bear with me. It’s going to sound crazy, but we’re at the same goal. I just want to make clear, a lot of people think, Well, this guy’s like some kind of hack who doesn’t believe in global warming. I’m not saying that; I’m just saying I think there’s a different solution.

So let me tell you the solutions that are out there. I’ll tell you the craziest one first, because then maybe I have a chance of winning your hearts and minds by the time I get to the third one. The craziest one is about — so it turns out that volcanoes provide a model for thinking about how to fight global warming. When really big volcanoes erupt, like Mount Pinatubo, which erupted in 1991, they spew sulfuric ash up into the stratosphere. And the sulfuric ash kind of turns into a haze, a sunscreen sort of thing, which reflects a bunch of the sun’s light before it can get into the atmosphere. So, after Mount Pinatubo, the temperature on the earth fell about 1, 2 degrees, for two or three years, until that ash finally fell down. When you get sulfuric ash way up in the stratosphere, it takes about two years to fall down.

So scientists said, Well, if we know that volcanoes can reduce the temperature of the earth, how could we mimic that, as humans? One possibility would be that you would detonate atomic bombs in various volcanoes from time to time around the planet, make them spew the ash up into the atmosphere.

But is there a better way? There’s, of course, a better way. You don’t want all the ash; all you want to do is get sulfur dioxide into the stratosphere. Right? And so, you hardly need any. It turns out that the amount of sulfur dioxide you need into the stratosphere, in order to reduce the temperature of the earth back to what it was in pre-industrial times, is as much sulfur dioxide as comes out of two garden hoses. So if you just turned a garden hose on full, let sulfur dioxide come out of it, into the stratosphere, and let it run, one to the North Pole, one to the South Pole, that’s all you need-according to scientific analysis- to put the temperature of the earth back to what it used to be.


Steven Levitt

So how do you do it? Well, these guys decided — these are real scientists — they decided that probably the simplest way to do it was, literally, to build a garden hose to the sky. So, using the kinds of products you could buy at the local hardware store — the kind of pumps you use in a swimming pool, and hoses — they got a patent on a ten-mile-long garden hose to the sky, which you, basically, put at a sulfur dump, and you just put it right up there. The total cost is about $100 million a year — not a trillion dollars a year, but $100 million a year to build this thing and maintain it — maybe $200 million a year. And they believe that you could just turn the spigot on and off and, essentially, control the temperature of the year. Nobody likes that idea, except for me. I’m the only guy — them and me are the only people who, apparently, like that idea. So they said, Well, okay. Environmentalist say, So what you’re talking about is the way to fight pollution and global warming is to pump pollution up into the atmosphere. And it makes people very nervous.

So they said, Well, here’s another way. There’s enough sulfur dioxide put out by big electric generators in China that if you just took two of those electric generators — you’ve got these big, long smokestacks. But if you actually made this smokestack run all the way up to the stratosphere, ten miles high — the problem is that if you put the stuff into the troposphere, it just falls right down as acid rain. But if you put it up into the stratosphere, it stays up for a really long time.

So, I said, What if we could find a way to build a smokestack that was ten miles high? All we’d have to do — the pollution is already being emitted — we just make the smokestack higher. And so they patented another patent, which was a big, long Mylar balloon, a hollow Mylar balloon that you attach to the smokestacks in China, and you just let the stuff that’s coming out of those smokestacks go all the way up to the stratosphere. That, by itself, would be enough to reverse global warming. But people hate that idea too.

So then they came up with a third idea, which, it’s the kind of thing that you might imagine an environmentalist would really like. Now, if you looked at a satellite picture of the globe, the oceans are very dark in color, and they also tend not to have very many clouds over them. So the fact that the oceans are dark is bad for global warming, because it means that they absorb a lot of heat. Dark things absorb heat; light things reflect heat. And the problem is that they’re absorbing too much heat and not reflecting it.

So the amount that we’re off, out of balance, is about 2%. If you could take the dark parts of the earth — the water — and cover them in clouds — which are light colored — that if you covered 3% of the ocean in clouds, that will reflect enough sunlight back that we could again go back to pre-industrial level of temperatures simply by having 3% more clouds over the ocean. I think most scientists agree that that’s true.

So the question is how to get clouds over oceans. Well, clouds don’t like to form over oceans, because clouds’ nuclei form around dust, and there’s not that much dust over the ocean, so that the clouds don’t form. But it turns out that salt also can be the basis of forming clouds. So the scientists have done some little experiments where they’ve shown that if you — basically, when boats go through the water, they throw up salt into the air, and those salts can form clouds. And, essentially, boats leave contrails.

So what they designed were some solar-powered dinghies which have GPS, and they putter around in the ocean. And they have a special thing in the back of them that sprays salt up in air so that they leave a nice big contrail. And you need about 10,000 of these boats, puttering around in the ocean, and they will leave enough contrails to cover 3% of the surface of the oceans. And for, again, about $100 or $200 million a year, we could reduce global warming. Or at least, essentially, what I’m talking about is buy 50 years of time to come up with other solutions along the way, while keeping the earth cool along the way.

The thing is, we believe this would work, but it’s never been tested — I don’t know why. I think governments are afraid to do it, and individual philanthropists have really shied away. So the total cost of doing an experiment which would tell us whether this technology for spraying clouds up in the sky was viable would be maybe $2 or $3 million — maybe $5, $10 million. It would, essentially, be an insurance policy on the future of the earth. If, at some point, we really became desperate and needed to cool the earth, we would know that we had a technology which, maybe not perfect, but that could do it, and do it in a hurry, because basically, we could cool the temperature of the earth in a couple months, if we had these dinghies up and running.

And, yet, these scientists have had virtually no luck getting any funding, and I think it’s because they’re violating the dogma of their own profession, which is that the only way to fight global warming is through behavior change.


Steven Levitt

So let me use that as a strange transition to talk a little bit about philanthropy, because as I began studying global warming, and I began getting to know these scientists, I thought two things: Number one, it would be trivial to find philanthropists who would like to have on their résumé that they did the $10 million-experiment that saved the world. Saving the world for $10 million seems like a really good deal to me.

As I began to work with these scientists to try to raise some money, I realized how completely and utterly wrong I was, that I didn’t understand philanthropy at all. It got me really looking into the entire production of charity. It shocked me when I really started thinking about how inefficient, I think, the current production of charitable goods is, in a couple ways. So let me hit on a couple of those.

The first is that foundations have a really strange model. Most big foundations are started, and their idea is that they should live in perpetuity. So someone takes a really big pot of money, and they put it aside, and they say, “We’re going to spend 5% of it a year, and we’re going to try to maintain the capital.” And the people charged with maintaining the capital are an army of bureaucrats who, as time goes on, view their job as how to perpetuate the foundation. Actually, the history of foundations is really sad one. In many cases, what always happens with foundations as well is that they typically start somewhat right-leaning, and they always end up way, way, way to the left. So now, more and more, what you’re seeing among those same foundations is mandatory liquidation after 30, 40 years, in order to avoid the bureaucrats taking over.

But, if you think about it, how would you run a business? Imagine a business. Imagine a business that said, “Here’s how we’re going to allocate our capital. What we’re going to do is every year, whether we have good investment opportunities or bad investment opportunities, we’re going to take exactly 5% of the capital we raise in the stock market, and we’re going to spend that. And the rest of it, we’re going to keep in the bank, trying to make sure that we never lose it. It’d be a terrible way to do business. You’d never to be able to go out and raise capital to do that. But why is it so attractive within the philanthropic space to run it like that?

The second thing which I think is crazy about philanthropy is that it’s taking on the world’s most important problems. Global warming, malaria — these problems are far more important, in many cases, than what regular old businesses — than what McDonald’s is doing. And, yet, there is a general belief that nobody should be paid to do it — paid well. If you want to work to solve the world’s problems, you should be paid one-third or one-fourth of what you’d be paid if you wanted to go work finance. How does that make any sense? It seems to be you want to allocate the world’s best talent to the world’s best problems. But somehow that just absolutely never happens.

The third problem is that the people who therefore go into running non-profits are true believers — the people who have faith, who are driven by other motivations. To my mind, those are exactly the wrong kind of people to try to solve problems, because they’re absolutely uninterested in evidence. I’ve been approached, like, 20 or 30 times by various non-profits, and they say, “We want to work with you.” And I said, “That’s great. I think the first thing we should start to do, by doing, is to actually determine whether or not your programs are making a difference.”

And they say, “We know our programs are making a difference.” And I say, “How?” They say, “This gentleman told me this,” or “I saw this child do this.” And I said, “Well, great. If we already know that it’s working, then it should be no hardship to go out and now let’s prove, using the kind of methods I’ve used before, that you’re really making a difference.” And I say, “You know, it’ll be wonderful.” And they always say no, because they can’t intellectually — emotionally, they can’t bear the risk of finding out that what they’ve spent their life doing isn’t working. They’d rather spend their lives, I find — most of the people who run charities — doing something that doesn’t matter than finding out that they’ve spent half their life doing something didn’t matter and go over and try to do something that does matter.

As a consequence, I think it’s — as a donor, as someone who’s trying to think about how to allocate your charitable dollars, it’s an incredibly hard problem, because there’s very little ability to ever know whether your money mattered. What I think people do is they allocate money according to things that feel right. It seems like a good idea, intuitively thinking. And I believe that the best charities, if they could really prove — adopt in a way that businesses do — evidence that things are working, it will completely change the nature of donors. So, if I’m a donor, and I can get a weekly report, a monthly report that says, “We’ve really, truly changed lives, and we can prove it to you,” that makes me want to give a lot more money than in the current system, where I give the money, and I have no idea; I just hope. But from the perspective of the wealthy, I don’t know what the answer is right now, because there’s nothing


Steven Levitt

out there that really gives you that kind of guidance.

So, with that in mind, I and a handful of people I know decided we could really make a difference, that we were going to start a company called The Greatest Good — we have started a company called The Greatest Good — which was going to work with philanthropists to try to identify the biggest problems, the ones that could be solved- to come up with creative, John Szilagyi-like solutions for how to solve this problem, and then work either with existing NGOs, or whoever it would be, to try to do this. And we had such high hopes, the same kind of high hopes I had when I showed up at MIT — again, completely not understanding anything about the problem that I was tackling. And I should have known better — — because the whole theme of this talk has been about kind of how technology and ideas matter and changing people’s behavior is almost impossible.

So, a year later, we have not convinced a single philanthropist of the wisdom of what we want to say. We’ve completely and utterly failed at the idea of changing people’s behavior so that they think about the problem differently. I mean, the irony is that before I went to be an economist, I was that management consultant, and I hated it. In order to pay the bills for the 20 people we got working, we realized that we might have to do some management consulting while we worked to build up the philanthropy part of the business.

What’s crazy is that when I go and talk to really, really rich, successful businessmen, and I give them my pitch about philanthropy. It’s now happened three or four times where they’ve said, “Now, the stuff in philanthropy is all fine, but did you say you do some business consulting?” And I say, “Yeah. “Now, that’s what I really need.” I’ve managed to find four really big, successful companies to work at management consulting on, but the deal is always, “If you can make me another million or two on my company, then we’ll start talking about philanthropy.”

The last thing I’ll say about philanthropy, my biggest moment, where I thought I was going to have a breakthrough, is when Bill Gates came to Chicago. He was visiting UC, and incredibly, he called me and said, “I want to talk to you” — something I never thought would happen — “I want to talk to you about education” — I was working in education. We ended up spending two hours talking about philanthropy. I thought, Bill Gates, of all people, I’ll be able to convince of the wisdom of what I’m talking about. We talked, and I gave him my spiel, and I felt like we were really making headway. Finally, towards the end of the conversation, I thought I’d made — I made all the same points I made to you. And I said, “So explain to me, when Steve Ballmer” — who runs Microsoft now — “when he has a good year, Microsoft has a good year, you pay him, what, $10, $20 million. When the person who runs your foundation, if they eliminate malaria, how much do you pay them?” And he said, “$100,000.” And, “Look, isn’t solving malaria a bigger deal than making Microsoft profitable?” And he looked at me, after two hours, and he said, “But it’s a non-profit.”(laughter)

Levitt: And I thought, Man, I’m really barking up the wrong tree here. If I can’t even convince Bill Gates of this, I’ve got no hope. So, on that low note, let me invite Ian up here to see if there are any questions. I guess the guys already passed on the questions; you either handed them in or not. But if you want to write down questions now, look, I’ll take — you can tell, I’ll take questions on anything. You can ask me real economic questions, and I’ll be terrible on those. But if I can fake it with the — I can fake it like any economist can, when it comes to real economic questions.

Truran: Well, certainly, thank you, Steve, for some what I’ll call unconventional thoughts, but very thought-provoking ideas. Hopefully, we all take that and apply it to the way that we do business or the way we do our personal affairs. I thought I would actually start off with one of the questions. I certainly don’t want to take the whole question-and-answer period, so I invite some questions to come forward. But last evening we talked about your research regarding incentivizing students and/or teachers to perform better. And, certainly, Bermuda, just like many other countries right now, is faced with challenges with regards to the education system. What advice could you give us, based on some of your research that you’ve done, with regards to thinking differently or perhaps approaching it differently?

Levitt: That’s a hard question. But let me start by saying that there’s no doubt that education is, essentially, probably the most important thing that society can do. And the idea that equality of opportunity, the idea that anybody can rise up, and if they’re talented and work hard, be successful is something that unifies all countries that have been successful. In the U.S., I think far worse


Steven Levitt

than Bermuda, we have struggled with public education. It’s really abysmal now what the inner cities of the U.S., what their school systems are. Graduation rates from high school in Chicago public schools: about 40%, 45%. And, in the modern economy, not having a high school degree is just an economic death sentence; there’s no question about that.

So, as we looked at — so one of the things that — because the only reason I’ve been — if I’ve failed in philanthropy, I’ve doubly failed in education. But I’ll tell you what hasn’t worked, more than anything. Looking at the problem, if you talk to — I talk to my college students — or especially if you talk to young people, and you try to figure out their willingness to delay gratification — kind of their time around it — and I do it with children, with a simple thing, where I say —

I show them a piece of candy, like a candy bar. And I’ll say, “Now, I have a candy bar. I’ll give you this candy bar now. Or, if you want, I’m going to be here again tomorrow; I’ll give you two candy bars. Or I’ll be here in a week; I’ll give you two candy bars.” And it’s a way of figuring out how much people are willing to give up good things today to get good things in the future. And it is amazing to me, whether you’re talking to 8-year-olds or the 18-year-olds who sit in my class, how many of them prefer the candy bar today than two candy bars a week from now, many of them two candy bars tomorrow.

And you start thinking about that. With my students, my college students, I have to estimate that their discount rates are at least 50 to 100% a year, which basically, if you extend that out in the future means, whatever happens to them ten years from now, they just don’t care about at all; it just doesn’t matter to them. And, with that perspective, the thought was, what we want out of kids — I mean, school is about making sacrifices today for benefits in the future. And if you think they don’t care about the future, you think they aren’t going to make those sacrifices.

So the idea was: Could you give people more direct benefits today, in order to incentivize them to work harder in school? So the obvious way, if you’re an economist, you do it with financial incentives. And I’ve done it; my friend Roland Fryer’s done it. And it is but almost a complete failure. In the trailer to the FREAKONOMICS movie you saw, there’s a young African-American kid who said, “Fifty bucks? I’m going to get straight A’s.” Well, it turned out that guy got all C’s and D’s. He wanted to do better. He — you know, the money, et cetera — because we went in, and we did a program in his school, where we were offering $50 a month to kids who did well in school — not even well; they just had to do okay. But, anyway, he did terrible. And all the students did. We have a very minor impact if we spend a lot of money.

Even worse than incentives for kids are incentives for teachers. People have now spent something like $20 million in a study that my friend Roland Fryer did, in which they gave money to schools to incentivize teachers — no impact whatsoever.

The biggest bang we actually got, strangely, was in incentivizing parents. At this high school, these junior high kids, ninth-grade kids, we paid the parents if their kids did well in high school. And, actually, that worked better than paying the kids or the teachers. The parents of ninth graders, for $50, were willing to do something that made their kids do better.

And then, a lot of other things that made me believe that, ultimately, the answer to education, ironically, is not school — that we ask schools to do something which is impossible, which is to educate children who are coming from households where the parents care not at all about the future of those children. Ultimately, I think it is a question of parents, not of either children or of schools, and that if we want to change the educational system, it’s got to happen at home.

Unfortunately, governments have almost no ability to do anything to parents — kind of completely off the realm of what governments are allowed to do. I might imagine you with licensed parents. They license real estate agents, make people get a driver’s license. But anyone can be a parent, and they’re just allowed to do it. And once you do it, you kind of do it however you want, and nobody cares, as long as there’s not any marks, bruises, and stuff on the kids.

So what we’ve done — and we don’t know yet if it’s successful — is we’ve tried to find a substitute for parents, essentially. We’ve gone into the inner city community in Chicago, and we take the kids, and we put them in daycare — in a preschool we’re running — and we keep them for 10 hours a day, 12 months a year. And the idea is that we will, essentially, be substitute parents for them. We’ll try to just do the things that parents would normally do for kids that these parents aren’t doing very much of. And we’ll try to, as much as we can, stay with these kids throughout their entire life and see if it will work.


Steven Levitt

I don’t know if it will work or not. Six months into it, what we’ve found is that we’re making a big impact on their test scores, which a lot of other people have seen as well. The question is: Can you actually carry this out longer? And I don’t know. But I think that’s a tough question, and there are no simple magic bullets, I think. But a lot of people have been very interested in finding the answer.

Truran:Great. Thank you very much. There are a number of questions that actually pertain to something you’ve already talked about, which is the climate change. So, if you don’t mind, I’ll actually — I don’t mean to disrespectful to those that have asked, but there are some that actually aren’t any different, and just to try and mix it up a bit. This one question says: I see healthcare as a topic on your short bio. What incentives work to get people to buy in and do the right thing, that is, getting those most able to pay for those that can’t afford to pay their share?

Levitt: You don’t even want to get me started on healthcare. I’ll start with an anecdote, though. Before David Cameron got elected prime minister, I happened to be in England, and the Tories asked me if I would come down and talk to them about policy. I thought that was a really bad idea on their part, because I’m the last guy you want to talk about government policy. But it was a nice honor for me, so I did it.

So, Cameron strides into the room — really impressive guy. And this was at a time when they were sure they were going to win the election. Now, they always blew it by the end, but they were ahead of its time. He said, “We’re going to have a terrible budget problem, and I’m wondering what ideas you have for solving our budget problem.” I said, “Well, what share of your budget goes towards healthcare?” And it was some staggeringly large number; like 30 or 40% of the total British government budget goes for healthcare. I knew the answer; I was kind of setting a trap for him. I said, “So when I go to see a doctor in the U.K., how much do I pay?”

And beaming with pride, he said, “No British citizen will ever pay a penny for healthcare when I’m prime minister; it’s one of the most wonderful things in the world.” And I said, “Okay. Well, I do have a policy idea for you.” He said, “Oh, great. What is it?” I said, “I think that, after you become prime minister, you should pass a law that says whenever a British citizen goes to buy an automobile at a car place, they should never have to pay a pregnancy- they should get whatever car they want absolutely for free.” He said, “That’s ridiculous. That’s crazy!” I said, “Well, if it’s such a great model for healthcare, why wouldn’t it be a good model for buying cars as well?”

Now, he didn’t like that one bit, I would say. And this meeting was very short. He walked out two minutes later; he was really irritated. But it’s really the truth. It’s that, when you have a good — and think of healthcare as a good, just like food is and just like cars are — that is absorbing now in the U.S. something like 17% of GDP — if you don’t treat it like other market goods, you’re going to be in trouble.

And the problem in the U.S., and I suspect in Bermuda that it’s even worse, is that nobody is paying on the margin for the healthcare that they’re provided. It’s like a God-given right to have it, so people make lousy decisions about it. The decisions for individuals and for doctors, they get treatments where the costs are exorbitantly more than the benefits. But, because you don’t pay the costs, that’s okay; you just need the benefit to be above zero. And the doctors get caught up, and they have all the wrong incentives. And it just doesn’t work; it just doesn’t make sense.

Although morally, it feels wrong to talk about life as if it’s just another good, we make those kind of choices all the time. You all — we make trade-offs. You know, every time you get out of bed, you take the risk that something bad will happen. Right? But you take that risk, because it comes with it — are other good things. You can’t live life — life in bed wouldn’t be that much fun. So, we tool around in boats in the ocean, and that’s dangerous. We live in places where hurricanes can come and destroy where we live. It’s just we take those risks, because that’s part of life, and it’s just something we have to accept.

And the thing I always say to people is, there will come a time not too long from now when we’re going to have to make choices about whether or not we’re going to keep our grandmothers alive on life support at $80,000 a month or whether we’re going to pay for our kids to go to college. And those are not the kind of decisions people like to make, but they will be the decisions we do make.

Now, there’s nothing wrong with insurance. We should insure people, for catastrophe risk, for people who can’t afford it. But for everyday medical contingencies, it should be the case that — and I believe — is that, on the margin, we should each be paying


Steven Levitt

between maybe 20 and 50% of the cost, at a minimum. So, the thing — before Cameron walked out of the room, I did give him one policy. I said, “Here’s my view. How much do you spend per year on healthcare, per person?”

I don’t remember what the number was, but it was some large number, like £4,000 a year or something like that.” And I said, “What I think you should do is you should take every British citizen, and at the beginning of the year, you send them a check for £4,000. And you say, ‘This is the money we would have spent on your healthcare. You’re now responsible for your healthcare. You have to pay for all your healthcare, up to some level. If it gets really big, you can’t afford it, we’ll cover some of it. But, basically, now you’re responsible.’” I said, “One thing I’m pretty sure of is that the cost of providing healthcare in Britain will plunge.” Because when people have to pay their own bills, they’re going, “Heck, I’m not going to go do this procedure.” Or “If I got to go pay for my own MRI” — so MRIs should only cost about three or $400, but when you get them at the hospital, they cost between five and $10,000, because the hospital just jacks up the price that goes to insurance. But, anyway, there’d be a market. You know, create a market where people want to start providing goods at the marginal conservative it would dramatically reduce it. I think it could actually save the British government a ton of money, and I think the citizens would love it. Cameron thought it was the stupidest idea he ever heard, and then he walked out of the room, and that’s the last time I ever talked to him. So my failures mount.(laughter)

Levitt: Truran:Economist versus politician. Mark Jennings is asking, if we can, to make this the last question: Which alternative energy source do you believe will most influence oil use: wind, solar, coal, natural gas, water, nuclear, or electric cars? Do you believe oil prices will continue to rise as a result?

I think it’s a great question; I don’t have a great answer to it. I think that oil prices — I do not think they’ll continue to rise. I think when you got an asset which is there, and it’s cheap, in very large supply, that it’s hard to see why oil? — and there’s enormous substitutes. So, at about $80 per gallon, there are a bunch of different substitutes for oil. So I think, in the long run, oil shouldn’t be more than about $80 per gallon. You got these huge shale reserves up in Canada, and solar and wind, at about $80 to $100 per gallon, end up being good substitutes. So I think, in the long run, that’s good.

Now, what I would have said — and I still will say it, but it will never happen — is that the best involves nuclear, that we should really be investing in nuclear technology. But I think the Japanese thing is going to turn out that probably nobody’s going to get hurt. The four guys who were spraying the water on it are likely to get cancer. But other than that, I think there’ll be very few long-term health repercussions of what happened in Japan. But I think that there is something incredibly frightening to human beings about nuclear power, because it’s invisible, that you just don’t know what it’s doing to you, which will prevent it.

But I think, from an environmental and a fiscal perspective, nuclear power is absolutely the way to go. There are new kinds of nuclear power, which are much better than the other ones, which have never been built, because it’s hard to get them approved. I think the problems with solar and wind is they just are not that efficient. And, in fact, they’re not that good environmentally. Building these solar panels, actually, it turns out, uses tons of energy. So it’s not that good for global warming; it takes a long time to recoup the energy. And electric vehicles are a complete fantasy. There will never be electric vehicles. Hybrid vehicles are wonderful. I don’t have time to go into it, but hybrid vehicles and electric vehicles are fundamentally different technologies. There’s no doubt that all vehicles should be hybrid vehicles in the long run. The chance of there ever being an electric — in which electric vehicles are — is zero. There’s a million problems with batteries, with the rare earth. It wouldn’t solve any of the global warming problems; it’s just some sort of fantasy. I don’t know who’s putting it forth, I don’t know why it’s happening, but it sounds good, and it appeals to people because of that.

So if I can steal three minutes, I want to tell one last story, because I’ve told you all about my failures; I want to end with one story about a success, where I actually made a difference. And I was talking to a group of venture capitalists in Chicago, and one of them raised their hand and said, “Well, what are you working on now?” And it turned out that the thing I was working on at the time was a study of street prostitution in Chicago. And I was putting my trackers out on the street corners, out with clipboards, and they were writing down — every time a prostitute did a trick, they would write down the information on the trick.


Steven Levitt

And it turned out, the guy who asked the question was from out of town. And he had, through the Internet, arranged a, quote, “date” with an escort in Chicago that night. And she did her tricks out of her apartment, and it turns out, when he went to her apartment that night, sitting on the coffee table was a copy of FREAKONOMICS. And he said, “I just met that guy today, and you know what? He’s collecting data on prostitution in Chicago.”

So the next day, I get an E-mail, and it says, “Hi. I’m a high-priced call girl in the city of Chicago. And, through a mutual acquaintance of ours, I’ve learned that you’re collecting data on prostitutes in Chicago.” She said, “I have a PalmPilot with all of the information on all the clients I’ve ever served. Is that the kind of data you wanted to collect?” And I wrote her back and said, “Absolutely, that’s the kind of data I’m trying to collect.” And she said, “Let’s meet for brunch on Saturday and talk about exchanging the PalmPilot.” I said, “Great.”

Now, the problem is, I have a wife and four young kids, and I had to explain to my wife why I was going to have a brunch with a prostitute. I said, “I swear to God, she called me, not vice versa; it’s just about the PalmPilot.” So we went and met a fascinating woman. Turns out she’s got a college degree; she’d worked on the Star Wars missile defense program. She was making $80,000 a year as the computer programmer in the city of Chicago, when she decided that being a call girl would be a better occupation for her. She quit her job, used her computer programming skills to make a Web page, and within two or three months, she was up and running, and she was working about 10 to 15 hours a week, and making two to $300,000 a year. And she could not have been happier about how her career had changed.

So we talked for about 10 or 15 minutes about the data, and then here we are at brunch, and so we resolved it. And I’m thinking, My God, I’ve got 30 more minutes to sit and talk with her. I’m pretty socially awkward to begin with, and what am I going to talk to her about? So, it turns out, because we wrote this FREAKONOMICS book and we were, quote, “business experts,” a lot of CEOs were calling me. So I had had the opportunity to sit with CEOs and ask them a bunch of questions. And I figured, well, I’ll just ask her the same questions I ask the CEOs about her business, and maybe I’ll learn something — at least I’ll kill the time until I can get out of here.

And it turns out she actually was wonderfully insightful about her industry, better than most of the CEOs I talked with; I felt like she understood what she was doing better than most CEOs. I finally tripped her up, though, because the hardest problems for most businesses is pricing — how to get prices right. And I asked her, “How do you choose your price?” And she said, “Well, I had no idea what to price, so I just went out on the Internet, and I saw a lot of other women were charging $300 an hour, so I decided to charge $300 an hour too.”

But that drives an economist crazy, because if there’s one thing economists know how to do is to set prices. We have this rule called the inverse elasticity of demand rule, and if you know the elasticity of demand, and you know your marginal costs, you know exactly what prices are. It doesn’t matter what your competitors are charging; you’re supposed to price according to this rule. So I thought, Could I come up with a question that would help me figure out if she was pricing correctly?

I knew she had a dedicated phone line that only her clients called her on. I said, “How do you feel when the phone rings?” And she said, “Well, you know, I’m kind of indifferent; I don’t really care whether the phone rings or not.” I said, “My God, I mean, you’re a local monopolist; you have a downward-sloping demand curve. That means that if you could charge the same price for the n+1 unit that you charge for the nth unit, you would absolutely want to sell more units. I mean, you’re telling me you’re indifferent; you can’t possibly be charging a high-enough price.

She looked at me, totally befuddled, no idea what I was talking about. But, look, I wasn’t there to maximize the profits; I was just trying to get her PalmPilot. So, we parted ways, and I thought that was it. But I teach at the University of Chicago; the few cases where I’m actually teaching, I teach a course on the economics of crime. And I decided, since I was studying prostitution, I should add a new lecture about the subject. And I tried to — it’s hard to write a good lecture, and I was struggling; I didn’t know that much about it, and it was incredibly frustrating.

And then I had this epiphany, a John Szilagyi kind of moment, in which I said, “I should just have this prostitute come and teach the class for me. I mean, she knows a lot more about the business than I do.” And I called her on the phone. I said, “How would you like to come and guest-lecture for my class?” She said, “Oh, you know, I’m a very private person, and I’m a terrible public speaker. I could never do that.” Well, I know a lot about economists and enough about prostitutes to know that we share one important feature in


Steven Levitt

common, which is, there’s no “can’t”; it’s just, “How much are you going to pay me?” You just got to figure out the right price. And so I said, “Well, what if I pay your hourly wage to teach my class?” She goes, “Oh, oh, I misunderstood.”(laughter)

Levitt: “For my hourly wage, I would be delighted. Just name the time, and I’ll come down and do it.” Anyway, she comes down, and she teaches my class; it turns out to be an unbelievably great lecture. I asked my students; a third of them said that it was the single-best lecture they saw in their four years at the University of Chicago, which is a sad statement about what me and my colleagues are doing in the classroom, but I think not inaccurate.

So, after she lectures, we do Q&A, and one of the students raises his hand, he says, “How much do you charge?” She said, “I charge $400 an hour.” Okay. And I become irate, because in the bargaining, I tried to be delicate, and I said, Well, I’d pay her her hourly wage, which I knew to be $300 an hour. And I thought we had some kind of relationship going, but then I realized that she’s just a total liar, and she’s lying to the students. She’s saying “I charge $400 an hour” just to get an extra hundred bucks out of me.

And it’s not like this is coming out of some grant. I can’t go to the National Science Foundation and say, “Well, I’m too lazy to teach my own class, so I hired a prostitute. I’m going to need you to pay for it.” So, I said — I’m thinking, $400. I’m thinking, I got to go get another $100 and pay for this, and I’m absolutely fuming.

And the next student raises her hand, and she says, “Well, how did you decide how much to charge?” And she turns to me, and she’s got this big, beaming smile on her face, and she says, “Well, you know, the very first time that I was with Professor Levitt” — she says, “The very first time that I was with Professor Levitt, he convinced me my services were far more valuable than the $300 I was charging. And I raised my price to $400, and it has been the best business decision I ever made.” Well, I don’t know, I haven’t been able to help with philanthropy or education, but if any of you know a prostitute, send her my way; I got dialed in when it comes to prostitutes. Thank you very much.(appluase)

Truran: Certainly, thank you, Steve, for some thought-provoking — hopefully, we will be able to utilize thinking differently today. We may not focus on prostitution and things, but I certainly encourage you to take some of the ideas that Steve has put out today, think differently about the way that we do business. Certainly, as you listen to today’s presentations, think differently about the way that it’s being presented to you, all the ideas that are being presented. Be willing to challenge them and have some healthy discussion about them. So thank you very much again. Thank you, Steve. We’re going to take a 15-minute break, and we’ll rejoin back in the room, where we’ll have our open-panel discussion. Thank you.

steven levitt.keynote address.2nd annual private wealth conference.bermuda

Economy & Finance