What if I told you that jumping off a cliff is entirely safe, except for gravity? Would you find my prediction insightful or useful? Strange as it may seem, this is precisely the kind of logic that underpins many of the models that economists build to help them understand the world -- and even to make policy recommendations on things such as financial regulation and inequality.
It's a serious flaw to which Stanford University finance professor Paul Pfleiderer has been trying to attract attention. As he argues in a recent paper, theorists make some pretty absurd assumptions to arrive at results or implications that are, in turn, relevant to policy. All too often, people -- including people involved in real policy matters -- ignore those assumptions and end up believing ridiculous things. After all, they've been demonstrated in an economic model....
There's nothing wrong with making assumptions -- even crazy ones -- to help get your mind around something. The deception comes in claiming that your conclusions have real-world relevance when the assumptions are nuts. Too frequently, Pfleiderer argues, economic theories are like chameleons that change their color to suit the moment. The chameleon hides its assumptions and makes bold claims, and then, when questioned, acknowledges its assumptions and says, “Hey, I’m only a model!”Bloomberg View
This trick of deception has now been enlisted in the debate over economic inequality, inspired by the phenomenon of Thomas Piketty's book "Capital in the 21st Century." Some economists have criticized Piketty's analysis of the drivers of inequality, saying that it might be just the consequence of simple things such as differences in personal patience (rich having more and the poor less) or random shocks to people's ability to earn over their lifetimes. Sniff their models more closely, and you may begin to smell chameleon....
Economists, Show Your Assumptions
Mark Buchanan
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