If there’s a central tension of modern economics, it’s the yawning gap between theoretic economic models and empirical economic reality.
Originally imported from the field of physics by the Dutch physicist-turned-economist Jan Tinbergen in the 1930s, economic models—discreet, algebraic formulas that represent economic relationships—soon began growing like weeds. Eventually they transformed economics from a science of verbal reasoning into a discipline dominated by Greek-lettered equations inscrutable to outsiders.
Perhaps the most famous economic model of the last few years belongs to French economist Thomas Piketty. His formulation r > g—reflecting his view that the long-run return on invested wealth (“r”) outpaces economic growth (“g”)—has been a target for critics of his influential 2014 study of the history of economic inequality, Capital in the 21st Century.
But those critics are missing the point, Piketty argues in a recent essay in the Journal of Economic Perspectives. While underscoring his belief that r > g plays a role in growing inequality, he notes that this is merely one aspect of his theory about the way inequality develops:
The role is relatively modest—as I believe the role of theory should generally be in the social sciences—and it should certainly not be exaggerated. Models can contribute to clarifying logical relationships between particular assumptions and conclusions but only by oversimplifying the real world to an extreme point. Models can play a useful role but only if one does not overestimate the meaning of this kind of abstract operation. All economic concepts, irrespective of how “scientific” they pretend to be, are intellectual constructions that are socially and historically determined, and which are often used to promote social views, values or interests.
This is something worth remembering the next time you’re perplexed by a complex-looking economic argument. Another thing to keep in mind is this succinct statement by the Nobel-winning economist Lars Peter Hansen, which he made on the terrific podcast EconTalk:
Models are always wrong. It seems kind of strange to hear that initially, but there is a sense in which models are simplifications; they are abstractions. And they are wrong.