Taking Models Too Literally

At Cafe Hayek, Don Boudreaux points us to a wise quote from Milton Friedman.  Below is a comment I left on that post, expanded:

 

In the highly stylized world of models, where information is perfect, markets are costless, where all preferences are known, where government is costless, and things never change, it is trivially easy to come up with exceptions to free trade and free enterprise. Shift a curve here, refuse to count costs there, and boom! a theoretical reason why tariffs or export subsidies can be beneficial.

However, when those stylized assumptions are relaxed, in other words in a more realistic world where information is imperfect, markets have transaction costs, where preferences are revealed, where governments have administration and operation costs, and where things change, these theoretical reasons disappear like a shadow in the sun. Conversely, the case for unilateral free trade becomes stronger, since it is not dependent upon those assumptions the way the other theoretical cases are; free trade is formulated under those assumptions, yes, but it is robust to movements away. Things like optimal tariffs are formulated under those assumptions but are not robust to movements away from those assumptions.

The true test of any theory is not how well it holds up in perfect conditions, or how well does it perform in the circumstances in which it was conceived, but how robust it is to movements away from those idealized conditions.  Economists from Adam Smith to Harold Demsetz and beyond have warned us against these nirvana fallacies.  True knowledge is gained when we stress-test our models and see how robust they are.  Testing this robustness gave us such fields as Public Choice, Law & Economics, Political Economy, Money and Banking, and the like.

Economic models serve a purpose: they are ways of thinking, methods of analyzing phenomena. However, they are not descriptive of reality. They were never meant to be. When basing policy off of those models, the policy-proponents are making a grave mistake: they are moving their models away from the abstract and into the descriptive. In other words, they are taking their models too literally. This literal interpretation of models can be extremely dangerous.

11 thoughts on “Taking Models Too Literally

    • Craig

      Other than an assumption of authority that doesn’t actually exist, there is no basis for forcing you to pay income taxes, Perhaps you should ask that question of the people who are actually forcing you to pay income tax – a group that doesn’t include Jon.

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        • But you are not being forced by Jon to pay income taxes to support a navy, so you might consider rephrasing your question. Just because something exists doesn’t make Jon responsible for answering questions about it. It’s not clear what your complaint is.

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        • Short answer: I do not think government lacks the authority to levy taxes, either legally or morally. But, income taxes are a more complicated issue; those I do think government lacks moral authority to levy

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          • Thanks Jon. I remember that post, and I enjoyed the discussion immensely.

            I think your definition of taxation is a little too broad. If all voluntary and non-voluntary transactionsnts can be called taxation, then that would cover all exchanges from being mugged at gunpoint to paying for groceries at the store and everything in between. If I enter into an agreement to buy a car and make payments, then I can call my payments “taxes” because I have agreed that the seller has a right to them. I can say I’m “taxing” my employer in exchange for my labor.

            I think it might be clearer if we limit the concept of “taxation” to transactions that include some government entity as one of the participants – government being an institution that claims a monopoly on the use of force.

            From your July Post: ” Contracts contain provisions in case one person reneges on his deal. These are voluntary agreements that contain elements of force if certain conditions are not upheld. So, the existence of force is not in and of itself a sign that the agreement is involuntary.”

            Yes, That’s absolutely right. The thing is, the initial agreement is voluntary. Both parties expect to benefit from the contract, and mutual consent is present. That’s not the case with taxation by government where we are forced to pay for things we don’t want and haven’t agreed to pay for, and forced to pay for things for other people we don’t even know.

            Above, you have rejected the notion that government has the authority to tax incomes. What types of taxes do you believe ARE legitimate, and what makes them different so that coercion is OK?

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