The Importance of Models

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David Brooks’ latest column has already been subjected to a lot of solid criticism, but I did want to highlight one thing he says which I think inadvertently illustrates why formal models are important and intuitive thinking about virtue won’t cut the mustard:

It all makes one doubt the wizardry of the economic surgeons and appreciate the old wisdom of common sense: simple regulations, low debt, high savings, hard work, few distortions. You don’t have to be a genius to come up with an economic policy like that.

Try to draw up a model—a simple one, but one where you do try to make sure that your numbers all add up—in which everyone has high savings rather than high debt. Households have high savings. Firms have high savings. The government has high savings. And the governments of your trading partners have high savings. But so do their citizens. And their firms, too. It’s the old wisdom of common sense! You’ll find that it doesn’t add up. Japanese people save by lending money to the Japanese government, which borrows. I borrow to buy a condo, and the money I’m borrowing is the money other people have saved in the bank. You put your money in the bank rather than leaving it under the mattress because the bank pays you interest. But they pay you interest because they can charge interest to other people—people who are in debt.

The old wisdom isn’t nutty or anything. Borrowing a ton of money so you can buy a fancy new car is probably a worse idea than buying a cheap used car and saving your money. But if you’re poor live in a city with bad mass transit and you borrow money to buy a cheap used car so you can make sure you’re on time for work every day, you’re making a prudent investment in your own future. Likewise, if you’ve got a successful store and you take out a loan to open a second location, you’re building the future of the American economy. Thriftiness is a good character trait because it tends to make people averse to accumulating debts for frivolous reasons. But if you try to build a systemic model, you’ll see that universal thrift doesn’t work at all.

Indeed, though thrifty people play an important role in making the economy function, they do so in part because their thrift creates resources that others can use to be venturesome and fuel innovation, entrepreneurship, and prosperity. Capitalist success stories are built on the ability and willingness of people to fail. For every hugely successful startup, you’ve got a dozen or more failures and behind those failures you’ve got bad loans. The willingness to issue those loans makes the world go ’round, and we need the savers because without them there’s no money to lend.