I chuckle at frequent angry emails accusing me of being an economic theorist who knows nothing about the real world. As my colleagues and students know, I am about as un-theoretical as an economist can be. But I recognize that in economics, as in the sciences, theory is indispensable to gaining insights that place what we observe in daily life into some coherent framework.
A mechanical metaphor helps explain this. (Bear with me even if you are not a motor-head.) Once, while traveling with a mechanically minded adolescent, we watched a heavily loaded truck pull away, uphill, when a traffic light turned green. The driver-side front corner periodically jerked upward several inches just as black smoke poured from the exhaust. Pointing that out, I asked my young companion why.
I was pleased at his answer: “When a diesel engine has to pull hard, it smokes. And when the engine has to work hard, its torque twists the truck’s frame, making one front corner bend up and the other one down. But when the driver has to shift gears, it takes the load off the engine for a couple seconds and it stops smoking. At the same time the frame stops being bent.”
That smart kid recognized that two observable phenomena – the tip of a truck bumper jumping up and down in synch with a cyclically smoky exhaust – both stemmed from the same cause, a diesel engine working hard to move a heavy load faster.
The phenomenon of a hard-working engine twisting the frame in which it is mounted demonstrates Newton’s Third Law of Motion, that for every action there is an equal and opposite reaction. That a diesel smokes more on acceleration stems from Priestly and Lavoisier’s explanation of combustion as oxidation and other chemists’ proving that elements like carbon and oxygen react in very specific proportions.
Those “theories” are among the most fundamental knowledge humans ever developed. The universe depends on them. But they are not inherently obvious.
A similar process of finding general insights from observed reality is why economists can explain why too-rapid growth of the money supply causes the general price level to rise or why people buy less of something as the price rises. They can show how coupons for breakfast cereal, senior-citizen discounts at restaurants and lower airplane fares bought 14 days in advance all manifest the same process of maximizing profits by charging different prices to different customers with different “elasticities of demand.” Theorizing thus is as important to understanding how people behave as it is to understanding why the moon orbits the earth, truck frames bend and diesel fuel burns.
Continuing the metaphor, sometimes new circumstances arise that render old explanations useless. As a teenager learning from a crusty old master how to re-install a distributor, I once asked “just what way does this engine turn over anyway?” “If you can’t even remember that, look at the damned fan,” he replied.
Indeed, for decades a radiator fan was driven directly by a car’s engine, joining with the forward motion of the vehicle itself to move air through the radiator. A quick look at which way the fan blades were bent indicated which way the engine turned.
Nowadays, however, radiator fans in most cars are driven by electric motors and thus indicate nothing about direction of rotation of the engine itself.
That is like what some saw happening in the 1970s when Keynesian policies to control an economy’s output, employment and prices no longer seemed to work the way they had in the 1950s and 1960s. The old theory somehow no longer related to new circumstances.
And sometimes a valid theory has important exceptions. Automotive radiator fans pull air from front to back. But bulldozer fans blow air forward. That is because dozers often have abrasive sand spilling over the top of the blade immediately ahead of the radiator. Sucking this sand-laden air backward through the radiator would rapidly wear away the radiator’s soft brass tubes and fins. And, since they seldom move more than a couple miles per hour, acting in conjunction with airflow from the movement of the vehicle is irrelevant for dozers.
A mechanic who didn’t know this, as I didn’t when I first owned a bulldozer, would reach exactly the wrong conclusion by “looking at the damned fan.”
Similarly, economic theory explains why, as the price of a product drops, its producers usually make less. But that isn’t always true for businesses that have very high fixed costs, since they need cash for their high debt-service requirements and even low prices generally cover their variable costs.. Cut prices and such firms may not reduce output at all, at least not until they go out of business.
That is important if you want to understand managerial decisions in dairy farming, off-shore fishing, horse racing tracks and myriad other businesses with high capital costs. The general rule of supply, “price down, output down,” is not wrong, just incomplete.
It is easy to criticize theorizing as a useless waste of time. But without it we would not improve our understanding of how our society and economy operate. We would be poorer over the long run than we need to be.
© 2011 Edward Lotterman
Chanarambie Consulting, Inc.