Economists are often criticized as academic theorists detached from the real world. To an extent this is valid, but economics without any theory would be useless. It is theory that enables us to organize useful insights from what we see in daily life into a coherent framework that allows us to explain still other things.
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 saw a heavily loaded truck pull away from a traffic light.
The left front corner periodically jerked upward several inches just as smoke poured from the exhaust.
Pointing that out, I asked him 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.
But someone needed to take a further step to explain this more generally.
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.
These ideas, that were only “theories” centuries ago, are among the most fundamental knowledge humans ever developed.
The universe depends on them. But they are not inherently obvious.
Yet once we understand them, we can apply these insights to solve new problems, like sending someone to the moon.
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.
Economists 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 trying to re-install a distributor, I once asked my crusty old mentor, “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, car engines drove fans directly.
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.
The old rule is useless.
That is like what some saw happening in the 1970s.
At that time, Keynesian policies to control an economy's output, employment and prices no longer seemed to work the way they had in the 1950s and ’60s.
The old theory no longer explained new circumstances.
Moreover, sometimes a valid theory has important exceptions.
Car fans pull air from front to back. But bulldozer fans blow air forward.
The reason is because bulldozers spill abrasive sand over the tops of their blades just ahead of the radiator.
Sucking this sand-laden air backward through the radiator would rapidly wear it away.
And dozers move so slowly that blowing against the slipstream is not an issue as it is with cars.
A mechanic who didn’t know this 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 turn out less.
But that isn’t always true for businesses that have very high fixed costs.
Why? Because 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, offshore fishing, horse racing tracks and myriad other businesses with high capital costs compared to operating ones.
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 wouldn’t improve our understanding of how our society and economy operate. We would be poorer over the long run than we need to be.
Economist Edward Lotterman teaches and writes in St. Paul, Minn. Write him at ed@edlotterman.com.
