Theory or Practice, Which Matters?

Theory or Practice, Which Matters?
STUDENT QUESTION:  I do understand that there is something special you get from experience that you cannot get from a book or class, but with classes having more hands on approaches can you think of something specific experience can give a person that pure education cannot?

MY RESPONSE: That’s an easy question. If one looks at the textbook, they will find that the textbook writer, a highly educated Ivy League Professor, David Colander, talks about economic theories as if they are all created approximately equal, except Keynesian Theory, which theory he really likes. Colander has probably forgotten more about various economic theories than most regular people have learned. And in my opinion, he is one of the best textbook writers I have ever read.

But here is the difference. I have found myself in the trenches with companies actually executing according to a  forecast that did not fit reality. When one is in the middle of a turbulent stream paddling for dear life, one does not worry about whether a theory may or may not apply, but whether you are paddling hard enough. When death and destruction try to muscle into your space, then you adapt to reality in ways that theory never prepared for or even contemplated.

Keynesian Economic Theory
Let’s apply this to reality. In the last 75 years the main concepts of Keynesian Economic Theory have been applied over and over again in the American economy starting with the Great Depression. Politicians who enjoy spending taxpayer’s money really like that Keynesian Economic Theory justifies big government and more or less unlimited  government spending. Yet an honest analysis of the last 75 years shows that Keynesian Theory does not work as advertised, has never worked in America, and therefore, to my small mind, will not work.

The latest example is the $800 billion stimulus bill advocated by President Obama which made it through Congress in early 2009. We were assured by the theory experts that passing the bill and thus applying economic theory would cause the unemployment rate to rapidly fall. Surprise, government spending did not work the way we were promised. Yet one prominent economist, Paul Krugman, (another highly-educated Ivy League Professor) called for a do-over, and said the reason it  did not work was that the package was too small and needed to be twice as large!

But who looks at history? No other economic theory justifies government spending like Keynesian Economic Theory and tenured professors in academia do not worry about their jobs or whether the theories work in reality, just that those theories work on paper. You know, econometrics, elegant curves, regression analysis,  and all that. And Keynesian Theory works quite well on paper.

It is just weird human behavior that we need to adjust, because IT IS NOT cooperating! So the next generation of students will learn Keynesian theory too, I suppose, and the madness continues!

Static Scoring versus Dynamic Scoring
That reminds me of another economic reality. If you want to increase economic activity, then lower tax rates. 100% of my students get that. But the government politicians refuse to study history and do not believe that an increase in economic activity is quickly followed by more government revenues, at lower tax rates. Four times out of four, (it has only been tried in America four times over the last 90 years) or 100% of the time, government revenues have grown with lower tax rates.

Works like a charm in practice, but not on paper. Why does it not work on paper? It is that pesky human behavior again, always changing by adjusting to new tax rates. This is because when we use paper, we use “static” scoring, but with lower tax rates, human behavior changes, so to capture this we must use “dynamic” scoring, which is lots harder and which thing the CBO (Congressional Budget Office) refuses to do.

Bottom line is that though there often is a wide gap between theory and practice, especially as regards economic theory, but unless one is motivated by results, one does not have to be concerned by whether the theory actually works in reality.



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