Crowding Out

Published Dec 26, 2022

Definition of Crowding Out

Crowding out is an economic concept that describes the decrease in private investment that results from an increase in government spending. That means when the government increases its spending, it competes with private investors for resources, such as capital and labor. As a result, private investment decreases, and the economy experiences a decrease in economic growth.

Example

To illustrate this, let’s look at an imaginary economy with two investors, John and Jane. John is a private investor who wants to build a new factory, and Jane is a government official who wants to build a new bridge. Both projects require the same amount of capital and labor. Now, if the government decides to fund Jane’s project, it will take away resources from John’s project. As a result, John’s project will not be able to proceed, and the economy will experience a decrease in private investment. This is an example of crowding out.

Why Crowding Out Matters

Crowding out is an important concept for understanding the effects of government spending on the economy. On the one hand, it shows that government spending can have a negative effect on economic growth. That means it is important for governments to be aware of this effect when deciding how much to spend. On the other hand, it also shows that private investment is an important factor for economic growth. Thus, it is important for governments to create an environment that encourages private investment.