|
|
|
|
Crowding out (economics)
|
| |
|
| |
In economics, crowding out is any reductions in private consumption or investment that occurs because of an increase in government spending. If the increase in government spending is financed by a tax increase, the tax increase would tend to reduce private consumption. If instead the increase in government spending is not accompanied by a tax increase, government borrowing to finance the increased government spending would increase interest rates, leading to a reduction in private investment.
Discussion
Ask a question about 'Crowding out (economics)' Start a new discussion about 'Crowding out (economics)' Answer questions from other users |
Encyclopedia
In economics, crowding out is any reductions in private consumption or investment that occurs because of an increase in government spending. If the increase in government spending is financed by a tax increase, the tax increase would tend to reduce private consumption. If instead the increase in government spending is not accompanied by a tax increase, government borrowing to finance the increased government spending would increase interest rates, leading to a reduction in private investment. There is some controversy in modern macroeconomics on the subject, as different schools of economic thought differ on how households and financial markets would react to more government borrowing.
Theory
If increased borrowing leads to higher interest rates by creating a greater demand for money and loanable funds and hence a higher "price" (ceteris paribus), the private sector, which is sensitive to interest rates will likely reduce investment due to a lower rate of return. This is the investment that is crowded out. The weakening of fixed investment and other interest-sensitive expenditure counteracts to varying extents the expansionary effect of government deficits. More importantly, a fall in fixed investment by business can hurt long-term economic growth of the supply side, i.e., the growth of potential output.
However, this crowding-out effect is moderated by the fact that government spending expands the market for private-sector products through the multiplier and thus stimulates – or "crowds in" – fixed investment (via the "accelerator effect"). This accelerator effect is most important when business suffers from unused industrial capacity, i.e., during a serious recession or a depression.
Crowding out can, in principle, be avoided if the deficit is financed by simply printing money, but this carries concerns of accelerating inflation.
Crowding out of another sort (often referred to as international crowding out) may occur due to the prevalence of floating exchange rates, as demonstrated by the Mundell-Fleming model. Government borrowing leads to higher interest rates, which attract inflows of money on the capital account from foreign financial markets into the domestic currency (i.e., into assets denominated in that currency). Under floating exchange rates, that leads to appreciation of the exchange rate and thus the "crowding out" of domestic exports (which become more expensive to those using foreign currency). This counteracts the demand-promoting effects of government deficits but has no obvious negative effect on long-term economic growth.
In the United States during the late 1990s, another kind of crowding out of exports occurred: large increases in private fixed investment and consumer spending encouraged high interest rates, a high dollar exchange rate, and hurt exports.
Crowding out is most serious when an economy is already at potential output or full employment. Then the government's expansionary fiscal policy encourages increased prices, which lead to an increased demand for money. This in turn leads to higher interest rates (ceteris paribus) and crowds out interest-sensitive spending. At potential output, businesses are in no need of markets, so that there is no room for an accelerator effect. More directly, if the economy stays at full employment gross domestic product, any increase in government purchases shifts resources away the private sector. This phenomenon is sometimes called "real" crowding out.
The negative effects on long-term economic growth that occur when private fixed investment are crowded out can be moderated if the government uses its deficit to finance productive investment in education, basic research, and the like. The situation is made worse, of course, if the government wastes borrowed money.
Health economics
In terms of health economics, "crowding-out" refers to the phenomenon whereby new or expanded programs meant to cover the uninsured have the unintentional effect of prompting those already enrolled in private insurance to switch to the new program. This effect was seen, for example, in expansions to Medicaid and the State Children's Health Insurance Program (SCHIP) in the late 1990s. State subsidized programs offered better benefits at a lower cost to those who did not have very comprehensive private health insurance.
Crowd-out can also result from employers opting to drop coverage in response to new or expanded programs, so that children of employees will turn to state programs for their coverage.
Therefore, high takeup rates for new or expanded programs do not merely represent the previously uninsured, but also represents those who have shifted their health insurance from the private to the public sector. This means that costs incurred by the government could be much higher than expected, and healthcare improvements as a result of policy change may not be as robust.
Some strategies to combat the effect of crowding-out are to instate waiting periods, to limit eligibility to the uninsured, to subsidize employer-based insurance, or to apply a premium to families at higher levels of income eligibility. However, crowding-out may not be entirely negative, and may reflect the fact that the insurance that many low-wage employees receive is inadequate, and the state program would present an improvement to healthcare access.
See also
|
| |
|
|
