The crowding-out effect is an economic theory that argues that increases in public sector spending lead to a decrease, and sometimes a cancellation, in private spending.
The main reason for crowding out is to reduce the government deficit; As the government borrows from the market to fill this deficit, the market demand for investment increases, the market currency value automatically increases, and interest rates rise.
The relationship between interest rates and lending is inverse, as once interest rates rise, demand for loans decreases, and vice versa. Once interest rates rise, the ability of merchants to borrow decreases, causing expansion and growth plans to stall, and the government sucks liquidity from the market, which has a huge impact.
The government borrows from the market by issuing bonds and guarantees, otherwise there are mandatory savings in the form of pension funds, etc. When these bonds are issued in the market people tend to invest in them; Due to its high credit rating compared to the private sector; They are less dangerous; What causes lower investment in the private market.
When governments finance infrastructure development projects, competition can take another form; This discourages private companies from operating in the same market area, making them unpopular, or even unprofitable, for the same purpose.
Governments are also raising tax rates, in which case individuals save less in the market; This reduces the money invested in the market, and the tax becomes money spent by the government on public spending. In other words, money is pumped from private market pockets into government coffers, while private entrepreneurs are left in the dark; Because when supply is less than demand, eventually prices will rise.
For more than a hundred years the effects of competition have been discussed in various forms, as capital was initially thought to be limited and confined to individual countries, and in fact so generally; Due to the decrease in the volume of international trade compared to today. In this context, increases in tax revenue for public works and public expenditures projects may be directly related to a decrease in the private spending capacity of a particular country due to the reduced availability of funds.
But many macroeconomic theories argue that the modern economy is operating far below its potential, which could allow government borrowing to actually increase demand by creating jobs; Thus stimulating private spending. This theory has gained popularity among economists in recent years, who note that during the Great Recession, massive federal spending on bonds and guarantees helped lower interest rates.
The effect of competition is not limited to the economic sphere, but extends to the sphere of social welfare. Competition can lead to social benefits, albeit indirectly; When governments raise taxes to introduce or expand welfare programs, individuals and businesses receive less discretionary income, resulting in less charitable giving. In this regard, spending on public sector welfare can reduce social welfare grants to the private sector, thus offsetting government spending.
The crowding-out effect may not have much effect on the market, or it may have no effect on the economy at all, and if the increase in government lending is not aggressive and the economic market conditions are good, the effect on private sector lending will be moderate and it can be said that government spending there Pros and cons to increasing government spending on the public good, but the private sector loses the deal.