Crowding-Out Effect

Posted by Lex, on July 16, 2010

 

What happens when the US government competes with private industry for capital?

No one’s really sure.

CrowdingOutEffect

When government borrows money, there is less money available for the private sector to invest in capital; this results in decreased economic output in the long run. Economists refer to this effect as crowding out. The red line shown above captures the most likely projection of debt as a percentage of GDP, incorporating crowding-out effects.

In the real world—where politicians are subject to political pressure, investors must compete with the government for capital, and citizens watch their government for cues before spending and investing—debt held by the public as a percentage of GDP skyrockets to 188 percent of GDP by 2027. From there, no one, not even CBO, can pretend to know where the economy will go.

Uncertainty has a depressing effect on the economy, since business leaders defer new investments in technology, capacity and hiring. The new UK government have created an austerity budget that will slash spending by $100b, a painful but necessary decision made in short order. In contrast, the Obama administration has punted its own debt reduction plan to a committee that will not report until after the mid-term elections, a purely political decision that extends any real efforts to come to grasp with mushrooming entitlement spending until at least 2011. This extends the uncertain economic environment and prolongs the effects of the recession on hiring, in particular. Payroll taxes are by far the largest contributor to the national fisc and unemployment benefits continue to drain the budget, a vicious cycle that has made a mockery of the president’s trillion dollar economic rescue plan. The money’s gone, the debt and interest remain on the books, and no one has a plan to pay for any of it.

Me, I’m thinking Krugerrands.

It’s going to be a rocky ride.

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Filed under Best of Neptunus Lex, by lex, Carroll "Lex" LeFon, Carroll LeFon, Lex, Politics and Culture

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