Crowding out (economics) facts for kids

Crowding out is a term used in economics. It happens when the government's actions make it harder for regular people and businesses to do certain things in the market. This usually means the government's activities take up resources or opportunities that others might have used.

Imagine a busy playground. If one big group (the government) suddenly takes up a lot of space or all the swings, it leaves less room for other kids (businesses and individuals) to play. That's a bit like how crowding out works in the economy.

What Is Crowding Out?

Crowding out happens when the government increases its spending or borrows a lot of money. When the government needs more money, it often borrows it by selling special bonds. These bonds are like IOUs that promise to pay back the money with interest.

How Government Spending Affects the Market

When the government borrows a lot, it creates a high demand for money. This can push up interest rates. Higher interest rates mean it costs more for businesses to borrow money to build new factories or for families to get loans for homes or cars. Because it's more expensive to borrow, businesses might decide not to expand, and people might put off big purchases. In this way, the government's borrowing "crowds out" private borrowing and investment.

Why Does the Government Borrow Money?

Governments borrow money for many reasons. They might need to pay for big projects like building new roads or schools. They also borrow to cover their expenses if they spend more than they collect in taxes. Sometimes, they borrow to help the economy during tough times, like a recession.

Types of Crowding Out

There are a few ways crowding out can happen:

• Financial Crowding Out: This is the most common type. It happens when government borrowing leads to higher interest rates, making it harder for private businesses and people to borrow money.
• Resource Crowding Out: Sometimes, the government might use up a lot of a specific resource, like skilled workers or certain materials. This can make those resources more expensive or harder for private companies to get, affecting their ability to produce goods or services.
• Psychological Crowding Out: This is less direct. If people believe the government is going to take over a certain area of the economy, private businesses might be less willing to invest there. They might worry about competing with the government or that their efforts won't be profitable.

Examples of Crowding Out

To understand crowding out better, let's look at some simple examples.

Government Borrowing and Interest Rates

Imagine there's a limited amount of money available for borrowing in a country. If the government decides to borrow a huge amount to fund a new space program, it will compete with businesses and individuals who also want to borrow. This high demand for money can cause banks to raise their interest rates.

• Before Crowding Out: A small business wants to borrow money at 5% interest to buy new machines.
• After Government Borrowing: The government borrows a lot, interest rates go up to 7%. Now, the small business might decide the new machines are too expensive, and they don't buy them. The government's borrowing has "crowded out" the business's investment.

Government Projects and Resources

Let's say the government starts a massive project to build a new high-speed rail system across the country. This project will need a lot of construction workers, engineers, and building materials like steel and concrete.

• Impact on Private Companies: Private construction companies might find it harder to hire workers or buy materials because the government project is using so much of them. This can make it more expensive for private companies to build homes or offices, or it might even delay their projects.

Is Crowding Out Always Bad?

Not necessarily. While crowding out can reduce private investment, government spending can also have benefits. For example, if the government invests in education or infrastructure (like roads and bridges), it can help the economy grow in the long run. These investments can make businesses more productive and create new opportunities.

The main debate among economists is whether the benefits of government spending outweigh the negative effects of crowding out. It often depends on what the government spends money on and the current state of the economy.

See also

In Spanish: Efecto desplazamiento para niños