In the context of economics, crowding out takes place when the resources which could have been used by the private sector for loans and investment are diminished because of increased spending on the government’s end.
There are different resources which could be used by the government to finance its spending. One of these is revenue from taxes. In this case, the private sector’s spending power is reduced because of an increase in taxes. The macroeconomic effect of this practice is relatively small compared to the usual alternative option.
If the government does not opt to increase taxes, the private sector’s access to investment options decreases due to government borrowing. When the government takes out loans, less capital is available to the private sector and interest rates increase. With increasing integration of the financial markets all over the world, interest rate increases may have an effect on where businesses choose to make their investments.
Governments’ credit ratings are considerably higher than those of regular companies, which makes it possible for them to secure huge loans easily. Therefore, crowding out puts many businesses at a disadvantage because it becomes more difficult for them to secure funds which may be necessary for helping them stay afloat.
Another possible alternative to crowding out is printing of more money to make up for the government’s deficit. However, this is not always a good option because increasing the money supply by printing more notes leads to inflation.
In some cases, the term crowding out is also used when the government provides a services or products which would usually be offered by private businesses.
