BackDe-jargoned | Crowding in
It refers to increased government expenditure in infrastructure which then attracts private sector
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As the government is preparing to present the Union budget later this week, it is being argued that expenditure in areas such as infrastructure should be increased, even if it results in higher deficit. The reasoning is that increased government expenditure in the area of infrastructure will fuel the investment cycle which will then attract private sector to invest. This is also referred to as crowding in of private investment. “... A balance may need to be struck with targeted public investments, carefully identified and closely monitored, by public institutions with a modicum of proven capacity for efficiency, and confined to sectors with the greatest positive spillovers for the rest of the economy. These may then be able to crowd in greater private investment," noted the Mid-Year Economic Analysis 2014-15, put out by the finance ministry in December 2014. The government has committed to contain fiscal deficit at 4.1% of the gross domestic product (GDP) in the current fiscal and bring it down to 3.6% of GDP in the next fiscal.
What is it?
If the economic activity is weak, the government can increase expenditure, which will raise the level of demand in the economy. Higher demand will attract businesses to invest in capacity creation, which will lift the overall activity in the economy. For example, if the government increases investment in physical infrastructure in a significant way, it will raise demand for steel, cement and construction equipment, among other things. This will encourage businesses to build capacities to be able to profit from the opportunity. Meanwhile, demand for labour will generate employment and income, which will increase demand for consumption goods. Normally, this combination is expected to lift investment and economic activity, leading to higher GDP growth.
However, a large and sustained government deficit can also lead to crowding out of private investments. Simply put, higher deficit will result in higher borrowing by the government, which can put pressure on the available funds in the market.
Higher demand for funds by the government can lead to higher interest rates. Higher interest rates, in turn, can discourage private investments (see more about this on https://bit.ly/1zyEyBi). Therefore, it is extremely important that government intervention, if necessary, is measured and judicious.
The present case
We will know the government’s actual position on the subject in the budget, but economists in the finance ministry seem to be in favour of higher deficit in order to increase public investment. “…consideration should be given to address the neglect of public investment in the recent past and also review medium-term fiscal policy to find the fiscal space for it," said the above-mentioned report by the finance ministry. There is absolutely no dispute that more public investment is needed in both social and physical infrastructure. However, instead of running a higher deficit, the government would do well by rebalancing its budget in favour of investment.
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