Question

Under what condition would crowding out not inhibit long-run economic growth? Under what condition would crowding out impede long-run economic growth?

Short answer

Crowding out would not inhibit long-run economic growth if the increase in government spending is directed towards productive public investments that boost the economy's productive capacity, compensating for or exceeding the decline in private investment. Crowding out would impede long-run economic growth if the increased government spending is directed towards unproductive or less productive public expenditures, leading to a decline in private investment without a compensating increase in productive public investment.

Step-by-step solution

Understand Crowding Out

Crowding out occurs when government spending increases, reducing private investment and consumption. This happens because the government's expenditure competes with private investment for funds in the capital market, thus leading to higher interest rates and reduced private spending. In the long run, this may affect the growth potential of the economy, as private investment is an essential driver of long-term economic growth.

Condition for Crowding Out NOT Inhibiting Long-Run Economic Growth

For crowding out to not inhibit long-run economic growth, the increase in government spending must be directed towards productive public investments that directly or indirectly boost the economy's productive capacity. These public investments could be in areas like infrastructure, education, or research and development. The condition for crowding out not to affect long-run economic growth can be stated as follows: The increase in government spending leads to higher productive public investments that compensate for or exceed the decline in private investment, resulting in a net positive effect on the economy's productive capacity and potential growth.

Condition for Crowding Out Impeding Long-Run Economic Growth

Crowding out would impede long-run economic growth if the increase in government spending is directed towards unproductive or less productive public expenditures and does not support the economy's productive capacity. In this case, the reduction in private investment caused by crowding out cannot be compensated by productive public investments. As a result, the economy's growth potential declines. The condition for crowding out to impede long-run economic growth can be stated as follows: The increase in government spending leads to a decline in private investment without a compensating increase in productive public investment, causing a net negative effect on the economy's productive capacity and potential growth. In summary, whether crowding out inhibits or does not affect long-run economic growth depends on the nature of government spending and how it impacts the economy's productive capacity.