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 does not inhibit long-run economic growth when government spending is focused on productive investments with positive externalities, the economy has spare capacity, and public debt levels are low. In contrast, crowding out impedes long-run economic growth when government spending is directed towards unproductive investments, public debt levels are high, and resource allocation is inefficient.

Step-by-step solution

Conditions for crowding out not inhibiting long-run economic growth

1. Public spending on productive investments: If government spending is directed towards productive investments that have positive externalities (e.g., education, infrastructure, research, and development), this could lead to an increase in the economy's long-term productive capacity, thereby countering the potential negative effects of crowding out. 2. Degree of spare capacity: If there is significant spare capacity in the economy, such as during a recession, the crowding out of private investment may not be as concerning. In this case, government spending can help utilize existing resources and potentially stimulate private investment as the economy recovers. 3. Low levels of public debt: If a country has low levels of public debt, it has more room to borrow and spend on productive investments without overly burdening future generations. In this case, crowding out may not hinder long-run economic growth, as the benefits of public investments could outweigh any negative effects on private investment.

Conditions for crowding out impeding long-run economic growth

1. Public spending on unproductive investments: If government spending is directed towards unproductive investments or is used for consumption purposes (e.g., transfer payments, subsidies), this will not contribute significantly to long-term productive capacity, thereby exacerbating the negative effects of crowding out. 2. High levels of public debt: If a country has high levels of public debt, increasing government spending is likely to lead to an increase in interest rates, which can crowd out private investment even more. This could result in long-term negative consequences for economic growth as resources are allocated away from the private sector. 3. Inefficient allocation of resources: Government spending may lead to inefficiencies in resource allocation due to political and bureaucratic processes, which could result in lower long-term economic growth. In this case, crowding out would reduce private investment in more productive uses. In summary, crowding out does not inhibit long-run economic growth when public spending is directed towards productive investments, the economy has spare capacity, and there are low levels of public debt. On the other hand, crowding out impedes long-run economic growth when government spending is allocated towards unproductive investments, there are high levels of public debt, and the allocation of resources is inefficient.