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Subject Area: Political Theory
Topic: Progress

Federal Expenditures ‘Crowd Out’ Private Investment - Leonard P. Liggio, Literature of Liberty, Winter 1981, vol. 4, No. 4 [1981]

Edition used:

Literature of Liberty: A Review of Contemporary Liberal Thought was published first by the Cato Institute (1978-1979) and later by the Institute for Humane Studies (1980-1982) under the editorial direction of Leonard P. Liggio.

Part of: Literature of Liberty: A Review of Contemporary Liberal Thought, 20 vols. 19781-982

About Liberty Fund:

Liberty Fund, Inc. is a private, educational foundation established to encourage the study of the ideal of a society of free and responsible individuals.


Federal Expenditures ‘Crowd Out’ Private Investment

Richard J. Cebula, Christopher Carlos, and James V. Koch

  • Center for Study of Public Choice, Virginia Polytechnic Institute and State University

“The ‘Crowding Out’ Effect of Federal Government Outlay Decisions: An Empirical Note.” Public Choice 36,2(1981):329–336.

Does the evidence support the claim that government spending and expenditures “crowd out” or contract private spending? The authors seek to answer this much-debated question by extending the scope of Abrams' and Schmitz' 1978 study; they examine the crowding out effect of aggregate federal government spending decisions upon purchases of new physical capital by private firms. By limiting their analysis solely to private investment in new physical capital, they believe that they can highlight the economic implications of crowding out for long-term inflation and short-term unemployment that results from federal government expenditures. The authors employ mathematical and quantitative models to test their hypotheses.

The authors empirically studied crowding out by examining the proportion of GNP devoted to private investment in new physical capital as a function of the proportion of GNP devoted to federal outlays. They studied three alternative models, all of which displayed evidence of (a) a definite pattern in which government spending crowded out private investment and (b) only partial, i.e. incomplete crowding out. These findings are compatible with earlier studies.

Two important policy implications flow from these findings. First, increases in federal government outlays tend to diminish private-sector investment in new physical capital. To the degree that this kind of crowding out occurs, private sector unemployment is generated. This clearly acts to weaken the stimulatory direct effects of increased federal spending since it inhibits the private sector. Second, to the extent that federal government spending leads to diminished investment in new physical capital, this diminishes the rate of capital formation. This tends to worsen long-term inflation by cutting down on the ability of “aggregate productive capacity” to keep pace with “aggregate demand.”

These two implications cast grave doubts on the wisdom of the federal government's decisions to increase federal outlays in various kinds of spending programs.