OPINIONISTA: The crowding-out myth

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Three economic effects of Covid-19 seem to be generally agreed upon. First, the developed world is on the brink of a severe recession. Second, there will be no automatic V-shaped recovery. And third, governments will, therefore, need to ‘support’ national economies for an indefinite period. But, despite this consensus, little thought has been given to what private firms’ prolonged dependence on government support will mean for the relationship between the state and the capitalist economy.

The main obstacle to such thinking is the deeply entrenched notion that the state should not interfere with long-term capital allocation. Orthodox economic theory holds that public investment is bound to be less efficient than private capital. Applying an oversimplified logic then leads to the conclusion that practically all investment decisions should be left to the private sector.

The two generally recognised exceptions are “public” goods such as street lighting, which private firms have no incentive to supply, and “essential” goods like defence that must be kept under national control. In all other cases, the argument goes, the state should allow private enterprise to select investment projects in line with individual consumer preferences.

But the crowding-out argument is wrong both theoretically and empirically. First, it assumes that all resources in an economy are fully employed. In fact, most market economies normally have underemployment or spare capacity, meaning that public investment can “crowd in” resources that otherwise would be idle. This was John Maynard Keynes’s key argument, and it cannot be stressed often enough.

Second, the state has in practice always played a leading role in allocating capital, either through direct investments of its own or by deliberately encouraging certain types of private investment. For example, Toyota, which started out as a textile-machinery manufacturer, became a leading global automobile producer from the early 1960s onward with the help of

 

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