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The Crowding-Out Myth

The argument that public investment invariably "crowds out" private capital is wrong both theoretically and empirically. States have always played a leading role in allocating capital, either through direct investments, or by deliberately encouraging certain types of private investment.

LONDON – 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 recognized exceptions are “public” goods such as street lighting, which private firms have no incentive to supply, and “essential” goods like defense 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. If the state were to substitute its own choices for such rational market-based allocations, it would “crowd out” higher-value activities, “pick losers,” and impede growth.

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