Crowding out (economics)

In economics, crowding out is a phenomenon that occurs when increased government involvement in a sector of the market economy substantially affects the remainder of the market, either on the supply or demand side of the market.

One type frequently discussed is when expansionary fiscal policy involving deficit spending reduces investment spending by the private sector: An increase in government spending "crowds out" investment because the government's increased need to compete with the private stock and bond market for loanable/investable funds requires it to offer higher interest rates to obtain the additional funds, making the private market less attractive by comparison and thus drawing funds away from the private-sector investment spending for which it functions as a substitute from the perspective of investors. This basic analysis has been broadened to multiple channels that might leave total output little changed or even smaller.

Other economists use "crowding out" to refer to government providing a service or good that would otherwise be a business opportunity for private industry, and be subject only to the economic forces seen in voluntary exchange.

Behavioral economists and other social scientists also use "crowding out" to describe a downside of solutions based on private exchange: the crowding out of intrinsic motivation and prosocial norms in response to the financial incentives of voluntary market exchange.