<< Chapter < Page Chapter >> Page >

By the end of this section, you will be able to:

  • Explain crowding out and its effect on physical capital investment
  • Explain the relationship between budget deficits and interest rates
  • Identify why economic growth is tied to investments in physical capital, human capital, and technology

The underpinnings of economic growth are investments in physical capital, human capital, and technology, all set in an economic environment where firms and individuals can react to the incentives provided by well-functioning markets and flexible prices. Government borrowing can reduce the financial capital available for private firms to invest in physical capital. But government spending can also encourage certain elements of long-term growth, such as spending on roads or water systems, on education, or on research and development that creates new technology.

Crowding out physical capital investment

A larger budget deficit will increase demand for financial capital. If private saving and the trade balance remain the same, then less financial capital will be available for private investment in physical capital    . When government borrowing soaks up available financial capital and leaves less for private investment in physical capital, the result is known as crowding out    .

To understand the potential impact of crowding out, consider the situation of the U.S. economy before the exceptional circumstances of the recession that started in late 2007. In 2005, for example, the budget deficit was roughly 4% of GDP. Private investment by firms in the U.S. economy has hovered in the range of 14% to 18% of GDP in recent decades. However, in any given year, roughly half of U.S. investment in physical capital just replaces machinery and equipment that has worn out or become technologically obsolete. Only about half represents an increase in the total quantity of physical capital in the economy. So investment in new physical capital in any year is about 7% to 9% of GDP. In this situation, even U.S. budget deficits in the range of 4% of GDP can potentially crowd out a substantial share of new investment spending. Conversely, a smaller budget deficit (or an increased budget surplus) increases the pool of financial capital available for private investment.

Visit this website to view the “U.S. Debt Clock.”

The patterns of U.S. budget deficits and private investment since 1980 are shown in [link] . If greater government deficits lead to less private investment in physical capital, and reduced government deficits or budget surpluses lead to more investment in physical capital, these two lines should move up and down at the same time. This pattern occurred in the late 1990s and early 2000s. The U.S. federal budget went from a deficit of 2.2% of GDP in 1995 to a budget surplus of 2.4% of GDP in 2000—a swing of 4.6% of GDP. From 1995 to 2000, private investment in physical capital rose from 15% to 18% of GDP—a rise of 3% of GDP. Then, when the U.S. government again started running budget deficits in the early 2000s, less financial capital became available for private investment, and the rate of private investment fell back to about 15% of GDP by 2003.

Questions & Answers

what is monopoly
Peter Reply
what is taxation
Peter
why do monopoly make excess profit in both long run and short run
Adeola Reply
because monopoly have no competitor on the market and they are price makers,therefore,they can easily increase the princes and produce small quantity of goods but still consumers will still buy....
Kennedy
how to identify a perfect market graph
Adeola Reply
what is the effect of scarce resources on producers
Phindu Reply
what is economic
Charles Reply
what are the type of economic
Charles
macroeconomics,microeconomics,positive economics and negative economics
Gladys
what are the factors of production
Gladys
process of production
Mutia
Basically factors of production are four (4) namely: 1. Entrepreneur 2. Capital 3. Labour and; 4. Land but there has been a new argument to include an addition one to the the numbers to 5 which is "Technology"
Elisha
what is land as a factor of production
Gladys
what is Economic
Abu
economics is how individuals bussiness and governments make the best decisions to get what they want and how these choices interact in the market
Nandisha
Economics as a social science, which studies human behaviour as a relationship between ends and scarce means, which have alternative uses.
Yhaar
Economics is a science which study human behaviour as a relationship between ends and scarce means
John
Economics is a social sciences which studies human behavior as a relationship between ends and scarce mean, which have alternative uses.....
Pintu
how will a country's population be equal to it's labour force
Hope Reply
what is the meaning of ppf
Obeng Reply
Production Possibility Frontier
Igbekele
What is Economic
Governor Reply
economic
Nwosu
Economics is the social science that deals with the unlimited human wants in the face of scarce (limited in supply) resources.
Azka
what is market
Gift Reply
marker is the interaction of buying and selling
David
market refers to the interaction of the processes of buying and selling of commodities between the buyer and the seller.
stephen
market is a place where two parties gather to facilitate exchange of goods and services.
Yhaar
what are some good sources of information to find trends in various Industries
James
how do on know that marketing is going on
Mutia
what is consumption
Raj
Using revenue
Prince
What is stock market
Prince
What are the marmet function
Odirile Reply
price elasticity of demand is the degree of responsiveness of a quantity demanded to the change in price of the commodity in question.
Gladys Reply
What does elasticity mean
Prince
Elasticity means change in demand with the change in price. It is elastic if the demand changes with the price change whereas it is inelastic if the demand is not affected due to change in price
Devesh
Okay
Olatunde
meaning
KP
okay
Binta
I have a question
Binta
what is the importance of learning economics?
Thelma Reply
it helps to make the correct choice
Gladys
it helps firm to produce products that will bring more profit
Gladys
the difference between needs and wants
londiwe Reply
needs are things that we basically can't live without wants are just luxury things
Thelma
needs are things without them we can't live but want are things without we can live
KP
what is education
KP
it's a process in which we give or receiving methodical instructions
Thelma
what is mixed economy
Amex
what is a deadweight loss? how monopoly creates a deadweight loss?
Ashraf Reply
who are u?
Lamine
haha
Cleaford
scarm
nura
what it this
Cleaford
hi y'all
Dope
how does group chat help y'all 🤔
Dope
hi y'all
Dope
how does group chat help y'all 🤔
Dope
how does group chat help y'all 🤔
Dope
to learn from one another
Lamine
oh okay
Dope
😟
Creative
Yes
Lamine
exactly
Adeola
what is type of economic
taiwo Reply

Get the best Principles of economics course in your pocket!





Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
Google Play and the Google Play logo are trademarks of Google Inc.

Notification Switch

Would you like to follow the 'Principles of economics' conversation and receive update notifications?

Ask