AIER: The Myth of the Crowding-Out Myth

Standard economic theory maintains that, in the absence of externalities, private investment works pretty well. Entrepreneurs tend to acquire the capital necessary to take on valuable projects because they stand to gain when those projects succeed and lose when those projects fail. Public investment, in contrast, is not subject to the same profit-and-loss mechanism. The relevant public sector decision makers have a hard time knowing whether a project is worth pursuing and have little incentive to act in accordance with that information when it is available.

If the resources required to take on various projects are scarce, we usually want the private sector to choose how those resources will be used. Private entrepreneurs will tend to ensure that resources are used to produce the most valuable goods and services in the least costly ways. Handing these investment decisions over to politicians is likely to result in less desirable projects. The more desirable projects that private entrepreneurs would have taken on will be “crowded out” by public sector investment.

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