What is Crowding Out of 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, economists call the result crowding out.

This argument does not claim that a government’s budget deficits will exactly shadow its national rate of private investment; after all, we must account for private saving and inflows of foreign financial investment.

The “crowding out” of private investment due to government borrowing to finance expenditures appears to have been suspended during the Great Recession. However, as the economy improves and interest rates rise, government borrowing may potentially create pressure on interest rates.