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What is the history of ‘crowding out’, and how has it been used as a justification for austerity and state deflation? Why have governments kept turning to austerity and continue to justify it?
The idea of ‘crowding out’ has long been a central canon of pro-market economic theory. The concept was first promoted at a global conference in Brussels in 1920 to discuss ‘sound economic policy’ in the postwar years. Given limited capital, asked the British delegation, will ‘Governments or private industry’ use it more productively? ‘The answer is private industry’. This argument was then central to a strategy of state-imposed austerity through cuts in public spending and wages applied in Britain and elsewhere in the early 1920s. If the state had borrowed more to meet its postwar pledges on housing and education, it was asserted, more efficient private activity would have been ‘crowded out’. The measures, based on the idea of an automatic trade-off between state and private activity, were, simply sound economics based on fundamental laws. These ‘laws’ drew on the doctrines of the early classical economists that free markets and minimal state intervention would bring equilibrium, stability, and optimal growth.
Governments have repeated this strategy of austerity based on ‘crowding out’ theory in the early 1930s, 1970s, 1980s, and the 2010s. These episodes are marked by almost identical justifications and similar impacts. In 1979, Chancellor Geoffrey Howe told the House of Commons, we must ‘roll back the boundaries of the public sector… to leave room for commerce to prosper’. In June 2010, launching another programme of spending cuts, the Chancellor, George Osborne, repeated this claim that public spending ‘crowds out’ private endeavour. Again, the presumption was that a more robust economy requires more private and less state activity, alongside the counter-intuitive idea that austerity was the route to growth.
So, does the austerity/crowding out theory stand up? The doctrine has only been applied in situations of economic crisis, high unemployment, and inadequate demand. Even at full capacity, there is still a choice over the appropriate balance between public and private activity. In the 1920s and early 1930s, slamming on the public spending brakes proved counter-productive. It cut demand and slowed recovery, with private and public activity ‘crowded out’. The strategy had minimal effect on improving public finances, but led a retreate on social programmes, while unemployment never fell below one million in the inter-war years. A hundred years on, the Osborne cuts have had a very similar impact. In one estimate, public spending cuts were said to have shrunk the economy by £100 billion by the end of the 2010s. None of this means that crowding out never occurs, however. It just takes very different forms from those advanced in neoliberal thinking, ones which have been largely ignored by government and mainstream economists.
Three Forms of Crowding Out: Balancing Private and Public Activity, Extraction, and Inequality
First, the idea that markets know best in nearly all circumstances has shifted the balance between private and public activity too far in favour of the former. The simple notion—private good, public bad—has long been overplayed by neoliberal theorists. Both have a role to play and the issue is getting the right balance between the two. State spending plays a crucial role not just in meeting wider social goals, but in supporting economic dynamism and stability. Private corporations do not operate in a vacuum. The profits they make stem from a too-often unacknowledged reliance on wider society, including the state. Business provides jobs and livelihoods, while responding to consumer demand. Society provides the workforce, education, transport, multiple forms of inherited infrastructure, and often substantial state subsidies.
Second, an increasing share of private activity has been geared less to building economic strength than to boosting personal corporate rewards. Early economists, such as the influential Italian economist Vilfredo Pareto, warned—in 1896— of the distinction between ‘the production or transformation of economic goods’ and ‘the appropriation of goods produced by others.’ Such ‘extraction’ benefits capital owners—those who ‘have’ rather than ‘do’—and crowds out activity that could yield more productive and social value. It delivers excessive rewards to owners and executives at the expense of ordinary workers and local communities. Extraction has been a key driver of Britain’s low wage, low productivity, and growth-sapping economy.
Third, there is the impact of the return of ‘luxury capitalism’ and extreme opulence which has come at the expense of meeting essential material and social needs. Compared with the 1970s, a decade when inequality and poverty levels were at historic lows, poverty rates have nearly doubled, while the UK is one of the highest users of private jets, contributing a fifth of related emissions across Europe. In housing housebuilders and developers have sat on landbanks and consistently failed to meet the social housing targets laid down in planning permission. Instead of boosting the supply of affordable housing, scarce land and building resources have been steered to multi-million-pound super-luxury flats. In London, Manchester, and Birmingham, giant cranes deliver top end sky-high residential blocks, mostly bought by speculative overseas buyers and left empty. The richest thus crowd out the poorest.
These three alternative forms of crowding out have imposed sustained harm on social and economic resilience. Despite this, governments have continued to apply the austerity-based theory of crowding out. Its latest application (from 2010) has not delivered the declared goal of ‘crowding in’ through faster recovery and growth, or improved public finances. Britain is currently being subjected to yet another wave of austerity, with the 2022 Autumn Statement announcing a new package of higher taxes and lower public sector real wages. This is again in the name of fixing the public finances and boosting growth. It’s the same short-term, narrowly focussed strategy that, by digging the economy into a deeper hole and cutting public investment, has consistently failed since the British asked the question 100 years ago.