Crowding-out is a term used to describe the effect that government borrowing has on private investment. When a government borrows money, capital is diverted from private hands, thereby reducing the amount of loanable funds available to private investors. All else being equal, namely the money supply, this will cause interest rates to rise, discouraging firms from expanding their operations.
Crowding-out also occurs with other capital, such as labor or raw materials. When these are used or consumed by government, it follows that they cannot be employed by private actors. Everyone sees the effects of government spending, such as public works projects or a new bridge. What is not so easily recognized however, are examples of the “not seen,” which Frédéric Bastiat described in his essay “That Which Is Seen, and That Which Is Not Seen.” Because capital was used in the construction of a new bridge, it cannot be used to expand a nearby factory.
- Crowding out on Wikipedia