191 – Crowding out

Crowding out is an economic theory that has been highly influential in Australia. It’s about situations where government tries to do things that would be better left to the private sector. Even if the governments do a good job, they may just displace equally good actions by private individuals. Here are some examples from the areas of health, agriculture and the environment.

On a recent visit to Canada I went for a walk in Johnson Canyon, near Banff. It was the day after Canada Day, and everyone was on holiday, with the result that the crowds were extraordinary. Here I was in a place of amazing beauty, which should have been promoting feelings of peace and restfulness, but I was crowded and jostled on all sides. If I’d known what it would be like, I’d have stayed away.

When governments intervene in the economy, they are so big they can be like a crowd on their own. They can have the same sort of effect on people as the crowds in Johnson Canyon had on me – making them decide not to do something positive they otherwise would have done.

For example, in Australia the Government provides free public health insurance. While this, no doubt, results in various benefits, it also crowds out investment in private health insurance, to at least some extent. Some people who would have invested in private health insurance make the judgment that it is not worth doing so when they can simply rely on the Government’s scheme.

Another example is public provision of agricultural extension. State governments in Australia used to provide a high level of extension support to farmers, primarily advice that helped the farmers enhance their production and profitability. In the last two decades, most states have greatly reduced their investment in this sort of support. Subsequently, there has been a substantial growth in the provision of private agricultural business consulting and technical consulting services to farmers, suggesting that these were being crowded out in the old days.

A third example (of a slightly different sort) is payments for provision of environmental services. Some have argued, for example, that paying farmers to do good things for the environment crowds out positive environmental behaviour that they would otherwise have done voluntarily. There is relatively little evidence for this, but Helena Clayton’s recently complete PhD at UWA shows that it is a realistic possibility in at least some cases.

Economists worry about crowding out because it can mean that we end up paying more overall for the same services. Even if governments were equally efficient and effective at delivering services as the private sector are, there are significant costs involved in running the tax system to collect revenue to spend on providing those services. Estimates of these costs of the tax system vary, but it may be that to spend $1 on providing a service, the government has to collect something like $1.20.

Add to that cost the realistic risk that governments might not be so efficient as the private sector at service provision, and there are pretty good reasons to avoid crowding out if possible. (In cases like health insurance, the social benefits might be judged to outweigh the loss of efficiency.)

In Australia, we have had National Competition Policy in place since 1995. A key aim of this policy is to force governments out of parts of the economy where they are perceived to be crowding out the private sector. Interestingly, the onus is put on governments to prove that they are not crowding out.

David Pannell, The University of Western Australia

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