This blog is the eleventh in our series on the key concepts to consider when thinking about local economic growth policies. We’re using the series to test-drive a way of explaining concepts in economic growth that we hope to use in new training and resources. We are keen to hear from readers, particularly those in local and central government, about whether they find these useful and accessible, and if there are other topics you would like to see us cover.
What is crowding out?
Crowding out is what happens when increases in public spending (or more broadly ‘activity’) lead to a decrease of private sector activity.
Most often, you will hear “crowding out” used in discussions around macroeconomics – the economics of the entire national economy – where the frequent concern is that increase in public spending may crowd out private sector investment or spending. In this blog we discuss crowding out as it applies to local growth.
Crowding out at the local level can happen in different ways, but the basic idea is that increases in public sector spending may compete with and “crowd out” private sector spending in the same geographical area, to the detriment of the private sector. This happens when local supply of a good or service cannot respond to the increased demand from the public sector. As supply exceeds demand, prices rise and the private sector has to scale back its purchases.
Crucially, the problem arises because supply is unable to respond. This means that crowding out won’t usually be an issue for goods and services that are easy to buy and sell across space – public sector spending on computers isn’t likely to crowd out private sector spending. But when supply can’t respond, crowding out can happen. For example, to continue the IT example, if a local government agency decides to significantly expand its IT workforce employed locally, this will drive up wages for IT workers causing problems (crowding out) for private sector firms that want to employ these same IT workers.
Crowding out is not inevitable and the problems of crowding out may lessen once the market has time to respond (in our example, more IT workers might move to the local area). And sometimes public sector spending may ”crowd in” private sector investment. Public investment can crowd in private sector investment if it reduces risk or, in some other way, increases returns on private sector activity. For example, in regeneration projects, public sector investment may crowd in private sector investment by making investment in the area more appealing. This concept of crowding in is closely related to that of multipliers discussed in a previous blog.
In short: Assessing the overall impact of any public sector investment requires careful consideration of the knock-on effects on the private sector.
What is displacement?
Displacement occurs when the increase in activity in one area comes at the expense of other areas. At large spatial scales, policy might actively encourage displacement. For example, some levelling-up policies might aim to grow activity in the north of England at the expense of London and the South-East.
But displacement at smaller spatial scales is problematic. For example, enterprise zones – which offer support to business investment – can result in displacement from businesses just outside that zone relocating to be inside. Perhaps good for the zone, but in this case all that money spent on incentives makes no difference to the total number of jobs or firms in the local economy.
Another example can be targeted support to specific businesses, which can result in displacement if they end up taking market share away from other non-supported local businesses.
What is leakage?
Displacement is a form of leakage – where the effects of a policy spread (or leak) to impact individuals, businesses, or other targets which are not the intended target of the policy. While displacement is negative for other areas, multipliers (as covered in a previous blog) are often positive.
In spatial policy, leakage can mean the effects of an intervention designed to target a specific geographic area leaking out to impact other areas. There’s usually nothing that policy can do to prevent leakage, but it matters for who might win and lose from a policy.
Why do we need to think about crowding out, displacement and leakage?
These concepts all describe ways in which a policy intervention can have unintended consequences. Increasing public spending as part of a policy intervention runs the risk of crowding out private sector spending for the same goods or services. Specifying boundaries for where an intervention takes place runs the risk of businesses inside the boundary benefiting at the expense of businesses outside it. And any policy targeted at a specific population or area can see its effects more widely.
What to consider when thinking about crowding out, displacement and leakage?
As these concepts describe unintended consequences, it’s useful to assess them by thinking through the theory of change for what an intervention is trying to achieve. Consider the intended outcomes, and how crowding out, displacement or leakage might undermine or affect those outcomes. This requires a strong grasp of the economic logic of the intervention, and how local economies work. It is arguably one of the trickiest things to assess and quantify but crucial for understanding if a policy is likely to achieve its stated objectives.
Once a policy is in place, monitoring these effects requires collecting good data on the wider community, set of businesses, or wider area beyond the ones targeted by an intervention. If there might be crowding out, keeping an eye on local private sector activity in the sectors affected by increased public spending will be important. If displacement is a risk, monitoring the number and employment of businesses in the area outside of the intervention geography will help. For leakage, identifying where this is likely to happen, whether through supply chains or displacement, and monitoring the relevant data associated with this will help keep track of whether the effects are leaking to other areas or groups.
How can I learn more?
- Our previous blog in this series on supply and demand will be helpful for understanding the underlying logic governing risks around crowding out.
- Our logic models guide gives advice on how to think about the economic logic of an intervention – important for thinking about whether these unintended consequences might arise and how much of a problem that would be.
- Leakage is an important concept for proponents of sustainable tourism – this article explores leakage in tourism and why minimising it matters for destination countries.
- For more on displacement, you can read our blogs from last year exploring the concept in relation to the new investment zone programme.
The next blog in our understanding key concepts in local economic growth series is on tradable and non-tradable sectors. Sign up to our newsletter to get an update on our next blogs, briefings and events.