CDS (I) 2021 General Knowledge · Question 4 of 120

Correct — A, Crowding in. The stem gives the direction plainly: government spending goes up and private investment goes up with it, induced by the public spending rather than squeezed by it. That is the crowding-in case. Two channels are usually named for it. The first is demand — in an economy with idle capacity, public spending raises incomes, sales pick up, and firms that had shelved projects find them worth doing after all. The second is infrastructure — a road, a port or a power line built with public money lowers the cost of private production along that corridor and makes investments profitable that were not profitable before. Both leave private capital formation higher than it would have been, which is precisely what the sentence describes. Note the two-word trap built into the option list: crowding in and crowding out sit next to each other and differ by one word, and they name opposite effects.

• (b)Deficit financing — Names how the extra spending is paid for, not what it does to private investment. Deficit financing is meeting expenditure that exceeds receipts by borrowing or by creating money; it is the cause side of the story, and it can end in crowding in or in crowding out.
• (c)Crowding out — The exact opposite effect, and the option most candidates lose the mark to. Crowding out is the contraction of private investment when government borrowing competes for the same pool of savings, pushes the interest rate up and makes private projects unviable. The stem says private investment increases, so this cannot be it.
• (d)Pumping out — Not a term in macroeconomics. The real phrase it plays on is pump priming — a modest injection of public spending meant to restart private demand — and even that names the government's action rather than the induced response.

Whether public spending adds to private investment or subtracts from it is one of the oldest arguments in macroeconomics, and the answer turns on how much spare capacity the economy has. With resources idle, extra public spending raises incomes and profitability and pulls private investment along — crowding in. With resources fully employed, the government's borrowing competes for a fixed pool of savings, raises the interest rate and deters private projects — crowding out. The composition of the spending matters too: capital expenditure that builds usable infrastructure crowds in more readily than revenue expenditure that does not.

CDS has now asked this pair from both ends, which makes them worth learning as one unit rather than two facts. Read the direction in the stem first — does private investment rise or fall — and only then pick the word. Anchoring to the 2021 exam, the crowding-in argument was central to Indian policy debate at that moment: the Union Budget presented weeks before this paper leaned heavily on public capital expenditure, on the stated expectation that it would revive private investment after the pandemic contraction. The claim is exactly the one this term names, and it has stayed at the centre of Indian budget commentary since.

• Crowding in is the rise in private investment induced by higher government spending.
• Crowding out is the fall in private investment caused by government borrowing raising the interest rate.
• Crowding in is more likely when the economy has spare capacity and when the spending builds infrastructure.
• Deficit financing describes how the gap between expenditure and receipts is met, not the effect on private investment.
• Pump priming is a limited public spending injection intended to revive private demand in a slowdown.

• Reading only the words 'government spending' and picking crowding out by reflex; the stem's direction is upward.
• Treating deficit financing, which is a method of funding, as if it were an effect on private investment.
• Being tempted by an invented term such as 'pumping out' because it resembles pump priming.

As a name-the-term item in either direction, or as a statements question on whether public capital expenditure raises or lowers private investment.

• practice — not a real PYQ

  Government borrowing that raises the rate of interest and thereby reduces private investment spending is described as

  • (a)crowding in
  • (b)crowding out
  • (c)deficit financing
  • (d)monetisation of the deficit

  Answer(b) crowding out — the borrowing competes with private borrowers for the same savings, credit becomes dearer, and marginal private projects are shelved.

• practice — not a real PYQ

  Crowding in is most likely to occur when

  • (a)the economy is operating at full employment of resources
  • (b)the economy has substantial unused capacity
  • (c)the government finances its spending entirely by raising taxes on firms
  • (d)the central bank simultaneously raises the policy rate sharply

  Answer(b) the economy has substantial unused capacity — with idle resources, extra public spending raises incomes and profitability instead of bidding scarce savings away from private borrowers.