Investment dollars need to be borrowed from somewhere. That comes from saving. So at any point of time, one can argue S=I. If at that instant of time, government suddenly decides to borrow more, the private sector will need to do with less.
However, we are concerned with the temporal movement of savings. That is how do savings S1 at time T1 change to savings S2 at time T2.
Suppose the govt decides to do nothing. There is an implosion in the economy. The govt did not borrow at time T1, yet because of the economic implosion, savings S2 at time T2 are 0 (for argument's sake), so the private sector can't borrow at time T2.
On the other hand, if the govt does something and the economy doesn't implode, savings S2 will be higher than in the scenario above. While there will be government borrowing, because of higher savings, the private sector too will be able to borrow something.
So basically, govt intervention should be such so that savings S2 at time T2 are higher than without government intervention.
1 comment:
I agree with your comments about M&A. If these studies are not adjusted for known factors driving returns, they are not valid. I read the stuff sometime back, will re-read and revert.
Thoughts on crowding out:
“So at any point of time, one can argue S=I. If at that instant of time, government suddenly decides to borrow more, the private sector will need to do with less. “
First, savings and investments are flows. So it is incorrect to say that saving = investment at “any point of time.” One can never say what is the saving/income/investment at time t(1). We can only make the following statement: saving = investment between t (2) –t (1).
Second, yes, S = I is an ex-post tautology over a period of time.
It is best to think of the crowding-out debate in terms of the ultimate resource: people
If people are unemployed, government will not bid away any workers from the private sector.
If people are fully employed, government will bid away workers from the private sector.
Investment can generate savings – can be self-funding overtime – in the presence of unemployment. Look at India’s savings experience, the rate rises in every boom.
Think of the argument in the following way: Government borrows X from the market. The process does not stop there but a chain of events starts. Govt. makes payments to some people to start the project. These guys will save some part based on their propensity to consume. Given a saving rate of say 30%, 30%*X is generated in funding in the first round itself. This chain continues. But there is one key assumption. The people to whom payments were made were not bid away from other projects, because if they were, there is no net addition to savings. In this case, only income (and therefore savings) lost elsewhere is compensated in the new project.
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