Crowding-Out Effect in the European Union and Candidate Country Turkey: Panel Causality Analysis

Crowding-Out Effect in the European Union and Candidate Country Turkey: Panel Causality Analysis

Binhan Elif Yılmaz (İstanbul University, Turkey), Ferda Yerdelen Tatoğlu (İstanbul University, Turkey) and Sinan Ataer (İstanbul University, Turkey)
DOI: 10.4018/978-1-5225-2245-4.ch012
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The effects of the government investments and private sector investments on the production, is an important academic argument subject between the Neo-classical school and the Keynesian school. Subject to the financing way of the government sector investments, accruing possibility of private sector investments decreases and crowding-out effect occurs with the behaviours of government sector which restricting the investment area of private sector or changing the investments plans. On the other hand Keynesian economist suggest that the economy is not always in the full employment level. By the hand of Keynesian multiplier mechanism which is increasing the public expenditures and decreasing the taxes, private sector would enhance its investments and crowding-in effect occurs. In this study, we aimed to test the existence of crowding out/in effects of the public sector investments on the private investments in the European Union and a candidate country Turkey with the panel causality tests, over the period 1970-2014.
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Investments are in the center place of capital accumulation. Capital accumulation is the most important and the most strategical factor of the economic growth with a qualitatively and quantitatively sufficient population and technological development. Private sector investments are the essential determinant of long term economic growth and for the expansion of production capacity, from the point of view of Neo-Classical thought.

In the countries which adopted the mixed economy, both of public sector and private sector are each producers and consumers in the economic and social life and have their own decision and choice possibilities. These two sector sometimes became opponent for each other or sometimes became component of each other in their activities. Therefore, determining the relationship between public and private sectors as the most accurate form, measuring the effects of them on each other and maintain the relationship between these two sector in a regular way, are important in terms of economic growth.

There are positive effects of public sector investments on the private sector investments. Public investment expenditures are able to increase the productivity of private sector investments. Especially, implementing the important infrastructure investments by the hand of government is an “invitation” for the private sector investments. The investments of public sector which are directed to the Human capital have an effects on the increasing the factor productivity. By that way, a complementary relationship occurs between these two type of investment expenditures. In this case an increase in the public expenditures enables an increase in the private investments. Besides, public sector supplies the public goods which are not proper to leave to the hand of private sector as defense and justice services and generates important positive externalities.

The economic rationale behind most of these studies resides in the idea that public sector investment is confined, by and large; to those goods and services that the private sector investment will not produce in optimal amounts, because it is both hard to ration their use and benefits to paying customers (the free rider problem) and they are subject to substantial short-up costs. These public goods are subject to substantial start-up costs. These public goods are, nevertheless, of critical importance to the proper functioning of a market system because they tend to generate large and widespread spillover benefits (Ramirez, 1994: p. 6).

However, public sector investments may crowding-out private investments if the relationship between them is based on substitutability. Hence, the relationship between public sector investment and private sector’s productivity may provide additional information about the relationship between public spending and private investment.

According to Neo-Classical perspective, subject to the way of financing the public investment expenditures, increases in the government investments can occur a crowding-out effect on the private sector investments. This crowding-out effect realizes directly or indirectly. The increases in the taxes because of enhancing government investments, restrict the fiscal and physical sources of private sector investments. In that case there is a competition between public sector and private sector and direct crowding-out effect occurs.

As a results of implementation of public investment expenditures in the fields which are also the activity area of private sector, government investments will be subsidied and acting without efficiency. (Ramirez, 1994: p. 6). In the scope of producing competitive products with the private sector, crowding-out effect deepens.

If the government finance its investments by increasing the tax load of private sector, in the short and mid-term, will have the crowding-out effect on the private sector. (Buiter, 1997: p. 310).

In other words, crowding-out effect occurs if the private sector changes its investments plans as a result of expectations directed to increases in the taxes because of inefficient public investment expenditures. The high taxes which are necessary for the public expenditures make the private sector hesitant to take risks and broke its investments enthusiasm. (Gwatney, 1998: p. 3).

Key Terms in this Chapter

Income Effect: The effect that occurs after the obtaining of debts. People or governments act like their revenues increased but actually the debts create a tax burden on the next generations.

Private Sector Investment: This term explains in the classical thought, regular investments which are realized by the free market firms.

Fiscal policy: The policies that the government pursues to response economic fluctuations with the fiscal tools which are hold only by the government such as taxation, debt policy and government expenditures.

Tax Burden: The ratio of the taxes that paid to the government in a particular term and the revenues that earned in the same term.

Crowding-In: Crowding-in effects explains that if government spending increase, demand for goods and services increase. This situation causes a need for enhancing production capacity of private sector and private sector investments increases.

Public Investment Expenditure: This term explains the investment expenditures which are realized by the hand of government. This may be for public goods and services which the private sector does not bear or must not bear because of their positive externalities. But the expenditures may include investments for private goods or services which private sector has to product, but the government intends to product them by the hand of Public Economic Enterprises.

Ricardian Equivalence Hypothesis: This hypothesis is stated by Barro, it explains that for the rational human, there is no difference to finance the public expenditures by taxes or by debts. Because individuals know the debts mean taxes for their next generations so they save their money and sources for the time that debts return.

Crowding-Out: With contrast to crowding-in, in the crowding-out effect, government spending increases the interest rates for tax rates, at this point private sector firms do not enhance their investments, they increase their savings subject to the way of financing the public sector spending. These government spending may be investment, current or transfer spending.

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