Carolyn Kaster/AP Photo
President Joe Biden speaks about jobs during a visit to semiconductor manufacturer Wolfspeed, Inc., in Durham, North Carolina, March 28, 2023.
The remarkable changes in manufacturing construction over the past year, since the passage of two key Biden administration industrial-policy laws, is rapidly putting to rest a concept that has been embedded into the old understanding of the economy.
The concept is called “crowd-out,” and it asserts that increases in government involvement in a business sector lead to reductions in private spending in that sector. For decades in Washington, this was not just an economic theory but something of an iron law. The Penn Wharton Budget Model, which is heavily influential in Washington, maintains that any government investment will reduce private capital investment. The model continually rated Biden administration policies that directed public spending as reducing GDP and private productive capital.
Even government economic modelers regard government investment as wasteful by definition. As the Prospect noted in its special issue on economic modeling, the Congressional Budget Office explicitly assumes that public-sector investments are half as productive as investments in the private sector. If a private-sector investment returns 10 percent on an annual basis, public spending of the exact same amount is supposed to return 5 percent.
This was never a particularly robust theory. It’s rooted in biases about government waste and private-sector efficiency, and it neglects the perfectly reasonable concept that private businesses, seeing the interest from public-sector investment in a particular sector, will crowd into it, if only to earn some of the spoils of all that public money.
We are nearly a year into the passage of the Inflation Reduction Act, and we have enough evidence to render this theory, which created disadvantages for policymakers trying to direct public investment, as essentially wrong.
As the Treasury Department has pointed out, total manufacturing plant construction has doubled, and real spending on computer, electronics, and electrical manufacturing, which through CHIPS and the IRA is one of the most targeted areas for public investment, has almost quadrupled in a year, adjusted for the increase in construction costs. Deutsche Bank notes that 18 new semiconductor facilities started construction in the U.S. between 2021 and 2023. European leaders have pronounced themselves stunned by the loss of hydrogen production facilities to the U.S., because of the commitment to public investment through the IRA.
Manufacturing construction spending, as Council of Economic Advisers member Heather Boushey recently pointed out, is at a six-decade high.
Under the crowd-out theory, policies like the IRA and CHIPS are supposed to shrivel up private investment, because there is a fixed pool of capital and any government use of it leaves less for others. But yesterday, White House spokesperson Andrew Bates stated that $500 billion in private-sector investment has been created by the slate of industrial-policy bills, with most of that showing up today in plant fabrication. Analyst Jack Conness puts the number lower, at $227 billion, but that’s still quite substantial for such a short time frame.
The Treasury report notes that real overall nonresidential construction (which doesn’t just include manufacturing) has gone up by 15 percent from November 2021 to April 2023. “Real public spending, which increased by 7 percent, did not crowd out real private spending, which increased by nearly 20 percent,” the report states. Treasury saw the same dynamic in infrastructure construction, where public spending is up over 20 percent but real private spending has still kept up, up around 14 percent. As Treasury puts it: “Again, the legislation increased public spending but has not crowded out private spending.”
The Biden administration bought into crowding in from the beginning. They’re being proven prescient.
This is happening at a time when interest rates are increasing due to the Federal Reserve’s inflation-fighting, and at a time when working from home is depressing commercial real estate. Under classical analysis, that should be enough to depress private investment. Yet it’s hard to see that from the sums being thrown around. And if you believe, as many do, that we’re on the cusp of a manufacturing “supercycle,” then monetary conditions are secondary to the opportunity created by public investment.
“There is enough public money in play to incentivize the private companies to lean into the effort by taking advantage of subsidies, grants, and the enhanced profitability outlook created by these fiscal commitments,” said Stephanie Kelton, author and professor at Stony Brook University.
A few years ago, when Kelton was on the staff of the Senate Budget Committee, she tangled with a top analyst at CBO named Wendy Edelberg about this very question. “I said, ‘Walk me through the crowding out thing,’” she explained to me. “Her argument was, if the deficit increases then interest rates go up, and people know that future tax rates will be higher so they draw out of the labor force.”
“I said, ‘How do you allow for crowding-in effects from investment?’” Kelton continued. “She looked at me like I had three horns.” As Kelton told me yesterday, what she predicted previously “is exactly what we are seeing with the IRA and CHIPS.”
The Biden administration bought into crowding in from the beginning. They’re being proven prescient. The public investments are leveraging private money in a host of contexts. “Public dollars are attracting private dollars, not displacing them,” policy analyst and venture capitalist Nick Hanauer wrote for our special issue on models. The jury’s still out on whether the jobs this flurry of public investment will bring in will be good jobs, but it’s very clear that this level of investment works at a basic level to draw in more economic activity.
Not everyone agrees with this analysis if you extend it out across the entire economy. Jason Furman, former Obama administration official and economics professor at Harvard, notes that overall private fixed investment is down for three straight quarters and below trend from before the pandemic by 2 percent. He doesn’t see that as an argument against the policies. “I support the policies. But I did not expect them to net add to GDP or jobs, at least on a one- or two-year horizon, and I don’t believe there is much or any evidence they have,” Furman said. “I cannot think of a better example of crowd-out in action than the current macroeconomic experience.”
Of course, that is a macroeconomic outlook, and looking at the aggregate commingles with the shooting up of interest rates. Semiconductor and clean-energy companies are fighting through that to complement public investment in ways that other firms are not. Whether you agree with Furman depends on whether you see public investment pushing up interest rates through the Fed’s response, or whether you see inflation as resulting from other pandemic-related factors.
It’s unclear whether CBO and the other budget models will use this real-world test of their theories to make alterations. CBO didn’t respond to a request for comment.
The White House is rightly playing up these investments as part of its “Bidenomics” national tour, highlighting the job creation potential and the fact that Republican officeholders where some of these investments are located have now switched to support the outcomes of a law they opposed. But this aspect is potentially more significant.
If crowding out has truly been discredited, and the idea of crowding in seen as legitimate, then lawmakers will become more open to it. More importantly, the budgetary numbers that drive Washington policymaking will suddenly make it much easier to conduct industrial policy, because the penalty for public investment will begin to disappear.
That could mean that public investments and even public options for all sorts of activities will become more viable. It’s amazing what a little real-world evidence can do.
