3.2.3.4 Displacement of Private Enterprise

Government spending can displace commercial activity in several ways:

  • It is funded by taxation, which reduces the money in the pockets of consumers and thereby reduces demand for goods and services.
  • Taxation also increases the costs of the commercial sector, thereby increasing the prices that companies need to charge and making them less competitive than similar companies in other countries.
  • When a government provides services with its own employees it competes for resources – labour, materials and finance – so that less of each is available to the commercial sector, which then has to pay higher prices. The relationship between supply, demand and market price is explained later (3.3.2).

These factors, taken together, mean that any increases in government spending can reduce the size and the competitiveness of the commercial sector – as well as reducing consumers’ ability to choose what they want to buy.

Arguments about the displacement of commercial activity largely cease to apply in a time of unemployment – when government spending uses spare capacity in the economy, creates jobs, creates demand for goods and services, reduces its unemployment costs and increases its tax income: a ‘Keynsian’ stimulus which can be a tool of macroeconomic policy, as described later (3.3.8.2).

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