Theory vs. Practice: Does Fiscal Policy Crowd Out Business Investment during Crises?
DOI:
https://doi.org/10.47611/jsrhs.v10i4.2066Keywords:
fiscal policy, crowding out, recession, business investment, south koreaAbstract
In 2020, the South Korean government aimed to mitigate the socio-economic impact of the COVID-19 pandemic by enacting a fiscal stimulus package worth 66.8 trillion won. Traditional economic theory warns that such deficit-financed expansionary fiscal policies can have the adverse effect of crowding out business investment, but the current literature is more divided: some argue that the crowding-out effect outweighs the multiplier effect of fiscal stimulus; some claim that the two effects cancel each other out; and others assert that the scale of crowding out is small, at least in recessions. It is important to study the existence and scale of crowding out during recessions to evaluate the soundness of fiscal policies as a countercyclical tool. Thus, this paper examines whether Korea’s fiscal policy crowded out business investment during two severe economic downturns: the “great recession” of 2008 and the “great lockdown” of 2020. The paper uses a cross-time case comparison of the two economic crises in the hopes of drawing generalizable conclusions for South Korea over time. The findings show that Korea’s facility investment continued to increase during the recent pandemic but decreased during the 2008 financial crisis. Was this due to crowding out? Further analysis suggests that the decrease in investment during the 2008 crisis was due to factors other than crowding out. Hence, the paper concludes that Korea’s fiscal responses to the two crises did not crowd out business investment and thus encourages the continued use of appropriately sized and targeted fiscal stimulus during recessions.
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