Does Public Spending Crowd Out Private Investment in Pakistan?

Abstract

This study examines whether public spending crowds out or crowds in private investment in Pakistan using the Auto Regressive Distributed Lag (ARDL) model over the period 1995–2025. The relationship between government expenditure and private investment is a key issue in macroeconomic policy, particularly in developing economies where fiscal policy plays a central role in promoting economic growth and development. While public spending can encourage private investment through infrastructure development and higher aggregate demand, the neoclassical view suggests that excessive government borrowing to finance expenditure may crowd out private investment by raising interest rates and reducing the availability of financial resources. The empirical findings reveal that government expenditure exerts a positive and statistically significant effect on private investment, indicating the presence of crowding-in effects in Pakistan. Tax revenue and trade openness also contribute positively to private investment. In contrast, public debt and inflation exhibit negative relationships with private investment, suggesting the existence of crowding-out pressures associated with debt-financed fiscal expansion and macroeconomic instability. The findings suggest that the impact of public spending on private investment depends largely on the composition and financing of expenditure rather than its aggregate size. Productive expenditures directed toward infrastructure and development projects appear to encourage private-sector investment, whereas excessive borrowing and inflation undermine investment incentives. The study recommends prioritizing development-oriented expenditure, improving fiscal discipline, and maintaining macroeconomic stability to promote sustainable private-sector growth in Pakistan.

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