Unemployment does not make crowding out less likely.

It is a popular claim that crowding out won’t occur (or that it’s less likely) where there are significant unemployed resources.

For example Robert Skidelsky made this claim in an otherwise excellent Independent article.

The “crowding out won’t occur...” argument is usually something like, “given full employment, an increase in government sending can only come about given a reduction in private spending (i.e. crowding out of some sort)”. Well, that statement is true by definition, which makes it a near useless statement. It doesn’t explain anything about cause-effect relationships or “transmission mechanisms”. Which means that the desired cause-effect relationship might not actually work. Put another way, the above desired outcome (private spending declining so as to make room for public spending) might not occur.

Or to put it yet another way, the argument is usually something like, “given significant unemployment, crowding out won’t occur because all those unemployed resources are just waiting for a source of demand, like government borrow and spend, to bring said resources into productive use”. Again, there is nothing about cause or effect.

Crowding out is the following phenomenon. Government borrows more, which pushes up interest rates (or lending criteria become more restrictive) which in turn reduces private sector borrowing, which at worst means there is no net effect on spending.

Now that cause effect chain will work regardless of the number or volume of unemployed resources, seems to me. To illustrate, suppose five million immigrants suddenly arrive in some country, complete with necessary skills, capital equipment, etc., but without any money. The unemployment rate (and the incidence of unemployment for other resources, e.g. capital equipment) would shoot up. But what’s that got to do with the extent to which a bank makes things difficult for a private sector borrower because government has collared the relevant savings? Absolutely nothing !

Put another way, as the advocates of modern monetary theory (aka functional finance) have pointed out time and again, aggregate demand will be inadequate if the private sector thinks its net financial assets (i.e. savings) are inadequate. That inadequacy is not altered one iota by the arrival of the above five million immigrants.