Programmed failure of US and Chinese economic stimulus plans: The 'absorption capacity barrier'

Despite impressive budgets, the two largest economic stimulus plans to date - those initiated by the governments of the United States and the People's Republic of China - are doomed to fail or at best to slightly soften the worst consequences of the current crisis. Beyond the very different characteristics of these two plans and economies, LEAP/E2020 anticipates that, in the next few months, their implementation will face an insurmountable obstacle in the short term, the “absorption capacity barrier”.

It a constraint that the European Union is familiar with, as it repeatedly faced it in the past twenty years, as a result of the increase of structural funds and the various enlargements. As in crossing the « sound barrier » in aviation, circumventing this obstacle requires the development of completely new procedures and methodologies whose implementation take many years. The European experience has shown that it takes time, lots of time in fact, to effectively spend hundreds of billions of Euros, Dollars or Yuans. But in the U.S. and Chinese cases, it is precisely the time that is lacking, thus ensuring that the economic stimulus plans will drift to two deadlock situations well-know to EU member States, i.e. waste and corruption on the one hand, unused funds on the other. In both cases the impact on growth will be null or even negative.

Before anticipating further the evolution of Washington’s and Beijing’s plans, LEAP/E2020’s team finds useful to review some European teachings as regards subsidies absorption capacity. As indeed, it is thanks to the European programmes, structural funds in the first place, then the PHARE programme and enlargement-related funds, that EU leaders and budget authorities discovered at the beginning of the 1990s the existence of this barrier related to a country’s capacity to absorb aids allocated to its economic development (1). If this awareness also rose in the framework of development aid programmes, it is within the EU that it was possible to realize that even rich and developed countries could prove incapable of using allocated funds (2). In the two concerned cases, US and China, it is this aspect that we deem relevant (3).

Budget amounts covered by the U.S. and Chinese plans are about three times higher than the European funds facing the absorption capacity barrier. Indeed, the American and Chinese stimulus plans are endowed with USD 785-billion and YUAN 4,000 billion, or EUR 577-billion and EUR 430-billion each in 2009-10. USD 288-billion of tax-reduction related to Obama’s plan must be withdrawn to get the exact amount of money distributed by US administrations and agencies, i.e. EUR 365-billion. On a yearly basis, the available amounts correspond to EUR 182-billion for Washington and EUR 215-billion for Beijing.

By way of comparison, EU member states today receive a European co-financing for an amount of EUR 347-billion allocated on the Structural Fund over 2007-2013, i.e. around EUR 70-billion per year. Therefore it appears that the stimulus plans initiated by US and Chinese leaders require a capacity of absorption even higher than in the case of the European funds in the past twenty years (4).

In terms of economic profile, we can consider that the diversity of situations and economic structures of EU countries provides a relevant sample for comparison with the diversity of American and Chinese situations. Like the EU, these two political entities have very large provinces or states whose GDP per capita varies greatly, whose population size and economic weight are very different and whose administrative, technological and economic infrastructures are also very different (5).

We can highlight two major differences, however, that are relevant in terms of public aid. Broadly speaking, in the United States, the states’ administrative infrastructure is rather low, while in China, public administration at all levels is rather well developed. EU Member States are generally midway between these two extremes.

However, several decades of European experience of major public programmes of regional and national economic development aid, have shown that if EU member states’ pace and capacity of absorption vary from country to country, the main difficulties to absorb funds are linked either to the lack of administrative capacity (lack of training or policy planning, and lack of appropriate budgets), or to the adjournment of payments or delays in the adoption of operational programmes (i.e. to the completion of funded projects).

There is a vast literature in Europe on the issue of the absorption capacity of EU funds. Of course, it is mostly focused on those countries enjoying the largest amounts, in particular on two extremes, the ‘very good students » and the « very bad ones », those who manage to make a good use of EU funds (at least in spending them) and those who failed to make any use of those funds, or even were suspended of their access to them. In the first group, we find for instance Spain and Ireland, while in the second group, we find Greece, Romania and Bulgaria (6). But countries like France or Italy have also faced problems of absorption capacity, involving the recovery by Brussels of billions of Euros not spent in time.

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Notes:

(1) There is a vast European literature on this subject. Among many other studies, one published by the University of Munich on 10/01/2009 is particularly instructive.

(2) Even the very rich and developed Luxembourg, though it is packed with investment bankers and financial experts of all sorts, cannot make use of the small amount of European funds it is entitled to. Source: Europaforum.lu, 07/02/2008. Furthermore, according to figures published in February 2009 by the European Commission regarding the use of the four Structural Funds (ERDF, ESF, EAGGF, fishing) over the 2000-2006 period, it appears that even good students like Spain can only spend 87% of the funds (despite more than twenty years of experience), and a founding member of the EU such as Italy stands at 85%. Poland, the largest of the EU’s new member states, only manages to absorb 76 percent of the available funds. Finland, Austria and Germany are in the lead with 95 percent. If we look at the Cohesion Fund, an instrument specifically designed for new member states and the main donor for large infrastructure projects, similar in this aspect with the American and Chinese stimulus plans, we observe that it presents the lowest absorption rate of all EU funding programmes, with an average of 65 percent only of the available money being used. In the case of this specific fund, Spain falls down to 75 percent and Poland to 52 percent. Only a few small member states manage to display good absorption rates, like Ireland with 80 percent, followed by Malta (80 percent) and Estonia (75 percent). The limited size of their infrastructure projects probably partly explains these results… not a very good omen for the absorption capacity of the large states and regions of the US and China. Therefore, a figure of 30% of non-absorption of their stimulus packages is very conservative.

(3) Ironically, it is partly these unused European funds which provide for the small economic stimulus plan initiated by the EU. Source: SecteurPublic, 01/30/2009

(4) In the case of China, we can consider that the new budget is nothing but a small extension of the public funding already at the center of China's growth in recent years… which paradoxically makes it rather inefficient for opposite reasons to the US plan, as we will see further.

(5) And problems too ! For instance, in the United States, the richest state is on the verge of a bankruptcy, announced for July 2009 by Californian Legislature’s chief budget analyst. Source: Los Angeles Times, 05/07/2009

(6) Given the current economic situations of Spain and Ireland, their status as "good performers" with respect to the use of EU funds should be thoroughly reviewed as the real estate building bubbles experienced by these two countries are certainly not unrelated to their “good use” of EU billions. The EU decided to suspend the disbursement of EU money to Bulgaria because of a very strong corruption related to the use of these funds. It is well known that in Italy the various mafias have become specialized in misusing EU funds. And in France, the country’s administrative centralization has long caused a significant under-spending of EU funds available.