Last week the Shanghai Composite Index reached its highest level since 2008. The rail sector in particular was a strong driver of growth, buoyed by recent discussion of a potential merger between China Railway Group Co and China Railway Construction Corp, the two largest train and rail equipment makers. More generally, the gains reflect a concrete commitment by the government to invest more than 800 billion Yuan ($128 billion) in the rail sector domestically over the coming year.
Railways form a key part of China’s future infrastructure plans both domestically, and internationally. The New Silk Road initiative, representing regional interconnectivity has been given a significant boost with more countries signing up to the China-led Asia Infrastructure Investment bank (AIIB). In addition, Chinese rail companies are challenging internationally for contracts, showing how far the industry has advanced in the past decade alone.
Yet, a new World Bank report draws attention to the manner in which freight rail services have lagged behind passenger rail within China. There is a real and pressing necessity to improve the regulatory and institutional environment for freight rail services, so domestic consumption will not be bottlenecked. Market orientated reforms similar to those enacted in America in the 1980’s would introduce competitiveness in the rail industry and converge with the priorities of the Chinese Communist Party (CCP) in several significant ways:
1. China needs the infrastructure in place to geographically redistribute economic growth.
Currently, the majority of industry centres along the eastern coast of China. The coastal cities are the overwhelming beneficiaries of Foreign Direct Investment. This problem was duly noted and addressed by the leadership with the Western Development Programme. However, Chengdu, Chongqing and Xi’an comprising the ‘West Triangle Economic Zone’ contribute nearly 40% of Western China’s GDP. This straggles growth and the flow of investment further westward. Policies are required to address this imbalance.
2. The Chinese government should privatise rail State Owned Enterprises (SOE) to encourage specialisation, and address shortages on the supply side.
At the turn of the century China’s accession to the WTO led to consolidation and increased government control over perceived ‘key’ industries. The proposed merger between China’s two biggest rail companies can be seen as a continuation of this policy, and possibly to deflect from corruption scandals engulfing the sector. However, this top-down approach will not reduce corruption, nor ensure innovation. For example, the majority of growth in freight has been through container based port thoroughfare. Yet out of 135 nationwide ports, only 10 were engaged in rail-waterborne logistics operations. The lack of on dock-rail capability is undermining the potential of growth in rail freight. Privatising the SOE would increase competition and the incentive of profit would force them to address these gaps in the market. Shifting focus to consumer demand in a bottom-up approach, would be a far more efficient proposition than government consolidation.
3. Approximately 33.2% of freight activity is conducted via roads and highways.
Pollution is a big issue in China. It is pre-occupying the minds and bodies of many Chinese citizens, and eating away at the legitimacy of the Communist Party. A recent documentary on air pollution went viral and was watched by over 150 million people, before the censors became nervous and pulled the plug. The main instrument of highway freight activity is the truck. However, in China the vast majority are these are old, and operate on extremely heavy diesel, spewing forth sulphur by the bucket-load. Improving rail intermodal logistics operations would increase freight activity (currently 17.4%). This would likely reduce road freight as a percentage of the total, meaning less congestion, and less pollution.
4. De-regulation would allow the national railway operator China Railway Corporation (CRC) to tailor services to customer needs, and increase innovation.
The state regulator CRC should focus on lowering tariffs and costs for rail freight services. This step would allow independent enterprise to flourish, and markets to foster competition and drive down costs. CRC should take a step back from complete management and let the markets decide which components of the supply chain should fall under the auspices of private enterprise. The current catch-all nature of the state regulator is a liability for innovation and services.
All of the aforementioned points are stated CCP policy goals, but the necessity for correct policy is paramount. Railways have the opportunity to power China into a new and prosperous future, however the leadership must have faith in the power and entrepreneurial spirit of Chinese enterprise and deregulate this key sector.
