Journal of Comparative Economics 38 (2010) 34–51
Contents lists available at ScienceDirect
Journal of Comparative Economics
j o u r n a l h o m e p a g e : w w w . e l s e v i e r . c o m / l o c a t e / j c e
Infrastructure development in China: The cases of electricity, highways,
and railways
Chong-En Bai a,b,*, Yingyi Qian a,c
a School of Economics and Management, Tsinghua University, Beijing 100084, China
b National Institute for Fiscal Studies, Tsinghua University, Beijing 100084, China
c University of California, Berkeley
a r t i c l e i n f o
Article history:
Received 21 October 2009
Available online 27 October 2009
JEL classification:
H44
L9
O14
R42
R48
Key words:
Infrastructure
Electricity
Highway
Railway
China
0147-5967/$ - see front matter � 2010 Published b
doi:10.1016/j.jce.2009.10.003
* Corresponding author. Address: School of Econo
E-mail addresses: [email protected] (
1 One commonly used approach is to estimate th
infrastructure (for example, Aschauer, 1989; Munnel
(for example, Hulten and Schwab, 1991; Tatom, 1991
Morrison and Schwartz (1996) and Lynde and Richmo
Li (2005) adopts a third approach and uses the chang
return to infrastructure investment. He finds significa
and Fan and Zhang (2004) and they both find positi
infrastructure increases property value (Haughwout, 2
Ying, 1988).
a b s t r a c t
Bai, Chong-En, and Qian, Yingyi—Infrastructure development in China: The cases of elec-
tricity, highways, and railways
This paper considers the development of the electricity, highway, and railway sectors in
China, with special emphasis on investment incentives. Statistical summary of the devel-
opment of these sectors is offered, followed by a detailed description of the institutional
background, including investment and pricing mechanisms. We also analyze investment
incentives based on the institutional background and present our estimates of the rates
of return to investment in these sectors. It is observed that some of the current practices
may serve as useful transitional arrangements even though they are not desirable in the
long run. Journal of Comparative Economics 38 (1) (2010) 34–51. School of Economics and
Management, Tsinghua University, Beijing 100084, China; National Institute for Fiscal
Studies, Tsinghua University, Beijing 100084, China; University of California, Berkeley.
� 2010 Published by Elsevier Inc. on behalf of Association for Comparative Economic
Studies.
1. Introduction
There is a large literature studying the importance of infrastructure to economic development.1 However, there is not
much systematic research on how infrastructure is developed. Many issues are worth consideration. One of these issues is
investment incentives. Infrastructure may yield significant social returns. However, this does not guarantee that investors of
infrastructure projects can get sufficient private return. How can one provide incentives for private investment? If there is
not sufficient private incentive to i ...
Journal of Comparative Economics 38 (2010) 34–51Contents lis.docx
1. Journal of Comparative Economics 38 (2010) 34–51
Contents lists available at ScienceDirect
Journal of Comparative Economics
j o u r n a l h o m e p a g e : w w w . e l s e v i e r . c o m / l o c
a t e / j c e
Infrastructure development in China: The cases of electricity,
highways,
and railways
Chong-En Bai a,b,*, Yingyi Qian a,c
a School of Economics and Management, Tsinghua University,
Beijing 100084, China
b National Institute for Fiscal Studies, Tsinghua University,
Beijing 100084, China
c University of California, Berkeley
a r t i c l e i n f o
Article history:
Received 21 October 2009
Available online 27 October 2009
JEL classification:
H44
L9
O14
R42
R48
Key words:
2. Infrastructure
Electricity
Highway
Railway
China
0147-5967/$ - see front matter � 2010 Published b
doi:10.1016/j.jce.2009.10.003
* Corresponding author. Address: School of Econo
E-mail addresses: [email protected] (
1 One commonly used approach is to estimate th
infrastructure (for example, Aschauer, 1989; Munnel
(for example, Hulten and Schwab, 1991; Tatom, 1991
Morrison and Schwartz (1996) and Lynde and Richmo
Li (2005) adopts a third approach and uses the chang
return to infrastructure investment. He finds significa
and Fan and Zhang (2004) and they both find positi
infrastructure increases property value (Haughwout, 2
Ying, 1988).
a b s t r a c t
Bai, Chong-En, and Qian, Yingyi—Infrastructure development
in China: The cases of elec-
tricity, highways, and railways
This paper considers the development of the electricity,
highway, and railway sectors in
China, with special emphasis on investment incentives.
Statistical summary of the devel-
opment of these sectors is offered, followed by a detailed
description of the institutional
background, including investment and pricing mechanisms. We
also analyze investment
incentives based on the institutional background and present our
estimates of the rates
3. of return to investment in these sectors. It is observed that some
of the current practices
may serve as useful transitional arrangements even though they
are not desirable in the
long run. Journal of Comparative Economics 38 (1) (2010) 34–
51. School of Economics and
Management, Tsinghua University, Beijing 100084, China;
National Institute for Fiscal
Studies, Tsinghua University, Beijing 100084, China;
University of California, Berkeley.
� 2010 Published by Elsevier Inc. on behalf of Association for
Comparative Economic
Studies.
1. Introduction
There is a large literature studying the importance of
infrastructure to economic development.1 However, there is not
much systematic research on how infrastructure is developed.
Many issues are worth consideration. One of these issues is
investment incentives. Infrastructure may yield significant
social returns. However, this does not guarantee that investors
of
infrastructure projects can get sufficient private return. How can
one provide incentives for private investment? If there is
not sufficient private incentive to invest in infrastructure, are
there enough incentives for politicians and bureaucrats to over-
come many difficulties to make public investment in
infrastructure? To address these issues, one has to understand
the insti-
y Elsevier Inc. on behalf of Association for Comparative
Economic Studies.
mics and Management, Tsinghua University, Beijing 100084,
China. Fax: +86 10 62785562.
C.-E. Bai), [email protected] (Y. Qian).
4. e production function with infrastructure as an input. Some find
significant returns to investment in
l, 1990; Rubin, 1991; Holtz-Eakin, 1994), while others do not
find significant returns to such investment
; Munnell, 1992; Kavanagh, 1997). Another approach is to
estimate the cost function. Using this approach,
nd (1992) both find evidence supporting a significant role of
public infrastructure in productivity growth.
es in interregional price gaps before and after the construction
of a railway in China to estimate the social
nt return to the investment. Other studies on the role of
infrastructure in China include Demurger (2001)
ve relationship between infrastructure and economic growth.
There are also findings that suggest that
002), reduces inventory costs (Shirley and Winston, 2004), and
cuts the cost of trucking firms (Keeler and
http://dx.doi.org/10.1016/j.jce.2009.10.003
mailto:[email protected]
mailto:[email protected]
http://www.sciencedirect.com/science/journal/01475967
http://www.elsevier.com/locate/jce
C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
(2010) 34–51 35
tutions surrounding infrastructure. Who is allowed to invest in
infrastructure? What are the restrictions faced by the investors?
In the case infrastructure is built with private investment, how
is the price for the use of infrastructure is regulated? In the case
of public investment, what is the environment faced by the
politicians and bureaucrats? Without a clear understanding of
these
institutions, it is impossible to understand the development of
infrastructure.
5. Before we can get the full picture, it is useful to start with a few
cases. This paper attempts to contribute to this first step
by investigating the development of the electricity, highway,
and railway sectors in China. We will not consider urban infra-
structure because relevant information is more difficult to find
and there are also too many aspects of urban infrastructure
for us to cover in this paper. We will not consider the
communication sector because its development seems less
problematic
than other sectors of infrastructures and certain success has
been achieved in the sector in many developing countries.
Among the modes of transportation, we will not consider
waterways, ports, civil aviation, or pipelines. Instead, we focus
on the sectors of electricity, highways and railways because
they exhibit unique Chinese characteristics and they also offer
interesting contrast among them.
For each sector we consider, we first offer a statistical summary
of its development in China. We present the capacity and
the output of the sector. We not only offer a snapshot of the
current situation, we also provide relevant historical statistics.
The paper also provides a detailed institutional background for
the development of each sector. We particularly empha-
size institutions related to investment incentives. These include
investment policies and the pricing of the services. Again,
the history of the institutions is presented, and the current
situation is described in greater details.
Based on the institutional background, we analyze investment
incentives and existing problems in each sector. Some
practices are part of the solution to providing investment
incentives and at the same time sources of economic costs in
terms
of distortion of investment decision and high prices paid by
6. consumers, and social and political costs in terms of corruption
and income inequality. We discuss both the benefits and costs
of these practices.
Finally, we present of estimates of the rates of return to
investment for each sector. These estimates provide quantitative
indication about incentives for investment outside of
government budget.
This paper does not consider a few aspects related to investment
in these sectors. One is the cost of acquiring the land
needed for the development. Another is the cost of complying
with environmental regulations and other regulations. We
focus more on the benefits of investment to the investors rather
than the costs. The cost issues await future research.
2. The electricity sector
2.1. Statistical summary
The development of the electricity sector has basically kept in
pace with the growth of real GDP (Fig. 1 and Table 1). From
1978 to 2007, the annual growth rates of installed capacity and
the amount of electricity generated were 9.1% and 9.2%
respectively. In the same period, the annual growth rate of real
GDP was 9.8%. In 2007, the total amount of electricity gen-
erated was 3256 billion kW-h, representing a 14.44% increase
over the previous year. Around 83% of the output was from
thermal power, 15% hydro power, and 2% nuclear power. The
total installed capacity was 713.3 GW.
On the demand side, household consumption accounts for 11%
of the total. Industry consumes 76.6% of the total, services
9.8%, and agriculture 2.6%, with industrial consumption,
especially that by the heavy industry, growing the fastest.
7. Given the price structure, the demand and supply of electricity
is basically in balance. According to the annual report of
the 2007 State Electricity Regulatory Commission, the
maximum shortfall of capacity during peak load in 2007 was
only
10 GW, a mere 1.4% of total installed capacity.
(Logarithm with 1978 Values Nornalized to Zero)
0
0.5
1
1.5
2
2.5
3
19
78
19
80
19
82
19
84
19
86
11. The first is the pre-reform period before 1978. At that time, the
degree of government control was even higher in the elec-
tricity sector than in most of the other sectors. The sector was
characterized by two features. One is that there was no sep-
aration of government functions, such as formulating and
enforcing regulations on entry, pricing, and system security,
from
business activities, such as electricity generation, transmission,
and distribution. Both functions were played by one govern-
ment agency, the Ministry of Electricity Industry and local
bureaus under the ministry, although the name of the agency
changed several times. The second is that all activities were
under rigid state plan.
Starting from a very low base, the electricity sector experienced
a period of rapid growth. At the end of 1949, the
total installed capacity in the whole country was only 1850
MW, generating 4.3 billion kW-h of electricity annually, with
annual per capita output of less than 8 kW-h. By the end of
1978, the total installed capacity had increased to
57,120 MW, with annual total output of 256.6 billion kW-h and
per capita output of 266 kW-h. The annual growth rates
of total installed capacity and electricity generation were 12.6%
and 15.1% respectively. Despite of the high growth rates,
electricity shortage was always a severe problem. Misallocation
as a result of rigid planning was partly responsible for
the shortage.
The second period is between 1978 and 2002. In this period,
state plan was loosened and government functions and
business activities began to be separated in this sector.
However, competition was limited and the bureaus of electricity
industry and later the electric power corporations played an
overwhelmingly dominant role in the sector. There were
three milestones in the reform process. The first was a 1985
12. electricity policy document approved by the state council
(SCC, 1985). This document allowed investment in electricity
generation from outside of the state budget, including
C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
(2010) 34–51 37
foreign investment. At the same time, it also allowed the
electricity generated by plants built with non-state-budgetary
funds to enter the market. As a result, two tracks with different
prices emerged in the electricity sector, one within the
state plan and the other outside. The second milestone was the
1987 state council policy of separating government func-
tions from business activities in the electricity sector. In each
province, an electric power corporation was set up parallel
to the government bureau of electricity industry. The 1985
policy of encouraging diverse sources of investment in the
electricity sector was reaffirmed. Because the provincial
enterprises were rather independent of one another, the market
was segmented. The third milestone was establishment of the
National Electric Power Corporation in 1997 and the sub-
sequent abolishment of the Ministry of Electricity Industry in
1998. After the abolishment of the Ministry of Electricity
Industry, the government functions in this sector became part of
the portfolio of the ministerial level State Economic
and Trade Commission.
The growth rates of the sector varied during this long period. In
the period of 1979–1984, the annual growth rates of total
installed capacity and electricity generation were 4.9% and
6.0% respectively. In the period of 1984–1997, however, the
cor-
responding rates were 9.2 and 8.8 respectively. In 1997, the
sector experienced surplus of supply, and the government then
decided not to approve any new investment in electricity
13. generation for the next 3 years. This turned out to be short
sighted.
By 2003, 22 provinces experienced severe shortage of
electricity supply and electricity had to be rationed again.
The third period started from 2002. The state council issued the
System Reform Plan for the Electricity Sector in February,
2002 (SCC, 2002), which shapes the current practices.
2.3. Current practices
2.3.1. Disaggregation
The 2002 plan consists of three main components. The first is to
separate electricity generation from its transmission and
distribution as well as other businesses. The National Electric
Power Corporation was broken up into two transmission and
distribution companies separated along regional lines, five
electricity generation companies, and four other companies
offer-
ing engineering and construction services for the electricity
sector.
With the implementation of the plan, the number of players has
increased significant, but the state still maintains a dom-
inant position in the market. At the end of 2007, there are more
than 4000 plants with installed capacity above 6 MW in the
electricity generation sector. Central government controlled
enterprises, including the five companies that spun off from Na-
tional Electric Power Corporation 5 years ago, had a 53.95%
share of the installed capacity, up 4.43% age points from the
year
earlier. Local government controlled enterprises had a share of
41%, down 4 percentage points, and private and foreign in-
vested enterprises had a share of 6.05%, down 0.16 percentage
points.
14. The transmission and distribution sector is mainly divided
between State Grid Corporation of China and China Southern
Power Grid, the two companies that spun off from the National
Electric Power Corporation in 2002 (SERC, 2008). Each power
grid company is a monopoly transmitter, distributor, and retailer
of electricity in its region. Generators sell power to the
power grid company, and their access to the grid is mostly at
the mercy of the latter, even though in some cases access is
supposed to be determined by a bidding process.
2.3.2. Pricing policy
The second component of the plan is to develop a new
mechanism for price formation. The idea is to let the market
play a
more important role in price formation in the sector in the long
run.
The price that consumers pay consists of four parts (NDRC,
2005a, 2005b, 2005c). One is the cost for the distributor to
acquire electricity from the generating plant, the second is the
losses in transmission and distribution, the third is the price
for transmission and distribution, and the fourth is government
surcharge. The price for transmission and distribution is
determined by the government based on the cost of transmission
and distribution. The cost for the distributor to acquire
electricity includes the price paid to the generating plant and
taxes paid to the government. The price paid to the generating
plants is a two-part tariff. One part is the capacity price
determined by the government that is independent of the actual
amount of electricity that is purchased, and the second part is a
unit price that is either determined by a bidding process
or by the government based on industry average cost, depending
on whether the region has set up a functioning electricity
trading system.
Different consumers pay different prices. Households pay the
15. lowest price, followed by agricultural users. Non-agricul-
tural business users pay the highest price.
2.3.3. Regulation authorities
The third component of the plan is to reform government
functions in the sector. The State Electricity Regulatory Com-
mission (SERC) was formed to regulate the industry but the
power to determine the prices in the sector rests with the Na-
tional Development and Reform Commission (NDRC). SERC’s
main charges are to maintain competition, protect the interests
of various stakeholders, enforce price regulation set out by
NDRC, and guarantee the security of the electricity system
(SERC,
2008). National Development and Reform Commission and its
local bureaus are responsible for determining the prices when
they are not determined by the market.
Table 2
Investment in fixed assets in urban area by jurisdiction of
management and registration status: production and supply of
electric power and heat power (unit:
billion yuan).
Year Total By jurisdiction By registration status By registration
status
Central Local Domestic HK, Macao, Taiwan Foreign State
Collective Private
2004 485.4 169.9 315.5 446.3 23.8 15.4 392.4 6.3 8.7
2005 650.3 219.4 430.9 601.6 31.3 17.4 507.7 6 12
2006 727.4 266.2 461.2 682.2 27.4 17.8 571.7 42.4 80.3
Sources: China Statistical Yearbook 2005–2007 (NBS, various
16. years).
38 C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
(2010) 34–51
2.4. Investment incentives
2.4.1. Sources of investment
Substantial amount of resources are invested in the electricity
sector each year. In 2007, 304.2 billion yuan was invested
in electricity generation and 245.1 billion yuan in transmission.
Investment in the sector is dominated by state-controlled
enterprises. This can be seen from the distribution of installed
capacity among various types of enterprises that we discussed
earlier. Table 2 also illustrates this point, among others. The
National Bureau of Statistics does not provide investment data
for the electricity sector alone, but it provides investment data
for electricity together with heat power, which should be
indicative of the electricity sector. From the table, we can see
that most of the investment was made by state-controlled
enterprises; most of the funds came from domestic sources;
local governments invested more than the central government.
As Table 3 shows, of the total invested amount, domestic loan is
the most important component. Self-raised funds follow
closely behind. Self-raised funds include extra-budgetary funds
from central government ministries and local governments,
as well as the self-raised funds of enterprises and institutions.
State budget is not an important component of the total
investment in the electricity sector. Note that Tables 2 and 3
show different amount of total investment. This is because
the two sets of statistics come from different sources and the
differences between them are statistical discrepancies.
2.4.2. Incentives and problems
A natural question to ask is: why are there incentives for
17. investment in the electricity sector given the dominant role
played by state-controlled enterprises.
In the pre-reform era, state plan was very rigid and large
amount of resources could be mobilized to develop a few
priority
areas of the economy, possibly at the expense of other parts of
the economy. Electricity was among the few priority areas.
The electricity sector grew very rapidly then, more so than the
whole economy did.
After economic reform started, state plan became less rigid and
priority was rebalanced. Without given sufficient eco-
nomic incentives, the electricity sector would not grow as fast
as they once did. This could explain why growth slowed down
in the first few years of economic reform.
Since 1985, economic incentives have been gradually
introduced. First, investment from outside of the state budget
was
encouraged and the producers were given more autonomy over
electricity generation from the new investment. Then, gov-
ernment functions and business activities were separated in the
sector, first at the provincial level in 1987 and later at the
national level in 1997. With this separation, electricity is no
longer considered a government service, albeit with a fee, but a
commodity produced and provided by enterprises. This could be
one explanation behind a sharp difference between China
and India in the electricity sector that electricity stealing is not
a significant problem in China and losses in transmission only
accounts for about 7% of total output and are mostly due to
technical factors. Enterprises that supply electricity in China
are
subject to less political pressure than they used to be and have
strong incentives to enforce payment by consumers.
18. At the same time, the price formation mechanism has gradually
become more market oriented, with the prices mostly
reflecting industry average costs and normal rates of return.
There are times when the price of electricity is not be allowed
to adjust accordingly even though the price of coal used to
generate electricity has increased substantially, but this mostly
happens during most difficult economic times.
Increased competition is another factor that drives investment.
With the 2002 break up of the National Electric Power
Corporation, and the establishment of other electricity
generating enterprises, competition among them intensified
even
though they are mostly controlled by the state. Among the big
firms, the competition is mainly about who will become
Table 3
Source of funds of investment in urban area by sector:
production and supply of electric power and heat power (unit =
billion yuan).
Year Total By sources of funds
State budget Domestic loans Foreign investment Self-raised
funds Others
2004 499.8 19.2 222.2 18 206.7 33.6
2005 643.7 25.6 296.7 13.6 269.7 38.1
2006 729 31.4 338.7 8.1 304.6 46.3
Sources: China Statistical Yearbook 2005–2007 (NBS, various
years).
C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
19. (2010) 34–51 39
the industry leaders and maintain that position. Both of the two
power grid companies and seven of the largest electric
power generating companies are among the 150 largest state-
owned enterprises under the direct control of the State-owned
Asset Supervision and Administration Commission (SASAC) of
the State Council. All of these state-owned enterprises are un-
der strong pressure to be among the top three enterprises in
their respective sector or face the risk of being restructured.
Furthermore, electricity generating enterprises are currently
competing fiercely for most important strategic assets of the
sector, plant sites that have convenient access to coal and water,
the supply of which is limited. They are worried that if
the ideal plant sites are all taken by their competitors, they
would face great difficulty expanding their capacity in the
future.
For all the power generating firms, they have to compete to sell
to the monopsonistic buyers of electricity, the power grid
companies that are separated along regional lines. This is
especially true for smaller power generating firms. If they do
not
gain enough scale and achieve sufficiently low cost, it is hard
for them to survive in the long run. Such competitive pressure
also gives firms strong incentives to invest.
Local governments are also an important force behind
incentives for investment in the electricity sector. A large
electric-
ity generating company is at the same time a large tax payer.
Sometime, the tax revenue from a large electricity generating
company can be a very substantial part of the tax revenue of a
county government. There is strong competition among
county governments to have the electricity generating company
located within their county, even when the region in general
enjoys strong geographical advantages in attracting the
company. One of the instruments the county government can use
20. is
concession on the land price that the county government charges
the company. Such competition among the local govern-
ments lowers the cost of investment in the sector and
encourages investment.
Even though the electric power grid companies face little
competition, they still have strong incentives to make invest-
ment. In 2007, investment in power grids accounted for 45% of
total investment in the electricity sector (SERC, 2008). Similar
to electricity generation, the way prices for transmission and
distribution are determined is one reason for the strong invest-
ment incentives. The prices are determined based on the
allowable costs, the allowable rate of return, and the related
taxes
(NDRC, 2005a). Possible tunneling by the insiders of power
grid companies through transfer pricing may also be a contrib-
uting factor behind the strong investment drive. All the power
grid companies are state owned and the sector is dominated
by two power grid companies. However, the provincial branches
of the companies enjoy considerable autonomy and many
investment decisions are made at the provincial level. Many of
the provincial power grid companies have a sister company
that is often owned by their employees or managers. The state-
owned provincial power grid company does many businesses
with the collectively owned sister company, including the
procurement of equipment, electricity, and other related
services.
On paper, the state-owned power grid companies may not be
very profitable. However, their collectively owned sister com-
panies are often very profitable. Dividend payment from the
sister company can be a substantial part of the income of the
employees of the state-owned counterpart. Such a relationship
between the two companies can create powerful investment
incentives for the state-owned power grid company. After all,
investment by the power grid company creates demand for
21. equipment and services and is good for the business of the sister
company, and this in turn benefits the managers and
employees of the power grid company. A consequence of this
practice is that the income of some managers and employees
of the power grid companies is much higher than that of similar
people in non-monopoly sectors. This has becomes a source
of resentment against income inequality.
It is possible that these strong investment incentives may give
rise to overinvestment. Indeed, there was surplus of supply
in 1997 and there have been concerns about overinvestment in
the last few years. However, the economy is growing very
rapidly and any surplus supply will soon be met by increased
demand. The aftermath of the 1997 experience is a case in
point. After the government suspended investment in electricity
generation for 3 years, shortage of electricity follows a
few years later. Of course, the economy will eventually slow
down and by then, overinvestment will become more costly.
The current system seems to work in the current environment
but may not be the first best arrangement in the long run.
The lack of foreign investment in the electricity sector is
interesting given that foreign direct investment has played a
very
significant role in other parts of the economy. Possible reasons
are as follows. The transmission and distribution sector is off
limit to foreign investment. Even though the power generation
sector is open to foreign investment, foreign invested gen-
erators are disadvantaged because local relationship is very
important for a generator to gain access to the grid, and to
secure
stable and cheap supply of coal. Furthermore, the most
important reason for foreign direct investment in China is not to
bring in capital, but to facilitate the transfer of knowhow (Bai,
Lu, and Tao, 2009). Technology in electricity generation is easy
to transfer even without long term participation of foreign
22. investors, and therefore, the role of foreign investors is not as
important as in many other sectors.
2.4.3. Rate of return to investment
Using data from the 2007 annual reports of the top 10 publicly
listed electricity generating companies, ranked according
to their total asset values in 2007, we estimate the average rate
of return on equity of these companies from 2000 to 2007
(Fig. 2). The rates range from 10.45% in 2002 to 12.78% in
2001. These rates are higher than the normal rate of return the
government uses to determine the prices, which is 1 percentage
point above the annual interest rate paid by long term gov-
ernment bonds. The high rates of return on equity are achieved
through leverage. They compare favorably with the rate of
return to capital of the whole economy net of urban residential
housing estimated by Bai et al. (2006).
We also estimate the rate of return to capital in the whole
electricity and heat power sector. We estimate the capital stock
of the sector using the perpetual inventory approach and the
investment data from 1950 to now, and derive the capital in-
come data by adding operating profits and production taxes of
enterprises. The rate of return is estimated by the ratio of
10.00%
10.50%
11.00%
11.50%
12.00%
23. 12.50%
13.00%
2000 2001 2002 2003 2004 2005 2006 2007
Fig. 2. Average return on equity of the top 10 publicly listed
electricity generating companies. Sources: corporate annual
reports.
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04
05 06
Year
Rate of Return to Capital in the Electricity Sector
0.050
0.100
0.150
0.200
Fig. 3. Rate of return to capital (net of depreciation) in
electricity and heat water sector. Sources: authors’ calculation.
40 C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
(2010) 34–51
capital income over capital stock at current price (see Appendix
A for detailed description of data and estimation method).
Fig. 3 shows that the rate of return has been fluctuating around
10% since the last 1990s. Again, these rates compare well
with those of the whole economy net of urban residential
housing estimated by Bai et al. (2006).
24. 3. Highways
3.1. Statistical summary of the transportation sector
The transportation sector has experienced very rapid growth
since 1978. In 1978, the total passenger-km was 174 billion,
but in 2006, it was 1919 billion, representing an annual growth
rate of 8.9%. Civil aviation grew fastest, from 2.8 billion pas-
senger-km to 237 billion passenger-km, or 17.2% a year.
Highways follow, from 52 billion to 1013 billion, or 11.2% a
year, and
then railway, from 109 billion to 662 billion, or 6.6% a year.
The passenger-km of waterways dropped from 101 billion to 74
billion, or �1.1% a year. Fig. 4 shows the growth in passenger-
km of various modes of transportation with the real GDP
growth as the reference.
Since different modes of passenger transportation have very
different growth rates, their relative shares in the sector in
terms of passenger-kilometer has changed significantly since
1978. Fig. 5 shows the shares in passenger-kilometers of var-
ious modes of transportation. It shows that highways have
replaced railways as the most important mode of passenger
transportation and the importance of civil aviation has increased
dramatically, from 1.6% to 12.3%.
Freight transportation has also experienced very rapid growth
since 1978. In 1978, the total ton-km was 983 billion, but
in 2006, it was 8895 billion, representing an annual growth rate
of 8.2%. Civil aviation grew fastest, from 97 million ton-km
to 9.4 billion ton-km, or 17.8% a year. Highways follow, from
27.4 billion to 975.4 billion, or 13.6% a year, then waterway,
from 378 billion to 5549 billion, or 10.1% a year. The ton-km of
railways and petroleum and gas pipelines grew at
(Logarithm with the 1978 Values Normalized to 0)
29. nt
Railways
Highways
Waterways
Civil Aviation
Fig. 5. Shares in passenger-kilometers of various modes of
transportation. Sources: China Statistical Yearbook (NBS,
various years).
(Logarithm with the 1978 Values Normalized to 0)
-1
0
1
2
3
4
5
19
78
19
80
31. 20
06
Year
GDP Indices
Railways
Highways
Waterways
Civil Aviation
Petroleum and Gas Pipelines
Fig. 6. Real GDP and freight ton-kilometers by various modes
of transportation. Sources: China Statistical Yearbook (NBS,
various years).
C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
(2010) 34–51 41
approximately the same rate, 5.2% and 5% respectively, with
the former going from 535 billion to 2195 billion and the latter
going from 43 billion to 166 billion. Fig. 6 shows the growth in
ton-km of various modes of transportation with the real GDP
growth as the reference.
The relative shares of different modes of freight transportation
have also changed significantly since 1978. Fig. 7 shows
the shares in ton-km of various modes of freight transportation.
It shows that waterways have replaced railways as the most
important mode of freight transportation. The importance of
highways increased dramatically from 2.8% in 1978 to 14.4% in
1998, but gradually declined to 11% in 2006.
The rapid increase in the volume of transportation is only
possible with the improvement of the transportation infrastruc-
ture. From 1978 to 2004, the length of highways increased from
890.2 to 1870.7 thousand km. From 1978 to 2006, the
32. lengths of railways in operation, civil aviation routes, and
petroleum and gas pipelines increased from 51.7 to 77.1, from
148.9 to 2113.5, and from 8.3 to 48.2 thousand km respectively.
Fig. 8 shows the growth of the lengths of transportation
routes. The growth in the length of highways is higher than that
of railways.
Among highways, expressways have been growing the most
rapidly. Their length increased from 100 km in 1988 to 45.3
thousand km in 2006. From 1988 to 2004, the length of all
highways grew at an annual rate of 4%, but the length of
express-
ways grew at a staggering annual rate of 44%. Fig. 9 illustrates
this phenomenal growth.
For the railway, we have some data about its technical
efficiency. The data shows that technical efficiency has also im-
proved together with the increase in the length of railways. Fig.
10 illustrates the trend of some of the indicators of technical
efficiency. We can see that the running speed of passenger
trains and that of the freight trains have both increased, with the
former increasing faster. The abnormality of the 2001 data
about freight train speed is probably due to a statistical error.
The
density of passenger transportation and freight transportation
both show significant improvement. The handling time of
freight first increased from 1985 to 1999 and has then gradually
come down since 1999.
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
36. 19
94
19
96
19
98
20
00
20
02
20
04
20
06
Year
Railways in Operation
Highways
Civil Aviation Routes
Petroleum and Gas Pipelines
Fig. 8. Length of Transportation Routes. Note: The 2005 and
2006 data for highways use a different definition from that used
for earlier years and are
therefore left out. Sources: China Statistical Yearbook (various
years).
37. Length of Highways and Expressways (Logarithm with the 1978
Values Normalized to 0)
0
1
2
3
4
5
6
7
19
88
19
89
19
90
19
91
19
92
19
41. Density of Passenger Transportation
(10 000 person.km/km)
Running Speed of Freight Trains
(km/hr)
Density of Freight Transportation (10
000 tn.km/km)
Handling Time of Freight (hour)
Fig. 10. The technical efficiency of railways. Sources: China
Statistical Yearbook (various years).
42 C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
(2010) 34–51
In summary, the transportation sector as a whole has grown
rapidly. The growth rates of passenger-kilometer and ton-
kilometer are not very far below the growth rate of GDP.
However, railway has lagged behind. Although its technical
effi-
ciency has been improving, its growth rates in terms of
passenger-kilometer and ton-kilometer are both much lower
than
that of GDP, and its length has also been growing much slower
than that of the other modes of transportation. As a result,
its shares in passenger and freight transportation have both
declined steadily. In the remainder of this paper, we will
discuss
the development of the highway and railway sectors
respectively.
C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
42. (2010) 34–51 43
3.2. Evolution of highway policy
The evolution of highway policy can be divided into four
stages, with more market elements introduced from period to an
initial system of complete central planning.
3.2.1. Central planning
Before 1978, it was a complete state planning system. The
central government was responsible for a few strategically
important national highways, and the local governments were
responsible for the construction and management of all
the other highways. Roads were considered a pure public
service. Investment funds came from state budget in the form
of a grant that did not carry any financial cost. Users did not
pay any toll, but they paid a monthly highway maintenance
fee based their vehicle tonnage. Because of shortage of funds
and lack of incentives, the development of highways was slow.
3.2.2. Decentralization
In the next stage, state investment funds in local projects were
changed from grants to loans in 1980 and the cost of
investment was shifted to the local governments. New fees were
introduced in the following years to increase the amount
of funds available for highway construction. Among the newly
introduced fees was vehicle purchase surcharge, which was
started in 1985. The surcharge was 10% of the price for
domestically produced vehicles and 15% for imported vehicles.
This
surcharge goes into the State Highway Construction Fund.
3.2.3. Introduction of tolls and their current regulation
Highway tolls were introduced in the third stage. It was first
experimented in Guangdong province in 1981 when the local
43. government borrowed from foreign investors to finance the
construction of four bridges along the Guangzhou–Zhuhai high-
way and raised funds to construct the Guangzhou–Shenzhen
highway. Tolls were collected to secure the financing of these
projects. Gradually, toll collection became a widespread
practice in the whole country.
Currently, highway tolls are regulated by the Highway Law that
was promulgated in 1997 and revised in 1999 and 2004.
Among other aspects, the law regulates the types of highway
that are eligible for toll, the number of years in which tolls can
be collected on a highway, the toll rates, the transfer of the
right for toll collection, the setting up of toll gates, and the
coor-
dination between provinces when the highway crosses the
provincial border.
According to the law, only three types of highways are eligible
for toll collection. One type includes highways built by
local governments above the county level with loans or funds
raised from enterprises and individuals. The second type in-
cludes the first type of highways of which the right for toll
collection has been transferred to an enterprise. The third type
includes highways built with investment from enterprises. The
first type is called government highways with loans to be
paid off (zhengfu huandai gonglu), and the remaining two types
are called commercial (jingyingxing) highways. All toll high-
ways must have technical grades and scales above government
specified thresholds.
The transfer of the right for toll collection has to be approved
by the Ministry of Transport for national government toll
highways, and the transfer has to be approved by the provincial
department of transport and submitted to the Ministry of
Transport for record for other toll highways.
44. The length of the toll period and the toll rates have to be
approved by the provincial department of transport. When the
right for toll collection of a government highway is transferred,
the length of the toll period should be agreed upon by the
two sides of the transaction and be approved by the authority
that approves the transfer. Toll rates have to be approved by
the provincial price regulator as well. The principle governing
the determination of toll period and rates is to allow the return
of the loans or funds raised for government highways and to
allow the return of investment with reasonable profits for com-
mercial highways. The toll period is also subject to State
Council regulation. According to the State Council Regulation
of Toll
Roads promulgated in September 2004, the maximum length of
toll period is 15 years for government toll roads in general
and 20 years for government toll roads in economically less
developed central and western regions; the corresponding max-
imum lengths for commercial toll roads are 25 and 30
respectively. The law and the regulation were not very clear
about
when the maximum toll period clock starts ticking when there is
a transfer of the right for toll collection. In some cases,
the clock starts from zero again after a transfer. There is clearly
a coincidence of incentives for both sides of the transfer
to agree on a longer period of toll collection. Meanwhile, the
two sides of the transfer often have close connection to the
government authority that is to approve the terms of transaction;
in the case of a government to enterprise transfer, the
transferor is the government authority. This loop hole is a
subject of much debate.
The setting up of toll gates must have the approval of the
provincial government. For highways that cross provincial
boundaries, the setting up of toll gates should be agreed upon
by all relevant provinces; if an agreement cannot be achieved,
45. the Ministry of Transport will make the decision. The principle
is to have unified collection and proportionate sharing of toll
fees.
3.2.4. Expansion of financing instruments
The institution of toll has paved the way for a wider range of
choices of financing instruments. There are several ap-
proaches one can take to finance highway construction in
addition to bank loans. One is to form a joint stock company
and raise funds in the form of equity investment. Another is to
issue bonds. The builder can also choose to sell the right
to operate to other investors or even go through an initial public
offering after the highway is completed and operated
44 C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
(2010) 34–51
for some time and toll income becomes predictable. The fund
raised from the transfer of right to operate can be used to pay
off bank loans or build new highways. There are also cases in
which the builder of the highway raises fund by issuing asset
backed securities with future toll income as the underlining
asset. An early example is Zhuhai Expressway. In August 1996,
Zhuhai City Government registered Zhuhai City Expressway
Company in Cayman Islands and used it as a vehicle to issue
200
million US dollars of asset backed securities. The proceeds of
the issue were invested to build railway and expressway be-
tween the cities of Zhuhai and Guangzhou.
3.3. Investment incentives
3.3.1. Sources of investment
According to the 2006 and 2007 Statistical Report for the
Development of the Road and Waterway Transportation Sector
46. published by the Ministry of Transport (various years), total
investment in road transport was 623.1 billion in 2006 and 649
billion in 2007. In contrast, total fiscal revenue of all levels of
governments was 3876 billion yuan and the total spending on
infrastructure from government budget was only 439 billion
(NBS, various years); that is, total investment in transport was
16% of all government revenue and 142% of government
budgetary spending on infrastructure. Clearly, it is impossible
to
finance the investment in road transport all by government
budget. Most of the funding has to come from other sources.
Table 4 shows the split of investment funds between central
budget and local funds, between domestic investment and
overseas investment, and between investment made by state-
controlled institutions and other firms. According to the Table,
the lion share of the investment is made by state-owned
enterprises, mostly controlled by local governments, including
pub-
licly listed companies in which the government has a
controlling share. In 2006, 604 out of 648 billion yuan of
investment
was made by these enterprises.
The records of the 12 publicly listed expressway companies are
also consistent with the above observation. Nine of the 12
companies are controlled by a holding company wholly owned
by a provincial government. Of the remaining three, North-
east Expressway Co. Ltd. is jointly controlled by the provincial
governments of Heilongjiang and Jilin; Huabei Expressway Co.
Ltd. is controlled by one of the largest state-owned enterprises,
China Merchants Group, through its expressway investment
arm Huajian Transportation Economic Development Center,
with Tianjin, Beijing, and Hebei governments as large
sharehold-
47. ers; Shenzhen Expressway Co. Ltd. is controlled by the city
government of Shenzhen, even though its largest shareholder is
Hong Kong Securities Clearing Company Ltd. Interestingly,
China Merchants Group is among the top three shareholders in 8
of the 12 publicly listed expressway companies, holding on
average 21% of the equity shares of these companies. The local
government owned controlling shareholders are generally under
the direct control of the local departments of transport, and
their average shareholding in these 12 companies is 42%. Other
large shareholders are asset management funds.
We use Jiangsu Expressway Co. which has 27 billion yuan of
assets, the largest among all publicly listed expressway com-
panies, to illustrate the ownership structure. Its controlling
shareholder is Jiangsu Transportation Holding Company, a
wholly state-owned enterprise under the provincial government,
and it holds 54.44% of Jiangsu Expressway Co., China Mer-
chants Group owns 11.69% and other eight largest shareholders
are J.P. Morgan Chase & Co., UBS AG, Sumitomo Mitsui Asset
Management Limited, HSBC Halbis Partners Limited, Schroder
Investment Management Limited, and three securities com-
panies in China.
According to the Statistical Report for the Development of the
Road and Waterway Transportation Sector published by the
Ministry of Transport (various years), the most important source
of the investment in road transport is bank loan, which ac-
counts for 40.7% of the total in 2006. The loans are backed by
government guarantees and toll revenue. The second most
important source is fund raised by the local government or
enterprises controlled by them, which accounts for 32.8% of
the total in the same year. Central government funding is small,
and is mainly used to subsidize the construction of national
trunk roads, road construction related to poverty reduction and
national defense. It comes from central government bond
and vehicle purchase tax. Few intercity highways are built
48. entirely with funding from government budget.
3.3.2. Incentives and problems
How can these enterprises yield sufficient returns to their
investment so that investment in road transport is sustainable?
One of the most important reasons is highway toll and the
regulations about toll. As long as the highway is not built only
with government budget and satisfies some technical conditions,
the operator is entitled to collect tolls on the highway.
Table 4
investment in fixed assets in urban area by jurisdiction of
management and registration status: road transport (unit =
billion yuan).
Year Total By jurisdiction By registration status By registration
status
Central Local Domestic HK, Macao, Taiwan Foreign State
Collective Private
2004 466.55 20.07 446.48 462.65 2.69 1.21 444.21 3.33 1.98
2005 558.14 28.44 529.70 550.58 4.98 2.58 520.31 4.21 4.22
2006 648.16 16.40 631.77 640.85 5.34 1.98 604.35 14.91 24.35
Sources: China Statistical Yearbook 2005–2007 (NBS, various
years).
C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
(2010) 34–51 45
The principle governing toll collection is that the operator can
recover the cost of investment. In the case where the operator
is an enterprise, the regulation on tolls also guarantees a
reasonable rate of return in principle.
49. The commitment of the regulation to guarantee the recovery of
investment cost or reasonable return to investment is
credible because most of the operators of toll highways have
strong connections to the regulator. The more likely problem
is regulatory capture by the operator, rather than lack of
commitment from the regulator. One example of capture is
extend-
ing the toll period beyond what is allowed by the State Council
regulation using loopholes therein regarding the transfer of
toll rights that we discussed above. Such an environment may
not be the first best for public interests, but in the case where
demand is strong and willingness to pay by the users is high, the
efficiency loss from capture may be lower than that from
lack of commitment.
Dealing with toll regulation is not the only area in which
government connection helps. We again use Jiangsu Expressway
Co. as an example to illustrate areas in which government
connection is important in the highway business. One is project
approval and toll regulation. When the company wanted to
upgrade the Shanghai–Nanjing Expressway in 2004, it needed
the approval of National Development and Reform Commission
of the central government. To recoup the cost of the upgrade,
it needed the approval of the provincial government to extend
the toll period for 5 years beyond the original toll period.
When they wanted to upgrade the Shanghai–Nanjing grade-two
highway to grade-one highway, they again needed the ap-
proval of the provincial government to extend the toll period by
12 years. The second is tax concession and land concession.
Companies can get tax exemption, reduction, or rebate when
they invest in key basic infrastructure. However, these conces-
sions have to be negotiated with the Department of Finance of
the province and approved by the Ministry of Finance of the
central government. The situation with land concession is
similar. The third is government help with commercial
financing.
50. To get bank loans, the company needs loan guarantee from
qualified entities. In the case of Jiangsu Expressway Co. loan
guar-
antee has been provided by its largest shareholder, Jiangsu
Transportation Holding Company, a wholly state-owned enter-
prise. Government connection has also been crucial for the
company to get approval for private placement of its shares
before its IPO and its listing on Hong Kong Stock Exchange and
Shanghai Stock Exchange. The last item is future investment
opportunities. Excluding those held by Jiangsu Expressway Co.
Jiangsu Transportation Holding Company still holds 2016 km
of expressway in its portfolio. The rights to operate these
expressways are potential investment opportunities for Jiangsu
Expressway Co. Similar to getting favorable terms of toll
collection, other benefits from government connection discussed
here also promotes investment.
The importance of government connection is not without its
costs. One result is that there are very few private firms
engaging in the highway business and another is that there is
very little foreign direct investment in the sector, as Table 4
shows. Another barrier for private firms to enter the business is
that a highway company has to have at least 30% equity to be
eligible for bank loans. Given the policy risks involved with
highway projects, it is very hard for private investors to raise
such fund.
The dominant role played by the government in highway
development comes with high political costs. Corruption is ram-
pant in this sector. Since 1997, 20 director generals or deputy
director generals of various provincial departments of trans-
port have been convicted of bribery. In the case of Henan
province, three consecutive director generals have been
convicted
of the crime one after the other in unrelated cases. The
provincial departments of transport have almost unchecked
51. power in
offering highway construction contracts, even though the
contracts are ostensibly offered by a tender process. In some
cases,
the officials leaked the reservation price to some bidders. The
officials also control a large sum of highway construction funds
and can allocate the funds to lower level highway authorities
with much discretion. The reason for the high incidence of cor-
ruption in this sector is not lack of penalty. Of the twenty cases
above, there are five death penalties. The temptation is so
strong that even the risk of death penalty cannot deter
corruption. Table 5 presents a list of bribery cases involving top
pro-
vincial transport officials.
3.3.3. Rates of returns to investment
To quantify investment incentives, we estimate the rate of
return to investment. Using data from the annual reports of the
12 publicly listed expressway companies, we find that the
average rate of return on equity is 10.5%, with an average
leverage
ratio of 40%.
We also try to estimate the rate of return to investment for the
whole sector. The National Bureau of Statistics of China
provides data on investment and the breakdown of value added
for the transport, storage and postal service sector. This in-
cludes all modes of transportation plus storage and postal
service. We use two methods to estimate the rate of return in
this
sector. One method is similar to the one used in Bai et al.
(2006). This method deducts economic depreciation from capital
income to get the net rate of return. The other method uses
accounting depreciation. More detailed description of data and
estimation method is given in Appendix A. The estimated rates
of return to capital are given in Fig. 11. The rates of return in
52. the transport, storage, and postal service sector are very
respectable; they compare favorably with the rate of return to
cap-
ital of the whole economy net of urban residential housing
estimated by Bai et al. (2006).
Fig. 12 shows the composition of fixed asset investment in the
transport and postal service sector in 2006. Investments in
highway transport and railway transport together account for
76% of the total. We will show later that the rate of return to
capital in the railway sector is much lower than the estimated
rate of return in the whole transport and postal service sector.
Therefore, we can speculate with some confidence that the rate
of return to investment in the highway transport sector
should give the investors strong incentives to invest.
Table 5
Top provincial transport officials convicted of bribery.
Year Province Rank of the official Penalty
1997 Henan Director general 15 years
2000 Sichuan Director general Death, commuted
2000 Sichuan Deputy director general Death
2001 Henan Director general Life
2001 Hunan Deputy director general Life
2002 Guangxi Deputy director general 11 years
2002 Guangdong Deputy director general 13 years
2003 Guizhou Director general 17.5 years
2004 Guizhou Director general Death
2004 Heilongjiang Deputy director general Life
2004 Yunnan Deputy director general 2.5 years
2005 Guangdong Director general 13 years
2005 Beijing Deputy director general Death, commuted
53. 2006 Henan Director general Life
2006 Jiangsu Director general 20 years
2006 Anhui Director general 10 years
2006 Hebei Deputy director general 14 years
2007 Zhejiang Director general Life
2008 Fujian Deputy director general Death, commuted
Xinjiang Director general No news of conviction
Source: collected by authors.
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97
98 99 00 01 02 03 04 05 06
Year
net of accounting deprecition net of economic deprecition
Fig. 11. Rates of return to capital: transport, storage, and postal
service. Sources: authors’ calculation, see Appendix A for
details.
58%
18%
54. 9%
7%
4%
3%
1%
Highway
Railway
Waterway
Urban Public
Aviation
Storage
Others
Fig. 12. Composition of fixed asset investment in transport and
postal service sector. Sources: China Statistical Yearbook
(NBS, 2007).
46 C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
(2010) 34–51
4. Railway
4.1. Evolution of policy
4.1.1. 1949–1982: rigid planning and low prices
The Ministry of Railway was part of the rigid planning system.
There was no separation of government functions with
55. business activities. The Ministry of Railway had very little
autonomy and the local railway bureaus had even less. Prices
were
uniformly set by the central authority. In 1955, the price was
0.0165 yuan per ton-kilometer for freight and 0.0149 yuan per
person-kilometer for passengers. By 1967, the freight price had
dropped to 0.01438 yuan per ton-kilometer.
C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
(2010) 34–51 47
4.1.2. 1982–1985: greater local autonomy and some profit
retention by the railway system
Some autonomy on planning, finance, employment, personnel
decisions was given to the local bureaus of railway. At the
same time, the railway system could retain some profit
according to a formula after tax payment. Railway service
prices
were increased but they still lagged behind the general price
level. Compared to 1955, the 1986 freight price dropped by
20.8% relative to the consumer price index and passenger price
by 15.7%.
4.1.3. 1986–1992: financial independence of the railway system
In March 1986, the State Council gave the railway system
greater financial autonomy and responsibility. The railway sys-
tem was exempt from income tax and a few other taxes. The tax
revenue and profit that were previously paid to the State
Treasury were now retained by the Ministry of Railway to
invest in the railway system. The railway system was separated
from state finance but the railway system itself was still the
same entity that combined government functions with business
56. activities. In this period, prices were increased by very large
margins.
4.1.4. 1993–2002: corporatization
In 1993, the railway system started experimenting with
corporatization. Guangdong railway bureau was restructured
into a corporate group in February, 1993. Then Dalian railway
bureau became Dalian Railway Limited in 1995. Guangz-
hou–Shenzhou railway was publicly listed in Hong Kong and
New York in 1996. The whole system went through corpora-
tization in 1999. Five non-core businesses including
engineering, construction, equipment, materials, and
communications
were separated from the Ministry of Railway and became
independent enterprises in 2000. The corporatization effort at-
tempted to separate government functions from business
activities in the system. In the same period, the price policy be-
came more flexible. Some variation is allowed in prices. Prices
were allowed to depend on the quality, route, and season
of the services.
4.1.5. 2002 – now: more price flexibility
The National Planning Commission issued a document in 2002
that allowed a lot more flexibility in railway prices. The
document referred railway prices as under government guidance
rather than determination. The document specified ranges
for price adjustment, instead of exact prices. Within the range,
the Ministry of Railway has the authority to approve the
application of price adjustment submitted by local railway
bureaus. Public hearings are also conducted before main price
adjustments are made.
4.2. Investment
57. As shown in Fig. 13, fixed asset investment in the railway
sector went through a few steps. It was more or less stable in
each of three periods: at around 20 billion yuan a year between
1991–1992, 57 billion yuan a year between 1993–1997, and
87 billion yuan a year between 1998 and 2004. However, it has
been increasing very rapidly since 2004. The growth rates are
51%, 52%, and 22% respectively in 2005, 2006, and 2007. One
possible reason for the recent rapid growth is the adoption of
the ‘‘medium and long term plans for railway network” by the
state council in 2004 (SCC, 2004). The plan includes a target
growth of 39% in the total length of railways from 2002 to
2020. The target was recently revised up to 67% (SCC, 2007).
From
Fig. 14, we can see that more than 80% of the investment in
basic construction in the sector has been made by the ministry
of
railway. Table 6 shows that almost all the fixed asset
investment is made by domestic state-controlled organizations,
and
around 90% of the investment is made by the central
government. Table 7 shows that state budget plays the most
important
in fixed asset investment in the railway sector. All these
observations are quite different from the electricity and
highway
sectors.
0
50
100
150
200
58. 250
300
1991 1993 1995 1997 1999 2001 2003 2005 2007
Year
Fixed Asset Investment in Railway (unit = billion yuan)
Capital Construction Improvement Vehicle Purchase
Fig. 13. Fixed asset investment in the railway sector: 1991–
2007. Sources: Yearbook of China Transportation and
Communications (CCCTCY, various years);
Statistical Communiqué of Ministry of Railway (MOR, various
years).
82.0%
84.0%
86.0%
88.0%
90.0%
92.0%
94.0%
96.0%
59. 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Year
Fig. 14. Share of capital construction investment made by the
ministry of railway. Sources: Statistical Communiqué of
Ministry of Railway, 1998–2007
(MOR, various years).
Table 6
Investment in fixed assets in urban area by jurisdiction of
management and registration status: railway (unit = billion
yuan).
Year Total By jurisdiction By registration status By registration
status
Central Local Domestic HK, Macao, Taiwan Foreign State
Collective Private
2004 84.63 75.27 9.36 84.63 0.00 0.00 83.78 0.42 0.04
2005 126.77 112.18 14.59 126.72 0.00 0.04 124.45 0.99 0.05
2006 196.65 176.55 20.11 196.56 0.03 0.07 191.79 3.61 1.16
Sources: China Statistical Yearbook, 2005–2007 (NBS, various
years).
Table 7
Source of funds of investment in urban area by sector: railway
(unit = billion yuan).
Year Total By sources of funds
State budget domestic loans Foreign investment Self-raised
funds Others
60. 2004 82.95 32.27 17.85 0.47 25.26 7.10
2005 128.84 44.62 33.37 3.03 38.84 8.98
2006 194.56 58.76 33.15 2.49 71.05 29.10
Sources: China Statistical Yearbook, 2005–2007 (NBS, various
years).
48 C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
(2010) 34–51
From Table 8, we can see that the railway system has been
profitable since 1998. However, the rate of return to invest-
ment in railway is low. Fig. 15 shows the rate of return to
capital since 1991. The rates are low in recent years even when
taxes are included in capital income. Given these low rates, it is
hard to imagine profit-oriented enterprises would have any
incentives to investment in the railway sector.
5. Conclusion
Of the three sectors we consider in this paper, railway stands
out being very different from the electricity and highways
sectors. The electricity sector, both in terms of installed
capacity and output, has kept in pace with the growth of the
econ-
omy, and so has highway transport in terms of business volume.
The growth in the length of expressways has also been phe-
nomenal. The railway sector, however, has seen its business
volume growing much slower than GDP for both passenger and
freight, and its share in the transport market shrinking fast. Its
route length has grown at the lowest rate among all major
modes of transportation.
One major difference between the railway sector and the other
two sectors is that the former is still very centralized and
its business is still essentially run by the central government,
specifically the Ministry of Railway. Almost all of the invest-
61. ment is made by the ministry. In contrast, in the electricity
sector and the highway sector, there is much autonomy at the
provincial level and at the enterprise level. Enterprises in these
two sectors have very strong profit orientation and many of
them are publicly listed companies, even though the government
often maintains a controlling share of them. Local govern-
ments are also motivated to help enterprises in the two sectors.
In the electricity sector, local governments compete for
investment in their region to increase their tax base, by offering
land concession among others. In the highway sector, local
governments are often one of the owners of the highway
companies and their incentives to help the companies are also
very
strong. Competition among enterprises created by
decentralization is another factor that drives investment in the
electricity
sector.
Prices in the railway sector are yet to be determined on
commercial basis, despite a general trend of relaxation of price
rigidity. Other goals dominate commercial viability in
determining the prices. There are clear indications that prices
are too
low for efficiency. According to the Development Research
Center of the State Council (2005), only 30–40% of the demand
for
railway freight transport is met. The shortage of railway
transport supply is especially severe for the transport of coal. It
is
Table 8
Financial indicators of the railway system (1991–2007).
Year 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
63. 640 713.3 787.2 865.6 929.4 1055
Net value of fixed
capital
101.1 107.2 119.6 219 240.9 288.2 311.4 345.8 381.8 383 458.4
515 565.8 628.8 666.8 769.7
Sources: Year Book of China Transportation and
Communications (CCCTCY, various years); Statistical
Communiqué of Ministry of Railway (MOR, various
years).
-0.050
0.000
0.050
0.100
0.150
19
91
19
93
19
95
19
97
19
64. 99
20
01
20
03
20
05
Year
Net of Taxes Gross of Taxes
Fig. 15. Rate of return to capital of the railway system (1991–
2006). Sources: Authors’ calculation based on data from Year
Book of China Transportation and
Communications (CCCTCY, various years).
C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
(2010) 34–51 49
sometimes difficult for passengers to get tickets too. As a result
of the low prices, the rate of return to investment in the rail-
way sector is very low and it is impossible to attract profit-
oriented investors in the sector. In contrast, prices in the other
two sectors are mostly determined according the principle that
the recovery of investment cost and sometimes reasonable
rate of return to investment are guaranteed. As a result, the rate
of return to investment is sufficiently high to attract invest-
ment in a sustainable manner. Of course, there is also risk that
prices in these sectors become too low due to political pres-
sure. Such pressure may affect investment incentives.
Observations suggest that investment in the railway sector is too
low. For example, even though there is clear advantage
65. of railway transportation of coal over highway transportation of
coal, the latter is still very common. About 25% of coal is
transported via highway out of Shanxi province, the largest coal
producing province in China. The province is investing
28.8 billion yuan to build more highways for coal
transportation. There is strong reason to believe that efficiency
should im-
prove if the capacity of the railway system increases to
accommodate such need for the transportation of coal. Recent
surge
in railway investment seems a welcome trend, but the new
investment is still made mostly by the Ministry of Railway, and
the jury is still out on whether it will be allocated to areas
where it is most needed.
The other two sectors are not without their problems. In the
highway sector, bureaucrats still have too much control over
the planning and approval of projects, the provision of loan
guarantee, the choice of contractors, the approval of toll terms,
and the approval of the transfer of toll rights. The relationship
between the bureaucrats and the enterprises in the sector is
too close. The resulting corruption problem is politically very
costly. It may also cause economic inefficiency. For example, it
may lead to poor quality and high cost of construction when
highway construction contracts are offered to the cronies of the
bureaucrats in charge. Regulatory capture resulting from the
close connection between the government and the enterprises
increases the cost of usage to the consumers. In the electricity
sector, some companies have strong market power. Companies
with strong connections to the government or have monopoly
power do very well financially. As a result, there is not a level
playing field for other firms to compete in. Employees in both
sectors tend to be compensated much better than employees
in other sectors. This increases income inequality and political
resentment.
66. In the short run, some of these problems may be part of the
solution. For example, the close connection of the firms to the
government in the two sectors may help prevent the regulators
from arbitrarily reducing the promised price after invest-
50 C.-E. Bai, Y. Qian / Journal of Comparative Economics 38
(2010) 34–51
ment has been made. Rent extraction opportunities that are
associated with investment in the sectors may cause overinvest-
ment. Naturally, overinvestment is inefficient. However, given
the high growth rate of the economy, any overcapacity will
soon be filled by newly developed demand and the efficiency
loss can be a tolerable sacrifice in exchange for rapid expansion
of the sector. In sum, some of these practices may serve as
useful transitional arrangements that solve problems in the short
run, even though they are not the first best solution in the long
run.
Acknowledgment
We thank the editor and an anonymous referee for their
comments and suggestions, China National Science Foundation
for financial support (grant number 70625002), and Zijian
Cheng, Qi Liu, Weiqing Luo, Zhenjie Qian, Changzheng Zhao,
and
Luan Zhao for their excellent research assistance.
Appendix A. The estimate of return to capital
A.1. Electricity and heat power
Capital income is proxied by operating profits and production
taxes of enterprises with independent financial accounts
before 1998 and of SOEs and non-SOEs with annual sales over
67. 5 million yuan since 1998 in electricity and heat water indus-
try from various issues of China Statistical Yearbook.
Capital stock at current price in electricity and heat water is
estimated by perpetual inventory method. The procedure is
as follows: (1) proxy investment in fixed assets in electricity
industry with that of SOEs before 1981 (source: DOI-NBS,
2002)
and the sum of capital construction and capital improvement in
electricity and heat water since 1981 (source: China Statistial
Yearbook, NBS, various years); (2) use this proxy and national
investment in fixed assets to estimate the share of electricity in
national fixed capital formation; (3) estimate fixed capital
formation in electricity industry with the share obtained in (2)
and
national fixed capital formation (source: DNA-NBS, 2007); (4)
use the composition of national investment in fixed assets
(source: China Statistial Yearbook, NBS, various years) to
separate the estimate in (3) into construction investment and
equipment investment; (5) price indices of construction
investment and equipment investment for 1978–1989 are
proxied
by prices indices of value added in construction industry
(source: DNA-NBS, 2007) and PPI in machine industry (source:
China
Statistial Yearbook, NBS, various years); price indices of
construction investment and equipment investment for 1990–
2006
are taken from China Statistical Yearbook (NBS, various years);
(6) estimate capital stock of electricity industry at 1978 price
by type of investment with price index for each type; (7)
estimate capital stock of electricity industry at current price by
type
of investment with price index for each type; (8) add up capital
stock at current price by type of investment to get capital
stock at current price in electricity industry. Please refer to Bai
68. et al. (2006) for detailed explanation of this method of esti-
mating the capital stock.
Capital returns net of accounting depreciation are estimated by
the ratio of capital income over capital stock at current
price.
A.2. Transport, storage, and postal service
The breakdown of value added in the sector is from DNA-NBS
(2007). The investment data are estimated with capital con-
struction in this sector before 1980. Those in other years are
similar to those in steps (2) to (7) for the electricity and heat
water sector.
Economic depreciation rate is estimated by the weighted
average of depreciation rate in construction investment and
equipment investment, using capital stock by the two types of
capital stock at current price as weights.
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Infrastructure development in China: The cases of electricity,
highways, and railwaysIntroductionThe electricity
sectorStatistical summaryThe history of developmentCurrent
practicesDisaggregationPricing policyRegulation
authoritiesInvestment incentivesSources of
investmentIncentives and problemsRate of return to
investmentHighwaysStatistical summary of the transportation
sectorEvolution of highway policyCentral
planningDecentralizationIntroduction of tolls and their current
73. regulationExpansion of financing instrumentsInvestment
incentivesSources of investmentIncentives and problemsRates
of returns to investmentRailwayEvolution of policy1949–1982:
rigid planning and low prices1982–1985: greater local
autonomy and some profit retention by the railway system1986–
1992: financial independence of the railway system1993–2002:
corporatization2002 – now: more price
flexibilityInvestmentConclusionAcknowledgmentThe estimate
of return to capitalElectricity and heat powerTransport, storage,
and postal serviceReferences
China’s infrastructure inve stme nt as a de ve lopme nt strategy
GPS’s 21st Century China Center welcomed Francis Fukuyama
for its seventh annual Sokwanlok
Distinguish Lecture Series
https://gps.ucsd.edu/news-events/news/chinas-infrastructure-
investment-as-a-development-strategy.html
Feb. 28, 2018 | By Rachel Hommel | GPS News
Held Jan. 29, the 2018 Sokwanlok Distinguish Lecture Series
was presented by Francis Fukuyama, who
has written widely on issues in development and international
politics. His research has been
fundamental in Chinese policy, reaching deep into the body of
collective wisdom in 21st century
politics.
74. Hosted by the 21st Century China Center at the UC San Diego
School of Global Policy and Strategy
(GPS), the standing room only event honors the ongoing
contributions of center founders Marion and
Kwan So who established this series as an avenue to foster
greater U.S. and China understanding by
bringing international thought leaders to campus.
GPS Professor Barry Naughton, who holds the Sokwanlok Chair
of Chinese International Affairs,
applauded Fukuyama’s fearless spirit and front-line insights
into China’s infrastructure trends and
policy.
“He is a genuine public intellectual and somebody who reaches
deep into the body of collective
wisdom,” said Naughton. “He produces idea, thoughts and
insights that can reach out to millions of
people and give them a deeper and more sophisticated
interpretation of public affairs.”
China’s Growth of Infrastructure
Discussing China’s model of state-led development, Fukuyama
showcased how China over the years has
engaged heavily on infrastructure investment, which is the base
for the “One Belt, One Road” initi ative
75. — a development strategy proposed by the Chinese government
that addresses connectivity and
cooperation between Eurasian countries.
Unlike Western development funding, which has increasingly
focused on issues like public health, good
governance, anti-corruption and women’s empowerment,
China’s domestic development has been
fueled by high levels of infrastructure investment such as
building roads, bridges and airports.
“No country has ever gotten rich by just investing in public
health,” said Fukuyama. “Infrastructure is
desperately needed – people want roads, electricity and this is
not being met by Western agencies.”
Drivers of Development Trends
Fukuyama offers three factors in the growth of the Chinese
infrastructure investment. First, in China,
there is an authoritarian advantage, resulting in the need for less
consultation, allowing projects to be
completed more rapidly. Second, geopolitical positioning has
become a main driver for these projects,
with foreign policy goals weighing in the investment decision.
And third, within domestic industrial
policy there is a strong need to maintain spending to keep
76. Chinese people employed.
“One of the mysteries is how these decisions and tradeoffs are
being made,” said Fukuyama. “China’s
banks are not designed as loss leaders or aid institutions.”
Looking at over 20 case studies in his research, Fukuyama
examines several studies where U.S. and
China were both building and competing in a region, exploring
commercial (Western) vs. relational
(Chinese) justification for project selection.
https://gps.ucsd.edu/news-events/news/chinas-infrastructure-
investment-as-a-development-strategy.html
https://fukuyama.stanford.edu/
http://china.ucsd.edu/
https://gps.ucsd.edu/faculty-directory/barry-naughton.html
In the case of Jamaica, the highway project aimed to connect
the capital with the main tourism areas, we
see that the Chinese wanted to build influence in the Caribbean.
“China knew they were going to lose money but it was a way of
showing their flag in an area that was
traditionally part of the American sphere of influence,” said
Fukuyama. “They compensated to stay in
the game.”
By contrast, Fukuyama highlighted a Western project, Power
77. Africa, a U.S. government-led partnership
under the Obama administration. The initiative indicated that
African states did not want health
programs as much as they wanted electricity, a single item
repeatedly stressed, with a goal of 20,000
megawatts of new clean power generation by 2020.
Unlike the Chinese, which have invested $60-70 billion dollars
in other projects in Sub-Saharan Africa
in the past decade, the U.S. invested $0 in Power Africa, even
with the backing of President Obama.
They became dependent on mobilizing private sector resources
to fund the project.
“These kinds of issues in the U.S. are extremely hard to
coordinate, especially with 12 agencies required
to make it work,” said Fukuyama. “The U.S. has not delivered
on any projects, it’s quite a contrast to
China.”
Lessons Learned
Rather than looking at the frameworks of approaches as either
transactional (Western) or relational
(Eastern), Fukuyama examines rates of return. Because the
Chinese overemphasize the positive and
undervalue negative, their approach tends to work less well
78. outside of China.
Whereas internal rates of return estimate future cash flows after
interest, salary and cost of construction,
infrastructure development rarely captures an external rate of
return, or whether benefits flow to the
broader society.
“Most infrastructure projects anywhere in the world do not
justify complete private sector funding
because they won’t make money,” said Fukuyama. “You can
make money on airports, toll roads,
electricity and utilities but most infrastructure projects are
really public goods.”
Fukuyama concludes that neither side’s approach to
infrastructure investment is the gold standard. The
West has too many safeguards, which leads to project lags and
increased costs. China lays out too much
capital, with limited awareness of financial risk. With tensions
created by both approaches, Fukuyama
encourages changing behaviors.
“This is not a well-oiled machine. Our failure to do
infrastructure projects is a microcosm of our larger
democratic political problem,” said Fukuyama. “I’ve coined the
term ‘vetocracy’ or rule by veto. In the
79. American political system, we have overdone it.”
Watch the recording of the lecture.
https://www.youtube.com/watch?v=f-jhYXP-zgA#action=share
Tune into the 21st Century China Center's China 21 podcast
episode featuring Fukuyama.
https://soundcloud.com/gps_ucsd/china-21-chinas-political-
order?in=gps_ucsd/sets/china-21
https://www.youtube.com/watch?v=f-jhYXP-zgA#action=share
https://www.youtube.com/watch?v=f-jhYXP-zgA#action=share
https://soundcloud.com/gps_ucsd/china-21-chinas-political-
order?in=gps_ucsd/sets/china-21
https://soundcloud.com/gps_ucsd/china-21-chinas-political-
order?in=gps_ucsd/sets/china-21
![Infrastructure
Electricity
Highway
Railway
China
0147-5967/$ - see front matter � 2010 Published b
doi:10.1016/j.jce.2009.10.003
* Corresponding author. Address: School of Econo
E-mail addresses: [email protected] (
1 One commonly used approach is to estimate th
infrastructure (for example, Aschauer, 1989; Munnel
(for example, Hulten and Schwab, 1991; Tatom, 1991
Morrison and Schwartz (1996) and Lynde and Richmo
Li (2005) adopts a third approach and uses the chang
return to infrastructure investment. He finds significa
and Fan and Zhang (2004) and they both find positi
infrastructure increases property value (Haughwout, 2
Ying, 1988).
a b s t r a c t
Bai, Chong-En, and Qian, Yingyi—Infrastructure development
in China: The cases of elec-
tricity, highways, and railways
This paper considers the development of the electricity,
highway, and railway sectors in
China, with special emphasis on investment incentives.
Statistical summary of the devel-
opment of these sectors is offered, followed by a detailed
description of the institutional
background, including investment and pricing mechanisms. We
also analyze investment
incentives based on the institutional background and present our
estimates of the rates](data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7)