Sharing Infrastructure and Improving Operational Efficiency

Abstract

Infrastructure, as a public good, has obvious spillover effects which contribute to economic efficiency while safeguarding the provision of public services. It balances efficiency and equity, and may effectively promote inclusive growth. China has already achieved significant accomplishments in infrastructure development: 5,198,000 km of roads and 146,000 km of railways (ranking No. 3 and No. 2 in the world in terms of total length, respectively), were in use as of end-2020. All the country’s urban and rural areas are connected to power grid, and 4G communication covers 99% of the country’s territory. According to the World Economic Forum, in 2019, China ranked No. 36 globally in infrastructure, which is higher than its ranking for GDP per capita. While production-oriented infrastructure (such as transportation, electricity supply, and communications) is evenly developed across the country, in terms of accessibility and affordability, there is still a gap between urban and rural areas. In contrast, there is a more pronounced regional and urban–rural gap in consumption-oriented infrastructure (such as water supply, gas supply, and environmental protection). Production-oriented infrastructure is attractive to investors, easily yields economic output, and the network effect is stronger, so local governments have greater incentives for investment. Future infrastructure construction should pay more attention to the issues of capital and operational efficiency. China’s future infrastructure construction focuses mainly on toll-free production-oriented infrastructure and consumption-oriented infrastructure, which generally lacks a profit base. Responsibility for investment is mainly borne by local governments, but the gap between local government revenues and expenditures has widened in recent years. Moreover, the government invests in and runs most infrastructure, resulting in a process that usually lacks healthy competition and efficiency. It is better for China to diversify financing and improve the operational quality and efficiency of its infrastructure.

Authors: Xin Yang, Wenjie Zhang, Jiani Liu, Xinhao Jiang, Chen Lu, Mingyang Yu, Yang Bai, Yuanfan Gu.

5.1 Status-Quo of China’s Infrastructure Development

As a public good, infrastructure has obvious externalities, and its development could enhance economic efficiency and guarantee society’s access to public services. However, this does not mean that the goal of inclusive growth may be automatically achieved by developing infrastructure arbitrarily. How to develop infrastructure in a manner that better promotes inclusive growth is the question this chapter attempts to explore, including defining the scope of infrastructure, analyzing the status-quo of infrastructure development, and clarifying the problems and better options for infrastructure development.

5.1.1 Infrastructure Promotes Efficiency and Contributes to Equity

Infrastructure refers to the physical engineering facilities that provide public services for social production and residential life, and is a public service system that is designed to safeguard social and economic activities in a country or region. Generally speaking, infrastructure is non-exclusive, features non-rivalry, and generates positive externalities. Infrastructure development drives economic growth and also enables the provision of better public services, contributing to inclusive growth. Specifically,¹ we believe that investment in infrastructure contributes to inclusive growth in four ways.

• (1) Job creation and economic activity. According to the National Bureau of Statistics, the number of people in China employed in the infrastructure construction industry in the public sector of urban areas was about 40.78 mn in 2020, accounting for 8.8% of urban employment nationwide. In addition, investment in infrastructure may also create new demand for economic activities, such as the construction of high-speed railways enhancing accessibility and establishing sustainable endogenous development in cities along the routes, effectively contributing to job creation and GDP growth.²

• (2) Improve output efficiency. Upon completion, infrastructure raises the production efficiency of each participant and thus increases output. For example, the development of drip irrigation, sprinkler irrigation, pipe irrigation, and other water-saving irrigation projects significantly improves irrigation efficiency and facilitates large-scale operation

• (3) Reduce transaction, logistics, and trade costs. For example, highways reduce transportation time and lower the cost of transporting goods. In turn, the reduction in travel costs supports the circulation of labor (the migration of workers between their homes and more urban areas), while the reduction in material transportation costs enhances the flow of products and indirectly raises personal incomes.

• (4) Improving the living conditions of low-income people and their access to public services. The construction of infrastructure and public utilities benefits low-income people. For example, assured access to safe drinking water improves the living conditions of residents.

Infrastructure development contributes to both efficiency and equity, thus achieving inclusive growth. The first three points discussed above focus more on the ability of infrastructure to improve the efficiency of economic production, while the last point centers more on people’s assured access to basic services.

The mechanisms by which production- and consumption-oriented infrastructure contributes to inclusive growth are slightly different. Production-oriented infrastructure (transportation, electricity supply, and communications) has stronger positive externalities and scale effects. This type of infrastructure also promotes greater networking between domestic and external markets (as roads connect people across vast distances), attracting investment to local markets and improving the efficiency of economic production. Consumption-oriented infrastructure (such as water supply, gas supply, and environmental protection) has stronger regional attributes and scale effects, and focuses more on the equity of access to public services.

5.1.2 Achievements and Problems of China’s Infrastructure Development

5.1.2.1 Large Scale and Fast Growth

According to the National Bureau of Statistics, in 2017, investment in infrastructure was about Rmb18 trn,³ with the CAGR for 2011–2017 reaching 17.3% (Rmb6.9 trn in 2011). The proportion of infrastructure investment to total social fixed asset investment rose about 5.9 ppt during this period, reaching 28.1% in 2017. The infrastructure investment as a share of GDP rose by about 8.0 ppt, reaching 21.3% in 2017. The total amount of infrastructure investment in China in 2017 was eight times that of the US and 16 times that of Japan, and the proportion of infrastructure investment to GDP in the US and Japan was 1.7% and 3.7%, respectively. Whether in terms of overall scale or growth rate, infrastructure investment is very important for China’s economic development. In 2017, investment in water supply, environmental protection, and public facilities amounted to 46% of overall infrastructure investment, transportation 34%; electricity supply, heating, and gas supply 17%; and communications infrastructure 3%.

China’s infrastructure competitiveness, which is a comprehensive index defined by the World Economic Forum (2019), ranks in the mid to upper range globally, but still lags behind advanced economies. The country ranked as the No. 36 most competitive out of 141 economies worldwide, (higher than its ranking for per capita GDP, which stands at No. 65), but remaining lower than that of advanced economies (with the US at No. 13 and Japan at No. 5). Communications and electricity supply are industries with smaller gaps between China and developed countries (Fig. 5.1).

Fig. 5.1

Source Vanderbilt, World Economic Forum, Global Competitiveness Report 2019, CICC Research

The global ranking of China’s infrastructure. Note Color shades represent numerical magnitude.

5.1.2.2 Declining Marginal Product of Investment

From 2008 to 2017, China experienced three boom and bust cycles of infrastructure construction in 2008, 2012, and 2016. However, the marginal impact of infrastructure investment on GDP growth is decreasing (Fig. 5.2). In investing in highways, for example, the internal rate of return (IRR) of toll expressways fell from 7–15% in the early years to 3–6% at present. The main cause is the rising cost of land appropriation, demolition, and raw materials. As a result, the construction cost of highways rose about 3–5 times (from about Rmb30 mn/km in the early years to about Rmb100–200 mn/km at present), but toll rates have not risen so much.

Fig. 5.2

Source National Bureau of Statistics, CICC Research

The marginal benefit of an infrastructure-driven economy is weakening.

For better development of infrastructure, two questions should be properly addressed: Is there disparity in the distribution of infrastructure now (with reference to regional, urban, and rural disparities)? What is an ideal management model for infrastructure development with respect to the source of funds, investors and operators, and the role of government?

5.2 Disparities in Infrastructure Development in China

Disparities can be defined as: (1) Accessibility, which measures whether residents have the same level of access to infrastructure services; and (2) affordability, which is the share of disposable income spent by users on infrastructure services.

5.2.1 Regional Disparity in Infrastructure Is Narrowing, but Urban–Rural Gap Remains Wide

There is still some regional disparities in China’s infrastructure as a whole. In terms of accessibility, there is a wide gap between urban and rural areas, whereas regional disparities exist but are gradually narrowing. In terms of affordability, spending on infrastructure as a share of disposable income is trending downward, and remains lower in China than in the US.

In terms of accessibility, there is inter-regional disparity, but the gap is narrowing. According to the National Bureau of Statistics, eastern China accounted for 37%, western China 31%, central China 25%, and northern China 7% of the cumulative infrastructure investment during 2003–2017. The CAGR in western and central China was 21.6 and 21.2%, which was higher than the 16.5% in eastern China. China’s Western Development Strategy formulated in 2000 has promoted a gradual reduction in the infrastructure accessibility gap between regions. However, the gap between urban and rural areas remains significant. Investment in fixed assets in rural areas was Rmb0.95 trn in 2017, while the total investment in the country was Rmb18 trn.⁴ According to the Ministry of Housing and Urban–Rural Development, fixed asset investment per capita for public utilities in 2020 was Rmb5122 in cities, which is 8.6 times the amount in counties.

China’s infrastructure affordability is improving. According to the China Statistical Yearbook and the US Bureau of Labor Statistics, China’s infrastructure spending per capita as a percentage of disposable income was 12.1% in 2019 (compared to 20.9% in the US during the same year),⁵ with China’s transportation accounting for 7.1%, gas supply 2.8%, and communications 2.2% (compared to 15.1% and 5.8% in the US for transportation and gas supply & communications). Meanwhile, China’s infrastructure spending as a percentage of disposable income declined by 0.8 ppt between 2014 and 2019, indicating improved affordability.

5.2.2 Disparity Is Narrow in Production-Oriented Infrastructure, but Remains Significant in Consumption-oriented Infrastructure

China’s production-oriented infrastructure is relatively well developed, and the accessibility to and affordability of some infrastructure even outpaces international levels.

• Transportation: In terms of accessibility, there are regional disparities in China’s transportation infrastructure, but the gap is narrowing. While there are still regional differences in rail and road density (in 2020, rail and road density in western China was about 20–25% compared to eastern and central regions). Rail and road density per capita in western and northeastern China were close to or even exceeded levels in the eastern and central regions (the road density per capita in the western region was 2.7 times that of the eastern region and 1.5 times that of the central region) in 2020.

Over the past 15 years, the gap in highway and rail density between regions has been shrinking, with a particularly significant decrease in western China. China’s transportation infrastructure may be more affordable than that of advanced economies: (1) The absolute road tolls and ticket prices of China’s transportation infrastructure range from 30 to 50% of that of advanced economies; and (2) transportation spending as a percentage of disposable income in China (7.1%) is about 8 ppt lower than that in the US (15.0%),⁶ and if broken down into urban and rural areas, the urban-rural gap in China (1.8 ppt) is narrower than in the US (6.0 ppt).

• Electricity supply: According to the World Bank, the rural electricity accessibility level in China reached 100% in 2016, and there is now no gap between urban and rural areas (cities reached 100% electricity access rate in 2000), which exceeds the world average (a 15 ppt gap between urban and rural areas). Affordability is more balanced among provinces. Residential electricity prices were around Rmb0.5/kWh in 2019, and the average ratio of domestic electricity expenditure to disposable income was 1.2%. According to the Pacific Northwest National Laboratory of the US Department of Energy, about 30% of states had a residential electricity bill to income ratio of 3–4% in 2017, and another 30% had a ratio that was higher than 5%, making China’s electricity price comparatively more affordable.

• Communications: In terms of accessibility, disparities in China’s communications infrastructure are gradually shrinking in all regions, with accessibility generally better than the global average. According to the China Academy of Information and Communications Technology and the Ministry of Industry and Information Technology, China’s 4G base stations cover 99% of the country’s land area, and all villages are connected to broadband. The fixed broadband user penetration rate is 33.6 households per 100 people in 2020, higher than the global average. The gap in internet penetration rate between urban and rural areas has narrowed and is better than the global level.

According to the China Internet Network Information Center, as of June 2021, China’s overall internet penetration rate reached 71.6%, better than the global average of 65.6%, with rural internet penetration reaching 59.2% and urban internet penetration at 78.3%, and the gap continues to shrink. The affordability of China’s communications infrastructure is also generally better than the global average. According to the report “The affordability of ICT services 2020” released by ITU and A4AI Alliance, the median price of entry-level fixed broadband in China in 2020 was 0.5% of monthly per capita income, much lower than the global average of 2.9%. The median price for mobile broadband in China in 2020 was only 0.5% of monthly per capita income, much lower than the global average of 1.7%.

Consumption-oriented infrastructure, such as water supply, sanitation, environmental protection, and gas supply, presents higher regional disparity and rural–urban gap, and is less accessible overall than abroad.

• Water supply: China’s water supply penetration rate needs to improve to reduce the obvious gap between urban and rural areas. According to the Ministry of Housing and Urban–Rural Development, in 2020, China’s urban water supply penetration rate was 99.0%, while that in counties, towns, and rural areas was 96.7%, 89.1%, and 83.9%, respectively. In rural areas, about 48% of usage is from pipe borne water, while 41% is from protected well water and springs.⁷ In terms of affordability, the price of water supply in China is also unevenly balanced between the northern and southern regions. The average unit price of tap water for southern residents is Rmb1.88/cbm, which is lower than that of Rmb2.85/cbm in the northern provinces, mainly resulting from the uneven distribution of water resources in the south and north of the country.

• Environmental protection: The sewage treatment rate in China’s towns and villages significantly lags behind those in cities and counties. According to the Ministry of Housing and Urban–Rural Development, the sewage treatment rate in cities and counties in 2020 was close to 100%, but the sewage treatment rate in the countryside was only 21.7% because the population in rural areas is scattered, and it is not convenient to provide centralized sewage treatment. In addition, there is still a regional gap. The average sewage treatment capacity per 10,000 people in the eastern region has reached 1900 cbm per day, significantly higher than in the central (1200 cbm) and western (1000 cbm) regions. In terms of solid waste treatment, there is also a wide gap between China’s urban and rural treatment capacity. According to China Statistical Yearbook, the treatment rate of domestic waste in cities and counties reached 99.8% and 98.3% in 2020, but in towns and rural areas it was 69.6% and 48.5%, respectively. In addition, in terms of regional treatment capacity, the average daily non-hazardous waste treatment capacity per 10,000 people in the eastern region reached 8.80 tonnes/day, while it was only 5.25 tonnes/day in the central region and 4.92 tonnes/day in the western region.

• Gas supply: There is a gap between urban and rural areas in terms of gas supply penetration rate, and the overall level is also far below that in the US. According to the data disclosed by the National Bureau of Statistics and the Ministry of Housing and Urban–Rural Development, China’s urban gas penetration rate was as high as 97.9% in 2020, while the rate in rural areas was only 35.1%. The gas supply penetration rate in the US reached 71.6% in 2020 (all natural gas), while China’s rate during the same year was only 55.3% (including natural gas, LPG, and town gas). In terms of affordability, gas is more affordable in urban areas than in rural areas, and there is still a gap between China’s overall level and that of the US. According to the National Bureau of Statistics, China’s urban residents spent 0.5% of final consumption expenditure on gas supply in 2017, while the ratio in rural areas was 1.2%, with the average overall ratio in China at 0.7%. According to EIA data, in 2019, the US spent 0.4% of final consumption expenditure on gas, so the affordability of gas in China is still weaker than in the US (Table 5.1).

  Table 5.1 Assessment of the current state of disparity in China’s infrastructure subsectors

In summary, due to strong economies of scale, China’s production-oriented infrastructure (transportation, power, communications) is well developed and affordable overall. Despite the low price, production-oriented infrastructure remains profitable and has a reasonable ROE (e.g., China’s data traffic prices are a third of that of the US, but the average net profit margin of China’s three major carriers over the past five years was 9.9%, while that of major carriers in the US was 10.7%). However, there are still large urban–rural and regional disparities in consumption-oriented infrastructure, and accessibility is lower than in most developed countries. Production-oriented infrastructure is more attractive to investors given its more visible performance and stronger network effect, giving local governments more incentive to invest in construction, which is probably one of the main reasons for its better development.

5.3 The Operation and Management of China’s Infrastructure

Globally, many countries continue to wrestle with the problem of infrastructure management. The properties of strong infrastructure externalities and long payback periods dictate that investment should mainly be led by government. However, China is not alone in its attempts to strike a balance between the kind of long-term management that governments can provide while ensuring the type of efficiency that has long been associated with the private sector.

China’s infrastructure management features the following characteristics.

• Local governments account for a relatively high proportion of infrastructure investment, but the fiscal gap has widened in recent years.

• Local governments’ infrastructure investment focuses mainly on toll-free production-oriented infrastructure and consumption-oriented infrastructure which generate either no fees or low fees.

• State-owned enterprises (SOEs) invest in most production-oriented infrastructure (e.g., railroad networks by the National Railway Group, communication networks by the three major operators, and power generation and power supply systems by the five major power companies and the two power grids), and usually operate it as well. Due to economies of scale in China, such investment provides a reasonable return, but is subject to inefficiency in industries in which there is heavy industry concentration.

5.3.1 Sources of Funding: Local Governments Accounts for a High Proportion of Funding Which Should Be Diversified

Chinese infrastructure investment is dominated by the government and SOEs. In 2017, total investment reached Rmb15.6 trn, and funding from the government accounted for 69.4%, SOEs 16.2%, public–private-partnerships (PPPs) 14.1%, and foreign capital 0.3%, corresponding to Rmb10.8 trn, Rmb2.5 trn, Rmb2.2 trn, and Rmb0.05 trn,⁸ respectively. We estimate that government-managed funds and the general public budget account for 19% and 16% of all funding from the government, corresponding to Rmb2.0 trn and Rmb1.8 trn, respectively,⁹ and the remaining government funding mainly comprises urban investment bonds (total issuance of about Rmb1.75 trn in 2017), special-purpose bonds (total issuance of about Rmb2 trn in 2017), and non-standard financial instruments (total issuance of about Rmb4 trn in 2017). In other words, except for PPP, infrastructure investment is basically led by the government or SOEs.

Local infrastructure investment accounts for a relatively high proportion of government investment, but the local deficits have widened. Government funding for infrastructure investment generally consists of fiscal funds (general public budget and government-managed funds) and debt funds (such as issuance of urban investment bonds or special-purpose bonds). As mentioned previously, after deducting investment by PPPs and SOEs (the total share of both being about 30%), the remainder is dominated by the government, with local governments bearing a majority of the investments.

Local governments provide 96% of the financial resources for infrastructure investment.¹⁰ According to China’s Ministry of Finance, in 2017, Rmb1.8 trn of the general public budget and Rmb2.0 trn in government-managed funds were invested in infrastructure, totaling about Rmb3.8 trn, of which the central government contributed about 4% (about Rmb140 bn) and local governments contributed 96% (about Rmb3.65 trn). The proportion of funds allocated for infrastructure investment in the general public budget and government-managed funds fluctuated from 15 to 17% at the local level from 2013 to 2017, while the funding from central government declined from 6 to 4%. Special-purpose bonds and urban investment bonds among debt funding are mostly issued by local governments which bear the majority of infrastructure investment (Fig. 5.3).

Fig. 5.3

Source National Bureau of Statistics, CICC Research

Percentage of sources of investment (left panel) and percentage of detailed sources of investment by government entities (right panel) in infrastructure (2017).

The gap between revenues and expenditures of local finance has widened. According to the Ministry of Finance, central and local fiscal revenue maintains a relatively stable 50–50 split following the tax reform of 1994. The share of local fiscal expenditure has expanded and reached 86% in 2020 (compared with about 70% in 1994). The local finance deficit, even after considering the transfer of payments from the central government to local governments, expanded from Rmb190 bn in 2008 to Rmb2.7 trn in 2020.

5.3.2 The Operational Efficiency Needs Improvement

As China’s infrastructure enjoys economies of scale, even with low fees, there are certain returns in the long term. For this type of infrastructure, the pace of marketization should be accelerated and social capital should be introduced. Laws and regulations also need to be improved to protect the rights and interests of social capital and to allow reasonable returns. As a result, we believe that operational efficiency should be improved.

In general, the nature of infrastructure in which local governments and SOEs invest differs, and therefore, the degree of marketization and efficiency of operation also differs. Local governments invest in infrastructure with a low degree of market-based operation, and invest in infrastructure that is generally consumption-oriented or production-oriented and which levies no fees. The economic returns for this type of infrastructure investment are not strong, and such infrastructure is usually operated by local SOEs and governments. For example, the main operators of urban water supply infrastructure are mostly SOEs which are usually not market-based, so operational efficiency is usually not high (Table 5.2).

Table 5.2 Government-led infrastructure investment and operating entities

To improve the operation of local infrastructure, it may be necessary to introduce a market-based model. The phenomenon of insufficient competition in the infrastructure sector is a legacy issue that persists, and is one of the factors leading to inefficient operations. For example, according to the Statistical Yearbook of Urban Drainage, the idle rate for sewage treatment capacity in counties reached 30% in 2016, and the load rate of sewage treatment ranged from 30 to 80%. The government should lower, in an appropriate manner, the barriers to entry for private firms in order to create competition. The role of the government may change from being an operator to a rule-maker, thus finding a balance between reasonable returns for enterprises and protecting consumers’ access to public services.

SOEs mainly invest in production-oriented infrastructure, including railroads, toll roads, electricity supply, and telecommunications, which achieves economies of scale and has the potential for profitability through market-based operations. For example, the average net profit margin of the A-share listed toll road sector over the past five years is 30%, and ROE is 11%; the average net profit margin of China’s three major telecom operators over the past five years is 10% and ROE is 8%. SOEs usually serve as both investors and operators. For example, the State Railway Group invests in railroads as the investment entity, and is also responsible for the unified scheduling and command of railroad transportation as the operation entity (Table 5.3).

Table 5.3 SOEs tend to integrate investment and operation

Moreover, SOEs invest in infrastructure in industries with high market concentration, and insufficient competition results in low operational efficiency. For example, the railroad industry is highly concentrated (the State Railway Group is the main operating entity), and the operational efficiency needs to improve. According to the Ministry of Transport, China’s rail freight market share has been declining since 1986. Its share of rail freight turnover declined from 44% in 1986 to 13% in 2016. After 2016, the country began to keenly promote rail freight, resulting in the share of rail freight recovering to 15% in 2020. China’s rail freight turnover per capita in 2019 was 1.58 mn tonne-km. These figures of efficiency of China fall behind those of benchmark countries in the world. Its inflexible pricing mechanism and lack of competitiveness (compared to the more flexible road transport), negatively affects the operational efficiency of railroads in China.

To improve the operational efficiency of China’s infrastructure, we believe that further effort is needed with regard to the following aspects. Firstly, the operation of consumption-oriented infrastructure is currently mainly the responsibility of local SOEs or government agencies. Competition and clear assessment indicators may be introduced in an appropriate manner, but the government must balance the relationship between the reasonable returns for operating enterprises and the basic guarantee of infrastructure services for residents. Secondly, for production-oriented infrastructure in industries with high concentration, efficiency can be improved through reform. Where it is possible to generate investment returns, infrastructure should be invested in and operated by corporate entities.