China needs sustainable funding for urban transport infrastructure boom

Zhirong Jerry Zhao says too much emphasis has been on 'innovative' financial tools at local level

PUBLISHED : Monday, 26 May, 2014, 3:43am
UPDATED : Monday, 26 May, 2014, 3:43am

China's economic take-off has been accompanied by a dazzling growth in transport infrastructure. There were a staggering 4.2 million km of highways by 2012, expanding from just 126,000km in 1949. Railroads in operation increased from 22,900km in 1952 to 98,000km in 2012, including more than 9,300km of high-speed rail.

In the subway boom, meanwhile, not only are megacities like Beijing and Shanghai adding new lines and extensions but smaller cities are also racing to open their first lines. The central government has given approval to 38 cities for at least one line by the end of the decade.

Behind this expansion, however, lie some serious concerns about China's transport infrastructure investments and whether these are sustainable. More studies are needed to examine the funding mechanisms, decision-making processes and policy effects. It is not clear whether the huge amounts of investment can be justified by economic gains, compared to alternative ways of spending in other policy areas.

Attention should also be paid to how the benefits are distributed to different groups and across different areas.

Finally, there are increasing concerns that China lacks reliable funding sources to pay back capital borrowing and sustain operating costs for transport facilities.

Indeed, China needs to get back to more "conventional" funding approaches that align with basic public-finance principles. Its urban infrastructure finance and transport investments in the past few decades may be characterised as a "government-led market operation", which has relied heavily on borrowing and fuzzy guarantees against future revenues at the local level. Beijing should gradually reduce its reliance on borrowing and financing, use more direct fiscal revenues (including central subsidies and earmarked local taxes and fees), and ensure investment decisions are made through more participatory, transparent and deliberate budgetary processes.

Beijing faces several distinct challenges in sustaining its investment boom in highways, high-speed rail and urban transit.

For the highway system, temporary toll waivers during holidays are not an efficient way to reduce public resistance to high tolls; neither would extending toll periods be an effective approach to pay back construction debts and sustain future operation. China needs to reduce its reliance on borrowing and tolling and improve decision-making about toll rates.

For high-speed rail, in addition to assessing the possible relationship between investment and economic returns, potential redistributive effects and equity concerns also need to be better understood. The use of private finance will not provide sufficient funding to pay back construction debts and sustain operations. Instead, joint fiscal efforts at the national and provincial levels are required.

For urban transit, such as subways, central or provincial governments could allocate a matching grant to help city governments cover capital costs, and use dedicated local revenue sources, such as a property tax, to subsidise ongoing operations and maintenance. Ultimately, cost sharing between the central and local governments need to be aligned.

Because of the public-good nature of transport facilities, it is unrealistic to expect them to pay for themselves without substantial fiscal support. Beijing needs to assist local governments.

While transport facilities have long-term benefits, since most will not generate sufficient operating profits for debt services, the government should consider using more pay-as-you-go fiscal revenues and rely less on financial tools, including borrowing, land transfer fees or public-private partnerships, that mainly put off funding responsibility to a future time.

Additional allocation of direct government funding and dedicated local revenue sources could make China's transport investment more sustainable.

Moreover, a more open and transparent decision-making process is required.

Questions will arise about where additional fiscal revenue may come from to reduce the reliance on market financing. Tax increases are not popular in any country, and this will especially be the case if a new property tax is used to pay for such public goods. But there is no free lunch in providing public services. And the decision should be made by the public, who need to find proper ways to shoulder the fiscal burden.

The transport sector is but one manifestation of the overall problem of fiscal imbalances in China. The system has delegated too much responsibility to localities that, when pressured, turned to "innovative" and often unregulated financial tools to make up for shortages of direct funding. Making China's transport sector more fiscally sustainable will be essential in creating a more balanced system.

Zhirong Jerry Zhao is associate professor of public administration in the Hubert Humphrey School of Public Affairs, University of Minnesota. This article is based a recent paper published by the Paulson Institute