This captures the tone of much reporting on Chinese HSR. People marvel at the rapid rate of construction, the vastness of the network, the quality of the service, and the ambitious plans for even more. Indeed, China has constructed 6,000 miles of HSR since 2008 and, as Sky reports, plans to invest the equivalent of 6o billion pounds ($97 billion) in the coming year. So China has a HSR network twice as long as the combined length of Japan's and Europe's networks and is spending heavily make it even larger.
Very often the growth of Chinese HSR is contrasted to the lack of growth in the author's country, as in the subtitle to the Sky News post. Indeed, China's 6,000 miles of HSR are a stark contrast to the US's 0 miles, and proponents of US HSR (notably the planned LA to San Francisco route) might be excused for using China's investment in HSR as a rhetorical lever against opponents. However, seemingly few people ask why China has invested so much more in HSR than other countries, or to question the wisdom of the massive scale of their investment.
One person who does so (albeit indirectly) is Michael Pettis in The Great Rebalancing. Pettis argues that China has been pursuing the Japanese growth model that is based largely on establishing the following three conditions:
- Undervalued Currency: the central banks systematically intervenes to keep the exchange rate down
- Low wage growth: labor policies ensure wages grow more slowly than productivity
- Financial repression: the government allocates credit and the central bank keeps interest rates below their equilibrium rate (Pettis, 203, p 53)
While having an abundance of savings and investment can spark wealth generation at first, when the existing stock of capital is low, eventually diminishing returns set in and the return on investment shrinks. However, the artificially low cost of capital encourages investment to continue at an above optimal rate. Pettis describes the situations as follows:
- "The longer heavily subsidized investment continues, however, the more likely that cheap capital and socialized credit risk will fund economically wasteful projects. Dirt roads quickly become paved roads. Paved roads become highways. And highways become superhighways with eight lanes in either direction. The decision to upgrade is politically easy to make because each new venture generates local employment, rapid economic growth in the short term, and opportunities for fraud and what economist politely call rent seeking behavior, while the costs are spread to the entire country through the banking system and over the many years during which the debt is repaid (and most at his rollover continuously)." (Pettis, 2013, p 90)
When reading the above passage, it is hard not to think of China's HSR as analogous to Pettis' hypothetical superhighway (or at least it was for me). Of course, one might argue that China is simply trying to catch up with the more developed world and is avoiding past (supposed) mistakes by building HSR instead of highways. One could argue that, since China is starting from such a low level of capital development that it would be a long time before they were in danger of overbuilding things like their transportation system. However, Pettis addresses this line of thought, as follows:
- "The problem with this reasoning of course is that it ignores economic reason for upgrading capital stock and assumes the capital infrastructure have the same value everywhere in the world. They don't. Worker productivity and wages are so much lower in China than in the developed world. This means that the economic value of infrastructure in China, which is based primarily on the value of wages it saves, is a fraction of the value of identical infrastructure in the developed world. It makes no economic sense, in other words, for China and have levels of infrastructure and capital stock anywhere near those of much richer countries because this would represent wasted resources - like exchanging cheap labor for much more expensive labor-saving devices." (Pettis, 2013, pp. 90-91)
The above passage gets right to the point I am raising about China's HSR. The primary advantatge of high speed rail is that it is high speed and therefore saves travelers time. Generally, the economic value placed on time saved is parameterized by wages and productivity. If I earn $20/hour, than spending an hour doing anything else represents an opportunity cost of $20 (i,e., the wages I could have earned). From a societal point of view, if my productivity is $70/hour, than having me do anything else represents an opportunity cost of $70 (i.e., the output I could have generated). So if a trip on a bullet train saves me 2 hours over another alternative, than the value of that savings is either $40 from the individual point of view or $140 from the society's point of view. Of course, this is an oversimplification that ignores, among other things, the fact that individual's generally value their free time at a higher rate than their wage (or else they working), but it gives you an idea of the type of calculation involved.
The point here is that, if we apply the same methodology (however oversimplified) to China, Japan, Europe and the US, the much higher wages and productivity in the last three would suggest that the economic benefit of HSR is much higher in them than in China. Yet China has chosen to build more HSR than all 3 countries/region combined.
This should at least raise an eyebrow or two, especially if one considers the conditions under which HSR has been successful elsewhere in the world. Tom Zoellner at the WSJ looks at the potential for HSR in the US and notes that the most successful routes in operation are those connecting capital and major business center in Japan (Tokyo-Osaka, 246 miles) and France (Paris-Lyon, 289). Besides connecting cities that provide a reliable passenger base, these routes fall in what Zoellner calls the sweet spot for revenue, distance of between 200 and 600 miles. Indeed, as Zollener notes, even the lumbering Amtrak, with trains averaging 68 mph, is able to capture 3/4s of the combined rail and air travel on the 225 mile route between D.C. and New York.
This suggests two points. First, that an extensive HSR system is questionable on the face of itself. We should expect to see 200-600 mile segments selectively placed between major metropolitan areas. Of course, if you have a string on larges cities 200-600 miles from each other, you might expect a longer line to connect them. However, you don't expect to see a huge network that includes an 1100 mile run through Tibet and the Gobi Desert to the far flung city of Urumqui.
Second, the example of the much lower tech US Northeast Corridor (NEC) suggests how much might be accomplished with less than high speed rail. Amtrak not only captures 75% of the non-automobile/bus traffic between DC and New York, but the four track NEC provides rail capacity for daily commuter trains. Where Amtrak has about 11 million passengers on its NEC trains (which includes the New York to Boston segment), the total passengers carried by Amtrak and various commuter rail services that use the NEC amount to 260 million/year. That's about a 22 to 1 ratio of commuters to intercity passengers.
Of course, another alternative to HSR, especially for routes over 600 miles, is airline travel, which China has not neglected. Indeed, Gordon Change at Forbes notes that China's Commercial Aircraft Corporation of China (COMAC) is hoping to start selling its C919 aircraft in 2016 and is hoping to sell over 4600 to Chinese airlines. However, though air travel in China is increasing at the rate of 10% a year, Chang notes that HSR travel has been growing at nearly three times the rate, 28%. He notes that subsidized rail prices are much lower than airline prices and have not seen increase in nearly a decade. So, Change argues that Chinese HSR is dampening demand for air travel and endangering future sales of its C919. However, he doubts that China will be able to operate the extensive network currently envisioned envision, and he notes that the rail operator is already $500 billion in debt.
Indeed, Pettis predicts future difficulties for the economy as a whole if the systemic imbalance between consumption and investment is not adjusted. The money being poured into HSR, and into may other infrastructure and manufacturing investments, may be sparking apparent short term growth, but this apparent growth may be masking the destruction of wealth if these investments are economically unsound. In the long run, any destroyed wealth will take the form of bad debt that will have to be paid down, which will slow future growth (or possibly cause a contraction in GDP). Pettis argues that if China does not take strong action to adjust its policies, it may face a Lost Decade similar to what Brazil experienced in the 1980s (Pettis, 2013, p 81-82).
This leads me to question whether China's investments in HSR, especially the current and future investments aimed at doubling the system, might ultimately be wealth destroying. Will they find themselves with a system that is greatly overbuilt and containing large segments that are untenable? While one might draw a fanciful parallel to the Simpson's monorail episode, more apt comparisons might be the overbuilding of American railroads at the turn of the last century or of the internet during the dot-com bubble. Both these examples involved over investment in infrastructure, one in steel rails and the other in fiber optics, that was ultimately unprofitable.
Of course, both the above examples left us with some infrastructure that, if not worth the cost of building, was nonetheless of enduring value. This is likely to be true of China's HSR as well. Indeed, it may well continue to be the pride of the nation even after its debt goes bad and large segments have to be abandoned or downgraded. After all, the NEC is the legacy of the Pennsylvania Railroad and then, after its merger with the New York Central) the notoriously bankrupt PennCentral.
Indeed, the more unequivocal example wealth destroying investment are likely to be in manufacturing where unprofitable firms are plowed under by their competition and their shuttered factories are of limited enduring value. In that sense, COMAC, if it fails to break up the Boeing-Airbus duopoly in midsized commercial aircraft, may end up looking like a more unmitigated failure than Chinese HSR.
Postscript: BBC Two has a report by Robert Preston that details the scale of Chinese investment and accompanying debt and warns of a future economic crisis.
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