The Broad Mind | Daily Notes: The Perils of China’s High-Speed Rail

China’s flagship $34 billion high-speed rail line operating between Beijing and Shanghai opens tomorrow, and will cover the 1300 km distance in less than 5 hours. The Wall Street Journal has a great article published today discussing the perils of China’s huge investment in this sector.

In China, large projects don’t have to go to the market for loans; the government directs the state-owned banks to lend to them, and if this is not concerning enough, the lending interest rate is mandated also by the state. When the government begins to set prices across sectors in an economy, a huge information gap is created, potentially creating a vast misallocation of resources. This is a recipe for creating structural imbalances and hidden risks. This is not to suggest that does not happens in market economies as well; a prime example being the housing bubble in the United States that led to the current global recession. However, this bubble was caused by precisely the same agent as in China, the state. Sustained intervention by the US federal government to keep housing prices artificially low in the United States over many decades (in order to meet the public policy objective of encouraging home ownership), helped in causing a catastrophic misallocation of resources and eventual market crash. It cannot be an exaggeration therefore, to suggest that while this mis-pricing of high-speed rail has achieved the enviable feat of blazing fast execution and efficiency, it carries a huge risk of financial devastation.

The Chinese government, of course takes a different view. They believe that building such a large and technically sophisticated system will give China a competitive edge over the rest of the world’s leading economies. For example, high-speed rail is able to link people in smaller cities of the interior with the large economic centers, allowing for greater integration of the domestic economy. The high-speed rail, according to Chinese officials, will also accelerate efforts to fulfill the long-term goal of developing China’s less populated and laggard western regions, which have not kept pace with the eastern provinces and their export-led boom.

Rapid augmentation of infrastructure is no doubt necessary, but it has to accomplished in a transparent, open manner to avoid the economic distortions that opaque decision-making causes. Thus, the manner of implementation is the real concern; there is no one who seriously questions that China desperately needs to build far more infrastructure. Many analysts expect the line to run on less than half capacity. The main reason for this is that high-speed railway ticket prices are usually double or higher than normal train fares. According the the WSJ article, the cheapest ticket on the Beijing-Shanghai line will cost 555 yuan ($86), or about 9% of monthly disposable per capita income of China’s urban population, and this fare is disturbingly close to low-cost airfares between the two cities.Thus, even with relatively higher fares, it seems highly unlikely that this line will ever make enough money to repay the large bank loans used to finance it.

– Vishnu Narasimhan

DISCLAIMER: This is an archived post from the Indian National Interest blogroll. Views expressed are those of the blogger's and do not represent The Takshashila Institution’s view.