China’s overinvestment: income level matters11 September, 2012, 3:01. Posted by Zarathustra
Earlier in our series on Chinese hard landing, we talked about over-investment. We wrote that relative to China’s economic output, China has quite enough of fixed assets, a point we want to go back to and clarify.
And since China’s NDRC approved various urban rail transit (essentially Underground) projects last week, and by a happy coincidence that The Atlantic Cities wrote that China’s subway boom has gone bust, we talking about subway.
The article helps to clarify one of the key issues here:
Part of the problem with China’s subways is their cost. At 500 million yuan per kilometer, or about $80 million, their pricetags are not that much cheaper than they are in Seoul, where wages are much higher.
To argue that there is an over-investment in railway (or anything else) is not equal to making an argument that China does not need any railway (or anything else). In fact, we actually believe that if the Chinese economy continue to grow after getting the short- to medium-term difficulties behind (and we are quite sure that it will certainly do), more cities will have Underground, and existing Underground network will be extended, and quality of the infrastructure and services will certainly have room to improve, just as in everywhere else.
But at Chinese level of economic output (or income level), China cannot afford that many at that quality and costs, thus they should not have built that many.
The result of building expensive subways while the society as a whole is not wealthy enough to pay for the tickets at a price that can cover costs is very obvious: either the operators have to set tickets at relatively low prices to get people actually using it, or otherwise the Underground system would be under-utilised as average people are unable to pay higher ticket fees for their daily commute. Either way, the operators will not make enough money to cover the costs, thus local governments or whoever investing in these projects are forced to take on debts, and then unable to repay them.
So it is hardly surprising to read something like this from China Daily that only 1 line out of all Shanghai Metro lines is profitable:
Ying Minghong, board airman of Shanghai Shentong Metro Group Co, said that only Line 1 is profitable. The income from ticket sales and advertising covers its daily operating costs, but is not enough to pay for maintenance or the interest on its loans. The city’s other lines are in debt.
Chen said that the interest on bank loans cost the municipal government several billion yuan, not to mention the cost of construction and other outlay.
Shanghai Shentong Metro Co had gross liabilities of 609.7 million yuan by the end of 2011, according to its annual report. The figure was 262.8 million yuan in 2009.
However, Yang Di warned that the report did not reflect the overall situation, since only what are deemed "optimal resources" are listed as a part of Shanghai Shentong Metro Co.
"I doubt there are more than five people in our company and the local government who know how much money the Shanghai metro loses every year. The problem is that it’s not a simple mathematical question of adding the government’s yearly subsidy and subtracting the metro’s annual operating costs," said Yang.
And that is Shanghai, one of the richest cities in China.
That is why the argument being made that China has not overinvested because total capital stock per capita is very low is utterly nonsensical in our view, because it totally ignores the fact that Chinese people, on average, are just a fraction as rich as Londoners, for example, and yet some Chinese cities are apparently enjoying better apparently better Underground system relatively to London’s Underground system.
Certainly, some projects might be able to generate reasonable returns if GDP per capita double, for example. But before that happens, they are not generating enough return.
So the problem of China’s overinvestment problem should be clarified. There are certainly areas or sectors in which the absolute level of investment is simply too high on whatever metrics. But more importantly, we think that at its current level of economic output, it might be impossible for Chinese people to pay the prices that would generate enough return on investments, and the consequence of that is an inevitable accumulation of debt, as we are seeing now, and the consequence of the accumulation of debt is negative for the economy, as we are seeing now.