Transporting China into the future

Stratfor.com

Since enacting its 2009 stimulus package, Beijing has dramatically expanded its transport infrastructure to better connect the major cities in the country's interior to the rich coastal provinces. Building out this infrastructure has led to increased foreign direct investment in Central China.

Attracting foreign direct investment is necessary to improve the Chinese interior's economic prospects – improvement that is important for Beijing's goal of transitioning from a heavily export-based economic model to one that utilises more domestic consumption. However, most of the areas being integrated with the coasts through new infrastructure (and thus receiving the most FDI) are already large urban centers, and many rural areas have been left behind. The continuing disparity between urban and rural areas in the Chinese interior will make it difficult for the country to establish a more balanced economic model unless other reforms are undertaken.

On average, FDI in the six official Central Chinese provinces – Hunan, Hubei, Shanxi, Anhui, Jiangxi and Henan – though still relatively small is growing far faster than the traditional coastal manufacturing hubs like Guangdong, Zhejiang and Jiangsu. While the Central Chinese provinces together accounted for only 26 per cent of total FDI in China in 2010 compared to 45 per cent in Guangdong and Jiangsu alone, the rapid rise of inland foreign investment suggests that manufacturing in these provinces is becoming more economically viable, in part because production costs are making coastal manufacturing more expensive.

Urban centers along the Yangtze River have received the most FDI. Located at the nexus of water, rail and road systems, these areas are more competitive with coastal hubs as suppliers of goods for the global market. In an extension of former Chinese leader Deng Xiaoping's original plan for coastal development, Beijing is counting on development in cities like Wuhan, Hefei and Chongqing to gradually lift surrounding rural areas as well. But that will take time and continued reliance on export-led growth until wealthy coastal and urban areas are ready to be a more active consumer base for Chinese goods.

Nonetheless, the increase in FDI to coastal and inland regions suggests that the basic tools for greater economic development and integration of central China are in place. Today, FDI in coastal provinces generally supports higher value-added industries like electronics manufacturing, financial services, and other high-tech and capital-intensive projects. Newer investment in Central China, on the other hand, is weighted heavily toward manufacturing – from low-value added products like toys to primary industries like resource and mineral extraction or textiles production. If this trend holds, it is theoretically feasible that as the coast transitions to more service-based industries, inland urban centers and eventually the rural hinterland will begin to take over the more advanced manufacturing currently performed by the coasts.

However, making that possibility into reality will require a more comprehensive, far-reaching and logistically sophisticated national transport infrastructure than currently exists.

China's Inland Infrastructure

Building an integrated transport network in interior China is not easy. The region's geography is rugged, leading to many distinct clusters of economic activity, each densely populated but relatively isolated from the others.

This in part explains the central government's historical difficulty in integrating the regions, economically and politically, as well as many of the challenges Beijing currently faces as it seeks to develop the inland economy. But while China's central provinces may be far from the development level of its coasts, Beijing is working to create an efficient, modern transport system. This system will serve as the backbone of inland development and facilitate future investment, both foreign and domestic.

Today, around 76 per cent of all freight in China, or roughly 23 billion metric tons, is transported by road.



China's road network is now the second-largest in the world after the United States, with roughly 81,000 kilometres (50,000 miles) of paved roads anchored by three sets of national expressways: 12 linking Beijing to urban centres as far as Lhasa, 28 that stretch north to south across China, and another 30 spanning east to west. By comparison, in 1992 China had only 574 kilometres of official expressway, and as recently as 2007 that number stood at roughly 45,000 kilometres.

An expanded expressway system is necessary, but reliance on roads at the expense of rail and waterway transport (which each account for around 12 per cent of total freight transport by tonnage) reflects an imbalance that will hinder Beijing's goal of more even, comprehensive development of the interior. While roadways potentially offer greater access to rural markets not reached by rail or waterways, they are also far more expensive – especially for long-distance transport.

Moreover, China's road freight sector is far less logistically integrated than rail or shipping, with the majority of transport contracted out to individual truck owners rather than nationwide companies. Road transport works well in coastal areas, where distance and the cost of fuel are not significant deterrents, but it is less viable as a means of freight transport from inland manufacturers to distant coastal ports. In this sense, a robust road transport network is a reflection of a relatively weak rail and inland waterway system. As the price of fuel rises and road freight becomes more expensive, China's incentive for expanding its rail network will grow.

Though China's rail industry suffered significant funding cuts following the July 2011 Wenzhou train crash, recent reports suggest that funding for both passenger and freight line construction will resume soon. This, along with expansion of transport capacity along the Yangtze River corridor, which accounts for more than 30 per cent of all inland waterway freight transport, will be crucial to Beijing's effort to attract more foreign investment to inland provinces.

Implications for the Hinterland

Despite significant progress in building infrastructure throughout China's interior, the continued funnelling of investment to key urban centres points to several challenges in the country's economic rebalancing. While central China's economic development is still in its nascent stages and will take many years to reach the level seen in places like Shanghai and Beijing, there is little evidence that areas outside the major transport and trading hubs, such as cities along the Yangtze River, are benefitting substantially.

The economic divide between China's urban and rural regions has long been one of the country's most serious problems. While coastal provinces have their own gap, the disparity in China's vast interior is even more difficult, exacerbated by distance (within provinces and from the coast), rugged geography and a much larger rural population. Changing that will require raising the purchasing power of coastal and inland urban centres to a new level, where they can begin to decrease China's reliance on export markets.

Over the last decade, wages in Central China rose quickly and in some parts of the region now stand at roughly 85 per cent of average coastal wages. But the greater apparent parity of wages between the interior and coast masks the widening fissure between rural and urban residents in both regions. In 2011, disposable income in urban centres across China was more than triple that in rural areas, and in some provinces, such as Shaanxi and Fujian, nearly quadruple.

Addressing this gap will require tackling a number of problems, from still-inadequate rural infrastructure to the country's current household registration (hukou) system and, perhaps most important, education. These reforms might gradually give rural residents more purchasing power and aid Beijing's goal of shifting industry farther inland, but they also bring new risks of local corruption, overcapacity and social instability. And if the objective is a robust inland consumer base, both rural and urban, it will take more than one generation to achieve.

China's continued reliance on an economic model based on export-driven growth is another obstacle to foreign investment and the development of inland China. Beijing is worried that this model could become untenable before the country is ready. Though the United States may increase its consumption of Chinese exports, Europe probably will not, and Chinese goods are likely to only become more expensive and thus less attractive as the country develops.

China is not the first country to face this problem, but it is by far the largest and most geographically diverse. Thus, while other countries like Japan made the transition from "workshop" to consumer relatively gracefully, such a transformation, if forced on China before the country is prepared, could significantly undermine the existing political and economic structure. The key for China, then, is time. With enough time (and FDI), the coastal cities, interior urban centres and inland rural areas could each transition to the next stage of development and the country could establish a more sustainable economic model. But as Beijing well knows, that amount of time is outside its control.

Stratfor.com Reprinted with permission of STRATFOR.