66037 China Transport Topics No.01 December 2011 Railway price regulation in China: time for a rethink? John Scales, Gerald Ollivier and Paul Amos World Bank Office, Beijing The system of price setting and regulation in China Rail (CR) has evolved since the 1950s from one of uniform prices controlled to low levels, to one aimed at recovery of aggregate costs, with some limited price differentiation. State regulation of tariff structures and levels remains. In the last thirty years, economic development has brought about four structural changes in the economic circumstances of the railway sector: active competition from other transport mode has diminished the market power of railways; extensive rail network development is helping address the earlier capacity shortage responsible for rationed services, by significantly broadening service options and increasing network capacity; CR needs to generate additional revenue to service its growing debt in a context where price stability is paramount; and the growth in average income and reduction of poverty means that passenger fare regulation undertaken for social reasons could now be more targeted, keeping in mind that affordability remains a major policy objective. So should State regulation of railway tariffs be further relaxed? This paper suggests some alternative approaches to railway price setting and regulation that might be usefully explored by the Government of China to stimulate internal economic vitality, to optimize the use and economic impact of new capacity, to increase railway revenues, to boost consumer demand, to make transport system more convenient and affordable, while keeping price stable. RAILWAY PRICES IN CHINA? type. A national railway construction surcharge was later introduced and levied on all freight to help fund The freight tariffs and passenger fares charged to infrastructure capital investment. In railway passenger China‟s industries and travellers for using public transport, fares were adjusted and the principle of railways in China must be approved by the State higher fares for higher quality classes of travel was Council. This responsibility is administered by the adopted. National Development and Reform Commission (NDRC), the State Council‟s macro-economic The balance of responsibility for price formation was management agency. NDRC regulates all China Rail also changed after the new Railway Law of 1991. (CR) tariffs as well as those of inter-Provincial joint Since then, the Ministry of Railways (MOR) has venture and local railways. initiated price formation by developing a government- guided price scheme, which it then submits to the Central control of prices was adopted when China‟s NDRC (and before 2003 to its predecessor, the State railway system was consolidated as a unified system Planning Commission or SPC). After NDRC has after 1949. In 1955, uniform tariff rates were imposed modified and approved the scheme, MOR instructs the for freight (based on a single rate per tonne-km) and 18 Regional Rail Administrations (RRAs) to for passenger-km (based on a single rate per passenger- implement the new tariffs. km) across the whole country. This uniform system, with some reductions in actual tariff levels imposed on Transparency was increased when a public hearing CR to support other sectors, and to counter inflation, system was introduced into price decision-making was maintained until 1982. more widely in China through a 1998 Price Law. As a result of policies adopted after public hearings hosted Beginning in 1982, in concert with overall national by SPC in 2002, MOR could adjust CR‟s passenger economic reforms, and recognizing a need for revenue fares in special periods (such as holidays and Chinese to fund system expansion, a new price system was New Year) within a certain range. With more intense permitted with a more diversified structure. Nine transportation market competition, railway freight freight tariff categories were adopted based on product tariffs also came to be adjusted annually and special China Transport Topics No.1 2 World Bank Office, Beijing pricing policies were adopted for certain train not choose to play such a strong role in the pricing of categories. other transport services like airlines, road haulage and inland shipping services. We believe there are a The system of freight tariffs and passenger fares on number of factors that may have been influential in China Rail has therefore evolved gradually from one of maintaining stricter control of railway tariffs. almost total uniformity and artificially low prices to one based on the need to recover aggregate railway The first is that CR has a near-monopoly in the supply costs while providing a limited measure of product of railway transport services in China. When a single differentiation and flexibility. While the „price organization has such a dominant position in supply of planning‟ role of the Ministry of Railways has been a socially important transport service it is natural that strengthened, strong State oversight and regulation of government should satisfy itself that the prices set by the actual tariff levels and structures adopted has the organization are reasonable. endured. A second factor may have been that, for a long period INTERNATIONAL PRACTICE in the past, the railway industry itself has not needed the greater pricing flexibility to attract new traffic that The governments of all the leading railway countries of a less heavily regulated pricing system would allow. the world regulated railway tariffs quite heavily in China rail has by far the most densely trafficked earlier stages of their development. Most have railway network in the world. On many routes demand subsequently modified their approach and given has consistently outstripped supply. It has not always railway operators much more freedom to set prices. needed to try to develop new services and win new Residual government regulation is usually targeted at customers because it may not have been able to handle misuse of that freedom in the case of freight tariffs, or the extra traffic anyway. Of course, price freedom targeted at specific social protections in the case of could have been used to „choke off‟ excess demand, passenger fares. For example, freight tariff formation but government has preferred to ration capacity by and regulation in North America, which has the largest imposing wider priorities (such as for coal trains to fire comparable freight rail system to China‟s, has led to a power stations, or passenger trains during holiday much wider range of tariffs and the frequent use of peaks) while encouraging China Rail to invest in the directly negotiated contracts between shippers and rail long-term capacity that it needs. operators; they are tailored not just to broad commodity types but to specific customers, industries Thirdly, the regulated prices system has until the last and routes with the aim of retaining traffic and winning few years provided adequate revenue. Until around new customers from road transport. In another 2003, a mixture of tariffs and the railway construction example, the railways of the European Union which, surcharge provided sufficient revenue, with some other like China, has a very large inter-city passenger rail emerging sources, to fund China‟s railway network, offer a wide and flexible range of ticket types development program with only limited support from and price, to try to attract more of the people who want the national budget for specific lines. to travel between cities, whether for business, personal or holiday reasons, similar to the practice in the airline Fourthly, and of particular relevance to passenger fares, industry. there has been a concern for the affordability of rail transport by the poorer sections of the community and THE CASE FOR THE CURRENT SYSTEM the large population of migrant workers and students who must travel large distances from time to time The origins of China‟s railway pricing system reflected between their home towns and villages and the regions its political priorities at that time but it is also and cities where they work and study. instructive to explore some of the reasons why China might not wish to retain such a strong role for the State Taken together, these issues constitute a seemingly in railway pricing, (with a correspondingly smaller role persuasive barrier against change. Indeed, the redesign for MOR and an almost negligible role for the RRAs). of tariff regulation does not appear to have been a The question is important especially as the State does major policy issue. Or if it has been, the case for China Transport Topics No.1 3 World Bank Office, Beijing redesign has not been able to overcome either the match tariffs to specific market segments will be concerns of policy-makers or the inertia that resides in essential to compete for traffic with other modes. an established and working system. Revenue adequacy may also be re-emerging as a However, we believe that railway price reform is crucial issue. One of the main roles of a well- becoming a more urgent issue and that market forces functioning pricing system is to earn the revenue are giving increasing weight to the case for change. needed to sustain the activity. The plan represents perhaps the biggest single and integrated program of THE CASE FOR CHANGE rail investment there has ever been in one country. It will undoubtedly bring long-term economic benefit to Let us consider each issue in turn. First, some consider China. But infrastructure investments that will serve CR to be a monopoly, but it is now a monopoly of rail society for decades, if not centuries, rarely have short- transport not of inland transport as a whole. In 1982 term payback periods. In the interim they will generate railway transport did indeed have a dominating share a significant burden of debt. To reduce the risk that of both freight and inter-city passenger travel markets MOR will need to call upon the central budget for in China. Since then, but particularly in the last ten support, it would need to generate additional revenue years, highway transport, inland shipping and airline primarily by attracting new customers, given the services have all improved and expanded their services current emphasis on overall price stability in China. To by leaps and bounds. Railways‟ modal share in China that end, MOR will need to be granted more freedom has greatly declined and far from having a general over its own pricing, not so that MOR increases the monopoly power it must now compete in most general level of tariff, but so that it can flexibly tailor transport markets that it serves. Of course, there are its product, pricing and packaging to match different some specific markets (depending on commodity and customer needs. Indeed application of these principles route) where CR still has significant market power. in railways in North America and Europe overseas has This justifies regulatory oversight of those cases, but typically led to lower average prices, higher utilisation does not imply a need for the State to approve and of assets, better services and higher revenue. regulate all railway prices. The affordability of rail passenger fares is naturally an In terms of capacity utilization, the progressive important concern when the railway system plays such implementation of the Mid- and Long-Term Railway an important role in regional and social cohesion as in Development Plan, now well under way, will more China. However, the present regulatory framework for than double the total capacity of China‟s railway passenger fares was established in 1982 when nominal network in the busiest corridors. The public rail GDP per person in China was less than one-sixteenth network is planned to be increased from around 75,000 of what it is now (around one 10th in constant prices); km in 2005 to 120,000 km in 2020. By 2020 half of the the poverty rate was then just over 50 percent, network will be double-tracked or electrified or both. compared to about 10 percent now. Arguably, what The dedicated high-speed passenger network will was a general regulatory imperative in 1982, could now contain more high speed rail line than in the rest of the be a more targeted intervention, supplemented by low- world put together and it will free capacity on existing cost off-peak fares. lines to meet freight demand. Three new regional inter- city systems will serve the main conurbations. High- Different countries have found different ways of capacity coal transport corridors based on China‟s ten handling this challenge. Some provide specific major coalfields will provide an annual coal transport concession fares to particular social groups, some capacity of 2 billion tonnes in 2020. The plan will allow a certain number of trips per year at discount herald an era in which, for the first time, CR managers fares, some regulate the prices of basic ticket types will be faced with a situation in which they must while allowing freedom of railway enterprises to actively seek to sell capacity rather than to ration it, charge market prices for other services like premium including spare freight train paths and unsold seats on services, restricted ticket types or tickets for peak travel passenger trains. Global experience indicates that times, and some offer a set of market-based deeply control over the pricing function and the flexibility to discounted fares during periods with lower demand. China Transport Topics No.1 4 World Bank Office, Beijing Price differentiation by user group, type of service, expressway and railway transport or freight type restrictiveness of ticket conditions, time of day, or day like international containers), while retaining some of week typically requires a more sophisticated ticket form of appeals procedure and dispute resolution retailing system than is currently used by CR. CR is for customers in case of misuse of market power. developing new ticketing systems but can only reap the  creating a “zone of flexibility” (i.e. a percentage full benefits of investment in ticketing systems if they range around the approved freight tariff rate) to are used to implement much more sophisticated pricing allow CR marketing staff to better respond to systems. For this, MOR needs more freedom over the individual shipper needs. pricing function.  directly negotiated railway-customer contracts The changes described together represent a dramatic (including prices) in cases where MOR monitors shift in the dynamics of China‟s transport industry and and certifies the legitimacy of any tariff discount in the economic paradigm within which CR must offered and the authorities find no negative operate. It is a shift which, in the view of the authors, competitive impact in such agreements. Such justifies a government examination of alternative negotiations may also lead to customers choosing models by which railway tariffs are set and regulated. higher service level for a higher price. SOME OPTIONS FOR REDESIGN These options could be a starting point. Some greater flexibility has already been granted on specific lines. While there is in our view a clear case for greater There is no doubt that, working together NDRC and pricing freedom, it is for China‟s policy makers to MOR could develop a new regulatory framework for determine how new tariff regulations might best be railway pricing and regulation in China that could work modified. Some options for consideration include: better for customers, for CR and for the economic benefit of all of China.  a step-by-step reduction of the scope of passenger tariffs regulated by the State, applying regulation ********** only to average tariffs or to a few specific tariffs with defined terms and conditions. Aside from John Scales is the China/Mongolia Transport Co- those specific tariffs, CR would be allowed to ordinator and Gerald Ollivier is a Sr. Transport introduce higher and lower tariffs with modified Specialist, both from the Beijing Office of the World terms and conditions (for example lower rate for Bank. Paul Amos is a transport strategy and advance purchase of seats during off-peak period) management consultant to the World Bank and based on market demand, without seeking previously the World Bank’s Transport Advisor. regulatory consent. This note is part of the China Transport Note Series to  piloting of a market-based pricing solution for a share experience about the transformation of the percentage of tickets available on an existing Chinese transport sector. For comments, please passenger line facing excess capacity. Market contact John Scales (jscales@worldbank.org) or Gerald based pricing flexibly matches supply and demand Ollivier (gollivier@worldbank.org), for different market segments resulting in a wider range of fares both below and above the current Any findings, interpretations and conclusions rates, while the average fare can be kept stable. expressed herein are those of the authors and do not necessarily reflect the views of the World Bank.  more diversified freight tariffs matched to specific Neither the World Bank nor the authors guarantee the “terms and conditions” (these might include accuracy of any data or other information contained in minimum volumes, types of train services, this document and accept no responsibility whatsoever guarantee of freight cars for loading, maximum for any consequence of their use. loading and unloading times, etc).  no regulation on tariff for freight routes and freight traffic types with high competition between transport modes (such as routes with parallel river,