Workin’ on the Railroad: Can a Public-private Transit Venture Succeed in China?

Two businessmen from Philadelphia, Pa., have launched a bold project to develop and run a mass transit system with the local Chinese government in Fuzhou, a city of approximately 1.5 million on the southeastern coast of China. If successful, it would be the first public-private railway system in China, according to Louis Thompson, former railways advisor for the World Bank and principal of Thompson, Galenson and Associates consulting firm.



Typically, foreign companies involved in infrastructure in China act as contractors or vendors rather than partners. Most of these companies are large multinationals such as Siemens, which opened its first office in Shanghai 100 years ago, and Bombardier, a Canadian company with 1,400 employees in China that manufactures rail equipment. “It would be very adventurous for any U.S. company, much less a small one, to get into this market,” says Marshall W. Meyer, a Wharton management professor. “The companies that have been successful in China are ones with long and deep experience there — for example, Citigroup and Coca-Cola. They have proceeded cautiously and built relationships over years.”



The Fuzhou transit project is the brainchild of Sam Katz, a public finance specialist who spent two decades working for government consulting firm Public Financial Management where he was involved in public infrastructure-related projects before going into business for himself as a financial consultant. Katz first visited China in July, touring state-of-the-art factories and meeting government officials as part of a trade mission. “I was stunned by the degree of physical development of China,” says Katz. He also was impressed by the large presence of multinationals in the country and China’s highly educated, youthful workforce.



At the same time, he became more aware of the country’s ongoing transition from an agrarian to an industrial economy and the investment opportunities this shift creates. “There will be another 300 million people moving off farms and into urban areas in years to come,” says Katz. But there is no municipal finance structure in place to pay for urban infrastructure. “All of the local governments have state-sponsored projects that they can’t finance. So they are looking for foreign investors and partners.”



Hoping to land an investment deal himself, Katz met with city officials in Fuzhou who told him about a 150-mile rail system they planned to develop if they could put together the financing. Within days, he had signed a nonbinding letter of intent and formed Penn Fuzhou Transit LLC with the city. After returning to Philadelphia, Katz asked real estate lawyer Robert D. Lane Jr. to join the project, since its success hinges largely on real estate development along the transit lines.



The need for mass transit systems in most of China’s major cities is obvious, experts like Thompson agree. Today, the country has more than 100 cities with populations of more than one million, compared to just nine cities with populations of more than one million in the United States. Continued urbanization and congested streets are mounting problems. “The streets are clogged with bikes, motorcycles, cars and taxis,” says Katz. “You already can barely move and only one out of every 20,000 people owns a car.” In Beijing, for instance, urban buses chug along at less than 10 kilometers an hour due to heavy traffic jams.



The World Resources Institute reports that the number of private cars in China is increasing at a rate of 15% to 20% a year. “In China, people love automobiles,” says Peter Lai, an engineer and planner with Parsons Brinckerhoff, a global transportation engineering firm, who managed the company’s Hong Kong office for five years. “If they have money, the first thing they do is buy a car.” Because of the popularity of cars and the lesser expense of developing roadways, private toll road development has been very popular. “The moment you put in a toll road, revenues start coming in,” says Lai. “It usually takes seven to 10 years to break even.”



But increased car usage is intensifying the country’s pollution problems. Respiratory and heart diseases related to air pollution are a leading cause of death in China, according to a report from the World Health Organization. “Seven of the 10 most polluted cities in the world are Chinese,” says Eric Orts, director of Wharton’s Environmental Management Program and professor of legal studies and business ethics. While “there is a huge need for environmentally sensitive policy,” any such policy has to take into account an inevitable surge in the number of cars. “The government must consider how it can develop public transportation that assumes the use of cars,” Orts adds. “Design of roads to be bike friendly and low-emission requirements for cars and trucks would be major elements of a rational approach.”



Wharton’s Meyer points out that China does have privately funded infrastructure projects like the urban expressways in Shanghai, and that some of these investments have turned out well. “But the tolls needed to recoup the investment are pretty high,” he says. “The wealthy people driving their cars can afford to pay the tolls. But in Fuzhou, where city officials say they need investors, the question is, are subway fares going to allow any return on investment?” In the U.S., Meyer adds, “virtually all the transit systems are now government owned. They used to be profitable. But once autos came along, the profitability of the transit systems went down hill.” Meyer notes that subway systems exist in the cities of Shenzhen and Beijing, and suggests that the process of building and managing these systems could offer valuable insights to potential transit investors.  



The Bus Option


Despite the obvious demand and need for mass transit in China, the big question is whether a private company can partner with the government to provide it. “It would be difficult to turn a profit: The investment is going to be huge and the return is small because you can’t charge enough for a ticket,” says David Shen, associate dean and professor at Florida International University’s College of Engineering and Computing and a member of the International Chinese Transportation Professionals Association. “For example, in Los Angeles, the railway system cost more than $330 million per mile to develop.”



Meanwhile, Bus Rapid Transit (BRT) offers a much less expensive alternative and is gaining popularity in China, according to Wendy Tao, a graduate of Wharton’s Environmental Management Program who is studying transportation planning at Berkeley. BRT involves using exclusive bus highways or operating on existing roadways that have been redesigned slightly to give traffic priority to buses. Either way, BRT is far less capital intensive than a rail system.



Katz and Lane, however, propose to make their project financially viable by acquiring and developing the real estate along the proposed transit lines. “An investment in rail enhances the value of real estate,” says Katz. “And yet in the United States, rail development has failed for political, economic or policy reasons to capture the benefit in real estate that rail created. Most systems don’t recover 50% of operating expenses.”



The idea of capturing increased land value to fund mass transit is not new. In Hong Kong, the MTR Corporation operates the railway and was given the rights to develop residential and commercial properties above the stations. According to Lai, who is also president of the International Chinese Transportation Professionals Association, the Hong Kong subway system is the only one in the world today that is making money.



However, Hong Kong’s success also has to do with high population density, Lai adds. “Hong Kong has enormous traffic per station. New York City constantly requires New York subsidies and they have six million riders a day and close to 500 stations. In Hong Kong, the whole population is just under seven million and their subway line has approximately 20 stations.” The greater Fuzhou metropolitan area has a population of around six million, too, but it is spread out over a much larger area than Hong Kong, and per capita income is much lower.



Of course at this stage, Katz and Lane have yet to work out the details regarding how much real estate they will get and where. “I do think the densities in many urban centers in China warrant subways and large scale mass transit,” says Tao. “However, the issues that are equally critical involve land rights around these transit stations.” Lane says that one of their key advantages is their relationship with Fuzhou officials. “We are joint venturing with the government,” he says. “We are not just an outside contractor.”



But with government corruption a significant problem in China, this relationship also has the potential to be their undoing. “Government corruption could compromise any public works project,” says Orts, who points to the Three Gorges Dam as “the most prominent environmentally related fiasco” in China. In addition to its environmental problems, this monumental project on the Yangtze River has been plagued by bribery and embezzlement scandals.



Another challenging issue in dealing with the Chinese government is its tendency to back out of a project or change its policy at any moment. Right now urban infrastructure is a priority, but several years ago, the government virtually halted urban train development. “Due to an issue regarding importing international vehicle stock” — many system components are imported from Germany, France, Sweden and other countries — “the  national government cracked down and put a stop to huge urban infrastructure investments,” Tao notes.



One company that has had significant experience in southern China is Hopewell Holdings, whose chairman, Gordon Wu, is considered one of the country’s pioneer investors. For the past 20 years, the Princeton-educated Wu has thrown the resources of his vast real estate and infrastructure development company into creating a transport system for China’s manufacturing operations in the Pearl River Delta, which includes much of Guangdong province and is strategically situated close to Hong Kong. Wu’s projects include the construction of several toll roads in that area, financed in part by Chinese investors, and a proposal to build a bridge that will link Hong Kong, Macau and China’s Zhuhai city. Yet according to a report last month in the South China Morning Post, the bridge’s price tag, which started at $15 billion, has now ballooned to $60 billion. “With the Guangdong and Macau governments calling on private entities to also bear the cost of the networks linking the bridge and main expressways in Guangdong province,” the newspaper report says, “it is enough to make anyone blanch…. Hopewell believes only very few heavy-hitting infrastructure firms could bear such a cost.” The “eye-popping bill,” the article adds, “has cast a pall over Hopewell’s efforts to find partners to compete for the bridge project.”



Wu has run into difficulties before in his Asian projects, including his construction of a $1.5 billion superhighway from Guangzhou to Shenzen in South China, and an elevated rail system in Bangkok. According to media reports, his problems in the past have stemmed from a tendency to take on too many projects as well as some difficult dealings with Asian officials. Yet Wu and company have shown no signs of slowing down. On November 10, following the Chinese Ministry of Communications’ announcement that “the Chinese government is going to invest RMB2 trillion [$247 billion] in constructing highways and toll roads in China in the next 30 years, Hopewell Holdings expressed that they would be interested in these projects and would capitalize on this golden opportunity to expand infrastructure development in China,” according to a report from Reuters.



Local Partners


Clearly, with regard to the Fuzhou venture, a number of questions must be answered before a clear plan emerges. “What is the role of the local government in condemning and acquiring property, and can it provide property on a schedule that makes sense? What is its role in the system — for instance, will it place restrictions on tariff policy?” asks Thompson. “And is the legal environment strong enough to support a sophisticated arrangement like this?”


Katz and Lane readily admit that they have a number of issues to work out. “We know what we know and what we don’t know,” says Lane. The pair plans to take on more partners as they proceed, including local Chinese developers who better understand the rules of the game in Fuzhou. Says Katz: “We’re brand new fish in a very big sea.”

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