China - Strategies for road freight development

Report No. 1 2600-CHA China Strategies for Road Freight Development February 17, 1995 Transport Operations Division China and Mongolia Department East Asia ancl Pacific Regional Office F CA i<' UF ( "I" Document of the World Bank  CURRENCY EQUIVALENTS (As of November 30, 1994) Currency Unit = Yuan (Y) $1.00 = Y 8.6 Y 1.00 = $0.116 FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES Metric System ACRONYMS AND ABBREVIATIONS ATA - American Trucking Association CFCs - Cargo Flow Centers CMST - China Material Storage and Transport Agency CNAIC - China National Automotive Industry Corporation COEs - Collectively Owned Enterprises EC - European Communities EDI - Electronic Data Interchange GATT - General Agreement on Tariffs and Trade GDP - Gross Domestic Product GNP - Gross National Product GOC - Government of China GOV - Gross Output Value JVs - Joint Ventures LOI - Land-Ocean Inchcape LTL - Less than Truckload MOC - Ministry of Communications MOR Ministry of Railways NEPA - National Environmental Protection Agency OECD - Organization for Economic Cooperation and Development PCD - Provincial Communications Department PRC - People's Republic of China PSB - Public Security Bureau RCTT - Regulation on Cargo Transport Tariffs RFS - Road Freight Service rpm - Revolutions per minute SEC - State Economic Commission SOEs - State-Owned Enterprises SPC - State Planning Commission TVEs - Township and Village Enterprises  CONTENrS Preface .......................................... Execuitive Summary .................................... 1 Ilntroduction ...................................... 1 2 Government Policies andRegulations ...................... 4 A. Institutional Arrangements. 4 B. Historical Development of the Industry .................... 5 C. Regulatory Framework .............................. 6 Licensing System .............................. 7 Price Control ................................. 8 D. Road User Charges and Taxation ....................... 8 E. Technical and Environmental Regulations .................. 11 F. Regulations on Joint Ventures and Imports ................. 13 Joint Ventures ................................. 13 Import Restrictions .............................. 14 G. Institutional Constraints at the Lca Level .................. 15 Regional Differences ............................. 15 Inter-provincial Cargo Movement ..................... 16 Truck Movement in Urban Areas ..................... 16 3 I)emand: Changes in Industrial Structure and Shippers' Requirements 18 A. Demand Trends .............................. 18 E%. Logistics Costs ........................... ... 20 C. Demand Forecasting .............................. 23 4 Supply: Industrial Organization, Operations, and Technology Base .. 24 A. Industrial Structure .............................. 24 State-Owned Enterprises .......................... 24 Collectively Owned Enterprises ...................... 26 Township and Village Enterprises .................... 28 Private Sector Operators .......................... 28 Own-Account Operators .......................... 30  4 Supply: Industrial Organization, Operations, and Technology Base (cont'd) B. Technology Base ................................. 31 Truck Equipment ............................... 31 Operating Techniques ............................ 33 C. Tariff and Cost Structure ............................ 34 Tariffs ...................................... 34 Costs ...................................... 36 Financial Conditions ............................. 37 D. Emerging Services and Facilities ....................... 38 New Services ................................. 38 Cargo Flow Centers ............................. 40 5 Issues and Approaches ................................ 42 A. Government Regulations ............................ 42 The Government's Role under the Market Economy . ........ 42 The Licensing System ............................ 44 The Pricing System .............................. 44 Truck Bans ................................... 45 B. Industry Structure ................................ 46 Reform of SOEs ............................... 46 Development of Private Operators ..................... 47 Development of COEs ......... ................... 48 C. Technology and Operating Strategies ..................... 49 Truck Equipment . .............................. 49 Managerial and Operational Skills .................... 50 D. Commercial and Financial Arrangements .................. 51 Market Protocols . .............................. 51 Access to Financial Markets ........................ 52 6 Agenda for the 1990s . ................................ 54 A. Policy Agenda for the 1990s .......................... 56 Facilitating the Move to a Market Economy ............... 57 Refocusing the Government Role ..................... 60 Improving the Quality of Service and Modernizing Operations ... 62 B. Operational Implications for Future Assistance .65  TABLES 1.1 Initernational Comparison of the Freight Modal Split .............. 70 1.2 Modal Split of Freight Transport in China (billion ton-km) ..... . . . . . 71 1.3 Modal Split of Freight Transport in China (million ton) ..... . . . . . . . 72 1.4 Average Distance of Freight Traffic by Mode, 1991 ..... . . . . . . . . . 73 1.5 Summary Statistics of the World Bank-Financed Transport Projects in China ........................................ 74 1.6 The World Bank-Financed Projects for the Trucking Sector ..... . . . . . 75 1.7 Capital Construction in the Transport Sector ...... . . . . . . . . . . . ... 76 1.8 Road Vehicle Registration in China ....... . . . . . . . . . . . . . . . . . . 77 1.9 International Comparison of Road Freight Services ............. ... 78 2.1 Maximum Permissible Weights and Dimensions of Selected Countries . . . 79 2.2 Road Accident Statistics in 1991 ....... . . . . . . . . . . . . . . . . . . . 80 2.3 International Comparison of Road Traffic Accidents ..... . . . . . . . . . 81 3.1 Key Economic Parameters by Province ...... . . . . . . . . . . . . . . . . 82 3.2 Key Social and Economic Parameters Associated with Road Freight Service by Province ............................... . . 83 3.3 Relationship between Light/Heavy Industries and Road Freight Services . . 84 3.4 Regression Analysis Summary ................. ... .... ... . 85 3.5 Truck Production and Import ............................. 86 3.6 Freight Traffic Carried by Highway Sector ......... . . . . .. . . . . . 87 3.7 Demand and Supply Parameters by Province ........ . . . . . .. . . . . 88 4.1 Traffic Carried by Trucks with Breakdown into SOE, COE, and Private Sector (ton-km) .............................. 89 4.2 Traffic Carried by Trucks with Breakdown into SOE, COE, and Private Sector (ton) ....... .............................. 90 4.3 CDmpetitive Strengths and Weaknesses of Specific Subsectors .91 4.4 Truck Specifications .92 4.5 Road Freight Services and Truck Fleet Growth ...... . . . . . . . . . . . 93 4.6 Key Road Freight Service Parameters by Province ..... . . . . . . . . . . 94 4.7 Key Performance Indicators of Road F7reight Services in China ..... . . . 95 4.8 China Highway Container Transport Statistics, 1991 ..... . . . . . . . . . 96 4.9 Main Financial and Cost Indicators of State-Owned Highway Transportation SOEs ................................. 97 5.1 Checklist for Management Action .......................... 98 5.2 Key Issues in Starting Up a Trucking Business in China .100  FIGUREs 3.1 "Controlled Economy" Supply Chain ........................ 101 3.2 Market Supply Chain ................................. 102 3.3 Relationship between Heavy, Light Industry Output and Railway, Truck Ton-Originated Volume ......................... 103 3.4 Relationship between Light Industry Output and Truck Ton-Originated Volume ............................. 104 4.1 Commodity Mix .................................... 105 4.2 Distribution of US Carriers by Specialized Line of Business ... ....... 106 CHARTS 2.1 Organizational Chart of the Government of China ................ 107 2.2 Organization of the Ministry of Communications ................ 108 ANNExES 1. Demand Forecasting for Road Freight Services in China .... ........ 109 2. Cost Comparison between Rail and Road Services ................ 120 3. International Comparison of the Regulatory Framework of the Trucking Industry ............................. 126 4. Modeling Shipper Mode Choice and Shipment Size Behavior ... ...... 131 5. Under-utilization of Expressways in China-Analysis from a Truck Operator's Perspective .......................... 147 6. Sample Business Plan for Transport Equipment Leasing Companies .... . 154 7. The US Tax System: Impact on Truckers ....... . . . . . . . . . . . . . 157 8. Regulation Governing Road Freight Services ...... . . . . . . . . . . . . . 162 BoxEs IN TEXT 2.1 A Crazy Quilt of Licensing Authorities ...... . . . . . . . . . . . . . . . . 8 2.2 Differences among Provinces in Pricing ...... . . . . . . . . . . . . . . . 9 4.1 The Resilience of COEs ........ . . . . . . . . . . . . . . . . . . . . . . . 27 4.2 Shipper Survey .................................... 28 4.3 LTL Services in China ................................ 36 4.4 Fuel Prices ............. . .. .. .. . .. .. . .. .. . .. .. . .. . 37 5.1 Business Cooperatives in Japan ....... . . . . . . . . . . . . . . . . . . . . 49 6.1 Typical Components of Trucking-Related Projects ..... . . . . . . . . . . 68 FIGURE IN TEXT 1. Logistics Cost Tradeoffs: Transport Costs versus Inventory Costs . . . 21  i PREFACE The World Bank conducted the Road Freight Development Strategy Study as part of a series of economic and sector studies in accord with the Chinese Government. Based on an agreement with the Planning Department of the Ministry of Communications, a Bank mission visited China in October 1992 and made field trips to Beijing, Shanghai, Wuhan, Shenyang, Guangzhou and Xian. The report also includes information gathered during Bank visits in 1993 and 1994. The mission consisted of Hernan Levy (team leader and stujdy director), Ronalc Kopicki (logistics specialist), Shunso Tsukada (transport specialist), who were the primary authors of this report, Tohru Ida (transport economist), who also contributed to it, Rai Cai (enterprise specialist), John Edhouse (trucking specialist) and Paul Wait (economist). The mission was assisted by the Planning and Transportation Departments of the Ministry of Communications, which provided invaluable information. The report was prepared on the basis of background papers provided to the mission and surveys conducted with the cooperation of local communications departments. The mission wishes to thank the Ministry of Communications, particularly Mr. Mao Jiaan, Director of the Planning Departiment, and other officials who provided informiation on the trucking industry; also, officials of the provincial and municipal departments of communications with whom it spoke during the field surveys. Without their assistance, it would have been difficult for the study team to fully grasp the problems and accomplishments of the Chinese trucking industry. Finally, the mission would like to express its appreciation to Messrs. Shahid Yusuf (then lead economist), Peter Harrold (then principal economist) and Jeffrey Hammner, all Bank staff who reviewed the report at various times; to Ralph Hueneman, of the University of Victoria and John Meyer, of Harvard University (external reviewers); and to Timothy Hau, Paul Guitink and Pierre Guislain (peer reviewers).   ii EXECUTIVE SUMMARY Introduction i. This study is part of a series of sector initiatives recently undertaken by the Bank to support the market reorientation of transport infrastructure and services in China. As the integration of China's domestic market is an important feature of the current economic development plan and an essential pillar of a market-oriented economy, the series includes studies on internal market development, as well as on the railway and highway sectors. A more efficient trucking sector will stimulate the development of internal markets, which, in turn, will create important economies of scale in production and promote growth in the less developed inland provinces. The Bank has offered recommendations to promote greater competition in domestic markets, combat restrictive practices, and reduce provincial protectionism. At the same time, the Government is allocaling greater resources to modernize and expand the transport infrastructure in order to remedy bottlenecks in the system and improve accessibility throughout the country. ii. Investments in transport infrastructure will prove fruitful only if transport services are efficient. However, these services are beset by problems, such as: (a) High costs and prices of trucking services present non-tariff barriers to inter-provincial trade and force shippers to turn, where available, to the already congested railway system. The major elements are maintenance and fuel costs, which account for more than 40% of total operating costs, and are much higher than international standards (normally less than 20%). (b) Trucks supplied by domestic manufacturers use outdated designs. Also, they are poorly maintained, which leads to a high rate of breakdowns that adversely affect operating costs, service reliability, and air pollution in urban areas. In addition, trucks often do not match the shippers' cargo needs. (c) Trucking enterprises are poorly managed. State-owned enterprises (SOEs), like other SOEs, suffer from over-staffing, heavy social welfare burdens, and lack of management autonomy. For their part, private operators have little opportunity to develop their management capacity due to limited access to capital and markets. In addition, a large number of commercial and industrial SOEs, which operate own-account trucks, have management problems that result in much lower utilization (of their trucks) than for-hire operations. (d) Chinese truckers are organized primarily for the suppliers' convenience, rather than to respond to customers' needs. Multiple levels of government control adversely affect the operators' capacity to adapt to the changing  iii environment. In spite of growing demand for long-distance and door-to- door service that is modem, reliable and intermodal, it is not yet available. And, poor service presents barriers to foreign investment in the production and distribution sectors. iii. Improving trucking services is a vital component of the strategy to strengthen market integration, since the development of an efficient for-hire industry will enable local manufacturers and distributors to gain access to distant markets, both domestic and international. In recent years, China's industry has shifted production to higher value and lighter density products. This product shift significantly increased the demand for faster, more reliable and more flexible transportation services--for which trucking is particularly well suited. The greater demand for trucking will also be driven by increased interaction between buyers and sellers, structural changes in the economy, and expansion of the road network to areas previously not served by modem land transport (or served by the already congested railway). iv. The trucking industry is particularly well suited to serve as a model for market reforms and as the principal subject, within the transport sector, for pro-market institutional, structural and regulatory experimentation. An opportunity exists not only to showcase reforms developed in the industry and transfer relevant improvements to other industries, but also, by increasing the efficiency and competitiveness of the industry, to challenge other transport modes (rail, water and air) to become more market- responsive and thus spread reform benefits beyond the tightly circumscribed market for trucking services. v. The industry is made up of four segments: (a) about 2,000 SOEs; (b) about 8,000 collectively-owned enterprises (COEs), including township and village enterprises (TVEs); (c) approximately 750,000 privately-owned enterprises; and (d) a great number of commercial and industrial enterprises that run own-account trucks, some of which provide for-hire trucking services under temporary licenses issued by local governments. In the early 1980s, the Government relaxed restrictions on vehicle ownership, which stimulated the rapid growth of private and own-account truckers, who have increased their market share principally at the expense of SOEs and COEs. Between 1985 and 1990, the trucking fleet increased by 65%, from 2.2 million to 3.7 million trucks; at the same time, the volume of cargo carried increased from 210 billion ton-km to 340 billion ton-km. Much of this growth reflects private and own-account trucking activity. vi. Under the new economic policies, China liberalized controls over trucking enterprises. It now allows relatively free entrance into the industry and flexible pricing within prescribed guidelines. Also, current licensing and permit requirements, although administratively cumbersome, do not pose a real obstacle for market entry. However, informal barriers continue to persist in the form of public procurement of transport services, where much of the control over carrier selection still resides with SOEs. Similar barriers are presented by limited access to capital because a state-directed credit system continues to channel it to state-owned truckers and own-account operators. Issues  iv vii. Policymakers are concerned with a number of issues that have long-term implications not only for trucking but for other industrial sectors as well. Their concerns include: (a) The changing role of governments, both central and local, under a market economy; (b) The effects of the major structural changes underway within the trucking industry. Current policy is caught between two conflicting objectives: On the one hand, it is attempting to open the trucking service industry to competition and, on the other, to avoid the closing of the SOEs which, in turn, would dislocate labor; (c) The opening of internal transport markets to foreign investment and the transfer of technology in terms of both management and operational techniques. In this context, the issue is how best to mobilize modern technology and capital to smoothly transform trucking services; (d) The development of professional norms, commercial standards, laws and other supporting institutions that will allow reasonably functioning markets to fully realize the benefits of competition. viii. During the past decade, the Ministry of Communications (MOC) ceased to own and operate trucking enterprises. At the same time, central and local governments significantly relaxed regulations on market entry and controls on carrier pricing. However, ownei-ship must be reformed further, and the remaining distortions and inequities in taxation and allocation of resources (within the sector) need to be eliminated. ix. Changes in national and provincial policies and the deregulation of important aspects of enterprise control have already caused profound changes in the structure of the trucking industry. Given the increasingly competitive economic environment, in which shippers have become more sensitive to costs and the quality of service, it is likely that an industry shakeout will take place within the next few years. In this environment, the better positioned and well-focused SOEs will most likely survive, while inefficient ones, which have fewer resources and less market clout, will probably fail. The Government is undertaking the difficult task of ensuring that an appropriate social security system (including unemployment insurance and a legal framework for bankruptcy procedures) is established. Until this materializes, the Government is unlikely to let SOEs fail on a massive scale. x. Other areas to be addressed are development differences among provinces. For example, the trucking industry in coastal provinces has been more successful than its counterparts in the inland provinces in securing the benefits of sophisticated management techniques, increased productivity, and technologically advanced trucks from overseas suppliers. Access to technology, mainly through joint ventures, has been a key  v development advantage for many provinces near major, international trade gateways. Coastal provinces are also introducing modem equipment for handling materials and unified load techniques, and have enacted various policies to encourage local trucking. For their part, some interior provinces continue to enforce "beggar thy neighbor's truck fleet" which frustrates inter-provincial trade. xi. China lacks intermediating institutions through which government policies more appropriate to a market economy can be applied to individual participants. For example, commercial standards that could define the rights and obligations of transport buyers and sellers do not exist. Professional codes of conduct are also lacking, as are institutions that can mediate or adjudicate disputes in commercial matters. Moreover, decentralization of Government authority has created a situation in which critical issues that affect fair competition among enterprises are resolved on a case-by-case basis. xii. One of the most important equity and efficiency issues is the allocation of capital among enterprises on the basis of economic merit. The financial sector of the Chinese economy is embryonic: Only since 1984 have local banks acted as financial intermediaries in mobilizing enterprise profits and personal savings and in applying these funds to investment projects. Even now, central, provincial and local transport authorities still determine credit allocations. In some provinces, private operators have little or no access to bank financing; and, limited access to capital is the single most significant factor constraining the development of a strong private sector in the trucking industry. Establishing policies and mechanisms that will allocate capital among competing trucking enterprises according to their economic merit is a major issue that requires more attention of transport as well as financial sector authorities. Agenda for the 1990s xiii. The trucking industry in China is at a crossroad. Old rules developed during the era of central planning no longer apply, but new ones either have not been established or are not yet in effect. The industry can no longer meet the needs of the expanded market-oriented manufacturing and service sectors. Thus, its policies must be radically changed and its services modernized. This will include (a) redefining the role of the Ministry of Communications (MOC) in a market economy; (b) accelerating the development of private trucking enterprises; (c) opening China to modem trucking technology and management methods; (d) developing non-government institutions to shape and promote competitive trucking service markets; and (e) linking policy reforms to those in other sectors, as well as to overall macroeconomic reform. Redefining Government's Role :iv. The Government's role and tasks in a market economy are fundamentally different than in a planned economy: It needs to shift policies, revise programs and  vi radically redefine the MOC's functions. To this end, it must review the resources and skills it will require. Along with other Government agencies, the Ministry will have to focus on: (a) Policies that facilitate the transition from a planned to a market economy in the trucking subsector; (b) Regulations that internalize social costs, such as those related to the environment, safety and congestion, so the market can allocate resources in a socially desirable way; (c) Regulations that establish basic rules for fair competition; (d) Guidelines that translate broad national policies into the trucking industry. xv. One of the key shifts will involve modifying economic regulations. Instead of directly managing the industry by setting licenses and tariffs, transport authorities (MOC and local communication departments) need to introduce a more transparent and simplified systern of economic regulations. For example, current licensing requirements will need to be .replaced by an open-filing system under which applicants can register their businesses without prior approval from the transport authorities. Such a system would not control market entry, but rather ensure that safety and environmental regulations are observed. As to pricing regulations, the current rate-setting system should be replaced by one where operators determine their own rates, which do not need prior Government approval. Instead, they would only need to file them with authorities--a move designed to discourage operators from discriminating against specific shippers. xvi. In order to promote competition (where the success or failure of individual participants reflects their service to customers), regulations must be developed to protect against anti-competitive and unfair practices. Thus, the Government needs to distinguish conduct that is appropriate and legal for competing enterprises from that which is not: For example, collusive practices such as price fixing, bid rigging and dividing nmarkets (among firms) should be made illegal. xvii. Another critical area of concern is the environment. Trucking operations create environmental costs and contribute to congestion and accidents. These costs have not yet been internalized and are thus not fully reflected in the pricing system. Environmental issues, particularly those related to air pollution and congestion, relate primarily to the urban areas. Solutions therefore often require area-specific approaches. Establishing satellite cargo-handling facilities or relocating these facilities outside city boundaries are ways to reduce urban environmental problems. Related to this is the issue of whether to continue "truck bans" (area-wide restrictions of truck movement) which operate in a number of major cities. Although they alleviate congestion, and therefore reduce pollution, they may also affect economic efficiency, and should be crafted in a way that minimizes this impact.  vii xviii. To be most effective, these changes will need to be coordinated through municipal and city governments. The central Government, however, will need to retain primary responsibility for policy guidelines in all these areas. Industrial Structure and Private Sector Development xix. As previously noted, the transition to the market economy will require a major restructuring of the SOEs. In spite of their declining market share, SOEs are still major providers of specialized services (such as the transport of hazardous materials and oversized cargo, and inter-provincial scheduled service). For its part, the private sector (almost all are individual owner-drivers), has not yet developed sufficiently to fill the gap that would be created if SOEs retreated from these market niches. xx. The Government's policy towards the SOEs should be directed to corporatization: The focus should be to create a market in which truckers of various types and size compete with each other, unassisted. However, corporatization will require various measures which include: (a) phasing ouit economic contracts and replacing them with a uniform tax system; (b) ending subsidies to SOEs, both direct and indirect; (c) separating ownership from management and completely delegating responsibility for day-to- day operations to the managers; (d) strengthening financial and overall management capacity and operational skills; and (e) formulating corporate plans that would enhance competitive strengths and mitigate weaknesses. xxi. Also, the Government should aim to privatize the SOEs where possible, since this would be the most straightforward way to create market-driven trucking enterprises. However, where wholesale privatization is premature (due to issues of social security and the legal framework), the Government should attempt to diversify SOE ownership. The measures would include: (a) introducing employee stock ownership, (b) converting long-term bank loans into stock, (c) forming joint-stock companies with other SOEs, and (d) establishing joint ventures with foreign partners. xxii. A related issue is the creation of a "level playing field" for all types of truck operators. In this respect, a key area to be addressed is access to the state-controlled traffic. Procurement practices by Government agencies, industrial and commercial SOEs, which are often based on non-economic factors instead of service quality and costs, need to be modified to encourage competition. xxiii. The development of a more efficient trucking industry begins with the creation of efficient markets. Thus, mechanisms need to be created that clearly communicate to shippers the price and quality of transport services. Also, a group of intermediaries could be created to link the shippers with the carriers best able to handle their freight. These market middlemen might take the form of consolidators, freight forwarders or agents. At present, some of these services are emerging, but they are still  viii mostly provided by states and/or SOEs. To this end, private sector participation should be encouraged. xxiv. Finally, a modem market economy requires multimodal services that involve highway transport (that is, door-to-door service packages that combine various subsectors). To this end, the Chinese railway, waterway enterprises and regional airlines will need to develop wholesale marketing programs and introduce discount rates for relailers. Modern Technology and Management Techniques xxv. China's technology base lags well behind international standards in both truck equipment and load handling. Thus, Chinese managers need to be exposed to best practices as employed in industrial countries. Progress can be made through a combination of education, technology exchange and joint ventures. And, as shippers and carriers increase their sophistication and performance expectations, this will promote the adoption of the best international practices. xxvi. The most effective way to improve the quality and productivity of freight hauling vehicles is to open Chinese import markets to foreign suppliers, thus giving all segments of the trucking industry access to efficient heavy hauling trucks. However, truck imports are limited by a complex system of import licenses and controls that protects domestic manufacturers, as it restricts imports to "priority" products and users. But, as Chinese markets open further, competition for truck sales will increasingly be based on vehicle productivity and full life-cycle costs; in turn, domestic manufacturers will be challenged to improve their designs and products. xxvii, Other factors that may accelerate the modernization process include the entry of foreign equipment leasing companies; these could facilitate not only the financing of equipment but also its import. If allowed to open, they could also address the foreign currency problem through joint ventures with foreign truck manufacturers or leasing companies. xxviii. To date, most joint ventures in transport have been limited to international services that allow partners to be paid or repatriate profits in hard currency. In the decade ahead, this activity could be extended to domestic markets such as the transport of refrigerated items and household goods, along with next-day package delivery. Development of Non-Governmental Institutions xxix. As Government intervention in markets decreases, authority will increasingly devolve to professional associations and other non-governmental groups. Such entities are needed to improve the quality of trucking services and advance the modernization of  ix managerial and operational systems. The existing highway transport association (and others) will need to develop further, with the goal of becoming completely autonomous. xxx. Professional associations can help set standards for commercial contracts, which would promote a businesslike relationship between buyers and sellers: Although the basic legal framework needs to be created by Government, business ethics and some standards can be better developed by professional associations. Also, they could develop training programs for management and marketing skills and offer professional certification for those who successfully complete the courses. However, as the associations develop, MOC and/or another agency will need to monitor them closely, due to the intrinsic nature of such groups to form cartels. Policy Linkages xxxi. The development of a competitive and market-oriented trucking industry has implications for other sectors and their reforms. For example, Chinese truck manufacturers do not respond to customer demand: Product mix does not relate to trucking needs and product design is generally outdated. Thus, reform in the trucking service sector would pressure manufacturers to produce equipment that would meet demand. xxxii. A competitive trucking industry might also spur the development of inter- modal transport industries and hence carry some of the benefits of market reform into other transport subsectors. Similar links exist between the trucking industry, the manufacture of consumer goods and wholesale/retail distribution. Thus, the trucking industry should be looked at as an integral part of larger supply chain. Operational hnplications for Bank Assistance xxxiii. As its infrastructure develops, China will increasingly need to adopt policies that ensure the new highway capacity is used optimally and that road transport services cover the costs and meet the standards required to support the market economy. For its part, the Bank will be an active lender for transport infrastructure for many years. Hence, the Bank should actively support reform within the service sector, which uses this infrastructure. xxxiv. Bank operations in trucking could attempt to create an enabling environment in which efficient operators, such as the private sector and TVEs, can grow and compete (particularly with SOEs), on an equal basis. Another area would be the modernization of trucking operations. This can be achieved by transferring technologies (such as vehicle dispatching systems and bar coding), as well as creating new marketing management systems, truck leasing companies and modem cargo-handling facilities to be operated by private sector initiatives. Also, operations should emphasize institutional issues, such as  x corporatizing the trucking SOEs, and strengthening professional associations so they can play a. role in human resource development. xxxv. Bank assistance could be considered for components of other transport projects--in particular, in highway projects (for example, building weigh stations), urban transport projects (such as relocating cargo-handling facilities to urban peripheries and introducing truck taxes in urban areas), and transport logistics projects (constructing inland container depots and widening highway bridges and intersections to accommodate tractor- trailers).   1. INTRODUCTION 1.1 For the past four decades, China's railroads were the backbone of the economy and the primary distribution system. They were particularly well-suited to support the planned economy and, even today, despite the changes in the economy that require more diversified transport services, railroads continue to be the predomiinant mode of transport. 1.2 During this time, road freight played a secondary role: Despite the emerging market for consumer products, which is more readily served by highway distribution, road freight accounts for only 25% of total haulagel/, which is lower than in other countries at a similar stage of development. This is partly due to the inadequate infrastructure and partly to poor trucking services. In turn, the lack of efficient highway transport hindered the development of internal markets and the integration of China's regions. 1.3 However, structural changes in Chinese industry are creating strong incentives for road transport services to improve. Increasingly, industrial production is shifting to higher-value and lighter-density products, which are typically produced in smaller lot sizes. This, in turn, has increased demand for the faster, more flexible service that tirucking can offer. 1.4 Trucking services are essential to linking the country's low-cost production centers with high-density consumption areas. Moreover, future increases in commercial interactions around the country will increase this demand. The problem is 'that at present, the quality and quantity of these services are unable to satisfy demand. For this reason, industrial and commercial enterprises increasingly move goods with their own fleets. 1.5 In the next decade, highway services may significantly improve their position relative to rail, especially as the roadways are extended. According to a Ministry of Communication (MOC) plan, 14,500 km of high-grade national highways will be constructed over the next eight years. Nevertheless, several institutional constraints may prevent the trucking industry from realizing its full potential. For example, over the past decades, it was slow to improve productivity or adopt advanced technology. This was due to a lack of competition, which was rooted in the structure of the for-hire trucking industry: Historically, monopolistic franchises for motor carriers were set up along product lines or geographical boundaries, which did not promote competition--either on a price or service basis. To correct these problems, industrial policies and marketing practices of individual enterprises will need to change. 1/ Unit, ton-km, a standard load-distance measure; year, 1990.  1.6 Major problems within the industry include: (a) ineffectively managed trucking firms, particularly state-owned enterprises (SOEs) that suffer from overstaffing, limited autonomy, and obligations to cover personnel welfare charges; (b) inefficient and outdated truck fleets that frequently break down2/ and do not match the needs of shippers; (c) operating costs that are high, particularly for maintenance and fuel, which account for more than 40% of the total3J; and (d) firms that are not customer-oriented. 1.7 Soon after the start of economic reforms, the Government, attempting to improve conditions, began to liberalize regulations and controls related to the trucking business. In 1983, it allowed the private sector to compete with state-owned and collectively owned for-hire enterprises; since then, it has progressively relaxed price controls. Further, in 1992, market mechanisms replaced the fuel allocation system. These initiatives made trucking services more available, with the result that the Government regards the industry as a model for market-oriented reforms. 1.8 However, the Government still supports the SOEs by providing soft loans, forgiving taxes and contract payments, and procuring their services at prices higher than market levels, while attempting to minimize the fiscal impact of these subsidies. Thus, despite improvements, service quality is still low, and the current (eighth) five-year plan intends to modernize and improve the industry further. 1.9 The Government appears to be pursuing a twofold strategy. First, it is attempting to reform SOEs and large COEs (collectively-owned enterprises). Second, it is increasing the access of small COEs and private enterprises to state-controlled freight. This strategy is designed to gradually increase competition among truck operators, and at the same time avoid drastic changes in the industrial structure that would create severe unemployment for which no effective social safety net exists. 1.10 In the trucking industry, there are few economies of scale and small firms have no inherent economic disadvantages. In fact, their flexibility, innovative drive and close interaction with customers should give them a significant competitive advantage over SOEs. And, as there is increasing demand for trucking services, private, for-hire trucking firms should develop rapidly. The Bank's 1992 Country Economic Memorandum for China, "Reform and the Role of the Plan in the 1990s," describes the pivotal role of trucking in the Chinese economy and identifies the industry as a priority area for reform. This perception is shared by the Chinese. 1.11 The objective of this study is to help the Government increase the market orientation of road freight services and define policies that could modernize trucking and enhance the industry's efficiency. Many of the recommendations address the need to enforce greater market discipline and more equitable policies that affect both public and private enterprises. Thus, it will aim to: 2/ An SOE truck operator in Shanghai reported that domestically produced trucks are not operational, on average, one fourth of the year. 3/ In Australia, maintenance costs account for 7% and fuel costs for 11%.  - 3 - (a) Describe current policies, shipper idemand, current operating practices, the technological base, and commercial and financial arrangements of the industry; (b) Assess the need for further institutional and policy reforms that will accelerate competition within the sector and between it and the other competing transport modes; (c) Present a medium-term agenda for Government policy reforms and actions that will accelerate the development of road freight services, modernize trucking operations, and enhance overall efficiency; (d) Develop a Bank strategy for future assistance in this subsector, including possible components to be incorporated in future highway projects. 1.12 The report is organized into six chapters. Chapters 2-4 describe current conditions. Chapter 5 focuses on possible reforms and recommends specific policy changes. Chapter 6 defines the policy reform agenda, which includes an action plan and operaidonal guidelines for Bank assistance. 1.13 The study team was careful to link its analysis and recommendations with other recent Bank sector work, including that on highway and railway strategy and transport development in southern China.4/ 4/ These include the Highway Management and Development Strategy [1994], Railway Strategy Paper [1993], Transport Development in Southern China [1992], Yangtze Economic Zone Transport Study [1992], Internal Market Development and Regulations Study [1994] and Automotive Sector Study [1993].  - 4 - 2. GOVERNMENT POLICIES AND REGULATIONS A. INSTITUmONAL ARRANGEMENrS 2.1 Several line agencies are responsible for various components of the transport sector. The Ministry of Communication (MOC) oversees road and water transportation, the Ministry of Railway is responsible for rail, the Civil Aviation Administration handles air traffic, and the Ministry of Energy oversees pipeline development. The State Planning Commission (SPC) coordinates overall policy, and some special-function agencies, such as the General Customs Administration, the Public Security Bureau, 1/ and the National Environmental Protection Agency, also have responsibilities. A related agency, the China National Automotive Industry Corporation (CNAIC), oversees the automotive manufacturing industry (see Chart 2). 2.2 Within the MOC, the Transport Administration Department is responsible for road transport, the Engineering Department oversees construction and maintenance, and the Planning Department plans the development of the national road network and formulates policy (see Chart 2.2). 2.3 The communications departments of local governments are largely responsible for road administration. Their organizational structure is analogous across different levels of the hierarchy (provincial, prefecture, county). While they report directly to the heads of their local governments on financial, managerial and personnel matters, they report to other communications departments, one level up, about transport policies and regulations. 2.4 Within the provincial communications departments (PCD), the highway transport administration bureaus administer road transport, and the highway administration bureaus are responsible for construction and maintenance. The provincial public safety bureaus handle traffic and safety and the provincial planning and economic commissions are responsible for transport coordination across modes. 2.5 Besides the above agencies, communications departments (in most cases PCDs) supervise the SOEs, while ownership normally rests with local government. As a result of recent economic reforms, the MOC is not very involved in the SOEs' daily operations; rather, it is more concerned with higher-level management issues. 1/ The Public Security Bureau oversees traffic management and transport safety, including vehicle registration and inspection, and drivers' licenses. The Public Security Bureau reviews safety issues, while MOC oversees the economic side of vehicle inspection.  - 5 - 2.6 The MOC established the China Highway Transport Association in July 1991 to improve Government-industry interactions and communication. Its purpose is to represent the interests of the industry to the Government, recommend policies related to highway transport (both for passengers and freight), conduct studies and research and modernize trucking services. It has 10 committees for specific transport activities such as container transport, oversized cargo transport, small package transport service, general cargo transport, hazardous material cargo transport, physical distribution, trucking service with special handling equipment, maintenance, passenger and taxi services. It has yet to become a professional association responsible for improving the services of its member operators and their management and operational capabilities, industry-wide. B. HISTORICAL DEVELOPMENT OF THE INDUSTRY 2.7 The regulatory structure of the trucking industry changed significantly during the last four decades. First, private truck operators were nationalized. Next, within the controlled economy, SOEs were given an exclusive right to offer for-hire service. And, last, during the period of economic reform, the trucking industry was gradually directed to operate with a market orientation. These three periods are outlined below. 2.8 Nationalizations (1949-56). When the People's Republic of China was founded in 1949, most truck operators were private. But, as socialism was introduced, private operators were merged into SOEs in a process that took seven years.2/ The early SOEs were relatively small and their fleets were composed mostly of old Annerican Fords. In addition, many pedicab and rickshaw drivers were encouraged to form collectively- ownecl enterprises (COEs). Because trucks were scarce, the early COEs had to carry most of their cargo in carts. 2.9 During this initial period, special transport committees were formed (at both the central and provincial levels) that had primary responsibility for transport planning. They set tariffs, coordinated transport demands, and allocated capacity to the SOEs within their assigned areas. Although they were originally expected to control all transport activities, the vast expanse and complexity of activities limited their power. 2.10 Controlled economy (1957-78). From 1957-78, the centrally planned economic system was in its prime, although problems began to emerge that ultimately reduced the role of the transport committees: After an initial surge of activity, their scope was gradually reduced to functions conceming the transport of food, raw materials, essential industrial material, and import and export items. 2.11 During the late 1950s, the SOEs expanded rapidly. Their fleets were composed mainly of imported heavy trucks purchased through barter trade with Eastern European countries, and domestic medium-size trucks similar to those in the Eastern block. 2/ Nationalization was completed in 1956.  - 6 - Trucking enterprises were restructured to better reflect socialist ideology and economic goals; also, they carried out Government instructions and transport plans. Marketing activities (such as sales and sourcing functions) were virtually nonexistent because the Government controlled this area. However, lacking competition, SOEs failed to meet users' needs, which, in turn, led to a surge of own-account operators in the late 1960s. As the number of these operators grew, the market share of the for-hire trucking industry declined and the financial situation of the sector worsened, leading to further deterioration of trucking fleets and services. Faced with the SOEs' increasing inefficiency, policy planners began to consider the benefits of competition. 2.12 Economic reform (1978-92). In 1978, the Government initiated economic reforms whose initial focus was on rural areas (restoring the family as the main unit on farms and progressively ending price controls on farm products) and urban areas (opening the economy to outside markets and establishing special economic zones to promote trade and foreign investment). In 1983, the Government recognized the importance of market mechanisms by stating that although the planned economy provided the framework for economic management, it would be adjusted by market mechanisms. In line with these economic reforms, the State Economic Committee (SEC) and MOC jointly issued a policy directive allowing highway transport to move into the free market, although it would still be part of the planned economy. The directive also stated that SOEs would continue to be the main providers of transport services, supplemented by COEs and non-transport SOEs (own-account). Further, it permitted farmers to purchase tractors and trucks. This action served to expand the township and village enterprises (TVEs) that, given the increasing trade of agricultural products and other goods between urban areas, moved into the cargo transport business. Initially, they carried their own cargo; later, they began to provide service to the public. 2.13 In December 1986, the SEC and MOC jointly approved the Tentative Regulation on the Management of Highway Transportation (Joint Regulation) which created a regulatory framework for licensing, customer and operator relationships, and rules for transport services. It marked a significant milestone in the transformation from a planned to a market-oriented economy. 2.14 Economic reform was further accelerated in 1992 when the Fourteenth Party Congress advanced the principle on economic management--which said that the economy should be driven by market forces and adjusted through planning mechanisms. As a result, the Government has taken a more liberal stance on all aspects of trucking. C. REGULATORY FRAmiEWORK Licensing System 2.15 The Joint Regulation states that licenses must be obtained from the appropriate transport authority (provincial, prefecture, or county communications departments) and must pertain to social needs, the applicants' capacity to provide services,  - 7 - their business scope, technical qualifications, and operational conditions. For example, the Shanghai municipality set out detailed licensing c:riteria that related to the (a) size of the fleet owned by truck enterprises, (b) vehicles' condition, (c) adequacy of parking facilities, and (d) proper certification for technical staff in charge of safety and vehicle maintenance. However, to facilitate entry into the sector, it has devised more lenient criteria for the minimum number of cargo vehicles, their condition, parking arrangements, and compliance with regulations. 2.16 Although the Joint Regulation appears potentially restrictive, in practice it is rather liberal and its main concern is to stimulate competition among transport operators. As long as operators meet basic criteria, it is easy for them to obtain licenses. For example, in Liaoning province, only one application was turned down in 1991; none was denied in 1992. Thus, once an applicant meets all the criteria, the transport authority issues a business permit. The applicant then takes the permit to the local office of the commercial/industry authority to receive a business license. 2.17 If own-account trucks are used in for-hire services, operators must obtain temporary business permits that are valid for up to three months. This is important for two reasons: First, it allows own-account operators to legally provide for-hire services (in many cleveloping countries this is prohibited), which makes service more available; second, it stipulates that own-account truckers' activities are controlled by transport authorities (in many developing countries these are not controlled). According to a Liaoning province official, about half of all own-account operators operate with temporary permits, which means that in practice, they essentially function as permanent for-hire businesses and take an increasing share of the road freight. 2.18 Besides trucking licenses, authorities also issue vehicle permits that ensure for-hire trucks meet safety criteria that pertain to engine performance, the vehicle's main systems, and gas emissions. Permits must be renewed annually, are valid throughout China, and must be carried on board the vehicles. 2.19 Before 1984, transport authorities registered vehicles, issued drivers' licenses, and conducted safety inspections. After that time, most functions were transferred to public security authorities who currently register trucks (regardless of whether they are used for hire), issue drivers' licenses, and inspect for safety annually. Licensing regulations vary among the provinces (see Box 2.1). Price Control 2.20 For decades, the policy has been to allow local governments to set prices under general guidelines issued by the MOC. Tariff adjustments proposed by the local commtnications authorities are submitted to the pricing authority of each local government to be approved and the rates are then reported to the MOC. To ensure the rates are observed, transport operators must submit uniform tariff vouchers (waybills) to the government authorities--so the latter can verify compliance with the approved tariffs. This  - 8 - Box 2.1: A CRAzY QUILT OF LICENSING AuTHoRITEs Trucking authorities correspond to underlying political jurisdictions. Movements to and from these jurisdictions require multiple permissions and authorities, which not only increase the cost of trucking services but also inhibit quick customer response. For example, the Truck Cargo Company of Sanguang City, a collectively owned enterprise that operates 262 for-hire trucks, maintains 18 separate licenses and approvals from municipal and provincial authorities to operate within Guangdong province. It employs three clerks whose principal duties are to maintain these licenses and approvals and to obtain special trip permits from authorities. In Guangdong, trucking enterprises based both within and outside the province have equal access to licenses and permits. Other provinces, however, are not so equitable. In Shaanxi, for example, truckers from outside the province pay higher tolls and can gain only limited access to trip permits that allow local deliveries. This has caused some truckers to avoid the province. differs from countries where transport operators set the prices and governments approve them (as in the United States and some European community countries). 2.21 As part of the economic reforms over the last 10 years, policies have shifted away from such rigid tariff control mechanisms. In 1984, the MOC issued a Regulation on Cargo Transport Tariffs (RCTT), that permits local governments to set cargo rates that differ from national standards. The RCTT allows them to consider local conditions (Article 57) and set tariffs that deviate from a standard rate by 20%, upwards or downwards. Now, as the pace of liberalization has quickened, even broader local discretion is being exercised (see Box 2.2 for regional variations). D. ROAD USER CHARGES AND TAXATION 2.22 Four types of road user charges apply to trucking services: (a) Vehicle purchase surcharge. This is a one-time payment of about 10% of ex-factory prices (15 % for imported vehicles) to the Government at the time vehicles are purchased. The surcharge is used mainly to fund MOC's contribution to the construction of new expressways. (b) Road maintenance fees (RMFs). These fees, used for road construction and maintenance, are annual and/or monthly payments made to the construction department of local governments. Fees are based on for-hire truck operators' transport revenues or on the capacity tonnage of own- account vehicles. Tax rates range from 12% percent (Liaoning province)  -9 - Box 2.2: DIFFERENCES AMONG PROVINCES IN PRICING The enforcement of regulations affecting highway transport prices differs among provinces. These differences appear to be based on (a) the geography and balance of underlying transport markets, (b) the market penetration of private operators, and (c) the provincial regimes' predisposition towards and experiences with market mechanisms. In terms of geography, provinces with the following attributes generally are the most responsive to the market: (a) a large portion of total movements involve long haul or interprovincial carriage, (b) a significant imbalance exists between inbound and outbound freight volume, and (c) inbound and outbound traffic varies with the seasons. Guangdong provides the best example: During the peak summer season, its producers of canned juice and preserved fruit bid trucking capacity away from other provincial markets. During the peak shipping season, prices rise to market clearing levels, well in excess of the 10%-20% cap prescribed by the MOC. With regard to market penetration, private operators handle substantially more than 50% of total truck volume, and intra-proviricial rates frequently dip below the 10%-20% band that MOC recommends for negotiated rates. Special discounts and rebates have become standard practice. Regarding administrative predisposition, bureaus in the provincial administrations are generally the most inclined to adopt market-oriented solutions to logistics problems and are least likely to implement directed policies. For example, the bureau chief in Guangzhou City has developed a set of market-gathering places where inbound trucks from other provinces meet and Guangzhou manufacturers can negotiate backhaul rates. to 15% (Shanghai and Hubei provinices) of total transport revenue raised from for-hire operations, and from Y 120-Y 150 per ton per month for own- account trucks. However, despite the original purpose of the fee, only 39% of tax revenues were spent for road maintenance in 1990. (c) Annual vehicle use tax. Annual vehicle taxes are paid to local taxation bureaus, based on vehicle capacity. The rates range from Y 28 per ton (Hubei province) to Y 42 per ton (S hanghai municipality). (d) Highway transport management fees. These are annual and monthly payments made to local transport administration authorities to cover administrative and other expenses rellated to transport services. The tax is based either on for-hire truck operators' transport revenues or on the total capacity tonnage of own-account vehicles. The tax rate is 1 % of the total  - 10 - annual transport revenue or the equivalent amount to be calculated for own- account operators. 2.23 Of these charges, the road maintenance fee is the largest, accounting for 82% of all charges, followed by the highway transport management fee (6.3%) and the vehicle purchase surcharge (5.7%). According to the report, "Highway Development and Management Issues, Options, and Strategies," the total national revenue from road maintenance fees and vehicle purchase taxes was Y 59.5 billion during the period of the seventh five-year plan (1985-90). This covered an average of 53% of yearly highway construction and maintenance costs, while vehicle purchase surcharges covered 8%, highway transport management fees covered 5 %, and the annual vehicle use tax, 3%. However, according to a 1991 study by the Highway Research Institute, approximately 36% of tax revenue from RMF is lost each year through exemptions. 2.24 The current system of road user charges does not include a fuel tax or a charge based on axle weight. Thus, as heavier trucks become more popular, existing charges will bear less relation to the cost of providing and maintaining the road network. 2.25 In addition to these charges, general taxes are levied on all business activities. Among five major state general taxes, the two related to trucking are a business tax charged on the turnover from the sale of goods and services and an income tax on profit. Local public security authorities also charge annual vehicle examination fees and driver's license administration fees, but the amounts are nominal. 2.26 The business tax is charged to those selling commodities and providing services such as transportation, construction, mail and communications. Tax rates range from 3%-15% of gross revenue, with trucking firms charged approximately 3%. For SOEs and COEs, the business tax must be paid periodically at predetermined rates, based on accounting records of sales. For small firms without good records, tax authorities base the amount on individual circumstances. 2.27 Current business income taxes were introduced in 1978 as part of the reforms, under which all business surpluses were passed on to supervisory authorities, while all deficits were covered by Government budgetary resources. A flat rate of 55% on taxable profits was levied for large- and medium-size enterprises, while smaller enterprises paid 7%-55%. Taxable profits were calculated on enterprise revenues minus expenses, costs (including depreciation), and the interest and principal paid on bank loans. 3/ 2.28 The effectiveness of this system was largely undermined by the "contract responsibility system,4/" which applies to most of the large- and medium-size SOEs. 3/ See CHINA: Industrial Policies for an Economy in Transition, World Bank Discussion Paper 1992. 4/ This is a system of contracts that set performance targets for various levels of government and SOEs, begun in the late 1980s.  - 11 - Contracts cover items such as profits, the level of investments, and wage and bonus policies. In practice, however, officials frequently exempt SOEs' taxes rather than have loss-making enterprises on their books. For the smaller enterprises, such as many trucking firms, itaxes are charged, because the contract responsibility system is more complex. 2.29 This pattem causes enterprises to be taxed inequitably. Further, because taxes can be negotiated, the incentive to obtain higher profits is reduced, and this leads enterprises to spend moire time and effort on negotiating with authorities.5/ E. TECHNICAL AND ENVIRONMEiNTAL REGULATIONS 2.30 Vehicle weights and dimensions. MOC limits maximum gross vehicle weight to 40 tons and vehicle dimensions to 4.3 meters in height, 3.5 meters in width, and 25 meters in length. These regulations are lenient compared to those of other countries (see Table 2. 1). For example, the 40 ton maximum exceeds that of Japan and the United States, while only Canada and a few European countries allow weights over this amount. Axle load is 10 tons per axle, which is comparable to world standards, but this limit is applied only to 4-wheel axles. Given the relatively poor road infrastructure, there does not seem to be an urgent need to revise the regulations on vehicle weights and dimensions. However, it would be useful to update the standards to allow trucks to use new technology. 2.31 Vehicle inspection. All road vehicles are required to pass an annual inspection of the following: (a) lights, brakes, steering, and other parts related to traffic safety; (b) engine knocking, body deformation, and other elements related to vehicle reliability; (c) speed, acceleration, engine horsepower, and other elements related to performance; (d) fuel supply, ignition, fuel consumption, and other elements related to economic efficiency; and (e) noise and emissions related to environmental protection. The MOC and Public Security Bureau (PSB) both inspect vehicles through their respective local agencies. The PSB primarily inspects technical aspects, while the MOC is concerned with economic issues, such as efficiency and operational performance. Some elements of the inspections are duplicated and need to be eliminated. 2.32 Traffic accidents. Highway safety is poor and the number of casualties and fatalities is high (see Table 2.3). Also, truck-related accidents are much more common than in other countries. One reason is that the truck fleet accounts for 66% of total vehicles in China; another is that traffic safety measures are inadequate. Road alignment, pavements, markings, signs, signals, and many other road elements need to be better designed and engineered for safe operation. Design and manufacturing standards for vehicles need to be improved, a driver education program developed, and traffic regulations need to be strictly enforced. 5/ Ibid.  - 12 - 2.33 Hazardous materials. Regulating the transport of hazardous materials is essential because of the potential public health and environmental dangers. Such regulations, however, are extremely complex, as they affect the entire supply chain, involving carriers, shippers, manufacturers and product packagers. The MOC has issued regulations to transport and handle this waste that are a good start towards a new regulatory function. However, to be implemented effectively, roles and authority within the central/provincial/municipal system of trainsport governance must be clarified, along with a more effective basis for adjudicating disputes between shippers and carriers. 2.34 The regulations state that transport authorities at various levels are responsible for implementing and supervising them and present a reasonable set of operating guidelines; however, they do not create the institutional arrangements for enforcing them. It also lacks a complete typology of hazardous materials and special handling, transport, packaging and safety precautions; thus, they will be difficult to enforce. Moreover, they allow carriers and shippers a great deal of latitude and presume both have the capacity to interpret and dutifully apply "best handling and transport methods"--which is probably not a prudent assumption. Instead, regulations need to be more precisely correlated with specific classes of substances and the chemical members of each hazardous material class named. 2.35 Environmental protection. The legal mandate with regard to the environment is embodied in the Environment Protection Act of 1979, the Ambient Air Quality Standards Act of 1983, and the Ambient Air Protection Act of 1987. Several organizations implement these statutes for vehicles, or have a role in reducing vehicle- induced pollution. These include: (a) The National Environmental Protection Agency (NEPA) is the main regulatory body and reports directly to the Environmental Protection Commission of the State Council. NEPA is responsible for drafting acts and standards that ensure environmental protection. It is affiliated with many research institutes, including the Chinese Research Academy of Environmental Sciences; (b) The Highway Research Institute under MOC conducts research related to emission control; (c) PSB inspects road vehicles for gas emissions and noise on an annual basis, at registration; (d) MOC also inspects road vehicles for gas emissions and noise; (e) CNAIC (China National Automotive Industry Corporation) is developing improved engine and vehicle technologies to minimize air and noise pollution.  - 13 - 2.36 The inspections performed by the PSB and MOC are limited to carbon monoxide and hydrocarbon emissions (while vehicles idle) and to particulates emitted from diesel engines (while vehicles accelerate). The lead and sulfur components of diesel fuel oil are not regulated. 2.37 No precise measurements exist to determine how much road traffic contributes to air pollution nationwide. However, a report by the Highway Research Institute notes that road traffic generates 39 % of the carbon monoxide, 46% of the nitrogen oxide, and 75% of the hydrocarbons in the ambient air within the third ring road in Beijing. 2.38 The following measures are required to reduce the air pollution attributed to trucks: (a) develop desulfurization technology and equipment; (b) switch from low- quality fuel oil containing sulfur to high-quality fuel oil; (c) cease to use lead (plumbic alkyl) as an antiknocking additive to gasoline; (d) develop a refining system to produce lead-free gasoline; and (f) develop an efficient diesel engine, which would allow it to be used more widely. Although less urgent, the Government could strengthen control on noise pollution, as well. F. REGuLATIONS ON JOINT VENTURES AND IMPORTS Joint V'entures (JVs) 2.39 To encourage the inflow of foreign funds and the use of advanced foreign technologies and systems, China has promoted joint ventures with foreign partners through tax incentives. These JVs pay no business income tax in their first two years and only 50% in their next three years. In addition, some provinces, such as Shanghai, impose no restrictions on repatriation of profits in foreign currency; others, however, limit overseas remittances. 2.40 JVs are also exempt from import controls. Equipment or spare parts needed from abroad are not subject to restrictions; also, they are exempt from foreign currency allocation controls, so long as the dollar amount of imports does not exceed the total investment made by the foreign partners. 2.41 Given the lack of modern transport equipment and the tight import controls on domestic enterprises, local governments and truck operators are enthusiastic about establishing joint ventures. However, certain restrictions apply: For example, a minimum investment from the overseas partner of 25% is required (as in all sectors), and a limit is placed on the maximum share allowed. In transport, it is 50% in many provinces, including Shanghai. This compares unfavorably with other sectors; light industry, for example, has no maximum restriction.  - 14 - 2.42 There are many trucking JVs in southern China. Most are with Hong Kong partners that have manufacturing bases in Guangdong, which is home to more than 1,000 JVs (compared with only 120 in all other provinces combined). Thus, the province has a much larger number of foreign trucks and enjoys easier access to imported spare parts. On the east coast, in areas such as Shanghai and Dalian, which are close to major ports, the JVs are larger than in the south, although their number is fairly limited. Thus, Shanghai, with more than 5,000 truck operators, has only 10 JVs, many of which are engaged in the inland movement of seaborne containers. For example, the Land-Ocean Inchcape (LOI) is a joint venture between the international trading firm, Inchcape, and a number of Shanghai municipality SOEs located in the immediate hinterland of Shanghai port. LOI's main business is to provide container drayage services to major inland points; it also provides container stuffing and stripping on site. LOI's imported tractor trailers were purchased through Inchcape's equity investments. According to LOI's manager, its operation is much more profitable than its Chinese competitors because its tractor trailers do not break down, while those that are domestically made are unusable for about one- quarter of each year. 2.43 JVs are an effective way to modernize the trucking industry. In other sectors, they have succeeded in transferring advanced operating systems and management techniques to Chinese enterprises. The same effect is expected in the trucking sector. However, foreign investors are cautious about entering into arrangements with Chinese counterparts in trucking (although Hong Kong investors are less cautious) mainly because the sector is not seen to be profitable and the road network is poor, which restricts the efficient use of the large articulated trucks. Thus, the areas which could attract JVs are limited to associations with (a) international multimodal transporters (such as container drayage to and from ports), (b) capital-intensive road haulage services (such as heavy-duty or oversize cargo transporters), (c) high-quality haulage services that accommodate the needs of foreign investors with manufacturing bases in China, and (d) leasing businesses that finance imported transport equipment. Inport Restrictions 2.44 Domestic production of trucks grew at a rate of 3.9% per year between 1971-91, beginning with about 60,000 units and reaching 360,000 units, while the level of imports remained static. Imports accounted for about 15% of the total supply in the early 1970s but dropped to less than 4% by the late 1980s, largely due to cost differences between domestic and foreign products. And, over the last two decades, imports have been tightly restricted because of the scarcity of foreign currency. However, by early 1993, restrictions on truck imports were relaxed, although duties are still relatively high and access to foreign currencies is limited. Also, duties have been adjusted many times: For example, tariffs on medium-size trucks were reduced in 1992 from 80% to 50%, and tariffs on heavy trucks were reduced from 70% to 30%. 2.45 Despite the reduction in tariffs, foreign models are still substantially more expensive than those produced domestically. For example, a domestic medium-size truck  - 15 - of four-five tons costs $8,000, while an imported equivalent costs $25,000; and, very few companies can afford such a price. Also, spare parts for imported trucks are not always available. Thus, if current trends continue, the industry could produce 500,000-600,000 units a year, within the next 10 years. This would further decrease imports to just 2.5%- 3% of the market. G. NsTrrUTIONAL CONSTRAINT AT THE LOCAL LEVEL 2.46 While the Government establishes the regulatory framework and overall policies, local governments have traditionally been given fairly broad discretionary powers to implement the regulations and directives within their jurisdictions. As a result, regulations governing trucking enterprises vary from region to region, which presents four major issues. Regionial Differences 2.47 As discussed earlier, the licensing system, which is a key regulatory elemernt, has been administered in a fairly liberal manner. In some urban areas, however, obtaining a license is difficult because of the limited availability of space for parking facilities, which is one of the licensing criteria. 2.48 Price controls have also been implemented liberally, wilh substantial variations. For example, most provinces allow tariffs to vary by about 20%, upwards and downwards, from prices set by provincial governments. While some only set ceilings for price variations, others, such as Shaanxi, do nolt require trucks with less than a 5-ton capacity to follow standard tariffs. Liaoning province does not enforce tariff regulations for inclividual private truck operators, while Shanghai municipality no longer requires trucks with full loads to follow the standard tariff, although less-than-truckload (LTL) trucks are still required to do so. The basic tariff structure, however, follows MOC guidelines and is nearly identical throughout the country. 2.49 Each region also differs in the way it applies the Government's industrial policies or benefits from central government programs. For example, within MOC's initiative to develop transport facilities, local governments have the freedom to select two capital investment projects every year for which the GOC provides Y 1 million. Another centrally initiated assistance program provides funds to replace older trucks whose mileage exceeds 500,000 kilometers: In Liaoning province in 1991, Y 5 million was provided under ihis program. 2.50 Also, local governments vary in the way they manage SOE_s, primarily because the handling of state assets, including equity investment to SOEs, is a matter of provincial jurisdiction, rather than a transport issue. The prevailing trend, however, is to award more autonomy to SOEs, reduce financial assistance to cover operational deficits, and thus encourage their diversification.  - 16 - 2.51 These differences mainly reflect the adjustments that are needed to implement Government policy and regulations within each constituency. Most deviations from central guidance involve a more liberal than restrictive approach. Inter-provincial Cargo Movement 2.52 It is widely believed that administrative barriers hinder the interprovincial cargo movement of trucks: Vehicles are reportedly stopped at checkpoints on provincial borders and asked to unload their cargo. However, although this may happen occasionally, it is likely the trucks are being checked to see if local taxes have been paid or if prohibited items are being transported outside of provinces, and not to restrict truck operations. 2.53 Nevertheless, some restrictions to interprovincial freight transport exist. For example, an interprovincial operator providing regularly scheduled transport must be authorized by the provinces involved, and such services are usually provided on a provincially reciprocal basis. This often excludes operators from a third province. 2.54 Also, although rarely documented, other locally-based restrictions are enforced. An interview held during the field visit to Guangzhou revealed that many provinces impose punitive road maintenance charges, additional tolls, and, in some cases, a restriction on the door-to-door service of truck operators based outside their provinces that allow local trucks to make the final deliveries of inter-provincial goods. Some provinces also require trucks crossing the border to obtain an administrative permit prior to making the trip. While this may be cumbersome, it is not perceived as a major constraint for inter-provincial truckers because the permits can be obtained with relative case. Moreover, many provinces plan to abolish this requirement. 2.55 Although some operators occasionally complain about restrictions on truck operations across borders, the overall situation seems to be improving. In the case of inter-provincial scheduled operations or business leases, however, the process often become cumbersome. Truck Movements in Urban Areas 2.56 Many major cities have imposed truck bans to reduce congestion.6/ The main restraints include areawide limitations and route limitations; most are a combination of the two. For example, in Beijing, trucks are restricted within the third ring road and particularly tough restrictions apply within the second ring road. In addition, route-by- route limitations are imposed to varying degrees. In general, bans apply to trucks with carrying capacities greater than one ton. These trucks cannot enter the city between certain 6/ Major cities where truck bans are imposed include Shanghai, Shenyang, Tianjin, and Beijing.  - 17 - daylig;ht hours, although restricted times differ from street to street; these variations promote confusion. 2.57 Truck bans also help reduce air pollution. However, many argue that trucks are penalized for pollution caused by other types of motor vehicles. Truck bans carry social and economic costs, which include (a) less frequent use because operating time is limited, (b) inconvenience related to shortened service hours (for those who use trucks) and (c) higher costs for trucking services, due to the first two constraints. In addition, truck bans are often complicated and not well publicized. Moreover, frequently-issued dispensations undermine the effectiveness of the whole system. Thus, social costs and benefits need to be more carefully examined and, where possible, a simplified system introduced that could lead to more effective enforcement.  - 18 - 3. DEMAND: CHANGES IN INDUSTRIAL STRUCTURE AND SHIPPERS' REQUIREMENTS A. Demand Trends 3.1 Market forces are beginning to reshape the industrial landscape, concentrating production and developing internal markets based on economies of scale. Due to these changes, the economy will increasingly rely on highway transport, because it is inherently more flexible than rail or water transport. 3.2 At present, Chinese transport serves inter-regional, intra- regional and intra-urban markets. Inter-regional transport (provided principally by rail and waterways), moves coal, oil, iron, steel, and processed food products on long hauls. For these products, road transport is restricted to corridors not adequately served by the other two modes or to products that require rapid delivery. State-owned trucking enterprises and the fleets of SOE manufacturing and distribution companies serve the longer-haul freight. 3.3 Intra-regional transport (provided by transport enterprises attached to local communication departments and private truckers) moves freight between ports or rail depots and inland origins and destinations, while intra-urban transport and rural transport, both provided by private operators and township and village enterprises (TVEs) that use trucks and agricultural tractors belonging to individuals and collectives, move a variety of products, usually in small-lot sizes, for short hauls. Tractors serve mainly rural transport needs. In 1991, 4.9 million tractors and 4 million trucks were used in rural and intra-urban transport. Tricycles and bicycles also play in an important role. 3.4 Past patterns of industrial location have influenced the spatial configuration of transport flows between production and consumption centers; and, a significant gap still remains between these patterns and an efficient spatial configuration. The patterns were the result of policies that favored industrial self-suffiency at the provincial and lower levels of government administration. For example, in 1987, 80 factories in 21 provinces produced refrigerators, over 100 factories in 26 ]provinces produced televisions, and 300 factories in 28 provinces produced washing machines. This 'economic autonomy' resulted in relatively low levels of inter-provincial freight flows. At the same time, demand for consumer products is highest in provinces where they are produced (generally for low-value rather than high-value products, although exceptions exist). Imbalances in supply and demand among provinces tend to be greatest for  - 19 - high-value and low-density products, such as televisions and cigarettes; their relatively low ratio of transport cost to retail price makes them attractive commodities for highway transport. 3.5 Increasing product differentiation, the proliferation of specialized products, brand labeling, and refined distribution channels have all changed transport patterns. Manlfacturers ship smaller lot sizes and serve a narrower range but a larger number of customers and markets; and this, in turn, requires longer hauls. Also, because more and more high-value consumer items are produced, both on a per capita and absolute basis (which implies increasing consumer demand and buyer sophistication), highway freight services will need to be of higher quality and more reliable: High-value products need faster services, less pilferage, etc, and can afford higher tariffs. 3.6 The demand for highway transport within specific provinces is closely related to the level of production and distribution (see Table 3.2). Moreover, demand is particularly sensitive to production in certain sectors. For example, an interesting relationship exists between light and heavy industry shares in the economy and modal shares in the transport economy: As demonstrated in Figures 3.3 and 3.4, there is a significant correlation between light industry and trucking services and between heavy industry and railway services. 3.7 While demand for highway transport overall is increasing, this is not happening for bulk and semi-bulk commodities. As shown in Table 3.6, such demand is either static or decreasing, whether measured in tons or in ton-kms. Coal, construction materials, iron and steel, fertilizer, grain, cement, timber, rnetallic ores, nonmetallic ores, petroleum, and salt (in order of importance) are the commodities moved most frequently. They are generally of low unit value and cannot support the higher rates charged by road transport. However, it could be that as China improves its road infrastructure and the efficiency and quality of trucking services, some of these commodities (especially those of higher value and which need to be carried for shorter distance), will increasingly be transported by road (instead of by rail). 3.8 Consumer products such as bicycles, televisions, clothing and books are moved most cheaply by highway transport--more frequently by TVEs, collectively owned enterprises, and private truckers than by the SOEs. Among bulk commodities, petroleum products are those hauled the longest lengths (197 km) and construction products are moved the shortest (27 km). 3.9 As noted above, demand for trucking service closely relates to that for commodities and manufactured goods. A cross-sectional analysis of such demand among countries suggests it increases with the level of economic activity at the rate of 170,000 ton-km per million  - 20 - dollars of GNP. 1/ The same figure applies in both industrial and developing counties, although the elasticity of demand differs: In developing countries, demand intensifies as the economies emerge. In industrial countries, the elasticity of road transport demand (measured in ton-km) with respect to GNP was 1.02.2/ In other words, a 1% increase in GNP resulted in a 1.02% increase in demand for highway services. The same elasticity for developing countries was approximately 1.25. These figures are useful to make projections of road transport demand in China (see Section C). B. LOGISTICS AND COSTS 3.10 Private, market-oriented distribution channels are beginning to develop. These will increase the shippers' awareness of logistics costs (the combined cost of transport and inventories determined by the transport-related attributes of products and the service-performance attributes of carriers). In determining the optimum transport mode, shippers in advanced economies typically compare transport costs (such as more frequent shipments and smaller lot sizes against less frequent shipments and larger lot sizes), with non-transport costs, such as inventories (see Figure 1). In general, the greater the ratio of value-to- weight for commodities and the lower the annual product use rate, the more significant the non-transport component of logistics costs. 3.11 High quality, reliable and flexible carrier services minimize the inventory component of total logistics costs. As developing economies grow, goods--which were originally moved in large lot sizes (that is, rail carloads) which had low unit costs--are increasingly transported in smaller lot sizes more frequently (that is, less-than- truckload and next-day air services); this reduces inventory requirements and lowers overall logistics costs. China is following this pattern due to growth in its light industries, whose products have a high value-to-weight ratio and whose production schedules tend towards smaller lot runs. 3.12 To determine the effects that non-transport (that is, inventory) logistics costs have on modal preferences, this study analyzed total logistics costs for six products and commodities that move in large volumes within China (Annex 4). Costs were determined for several different truck sizes, as well as for rail shipment sizes of building tiles, wearing apparel, rolled paper, televisions, books and bicycles. The analysis suggested the ratio of logistics costs to the delivered price of products ranged from 0.8% for televisions to 9% for tiles. Given the sharp increase of railway fares and labor costs in cargo handling, this ratio 1/ Esra Bennathan, Julie Fraser, and Lou Thompson, WMat Determines Transport Demand? World Bank working paper. 2/ Ibid.  - 21 - Figure 1: LoGiTcs COST TRADEFomS: TRANSPORT CosrS VERSUS INvENTORY COS TUb pt/ c at utt is expected to reach a much higher percentage in the near future. In general, the higher the ratio, the shorter the distance goods can be moved commercially (see Annex 4, Tables 3 to 7 for more detail). 3.13 A significant volume of materials/commodities continues to be managed exclusively by the state. To transport these goods (vparticularly intermediate industrial products that pass between state-owned hleavy industrial facilities), the Government relies on a centrally administered allocation and distribution system, which also handles primary metals, minerals, capital and consumer goods. The system creates relatively long distribution channels with extremely large storage and handling facilities such as warehouses, sheds and outdoor holding areas (see Figure 3.1). These channels appear to be inflexible (that is, the carriers, shipment lot sizes, routing and handling patterns do not vary from shipment to shipment). Also, products move in large lot sizes to and from central storage areas regardless of service requirements. In general, the system is supply driven and appears to be administratively insulated from the holding costs associated with the products moving to final sale. This results in slow cycle times and large stockpiles of products and commodities. More importantly, these excessive inventories tend to create disincentives toward technological and prodouct innovations. By contrast, a market-oriented supply chain is much shorter (see Figure 3.2); here, the incentive to minimize holding costs results in products moving more rapidly through the distribution channels, which reduces the cost of inventory in transit and storage. 3.14 Continuing economic controls and state involvement have the following effect on the logistics systems:  - 22 - (a) Heavy industrial production and distribution are planned on the basis of a one-year supply. Iniventories are accumulated to harmonize with the state-controlled supply chain over a corresponding one-year period. For example, the China Material Storage and Transport Agency (CMST), which is the largest buyer and seller of heavy industrial products in China, distributes 20-30 million tons per year of heavy industrial products. Through its 16 regional affiliates, CMST manages the distribution of intermediate and capital goods between controlled industry sectors. For this purpose, it operates 20 million square meters of warehouse space and 4 million square meters of open space to hold construction material. However, the agency is not accountable either for the inventory holding costs of the products it distributes and ships, nor for product spoilage and devaluation during the long holding period; (b) CMST's routes are based on transport rather than logistics costs. For example, commodities that move more than 200 km. are hauled by rail while short hauls are consigned to trucks without regard to product value. Of the products moving under CMST's control, less than half, or about 40%, move by truck. Its current transport cost spread is currently 30 fen per ton-km for highway transport and 5 fen per ton-km for railway transport. Thus, CMST prefers rail because these costs directly affect its budget; however, a more comprehensive analysis that considers all logistics costs (including inventory, pilferage in transit, etc) would probably shift a higher percentage of CMST freight to the road. (c) Most SOEs purchase intermediate goods long before they enter into production schedules. Thus, they routinely stockpile inventories to avoid work stoppages and ensure continuous production. This practice of accumulating inventory, cost-free, in the planned economy is rewarded because it is considered forward planning and a risk-avoiding strategy (labeled "inventory hedging"). However, such a strategy carries a high cost: A 1984 CMST study found that 16.3 million tons of inventory deteriorated in storage and had to be written off; also, cargo losses and in-transit damages were estimated at about $12 billion per year. In an attempt to reduce the excessive loss, a General Packaging Company was formed, at the Government's initiative, to promote fully enclosed container transport which is known to reduce in-transit and inventory damage losses. The General Packaging Company is also improving loading techniques, packaging and dunnage. Nevertheless, market penetration has been slow and containerized transport remains the exception to the rule.  - 23 - (d) In addition to the direct economic costs of holdingl high inventory, the negative effects on industrial innovation constitute an indirect cost. In effect, excesive inventory holdings mean that the cost of any product or production innovation will be greater because it would destroy much of the inventory investment in the process. C. DEMAND FORECASTING 3.15 The forecasting methodology used in this report to project future growth in road freight demand employed a regression analysis. First, a model was designed that related GNP to freight demand (using historical data). The GNP and freight demand expressed both in terms of per ton and ton-km demonstrated a high correlation between the two variables. Model calculations yielded correlation coefficients of 0.974 between GNP and tonnage and 0.972 between GNP and ton-km. The model also determined truck requirements and showed a high correlation (of 0.988) between freight demand (per ton and ton-km) and the size of truck fleet (see Table 3.4). 3.16 The forecast for freight demand and truck fleets was based on low-, medium- and high-growth scenarios that correspond to annual average GNP growth rates at 8.0'S, 9.5%, and 11.0% from 1991- 2005, respectively (more specifically, 8.5%, 10.0%, and 11.5% for 1991- 95; 8.0%, 9.5% and 11.0% for 1996-2000; and 7.5%, 9% and 10.5% for 2001-2005). Average growth of road transport for the next 15 years was projected to be 8.0%, 9.5% and 11.0% a year in terms of tons, and 9.9%, 11.4% and 13.3% a year in terms of ton-km. Therefore, the elasticity of road freight tons is equal to one, relative to the GNP, while that of the road freight ton-km is greater than one (1.24 for the low- growth scenario, 1.22 for medium-growth and 1.21 for high-growth). Road freight demand measured in ton-krn is expected to grow at a faster rate than demand in terms of tons, because the average length of haul is projected to increase progressively over the next 15 years. 3.17 According to the forecast, the size of the truck ifleet is expected to grow between 8.5% -11.7% per year, a slightly lower rate than that of ton-km. This means 0.8-1.3 million trucks will neecd to be supplied yearly, including replacements; but, since domestic production supplied only 0.36 million trucks in 1991, this sector or imports will have to expand drastically to meet such high demand.  - 24 - TRUCK FREIGHT AND FLEET FORECAST GNP Freight ton Freight ton-km Truck Fleet Year Case Avg Avg Avg Avg Annual (bil- Annual (tril- Annual (mil- Annual Growth lion) Growth lion) Growth lion) Growth (%) (%) (%) (%) 1990 Actual - 7.2 - 0.34 - 3.7 2005 Low 8.0 22.9 8.0 1.39 9.9 12.6 8.5 Medium 9.5 28.1 9.5 1.74 11.6 15.6 10.1 High 11.0 34.4 11.0 2.18 13.3 19.4 11.7  - 25 - 4. SUPPLY: INDUSTRIAL ORGANIZATION, OPERATIONS AND TECHNOLOGY BASE A. INDUSTRIAL STRucTuRE 4.1 The trucking industry is undergoing dramatic changes in composition and market share. The for-hire subsector is made up of three distinct segments (each with a unique relationship to the Government that affects its independence, capital funding and development opportunities). The three are (a) about 2,000 state-owned enterprises (SOEs), which account for 7% of the market share in terms of ton-km; (b) about 8,000 collectively- ownedl enterprises (COEs), with a market share of 4%; and (c) about 750,000 private operators, 1/, with a market share of 23%. Traffic (ton-km) carried by the private sector grew at an average annual rate of 12% in the last six years, while the other segments experienced no growth.2/ Besides the for-hire operations, there are huge numbers of own-account trucks that account for 67% of all freight movement (see Table 4.1). This is much higher than the figure for own-account operators in countries such as the U.S. (47%), Japan (30%), and Germany (32%). State-Owned Enterprises 4.2 Most SOE trucking firms are owned by either provincial or municipal governments, are typically managed by several divisions and operate through multiple service branches. This arrangement where neither owner nor managers are intrinsically business-oriented creates some disadvantages in the new market economy. For example, SOE managers are selected for their technical knowledge, or in some cases, for their political alignments. The lack of commercial-type management skills coupled with a general lack of management skills (as opposed to technical operating knowledge) places SOEs in a weak competitive position with the other segments of the industry. Also, SOEs are the high-cost carriers in a market that is becoming increasingly competitive. In addition to their disadvantages with respect to labor and capital productivity (when compared to that of private operators and COEs), most are obliged to pay 25% -35% more in unit labor costs than private operators to cover social costs such as retirement, medical care and housing. 4.3 SOEs are aware of their disadvantageous position. Thus, they have retreated from short-haul markets and are redeploying their resources into markets where they have a cornpetitive advantage, that is, markets that rely on inter-regional networks formed by 1/ Consultant's estimate for 1991: MOC's most up-to-date data indicated there were 600,000 private sector truck operators in 1990. 2/ Data for the transport volume (ton) are also available, but the data for the private sector seem to be less reliable because of that sector's tendency to understate tonnage handled to evade taxes.  - 26 - cooperating SOEs, such as less-than-truckload (LTL) and containerized freight service networks. SOEs are also using their superior access to capital to purchase specialized equipment that can be used to move hazardous loads or large, heavy and oversized loads3/. Significantly, they do not enjoy any technological advantages, either in the trucks they operate (most of which are manufactured in Eastern Europe or domestically) or in communications technology and operations-control systems. Because of the poor maintenance and quality of domestic trucks, many are not usable (39 % of their truck fleet is not working, as indicated in Table 4.9). In addition, much of their equipment needs to be replaced. Indeed, 30% of the SOE fleet is fully depreciated. Further, their lack of load management systems and information technology may actually cause diseconomies of scale because of SOEs' broad geographic coverage. 4.4 Some of the specific challenges they face include: (a) Old equipment. Equipment is outdated and often used beyond its economic life. It congests the highways, pollutes the environment and adversely affects service and reliability. Indeed, the fleets need wholesale replacement; (b) Limited control over operating costs. SOE managers cannot control costs (for example, labor and management overhead, and social welfare costs). Thus, the Government has begun to change policies on an experimental basis to separate out the social costs; (c) Risk-aversive environment. Management incentives for improving profits are limited, and the bureaucratic environment in which managers operate dampers initiative and the inclination to act decisively. The result is an extremely risk-averse environment in which several levels of decision makers must sign off before internal recommendations can be acted upon; (d) Uneven management. The quality of their general mlanagers is uneven; many lack a marketing orientation or the capacity to identify problems and set priorities to fix them; (e) Disappearance of traditional customer links. Traditional and long- standing relationships still bind SOE trucking firms to SOE manufacturing and distribution customers. But, as heavy industry and commodity markets continue to open and as more SOEs are corporatized, these traditional relationships will become "arms length" and the market position of SOE truckers will continue to deteriorate. (f) More stringent fiscal enviromnent. The enterprises, particularly those with chronic operating losses, receive only limited bank credit. And, at present, the Government is covering fewer of the operating deficits. Hence, little opportunity exists for SOEs to finance the costs of radically re- positioning businesses or upgrading technology bases. 3IIt should be noted that although SOEs have access to capital, they must go through tedious administrative jprocedures and not all requests are approved.  - 27 - 4.5 In general, managers in SOE trucking enterprises have not adapted to increased customer service expectations. As the table in Box 4.2 suggests, SOEs scored poorly in a recent customer satisfaction survey. Among competing industry segments, the SOEs' strongest point is their acceptance of liability for loss and damage when settlements are made on shipper claims. Unfortunately, in terms of market orientation, SOE salespersons lack the necessary skills, authority to negotiate deals, and incentives to match private competitors. Collectively Owned Enterprises (COEs) 4.6 Although COEs are generally less well capitalized than SOEs, they are more flexibLe and economically resilient (see Box 4. 1). Also, they are better focused on specific markets. Originally established under the auspices of the city, prefecture and county governments, they were gradually awarded broader autonomy than even SOEs to pursue diverse business opportunities. Best described as community owned, the owners consist of a set of collective members, their families and selected new members, all of whom exchange their capital or equipment for membership. COE staff include formerly self- employed pedicab and rickshaw drivers. Box 4.1: THE RESILIENCE OF COEs According to the director of a COE in the Lianhu district, "We do not enjoy the same advantages as SOEs. However, we have more decision-making authority compared to the SOE directors. If we do a good job, the company grows; if we make mistakes, we will go bankrupt. Therefore, we are risk conscious and have to aggressively diversify into other businesses. If we rely merely on the revenues made through provision of road freight service, we cannot feed our employees. This is particularly true at a time when supply is increasing and cornpetition is getting tougher. In fact, we will do whatever is necessaiy to benefit the enterprise and the employees." 4.7 The COEs' features, which have led to their economic resilience and adaptability, include: (a) Responsibility for their own profit and loss performance since their inception; when they experience losses, individual members lose profits; (b) Less integration with the state planning apparatus than SOEs. Thus, they exercise management authority more freely and have developed sales and marketing skills well beyond merely taking orders, which is the practice among SOEs. (c) Development of market niches in which the quality of their services or unique service delivery distinguishes them in increasingly competitive markets;  - 28 - (d) Use of their retained earnings to raise wages, improve the welfare of their employees, and invest in new equipment and vehicles for expansion, whereas SOEs must follow government orders; (e) Limited fringe benefits and a smaller welfare package than SOEs. Therefore, although COEs may feel less secure, employees are more highly motivated. 4.8 Although beset by some of the same problems as SOEs (such as outdated trucks, lack of capital, and heavy social burdens), most COEs have adapted to the changed economy and improved their performance. In recent years, they have managed to: (a) alter prices in response to market changes; (b) aggressively diversify businesses into other service industries, such as taxi service, restaurants, guest-houses and retail stores, to solve overstaffing problems; (c) lease trucks to employees on a contractual basis to ensure that fleet size is well matched to market demand; and (d) hire part-time workers to handle cargo, thus reducing overall operational costs. Box 4.2: SHIPPER SURVEY The table below summarizes a "quality of services" survey of the four segments of the Chinese trucking industry. The assessments represent the composite views of traffic managers of state-owned manufacturing firms. Interviews were conducted in November 1992. Individual cells in the matrix are ranked on a scale of 1 to 5, from least to most favorable. QUAUTY ASSESSMENT AND RANK Match Service Transit Loss and Flexible equipment Overall quality Price time and damage hours of to shipper quality factors flexibility reliability frequency service needs rating Importance to shippers 5 4 3 2 1 - SOEs 1 1 4 1 1 23 Private 4 4 1 4 4 47 COEs 3 3 2 3 3 39 Own-account 2 2 3 2 2 33 Source: Mission interview during field visit in 1992. 4.9 In general, although COEs are not as well equipped as SOEs, they have managed to compete successfully. Although they lost 2.4% of market share since 1986, based on interviews with shippers in Shanghai (during the field visit), it appears they give good marks to COE truck operators. Given their relatively strong market orientation, COEs will probably recover from the setbacks.  - 29 - Township and Village Enterprises (TVEs) 4.10 TVEs represent a growing sub-segment of COEs. Their presence is particularly strong in the Yangtze Delta region and in Jiangsu and Zhejiang provinces. Launched into trucking in the mid-1980s when the Government relaxed restrictions on truck ownership, some are engaging in for-hire services, while others carry cargo as own- account operators. Most TVEs, however, provide trucking service as a side business. 4.11 While COEs fall under various categories according to the Government agencies that administer them, TVEs are collectively-owned businesses whose custodial agencies are townships or villages. They attribute their recent rapid development to the growth in economic activities around suburban areas. Although they previously depended on farming, they now actively engage in marketing with shippers in townships and villages (with whom SOEs and municipality-level COEs have shown little interest). Further, because of the need for backhaul cargo, TVEs have begun marketing in cities. 4.12 Although TVEs might be smaller than provincial or municipal COEs, they are often more efficient. This is partly because they were established laiter than COEs (after the mid-1970s) and thus are not a product of the planned economy. In fact. they have never been factored into state plans. And, because urban areas have been more tightly regulated than townships and villages (due to their concentrated economic output), TVEs, which are set up outside urban areas, retain more freedom than COEs. In fact, foreign investors prefer to form joint ventures with TVEs rather than SOEs or COEs. Private Sector Operators 4.13 Private sector growth has been impressive since 1984, when operators other than SOEs and COEs were first allowed to obtain licenses to offer for-hire trucking services. From a zero base in 1984, this sector grew to 750,000 participants in 1991. As indicated in Table 4.1, it has maintained an average annual growth of 12% since 1986. This marks a sharp contrast to zero or below zero growth for both SOEs and COEs during the same period. 4.14 Private operators increased their market share by capturing new markets and customers--being particularly strong in satisfying ad hoc demands for transporting miscellaneous goods. While they have grown faster in the coastal areas than in the vast hinterland, growth has been particularly remarkable in Guangdong province, where reform has gone farthest: In 1992, private trucks in Guangzhou accounted for more than 50% of the city's total, compared to only 13% nationwide. Private operators hanidled 63.6% of the city's total cargo volume, compared to 23% nationwide. 4.15 The performance of private operators in other cities and provinces is equally impressive. For example, the percentage of total cargo transport tonnage and movement captured by private operators in Shaanxi reached 13.2% and 20.9%, respectively, in 1991, while it was 3% and 9.7%, respectively, for the SOEs. The same situation prevails in Hubei, and Beijing. In Hubei, the number of privately operated trucks accounted for 6.4% of the provincial total, while SOEs accounted for 4.4%. In Beijing, private sector market  - 30 - share measured in terms of cargo tonnage and movement reached 11 % and 13.4%, respectively, in 1991. 4.16 Private operators in most cities, including Shanghai, Wuhan in Hubei province, and Xian in Shaanxi province, share the following characteristics: (a) They are generally small-scale, owned by individuals (owner-drivers) who operate only one truck. They often start with second-hand, fully depreciated trucks purchased from SOEs and own-account operators. However, an increasing number now operate more than one truck. One Beijing private operator, for example, started his business in 1985 with a 5-ton truck, a Jiefang, and now owns five new 5-ton trucks, all Dongfengs; (b) Often they are experienced drivers who worked at SOEs and COEs, former automobile mechanics, or former service procurement managers. Thus, they frequently know the business and understand the problems of SOEs, the demands of the market, and customers' needs. When they start their own businesses, they usually know where to find orders; (c) Most private operators begin by using private savings or borrowing. As their businesses grow, they reinvest their earnings to expand; (d) Many private operators in Beijing, Wuhan, and Xian differentiate their services based on customer needs. For example, many provide 24-hour, round-the-clock service; others offer prompt delivery, flexible working hours, and damage-free cargo handling. Private operators also use various marketing and sales tools, such as flexible pricing and long-term-contract discounts. They often target small-scale manufacturers as their major customers (such as in Jinghua in Zhejiang province, a small city approximately 250 km. south of Shanghai, where small industries have been booming since the 1980s); (e) They match their fleets to their customers' needs, while neither SOEs nor COEs offer a sufficient number of light and heavy trucks to satisfy demand. Conversely, private operators generally fill the void with light trucks (where these are available). Indeed, many private truckers in Guangdong province provide trucking services using mini-trucks with loading capacity of less than 0.6 ton. 4.17 Except in Guangdong and its neighboring provinces, where private operators are developing quickly by taking advantage of the rapid growth of light industry and their close ties with Hong Kong, trucking operators are still constrained from expanding their busineses: (a) Small family-based truckers with one or two trucks generate business largely through old business ties and personal connections. As long as the business goes well enough to feed their family, they are satisfied and do not try to expand the number of clients;  - 31 - (b) Many are former drivers or mechanics who have neither a high school education nor any prior managerial experience. Their lack of management skills, in particular, poses a major barrier to transforming their businesses into modem, large-scale trucking operations; (c) Capital formation for private operators is largely through family savings and personal borrowing. They generally feel uncomfortable raising funds through bank loans because they do not understand the lending process and are often unwilling to disclose financial information; (d) Private truckers can only employ a limited number. In Shanghai, for example, individual operators cannot hire more than eight employees, a cap that hinders expansion. Even if they want to corporatize, the legal framework in most provinces does not allow it. Own-Akccount Operators 4.18 As restrictions on vehicle ownership were relaxed, the nurnber of own- account trucks grew at a much faster pace than for-hire trucks. Between 1986-91, the former grew from 130 billion ton-km to 228 billion ton-km, an annual compound growth rate of 11.9%. This far exceeds the corresponding rate of for-hire trucks (7.2%). The result is many more own-account trucks, which now account for 79% of the total fleet. 4.19 Contrary to some perceptions, competition between for-hire and own-account operations is not as intense as in other developing countries, where illega]l services and fierce competition are major issues. The main reasons include the following: (a) The market for road freight services is still expanding, and an inadequate supply is a more serious problem than fierce competition within the industry; (b) The activities of own-account truckers are regulated under the same licensing system that applies to for--hire truckers. 4.20 Hoever, own-account trucks still constitute something of a threat to the for- hire sector. Many large, state-owned manufacturing firms operate their own fleets, which fall outside the control of the MOC (as they are managed by other industrial departments). Further, liberalized entry into the for-hire business opened the door for aggressive own- account fleet managers to solicit freight and generate incremental revenues using otherwise dormant trucks or empty backhauls. Also, they have an opportunity to undercut the prices offered by for-hire truck operators because they have guaranteed base traffic volumes through their affiliation with their parent enterprises. Moreover, different tax regimens create an imbalance: While revenues from main businesses are subject to taxes of 22%- 55%, those from sideline business must pay only 15 %-35 %. Also, they enjoy a competitive cost advantage from cross-subsidies between manufacturing and trucking functions within the same enterprise and from cost-plus prices they can pass on to the captive customers of their manufacturing affiliates. Addressing these inequities is a major policy concern.  - 32 - 4.21 Own-account fleet operations are usually established to resolve bottleneck problems and, once started, grow incrementally along with the manufacturing enterprises of which they are a part. While the decision to buy trucks/equipment is generally based ooon a desire for easy access to services, in some cases the purchases are warranted (where no similar service exists): Sometimes they have special equipment designed to hold odd-dimension or fluid products that for-hire firms may not own. Or, they may have new general-purpose equipment that provides more reliable service than the older equipment that for-hire carriers can furnish. In either case, the decision to start an own-account fleet may depend more on access to capital than on a rigorous economic analysis of transport alternatives. Ironically, equipment shortages experienced by for-hire trucking companies in the 1970s and 1980s stimulated the development of own-account fleets to the extent that overall productivity of equipment was reduced (see Table 4.6) B. TECHNOLOGY BASE Truck Equipment 4.22 The technology base of the trucking industry involves truck design, information systems, cargo handling, traffic planning and control, general management, equipment maintenance, maintenance facilities, and spare parts. Access to technology differs among the various segments of the trucking industry; however, differences are relatively small compared with the disparity between China's technology, in general, and that in Organization for Economic Cooperation and Development (OECD) countries (it lags 15 years behind). 4.23 Most trucks are variations of two domestic models, Jiefang and Dongfeng, and most heavy trucks are imported from Eastern Europe (the table below gives the composition of the SOE truck fleet). These vehicles include the Tatra, Maz, Steyr, KaMaz, and Roma models. Domestically-manufactured vehicles account for 73% of the total with annual domestic production currently exceeding 500,000. Vehicle replacement is low, however; only 9.8% of the fleet is replaced annually, which corresponds to an 11- year economic life. Of the total fleet, 30% have run 200,000 km.-500,000 km., and 1% have run more than 500,000 km. The average age of freight hauling vehicles is 6.4 years. COMPOS1TION OF THE SOE TRUCK FLEET BY SIZE OF TRucK Truck types Heavy Medium Light Specialized Total Average tonnage 21.4 4.2 2.1 11.2 6.4 Number of trucks 12.7% 84.1% 1.0% 2.0% 100.0% Total tonnage 42.0% 54.0% 0.3% 3.4% 100.0% 4.24 Trucks owned by industrial SOEs (own-account trucks) are generally newer and better matched to their needs than are those owned and operated by trucking SOEs.  - 33 - Still, both own-account and for-hire trucks are typically superior to those used by collectives and private operators. 4.25 If China maintains its current truck manufacturing policy, which involves manufacturing component sub-assemblies under licenses (mainly for ]L970s Eastern European models) for technology that is not easily integrated or suitable for producing modern vehicles, trucking operations will continue to be costly. 4.26 Two major truck manufacturers operate domestically: the First Auto Works, which produces the Jiefang Truck Line, and the Second Auto Works, which produces the Dong.Feng Line. In addition, several joint ventures produce trucks; also, some produce critical components and sub-assembly systerns for the two original equipment manu:facturers. Further, China has entered into a number of technology transfer and licensing agreements with foreign manufacturers, mostly to produce vehicle components. Unfoitunately, individual components cannot always be combined efficiently into a single truck (or car). Thus, domestically produced trucks are not likely to soon meet the standards and quality of technologies and manufacturing practices adopted elsewhere. 4.27 The engineering of high quality, high performance trucks in OECD countries has progressed substantially over the past two decades. The practice of matching components (engines, clutches, transmissions, and rear axles) with clearly defined duty cycles is standard where manufacture-to-use techniques, together with sophisticated maintenance programs, translate into superior productivity, reliability, extended road life, and safe service. In comparison, China's technology is about 20 years behind. 4.28 Domestic trucks are supplemented, particularly the heavy-haul models, by trucks imported from various Eastern European countries. Most were imported through barter trade during an era characterized by chronic hard currency shortages. Also, a few are from Western Europe, the UK, US and Japan (from which they import a significant number of mid-range trucks, notably Nissan and Isuzu, which are rnost common, particularly in Guangdong province). 4.29 The largest share of domestically produced trucks are gasoline powered. Most Eastern European trucks, on the other hand, are diesel powered and are operating well beyond their economic life. Among the SOE fleet, for example, 30% exceed their depreciable life (normally 10 years). 4.30 Operating practices tend to reduce the trucks' performance even further. Overloading by as much as 50% is widespread, which shortens the econornic life of both trucks and the improved roadways on which they operate and often damage highways. It was rioted that some companies worked their prime movers (that is, Volvo, F-12s) at load levels 30%-50% higher than that allowed for the same vehicle in Western countries. 4.31 Horsepower per ton (hp/ton) is a comprehensive measure that can be used to compare China's domestic truck technology with that of other countries: The ratio for multi-axle vehicles now operated in China is 3.8-5.0 hp/ton. However, these could be raised to a minimum of 6.0 hp/ton by (a) introducing more powerful engines, (b) using aluminum alloys and ceramics to reduce engine weight, and (c) reducing the relatively high chassis and body weights that characterize current Chinese models. In parlticular, specific  - 34 - engine design features could offer substantial benefits in terms of improved efficiency, safety, and environmental impact. Future engine design objectives should include the following: (a) high torque at low engine speed, (b) slower overall engine speed, (c) maximum horsepower at less than 2,000 rpm (revolutions per minute), and (d) lower fuel consumption. 4.32 The mix of trucks produced is also a problem: Too many medium-size trucks are built, although there is a conspicuous shortage of heavy tractor trailer combinations. This mix is not suitable to the evolving composition of freight in China's new economy, or to what the trucking companies would require. Indeed, the practice of matching vehicle designs with duty cycles and customer specifications for medium- and heavy-duty vehicles is completely absent. Moreover, the lack of effective interaction between truck manufacturers and truck users and an unresponsive distribution system have hampered technological advancement. As a result, truck equipment assigned to specific SOEs and COEs is inappropriate and corresponds even less to the needs of private operators. 4.33 Trucks manufactured domestically have the following weaknesses: (a) inability to reach full speed limits, (b) dramatic slowdown as they approach a modest grade, and (c) rpms that are too high (greater than 2,400) to attain full power and maintain speed. 4.34 The fleet needs to be upgraded with modem equipment; (see Table 4.4 for the specifications of typical Chinese trucks) and the question is how best to accomplish this. Heavy trucks imported from Eastern Europe do not adequately fill the performance needs. The fleet do not have high (greater than 220) horsepower equipment, and this means the trucks cannot compete economically with rail. Moreover, the general use of gasoline-powered trucks 4/ pollutes the air and restricts the ability of the vehicles to carry payloads competitive with rail. One result of the obsolete vehicle technology is that standards for exhaust emissions and safety features are weak. 4.35 The use of outdated technology and inappropriate equipment, which is poorly maintained and overloaded, incurs the following social costs: (a) unnecessary pavement damage, which causes roads to break up quickly that, in turn, causes excess cargo damage; (b) excessive fuel consumption; (c) excessive exhaust emissions; (d) a great deal of traffic congestion and (e) poor customer service because of breakdowns. Operating Techniques 4.36 As is the case with equipment technology, truck operating practices also lag behind OECD best practices. Among Chinese provinces, the most advanced technology and operating techniques are applied in Guangdong, where companies use unitized and palletized cargo handling techniques as well as radio equipment for dispatching trucks. But, nowhere in China are there effective fleet operating control systems for load matching and trip planning. 4/ A gasoline engine is more polluting than diesel if neither is equipped with an emission gas control device. This is particularly true of the heavy-duty trucks, because gasoline engines are less fuel efficient.  - 35 - 4.37 An increasingly important issue is the management of urban ifreight (pickup and delivery). In most countries, freight is carried over a relatively short distance within urban areas. Two-way radio communications, or in some cases mobile telephones, are used extensively in pickup and delivery operations in OECD countries to improve equipment and driver use. Real-time dispatch and driver control provide several benefits for drivers, who can be (a) diverted to a pickup or backhaul for which they might otherwise not be available; and (b) alerted to any problems encountered, such as delays, queries, and inability to load or unload at the pickup or delivery point. Also, drivers can advise dispatchers about delays so the latter can notify customers and contact other truckers on the road in cases of delays or breakdowns. In addition, company managers can obtain real-time information that will allow them to modify load planning and scheduling to meet customers' needs. In view of the significant productivity gain which can reach the magnitude of 20 % -25 %, large-scale truck operators and/or cooperatives of truck operators should consider introducing a radio dispatch system. 4.38 In addition, other technologies could be introduced over the longer-term. Over the past decade, logistics management in OECD countries has become highly efficient and increasingly sophisticated. However, little evidence exists that China is adopting any of the cutting-edge technologies and methods used to improve physical distibution. These include asset management software, electronic data interchange (EDI), and bar coding. These technologies further enhance the primary benefit that highway transport offers to shippers, as they minimize shipper logistics costs. C. TARIFF AND COST STRUCTURE Tariffs 4.39 The Chinese tariff structure is uncomplex and used country-wide. Pricing for nmost freight is based on load-distance (ton-km). As mandated by the MOC, tariffs serve mainly as guidelines around which prices can vary up to 10%-20%. 4.40 The structure is organized by commodity type, hierarchically. First, comrnodities are classified into common cargo and specialized cargo. The common cargo classification is divided into three subclassifications: bulk, packagecd, and fragile. Specialized cargo is divided into four categories: normal hazardous materials, special hazardous materials (explosives), high- value cargo, and oversized loads. The latter is subdivided further into four groupings that depend on the size of the load (4-6 tons, 6-10 tons, over 10 tons, and over 20 tons). While separate rate levels are set for each classification, they all are derived from the bulk commodity rate or base rate. For example, the reference rate for packaged freight is 110% of the base rate, while that of fragile freight is 120%. Additional upward rate adjustments are made for small-size shiprnents or small trucks (see Box 4.3). Further adjustments are based on specialized truck equipment. Because tariff levels do not bear any relationship to costs, pricing guidelines, as well as actual pricing practices, appear to be ad hoc. The concept of multiple commodity classifications is intuitively reasonable (for example, higher handling costs and more exacting handling requirements are associated with hierarchically organized commodity classifications), but it is unclear whether the order of magnitude of these price  - 36 - Box 4.3 Modern Techniques Inprove Distribution Asset management software is used to track product levels through the entire distribution channel, regardless of where the product is or which distributor carries it. It works in conjunction with specific bar coding and EDI protocols. It allows trading partners in a buy-sell transaction to deal flexibly with one another at compatible transaction information levels. Normally, carriers deal at a product number level or by customer identification (ID) or point-of-sales (P.O.S) number. Shippers and receivers deal with product-specific information. The software cross- references several levels of product information and integrates the data used by carriers and shippers through the entire distribution channel. EDI involves computer-to-computer transmission of information without the need for human intervention or interpretation. It also assures zero-defect information control and quality continuity in all exchanges, even as the process becomes more complex. Without EDI, carriers, shippers, forwarders and receivers must input basic data into multiple systems, each with its own requirements. The bar code contains standard symbolic language read easily by machines and is used to characterize products moving through a distribution channel. Several bar code languages have been developed in OECD countries, each of which consists of unique vertical lines of varying density, width and spacing. The languages are scanned and communicated through EDI information networks. Widely used bar code languages include uniform product code (UPC) labels applied for individual consumer products, code 39 labels used in manufacturing, and code 54 labels. variations appropriately reflects differences in cost. 4.41 The MOC establishes the overall policy under which prices are set and each province determines its own base under general MOC directives. For example, in Beijing, the base rate for common cargo is currently 27 fen per ton-km, and the base rate for specialized cargo is 37 fen per ton-km. Conversely, in Shanghai, no price controls have applied to full truckload cargo since April 1992. Only LTL price controls remain (43 fen per ton-km). In Wuhan, no price controls apply on any cargo movements under five tons. 4.42 The application of reference rates also varies widely among trucking industry segments. In general, SOEs normally set prices based on guideline standards, while private operators set prices based on market conditions. Both private operators and COEs are aggressive marketers, frequently undercutting SOE prices, which they use as an umbrella for their own discount price structures. Where service quality is important, private truckers price above the SOE rate umbrella. Both private operators and COEs frequently price their service on a spot basis, related to daily supply and demand balances within local service markets. When these open markets exist, SOEs usually do not participate. Their services are typically based on standing prices, which in turn are supported either by published reference tariffs or by contracts filed with the MOC. Handshake contracts, which both private operators and COEs customarily use, are difficult to enforce or adjudicate. In the same way, they increase the risk to shippers, who may also find informal agreements difficult to enforce.  - 37 - Box 4.4: LTL SERVICES 1N CHINA In 1983, an interprovincial less-than-truckload (LTL) service network made up of 33 provincial trucking enterprises was formed, with bases in all the major cities. Since then, the LTL market has grown at a rate of 10%-20% a year. Because significant levels of fixed asset commitments are needed to provide LTL service, and because provincially centered SOEs are in the best position to secure capital and forge network relationships, SOEs dominate the LTL sector. The kinds of commodities that move by LTL service are principally consumer goods, including both durable and nondurable items. These are typically the products of light manufacturing industries and move through distribution channels controlled either privately or through collective distributors. The rapid rise in LTL services signals the emergence of a consumer product market and the development of a strong private retail/wholesale sector. Rates charged for LTLs reflect both the higher cost andl the higher value associated with this service. Their movements are much longer than truckload movements, and rate guidelines and regulatory regimes of destination provinces usually apply. Box 4.5: FuEL PRICES Almost all petroleum consumed by the transport sector is produced domestically in China. Until recently, gasoline and diesel prices were controlled. This system, however, was abolished in January 1992. Since then, all fuels used for trucking services have been sold at the market price regardless of whether the purchaser is an SOE, COE, or private sector operator. The decontrol of fuel prices caused a substantial increase in prices from Y 700/ton in 1991 to Y 1,900/ton in 1992 for gasoline and from a little more than Y 600/ton to Y 1,700/ton for diesel. Costs 4.43 Differences exist among information sources about the cost structure of China's trucking industry (see the table below for the typical cost structure of for-hire enterprises). These differences are due to the classification of specific costs, while others are derived from the various types of carriers surveyed. Data sources, however, do agree on several points. For example, the most notable aspect of trucking costs, particularly those of SOEs, is their relative lack of volume variability; operating costs do not change with ithe level of cargo. This is partly due to the high fixed costs stemming from social welfare functions that SOEs perform, including salary payments to retired personnel.  - 38 - COST STRUCTURE OF TRUCKING OPERATORS (percentage) Australian Road MOC's YEZTS /b Transport data /a Report Association Wages 7.15 10.00 46.0 Fuel 20.67 23.80 10.7 Tires 6.30 5.50 1.5 Maintenance 20.83 32.10 7.0 Depreciation 5.99 6.90 12.8 Licenses and taxes 14.36 9.00 12.4 Overheads 24.70 12.7 9.6 /a Based on the data of SOEs. /b YEZTS: Yangtze Economic Zone Transport Study. 4.44 Chinese trucking costs differ from those in OECD countries in the following ways: (a) Labor costs are a much lower component of total operating costs. In the United States, for example, these typically account for more than 50% of operating costs; (b) Fuel, on the other hand, is a more significant cost, mainly because of inferior engine technology, use of the wrong vehicle for specific freight tasks, and overloading; (c) Maintenance costs are three-four times higher, again mainly because of poor equipment, overloading, and inappropriate use of the equipment; (d) Depreciation is higher, in spite of lower depreciation rates, because a relatively high proportion of the purchase cost of vehicles and parts is included in the overall cost. Financial Conditions 4.45 Due to increased competition from private truck operators, SOE transport companies have been much less profitable in the last few years. For example, the gross profit margin from the passenger and freight transport service declined from 11.7% in 1985 to 3.5% in 1991. As Table 4.9 indicates, this decline can in part be attributed to the SOEs' low revenue growth.  - 39 - 4.46 Although trucking SOEs are still making money in aggregate terms, many, particularly in large urban centers where competition is most keen, are losing money. Since the 1980s, provincial and local governments have become increasingly reluctant to bail ouIt the ailing SOEs. Although no data are available on the amount of the subsidies they received, informed judgment suggests it is relatively small. Government policy toward these SOEs appears to encourage business diversification in order to cover losses within the trucking sector. Companies that are still losing money even after such efforts are encouraged by the Government to merge into healthier SOEs. Of course, a number of trucldng SOEs continue to demonstrate good financial performance. These invariably focus on the market segments where a competitive advantage can be maintained over private operators, such as with transporting oversized cargo and hazardous materials and scheduled service of LTL cargo. D. EMERGING SERVICES AND FACILITIES New Services 4.47 In market-oriented economies, innovation and testing of new transport services are the principal ways through which service providers adjust and adapt to their customers' needs. The MOC's policies at the provincial, municipal and county levels have fosteredl active experimentation and the successful development of new service designs. This is a direct result of recent economic reforms, particularly of liberalizing entry restrictions. In many provinces, service is being tailored to respond to customer needs. However, this varies among provinces: For example, coastal and southern provinces lead the way in responding to new market challenges with innovative service designs tailored to the logistics needs of local manufacturers, exporters, constructions enterprises, and tradespeople. 4.48 Stimulating innovative services could be a major function for provincial departments of communication. One issue is the transferability of successful new designs among provinces, as most innovations are developed in a particular province. However, at present, no mechanism seems to exist to transfer them. 4.49 A second issue involves inter-regional transport. Several specialized service networks have been created in the past five years that share a common organizing principle; most are built on cooperative operating and joint marketing agreemrents that are exclusive to SOEs. In each case, participating SOEs or collectives are given an exclusive local market franchise in exchange for their participation in the network. However, these networks are actually monopolies that will probably have no incentive to ilmprove their services once they mature, unless they are challenged competitively by parallel networks. 4.50 Generally, the emerging service innovations fall into four categories: (a) public imarkets for transport services, (b) inter-regional services based on multicarrier service networks, (c) services that link different modes, and (d) the use of shipper and carrier intermediators or brokerage services (see the table below for details). 4.51 Further development of new services is possible in four areas, based on:  - 40 - TRUCKING SERVICE INNOVATION Service design Description Examples Public markets These markets are strategically located around the perimeters of Wuhan, some near rail transfer stations. A similar transport market has evolved in Xian and Guangzhou where private and col- lective truckers have established a set of retail transport markets on their own. Small volume, incidental shippers can come together with small-scale truck opera- tors-principally collectives and private truckers-to negotiate prices and terms for shipments of less than five tons. Also, long-haul truckers that seek backhual cargo use them. Interregional network services Service elements of the nationwide LTL network that is forming include scheduled interprovin- cial linehaul services and reciprocal pickup and delivery services with local markets. The carriers that originate the freight collect the revenues and divide them among participants. Several nationwide networks have emerged in the past five years. The most notable of these is the nationwide LTL network, which serves 65 major urban centers, and whose members are SOEs. Multimodal services Multimodal service networks link several truck operators in a single truck-rail-truck movement. Each operator also provides local pickup and delivery. A similar network exists for bulk commodities that are transported beyond local transfer centers served by rail. The first of these centers was set up outside Wuhan in 1984. A nationwide domestic container network was recently established, that relies on rail linehaul to link 42 container consolidated depots. This network ties together consolidation/deconsolidation operators at the origin and destination end of each movement. Shipper carrier intermediation Provincial SOEs have also been instrumental in starting up a number of truck-oriented services that broker or mediate between carriers and shippers. These activities have emerged most notably in cities that are large import/export gateways, such as Shanghai and Beijing. In Wuhan, the Bureau of Communications has set up a customer service center that assists in matching specific shipper loads with the hauling capacity of specific carriers. The service center also monitors prompt load acceptance, transit time, and carrier service reliability. In Shanghai, an SOE is providing load-matching service between truck operators and shippers.  - 41 - (a) Logistics information and data exchange among trading partners through electronic data exchange; (b) Forward product supply and in-market storage of various products in high demand; (c) Value-added customer support, including safe delivery, unpacking and setting up products, delivery of selected freight on a promotional basis; (d) Temperature-controlled transport, which pertains to fresh ancl frozen food, pharmaceuticals and chemicals. Cargo Flow Centers 4.52 A recent MOC policy initiative deserves special attention. To create efficient cargo flow systems, the Ministry is advocating a cargo flow center (CFC) scheme; this would develop cargo transshipment centers at the peripheries of cities and create a network of CFCs for the major cities. It plans to construct one or two CFCs every year until 43 are erected. Under the MOC's guidance, local governments formulate citywide plans for CFC construction, submitting their plans to the Ministry for authorization. 4.53 A CFC is a multifunctional transshipment center equipped with facilities for (a) moving goods from rail or water to trucks or from long-distance trucks to local delivery and pickup trucks; (b) storage; (c) drivers (including canteens and lodging); and (d) vehicle service (parking lots, repair workshops, and gasoline and diesel filling stations). Long- distance trucks operate to and from these centers without entering urban areas, and local trucks use them to make deliveries or pickups. Variations occur according to the functional requirements of each province; some put particular emphasis on multimodal functions, incorporating rail or inland water transfer facilities. A CFC may also function as a clearinghouse, providing backhaul cargo and capacity information to shippers as well as truckers. CFCs are intended to be common user facilities, with either ad hoc user charges or leasing fees imposed. 4.54 The CFC concept originated in the mid-1980s to alleviate congestion in Beijing by diverting through-traffic to existing and planned ring roads. Local governments have responded positively; most major cities (Shanghai, Shenyang, Beijing, Wuhan, and Xian) have formulated similar plans with different: concepts and designs, and some have acquired land for construction (Shanghai and Shenyang). Typically, each city will construct five to eight CFCs in its administrative zone. With an estimated construction cost of Y 50 million for one center, the entire plan for each city calls for an investment of Y 250 to Y 400 million over a 10-year period. 4.55 Given the rapid growth of cargo movement to and from cities and the limited capacity of the transport infrastructure, the planned CFCs are a justifiable expense, particularly to alleviate traffic congestion and conserve energy. However, given the scale of the investment and its centrally planned approach, the danger is that the result may be another constraint to truck movement, limiting the routes trucks can take and reducing overall efficiency. Therefore, MOC should address three main issues. The first is  - 42 - whether local governments should take the initiative for CFCs and the extent to which they should be involved. The second is whether the entire plan is too ambitious; instead, it may be more practical to construct a few different types of CFCs in selected locations on a pilot basis to examine their feasibility. The third concerns the construction and operation of CFCs themselves--whether they should be constructed by SOEs or the private sector, or if separate entities should undertake their construction and operation.  - 43 - 5. ISSUES AND APPROACHES A. GOVERNMENT REGULATIONS 5.1 Legislation and regulations have become important components of reform efforts because they determine the basic framework for an industry. However, once formulated, they are difficult to change: The legislative process is lengthy, and it cannot be avoided. As a result, adaptation to new conditions is slow. 5.2 In general, however, regulations on trucking services have kept pace with economic reforms, although a gap exists between some and the most recent economic policy. While this has been addressed by liberal interpretation and application of regulations, these will eventually need to be restructured to accommodate the following: (a) Delegation of broader authority to executing agencies (mainly to the MOC and provincial governments) to enable them to adjust quickly to the changing environment without going through tedious amendment procedures. However, it will be important to maintain a balance between central authority and provincial devolution; (b) Professional associations of road transport operators 1/ that can improve commercial practices and upgrade the truck operators' managerial and operational capabilities. These improvements can be accomplished through training, the development of professional standards, and issuance of professional certificates to qualified individuals in specific operational techniques such as driving and truck maintenance. However, because of the nature of professional associations, the MOC should closely monitor their activities, particularly cartel-type actioons that exclude newcomers and create tacit agreements on tariffs and marketing; (c) Establishment of basic principles that deal with the relationship between transport operators and shippers. However, the Government should confine itself to the responsibilities of users and suppliers, including which parties assume the burden of proof for failure to fulfil the obligations of transport operators. The Govemment should also stipulate basic regulations needed for consumer protection. The Government's Role under the Market Economy 1/ The China Road Transport Association was created in 1991, and MOC has attached strategic importance to its activities.  - 44 - 5.3 Many of the principles the transport agencies currently promote under overall economic reform efforts (market orientation and advancing the private sector) undermine the traditional role of the agencies and call into doubt their very existence. While these traditional functions are losing their importance, the Government must address new issues more vigorously: It should support a shift towards a more market-oriented economy by endorsing and implementing the following objectives: (a) Establish a well-functioning market by eliminating price distortions, removing various institutional barriers (including restrictions on equitable access to capital and labor), and implementing policies that prohibit anticompetitive practices; (b) Internalize external costs that, without Government intervention, would not be reflected in market prices; (c) Translate national policy goals into operational guidelines for the trucking industry (addressing, for example, energy conservation, environmental protection, and the development of economically disadvantaged remote areas); (d) Ensure basic fairness and order (for example, protect consumers and penalize carriers that violate laws and regulations such as those related to safety, work conditions and other legal obligations). 5.4 These objectives would be translated into the following basic Government functions: (a) Formulating and implementing laws and regulations to ensure safe and environmentally desirable trucking operations, and maintain minimum regulations designed for consumer protection; (b) Issuing policy guidelines to improve the quality of services and promoting intermediate activities and innovative systems, such as clearinghouses, that would improve the industry's efficiency; (c) Devising and implementing regulations that prevent the abuse of monopolistic power or the formation of cartels, and that restrict unfair practices in individual transactions; (d) Establishing taxes and a road user charge system that would raise revenues with the least distorting effect on economic efficiency, while ensuring the system is implemented equitably and with administrative ease; (e) Compiling statistics and collecting data related to road freight service activities and disseminating this information to the public; (f) Resolving conflicts with other sectors, such as automobile manufacturing, port and rail, to ensure smooth cargo transshipment between different modes of transport.  - 45 - The Liicensing System 5.5 As previously stated, licensing can be used to control either quantity (of service providers) or quality. Quantity control was abandoned by Japan in 1991 and by the United States in 1980, which instead focused on quality; also, many Western European countries have adopted the quality control approach (see Annex 3). 5.6 China, as well, should follow the quality control approach. Such control is essential, and, given the poor quality of operations and low safety standards, the Government will need to monitor the industry. A licensing system based on quality control would be an effective way to ensure safe operations. However, because of the large number of truck operators and the time needed to examine applicants' equipment and facilities, administering such a system would be difficult. Thus, a more manageable approach would be to introduce a filing system under which truck operators would be required only to file business plans 2/ with transport authorities. After this, they could begin providing services without waiting for Government authorization. But, if they violate regulations, they would lose their authorization to operate. In this scheme, government intervention would focus more on monitoring business practices and compliance with safety standards than controlling entry. The presumption would be that individual operators were fit and able to serve shippers' needs; also that vehicles and drivers met safety regulations and were fit for service. The advantage is that it would relieve transport authorities of having to examine all applications for licensing and would free up, staff to focus on enforcement. 5.7 When competitive practices are well established and effective mechanisms exist to ensure fair competition and prevent anti-monopolistic practices, filinig of business plans could be eliminated altogether. The Pricing System 5.8 Current pricing regulations are restrictive but they are not a major threat to free competition, mainly because of the increasingly liberal manner in which they are administered by local transport authorities. However, regulatory restrictions on pricing need to be lifted and price guidelines reformed so as to minimize the discrepancy between the literal regulations and their actual application. 5.9 An operator-initiated pricing systerm would be appropriate with decreasing input from the government. In the short and medium term, the Government may consider it reasonable to retain certain monitoring functions, but the onus would be oni operators to set reasonable rates. They would notify the transport authority of their intended tariffs before introducing them, but the price would become effective at the time of filing (without prior approval): When warranted, authorities would assess whether the tari.ffs were non- discriminatory and applies equally to all customers (with the exceptions stated in the operator's tariff application). In the long run, once more competition develops within road 2/ A plan which describes major elements of business activities including trucking fleet, headquarters and branch offices, parking facilities, and organizational structures.  - 46 - transport, and with other transport modes, tariff filing requirements could be lifted to permit faster service and pricing responses to changing demand and supply conditions. 5.10 Thus, instead of formalizing tariffs, the Government would provide the public with information about those that had been filed. If a significant deviation from a filed tariff is reported (usually by consumers' complaints), officials could investigate whether the amount deviated greatly from the one listed, and if it discriminated against certain customers. If a violation were found, the truck operator would be fined. 5.11 Within the current system of decentralized government, responsibility is diffused among provincial and municipal authorities. Some of these are pursuing their own agendas which are designed to benefit local truckers and create disadvantages for those who live outside the area. Such policies are shortsighted and counter to the development of inter-provincial trade and commerce. Thus, authorities should make the MOC responsible for promoting inter-provincial commerce (all other authorities would be subordinate in this arena). To this end, several reforms are needed: (a) Authorities must set policy to cover inter-provincial commerce and the hierarchy of authority regarding its promotion; (b) A zero-based review must be made of the institutional constraints and de facto barriers that hinder the efficient transport of goods beyond provincial and municipal boundaries. Analyses should focus on tradeoffs between local costs (increased congestion) and general social benefits (the accelerated development of internal markets); (c) Recommendations from the review should turn to the issue of law. If needed, a quasi-judicial function should be instituted under the MOC to mediate disputes among provinces and between trucking enterprises and provinces related to fair access to interprovincial transport markets. Truck Bans 5.12 As noted in Chapter 2, trucks are banned in several major cities. However, the regulations tend to be complicated and enforcement costly. In addition, frequent dispensations undermine their effectiveness. Thus, instead of physically restricting truck movements, it may be more useful to introduce a pricing system that would achieve a similar effect but in a more rational manner: For example, only vehicles registered as "urban trucks" would be permitted to enter the inner city. Small trucks (with loading capacity under a certain limit, say, two tons) would be exempt from this restriction. To obtain such registration, owners would pay an urban truck tax each year to public security or transport authorities, and these trucks would be given easily identified number plates. For this system to work, transshipment facilities need to be built at the cities' peripheries.3/ 3/ A similar but slightly different approach was proposed in the Report for "Seventh Plan Urban and Regional Transport" for the metropolitan area of Bangkok (Working Paper No. 2 on 'Freight"), 1990.  - 47 - B. INDUSTRY STRUCTURE 5.13 The trucking industry is characterized by large-scale and often inefficient SOEs and a huge number of small, private operators (owner drivers)--with COEs bridging a smalL part of the gap. Thus, the challenge is to develop private enterprises with adequate technologies and a large enough scale of operations to be efficient. Possible approaches include (a) reforming the SOEs and/or diversifying their ownership (see pama. 5.19), (b) creating an environment where competitive and simall private operators can expand their businesses and (c) developing COEs into more commercially and better managed companies. Reform of SOEs 5.14 Faced with tougher competition from private operators and own-account trucks, the SOEs' market share has significantly declined. Given the GJovernment's apparent unwillingness to continue subsidizing them, it is likely that an industry shakeout will occur in the next few years. The better-positioned SOEs, particularly those that have integrated their operations into inter-provincial networks, will probably survive, while the less focused and more inefficient will either be absorbed by larger or more efficient ones or will fail. Given this situation, the goal should be to transform them into more market- oriented entities, by corporatizing them. 5.15 To this end, the following should be considered: (a) The management of each SOE needs to have total control of all operating costs. In addition, it needs to be strengthened through recruitment of technically proficient personnel who can translate strategies into financial and capital accomplishments. Further, its compensation should be tied to profit and loss performance; (b) SOEs need to be organized into profitable entities with separate income, asset, liability, and capital budget accounts. Any cross-subsidies would then be easily identified and corrected. In particular, the general policy of combining passenger and freight operations needs to be examrined; (c) Each SOE needs to create a corporate plan that would enhance its competitive strengths and mitigate weaknesses. The plan should address opportunities for market repositioning and asset redeployment, both of which would allow the carrier to carve out defensible market niches. In this context, consideration should be given to mergers and alliances with other SOEs and diversification into specialized freight markets. A good starting point would be for each to create an inventory of its customers' transport needs; (d) SOEs need to be relieved of the burden of providing social benefits (as much as is possible). This could be done by separating the responsibility for medical care, pensions, and housing benefits from individual enterprises  - 48 - and transferring it to a third party. Also, employment benefits should be portable so their provision no longer depends on an enterprise's existence. Initiatives in this area have occurred on a pilot basis in connection with a Housing and Social Security System Reform Project that has been prepared (for Bank financing). 5.16 The training and motivation of trucking company managers will be pivotal if the SOEs are to survive. The environment in which these entities will compete over the next five years will include high-demand growth, customer pressure to improve service, limited access to capital and noncompetitive labor costs. Because current managers are poorly equipped to face these challenges, developing their skills is a priority. (See Table 5.1 for a list of actions). 5.17 A fundamental problem with SOEs is their lack of profit orientation. For example, accounting methods are inadequate to diagnose and remedy specific performance problems. But, since motor carriers operate in a relatively homogeneous financial environment, common accounting principles could be developed and applied generally to all SOEs. In this regard, it should be noted that in July 1993, a new accounting standard was introduced for all sectors. The next issue is how to apply this standard when analyzing the financial performance of trucking SOEs. 5.18 At the same time, where possible, provincial and local governments should pursue the privatization of SOEs since it would be the most straightforward way to create market-driven trucking entities. However, given the lack of a social safety net and inadequate legal framework, immediate privatization may not be feasible. Thus, authorities could attempt to diversify ownership. This would include (a) introducing employee stock ownership, (b) converting long-term loans from the banks into stock, (c) forming a joint stock company with other SOEs, and (d) establishing joint ventures. Development of Private Operators 5.19 The development of private trucking enterprises is compatible with and a necessary condition of the reform and restructuring of SOEs. Thus, the objective would be to create an environment in which all enterprises allocate their internal resources based on the attainment of maximum economic gains, regardless of their nominal ownership; in such an environment, all enterprises would rise or fall according to market principles. 5.20 To develop a more efficient private sector, conditions must be equal for all truck operators. However, at present, access to financial institutions and new equipment is often limited to large SOEs. Thus, authorities must promote the development of financial institutions that could supply capital to private sector operations. 5.21 The development of third-party services, unaffiliated with any of the specific highway suppliers, would be particularly valuable in providing services for (a) communication networks, (b) pallet exchange, (c) cargo insurance, and (d) credit ratings.  - 49 - Box 5.1: BUSINESS COOPERATIVES IN JAPAN The Japanese Government introduced a "Law on Cooperatives for Small and Medium Scale Enterprises" which outlined the basic legal framework of various types of cooperatives (including business and credit cooperatives). Those established by virtue of this law are legal entities that must serve their members. One of their characteristics is that members, while joining cooperatives and benefiting from their activities, can still maintain their independent business operations. Cooperatives have been widely used in Japan and cover all industrial and service sectors. Their size typically ranges from 7,000-1,000 members. The trucking sector consists of 1,575 cooperatives (as of August 1992). Typical activities include (a) joint marketing; (b) management of jointly owned cargo handling facilities (including those for transshipment from long distance trucks to delivery trucks), warehousing, parking, loading and unloading; (c) collective purchasing of fuel, tires, and other parts and equipment; and (d) networking of individual movers for providing nationwide service. If the cooperative system is to be applied to China, possible activities could include (a) purchasing trucks and other equipment, which could be leased to members and eventually transferred to members; (b) jointly purchasing fuel, goods, and equipment (stronger purchasing powers could bring about deeper discounts, prioiity allocations, or both); (c) performing clearinghouse functions, including the provision of backhaul cargo information; (d) marketing collectively, including taking orders; (e) operating jointly owned cargo-handling facilities; (f) forming networks to provide inter-provincial services or simple interlink networks; and (g) jointly using wireless communication services. 5.22 Another area that requires special attention is the modernization of the private sector trucking industry. Most private truckers are owner drivers that are usually poorly equipped and unable to provide high quality service. To improve conditions, operators could form cooperatives, as occurred in Japan (see Box 5.1). Possible areas of collaboration include joint use of telecommunications systems, provision of guarantees to financial institutions, and the formation of service networks that enable members to cover broader geographical areas. While the cooperative approach can take a variety of forms, the major benefit is that it allows members to enjoy the benefits of scale without sacrificing autonomy. 5.23 The lack of a legal framework through which individual operators can expand. must also be addressed: To enlarge, they must be able to form private enterprises, and this can only be arranged in a few provinces (where legal provisions exist for "limited liability" and "joint stock" companies). Development of COEs  - 50 - 5.24 COEs enjoy some unique advantages in the trucking industry. While they retain many of the SOEs' characteristics, they are also similar to private operators (see Table 4.3 for a comparison between SOEs, COEs and private operations). For this reason, some of the discussions concerning SOEs also apply to COEs, particularly those that are traditional and large-scale. 5.25 Many of the issues related to private operators apply to COEs, particularly TVEs--since they serve markets that would otherwise be served by the private sector. These COEs are more reliable than private operators because of the continuity of their service and the size of their business operations, although they are still less flexible (in accommodating specific customer needs). As is the case with private operators, most COEs and TVEs are locally based, because they still lack sufficient management capability, skills and financial resources to expand. C. TECHNOLOGY AND OPERATING STRATEGIES 5.26 The relatively undeveloped level of trucking technology affects all segments of the industry. As noted in the previous chapter, the technology and operating practices lag well behind that of OECD countries. However, opportunities exist to upgrade technology and foster its transfer as well as to improve managerial and operational skills. Truck Equipment 5.27 Road freight transport equipment is outdated; further, the differences in design and productivity between truck fleets in industrialized countries and China are significant. For example, when compared with Western European, US and Australian vehicles, Chinese trucks are fuel-inefficient (6.4 liters/km vs. 3.4 liters/km), underpowered (4 hp/ton vs. 7 hp/ton)4/, overloaded (at rates of 150% compared to 110%), and often inoperable (lost time at 30% compared to 10%). 5.28 Over the past 10 years, technology has improved substantially in OECD countries. For example, fuel efficiency improved by 25% as a direct result of diesel engine technology. Moreover, in addition to superior component technology, the sector has greater capacity to integrate diverse components manufactured by different producers into a single model truck. However, in China, the state-controlled production and distribution system does not allow for build-to-use flexibility. Nevertheless, an appropriately matched engine, drive train, transmission, and rear axle differential can significantly improve a vehicle's hp/ton performance; also, such matching can ensure high engine torque and slow engine operating speeds. Higher hp/ton ratios bring superior performance under load, better road speed, more responsiveness in traffic, and longer economic life. 5.29 The technology gap is too great for China to close by developing an advanced truck technology of its own for the next several years. Instead, high productivity 4/Hp/ton represents engine horsepower/gross vehicle weight.  - 51 - heavy truck equipment should be imported--especially three-axle trucks, which are capable of pulling three-axle semitrailers. At present, however, both tariff and nontariff barriers block truck imports. For this reason, it is recommended that tariff barriers on imports be reducecl to a minimum, as access to foreign currency is improved. This could be done on a negotiated basis and could involve the following reciprocity: Foreign original equipment manufacturers would develop distribution channels (spare parts stores, maintenance bases, and vehicle distribution centers) and open them to all buyers in exchange for access to an open Chinese market. Another approach could be to promote leasing businesses: Joint- venture companies that import foreign trucks could lease them to users in China. Foreign partners could be either OECD truck manufacturers or foreign-based leasing companies. However, for this option to be viable, a legal framework would need to be developed. Managerial and Operational Skills 5.30 Several areas in which Chinese operating practices are below best practice standards include the following: (a) Asset management. Maximizing the productive use of vehicles, backhaul capacity, and terminal facilities is a critical factor in determining profit and losses. Measurement and management control tools do noit seem to be currently used by any Chinese truck operators; (b) Customer service and sales. The ability to respond quickly and reliably to customer needs requires support systems and specially trained personnel; however, most trucking firms have neither; trucking firms (particularly SOEs) must be transformed fundamentally, so they can move beyond merely taking orders; (c) Preventive maintenance. The economic life and reliability of truck equipment can be extended significantly through periodic and regular preventive maintenance, which should include a major overhaul at some point in a truck's useful life. Current high repair costs reflect poor maintenance; (d) Purchasing and inventory manageiment. Purchasing in large. quantities or on consignment can help reduce costs, including those of fiuel, tires and spare parts. To control these items once they are purchased, systems to track inventory and costs must be developed; (e) Employee training. Trucking is a labor-intensive activity; customer service can be improved and operating costs reduced through systematic training of employees. 5.31 These operating practices will require changes in managerial and operational arrangements such as the following: (a) Injecting new talent. New management positions within trucking enterprises should be created for inidividuals who can devise and introduce  - 52 - successful strategies. These slots should be filled with graduates of technical institutes and universities, particularly those with strong analytic skills and the motivation to lead. The faculty of the Xian Technical Institute indicated that at present, very few of their graduates take positions with trucking companies. To reverse this situation and provide appropriate incentives to graduates, new positions within SOEs and COEs could be created; (b) Refocusing training programs. Training programs of the provincial communications departments require mid-level managers to spend three months out of every five years in training. However, the curriculum is irrelevant to the new market-oriented economic environment. Thus, programs need to be redesigned. To this end, managers need intensive technical exchange and training that could be obtained through professional organizations in industrial countries. The Bank has taken the initiative to design a joint training program between the Xian Highway Institute and the American Trucking Association; (c) Building professional esprit. Local professional associations of transport managers need to be created. Members could meet periodically to share their business experience and hear outside speakers. Such organizations could also be used to develop professional standards of conduct; these are needed to address the regulatory gap in China's market economy that involves conduct not explicitly illegal but which is a barrier to efficient market operations (for example, commercial bribery and personal for-profit use of company equipment). Professional associations could also issue certificates to those who meet technical standards in areas such as driving, vehicle maintenance and safety. D. COMMERCIAL AND F)NANCIAL ARRANGEMENTS 5.32 As the trucking industry grows and interaction with other sectors becomes more sophisticated, it will require a more mature buyer-seller relationship defined in market protocol guidelines and more diversified financial arrangements, including equipment leasing. Market Protocols 5.33 To operate efficiently, the freight transport market has two prerequisites. On the demand side, carriers must be selected rationally, based on a clear assessment of total logistics costs. On the supply side, open entry and unconstrained competition, including competition for capital, is essential. 5.34 Demand-side blockages such as intra-enterprise affiliations or self-dealing (that is, an enterprise buying/selling services to itself), hamper rational decision making. Such practices prevail, particularly among state-owned manufacturing enterprises. In other countries, however, the interplay between the forces of demand and supply has created an  - 53 - efficient distribution system (through standardization, clarification of carrier roles and functions and increased awareness of the needs and constraints within distribution channels). Several of the information technologies (asset management, electronic data interchange, and bar coding) require the creation of information exchange standards that would apply across modes and organizations. The development of standard high-cube highway trailer configurations and pallet design also requires interplay between demand and supply in the industry. This interchange is best promoted through professional associations. 5.35 A critical area related to the above involves the relationship among common carriers, shippers and consignees. As participants in market-oriented distribution, for-hire carrieirs assume commercial responsibilities as agents of the shipper or receiver. For example, they collect payments for cash-on-delivery (COD) shipments or confirm delivery of other shipments. Also, they assume third-party liability in delivering the appropriate count of packages that shippers confirm were originally tendered. Commercial laws and standard model clauses that elaborate all the contingencies that could arise within various commercial iterations do not exist; and, a simple contract between carrier and shipper cannot fully encompass all that is needed to further the orderly development of market- oriented commercial transactions. Thus, market protocols (the professional, legal and ethical guidelines that facilitate commercial interactions) must be developed to improve the commercial environment for trucking. 5.36 Such protocols (governing buyers sellers and carriers) are only now beginning to operate in China's freight markets. However, this can be accelerated by the following initiatives: (a) Raising the level of logistics sophistication and customer service expectations through forming local professional associations of traffic managers. Such associations could spread the word on best practices; (b) Clarifying the rights and obligations of both shippers and carriers. Commercial codes and standard model clauses that cover areas of potential conflict and are open to progressive judicial interpretation could be extremely useful. The MOC recently drafted new legislation 5/ that addresses this need. Access to Financial Markets 5.37 Access to capital markets is severely limited for most truck operators. Commercial bank credits remain principal instruments of state policy, rather than efficient mechanisms through which to allocate capital. Among the four segments within the industry, access to bank credit varies in direct relation to the importance of individual enterprises in executing state production plans; in this context, privately and collectively- owned trucking operations are at the bottom oi the pecking order. Given the current 5/ The draft legislation was not made available to the mission.  - 54 - financial system, personal savings and internally generated funds will remain the principal sources available to private operators. 5.38 Alternatively, a profit-oriented financial intermediary could allocate limited capital resources among competing users based on their creditworthiness and profit potential. Such an intermediary could help channel scarce capital to the most productive users. A particularly attractive form of intermediary is a leasing company; the mini- business plan in Annex 6 outlines a preliminary structure for an equipment leasing company. 5.39 Variations of leasing arrangements could achieve the following: (a) to accommodate the temporary needs of users of specific equipment; (b) to help those who cannot mobilize adequate funds to purchase necessary equipment; (c) to help operators lease the type of equipment not readily available in the domestic market (such as imported high-efficiency tractor-trailers); (d) to allow operators to lease well-maintained equipment, relieving them of having to keep spare parts and extra workers: and (e) to help clients purchase a package of transport services that includes well-maintained truck equipment and trained drivers. In China, options (a), (b) and (c) (to help for-hire operators) are obviously needed. In addition, non-trucking SOEs, foreign-based companies and joint ventures may need to lease the services provided in (d) and (e). 5.40 The greatest impediment to developing such leasing businesses is the lack of laws that can ensure the seizure of leased property when lessees fail to pay the charges. While a provision exists that protects debtors' rights to possess property in use, none exists to enable lessors to recover property. In addition, no established legal procedure exists to seize goods/equipment. Other impediments include the lack of secondhand markets and an underdeveloped financing system. Developing the system would require three levels of financial intermediaries such as a retail system through which leases could be generated and serviced, a wholesale system through which funds could be mobilized and the necessary assurances and guarantees for offshore investment provided, and an offshore market into which debt (fully collateralized with transportation equipment) or appropriately bundled leases, could be sold. 5.41 Bank assistance could help promote the leasing concept. The next steps would include (a) defining its technical assistance and financing role; (b) developing a detailed business plan for the leasing company concept; (c) selecting one or two provinces for pilot projects; (d) selecting retail and wholesale participants; (e) designing model financial instruments for the retail and wholesale international levels; and (f) selling the project to foreign investors, particularly truck manufacturing companies in OECD countries.  - 55 - 6. AGENDA FOR THE 1990s 6.1 The Fourteenth Party Congress defined China's economic development agenda for the decade ahead as the realization of a "socialist market economy," one in which markets, not government administrators, allocate resources to their most economic use. As outlined in the most recent country economic memorandum,l/ this agenda will require macroeconomic reforms in the following key policy areas: (a) the fiscal and financial sector, to strengthen macroeconomic management, (b) government institutions, to meet the demands of the new economic order, (c) state-owned enterprises, (d) social services, to separate them from enterprises, (e) prices, (f) economic laws and regulations and (g) trade and exchange rates. 6.2 In addition, sector reforms are needed to relieve production bottlenecks and facilitate the development of new markets. Also, the roles of the private and public sectors in transport will need to change to increase competition among transport modes and carriers, and to further develop markets for transport services, which have only recently emerged. 6.3 The trucking industry is particularly well suited to serve as a model for market reforms and as the principal subject, within the transport sector, for pro-market institutional, structural and regulatory experimentation. An opportunity exists not only to showcase reforms and transfer innovations to other industries, but also to challenge other transport modes (rail, water and air) to become more market responsive and hence spread benefits beyond trucking. (a) Trucking has an especially close relationship to small-scale enterprises and particularly to those in the retail and wholesale trades. Experience in Eastern Europe suggests these enterprises are among the firsit to develop in a market economy; and, their rapid growth requires a responsive transport and logistics capability; (b) It is important to improve the market responsiveness of industries, so as to replace direct controls: A market-responsive transport sector, led by the trucking subsector, could help minimize inventory levels and make production more demand-oriented; (c) The Government has already singled out the trucking industry as one that offers the potential for early market reform; it has introduced pro-market policies that facilitate entry and liberate prices; 1/ China: "Updating Economic Memorandum: Managing Rapid Growth and Transition," June 1993, the World Bank.  - 56 - (d) Many new market-oriented institutions are already being tested in the provinces. In this effort, trucking is a particularly popular area, largely because it directly affects the development of products. Over the next few years, results from these experiments can serve as the basis for unique solutions to motor carrier reform; (e) The technology base on which the industry rests is not complex, which makes it easy for new operators to enter the market. 6.4 The 1990s reform agenda, which requires a shift in policies, is designed to create an enabling environment where all participants in the industry can compete on an equitable basis and efficient operators can grow rapidly. 6.5 One fundamental shift will be for MOC to influence development in the industry indirectly, rather than directly (as it did previously). This will require the separation of the Government's regulatory and operating functions. Also, regulatory mechanisms will need to be redesigned so as to address critial emerging issues such as the environment, safety, consumer protection, and fair competition. However, both central and local governments should intervene only when the social costs of providing transport services exceed the marginal cost of providing services to the enterprise. In such cases, the MOC should find regulatory or taxing mechanisms that internalize social costs and allow these to be reflected in the cost of the service. 6.6 Increased participation of private operators in the market (due to relaxed entry and pricing practices) over the past 10 years has already profoundly changed the structure of the trucking industry; and, the next round of reform will not only affect the differential growth rates of competing segments but also the economic viability of specific segments, particularly SOEs. In this respect, the corporatization of SOEs and diversification of ownership are issues that require changes in the policy framework outside the purview of transport authorities (such as social security reform, company incorporation and bankruptcy). 6.7 Professional associations within the industry could fill the void left by the Government's retreat from direct intervention in transport markets. Also, they could help improve commercial standards by developing model contracts and handling consumer complaints. Further, they could develop standards for professional ethics, for accounting principles, and for equipment exchanged among different carriers (such as for unitized loads and pallets). In addition, they could handle training, since managerial and operational skills must be improved if the industry is to modernize. However, the existing association is still subject to Government control and cannot assume these various functions. Also, as the industry could begin to form cartels, the MOC and its provincial counterparts should closely monitor the associations' activities. 6.8 The most effective way to improve the quality and productivity of freight hauling vehicles is to open China's markets to foreign suppliers, particularly of those vehicles (such as large powerful trucks) that domestic manufacturers do not produce. Currently, truck imports are controlled through a complex system of import licenses and foreign currency allocations. However, when the import markets are liberalized (as a result of China's bid to join GATT), foreign competition for truck sales will challenge  - 57 - domestic manufacturers to re-engineer their vehicles (to be more productive and less costly, over the full life-cycle). The opening to imports should be gradual and linked to overall trade liberalization policies. 6.9 Developing a competitive and market-oriented trucking industry has implications for other sectors. For example, a competitive trucking industry would affect the pricing strategy and quality of rail services. Similarly, the effects of market reform in the highway services sector would spill over into truck manufacturing. Until now, producers have not been customer-oriented: Product mix is mismatched with trucking needs, trucks are not designed to carriers' needs, and product design is generally outdated. Nor have they developed a distribution network that supports new truck sales by providing forward inventories of parts and service capabilities. However, a competitive trucking indusry, with more access to foreign equipment and services, will induce efficiency improvements and innovation in domestic services related to trucking, both competitive (such as rail) and complementary (such as truck manufacturing and shipping service). A. POLICY AGENDA 6.10 Some of the changes of the past 10 years have included the diversification of truck operators (including increasing numbers of small-scale private operators and TVEs), greater availability of services and the emergence of new services. These changes must be promoted even further by the elimination of institutional constraints. 6.11 Several other areas need to be addressed. For example, the quality of service has to be upgraded and efficiency improved. Also, environmental and safety problems (caused by the industry's rapid expansion) must be resolved. Further, as the economy matures, the industry will face new types of issues such as competition policy and the buyer-seller relationship, which includes consumer protection. 6.12 These issues require a new approach. Thus, the Government will need to establish well-functioning market mechanisms and supplement them with regulations in areas where the market cannot effectively resolve difficulties. 6.13 MOC and its provincial counterparts must design and introduce new policies, and their roles will change (see Chapter 5) to accomplish the following: (a) To facilitate the transfer from the planned to the markeit economy by eliminating existing institutional and organizational impediments and establishing basic rules for fair competition; (b) To refocus the government role so as to limit it to the rnaintenance of minimum regulations to ensure the safety of trucking operations, preserve the environment, and establish equitable buyer-seller relationships; (c) To help improve the quality of service and modernize the operational/managerial system through indirect policy guidance and increased interaction with shippers and truck operators.  - 58 - I. Facilitating the Move to a Market Economy 6.14 The first group of actions would establish a market environment where various types of truck operators (regardless of the scale of operations or form of ownership) can compete and efficient operators can expand their businesses. These actions would: (a) promote the SOEs corporatization and diversification of ownership, (b) develop private sector enterprises, (c) create competition policy, and (d) establish a more flexible regulatory framework so truck operators can respond to changing market conditions more swiftly. Objective I-1: Enhance Corporatization of SOEs and Pursue Diversification of Ownership 6.15 Policies needed to advance the corporatization of SOEs were detailed in Chapter 5. Specific actions include: (a) Eliminating all subsidies (direct and indirect), to SOE trucking firms; (b) Phasing out the economic responsibility system and replacing it with a uniform tax system; (c) Creating an independent board of directors for each SOE to which the management would be accountable; (d) Repaying all outstanding loans to local governments and substituting arms length bank credits for which the lending criteria would be the creditworthiness of individual enterprises; (e) As financial expediency dictates, facilitating the merger, reorganization, or divestment of assets among SOEs. 6.16 At the same time, where possible, governments should pursue the SOEs' privatization since this would be the most straightforward way to create market-driven trucking entities. However, in some areas, immediate privatization may not be feasible due to the inadequate safety net and lack of legal framework. In those cases, diversification of ownership should be pursued. This would include (a) offering stock ownership to employees, (b) converting long-term bank loans into stock, (c) forming joint- stock companies with other SOEs, and (d) establishing joint ventures. 6.17 Although COEs are generally more efficient than SOEs, they also need to focus their strategies and become more financially autonomous, as well as corporatized. Also, both need to develop their skills, particularly in managing finances and assets, and marketing. Key Actions  - 59 - The MOC (and its provincial counterparts) should establish guidelines for systematically corporatizing SOEs and COEs, diversifying their ownership, and, eventually, privatizing them. The guidelines should addlress not only issues of corporate governance, but those associated with transforming the enterprises into slimmer and autonomous legal entities. In this context, economic responsibility contracts concluded between governments and SOEs have to be revised so the enterprises have greater autonomy in managing and operating the trucking business; ownership rights need to be clarified so they can be conveyed. Ojective 1-2: Development of Private Sector Enterprises 6.18 The development of a competitive private sector begins with creating a level playing field for all types of trucking operators. At present, transport services procured by governments and SOEs are often based on noneconomic factors, rather than on quality and costs. Thus, procurement practices should be modified to encourage competition. Also, reforms are needed to efficiently allocate capital within the sector. Competition can be enhanced if financial institutions are developed that could supply capital to private truck operators. 6.19 A major problem is that private operators lack the basic knowledge of business practices and large-scale trucking operations. To correct this, professional associations could train those who are willing to absorb new knowledge and technology. In liglht of the limited time available for training (owner-drivers cannot be away from their business for long periods), authorities should consider home study programs. Key Actions * MOC should improve the truck operators' access to financial resources. This would include encouraging the creation of financial instruments (such as leases and equipment trusts and certificates) designed to provide the industry with private capital. * MOC should study the viability of business cooperatives and, if these succeed, it should promulgate the laws needed to introduce them on a broad scale. Cooperatives might also guarantee loss and damage claims for participating carriers. * Professional associations should broaden their membership beyond enterprises to include individuals and should provide training to individuals and small-scale operators. bjective 1-3: Formulation and Inplementation of a Competition Policy for Trucking  - 60 - 6.20 Many in China regard the market economy as a competitive free-for-all, without rules. No overall competition policy has been devised nor has a specialized antitrust commission been formed, although some initiative was taken in 1993 to create a legal base for antitrust sanctions. The problem is that as the country's domestic markets mature, operators might engage in unfair practices, or dominant operators or groups might abuse their market power. Thus, minimum rules must be set to ensure that competitive efforts are appropriately channeled toward socially beneficial ends. To this end, MOC or another appropriate agency should monitor market activities of both trucking operators and associations and, if needed, should devise regulations to restrict unfair trade practices and anticompetitive activities. Key Actions * MOC should prepare guidelines that indicate which trade practices are regarded as unfair, anticompetitive, or both, and issue them to local communication departments. * If stricter enforcement is needed, MOC should draw up regulations to restrict unfair practices and anticompetitive activities. The Government should decide whether to make MOC or another agency responsible for moitoring and enforcing competition regulations. Objective 1-4: Establishment of a Flexible Regulatory Framework 6.21 The country's economic regulations need to be revamped into a simpler and more transparent form, which would facilitate the operators' entry and exit to the market. Major regulatory changes would include: (a) Replacing the current licensing system with a simplified one in which operators can launch for-hire trucking companies by simply filing a business plan with the Government (but not obtaining prior approval). If they violate transport-related regulations, authorities would apply administrative sanctions. This system would focus on monitoring a company's business activities, rather than checking on applicants' qualifications; (b) Shifting the setting of rates from the Government to a system where operators set prices and file tariffs with transport authorities. The latter would take action only when tariffs grossly deviate from the rates on file and use their market power to discriminate against specific shippers; (c) Reviewing current vehicle registration practices that require trailers to be registered with a specific prime mover (the tractor owner or operator) and modifying them so tractors and trailers can be interchanged and used separately.  - 61 - Key Aictions * MOC and SPC should modify existing regulations (that is, ithe Tentative Regulation for the Management of Highway Transportation) to incorporate the changes noted above, or incorporate them in new legislation. * Transport authorities should compile price information based on the tariffs filed (by operators) and disseminate aggregate data to the public so the market can function more efficiently. * MOC and the Public Security Bureau (PSB) should review the current vehicle inspection system and coordinate efforts so as to eliminate any duplicated regulations/facilities. * PSB should review the current registration practices for tractor-trailer combinations, and allow them to be registered separately. II. Refocusing the Government Role 6.22 As the sector shifts from a planned to a market economy, the Government will need to address problems involving the environment, safety and commercial guidelines, as these cannot be solved by the market alone. Actions could include (a) rationalizing road user charges, (b) strengthening measures that support the environment and saiety and alleviate congestion, and (c) developing equitable buyer-seller relationships. Sj~ective 11-1: Rationalize Road User Charges 6.23 Most road user charges are based on the revenue earned by the trucking sector, while they bear little relation to truck usage and no relation to axle weight. Thus, charges do not reflect actual costs of operating vehicles and maintaining the road network; this has led operators to heavily load their trucks--which damages road surfaces. 6.24 To correct this, user charges more closely related to road use need to be imposed instead of merely taxing output. In this regard, a fuel tax offers several advantages: It could be efficiently and equitably collected at the refinery or pump; it is an input tax; it encourages operators to decrease their use of one or more inputs; it encouirages greater fuel efficiency, both through the use of larger vehicles and improved load management; and, it has the added advantage of being easy to administer and difficult to avoid. Thus, the following measures should be adopted: (a) Fuel taxes should be introduced for financing road construction and the current road maintenance fee should be used strictly for road maintenance; (b) Vehicle purchase surcharges and annual vehicle taxes should be modified and replaced with ones based on axle loading. This should encourage the use of efficient vehicles that cause less damage to road surfaces;  - 62 - (c) An equitable tax should be adopted that equalizes the burden on various segments of the trucking industry--particularly of for-hire and own-account trucks. 6.25 In this context, MOC should consider the impact of changes in revenue sources on government agencies at the central and local levels, and the administrative ease of collecting taxes and charges. Key Actions * MOC, cooperating with other agencies, should initiate a study of the current system of road user charges on the trucking industry, including own-account and agricultural tractors, and should recommend reforms. * MOC should begin discussions with the State Tax Bureau, the Ministry of Energy, the Ministry of Finance and other agencies to implement these recommendations. Objective II-2: Strengthen Measures which Support the Environment and