Fung-nr106

An Overview of Air Cargo Industry in China: The Impact of Globalization and WTO Accession Michael Ka-yiu Fung1, 3 Anming Zhang2, 3 Lawrence Leung1 and Japhet Law1, 3

1

Department of Decision Sciences and Managerial Economics, Faculty of Business Administration, The Chinese University of Hong Kong.

2

Sander School of Business, The University of British Columbia.

3

Aviation Policy and Research Center, The Chinese University of Hong Kong

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Abstract This paper provides an overview of China’s air cargo industry. China’s recent accession into the WTO establishes the country’s commitment to liberalize distribution rights, relax restrictions on services such as logistics and to create opportunity for foreign investors. However, the industry has been fragmented and is operating with little market mechanism. It is highly protected and regulated, and is dominated by state-owned enterprises, with strong regional monopoly and rigid functional demarcations. We will look at how this fragmented industry has coped with the growing need of modern logistics management, which requires integration, both physically and with information, in managing supply chains. Relevant research issues that are pertinent to the understanding of this transitioning industry are raised.

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1. INTRODUCTION Paralleling to her phenomenal macro-economic expansion over the last two decades, China has grown into one of the world’s major manufacturing centers and is now the No. 2 (after the United States) destination of the world’s foreign direct investment. These developments certainly stimulate the demand for freight transportation (Table 1). In fact, China’s air cargo volume has experienced a rapid growth, from 89 thousand tons in 1980 to over 2 million tons in 2002, with an average annual growth rate more than 15% in the period. Nevertheless, it pales in comparison with the country’s ocean cargo in terms of tonnage, Although there are some synergies between aviation and marine logistics, these two sectors are largely separated. In China, air cargo is shipped primarily in the belly of passenger aircraft. Thus, air cargo activities are concentrated at major cities such as Beijing, Shanghai and Hong Kong where passengers demand are among the highest. As shown in Table 2a, air cargo throughput in major Chinese cities has tremendously increased in the 1990s: 400% growth in Beijing, 460% in Shanghai, and 200% in Guangzhou. This impressive expansion was partly due to the increase in connections. As a result of rapid development of China’s aviation market in the 1990s, major airports in the country become better connected to both domestic and international networks (Table 2b). Hong Kong has been serving as the predominant gateway for China’s air cargo since 1980 (Table 3). For many years, a large portion of the country’s export air cargo traveled to the Pearl River Delta and then on to Hong Kong where they are consolidated and shipped to overseas destination. In 2002, as indicated in Table 3, the air cargo throughput in Hong Kong still accounted for almost 40% of total throughput in China despite of the rapid growth of air cargo throughput in both Shanghai and Beijing in the 1990s. While Hong Kong retains its dominant role as an air cargo gateway, it now primarily serves southern China, with the Beijing gateway taking over air cargo originated in northern China and the Shanghai gateway handling those from

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central China (Figure 1). Such North-East-South split of the air cargo pie in China between the three gateways is likely to continue.

The emergence of the new international airport in

Guangzhou will raise the need for collaboration between Hong Kong and Guangzhou.

Figure 1

During China’s rapid economic reform, it is obvious that state-owned enterprises (SOEs) are giving way to other enterprises. Currently, the output by non-state sector - collectives, private enterprises, and joint ventures (JVs) - accounts for as much as 50% of China’s Gross Domestic Product.

In many industries, state-owned enterprises are seemingly not as competitive as

privately-owned or JV enterprises. However, this is not the case with the air cargo industry. Considered as a strategic industry − in that it has significant national security implications and

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long-term economic impact − the industry is highly regulated and protected, and is still dominated by state-owned enterprises. Many have characterized the logistics industry in China as under-developed, fragmented, and with local protectionism resulting from the dominance of SOEs, which enjoy the privileges of monopolistic regulations (Baldinger 1998, Mann 2001, Power 2001, Jiang and Prater 2002). Foreign logistics companies typically only operate between major cities and are not allowed to offer nationwide services. Barriers with tight state control exist at the provincial and city levels. Nationwide distribution is difficult and limited, and relies on local players (typically SOEs) using outdated equipment and material handling devices. In this paper, we explore the issues and factors that have shaped this industry in China. To encapsulate these issues, we propose the framework shown in Figure 2. Here we posit that the industry has the following inherent factors: •

Highly regulated, and

•

Dominance of SOEs with functional and regional interests.

These factors are major reasons that the industry is highly fragmented and encumbered with pervasive regional protectionism. However, to manage air cargo processes successfully, different components of the shipment process need to be integrated, physically and with information. With the industry’s fragmentation and regional protectionism, air cargo service providers are faced with the very difficult task of providing such integration. Many SOEs resolve this integration problem by forming alliances with other SOEs with either regional or functional interests, in the form of a new company. Such proliferation of cross ownership of SOEs is a distinctive aspect of China’s air cargo industry. We suggest that such ownership arrangement largely disguises the weaknesses of the industry. We posit that the industry as a whole has a competitive environment that is limited by regulation, entry barriers to foreign companies, and policy constraints on aviation.

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Strategic Industry & Decentralization

SOEs' Functional/Regional Specialization

Regional Protectionism

Fragmentation

Air Cargo Business Processes Hybrid Ownership Alliances of Functional and Regional-based SOEs

Regulated Competition, Inefficiency Barriers, Patch-up Network

Figure 2. Characteristics of China’s Air Cargo Industry

However, the industry must address many of the aforementioned fundamental problems as it embraces the impact of globalization, China’s accession into the WTO, and China’s economic reforms. Clearly, China is to liberalize distribution rights and relax restrictions on logistics services. As a consequence, business opportunities for foreign investors will be created. We shall look at how this fragmented industry has coped with the growing need of modern logistics management, and identify various barriers to foreign companies and policy constraints. We shall further examine the impact of WTO accession on the industry, especially its implications for foreign air cargo logistics companies. Finally, a set of relevant research issues will be raised.

2. AIR CARGO BUSINESS PROCESSES AND CHINA’S CURRENT SITUATION

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2.1 Basic Concept The air cargo shipping process is a time-definite endeavor requiring the collaboration and co-ordination of multiple parties: shippers, freight forwarders, trucking companies, shipping companies, customs, warehousing agents, airport terminals, airlines and consignees (Figure 3). It is also an information intensive process involving electronic agents for customs declaration, querying the flight schedule, booking, tracing the cargo status, etc.

Shippers

Trucking Shipping

Warehouse

Domestic Airport Terminal

Trucking

International Airport Terminal

Trucking

Domestic Airline

Customs Inspections Legend

International Airline

Consignee

Parties involve in Physical flow Physical flow Alternate flow

Figure 3. Air Cargo Shipping Process In most developed economies, a shipper can outsource its logistics functions to logistics service agents.

An agent might specialize in the provision of a single logistics service

(warehousing, trucking, etc.), or might provide a range of services (e.g. 3rd party service providers), or might even be able to provide logistics support for the entire shipment process (e.g. 4th party service providers, integrators). Among these agents, freight forwarders have a unique role. Analogous to a travel agent, a freight forwarder handles a shipper’s request and is typically responsible for the management of a shipment and acts as a liaison with other agents for the client. Forwarders also provide a range of logistics services. More generally, 3rd party logistics

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service providers are critical in the provision of integrated logistics, an essential element in managing supply chains (Chu, et al. 2004). In China, a very high proportion of shippers are 1st party service providers which deliver cargo to gateway airports via in-house resources, resulting in poor utilization of such resources. It has been estimated that the cost of moving goods is 50% higher than that of the U.S. If one takes into account of the huge difference in wages between the two countries, the actual efficiency gap is considerably higher. Sinotran, a SOE, is the only nationwide 3rd party logistics provider. While it has 3,000 trucks and 160 standard and refrigerated warehouses, it also has 47 domestic subsidiaries and 263 domestic JVs (Gates 2001), and has been characterized as extremely decentralized with little to no central coordination (Morgan Stanley 2001). An important aspect of managing supply chains is in integrating trading, distributing and marketing. Historically in China, these three sectors are under strict state control with little to no integration (Baldinger 1998). Distribution rights and import rights are separated (Mann 2001). Foreign companies are prohibited from consolidated distribution activities, possibly until 2005. Export-oriented firms, which are located mostly in China’s Special Economic Zones, may be less affected by regional problems as well as trading regulations. On the other hand, market-oriented firms typically need to have a large-scale nationwide network. These firms outsource distribution to logistics providers, which would work with a variety of local service providers to establish a “patch-up” nationwide distribution network. Supply chain related costs can be 30% to 40% of wholesale prices in China, compared with 5% to 20% in the U.S. (Tanzer 2001). For marketoriented firms, the issue of effective managing their inland supply chains is important for their long-term business success in China (Jiang and Prater 2002). 2.2 Modern Air Cargo Logistics Needs Modern air cargo logistics needs to be smooth, time and cost effective, and have a great deal of traceability. Integration and consolidation are the keys to achieve these goals. The

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integration has to cover different modes of travel, different types of logistics services, as well as different geographic regions. Modern air cargo logistics, therefore, requires the cooperation and collaboration of many industry agents (forwarding, trucking, warehousing, customs, terminal operators, airlines, etc.) as well as similar agents in other regions. Also, with the trend of globalization and e-business practices, the air cargo shipment process needs to be managed with effective information technology (IT). The need to integrate the respective agents of an air cargo shipment process is unprecedented. Much of that will relate to speedy delivery, reliable handling and shipping, network-friendly, global standards, etc. With respect to physical infrastructure, China’s major development has largely been centered around major metropolitan areas. The transportation infrastructure beyond these major metropolitan areas remains very much undeveloped. Such inadequate infrastructure has created problems for distribution beyond those city limits. It also means that it is very difficult to form distribution networks of a comprehensive nature. The development of information infrastructure is somewhat analogous to the physical infrastructure in that such development is primarily limited to regional interests - again, major metropolitan areas. Even in these big cities, the use of information infrastructure is quite limited. Currently in China, electronic customs pre-declaration using electronic data interchange (EDI) is required by the Customs Bureau in major airport cities. The first phase of electronic customs processing system (Eport) is currently being tested in Shanghai, Tianjin, and Guangzhou. E-commerce activities are relatively light. There is only limited use of internetbased information systems services provided by agents of the air cargo industry for their customers. There are no industry-wide standards or requirements on the use of IT. Only Class A forwarders are authorized to book cargo space and obtain master waybills directly from airline. Communications between airlines and forwarders are typically through fax

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and phone calls. Most airlines operating in Beijing and Shanghai subscribe IT services from SITA’s Super Cargo System for their cargo management. Joint ventures involving strong international partners (e.g. Exel-Sinotrans Freight Forwarding Co Ltd., Encinal International Freight & Transportation) are usually very strong in IT usage. All four major integrators, namely, DHL, UPS, FedEx, and TNT, have joint ventures in Beijing and Shanghai. They provide high quality, IT intensive air express services comparable to those offered in the rest of the world. Both warehouse management and trucking companies need to be licensed to operate. Only Class A forwarders or terminal operators can own and operate a bonded warehouse. Computer control and machine operated racking systems are used in some of the new air cargo terminals.

Major operators are in the process of installing bar coding systems in their

warehouses. The trucking agents are mostly small operators or freelancers and typically do not operate with computer support. The Customs is also actively working on migrating the existing EDI system to a web-based system. 3. SOEs, TASK SPECIALIZATION, AND FRAGMENTATION State-owned enterprises (SOEs) play a dominant role in China’s air cargo industry. Given its strategic importance in national security and long-term economic impact, the industry is regulated under the State Council by which air cargo SOEs are basically under three groups of offices (Figure 4): - First group: ministries and commissions, where we find bureaus for trade and economic, transport, and postal service, etc.; - Second group: offices under the State Council, where we have registry, civil aviation, and customs. For example, the Civil Aviation Administration of China (CAAC) is an office under the State Council which regulates the airline industry;

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- Third group: provincial governments and governments of municipalities, e.g. Beijing and Shanghai. State Council

Ministries & Commissions State Dev. & Reform

Information Industry

Railways

Enterprise -- Enterprise Registration Registration Int’l Exchange Exchange -- Int’l & Cooperation Cooperation &

Civil Aviation

Administrative Division Gov. Gov. of of Municipalities Municipalities e.g. e.g. Beijing, Beijing, Shanghai Shanghai

Provincial Provincial Gov. Gov. e.g. e.g. Guangdong, Guangdong, Fujian Fujian

City City Gov. Gov. with with Sub-provincial Sub-provincial Ranking Ranking e.g. Shenzhen, e.g. Shenzhen, Guangzhou, Guangzhou, Xiamen Xiamen

……

-Tariff -Tariff Collection Collection -Customs -Customs Clearance Clearance

Industry & Commerce

……

Int’l Econ. Econ. & & -- Int’l Trade Relations Relations Trade -WTO -WTO

Customs

……

Highway -- Highway Waterway -- Waterway

Commerce

……

Transport -- Transport

Transport

……

Telecom -- Telecom Post Bureau Bureau -- Post

……

……

…… Dev. Planning Planning -- Dev. Regional Econ. Econ. -- Regional Transport -- Transport

Offices Directly Under State Council

Regulation -- Regulation Planning Planning -Transport -Transport Airport -- Airport

Source: China.org.cn (May 2003)

Figure 4. Air Cargo related interests under China’s State Council SOEs were established under the premise of task specialization, a concept dating back to the industrial revolution. Each SOE is created to specialize in a mode, a region, or a specific air cargo service. A SOE that operates in freight forwarding would have little interaction with enterprises that specializes in aviation. Also a freight forwarding enterprise operating in a particular region would have very limited interaction with a freight forwarding enterprise in another region. The original goal of task specialization is efficiency in the task itself. However, the over-emphasis on specializing on individual tasks has given rise to major problems in dealing with the entire air cargo logistics process. The problems are due to fragmentation. Task specialization commonly breeds fragmentation. These fragmented and stand-alone enterprises have developed without consideration of each other. It is not uncommon to see differences in practices or rules across different regions or modes or services. And when crossunit or cross-region problems arise, there is no effective central authority to solve such problems.

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There are no designated entities dedicated to solving cross-sectional problems or to making sure that the air cargo shipping process is smooth.

Without a regulating entity to oversee the

fragmented pieces, a smooth shipping process is not likely. Beyond the task specialization, the biggest impact of political/legal barriers on China’s logistics is regional protectionism (Jiang and Prater, 2002). The essence of China’s economic reform since the late 1970s has been to introduce a market mechanism with economic decentralization. As the economic reform has devolved economic authority to local governments, localized SOEs would typically incline to maximize local economic growth, employment, social stability, and tax revenues. This regional decentralization induced local governments to protect local firms, as they became the main source of revenue for the local governments. It is quite common to see SOEs with regional power promoting their own products, e.g. Shanghai and Hubei each protect their own cars, Volkswagen and Citroen respectively, and legislate to bias the other product in their respective markets. As a result, China’s domestic market became more fragmented, with an increasing number of local protectionist measures ranging from roadblocks to technical standards (Li and Zhang, 2003).

4. HYBRID OWNERSHIPS: AN ALTERNATIVE OF INTEGRATION? How are different fragmented state-owned enterprises integrated? SOEs simply form alliances and partnerships with each other. One can imagine these SOEs directly under the State Council as the “prime SOEs.” Then we have a huge matrix of hybrids and hybrids of SOEs. They involve cross-ownership (owned by SOEs across different regions, modes, and services). And it is not uncommon to find a SOE that has subsidiaries and/or partnerships along the air cargo logistics chain. Some examples of cross-ownership and vertical ownership are shown in Figures 5, 6, 7 and 8.

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CAAC

State Council

China Eastern Air Holdings. Co. State-owned Assets Supervision and Administration Commission

61.64%

China Eastern Airlines Corp. Ltd.

China Ocean Shipping (Group) Company (COSCO) 30%

70%

China Cargo Airlines Ltd.

Source: China Eastern Airlines Corp. Ltd. Dart Express Group Notes: English name of the company with ( *) is translated by the Authors

Figure 5. China Cargo Airlines: Alliance of Logistics and Air Transportation

CAAC China Southern Airlines Group 65.2%

China Southern Airlines Co. Ltd.

49%

China Post

61%

GuangzhouBaiyun International Airport Co. Ltd.

51%

29%

China Post Airlines

Yingxin (SZ) Investment and * Development Co. Ltd. 10%

GuangzhouBaiyun International Logistics

Source: China Post Guangzhou Baiyun International Airport Co. Ltd. Notes: English name of the company with ( * ) is translated by the Authors

Figure 6. China Post Airlines: Alliance of Postal and Air Transportation

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Shenzhen Government Shenzhen Investment Holdings Corp. 44.25%

Shenzhen International Holdings Ltd. 100%

Total Logistics (Shenzhen) Co. Ltd. 50%

50%

Shenzhen Airport International Express Supervision Center Co. Ltd.

Guangzhou Changyun Total Logistics Co. Ltd.

Source: Shenzhen International Holdings Ltd.

Figure 7. SAIESC: Alliance of Government and Airport, Same Region

Shenzhen Government

Shenzhen Airport (Group) Co. 63.99%

Shenzhen Airport Co. Ltd

Total Logistics (Shenzhen) Co. Ltd. 50%

China Eastern Airlines Corp. Ltd. 50%

50%

Shenzhen Airport International Express Supervision Center Co. Ltd.

50%

Dapeng (Shanghai) International Forwarding Co. Ltd.

Source: Shenzhen Airport Co. Ltd.. Shenzhen International Holdings Ltd. Air Tiger Express Companies, Inc. Dapeng (Shanghai) International Forwarding Co. Ltd..

Figure 8. Dapeng: Alliance of Airport and Airline, Across Regions

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As shown in Figure 5, China Cargo Airlines Ltd., a company specializing in cargo and mail transport in China, is a joint venture by COSCO, a provider of shipping, modern logistics and freight forwarding services, and China Eastern Airlines, a Shanghai based airlines company. It is an example of an alliance of two task-specialized SOEs (logistics and air transportation). Similar example shown in Figure 6 is China Post Airlines, a company providing services in air mail, air cargo and air freight forwarding, which is a joint venture by China Post, a specialized postal service provider in China, and China Southern Airlines. A different example shown in Figure 7 is Shenzhen Airport International Express Supervision Center Co. Ltd., a company providing customs supervision and express cargo handling services at Shenzhen Airport. It is a joint venture of a subsidiary of Shenzhen Government, Total Logistics (Shenzhen) Co. Ltd., a provider of total logistics and transportation services in Shenzhen, and Shenzhen Airport Co. Ltd., also a subsidiary of Shenzhen Government. This joint-ownership represents an alliance of two task-specialized SOEs (airport and logistics) within the same region (Shenzhen). Similar example shown in Figure 6 is Guangzhou Baiyun International Logistics, a company specializing in air cargo, air express, and third party logistics services, is a joint venture by Guangzhou Baiyun International Airport Co. Ltd. and China Southern Airlines Co. Ltd., a Shenzhen and Guangzhou based airlines company. Again, this company represents an integration of two tasks (airport and airlines company) within the same region (Guangzhou). Finally, as shown in Figure 8, Dapeng (Shanghai) International Forwarding Co. Ltd. is an example of joint venture of a regional- & task- specialized SOE (Shenzhen Airport) and another regional- & task- specialized SOE (China Eastern Airlines Co. Ltd. – a Shanghai based airlines company). The formation of this company represents an integration of two tasks (airport and airline) and two regions (Shenzhen and Shanghai) through joint ownership.

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In examining the air cargo industry in China, the key irony appears to be that state-owned enterprises have task-specialized in an industry where integrating is equally as important if not more important. With alliances of functional and regional-based SOEs, the state firms have not done a good job in integrating air cargo shipments, individually and collectively. The abovementioned examples of cross ownership and joint-ownership do not represent efficiency improvement in managing the shipment process. Their collaborations are based on convenience. There are no real integrations in a structural sense. It is not true cooperation and integration as these SOEs may engage in risk-sharing collaboration rather than pursuing efficiency in the formation of joint venture. Clearly, the industry lacks competition because of a lack of market mechanism. The lack of competition and integration mechanism also allows regional monopoly as well as monopoly within a specific service to be developed. It is quite typical to find inefficiencies such as poor consolidation and integration of shipments, and inadequate utilization and allocation of resource.

5. BARRIERS TO FOREIGN COMPANIES AND POLICY CONSTRAINTS Foreign companies are attracted by the huge potential of China’s air cargo logistics market. However, tremendous barriers to foreign participation in China’s air cargo sector exist, arising from domestic regulations, guidelines, institutions and administrative mechanism. Unlike trade in goods, trade in services is intertwined with domestic regulations and administrative systems. Thus, liberalization of trade in airfreight services cannot be achieved without substantial domestic regulatory, institutional and administrative reforms. Trade barriers are easily embedded in domestic regulations, institutions and administrative procedures. As can be seen below, these barriers not only limit market access but also make it difficult to have integrated national air cargo logistics services. 5.1 Market-Access and Regulatory Barriers

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Foreign companies have encountered “market access” barriers, i.e., regulatory restrictions that prevent foreign companies’ entry, especially prior to China’s accession to the WTO. Foreign entry into the distribution/logistics industry is restricted by license and JV requirements. International JV could offer air express, general cargo and forwarding services but foreign companies could only hold up to 50% ownership. The Chinese partners of those JVs are mainly domestic state-owned companies. Table 4 lists regulations on air cargo logistics-related industries prior to WTO accession.

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Industry

Regulatory Barriers on Foreign Companies

Freight transport by rail and

- JV partnership allowed to cross boundary operations with Hong

road (in trucks or cars)

Kong only

Storage & warehousing

- Permit to own warehouse in Free Trade Zones (FTZs) for their company own use - No ownership or management of warehouses is permitted outside FTZs

Freight forwarding

- Minority share investment in JVs is accepted - Limited to certain geographic areas

Table 4. Regulatio ns on Air Cargo Logisticsrelated Industrie s Prior to WTO Accession

- Generally not allowed to handle domestic freight forwarding Aircraft repair and maintenance - Minority share investment in JVs is accepted Courier services

- JVs are accepted, with foreign capital investment not less than US$1 million, and Chinese partner holding at least 50% - Generally not allowed to do domestic express business - One year to set up branches and five years to form another JV

O n licensing, companie

s are required to hold certain licenses to engage in ground transportation, bonded warehousing, customs clearance, and related services. In airfreight forwarding business, there are four classes: Class A license holders are major forwarders authorized for airlines booking, customs clearance and consolidations. They typically have their own warehouse facilities. Class B includes international forwarder agents. Class B forwarders have permanent offices but usually have no warehouse facilities. Classes C and D are forwarders outside major air cargo hubs (e.g. Shanghai, Beijing), or small agents feeding business to class A forwarders. The differences between class A and other licenses include: Class A forwarders are able to perform a full range of own controlled logistic services, customs brokerage, customs supervised warehouses and bonded trucks, contracting with carriers for rates and space, and issuing master way bill to class B forwarders. They also have direct control of all operational aspects as well as direct access to updated information from authorities. Class A license is reserved for large domestic firms; consequently, to obtain the license, foreign companies need to form a JV with large Chinese firms. Such license

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requirements handicap efforts by foreign services providers to organize an efficient or comprehensive logistics network. In addition to having a class-A license, an airfreight agency needs to obtain a host of other licenses such as CAAC License–International airfreight, CAAC License–Domestic airfreight, Trucking License for each province and city, etc. Although there are some major foreign forwarders, domestic companies dominate the market, owing in part to the license and JV requirements. 5.2 Local Protectionism Apart from cumbersome licensing requirements, these requirements differ by region, thereby creating difficult operating problems for foreign companies – and in many instances, for domestic firms from other regions too. Since the trucking license is at the provincial/city level, a licensed company in one place may not be allowed to operate in other provinces. If a company wants to have inter-provincial operations, it needs to apply licenses for both places. Furthermore, company needs to re-apply new licenses if it opens subsidiaries in other provinces. Business scope of the subsidiaries needs to be confined within the mother company’s. In most of the cases, the application needs to be reported to government offices of the state, the province and the city. For instance, a JV freight forwarding company needs to provide report from the original local Ministry of Foreign Trade and Economic Cooperation (MOFTEC) and recommendation letter from the local MOFTEC in the planned city.1 These complicated processes are a result of protectionism among local governments that seems to be a usual practice in Chinese society where local people call it “different customs in each village.” Since there is no centralized organization to certify the license, provincial governments need to protect themselves from a fake license. In addition, the re-application can bring extra income to the local office as there are application fees from the applicants. 1

This is stated in the application procedure of foreign international freight forwarder license published by MOFTEC on 9th September 1996, regulation 12.

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Even at the local level, there is oftentimes no central authority responsible for licensing supervision or for resolving other business problems. For example, inter-airline contracts have to be negotiated separately with the operations, sales, interline, and other functional managers at each airport. All of the above factors are conducive to “local protectionism,” which refers to the role of local governments in protecting their own companies (markets) against foreign companies, or companies from other regions, by failing to fully enforce the national law. 5.3 Institutional Barriers A further constraint for the growth of private sectors, domestic or foreign, is heavy government involvement in the air cargo logistics industry. As indicated in the introduction section, the economic reform has gradually changed the ownership of enterprises in China, especially in the manufacturing sector. But in the transport and logistics sectors the change has been relatively small. China’s three largest carriers – Air China, China Eastern and China Southern – are still majority state owned. As a result, governments are likely to have too large a stake in their success to allow for quick, large-scaled foreign entry. Furthermore, airports are owned and run by governments with foreign ownership of Chinese airports being capped by 49%. Road transport, forwarding, storage and warehousing, and courier services consist mainly of small companies, many of which are owned by local governments and are subject to local protectionism discussed above. In addition, major airport cargo terminals are owned by domestic incumbent airlines, thus creating a conflict of interests in handling freight going through the airports. Air China operates the main cargo terminal at the Beijing Capital International Airport (BCIA) that handles close to 90% of total air cargo volume through Beijing. As a consequence, Air China can not only exercise its monopoly power in charges but also discriminate cargoes that go to its rival airlines.

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Similar arrangements occur in Shanghai where China Eastern, through its cargo unit China Cargo Airlines, is the operator of the dominant cargo terminal in the airport. 5.4 Government Functional and Inter-modal Barriers The existing government structure has not kept pace with the industrial development. First, there is no single regulatory/administrative body governing since air cargo logistics, which is a new sector in China. Instead, different components of the sector usually belong to different government agencies. For example, as illustrated in Figure 4, the Ministry of Foreign Trade and Economic Cooperation (MOFTEC), the CAAC, the Ministry of Posts and Telecommunication, and the Ministry of Security, all of which are under the State Council, all have influence over foreign airlines and freight forwarders in China. Secondly, vertical and horizontal divisions within government functional systems constrain the sector’s development. In particular, the functional system that applies to transportation is divided according to the mode of transport, and the same systems operate at both local and higher levels of government. Responsibility and power overlaps between the departmental and regional administrations. Such a government structure also creates a barrier to efficient inter-modal transportation. Nearly all air cargo movements are inter-modal, since freight must move to and from airports via surface mode (usually trucking). As different modes are under different government agencies and are subject to different speeds of liberalization, it would be hard for integrators to have a seamless inter-modal operation. There are cases where domestic regulatory policies or restrictions are applied to other sectors (e.g. ground transport, telecommunications) which are ancillary to airfreight transport, but nonetheless critical to a foreign carrier’s ability to provide competitive airfreight services in the domestic market. As indicated above, a host of local regulations, such as licensing and ownership restrictions, limit foreign participation in ground transportation. This means express carriers must obtain their road transport through local contracting. 5.5 Administrative Barriers

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Administrative barriers arise from interpreting or implementing government policies – e.g. transparency of regulatory and administrative information which directly or indirectly prohibits services trade and foreign investment. Foreign companies have expressed concerns about excessive documentation requirements, lack of publicity of regulations, and lack of transparency of court rulings on business disputes. More specifically, the concern for transparency of regulations and court rulings arises from the fact that an airfreight logistics service provider needs to deal with various levels of administrative bodies and comply with many local regulations. In addition, there is an insufficient number of inquiry points for dissemination of regulations, policy guidelines and operation restrictions that pertain to the provision of air cargo logistics services in China. 5.6 Customs Barriers A major administrative body that is involved in air cargo trade is customs. Customs administrations perform two basic functions: trade facilitation, and customs control. The former implies reliable, timely customs clearance, whilst the latter refers to measures that are to prevent the infiltration of illicit drugs or other hazardous substances, protect intellectual property rights, and in particular, collect tariff revenue, and that usually are timing-consuming. As a result, the two functions may conflict with each other. Historically, revenue-raising through tariff collection was a major function. As tariff rates have come down over the years, the revenue-raising function has diminished in relative importance. While continuing to fulfill their legal duties, customs administration becomes an important component in international transport services. Since the air cargo sector deals with flows of time-sensitive, high-value goods, the trade facilitation role of customs is particularly important as compared to other modes of transportation. Arbitrary or unpredictable customs clearance delays are incompatible with just-in-time manufacturing and distribution behind many airfreight commodities, whereas arbitrary or unexplained changes in classification or valuation of goods can disrupt logistical flows.

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Supplier

order processing

Merchandiser

11% local distribution

shipment preparation

13%

12%

International Freight Forwarder

Domestic Transport Agent

customs formalities

international transit

22%

Customs Brokerage

42%

Figure 9. Time Components in China’s International Cargo Flow

For developing countries like China, revenue-raising (tariff collection) remains the main function of customs. Correspondingly, manifest acquittal prior to delivery remains the norm of the cargo clearance process. As a consequence, the customs suffers from information overload, with its consequential delays on clearance time and unpredictability in the delays. Manufacturers, logistics companies, traders, air cargo integrators and airlines, all have identified China’s timeconsuming customs clearance procedures as a key constraint on development of China’s air cargo industry. Figure 9, taken from Ruo (2002), shows that, in China, the time spent on crossing customs accounts for 42% of the entire international cargo flow. As far as air cargo is concerned, the time lost at the customs can be critical to the development of the industry. 5.7 Infrastructure Barriers Inadequate airport and other infrastructures is a major impediment to the growth of air cargo logistics industry. In most of the 1990s, only 10% of the airports were capable of 23

accommodating large aircraft (B747 and MD-11). Passenger terminals operated, on average, 15% over their capacity at major airports, whereas air cargo terminals and facilities could only handle 65% of potential demand. Moreover, the modernization of air traffic control systems was badly needed. In addition to airport capacity, China lacks transport/logistics related infrastructure. This includes road networks and technological capabilities. China’s communications technology and transportation networks are still much underdeveloped as compared to developed economies. In customs, although EDI was initiated in 1992, there is still no schedule for mandatory electronic customs declaration and clearance. Utilization of EDI is still primitive and the customs clearing process remains, largely, a manually driven process. While some efforts of applying information technology are being pursued, it appears that it may be a long time before China would have a comprehensive electronic customs clearing process. Infrastructure is also needed to ease efficient freight movement through inter-modal terminals. Finally, there is an imbalance in the development between the eastern and western parts of the country. 5.8 Aviation Policy Constraints Since air transportation is a key component in the movement of airfreight, restrictive avaition policy can also act as a constraint to foreign participation. Like most countries, China closes her domestic air routes to foreign companies. For international routes, all commercial aspects of air transportation have been governed by the restrictive bilateral air service agreements since the Chicago Convention held in 1944. China has been part of the bilateral system, and has in general adopted conservative international aviation policies; see Zhang and Chen (2003) for a detailed discussion on the subject. The conservative approach has resulted in limited air traffic rights between China and the rest of the world. Given the limited traffic rights, the route/flight frequency allocation within mainland China was biased towards to Beijing, China’s capital. In 1996, Beijing had 54 international

24

routes. In comparison, Shanghai, which is China’s economic and commercial center, had 32 international routes and Guangzhou, the capital city of Guangdong Province that accounts for 40% of China’s foreign trade, had 17 international routes (Table 3). While Beijing’s airfreight was only 73% of Shanghai’s, it was No. 1 in air passengers. Unfulfilled airfreight demand in Shanghai was shipped to Beijing (or Hong Kong) for outbound; similarly, international inbound traffic flied to Beijing first, and then was shipped to Shanghai, thereby resulting in extra time and cost for shippers and carriers. The sub-optimal cargo network could be an impediment to air cargo growth. However, as can be seen from Table 3, the situation was much improved in 2002. 6. IMPACT OF WTO ACCESSION 6.1 WTO Commitments After almost 15 years of negotiations, China was accepted as a member of the WTO in November 2001. With WTO membership, China is to adopt trade liberalization measures consistent with WTO rules. Implementation of these liberalization measures implies a substantial reduction in tariff and non-tariff barriers across all economic sectors. Moreover, the accession agreement stated that the barriers to market entry to various service sectors would be totally eliminated by 2005. Pertaining to the air cargo industry, the spirit of WTO entry is to liberalize trading and distribution rights for foreign companies, to relax restrictions on services such as logistics, and to create opportunity for foreign investors in the air cargo industry. Table 5 shows the relevant WTO commitments on transportation and logistics services. In particular, foreign companies can assume majority ownership in forwarding and warehousing very soon (some of which is already

3

Traffic rights were defined in the widest sense to include routes, capacity, pricing and the criteria for the designation of airlines. Specifically, paragraph 6(d) of the annex states: “Traffic rights mean the right for scheduled and non-scheduled services to operate and/or carry passengers, cargo and mail for remuneration or hire from, to, within, or over the territory of a member, including points to be served, routes to be operated, types of traffic to be carried, capacity to be provided, tariffs to be charged and their conditions, and criteria for designation of airlines, including such criteria as number, ownership and control.”

25

happening). They can become wholly-owned enterprises in the not too distant future (certainly no later than three and four years).

26

Upon Entry: Dec. 11, 2001

Sector

Status*

Year One: By Dec. 11, 2002

Status*

Year Two: By December 11, 2003

Year Three: By Dec. 11, 2004

Status*

Majority foreign equity permitted

Permitted 2004-06 (freight only)

Rail Transportation

Up to 49% foreign equity permitted

Road Transportation

Up to 49% foreign equity permitted

Majority foreign equity permitted

Permitted as of Dec. 1, 2002, but capped at 75%. Higher proportion permitted in certain sectors and in western areas.

100% foreign equity permitted

Warehousing and Storage

Up to 49% foreign equity permitted

Majority foreign equity permitted

Warehousing permitted for road transport and BMN.

100% foreign equity permitted

Freight Forwarding

Up to 50% foreign equity permitted, with certain conditions.

Majority foreign equity permitted with certain conditions.

Permitted as of Jan. 11, 2003, but foreign equity capped at 75%

Permitted 2002-03 (freight only)

5 year waiting period for second JV.

Waiting period for second JV reduced to 2 years. National treatment for registered capital requirements for branches.

Year Four: By Dec. 11, 2005

Year Six: By Dec. 11, 2007 100% foreign equity permitted

100% foreign equity permitted. National treatment for capital requirements for subsidiaries.

* As of August 2003. Source: Bolton and Wei (2003)

Figure 10. China's WTO Commitments on Transportation and Logistics Services

27

Status*

No limits on foreign participation after 2006.

Note that Table 5 does not cover air transportation, which is a key component of air cargo movement and logistics. In effect, air transportation is currently not under the WTO multilateral framework. Nonetheless, the Uruguay Round of the General Agreement on Tariffs and Trade (GATT), the predecessor of the WTO, did succeed in applying multilateral trade disciplines to three, though relatively minor, aspects of the air transport sector. This was done in the form of a separate “Annex on Air Transport Services” under the General Agreement on Trade in Services (GATS). The three aspects were aircraft repair and maintenance, selling and marketing of air transport services, and computer reservation system (CRS) services. As a result, the current restriction of minority share investment in international JVs in aircraft repair and maintenance (recall Table 4) will be lifted under the WTO. 6.2 Recent Liberalization Measures in Aviation Policy Despite the success in in applying multilateral trade disciplines to the three air transport services, the Annex specifically excluded measures affecting traffic rights and services directly related to the exercise of traffic rights.3 Although the GATS rules provide that the Annex will be reviewed at least every five years, the first review in 2000 did not accomplish much. As a result, air transportation, per se, is not covered by China’s WTO agreements. Nevertheless, consistent with the spirit of her WTO entry, China has recently taken various liberalization measures in the sector. In international bilateral aviation policy, the significant recent developments include: First, a new ASA was signed between Beijing and Hong Kong in 2000, which allows carriers to increase their capacity by a combined 60% and partly remedies the capacity imbalance between Dragonair and mainland carriers. In early 2003, Cathay Pacific applied for operating rights to Beijing, Shanghai and Xiamen. Hong Kong and mainland authorities have responded the request rather quickly by granting Cathay

regulatory

approval.

Cathay

would

28

have

daily

return

flights

to

Shanghai/Beijing/Xiamen at the frequencies of 4/3/1, compared to Dragonair’s 8/6/2 and its planned 10/8/2. This provides an indication of Beijing’s commitment to liberalization. It has been reported that the on-going negotiations between the mainland and Hong Kong may include 5th freedom rights for their respective carriers. Second, in 1999 China and the U.S. implemented an expanded ASA, which included a fourth carrier from each side and an increase in weekly services from 27 to 54 (U.S. DOT News Release 52-99, April 9, 1999). UPS was added as the fourth carrier from the U.S. Together with FedEx, the other U.S. all-cargo carrier, the addition of UPS has further stimulated competition in China’s air cargo market. Because some important U.S. carriers (Delta, American) are not included in the designated four, expanded code-sharing arrangements (Delta + China Southern; and American + China Eastern) are an important additional mechanism of liberalization. Third, since May 22, 2003, Singapore Air Cargo has been granted the fifth-freedom right from Singapore, to Xiamen and Nanjing, to Los Angeles, Chicago, Anchorage in the U.S. (SinoCast China Business Daily News, May 26, 2003). This is a very rare event in which China granted the 5th freedom right to a foreign company. Finally, China declared an “open skies” arrangement for Hainan Province. Under the arrangement, the CAAC will waive the right to reciprocal air rights in exchange for new services to Hainan and will not require existing bilateral ASAs to be renegotiated. Further, it will not restrict the country of origin of carriers flying to Hainan, and will allow both passenger and cargo operations. In addition, the CAAC will enact a new landing-visa program in Hainan for citizens of all nations (South China Morning Post, July 16, 2003).4

4

A main purpose of the open-skies policy is to help the southern island to compete with the rival tourist centers in Southeast Asia. According to CAAC figures, 12 million people visited Hainan in 2002, but just 3%, or 389,400, came from outside China. By comparison, in 2001, about 2.7 million foreign tourists visited Phuket in Thailand, and nearly 1.3 million foreign travelers visited Bali in Indonesia.

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6.3 Regional Protection or Monopoly to Continue? As indicated earlier, local protectionism refers to the role of local governments in protecting their own companies (markets) against foreign companies, or companies from other regions, by failing to fully enforce the national law. Fragmentation coupled with local protection have meant that regional state-owned enterprises have been able to survive and even prosper without much consideration to competition. The air cargo logistics industry has experienced so much regional monopoly for so long. It is also an industry where cooperation with the local government is a major advantage. With the WTO entry, is it likely that such local protectionism or monopoly will continue for a still quite while? Air cargo logistics is a service sector, and services trade under the WTO is governed by the GATS. The two most important principles of the GATS are the most-favored-nation clause and national treatment. In particular, application of the national-treatment principle to service industries would require that foreign companies are treated the same as comparable domestic companies. On the other hand, a country’s WTO commitments dictate, in general, that the country must open market access throughout its entire territory. Taken together, these two observations would suggest a negative answer to the above question. There are, however, at least two possible causes for concern. First, Bosworth (2002) points out that the obligations under the GATS covering sub-national governments are weaker than those applying to national governments. The requirement is that members take only “reasonable measures” to ensure that sub-national governments meet their obligations. Fortunately, China’s commitments under its Protocol of Accession specifically require that it maintain a uniform system of administration. Further, the Central Government is required to establish a mechanism whereby those concerned about problems of regional protection may

30

bring their concerns to its attention. These specific provisions seem likely to make the disciplines on China stronger than those under general WTO rules (Luo and Findlay, 2002). Another possible cause for concern is derived from the fact that China is a vast country with regions at different levels of economic, legal and administrative development, and has historically been riddled with local protectionist measures. The WTO-entry promises have been negotiated between China’s Central Government and other WTO member countries, but the implementation of these commitments is likely to occur at the local provincial, municipal, county, and town levels. Li and Zhang (2003) found that China’s WTO entry will facilitate domestic regional liberalization, but that WTO accession won’t necessitate her domestic regional liberalization. The latter result has important business and policy implications, as local protectionism may limit the scope of gains from China’s WTO entry. Finding solutions to local protectionism will not only bring benefits to consumers, but also ensure that the promises China has made in her WTO application can be fully implemented. For the past decade, the central government has tried to use threats and intimidation to bring local governments into line. Yet the impetus of WTO entry appears to prompt an array of new thinking that seeks to tackle the problem’s deeper roots. As discussed earlier, cumbersome and region-specific licensing requirements are conducive to local protectionism. Streamlining the administration system will help break down the scope to apply protection at the departmental and local levels, and therefore needs to be accelerated in order to meet WTO rules. 6.4 WTO Accession and Enterprise Reform In general, the evolution of China’s SOE reform can be divided into three phases: i) pilot reforms during 1979-83; ii) increase of enterprise autonomy during 1984-92; and iii) ownership restructuring since 1993 (Lin and Zhu, 2001). Pilot programs were first introduced

31

in selected enterprises to delegate decision-making authority and link reward to performance. Then, the enterprise responsibility system was introduced, which significantly increased the decision-making autonomy of SOEs. The establishment of a “modern enterprise system” was adopted as a SOE reform strategy at the 15th Chinese Communist Party Congress in 1997. The main measure for establishing a “modern enterprise system” among SOEs is ownership restructuring or so-called shareholding reform. The original objective of this ownership reform is to separate ownership from management by transferring the supervision authority over state assets in restructured enterprises to agencies that specialize in state assets management. However, initial supervising authorities of SOEs may seek to retain their power in various ways such as forming holding companies disguised as “independent” state asset management entities, and taking stakes in restructured enterprises through institutional and even individual investors that they control (Lin and Zhu, 2001). The reform of China’s airline industry can also be divided into three stages (Zhang and Chen, 2003). Prior to 1979, the industry was a semi-military organization with the Civil Aviation Administration of China (CAAC) as a department of air force for most of the years. The first stage occurred between 1979 and 1986, and the aim was to bring back business aspects to air transportation. The policy of “self-responsible for losses and extra-profit retention” towards the airline sector was adopted. The second stage began in 1987 when the CAAC set up six independent state-owned trunk airlines. The main goal was to separate the CAAC from direct airline operation. Further, the entry of new carriers was accommodated, if not encouraged, by the policy reform; as a result, the CAAC monopoly was broken. The third stage began in 1993. Recognizing the problem of too many carriers (more than twenty domestic airlines), the CAAC began to shift to a policy of consolidation. One outcome of this stage is that instead of an airline operator, the CAAC has evolved to become mainly a regulator, as it should have been in the first place. The airline reform appears to be quite

32

successful, especially as compared to the reform of other sectors (Taplin 1993, Le 1997, Zhang, 1998, Zhang and Chen 2003). Zhang and Chen (2003) showed that the total factor productivity of China’s airlines has gained significantly and the gain was higher than the gains found in other Chinese SOEs. The WTO entry has provided additional impetus and momentum for China’s enterprise reforms. In particular, it will deepen the SOE reform in two aspects: i) separation of ownership and operation; and ii) privatization of SOEs. Currently, as illustrated earlier, the offices under the State Council still both regulate and operate a business in many sub-sectors of air cargo logistics, thus leading to a clear conflict of interests. While China has deliberated such separation for a while, it is only recently that clear signals of such implementation are forthcoming. Airport decentralization is such an example. At the beginning of 2002, the CAAC decided to surrender airport control to local governments. The reform would separate the CAAC’s regulatory role from its ownership and operating roles, paving the way for more market-oriented management 5 Nevertheless, implementing such separation is a major challenge. Some perplexing questions remain, including: Can an industry which has been regulated and protected for so long be opened up to fair competition? What will happen to those matrices of hybrid state-owned enterprises? Regarding to further privatization of SOEs in the post-WTO era, the economic reforms since 1978 have greatly transformed China’s economy from a centrally planned economy to a relatively more market-oriented economy. One major feature of the Chinese reform process is the massive entry of non-state enterprises (McMillan and Naugton, 1992). In 1978, just before the implementation of economic reform, state-owned enterprise accounted for 78% of China’s industrial output. As a result of economic reform for more than twenty years, there is a more diversified ownership structure in the industrial sector: wholly 5

The CAAC will retain administration control over Beijing’s Capital International Airport and airports in politically sensitive Tibet.

33

state-owned firms (44% of total industrial sales in 1997), collective-owned firms (26% of the sales), mixed state- and private-owned firms (24% of the sales), and wholly private-owned firms (6% of the sales) (Liu and Gariano, 2001). China has also been one of the hottest choices for foreign direct investment. According to Beamish (1993), no country had more equity joint venture formation than China during the 1980s. Since the WTO entry will accellorate the entry of foreign companies, we expect the privatization trend will continue, especially in the air cargo logistics sector. 7. IMPLICATIONS FOR FOREIGN AIR CARGO LOGISTICS COMPANIES 7.1 Foreign Direct Investment As described in Section 6.1, China’s entry to the WTO has allowed foreign companies to assume majority ownership in forwarding and warehousing now, and to become whollyowned enterprises in the not too distant future. Consistent with the WTO-entry spirit, China has recently made important concessions by allowing foreign companies to take larger equity stakes in domestic airlines. Since 2002, foreign investors are allowed to take stakes of up to 49% (so long as no single investor holds more than 25%), compared with the maximum 35% allowed under earlier regulations. China Southern, the country’s largest carrier, is already 35% held by foreign investors, while China Eastern is about 33% foreign owned. China Eastern had indicated that it would apply to increase its foreign participation. As a result of (gradual) relaxation of foreign ownership restriction, FDI in China’s air cargo industry has been occurring for the last several years. Here are four examples. First, in May 1994, the CAAC announced that it would allow foreign investors to enter joint ventures with, or buy stock of, domestic airlines. A ceiling was set at 35% of capital and 25% of voting stock. The first, and indeed the largest, investment was George Soros’ US$25 million acquisition of a 25% stake in Hainan Airlines in 1995. (Through successive share placements, Soros’ stake has fallen to 14.8%.) Second, the first all-cargo airline, China Cargo Airline

34

(CCA), was established in 1998, and was owned 70% by China Eastern and 30% by COSCO (which is a major transport/logistics company in China). In April 2003, the State Council approved the sale of a 25% stake in CCA to Taiwan’s China Airlines, which has substantial air cargo business. The deal makes China Airlines to be CCA’s second-largest shareholder after China Eastern, which now has 55%, and COSCO to have a 20% share. Third, China’s second all-cargo air carrier took off after Hainan Airlines had been granted approval to operate Yangtze River Express (Aviation Week & Space Technology, February 25, 2002). The new venture focuses on airfreight transportation, express delivery, freight forwarding, ground transportation, and warehousing as well as e-business. Fourth, Jetwin Air Cargo, the third cargo airline in China, became China’s first foreign-invested – and privately owned – airfreight carrier after a Hong Kong-based property company took a 35% stake of the airline in 2003. 7.2 Prediction on the Size and Structure of China’s Air Cargo Market Paralleling to her phenomenal macro-economic expansion, China has grown into one of the world’s major manufacturing centers and is now the No. 2 destination for the world’s FDI flow. These will certainly stimulate her airfreight demand, and China’s WTO accession will further result in rapid growth to the air cargo market. In its World Air Cargo Forecast released in May 2003, the Boeing Company forecasted 6.4% annual growth in world air cargo between 2001 and 2021 (Boeing, 2003). Domestic China will be the fastest growing market in the world, averaging 10.3% per year for the forecast period (see Figure 10). Furthermore, according to Boeing (2003), China’s air passenger traffic market is growing at 7.6% annually over the 2001-2021 period. With this growth rate, China, already the 4th largest passenger market and the 5th-largest freight one in the world, is expected to become the largest commercial aviation market outside the U.S. by 2021 – generating demand for more than 1,900 new jet airplanes worth US$165 billion over the next 20 years.

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Asian Cargo Growth, 2001-2021 Growth, %:

North America

Wo rld average 6.4%

4.4%

Europe-Latin America

5.0%

Europe-Africa

5.0%

Europe-Middle East

5.1%

Intra-Europe

5.6%

Europe-Southwest Asia

5.9%

Europe-North America

6.5%

Latin America-North America

6.5%

Europe-Asia

7.0%

Asia-North America

7.5%

Intra-Asia

8.4%

Domestic China

0.0%

10.3%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Figure 10. As long as the air cargo industry remains a strategic industry, it is very likely that there will always be the presence of state-owned enterprises in one form or another, simply because the government will wish to retain a certain degree of control on the industry. However, the competitiveness of these state-owned enterprises will need to be substantially strengthened, as their implicit advantage of government protection will be gradually eroded when the industry opens up after the WTO entry. As a result, there should be quite a bit of consolidations of state-owned enterprises. The huge matrix of hybrids state-owned enterprises will likely be consolidated to become more competitive as regulating and business operating are to be separated. In the airline industry, the WTO entry has provided major impetus for China to examine the competitiveness of her state-owned carriers. Following deregulation in the 1980s, China developed a highly-fragmented domestic airline industry, with more than two dozen carriers, some with only two or three planes. After three years of preparations, China

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officially launched three new aviation groups on October 11, 2002 by consolidating the ten carriers under the central government control, each of which would have assets of about US$6 billion (50 billion yuan) and fleets of more than 100 aircraft (Far Eastern Economic Review, December 10, 2002 ). The three anchoring carriers are Air China, China Eastern and China Southern; the three consortia will account for about 80% of flights inside China. The move is an important step in a plan to make the country’s fragmented airline industry more competitive in the face of rising international competition post-WTO and to give airlines greater autonomy from the CAAC in decision making. Outside the consortia, highly successful upstart Hainan Airlines, which emulates such low-cost carriers as Southwest and Ryanair, will almost certainly survive and prosper. By virtue of its non-CAAC status, Hainan hires foreign pilots and flight attendants, enjoys freedom in aircraft procurement, and fills a market (mainly tourist flights and feeder routes from smaller cities) that is different from those of the big three. Hainan’s net profit nearly doubled in 2002, lifted by greater domestic travel and strong expansion. Hainan Airlines is the fourth largest carrier in the mainland (about 9% of the domestic market), with assets of about US$2.4 billion and 68 planes. Finally, it has been speculated that the remaining airlines might form a consortium. 7.3 Prediction on Emerging Patterns of Air Cargo Services Supply Clearly, the air cargo business is set to grow in the Chinese mainland, but the shape of this growth has yet to be determined. As indicated earlier, air cargo in China is shipped primarily in the belly hold of passenger aircraft. This is not unique to China, however, and in fact may be considered a feature of Asia’s air cargo industry. In Hong Kong, for instance, between 55% and 60% of airfreight are carried in the belly compartment of passenger aircraft. As a consequence, in Asia, passenger airlines have competed keenly for general air cargo business. This model is in sharp contrast to the pattern developed in the U.S. where the

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fact that most passenger carriers use narrow-bodied aircraft for their domestic operations has put severe limitations on their capacity to carry cargo. As a result, dedicated air express carriers have emerged, using a combination of wide- and narrow-bodied aircraft, over 20 years raising their share of cargo carried from 4% to 60% (Zhang and Zhang, 2002a). While the air cargo growth in Asia in general will not likely converge to the U.S. pattern, there is good reason to believe that China will likely move towards the U.S. model. This prediction is based primarily on the existence of a (potentially) large domestic market, which should be conducive to the use of narrow-bodied aircraft for passenger traffic, and to the separation of passenger transport services from cargo services. In effect, we have already seen some signs of this separation happening (see the discussion on the establishment of the three all-cargo airlines in Section 7.1). More recently, it was reported that China Southern planned to set a new all-cargo airline soon (Hong Kong Da Gong Bao, January 28, 2003). This development of separating cargo from passenger services will have a significant impact on policy and air cargo market liberalization. In particular, it will make the cargo liberalization easier than would be otherwise. One of the most difficult, but key, issues in the negotiation of international air services agreements is that negotiation of cargo rights may not be easily separated from negotiation of passenger rights in those circumstances where cargo and passenger products are jointly produced (Zhang and Zhang, 2002b). Fortunately, the segregation of the cargo and passenger operations foreseen for China is in parallel with the liberalization trend and policy in international aviation market. There is an effort to put air cargo under the GATS. There is a stronger rationale for cargo liberalization – the optimal air cargo routing is circular rather than bilateral – than passenger liberalization, thereby requiring 5th/7th freedoms that cargo can go through third countries. There is also a stronger push by relatively concentrated shippers and governments. Low transportation cost is a key to the international competitiveness of a firm, a region and a nation.

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7.4 Risk Factors for Foreign Investment Although major service providers in logistics and transportation look forward to a vast and growing market as a result of further and deeper liberalization in the post-WTO era, they have to compete in a transforming economy which is significantly different from the kind of market economy in developed countries. Airlines, airports, air cargo terminals, road and rail transport, storage and warehousing, container station and depot services and airports are some of the areas where more foreign investment could be attracted. Foreign investment is also needed in upgrading the information systems used in air cargo operations and in customs clearance procedures. On the other hand, the successes of foreign joint ventures operating in China have been mixed over the years. There have been many reasons for their lack of success. One reason that is often cited is the misrepresentation of competency by local partners. Typically, a local partner that appears to be strong on paper does not materialize to be so. And as minority partners, foreign companies are often left with limited power to effect changes. With WTO accession, foreign companies can assume majority ownership and can even be sole owners of enterprises in China. More importantly, as only the fittest state-owned enterprises will survive the gradual open competition, foreign enterprises can seek local JV partners that are truly strong. Whether an enterprise is state-owned, privately-owned, or jointventured, it is also quite clear that share-holding will be the norm in the future. Below, we discuss some of the risks facing a foreign investor in air cargo logistics. The air cargo industry includes many state-owned enterprises. In general, although many supposedly logistics service providers claim expertise in the industry, their know-how in logistics operations are not comprehensive. Many such companies are managed with shortsightedness, and there is no clear responsibility within the operations. The mind-set of having vertical integration is quite typical for companies in China. Many companies operate their

39

own trucking companies or river carriers, as well as having their own warehouses. The poor logistics-related infrastructure in China provides both difficulties and challenges. It also means opportunities as well as risks. For illustration, consider some of the risk factors involved in the establishment of a high-tech third-party logistics center in major air hubs such as Shanghai or Beijing. 1) Risk of JV management problems: Having a good JV partner in China is often half of the battle. Many stories of failure have been documented and they often trace the reasons of failure to the management problems that typically occur between the local partner and the foreign investor. The foreign investor and the local partner need to work out many of the management issues. For an intelligent logistics center, there will likely be considerable developmental difficulties. The need to assemble a knowledgeable team early in the center development is crucial. This is commonly referred to as the core competence, an essential ingredient in the successful business development and implementation. 2) Regulation risk: As pointed out previously, the regulatory bodies in air cargo logistics are not well defined. There is a great deal of room in reorganizing as well as liberalizing many of the air cargo related regulations. The risk of the government over-regulating the logistic center is also a plausible concern. Furthermore, in the post WTO era, foreign companies are likely to find a great deal of opportunities in developing physical and information infrastructure that are oriented towards integrating the many existing fragmented clusters across China. Here, foreign companies may need to deal with regulatory and administrative barriers (associated with local protectionism) at various departments and regions. 3) Risk of competition: Competition could be a risk concern. Regionally, while Shanghai (for example) is to be developed to be a major air cargo hub in East Asia, competition from major cities such as Hong Kong, Beijing, Guangzhou and Singapore will be keen. However, Shanghai is unlikely to be stopped in becoming the major air cargo hub of China. Perhaps the

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more worrisome concern is that of having competition between foreign investors in Shanghai. It is quite clear that many foreign investors are eager to engage in setting up logistics operations in Shanghai. Within Shanghai itself, other 3rd party logistic centers may be constructed competing for air cargo shipments. Integrators will be a major presence in the air cargo industry in Shanghai as the recent liberalization moves in Chinese aviation that are designed to encourage foreign investment continues. In addition, e-commerce is very new to Shanghai. Shanghai will be a major battleground for e-commerce activities in air cargo logistics. 4) Construction and technical risks:

In providing air cargo logistics services, foreign

companies may need to engage in facility and infrastructure constructions. Construction risks involve the risk of having cost over-runs and the risk of not able to build the center according to the technical specifications. The building of an intelligent warehouse may be somewhat different from building a conventional warehousing facility. For instance, the problems involving the construction of telecommunication features in the logistics center must be addressed. 8. CONCLUDING REMARKS AND FURTHER RESEARCH ISSUES Our main objectives in writing this paper are to provide an overview of air cargo industry in China, and to discuss the implications of globalization and WTO accession for foreign air cargo logistics companies. We found that China’s air cargo industry has been fragmented and is operating with little market mechanism. The industry has been highly protected and regulated, and is dominated by state-owned enterprises, with strong regional monopoly, owing to prevalent local protections, and rigid functional demarcations. The industry has no single regulatory/administrative governing body. Instead, different components of the industry usually belong to different government agencies. For instance, the functional system that applies to transportation is divided according to the mode of transport,

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and the same systems operate at both local and higher levels of government. Responsibility and power overlaps between the departmental and regional administrations. This fragmentation, by both air cargo logistics functions and by regions, is against the growing need of modern logistics management, which requires integration, both physically and with information, in managing supply chains. At the moment, different fragmented stateowned enterprises simply form alliances and partnerships with each other, in an effort to address the problem. We have a huge matrix of hybrids and hybrids of SOEs, which involve cross-ownership (owned by SOEs across different regions, modes, and services). And it is not uncommon to find a SOE that has subsidiaries and/or partnerships along the air cargo logistics chain. However, the alliances of functional and regional-based SOEs have not done a good job in integrating air cargo shipments, individually and collectively, and do not represent efficiency improvement in managing the shipment process. Foreign companies are attracted by the huge potential of China’s air cargo logistics market. However, tremendous barriers to foreign participation in China’s air cargo sector exist. As analyzed in detail in the paper, they arise from a variety of sources, ranging from domestic regulations, guidelines, institutions and administrative mechanism, to infrastructure and policy constraints. On the other hand, China’s recent accession into the WTO establishes the country’s commitment to liberalize distribution rights, and relax restrictions on services such as logistics. In addition, consistent with the WTO entry, China has taken a series liberalization measures toward air transportation, which, per se, is not under the WTO framework and so is not covered by China’s WTO agreements. Together with the size of China’s air cargo market, the WTO entry would create tremendous opportunities for foreign investors as well as foreign air cargo logistics companies. Our analysis of the risks facing a foreign investor in air cargo logistics suggests both opportunities and challengers.

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There are a number of potential areas for future research. First, given the historical background of the industry, it would be very interesting to predict its future evolution from the perspective of changing ownership structure in the air cargo logistics industry. The latter is taking place at a rapid pace owing to both the deepening of China’s SOE reform, which includes separation of ownership and operation, share-holding enterprises and privatization, and the relaxation/elimination of foreign ownership restrictions following WTO accession. Interesting research questions would be: will hybrid ownerships – i.e., alliances of functional and regional-based SOEs identified in the paper – be given way to integration, and if so, what will be the impact on the industry and the shippers? Second, this paper has described the (potential) tension between the current institutional arrangements (especially, barriers arising from across regions and across modes) and the integration requirements of the modern air cargo logistics management. It would be important to analyze this tension or conflict by explicitly modeling the efficiency criteria for the cargo operations, such as cost minimization, or service quality maximization, or both. Finally, as mentioned in the paper, the air cargo growth in Asia in general will not likely converge to the U.S. pattern, in which air cargo transportation is provided by dedicated express carriers. On the other hand, there is good reason to believe that China will likely move towards the U.S. model, and there are some signs of this happening. But how long will this take? It takes over 20 years for dedicated express carriers to dominate the air cargo market in the U.S. A comparative study between the U.S., Asia and China will be useful in answering this question, as well as in pointing out both business opportunities and overall economic impacts that will arise in the process.

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Table 1. Air Cargo Throughput (‘000 tonnes) Year Sea Transport Ann. Growth % 1952 51,410 1957 154,380 1962 174,640 1965 229,930 1970 254,440 1975 349,870 1978 432,920 1980 426,760 1985 633,220 1986 829,620 31% 1987 809,790 -2% 1988 892,810 10% 1989 874,930 -2% 1990 800,940 -8% 1991 833,700 4% 1992 924,900 11% 1993 979,380 6% 1994 1,070,910 9% 1995 1,131,940 6% 1996 1,274,300 13% 1997 1,134,060 -11% 1998 1,095,550 -3% 1999 1,146,080 5% 2000 1,223,910 7% 2001 1,326,750 8% 2002 1,418,320 7% Source: China Statistical Yearbook, Various years.

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Air Transport 2 8 18 27 37 47 64 89 195 224 299 328 310 370 452 575 694 829 1,011 1,150 1,247 1,401 1,700 1,970 1,710 2,020

Ann. Growth % 15% 33% 10% -5% 19% 22% 27% 21% 19% 22% 14% 8% 12% 21% 16% -13% 18%

Table 2a. Air Cargo Throughput in Major Chinese Cities and Hong Kong (tonnes) Beijing* Total 1980 1985 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

37,850 105,333 141,972 152,168 187,115 225,287 242,120 371,384 390,098 457,540 511,142 628,209 774,205 591,195 629,045

Ann. Growth % 7.2% 23.0% 20.4% 7.5% 53.4% 5.0% 17.3% 11.7% 22.9% 23.2% 6.4%

Shanghai* total 21,207 67,964 126,768 155,620 186,632 235,625 270,216 366,302 408,021 476,011 571,774 765,819 878,902 804,465 1,074,870

Guangzhou*

Ann. Growth % 22.8% 19.9% 26.3% 14.7% 35.6% 11.4% 16.7% 20.1% 33.9% 14.8% 33.6%

total 25,432 57,788 125,356 151,216 171,374 188,262 233,856 278,797 320,951 351,770 407,570 448,117 491,868 456,270 496,880

Ann. Growth % 20.6% 13.3% 9.9% 24.2% 19.2% 15.1% 9.6% 15.9% 9.9% 9.8% 8.9%

Hong Kong# total 268,724 461,597 834,803 893,526 1,016,207 1,202,868 1,359,197 1,504,443 1,649,471 1,822,168 1,669,665 2,086,155 2,256,769 2,145,072 2,571,361

Ann. Growth % 7.0% 13.7% 18.4% 13.0% 10.7% 9.6% 10.5% -8.4% 24.9% 8.2% -4.9% 19.9%

Sources: Annual Report of Hong Kong Civil Aviation Department and Statistical Data on Civil Aviation of China, Various issues. * 2001 and 2002 data contain mail and cargo, others include luggage as well # Hong Kong data contains mail and cargo, and collects according to fiscal year, e.g. 1980 data contains April 1980 to March 1981

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Table 2b. Changes in Air Cargo Throughput and Connections, 1990-2002 1990 1996 2002 Connections Connections Connections Cargo Cargo Cargo Domestic Int’l Total Domestic Int’l Total Domestic Int’l Total Shenzhen n/a n/a n/a n/a 90,435 25 2 27 288,644 71 3 74 Xiamen 17,884 2 3 5 91,589 19 8 27 109,984 39 10 49 Haikou 7,372 3 1 4 39,678 11 11 53,829 43 1 44 Shanghai 126,768 19 13 32 408,021 38 32 70 1,074,870 70 52 122 Wuhan 8,172 3 0 3 34,464 14 14 51,882 36 2 38 Beijing 141,972 22 35 57 390,098 44 54 98 629,045 67 53 120 Guangzhou 125,356 31 7 38 320,951 40 17 57 496,880 66 18 84 Chengdu 34,604 7 1 8 99,727 23 3 26 162,391 64 7 71 Xian 18,780 4 0 4 49,031 11 4 15 65,292 41 9 50 Shenyang 13,113 3 1 4 32,781 8 4 12 56,799 25 9 34 Sources: China Statistical Yearbook and Statistical Data on Civil Aviation of China, various issues City

* 2002 data contain mail and cargo, others include luggage as well ** Hong Kong and Macau routes are counted as regional route and classified as International connection cities in the table

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Table 3. China and Hong Kong Air Cargo Throughput (tonnes) Hong Kong#

China*

Total Ann. Growth % Total Ann. Growth % 1980 157,390 268,724 1985 390,934 461,597 1990 658,405 834,803 1991 787,366 20% 893,526 7% 1992 998,269 27% 1,016,207 14% 1993 1,229,064 23% 1,202,868 18% 1994 1,499,717 22% 1,359,197 13% 1995 1,961,543 31% 1,504,443 11% 1996 2,288,502 17% 1,649,471 10% 1997 2,571,312 12% 1,822,168 10% 1998 2,883,601 12% 1,669,665 -8% 1999 3,467,351 20% 2,086,155 25% 2000 4,001,776 15% 2,256,769 8% 2001 3,392,759 2,145,072 -5% 2002 4,018,341 18% 2,571,361 20% Sources: Annual Report of Hong Kong Civil Aviation Department and Statistical Data on Civil Aviation of China, Various issues. * 2001 and 2002 data contain mail and cargo, others include luggage as well; Cargo throughput data in China excludes Hong Kong data # Hong Kong data contains mail and cargo, and collects according to fiscal year, e.g. 1980 data contains April 1980 to March 1981

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