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

1
 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.

2
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

3
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

4
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.

5
 Strategic SOEs'
Industry & Functional/Regional
Decentralization Specialization

Regional Fragmentation
Protectionism

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

6
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.

Trucking
Shippers Shipping Warehouse Trucking

Domestic
Trucking Airport
Terminal

Inter-
national Domestic
Airport Airline
Terminal

Customs
Inspections

Legend

Inter- Parties involve in

Physical flow
national Consignee Physical flow
Airline
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

7
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 market-

oriented 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

8
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 internet-

based 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

9
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;

10
 - Third group: provincial governments and governments of municipalities, e.g. Beijing

and Shanghai.

State Council

Ministries Offices Directly Administrative

& Commissions Under State Council Division

City
City Gov.
Gov.
Gov.
Gov. of
of Provincial
Provincial with
with Sub-provincial
Sub-provincial
State Dev. Information Industry & Civil Municipalities
Municipalities Gov.
Gov. Ranking
Ranking
Railways Transport Commerce Customs e.g.
e.g. Beijing, e.g.
e.g. Guangdong, e.g. Shenzhen,
& Reform Industry Commerce Aviation Beijing, Guangdong, e.g. Shenzhen,
Shanghai
Shanghai Fujian
Fujian Guangzhou,
Guangzhou,
Xiamen
Xiamen
……

……

……

……

……

……

……

……
-- Int’l
Int’l Econ.
Econ. &
& -Tariff
-Tariff -- Enterprise
Enterprise -- Regulation
Regulation
-- Dev.
Dev. Planning
Planning
-- Telecom
Telecom -- Highway
Highway Trade Relations
Trade Relations Collection
Collection Registration
Registration Planning
Planning
-- Regional
Regional Econ.
Econ. -- Transport
Transport
-- Post
Post Bureau
Bureau -- Waterway
Waterway -WTO
-WTO -Customs
-Customs -- Int’l
Int’l Exchange
Exchange -Transport
-Transport
-- Transport
Transport
Clearance & Cooperation
Cooperation
Clearance & -- 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 cross-

unit or cross-region problems arise, there is no effective central authority to solve such problems.

11
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.

12
 State Council CAAC

China Eastern Air Holdings. Co.

State-owned Assets 61.64%
Supervision and
Administration Commission
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.

61%
49%
GuangzhouBaiyun Yingxin (SZ)
International Airport Investment and
China Post
Co. Ltd. *
Development Co. Ltd.
51% 29% 10%

China Post
Airlines 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

13
 Shenzhen Government

Shenzhen Investment
Holdings Corp.
44.25%

Shenzhen International
Holdings Ltd.

100%

Total Logistics
(Shenzhen) Co. Ltd.

50% 50%

Shenzhen Airport Guangzhou

International Changyun Total
Express Logistics Co. Ltd.
Supervision
Center 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 China Eastern

(Shenzhen) Co. Ltd. Airlines Corp. Ltd.

50% 50% 50% 50%

Shenzhen Airport Dapeng (Shanghai)

International Express International
Supervision Center Co. Ltd. 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

14
 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.

15
 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 above-

mentioned 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.

17
 Industry Regulatory Barriers on Foreign Companies
Freight transport by rail and - JV partnership allowed to cross boundary operations with Hong
Table 4.
road (in trucks or cars) Kong only
Regulatio
Storage & warehousing - Permit to own warehouse in Free Trade Zones (FTZs) for their ns on Air
company own use Cargo
Logistics-
- No ownership or management of warehouses is permitted outside related
FTZs Industrie
s Prior to
Freight forwarding - Minority share investment in JVs is accepted
WTO
- Limited to certain geographic areas Accession
- Generally not allowed to handle domestic freight forwarding
Aircraft repair and maintenance - Minority share investment in JVs is accepted
O
Courier services - JVs are accepted, with foreign
capital investment not less than US$1 million, and n
Chinese partner holding at least 50%
- Generally not allowed to do domestic express business
licensing,
- One year to set up branches and five years to form another JV 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

18
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.

19
 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.

20
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

21
 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.

22
 Supplier order processing Merchandiser
11%

shipment preparation local distribution

12% 13%

International Domestic
Freight Transport
Forwarder Agent

international transit customs formalities

22% 42%
Customs
Brokerage

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 time-

consuming 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 Year Year Two: Year Year Four: Year
Entry: One: By By Three: By Dec. Six: By
Sector Dec. 11, Status* Dec. 11, Status* December By Dec. Status* 11, 2005 Dec. 11, Status*
2001 2002 11, 2003 11, 2007
2004
Rail Up to 49% Permitted Majority Permitted 100% No limits on
Transport- foreign 2002-03 foreign 2004-06 foreign foreign
ation equity (freight equity (freight equity participation
permitted only) permitted only) permitted after 2006.

Road Up to 49% Majority Permitted as 100%

Transport- foreign foreign of Dec. 1, foreign
ation equity equity 2002, but equity
permitted permitted capped at permitted
75%. Higher
proportion
permitted in
certain
sectors and
in western
areas.

Warehousing Up to 49% Majority Warehousing 100%

and Storage foreign foreign permitted for foreign
equity equity road equity
permitted permitted transport and permitted
BMN.

Freight Up to 50% Majority Permitted as Waiting 100%

Forwarding foreign foreign of Jan. 11, period for foreign
equity equity 2003, but second JV equity
permitted, permitted foreign reduced to 2 permitted.
with with equity years.
certain certain capped at National
conditions. conditions. 75% National treatment for
treatment for capital
5 year registered requirements
waiting capital for
period for requirements subsidiaries.
second JV. for branches.

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

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

27
 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 have daily return flights to

28
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.

29
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 wholly-

owned 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.

35
 Asian Cargo Growth, 2001-2021
Growth, %:
Wo rld average 6.4%
North America 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 10.3%

0.0% 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

36
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

37
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.

38
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 joint-

ventured, 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 short-

sightedness, 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

40
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,

41
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 state-

owned 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.

42
 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.

43
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Table 1. Air Cargo Throughput (‘000 tonnes)

Year Sea Transport Ann. Growth % Air Transport Ann. Growth %

1952 51,410 - 2 -
1957 154,380 - 8 -
1962 174,640 - 18 -
1965 229,930 - 27 -
1970 254,440 - 37 -
1975 349,870 - 47 -
1978 432,920 - 64 -
1980 426,760 - 89 -
1985 633,220 - 195 -
1986 829,620 31% 224 15%
1987 809,790 -2% 299 33%
1988 892,810 10% 328 10%
1989 874,930 -2% 310 -5%
1990 800,940 -8% 370 19%
1991 833,700 4% 452 22%
1992 924,900 11% 575 27%
1993 979,380 6% 694 21%
1994 1,070,910 9% 829 19%
1995 1,131,940 6% 1,011 22%
1996 1,274,300 13% 1,150 14%
1997 1,134,060 -11% 1,247 8%
1998 1,095,550 -3% 1,401 12%
1999 1,146,080 5% 1,700 21%
2000 1,223,910 7% 1,970 16%
2001 1,326,750 8% 1,710 -13%
2002 1,418,320 7% 2,020 18%
Source: China Statistical Yearbook, Various years.

46
Table 2a. Air Cargo Throughput in Major Chinese Cities and Hong Kong (tonnes)

Beijing* Shanghai* Guangzhou* Hong Kong#

Ann. Ann. Ann. Ann.
Total total total total
Growth % Growth % Growth % Growth %
1980 37,850 - 21,207 - 25,432 - 268,724 -
1985 105,333 - 67,964 - 57,788 - 461,597 -
1990 141,972 - 126,768 - 125,356 - 834,803 -
1991 152,168 7.2% 155,620 22.8% 151,216 20.6% 893,526 7.0%
1992 187,115 23.0% 186,632 19.9% 171,374 13.3% 1,016,207 13.7%
1993 225,287 20.4% 235,625 26.3% 188,262 9.9% 1,202,868 18.4%
1994 242,120 7.5% 270,216 14.7% 233,856 24.2% 1,359,197 13.0%
1995 371,384 53.4% 366,302 35.6% 278,797 19.2% 1,504,443 10.7%
1996 390,098 5.0% 408,021 11.4% 320,951 15.1% 1,649,471 9.6%
1997 457,540 17.3% 476,011 16.7% 351,770 9.6% 1,822,168 10.5%
1998 511,142 11.7% 571,774 20.1% 407,570 15.9% 1,669,665 -8.4%
1999 628,209 22.9% 765,819 33.9% 448,117 9.9% 2,086,155 24.9%
2000 774,205 23.2% 878,902 14.8% 491,868 9.8% 2,256,769 8.2%
2001 591,195 - 804,465 - 456,270 - 2,145,072 -4.9%
2002 629,045 6.4% 1,074,870 33.6% 496,880 8.9% 2,571,361 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

47
 Table 2b. Changes in Air Cargo Throughput and Connections, 1990-2002

1990 1996 2002

City 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

* 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

48
Table 3. China and Hong Kong Air Cargo Throughput (tonnes)

China* Hong Kong#

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

49