Policy Analysis on Different Water Management Systems in China:
Utilizing a CGE Model on Drought Simulation
Graduate School of Life and Environmental Science, University of TSUKUBA, Shuai Zhong*
Reitaku Institute of Political Economics and Social Studies, REITAKU University, Mitsuru Okiyama
Faculty of Economics and Business Administration, REITAKU University, Suminori Tokunaga
1. Introduction
The water management system plays an important role in coordinating water use and economic
growth. However, the reform of the water management system in China is still in progress.
Accordingly, competition for water among farming and industrial users as well as households becomes
one of the key concerns in the context of the limited quantity of water under various water
management systems. The key question is that which system is superior for agricultural production
and rural households in the case of drought? This study will answer this question by utilizing acomputable general equilibrium (CGE) model with different water management systems.
2. Water Parallel Pricing System and Water Pricing System
Water price in China is determined politically and by top-down administrative commands rather
than by the market. The present pricing processes for irrigation water and pipe water are parallel dueto the fragmented water management system, where the total supply of irrigation water is regulated by
the government and that of pipe water is dependent on the pipe water production (namely, the waterparallel pricing system, or WPP). However, this system caused significant price distortions between
the irrigation water price and the pipe water price1 (see Figure 1).
Ministry of Housing and Urban
and Rural Construction (MHURC)

Social marginal cost:(1) Direct cost of resource;(2) User or depletion cost(3) Environment cost (tax)

Piping water networks operated bystate-owned and private company

Volumetric pricing(yuan/ m3)

Water Parallel
Pricing System

Second best solution: misallocationof inter-sectoral water

Pipe water

Pipe water price
Ministry of Water
Resource (MWR)

Low
High
Irrigation water cost

Surface water irrigation regulated
administrated by provincial andlocal government agencies

Ministry of Agriculture (MOA)
and local water authorities

Non-volumetric pricing(or Area pricing, yuan/mu)(1) Payment to water authorities;(2) Payment to village collectives;(3) Cost of water pumping(4) Water resource levy

Irrigation water

Figure 1 Fragmented water resource management and water parallel pricing system
Source: made by the authors according to the literature review.

China’s integrated urban and rural water affairs management reform was planned to restructure
the water management by setting up the Water Affairs Bureau (WAB) to incorporate part of all of thefunctions of resources management, service regulation and environment management, or re-designing
1

The detailed discussion about water parallel pricing system can be found in Zhong, Okiyama andTokunaga (2014a), Xie (2009) and Nitikin et al. 2012.

the functions of the current pricing system. And then a volumetric pricing reform should be promoted
for both of irrigation water and pipe water such that both irrigation water and pipe water are priced
according to their social marginal costs [1] (namely, the water pricing system, or WP, see Figure 2).
State-owned or privatecompany (water production
and distribution sector)

Water Affairs
Bureaus (WAB)

Pipe waterSocial marginal cost
(1) Direct cost of resource;(2) User or depletion cost(3) Environment cost (tax)

Pipe water price

Volumetric pricing(yuan/ m3)

Integrated water

Piping water
networks andirrigation
infrastructure

Water Pricing
SystemLegend:Payment:
Regulation:

Irrigation water priceFirst best solution: efficient
allocation of inter-sectoral

Irrigation water

Figure 2 Reform to the integrated water management and water pricing system
Source: made by the authors according to the literature review

3. SAMs and SCGE models with Different Water Management Systems
Based on the literature review and a survey for rural households, we constructed two social
accounting matrixes (SAM) with two different water management systems: a SAM with the waterparallel pricing system (SAM-WPP) and a SAM with the water pricing system (SAM-WP). These two
SAMs are used in three static CGE models: the SAM-WPP is for the model with water parallel pricing
system (SCGE-WPP), where the subsidy is imposed on the irrigation water price; the SAM-WP is forother two models with the water pricing system under two cases: the system under current reform(SCGE-WP_A), where the subsidy is on the price of integrated water; and the system under further
reform (SCGE-WP_B), where the subsidy is undertaken by the producer price of farming products.
Composite commodities sold in the domestic market (domestic
supply)𝝈𝑴Export product
Import product
Domestic product 𝝈
𝑬
OutputComposite commodities sold in the domestic market (domestic
supply)𝝈𝑴Export product
Domestic product
Import product𝝈𝑬
Output𝛔𝐨𝐮𝐭𝐩𝐮𝐭 = 𝟎

Value-added

𝝈𝑽𝑨 = 𝟏

Composite Labor

Capital𝛔𝐨𝐮𝐭𝐩𝐮𝐭 = 𝟎

Intermediate input

Value-added

Subsidy imposed

𝝈𝑳𝑾 = 𝟎. 𝟐

𝝈𝑳𝑩 = 𝟎. 𝟖

Composite Labor

CapitalNon-Irrigation Land𝝈𝑳𝑩 = 𝟎. 𝟖

Composite water

Irrigation Land

Agricultural labor Non-agricultural labor

Intermediate input
𝝈𝑽𝑨 = 𝟏

Non-Irrigation Land Composite irrigation land-water

Subsidy imposed

𝝈𝑳𝑾 = 𝟎. 𝟐

Agricultural labor Non-agricultural labor
𝝈𝑾𝑨𝑹𝑷 = 𝟑𝟎

Irrigation water

Composite irrigation
land-water

Irrigation Land

Pipe water

Integrated water= initial irrigation water+ initial pipe water

Figure 3 Nesting CES production structure of farming sectors in the SCGE-WP_A

Figure 3 Nesting CES production structure of farming sectors in the SCGE-WPP and SCGE-WP_A
Composite commodities sold in the domestic market (domestic
supply)𝝈𝑴Export product
Domestic product
Import product𝝈Composite commodities sold in the domestic market (domestic
supply)𝝈𝑴
Domestic product 𝝈 Export product
Import product
𝑬

𝑬

Subsidy imposed

Output𝛔𝐨𝐮𝐭𝐩𝐮𝐭 = 𝟎

OutputValue-added
𝝈𝑽𝑨 = 𝟏

Composite Labor

Capital𝝈𝒐𝒖𝒕𝒑𝒖𝒕 = 𝟎

Intermediate input

Composite Value-added and Water

Non-Irrigation Land𝝈𝑳𝑩 = 𝟎. 𝟖

Agricultural labor Non-agricultural labor

Composite irrigation
land-water
𝝈𝑳𝑾 = 𝟎. 𝟐

Irrigation Land

Intermediate input except water input

𝝈𝑽𝑨𝑾 = 𝟎. 𝟓
Value-added
Integrated Water = Initial Pipe Water
Integrated water= initial irrigation water+ initial pipe water

𝝈𝑽𝑨
Non-agricultural labor Capital

Figure 4 Nesting CES production structure of farming sectors in the SCGE-WP_B and other sectors
The production sectors are separated into two categories: i) farming sectors, which include paddy,
wheat, corn, vegetable, fruit, oil seed, sugarcane, potato, sorghum and other crops(see Figure 3 and theleft side of Figure 4); and ii) other sectors, which include the non-farming agricultural, industrial andservice sectors (see the right side of Figure 4). The production function type is defined by the nested
constant elasticity of substitution (CES) function. Moreover, in the CGE-WP_A and the CGE-WP_B
for farming sectors, the values of integrated water are equal to the sum of the initial irrigation waterand the initial pipe water; for other sectors, it is same as the initial pipe water.
4. Simulation Design and Results
In simulations, we fix the total water supply. In the water parallel pricing system, the total
irrigation water supply is fixed by introducing the market clearing equation of irrigation water. In both
the water parallel pricing system and the water pricing system, we fix the output of the waterproduction sector (water supply): within the water parallel pricing system, it is theoutput of the pipe water production sector (WAP); within the water pricing system, it is the output of
the integrated water production sector (WAT). For faming commodities, their outputs defined in thesethree models cannot be compared. Thus, the following analysis will focus on their domestic supply.
Drought, -10%

Drought, -20%

0
-1000

Drought, -30%

0

WPP

WP_A

WP_B

-2000

-2000

-4000

-3000

-6000

-4000

-8000

0

WPP

WP_A

WPB

WPP

-5000

WP_A

WPB

-10000-15000

Rural households’ welfare (EV)

Rural households’ welfare (EV)

Rural households’ welfare (EV)

Urban households’ welfare (EV)

Urban households’ welfare (EV)

Urban households’ welfare (EV)

Drought, -10%

Drought, -20%

0Drought, -30%

0

WPP

WP_A

WP_B

-0.5

-0.5

0

WPP

WP_A

WP_B

Drought, -20%

Drought, -30%

40

80

200

30

60

150

20

40

100

10

20

50

0

0

Irrigation Pipe water Integrated Integrated
water price pricewater price water price(WPP),(WPP), (WP_A), % (WP_B), %change level, %WP_B

Domestic supply of farming commodities

Domestic supply of farming commodities

Drought, -10%

WP_A

-1

-1

Domestic supply of farming commodities

WPP

-0.5

0

Irrigation Pipe water Integrated Integrated
water priceprice water price water price(WPP),(WPP), (WP_A), % (WP_B), %change level, %Irrigation Pipe water Integrated Integrated
water price price water price water price(WPP),(WPP), (WP_A), % (WP_B), %change level, %Figure 5 Results on households, farming commodities and the water prices
Source: derived from model simulations.

Figure 5 shows that the WPP is still better than the WP_B in protecting the domestic supply offarming commodities from the severe drought because the decline in this supply is less. However, thelosses in welfare for rural households in the WPP are worse than those in the WP_B.
Table 1 Results of the Drought-30% on water distribution
Unit, %
Total water demand in farming sectors
Total water demand in industrial sectors
Total water demand in service sectors
Total water consumption of households
Total water supply

Source: derived from model simulation.

WPP-30.09-28.28-35.88-17.20-30.00

WP_A-33.25-28.12-31.62-15.60-30.00

WP_B-36.52-22.64-24.52-12.68-30.00Table 1 shows that the decline in the water demand of farming productions in the WP_B is lower
than in the WPP and the WP_A, which is the reason for the more significant decreases in the domestic
supply of farming commodities in the WP_B than in the WPP and the WP_A. However, households’
water consumption decreases by 17.20% in the WPP, which is lower than that in the WP_A and the
WP_B (where it decreases by 15.60% and 12.68%, respectively). Accordingly, the WP_B is the best
option for households because it provides more water for consumption with the lowest increase in thewater price. Moreover, the WP_A is the worst case for rural households because the loss of theirwelfare is worse than in the WPP and WP_B.
The flow charts for the impact of Drought on the WPP, WP_A and WP_B are shown in Figure 6,
7 and 8 respectively. These flow charts are focus on the total level of farming production andconsumption rather than a specific crop. The story is similar but the changing level is different among
these three systems. For example in WPP, Figure 6 shows that the domestic supply of farming
commodities will be narrowed and their selling price would be higher in the case of a severe drought
which decreased the total water supply. Accordingly, farmers must employs more capital, labor andnon-irrigation land, and then the wage of non-agricultural labor and the returns of capital andnon-irrigation land would be higher, which would increase households’ income, especially rural
households. However, higher income could not compensate for the losses in households’ welfare.
For the simulation of the WP_A and WP_B as shown in Figure 7 and Figure 8, the irrigationwater supply and the pipe water supply should be changed to the integrated water supply. In particular,
the total imports of farming commodities increase in the WP_B but decrease in the WPP and the
WP_A, which means that based on this system, it is more likely to increase the imports of farming
commodities to protect households’ welfare from the drought by relying on the highest increases in theprice of farming products.
Legend:Decrease level (more to less):

Return to Capital

Irrigation Water Price

Wage of Agricultural labor

Export prices

Agricultural Labor Demand

Capital Demand

Exchang
Exports

Irrigation Water supply

Farming Water Demand
Farming Outputs

ImportDemand of Composite
Irrigation Land-water

Return toirrigation land

Consumer Price
Index (CPI)
Return to nonirrigation land

Price of
Farming

Imports

Non-irrigation Land demand (Fixed)
Rural Households’ income

Pipe Water Price

Pipe Water supply

Demand of Domestic Supply ofFarming Commodities

Integrated Water Demand usedin Industry and Service

Rural Households’ Consumption

Price of In. Se. Products

Output of Industry and Service

Demand of Domestic Supply
of Industry and Service

Rural
Households’
WelfareFigure 6 Flow chart of the impact of drought on the water parallel pricing system (WPP)
Source: constructed by author

Moreover, we can still find that the losses in the rural households’ welfare in WP_B are less thanin the WPP and the WP_A. That’s because they benefit from highest increase in their income and lessdecrease in their consumption in the WP_B. Precisely, highest increase in their income in this system

results from more significant increases in the returns of the capital and to non-irrigation land and in thewage of agricultural labor. The increases in the return and the wage in the WPP and the WP_A,
however, are less; thus the decrease in their welfare will be more significantly.
Legend:Decrease level (more to less):

Return to Capital

Integrated Water Price

Wage of Agricultural labor

Export prices

Agricultural Labor Demand

Capital Demand

Exchang
Exports

Integrated Water supply

Farming Water Demand
Farming Outputs

Demand of Domestic Supply ofFarming Commodities

Demand of Composite
Irrigation Land-water

Return toirrigation land

Consumer Price
Index (CPI)
Return to nonirrigation land

Price of
Farming

Imports

Non-irrigation Land demand (Fixed)
Rural Households’ Consumption

Rural Households’ income
Price of In. Se. Products

Integrated Water Price

Integrated Water Demand usedin Industry and Service

Integrated Water
supplyImport

Rural
Households’
WelfareDemand of Domestic Supply
of Industry and Service

Output of Industry and Service

Figure 7 Flow chart of the impact of drought on the water pricing system under current reform (WP_A)
Source: constructed by author
Legend:Decrease level (more to less):

Return to Capital

Integrated Water Price

Wage of Agricultural labor

Export prices

Agricultural Labor Demand

Capital Demand

Exchang

Exports
Integrated Water supply

Farming Water Demand
Farming Outputs
Demand of Composite
Irrigation Land-water

Return toirrigation land

Consumer Price
Index (CPI)
Return to nonirrigation land

Price of
Farming

Imports

Non-irrigation Land demand (Fixed)
Rural Households’ income

Integrated Water Price

Integrated Water
supplyImportDemand of Domestic Supply ofFarming Commodities

Integrated Water Demand usedin Industry and Service

Rural Households’ Consumption

Price of In. Se. Products

Output of Industry and Service

Demand of Domestic Supply
of Industry and Service

Rural
Households’
WelfareFigure 8 Flow chart of the impact of drought on the water pricing system under further reform (WP_B)
Source: constructed by author

5. Conclusion
Based on three SCGE models with different water management systems, the simulations aimed to
select the superior policy option between the water parallel pricing system and the water pricing
system when a severe drought occurs. The results showed that the domestic supply of farming
commodities would be decreased and then their selling price would be raised. Accordingly, farmers thedemand for labor, capital, and non-irrigation land would be increased, and thus the wage of
agricultural labor and the returns of capital and non-irrigation land would be higher, that would

increase households’ income, especially for rural households, while higher income could notcompensate for the losses in households’ welfare. Furthermore, the water pricing system under thecase of further reform was better for rural households. This was because households in this system
would benefit from a higher increase in income and less decrease in consumption. However, thedecrease in the farming water demand was more significant, and thus the decline in the domestic
supply of farming commodities was more severe. In addition, water users in this system would benefit
from the lowest increase in the water price.
Endnote:[1]: In the current water parallel pricing system, the supply curve of irrigation water is depicted in theright side of the upper half of the following figure as a vertical line, and the irrigation price isdetermined by the government, which involves the subsidy. The right side of the upper half of thefollowing figure shows the determination of the pipe water price, where the pipe water price is higher
than the marginal cost and equal to the social marginal cost when the environment cost is included. In
the current reform of the water pricing system (see the middle part of the following figure), theintegrated water price contains both the irrigation water price and the pipe water price, which meansthat both irrigation water and pipe water will be priced with the volumetric method. Thus, their prices
will be equal their social marginal costs, and the price of water for irrigation will still contain a subsidy
to protect the agriculture and farmers. In the further reform of the water pricing system (see the bottom
half of the following figure), the integrated water will be priced at its social marginal cost level as
undertaken by all water demand sectors, and the subsidy will be imposed on the prices of agricultural
products so that the actual prices of agricultural products will be lower than their marginal costs level.
PP

Q = water amount;S
Irrigationwater price

Note:

S’

Pipe water priceS

P = water price;

Marginal cost level

Subsidy

S = water supplyDDQ

curve;

Q

S’ = water supply
curve

Current water parallel pricing system

with

the

externalities;

Current reform to the water pricing system

D = water demand
curve;S’P

Pagricultural = priceSofIntegrated water price
Subsidy

agricultural

products;

Price of water for irrigation

D

Qagricultural=

Q

amountofagricultural
Future reform to water pricing system

P
Integrated
water priceproducts;
S’
S

Pagricultural

Sagricultural

curve of agricultural
products;

Marginal cost level
SubsidyD

Sagricultural = supply

Actual Price ofagricultural products

Dagricultural

Dagricultural=

demandof

curve

agricultural products

Q

Qagricultural