Unintended distortion of regulating water use: Evidence from China

The Chinese government has been using water efficiency targets to manage commercial, institutional, and industrial water use across the country. This paper argues that water efficiency targets may influence provincial administrators’ preferences in tightening water regulation in cities with higher water use while disproportionately overregulating water use in productive cities to satisfy their efficiency goals. I develop a city-level production model with water regulation preferences and show that the unintended distortion of water regulation in response to water efficiency targets leads to efficiency loss of resource allocation and further reshapes regional output across cities, especially for productive cities. Using a sample of city-level water data from 2006 to 2016 in China, this paper empirically investigates the impact of the Three Red Lines (TRL) policy on provincial administrators’ preferences in water use regulation. The results indicate that the elasticity of water regulation in response to the policy is approximately −0.64 to −0.8 and has resulted in tighter water regulations for cities with higher economic outputs. Quantitatively, eliminating water distortions would reshape water use across cities and increase the aggregate output of an entire province by up to 0.069%. The results imply that possible consequences of the political consideration of provincial administrators in satisfying water efficiency targets include inefficiency and inequality in water allocation.