Can Transverse Eco-compensation Mechanism Correct Resource Misallocation in Watershed Environmental Governance? A Cost-benefit Analysis of the Pilot Project of **n’an River in China

Abstract

Correcting resource misallocation that creates productivity and welfare losses is the key to correcting transboundary basin pollution. China has proposed a transverse eco-compensation mechanism (TECM) based on the traditional Coase scheme to solve the pollution of transboundary watersheds. But whether it can correct the misallocation of resources that cause productivity and welfare losses has been ignored in existing literature. This paper first conducts a theoretical analysis of the TECM’s resource allocation effect and operation mechanism. And on this basis, we use the cost–benefit analysis (CBA) method to show how TECM produced actions in relevant upstream regions towards correcting excessive pollution, and how TECM provided economic incentives for these regions to undertake these actions. The CBA analysis results are consistent with the theoretical analysis. The TECM project will benefit the upstream region with a discount rate of 3%, and the present value of the net income is 96.4 million yuan. The conclusion still holds in the case of different discount rates. The above results show that the TECM can correct the resource misallocation that creates productivity and welfare losses in cross-basin environmental governance, and provide economic incentives for upstream areas to correct environmental resource misallocation (excessive pollution). Finally, the TECM model has important policy implications for solving the problem of cross-basin pollution in other similar countries.

Appendices

Appendix 1: Selection of Reference Regions

In this study, we can regard the regions where **n'an River doesn’t flow through as the reference regions. According to China’s administrative division, the southeast Anhui Province includes Wuhu City, Chizhou City, Xuancheng City, and Huangshan City. The upper reaches of **n'an River mainly include the whole territory of Huangshan City, and its mainstream mostly flows through three areas: the central city, Qixian and **uning County. Huangshan City and Jixi County became the first pilot area of TECM. Other regions (3 central cities and 12 counties) where **n'an River doesn't flow through are not included in the scope of compensation.

Referring to Qiu and He (2017), we select variables that can reflect regional natural conditions, economic development and social conditions for comparison. Since both pilot and reference areas are located in the hilly area of southeastern Anhui Province, their natural endowments and political environment are very consistent. Therefore, we further compare the economic and social conditions, including the level of economic development, industrial structure, government fiscal expenditure, and population size. The indicators are selected as follows:

The level of economic development: the per capita GDP and the income gap between upstream and downstream areas (Cole 2004); Industrial structure: the ratio of value-added of secondary industry to GDP (Friedl and Getzner 2003); Population size: the natural logarithm (base E) of population size (Panayotou 1997); Government fiscal expenditure: the ratio of government fiscal expenditure to GDP (He and Zhang 2021). The comparison results are shown in Table 19. The results show that there is no significant difference in the mean value of the main economic indicators. Therefore, these regions are suitable reference areas. Finally, we use the average of each indicator in all reference areas to calculate the associated cost–benefit.

Table 19 Comparison table of major economic indicators in 2006–2010

Appendix 2: indirect costs of TECM projects

Referring to “Study on the Ecological Co-construction and Sharing Mechanism of **n’an River Basin” (China Institute of Water Resources and Hydropower Research 2006), we use indirect methods to analyze and calculate indirect cost. The calculation idea is as follows: select areas similar to the experimental group but not affected by TECM’s economic development as the reference object, and compare the economic difference. Approximately regard the difference between the two as the economic loss of environmental protection:

$$IEC_{t} = (gdp_{CG} - gdp_{EG} ) \times N_{EG}$$

where IEC_t is the cost of discontinuing the polluting industries; gdp_CG is the per capita GDP of polluting industries (agriculture and industry) in the control treatment area⁹; gdp_CG is the per capita gross industrial production value of polluting industries in the experimental group area; N_EG is the population of the experimental group. The specific calculation results are shown in Table 20.

Table 20 The indirect cost of TECM