Is it true that "Everyone's a winner?" Dams in China and the challenge of balancing equity and efficiency during rapid industrialization

Jesse and I both come from the Sustainable Development PhD Program at Columbia which has once again turned out a remarkable crop of job market candidates (see outcomes from 2012 and 2011). We both agreed that their job market papers were so innovative, diverse, rigorous and important that we wanted to feature them at FE.  Their results are striking and deserve dissemination (we would probably post them anyway even if the authors weren't on the market), but they also clearly illustrate what the what the Columbia program is all about. (Apply to it here, hire one of these candidates here.) Here is the third and final post.

Large infrastructure investments are important for large-scale industrialization and economic development. Investments in power plants, roads, bridges and telecommunications, among others, provide important returns to society and are compliments to many types of private investment. But during rapid industrialization, as leaders focus on growth, there is often concern that questions of equity are cast aside. In the case of large-scale infrastructure investments, there are frequently populations ("losers") that suffer private costs when certain types of infrastructure are built -- for example, people whose homes are in the path of a new highway or who are affected by pollution from a power plant.

In public policy analysis and economics, we try to think objectively of the overall benefits of large investments to an entire society, keeping in mind that there will usually be some "losers" from the new policy in addition to a (hopefully larger) group of "winners."  In the cost-benefit analysis of large projects, we usually say if that a project is worth doing if the gains to the winners outweigh the loses to the losers -- making the implicit assumption that somehow the winners can compensate the losers for their loses and continue to benefit themselves. In cases where the winners compensate the losers enough that their losses are fully offset (i.e. they are no longer net losers), we say that the investment is "Pareto improving" because nobody is made worse off by the project.

A Pareto improving project is probably a good thing to do, since nobody is hurt and probably many people benefit. However, in the case of large infrastructure investments, it is almost guaranteed that some groups will be worse off because of the project's effects, so making sure that everyone benefits from these projects will require that the winners actually compensate the losers. Occasionally this occurs privately, but that tends to be uncommon, so with large-scale projects we often think that a central government authority has a role to play in transferring some of benefits from the project away from the winners and towards the losers.

But do these transfers actually occur? In a smoothly functioning government, one would hope so.  But the governments of rapidly developing countries don't always have the most experienced regulators and often pathologies, like corruption, lead to doubt as to whether large financial transfers will be successful.  Empirically, we have little to no evidence as to whether governments in rapidly industrializing countries (1) accurately monitor the welfare lost by losers in the wake of large projects and (2) have the capacity necessary to compensate these losers for their loses. Thus, establishing whether governments can effectively compensate losers is important for understanding whether large-scale infrastructure investments can be made beneficial (or at least "not harmful") for all members of society.

Xiaojia Bao investigates this question for the famous and controversial example of dams in China. Over the last few decades, a large number of hydroelectric dams have been build throughout China. These dams are an important source of power for China's rapidly growing economy, but they also can lead to inundation upstream, a reduction in water supply downstream, and a slowed flow of water that leads to an accumulation of pollutants both upstream and downstream.

Bao asks whether the individuals who are adversely affected by new dams are compensated for their losses. To do this, she obtains data on dams and municipal-level data on revenue and transfers from the central government.   She uses geospatial analysis to figure out which municipalities are along rivers that are dammed and also which are upstream, downstream or at the dam site.  She then compares how the construction of a new dam alters the distribution of revenues and federal transfers to municipalities along the dammed river, in comparison to adjacent municipalities that are not on the river.

Bao finds that the Chinese government has been remarkably good at compensating those communities who suffer when dams are built.  Municipalities upstream of a dam lose the most revenue both while the dam is being built and after it become operational. But at the same time, the central government increases transfers to those municipalities sufficiently so that these municipalities suffer no net loss in revenue. In contrast, populations just downstream look like they benefit slightly from the dam's operation, increasing their revenue -- and it appears that the central government is also good at reducing transfers to those municipalities so that these gains are effectively "taxed away." The only group that is a clear net winner are the municipalities that host the actual dam itself, as their revenue rises and the central government provides them with additional transfers during a dam's construction.

These findings are important because we often worry that large-scale investment projects may exacerbate existing patterns of inequality, as populations that are already marginalized are saddled with new burdens for the sake of the "greater good." However, in cases where governments can effectively distribute the benefits from large projects so that no group is made worse off, then we should not let this fear prevent us from making the socially-beneficial investments in infrastructure that are essential to long run economic development.

The paper:
Dams and Intergovernmental Transfer: Are Dam Projects Pareto Improving in China?
Xiaojia Bao  
Abstract: Large-scale dams are controversial public infrastructure projects due to the unevenly distributed benefits and losses to local regions. The central government can make redistributive fiscal transfers to attenuate the impacts and reduce the inequality among local governments, but whether large-scale dam projects are Pareto improving is still a question. Using the geographic variation of dam impacts based on distances to the river and distances to dams, this paper adopts a difference-in-difference approach to estimate dam impacts at county level in China from 1996 to 2010. I find that a large-scale dam reduces local revenue in upstream counties significantly by 16%, while increasing local revenue by similar magnitude in dam-site counties. The negative revenue impacts in upstream counties are mitigated by intergovernmental transfers from the central government, with an increase rate around 13% during the dam construction and operation periods. No significant revenue and transfer impacts are found in downstream counties, except counties far downstream. These results suggest that dam-site counties benefit from dam projects the most, and intergovernmental transfers help to balance the negative impacts of dams in upstream counties correspondingly, making large-scale dam projects close to Pareto improving outcomes in China.
In figures...

In China, Bao obtains the location, height, and construction start/stop dates for all dams built before 2010.

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For every dam, Bao follows the corresponding river and calculates which municipalities are "upstream" and which are "downstream." She then computes finds comparison "control" municipalities that are adjacent to these "treatment" municipalities (to account for regional trends). Here is an example for a single dam:

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Bao estimates the average effect of dam construction (top) and operation(bottom) on municipal revenues as a function of distance upstream (left) or downstream (right).  Locations just upstream lose revenue, perhaps from losing land (inundation) or pollution. Locations at the dam gain revenue, perhaps because of spillovers from dam-related activity (eg. consumer spending). During operation, downstream locations benefit slightly, perhaps from flood control.

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Government transfers during construction/operation upstream/downstream. Upstream locations receive large positive transfers. Municipalities at the dam receive transfers during construction. Downstream locations lose some transfers (taxed away).

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Transfers (y-axis) vs. revenue (x-axis) for locations upstream/downstream and at the dam site, during dam construction. Locations are net "winners" if they are northeast of the grey triangle. Upstream municipalities are more than compensated for their lost revenue through transfers.   Municipalities at the dam site benefit through revenue increases and transfers.

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Same, but for dam operation (after construction is completed). Upstream locations are compensated for losses. Benefits to downstream locations are taxed away. Dam-site locations are net "winners".

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