Improving water policy analysis in CGE models: Deriving substitution elasticities from biophysical crop data in a case study for Egypt

A key challenge in modeling water scarcity in computable general equilibrium (CGE) models is getting the substitution elasticity between water and the other inputs right. This paper develops a novel method to derive the values of the substitution elasticity between water and land by implementing a one-way bottom-up linking from a crop model into a CGE model. Using biophysical relationships from a crop model, we calibrate the shape of the production function of agricultural activities in the CGE model. Furthermore, crop water requirement coefficients are imposed as biophysical constraints on the substitution in crop production. To demonstrate the advantages of this approach, we apply it to an irrigation water tax shock using SAM data for Egypt 2019 and compare the impacts under these derived elasticities with the elasticities of the GTAP-WATER model. The results show that our approach is similar to that of GTAP in the short run. However, in the long run, we find that the impact of the policy on agriculture is larger under the novel approach than under the GTAP elasticities. This method could be applied to other cases using region-specific crop model parameters to study water policy, water use efficiency, agricultural production, and rural development.