With increasing industrialisation and urbanisation, more and more of China’s scarce water resources are being transferred from low-value agricultural use to high-value industrial and domestic uses. The challenge now facing decision makers is how to resolve the conflict between increasing food demand and decreasing water supply without undermining the growth of cities and the industrial sector. Along with water shortages, water use inefficiencies are apparent. An analysis of some causes of these inefficiencies is provided. They include attenuated property rights, artificially low water prices, lack of user participation in irrigation district management, fragmented government management, and lack of a compensating mechanism between upstream and downstream users. It is concluded, against the background of a transitional economy, that the lack of economic incentives in the allocation of water is the principal reason why shortage and waste coexist in Chinese irrigated agriculture. Owing to failures in both markets and governments, it is argued that water resources should be allocated through a quasi-market.