Mongolia's Economic Prospects

Resource-Rich and Landlocked Between Two Giants

Matthias Helble, Hal Hill, Declan Magee

• Publisher: Asian Development Bank
• Year: 2020
• ISBN:
  9789292622497
• Topic: Economics
• Subtopic: Macroeconomics
• Index: Economics

This publication examines Mongolia's recent economic development and outlines reforms that would help the country take advantage of its many opportunities. Mongolia is rich in natural resources and, although landlocked, is well-placed to boost trade with its two giant neighbors. The country needs to diversify its economy beyond mining, enhance economic stability, and increase employment. To maximize Mongolia's potential the government can improve macroeconomic management, enhance the skill base, and provide hard and soft infrastructure to promote trade and efficient logistics. Governance and institutional reforms are also crucial. The government will need to continue to drive reforms so that they are well implemented and deliver the intended change.

CHAPTER 1
The Economy: An Overview

Hal Hill and Matthias Helble

Mongolia is a lower-middle-income, landlocked, and resource-rich open economy that is in transition. These features, together with the country’s rich history, have defined its development trajectory in the recent past and are shaping its economic future.

With the looming collapse of the Soviet Union in the late 1980s and the withdrawal of Soviet troops from Mongolia, largely peaceful demonstrations demanding democracy gathered momentum from late 1989 in Ulaanbaatar’s Sukhbaatar Square and other major points of public assembly. In March 1990 the government agreed to have the country’s first multiparty elections, which were held in July. The Mongolian People’s Revolutionary Party won and invited opposition figures into a coalition administration.

The country then embarked on a radical new economic and political strategy that included consolidating democratic practices, “big bang” economic liberalization, and the normalization of relations with countries other than the Soviet Union, including, importantly, the People’s Republic of China (PRC) and the United States. In 1991, Mongolia sought membership in the Asian Development Bank, the International Monetary Fund, the World Bank, and the World Trade Organization,¹ and support from Western donors.

The transition from a centrally planned, communist, Soviet-dependent economy to an independent, market-oriented economy was both chaotic and rapid, and undertaken with little advance preparation. The economy and living standards had been sustained by very large Soviet aid, and the country ran a large trade deficit with the Soviet Union, equivalent to about 30% of gross domestic product (Pomfret 2002). This aid, which included energy, food, raw materials, capital equipment, and market access, abruptly ended. The ownership of practically all state assets, including dwellings and livestock, was privatized. The subsidies that had sustained state-owned enterprises, which dominated the economy during the Soviet era, were terminated. Public social services, including education, health, and pensions, were severely curtailed. Living standards plummeted, although this was mitigated in part by the large-scale return to a subsistence and nomadic economy. In the chaos, electricity and other basic utility services were cut off for a year or more in some regions. Mongolia’s economic contraction was one of the severest in post-Soviet economies (Pomfret 2002). Put simply, the institutions to manage a market economy were not in place.

The country more or less weathered the storms of the transition period. Elections in 1992 returned the government with a mandate to moderate the pace of liberalization and tackle deteriorating living standards. The worst of the economic decline was over by 1993, from when the economy began a slow recovery. A backlash against reforms resulted in a change of government through democratic means, with the Democratic Union coalition taking power in 1996. Despite this turbulence, Mongolia was on the path to becoming a modern, democratic, and market-oriented economy.

This chapter, in its analysis of the Mongolian economy, examines the factors that shaped the country’s democratization and strategies that can accelerate its socioeconomic development. In doing this, it is important to draw attention to Mongolia’s distinctive historical, institutional, and structural characteristics as contextual factors. In essence, these include the following six features:

•The economy and its institutions retain many of the features of a country and a polity in transition even though it has been 3 decades since the transition from a centrally planned to a market economy started.

•Geography and natural resource endowments shape Mongolia’s development outcomes. With a population of 3.31 million people (2020) and an area of 1.56 million square kilometers, Mongolia is the world’s least densely populated country, and therefore as a corollary, its resource-based activities have a strong potential comparative advantage.

•The landlocked country (one of 49 in the world) has the special characteristic of sharing a border with two powerful economies, the PRC and the Russian Federation.

•Mongolia has a harsh climate. Much of the country is snow-covered and inaccessible for as much as half the year, and is vulnerable to environmental fragilities.

•Mongolia has a highly unusual economic structure dominated by the capital city and mining, which account for about 65% and 20% of gross domestic product (GDP) respectively. The GDP of this small, dualistic economy was just $13 billion in 2018.

•The high concentration of exports is caused by Mongolia’s small size, geography, and natural resource endowments. The country has one of the world’s highest export concentrations (in products and market destination) outside the Middle East.

This introductory chapter, which draws on the study’s seven other chapters, is organized as follows: the next section gives an overview of Mongolia’s socioeconomic characteristics and development, and is followed by an analysis of the economy’s performance. The chapter closes with policy recommendations.

1.1 Economic Overview

Special challenges of transition economies

Mongolia retains many of the features of a typical transition economy that undertook a “big bang” liberalization. The policy decisions taken during the early 1990s—including the macroeconomic policy settings affecting the speed and extent of liberalization—continue to be felt. According to Dwight H. Perkins, a leading authority on transition economies, “the move from a centrally planned economy to a market economy is more complex than often assumed. A wide variety of institutions must be created—often from scratch—when a country transitions from a command system to a market system. The managers of these new institutions must also learn to operate in a very different way than in the old system, and that can take time” (Perkins 2018).

Pomfret (2002) sets out the issues clearly. There is no textbook that charts the path of transition from central planning to a market economy. The elements of transition may be classified into six major areas: price and trade reform, macroeconomic policy, enterprise reform, financial reform, labor markets, and social policies. Mongolia followed the experience of most transition governments in losing control of macroeconomic policy because of soft budget constraints and large, unsustainable fiscal deficits. But like most other countries that went through this transition, the government managed to regain at least a semblance macroeconomic control, partly with the assistance of four International Monetary Fund (IMF) programs during the 1990s. Mongolia’s prices and international trade were liberalized quickly and effectively.

In most transition economies, enterprise reform was messy and “kleptocracies” thrived because of an absence of regulatory frameworks and competition policies. In these countries, the efficiency gains that could have been expected from privatization rarely materialized. In Mongolia’s case, the rapid transition to democracy may have ameliorated some of these problems, but the divestment of state assets was not orderly. Financial reform was also difficult. Crises in the banking sector are common to most economies in transition, a reflection in part that banks in centrally planned systems are an arm of the state and are geared to the needs of state-owned enterprises. Governments in most cases were slow to introduce prudential and other reforms, and were reluctant to relinquish control over the allocation of capital. Mongolia fits this pattern, with its highly concentrated bank structure and recurring financial scandals, including those at the Development Bank of Mongolia (DBM).²

Living standards in most transition economies fell sharply, as secure employment in the public sector shrank, cradle-to-grave welfare systems were dismantled (or their coverage greatly eroded), and inflation hurt those reliant on wage incomes. These were all characteristics of Mongolia’s transition.

On socioeconomic outcomes, the country experience of transition economies varied from modest and relatively brief declines (several East European countries and Viet Nam) to catastrophic and protracted effects, especially where conflict ensued. The pace and nature of liberalization was in retrospect a determining factor for these outcomes. As Pomfret (2002: 119) puts it, “the best performing European and Asian economies, Poland and the [PRC], have both been characterized by slow privatization, … while … the relatively rapid privatization in the [Russian Federation] is widely viewed as a significant source of generally mediocre performance.” That Mongolia privatized and liberalized more quickly than most other transition economies raises the question of whether it is still grappling with the repercussions of decisions taken in the 1990s. This is a recurring theme in the current chapter.³

Eight stylized facts on the economy

There is a growing body of literature on the defining features of the Mongolian economy and its development trajectory and outcomes. The World Bank (2018d) identifies the key development challenges as macroeconomic instability; the need for economic diversification; poverty reduction and unemployment; improved infrastructure, transport, and environmental amenities; and governance. USAID (2010) draws attention to a broadly similar set of issues: the need for economic diversification; the country’s geopolitical position; inflation; the development of the domestic financial sector; the social agenda as it relates to poverty, unemployment, and the economic divide; food security; infrastructure and transport; the environment; and governance and planning. The IMF has produced several reports on the Mongolian economy, such as IMF (2008), in addition to its ongoing monitoring under Article IV and program agreements, such as IMF (2018c). Consistent with these reports, the following are eight stylized facts that characterize the economy’s development and potential.

Historical legacies. Mongolia can, as noted earlier, be understood only in the context of its distinctive history. The country dates its modern history from the Chinggis Khan era, 1206–1227, when the Mongolian empire extended to the Middle East and beyond. This meant that trade routes between Asia and Europe became relatively safe for travel, resulting in an expansion of trade. Openness to the world, and a willingness to embrace foreign cultures, marked the mentality of Mongols. For most of the 20th century, however, the country was isolated economically, politically, and socially apart from its connections to the Soviet Union and Council for Mutual Economic Assistance (COMECON). Following the Sino-Soviet split in 1960, Mongolia was cut off from a neighbor with which it had important contemporary and historical ties, until relations with the PRC were normalized in 1987. That all changed in 1990: an authoritarian state gave way to an elected democracy, the country opened up to international trade and investment, its citizens were free to travel, prices were determined in the market place, the state no longer provided employment and old-age security, and private ownership became the norm.

In a new climate of openness, Mongolia’s policy makers and society in general had no experience in dealing with foreign traders and investors, especially the sophisticated large mining companies that began to enter the country. Although democracy took root quickly, independent agencies and checks on the legal system, electoral processes, monetary and financial regulators, and much else in government had yet to be put in place. Inflation quickly accelerated. The currency became internationally traded and volatile. International relations had to be established in a rapidly changing world order. Rising poverty and inequality stoked social problems. The government’s inexperience at economic management saw international debt escalate to unsustainable levels. Not surprisingly, as Rossabi (2005) puts it, the “shock therapy,” and the individuals and institutions associated with it, became deeply unpopular and foreshadowed the later introduction of stop-gap populist fiscal and other measures. These legacies are still being felt.

Democratic progress, institutional deficits. Democracy was quickly and durably embedded in Mongolia (Rossabi 2005). Mongolia has held national elections every 4 years since 1992 and 1993. The two main parties, the Mongolian People’s Party⁴ and the Democrats, continue to dominate politics and political change is generally peaceful. Because of this, Mongolia ranks highly on indexes of political freedom, as discussed later in this chapter and examined in detail by Byambajav Dalaibuyan and Julian Dierkes in Chapter 7. Mongolia’s media and social media largely operate without restrictions and the country has a vibrant civil society.

These democratic freedoms, however, have yet to translate into significant improvements in institutional quality, notwithstanding a high level of literacy; gender balance; freedom to travel abroad; and, in this century, rising living standards. Apart from voice and accountability, important though this is, there is limited improvement in institutional quality. Bureaucratic reform has been slow and civil servants are poorly paid, forcing many to moonlight or seek other ways to supplement their salaries. Administration change brings a high turnover of civil servants. Independent checks on government (apart from the ballot box) are weak, and the country lacks a high-powered anticorruption agency with prosecutorial powers. Anecdotal evidence suggests the quality of basic government services, including education, health, and agricultural extension, may be weaker than it was during the communist era. The development of an independent and trusted legal system is slowly evolving.

Geography. Mongolia has a unique and challenging geography. Even though there is no systematic global evidence that geography at an aggregate level is a significant factor in economic development, it has shaped Mongolia’s population settlements, economic activity and general economic development, and spatial economic patterns in several significant respe...

Table of contents

• Front Cover
• Title Page
• Copyright Page
• Contents
• Tables, Figures, and Boxes
• Foreword
• Acknowledgments
• Author Profiles
• Abbreviations
• 1. The Economy: An Overview
• 2. Macroeconomic Management
• 3. Managing the Natural Resource Abundance
• 4. Economic Diversification Beyond Mining
• 5. International Dimensions of National Development: Trade, Foreign Direct Investment, and Labor Migration
• 6. Infrastructure and Connectivity
• 7. The Business Climate: Institutions and Governance
• 8. Living Standards, Labor Market, and Social Development
• References
• Back Cover