Mongolia

Sources of Growth
World Bank Country Economic Memorandum, 2007

Presentation
by Sudarshan Gooptu
Lead Economist, World Bank

Ulaanbaatar, October 2007.

What this Economic Report is all
about…
z Uses a state-of-the-art analytical framework, along
with direct and indirect evidence, to identify
“bottlenecks” to sustained and broad-based
growth in Mongolia.
z Key Questions:
– What will it take to keep the current high rates of
economic growth to continue in Mongolia?
– What needs to be done to ensure that the fruits of this
growth process benefits all in Mongolia, especially the
poor?
Here are a few facts…
z Looking at overall macroeconomic economic indicators,
Mongolia is in the midst of good times.
z Looking deeper one sees that:
‰ Over the past ten-year period, the sources of real GDP growth have
become very concentrated, and heavily dependent on mining and
livestock-based activities.
‰ Mongolia’s heavy dependence on a few commodity exports—
cashmere, copper and gold—have made its economy very
vulnerable to fluctuations in commodity prices and natural
disasters.
‰ Employment generation has been elusive despite having a young
and educated labor force.
‰ The population of the country is becoming increasingly
concentrated in and around Ulaanbaatar.
Dependence on primary goods has grown
in the past few years

z Two economic activities - livestock herding and mining -

represented more than 40 percent of real GDP in 2005
z Three commodities – copper, gold and cashmere –
accounted for 67 percent of Mongolia’s exports in 2005
z The vast majority of manufactured exports were textiles and
apparel

0.35 100%

90%
0.30
80%
0.25 70%
Herfindahl Index

% of exports
60%
0.20
50%
0.15
40%

0.10 30%

20%
0.05
10%

0.00 0%
1990 1995 2000 2004

Herfindahl Index Export share of five largest exports

 Mongolia is the 37th least diversified
economy among a group of 100 countries
1.00
0.90
0.80
0.70
0.60
0.50
0.40
0.30
0.20
0.10
0.00

y
a

na
lia

lic

an
an

ua
di
na
go

ub

ha
st
st

bo

ug
ki
et

kh
on

ep

G
m

Ur
be
Vi

za
M

Ca
R

Uz
Ka

yz
rg
Ky

Herfindahl Index Hirschman Index

Source: Database on export diversification (PRMED).

The higher the index, the lower the degree of diversification
Recent Mining Sector expansion
can be a good thing…
Figure 1.3: Mining Sector Performance, 1996-05
25% 180

160

20%
Mining GDP 140
z Despite the apparent near
15%
120
doubling of the share of
Mining Share in GDP 100

80
mining activity in GDP
10%
60
between 2001-05, when one
5%
40 examines the same ratio at
20 constant prices, the effect is
0%
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
0 much less pronounced—
Source: National Statistical Office of Mongolia.
mining has only increased its
1,400
Figure 1.4: GDP Performance, 1996-05
CONSTANT PRICES (Base year = 2000)
share in GDP by two
GDP
percentage points over the
1,200
decade.
Billions of 2000 Tugriks

1,000

z This serves to underscore that

800
Non-mineral GDP the recent expansion of the
600
sector has primarily emanated
400
Mining GDP from the price effect.
200

0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Source: National Statistical Office of Mongolia.
 Environmental Impacts need to
be managed
z Mongolia’s pastoral land and natural resources (including
forest and wildlife resources) are vast and clearly a huge
potential source of future economic growth.
z Given the dominance of the economy on natural resources
and livestock sectors, it is even more critical to minimize
environmental degradation and prudently manage
Mongolia’s vast pastoral land.
z This will help keep the productivity of these scarce
resources high, and depletion of the country’s “true
wealth” low (when valued in terms of the potential from its
exhaustible and non-renewable resources).
Value added per worker in Mongolia
is low except in mining
7000

6000
LCU in thousands

5000

4000

3000

2000

1000

0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Agriculture Manufacturing Mining Services Total

Source: Staff estimates based on data from Mongolian Statistical Yearbook (2004)
and Government of Mongolia
The future will depend on what is done today

The government has taken some recent measures which

are steps in the right direction:

¾ Reform of the tax code and strengthening of tax

administration

¾ Development of a more robust public financial

management system, that is far more open and
transparent

¾ Anti-corruption efforts aimed at disclosure and

strengthening institutions for prosecution of corruption
 Mongolia’s strategic location presents vast opportunities
Regional integration: Increased trade links with China and Russia

Russian Trade with China

• Opportunities from increasing
trade between its neighbors 12,000
Export 10,107
10,000 Import

• 30% annual growth in 8,000

In US$ million
international rail freight transit 6,000
4,748

through Mongolia 4,000 3,169

2,000 1,160

-
1998 1999 2000 2001 2002 2003 2004
Share of Russia – China trade to total Mongolia trade (%) Source: UN Comtrade

62 61
Exports
60
Imports
58 57

56
54
• Trade with Russia and China
54
accounts for almost 60% of
52 51
50
Mongolia’s external trade
48

46
2001 2005

Source: Mongolia Statistical Yearbook

 Supported by domestic integration

Size and Growth of UB and Aimag Centers

• Opportunities for better (Size of circle represents current population)

sub-national connectivity in 1,200

vast and thinly populated 1,000
country Erdenet
800

GDP/Capita
600
• Leveraging mining related Ulaanbaatar
400
infrastructure to ensure
200
sustainable provision of
0
infrastructure services to -4 -2 0 2 4 6 8
mining towns and adjoining Population Growth (% )
communities Source of raw data: Mongolia Statistical Yearbook

However, opportunities stemming from recent growth could be

limited by considerable challenges in infrastructure service provision
 Rapid urbanization that needs to be managed and
planned for
Mongolia’s Urban Population

2,500 By 2030, 67% of Mongolians

will be living in urban areas, with 2.3 million
highest concentration in UB
245,000 additional
2,000 inhabitants in urban
areas from 1990 to 2005

1,500
in 1,000

1,000

500

0
50

55

60

65

70

75

80

85

90

95

00

05

10

15

20

25

30
19

19

19

19

19

19

19

19

19

19

20

20

20

20

20

20

20
Source: United Nations

By 2030, 67% of Mongolia will be urbanized

 Inequitable distribution of infrastructure services
and regressive pricing regime
Access to Infrastructure Services by Poverty Status
• Non-poor have better access 80
Non-poor
to infrastructure services 70
Poor
60

Population (%)
• Only 30% of the poor have 50
40
access to all three services 30

(improved water source, 20

10
sanitation, and electricity) 0
Improved water Sanitation Electricity All three
source

Source: Mongolia Household Income and Expenditure Survey Report

Utilities Consumed by Non-poor Are Priced Below Cost
Percentage of Cost-Recovery Tariff

100

80

60
• Fuel used by apartment dwellers
40
are priced below cost
20
• Ger area residents pay the full
0
cost for the coal they use
Residential Electricity District Heating Coal

Efficiency Gains Price Increase Existing

Source: World Bank, Mongolia Infrastructure Strategy Report 2007.
 Absence of economies of scale
Mongolia: Income Density (2005)
100,000,000
• Income density per sq km is
899,399
GNI per km in US$

1,000,000 low relative to global average

2

10,000 1,118 • Lowers economic feasibility of

100 network extension
1
a

Mongolia: Relative Water Provision Cost, 2005

na

s
lia

e
ge
te
ni

or
n
go

i
wa

ra
a

a
Ch

ap
rit

St
on

ve
ts

(relative to a benchmark city of 250,000 residents)

ng
au

lA
Bo
M

te

Si
M

ba
i
Un

lo
G

1000 1.8
Source: World Bank, Mongolia Infrastructure Strategy 900 1.6

Relative Cost per Person

Report, 2007 800 1.4
700 Population 1.2

Population
600 Relative Water Provision Costs 1
500
0.8
• Due to low economies of scale in 400
0.6
300
water provision, small cities face 200 0.4

100 0.2
higher costs per capita 0 0

ar
ar
n

an
d

on
ii

t
ne
an

aa

lg

sa
ov

at
at

kh
or
O

de

ba
ba

al
sh

kh

Kh

ar
ib

Er
in

an
or

kh

D
ho
Sa

nd

Su

la
C

U
O

Source: World Bank, Mongolia Infrastructure Strategy

Report, 2007.
 Business Environment
Rankings slipping
Ease of... 2006 rank 2005 rank Change in rank

Doing Business 45 41 -4

Starting a Business 55 54 -1

Dealing with Licenses 34 35 +1

Employing Workers 61 57 -4

Registering Property 17 17 0

Getting Credit 65 59 -6

Protecting Investors 19 18 -1

Paying Taxes 56 53 -3

Trading Across
162 161 -1
Borders
Enforcing Contracts 41 40 -1

Closing a Business 115 113 -2

Source: Doing Business, 2007

 Business Environment
What Mongolian businesses have to say
(% of firms that perceives the particular constraint to be a major or severe obstacle)
60
Europe and Central Asia East Asia and Pacific
50
40
30
20
10
0
financing

instability
Tax admin.

Water
uncertainty
Corruption

financing

Licensing and
Tax rates

Crime

competitive
Transportation
Access to land

Customs and
Access to

Electricity
Legal system

regulations

Telecom
Cost of

Worker skills
Macro.

trade rules
Policy

Labor
Anti-

permits
 Corruption is the most frequently cited impediment to doing
business in Mongolia

 …and the share of Mongolian firms that view corruption as a

major or severe obstacle is higher in Mongolia than in most of the
62 other countries for which comparable investment climate
survey data are available
 Business Environment - The basic diagnosis…
Why corruption and a lack of accountability and transparency
in government-business interactions are the central
impediments
Table 1 : Corruption pervades every sphere of business activity
% of firms that view corruption as a % of firms paying bribes for electricity
major or severe obstacle 56.5 connection 26.0
Value of gift expected to secure % of firms paying bribes for telephone
government contract (% of contract) 4.3 line 23.0
% of firms indicating that political ties % of firms paying bribes for water
are important for business 47.1 connection 15.0
% of cases where unofficial payments % of exporters paying bribes for
needed for registration 15.2 customs clearance of exports 25.0
% of cases where unofficial payments % of importers paying bribes for
needed to obtain licenses and permits 22.2 customs clearance of imports 22.6
Source: Mongolia Productivity and Investment Climate Survey, 2004.

 The evidence indicates that corruption and a lack of transparency and

accountability pervade almost every sphere of business activity
Do Mongolian firms “innovate”?

z Diversification of the production structure requires

“discovery” of an economy’s cost structure
¾ Firms must adapt new technologies to local conditions and
“discover” which products they can produce at low enough
cost to be profitable

z Mongolia’s manufacturing base is narrow but this is

not because firms do not attempt to export new
products; every year in the period 2002-06
¾ New exports were 30% of exports at the 4 digit level
¾ Of these, 70 to 80% were new manufactured exports
¾ But half of new exports were discontinued next year, and
manufactured exports represented a large share of these
new exports discontinued the following year
 What are the “binding”
constraints?
z Infrastructure bottlenecks that have led to costly
transport, complex logistics, and long transit
times.

z Distortionary taxes, including lately in mining

sector activities, and complex customs and trade
rules that have increased the implicit cost of doing
business in Mongolia.
 What are the “binding”
constraints? (contd.)
z Need for better coordination.
– laws and regulations

– trade and logistics

– sector strategies and implementation plans

– resource use and environmental degradation.

z Growing corruption and inadequate contract

enforcement
z The high cost of capital
 The “How to...?”
z To get “quick wins” there is the need to deal with these
impediments to sustained growth through:
– investment climate reforms,
– productive public investment projects with large spillover
effects, and
– by addressing workforce issues to deal with their
underutilization and skills mismatches.
z It will not only foster mining sector development, but
should help diversify Mongolia’s non-mineral exports
– To enter new markets (at home and abroad) and create jobs.
– To motivate firms to provide additional products/services,
and
– To improve quality and efficiency.
 EXAMPLE: Need for Better Coordination in
CASHMERE SECTOR
z Firms need services requiring simultaneous, large scale
investments in order to:
– expand output of existing products;
– improve quality;
– expand the number of exported goods;
z Large informal exports of raw cashmere to China are an indirect
signal that the government has failed to address coordination
issues in important sectors such as the cashmere industry
– Herders lack finance, information and infrastructure to improve
cashmere quality
– Processors lack incentives and are reluctant to form strategic links
with herders
z Some of the consequences are:
– Shortages of quality raw cashmere
z force processors to operate below capacity

z an obstacle to FDI from luxury makers of cashmere goods

– Environmental degradation
INFRASTRUCTURE: Mongolia’s investment needs for the
next 10 years: Getting the priorities right
30
2005-2015 1995-2005
25

Investment % GDP
20

15

10

0
Telecoms Energy WSS (Full) WSS Transport Transport
(Reduced) (Reduced) (Full)

Source: Mongolia Infrastructure Strategy Report

• GoM proposed total infrastructure investment can reach up to an unaffordable and

unsustainable 48% of GDP

• According to estimates in the World Bank Infrastructure Strategy Report (2007),

reducing the list of investments would still amount to an unprecedented 22% of GDP

• Financing constraints would necessitate tough choices and prioritization among

investment options

• However, financial engineering is no substitute for sound project design (tax payers
and users must pay)
Even then there are risks that will
have to be contended with…
z Threats of “Dutch Disease” that has plagued most mineral
rich countries.
z Fiscal policy stance and populist spending programs
(threats to fiscal and debt sustainability)
z Domestic policies that may influence the investment
climate and the country’s attractiveness to foreign direct
investment, including taxation policies.
z Perceptions of corruption and weak governance that tend
to raise the costs of doing business
z Environmental risks.
This calls for…
z Good management of windfalls with the goal of
maintaining macroeconomic stability, and with due
consideration to fiscal and debt sustainability.
z Prudent investment of the windfalls to support
productive investments and broad-based growth;
z Institutionalizing counter-cyclical fiscal policy through
the budget rather than off-budget vehicles, and
z Implementing the new anti-corruption law and the
Extractive Industries Transparency Initiative (EITI) in
mining must take precedence as well. This requires
the Government to maintain an ongoing financial
commitment to collect, compile and publish its
mineral revenue statistics over time.
as well as…
z Improved pastoral and livestock management
practices. This needs to recognize the critical link
between land, water and livestock in designing risk
mitigation interventions.
z A multi-dimensional approach to dealing with
environmental impacts of mining activities and air
pollution control in the densely-populated urban-
areas (such as Ulaanbaatar).
 Policy Recommendations
Dealing with Infrastructure Bottlenecks
Overall Direction of Reform
Measures
z Prioritize infrastructure public
investments.
z Formalize sector investment
strategies in infrastructure
sectors with due consideration
to appropriate costing and fiscal
sustainability.
z Issue regulations to guide
public-private partnerships in
infrastructure construction and
service delivery.
Policy measures to introduce now
z Pricing
– Aligning prices with costs of provision
to free up resources for maintenance
and expansion
– Implementation of transparent, well-
targeted subsidy mechanisms to protect
the poor
z Efficiency and governance
– Efficiency improvements to help
mitigate necessary price increases
– Improved governance including policy
and regulatory reform to help attract
new sources of investments from within
and outside Mongolia
z Better planning
– Better allocation of resources to ensure
high economic returns and greater
poverty reduction impacts
– Prioritize potential projects and
maximize the roles of private sector and
civil society
 Policy Recommendations
Dealing with Distortionary Tax Regime
Overall Direction of Reform
Measures
z Carefully design Mining
Taxation Package and
Investment Agreements with
Mining Companies.
z Improve tax administration.
z Improve inspections regime
and undertake efforts to
disseminate information on
firms/consumer rights and
requirements in the context of
audits and inspections.
z Improve Customs
Administration
Policy Measures to implement
now
z Reconsider and re-evaluate the
mining royalty rates, the
windfall profits tax, and the
share of equity participation by
the State in mining projects.
z Efficient Management of
Savings: Establish clear fiscal
rules for management of
Development Fund resources
and mining revenues.
 Policy Recommendations
For Better Coordination
Overall Direction of Reform Measures
z Reduce transport costs and
complex logistics that are faced by
firms that rely on trade for their
growth opportunities (in mining
and non-mining sectors).
z Government policies should
accompany rather than attempt to
offset the ongoing migration and
economic concentration that one
is seeing in Mongolia today.
z The role of Information and
Communications Technology
(ICT) in facilitating the
acquisition, dissemination and use
of knowledge across a country is
critical in today’s rapidly growing
Mongolian economy, more so
given the vast geographical
territory that needs to be covered
by information.
Policy Measures to implement now
z Carefully select public
infrastructure investments to link
economic nodes/hubs and that have
non-sector specific benefits.
z Begin discussions on harmonizing
customs and border trade
regulations for goods and services
with Mongolia’s key neighboring
trading partners.
z Provide information to herders
about cashmere/meat products
market demand and prices.
z Encourage cashmere processors to
form strategic links with
downstream agents and improve
their productivity.
 Policy Recommendations
To combat Corruption and improve
Contract Enforcement
Overall Direction of Reform Measures
z Implement Freedom of
Information legislation
facilitating easy access for all to
government information.
z Fiscal and public financial
transparency of central and local
budgets.
z Periodic implementation and
publicizing of country
governance, anti-corruption and
public expenditure tracking
surveys.
z Facilitate citizen monitoring of
overall progress in reform program
implementation.
z Upgrade professional skills and
ethics of public employees through
focused training efforts.
Policy Measures to implement now
z EITI Implementation: Establish
multi-stakeholder committee.
Agree on reporting templates.
Prepare for disclosure and
dissemination of EITI report on
government’s mining related
payments and revenues.
z Implement Asset and Income
Declaration Law for senior civil
servants, candidates running for
public office, public sector officials,
and Parliamentarians.
z Revise procurement regulations
and competitive bidding thresholds
so as to create a level playing field
in public sector procurement of
goods and services.
 Policy Recommendations
Dealing with High Cost of Capital
Overall Direction of Reform
Measures
z Improve financial
intermediation
z Develop inter-bank market.
z Consolidate banking sector to
help reduce administrative
overhead costs and excessive
competition for deposits.
z Desirability and alternatives to
deposit insurance should be
evaluated.
Policy Measures to implement now
z Laws and regulations for SCCs,
NGOs and Finance companies
should more closely regulate
deposit taking activity and
promote soundness of small and
micro financial intermediaries.
z Improve credit reporting and
registration of securities
interests.
z Prohibit/strictly control cross-
ownership of financial and non-
financial enterprises.
Country Economic Memorandum
is available on
http://www.worldbank.org/mn/publications