How Mongolia Is Handling Its Mining Bonanza

US-China Rivalry and Digital Connectivity in the Indo-Pacific

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Is Mongolia’s prosperity being built at the expense of its future stagnation? A growing number of experts believe that the country is becoming over-reliant on mining-led growth. Making matters worse, the government is only saving a measly one cent of each dollar earned from its mineral output.

 

To expedite mineral shipments, the government had pledged to build a separate railway by this year from the massive Tavan Tolgoi coal mine to expedite coal deliveries through the South Gobi corridor. But it failed to secure financing.

A steep rise in Mongolia’s indebtedness was happening well before the Covid-19 pandemic slammed the economy, while saving rates take a steady fall and oligopolistic ownership structures tighten their grip on key industries.

 

All of this has had the effect of chipping away at the country’s long-term competitiveness. What are the indicators? Consider just three from a lengthening list: a growing exodus of skilled human capital; a falling rate of female participation in the labor force; and diminishing prospects for diversified development. To cap it off, there’s been a gradual weakening of the country’s institutions: autonomy, transparency and accountability are being sacrificed at the altar of preserving the status quo.

 

Given the significant and immediate benefits of mining-led growth, Mongolia’s leaders have been suffering from a great temptation to focus on the near term. It is commendable that since the advent of large-scale mining in 2004, Mongolia’s economy has grown at an average rate of 7.2 percent per year, making it one of the fastest-growing economies in the world. Growth has translated to sustained poverty reduction without a significant increase in income inequality. Quality of life has improved, with Mongolia compared favorably with its peers in terms of the stock of human and physical capital. All these factors have been made possible by significant mineral revenues and a high level of external borrowing, providing the means to support a generous (but inefficient) social assistance system and a large public investment program.

 

Success with Challenges

 

In the shadow of success have grown many of Mongolia’s enduring challenges, further exacerbated by climate change and the Covid-19 pandemic. Mongolia’s rapid growth has been obscured by its extreme macroeconomic volatility and frequent boom-and-bust cycles. Growth has almost entirely come through capital accumulation and the intensive use of natural capital rather than sustained productivity growth. Elimination of extreme poverty owes more to the generous social transfer system than to the creation of abundant well-paying jobs. Instead of using mineral wealth to gradually reduce its dependence on the extractive sector, Mongolia has become increasingly addicted to it. Such complacency is ill-timed, especially as demand for key minerals is likely to tumble. This will be due to climate change concerns, a shift of investors’ preference toward sustainability, China’s ambitious goal to reduce coal consumption and the persistence of the pandemic shock.

 

Mining has always been an important part of Mongolia’s economy, and this dependence has intensified in recent decades. Following the discovery of major new mineral resources (coal deposits and gold-copper ore) in the early 2000s, the economic significance of the mining sector increased, surpassing that of the traditional livestock sector. The Erdenet Copper mine opened in 1974, and for quite a time it was one of the largest copper mines in the world.

 

Today, mining accounts for nearly a quarter of gross domestic product (GDP), up from a tenth in 2000. Inflows of foreign direct investment (FDI) are mainly concentrated in the mining sector, which has seen its share go up from 44 percent of total FDI in 2000 to 73 percent in 2019. Mineral exports represent around 90 percent of total exports and 26 percent of fiscal revenues. Mongolia’s mining sector concentrates on a few products and export destinations. In fact, coal, copper and gold averaged 70 percent of total exports over the past five years; and exports to China alone reached over 90 percent of total exports.

 

Mining wealth has been associated with rapid growth, low poverty headcount and a moderate level of inequality. Since the commencement of large-scale mining in 2004, Mongolia’s economy has grown rapidly. Extreme poverty has been eliminated and inequality has not increased dramatically, although 28 percent are poor — according to the official poverty line. The country enjoys relatively strong human capital, and the quality of infrastructure, though scarce given the size of the country and low population density, is nevertheless comparable with other lower middle-income countries. (In The Changing Wealth of Nations, published by the World Bank in 2018, human-capital wealth is defined as the present value of future earnings for the labor force.)

 

Needing Diversified Growth

 

Many of these gains can be traced to generous social assistance and a large public investment program, financed by mineral revenues and external borrowings. Yet, experts and studies point to a key fact: such spending has often been poorly targeted and inefficient, failing to lay the foundations for more diversified growth.

 

The focus on preserving mining-driven prosperity has meant underutilization of other factors of production. Mongolia ranked 51st globally in the World Bank’s Human Capital Index, higher than its income-level ranking (92nd), largely due to its high educational attainment. This implies that Mongolia’s people have the skills, health, knowledge and resilience — human capital — to become more productive, flexible and innovative. Alas, Mongolia does not make full use of this capital, as evidenced by the country’s status as an outlier among its peers when it comes to the utilization of human-capital wealth in its production process. At the same time, many who assess Mongolia’s performance on institutional capital (for example, rule of law and corruption control) say that the country has deteriorated in recent decades. It has substantially underperformed with regard to its aspirational peers, as its growth remains dominated by the exploitation of natural capital.

 

With such a measly amount of mineral revenue saved, it raises the question of where the money has gone. Much has been spent on programs that are politically popular. Since mineral revenues are part of the consolidated budget, and money is fungible, it is not possible to track how every tugrug, the country’s currency, was spent. But a comparison of the spending pattern before the advent of mineral wealth (1998-2003) and after (2004-19) is revealing. It shows that the public spending pattern did not change in the first few years of increased mineral revenue, which also overlaps with the period of a declining ratio of public sector debt to GDP. But coinciding with the 2008 general elections and continuing through the next two elections, in 2012 and 2016, there were significant spikes in spending on social transfers (3.1 percent of GDP), public investment (6.3 percent of GDP) and wages and pensions of civil servants (1.8 percent of GDP). Since mineral revenues account for 6.7 percent of GDP during this period, some of the additional spending was financed through new borrowings.

 

Political convenience, and not economic merit, appear to determine how mineral revenue has been utilized. Based on my analysis, and under the assumption that mineral revenues were largely spent on the above three items, one can conclude that nearly 56 percent of mineral revenues were spent on public investment, 28 percent on social transfers, and 16 percent on wages and pensions. It is later shown that Mongolia’s public investment program is inefficient by global standards, and the generous social transfers have been cited as a possible cause for anemic productivity growth.

 

There are encouraging signs of mineral revenues being invested more prudently in recent years, giving the government an opportunity to build on its own reforms. Mineral revenues averaged 7.2 percent of GDP during 2017-19, one of the highest levels in the last decade. But instead of using it to further top off social transfers and public investment programs — as done in the past — the government has allocated a large part of it to productive funds and to retire high-cost debts. In fact, 2017-19 marked a decisive shift in fiscal management, with the fiscal balance in surplus in two of the three years, three consecutive years of decline in the public debt-to-GDP ratio and more than 2.5 percent of GDP transferred to the Stabilization and Future Heritage Funds.

 

While significant, these improvements are susceptible to reversal should the political architects of these leave office. The current administration should build on its recent track record to introduce institutional changes that ensure that mineral revenues are prudently used irrespective of which party and people are in power.​

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