Economy & business

“Enhancing the contribution of preferential trade agreements to inclusive and equitable trade: The case of Mongolia” (Part I: slightly abridged)

By Namsrai BATNASAN, Professor, Business School, National University of Mongolia

In the new era of globalization, every country aims to boost the income of its people and improve the quality of life by revising the terms of trade using demand opportunities in foreign markets, by increasing the efficiency of trade participation, and by improving trade balance. However, integration of a national economy with the world economy through exchange of goods and services, capital flows, technology, information, and labor migration, ultimately requires greater liberalization of trade.
Over the years of transition, Mongolia has gradually implemented policies to liberalize its foreign trade and foreign investment regimes with the objective of promoting economic growth and economic sectors through an active trade policy, and increasing the country’s exports. Ever since, the impact of liberalization on the economy of Mongolia and, in particular, on the lives of its people, has become a hotly debated issue.
However, during the transition, Mongolia went through several turbulences; the country had to go through a long and hard way towards restructuring its obsolete economic system, opening its market, liberalizing trade, putting in place a system with a greater degree of competition and a broad-based ownership of assets, all of which have helped in overcoming the economic downturn of the initial years of transition and stabilizing the economy.
For the purpose of current study, liberalization is viewed purely in its trade and economic dimensions –  defined as removal of self-imposed barriers to trade and services; establishment of bilateral trade and economic cooperation agreements; and participation in multilateral trading arrangements.
Trade liberalization through preferential trade agreements may have enormous impact on trade and investment flows among countries. Preferential access to foreign market is obviously a source of economic efficiency, which ultimately leads to economic growth, employment generation, poverty and inequality reduction.

Trade and economic situation in Mongolia

Mongolia is a landlocked country, sandwiched between two giant neighbors – Russia and China – and located in the plateau of Central Asia, very far from seas and oceans and key international road and transport networks. The nearest seacoast1  from the country is located at a distance of over 1700 km.
Mongolia is the 17th largest country in the world in terms of the size of its territory of 1,564 million square kilometers and is larger than the combined size of Great Britain, Germany and France. The geography of this vast territory is characterized by towering mountains in the west, wide and open steppes in the east, the great Gobi Desert in the south and taiga forest in the north. Its climate is characterized by long winters with frequent snow blizzards and dzud or severe winter conditions; spring with persistent winds; hot and dry summers with low precipitation; and a short vegetation season.
The country’s population is relatively small though. As of 2015, the country’s population was just over 3.2 million, of which 45.7 percent lived in the capital city of Ulaanbaatar and 15.8 percent lived in the central region, where the capital is located. At the same time, none of the 21 administrative units outside the capital contained more than 5.0 percent of the population. Thus, population in rural areas is spread over vast distances, which makes Mongolia one of the most sparsely populated countries in the world.
Geography, location and demographics plays a critical role in Mongolia’s economic development. The country’s small population compared with its vast territory is a cause of some national weakness. Especially population in rural areas potentially suffer certain economic and social disadvantages due to the problems of distance and remoteness. Markets in rural areas are small while the costs for providing infrastructure such as roads, schools and health centers to remote areas are high.
It is basic economics that a market will come into existence only if the potential gains from market transactions exceed the transaction costs. Because of the small market, caused by scattered and small population, low level of income; markets have not developed in rural areas. The more scattered the population, the more inefficient to make an investment, and more expensive it becomes to produce and consume. Thus, businesses in rural areas are not well developed and rural agricultural sector fails to attract both foreign and domestic investments.
Geographical location is a principal driver of opportunities and the cost of living in Mongolia, especially considering the poor state of roads in remote regions, and the relatively high cost transportation externally and internally. Yet paradoxically rural isolation is eliminated by the transport infrastructure, with rural communities facing problems both in terms of market access and costs of production. Therefore, economic survival is difficult for rural businesses struggling to compete relative to businesses in urban areas. In addition, being a landlocked country Mongolia itself is isolated from world markets. Great distances, extreme weather conditions and a sparse and isolated population, are all contributing to the low competitiveness of Mongolia’s export products on the global market.
Pre-transition Mongolia was a least industrialized country, very much dependent on the former Soviet bloc nations for assistance and grant aid. However, within the bloc, Mongolia’s economy was one that was the most dependent on foreign grant aid and assistance, the country successfully traded within the bloc under the concessional terms of trade guaranteed by the Council of Mutual Economic Assistance (CMEA)2. Per capita GDP at that time was only USD1664.6 and the country’s total trade turnover was close to only USD1.5 billion3.
At the beginning of the 1990s, the people of Mongolia made a historic decision to overhaul both its political and economic systems and made their transition to market economy. Two decades later, after the collapse of centrally planned economy, Mongolia, a country that was dependent on foreign aid and assistance and with a small economy, had made giant strides of success in its economic transition.
After the disintegration of the socialist bloc in 1991, Soviet aid, which had until then played a critical role in the country’s economy, came to a screeching halt and stopped altogether. This aid then amounted to almost 30 per cent of the GDP4.  At the same time, Mongolian economy was dealt another severe blow with the dissolution of the CMEA, which then accounted for more than 90 per cent of Mongolia’s external trade5.
The combined effect of these dramatic external shocks inevitably pushed the country’s economy to its brink. Between 1990 and 1993, the country’s GDP fell by 20 per cent and total investment shrunk by 28.2 percent6.  Industrial and construction sectors went through a plummeting by 25 and 70 per cent respectively7.
Like many other former socialist economies, Mongolia experienced hyperinflation in the first few years of transition, followed by steady disinflation in subsequent years. The annual inflation rate reached an unprecedented peak of 325.5 per cent in 1992 and 183.0 per cent in 1993, which then fell rapidly, dropping to a single-digit unit by 20008.  The sharp decline in domestic production and the loss of external markets led to the emergence of ‘twin deficits’ – on fiscal and current accounts.
In the mid-1990s the Mongolian Government, for the purpose of stabilizing the economy, opted for a transition strategy, which in economic jargon is popularly known as “shock therapy”. Prices were liberalized, state-owned enterprises were privatized, free trade regime was introduced, balanced budget were achieved, an independent central bank and a fully convertible flexible currency were introduced.
These measures to stabilize the economy and promote foreign and domestic investments have enabled Mongolia to rescue its economy from a deep crisis in the early years of transition. GDP, which was declining at an average by 7.3% a year in 1990 and 1993, was growing by an average of 3.0% a year during the years between 1994 and 20009. In 2003, Mongolia’s per capita GDP reached the pre-transition level of per capita income10.  (See Figure 1)

    The collapse of the socialist system, the abrupt transition to a market economy and the accompanying measures adopted to stabilize country’s economy had dramatic consequences on employment, poverty and income disparity, as well as on the living conditions of people of the country as a whole.
An upward trend of economic growth has been observed since 2000, and average annual growth rate of GDP during 2001 – 2012 reached 8.2 per cent11.  The economy had grown more than 10% per year between 2011 and 2013, largely on the strength of mining-based exports and high government spending, before slowing down to 7.8% in 2014 and 2.3% in 2015. (See Figure 2) Mongolia’s per capita GNI reached USD 4377.3 in 2012 which thereafter steadily declined to USD 3967.8 in 201512.

    Obviously, trade liberalization was the most important element of Mongolia’s open economic policy during the transition period. At the beginning of economic transition, Mongolia’s trade policy was focused more on internal economic situation with an emphasis on protecting domestic production. Trade liberalization was expected to deal rapidly and most efficiently with two major flaws of centrally planned economic system, namely, (1) the distorted price structure, inherited from the previous system, and (2) centralized, highly integrated and inefficient production system.
During the years of transition, Mongolia gradually implemented policies to liberalize its foreign trade and foreign investment regimes, promote economic growth and economic sectors through active trade and investment policies, and increase the country’s exports. It is clear that trade policy was also aimed at strengthening Mongolia’s position in the regional and global markets, and integration into regional and world economies.
Trade liberalization in Mongolia started under conditional agreements with IMF and the World Bank as part of Structural Adjustment Program and later, under multilateral trade regulations of World Trade Organization (WTO).  On 29 January 1997, Mongolia officially entered WTO and was one of first economies in transition to become its member. Following this, Mongolia made major improvements in its trade and business environments. Mongolia pledged to reduce tariff and non-tariff barriers to trade.
Mongolia liberalized its trade by removing self-imposed barriers to trade and services by concluding bilateral trade and economic cooperation agreements and by participating in multilateral trade arrangements. Mongolia reduced its average nominal tariff rate and eliminated almost all licenses for export and import commodities. In 1997, import customs duties were removed, between 1999 and 2000 import tariffs were imposed at 5.0%13, in 2001 it was 7.0% and from 200214  the current tariff rate of 5.0% was introduced15,  which compared to many countries is fairly low and this shows that the country is committed to a more liberal trade. Mongolia reduced barriers to FDI in many industrial sectors, excluding air transportation, telecommunication services and state-owned power industry. Mongolia stopped all export and domestic subsidies in all economic sectors, facilitated customs standards, sanitary and phytosanitary restrictions, and product specifications.
A few export items were still a subject to export duties. Today, it is applicable only to raw cashmere, camel wool and ferrous and non-ferrous metal scraps, including copper, aluminum and iron. Export prohibitions affect drugs, narcotics, and certain kinds of hazardous and toxic chemicals. There is no quantitative restriction on either exports or imports. Export licensing is required for specific items such as paleontological and archaeological finds, fire guns, weapons, blood and blood products and radio-active elements. Import licenses are required only for items such as weapons, ammunition, explosives, etc. The country has acceded to many related international trade conventions, including Harmonized System Convention, TIR convention and Settlement of Investment Disputes etc.
Subsequently, some very important changes have taken place in the economy during this period that could have a potentially far-reaching benefit for the sustainability of future trade. More importantly, the country has achieved trade expansion by diversifying both the export destination and import sources far beyond the former Soviet bloc. Aside from the former Soviet bloc countries, China, Japan, South Korea, Germany, United Kingdom, and Kazakhstan have become major trading partners of Mongolia. (See Table 1)

    And since 1990, Mongolia’s trade turnover has grown almost 7 times over compared to its pre-transition level16.  In 2016, Mongolia’s trade turnover reached its peak during which total export value of the country was USD 4916.3 million and total import USD 3358.1 million17.
Mining and animal husbandry raw materials and textile constitute the bulk of Mongolia’s export. In 2015, the percentage share of these products accounted for as much as 95% of the total export. Hence, Mongolian economy has remained vulnerable and dependent, to a large extent, on external factors, including price and demand of raw materials, especially owing to the economic situation of its main markets – China and, to a lesser extent – Russia.
In general, the trade policy of Mongolia, since its transition to market economy, was targeted at promptly adapting to changing economic environment, as well as addressing the country’s economic challenges, mitigating the impact of transition and integration into world economy.
Mongolia has abundant natural resources and has vast potential for economic development. Today, the country’s economy is at a crucial crossroads of a new phase of its development, thanks in particular to the development of world class giant mining deposits.
Oyu Tolgoi (OT), the copper and gold mine in the South Gobi, holds over 35 million tons of copper and 1,275 tons of gold. In October 2009, the Government of Mongolia signed an investment agreement with Ivanhoe Mines of Canada and Australian mining giant, Rio Tinto for the development of OT. Its production began in 2013 and when it will reach its projected capacity by 2017-2018, it will annually supply 1.8 million tons of copper concentrate, which is close to 3 per cent of world output.
Another giant deposit Tavantolgoi (TT) has more than 6 billion tons of coal, one third of which is coking coal. Although Tavantolgoi has been in operation since 1967, its production has fallen short of planned targets and expectation. Coal production at Tavantolgoi increased sharply when the state-owned mining company Erdenes TT and a consortium of private corporations Energy Resource Group started mining at Tavantolgoi.
These investment projects present a unique development opportunity for the Mongolian economy as a whole. At the same time, the mining boom presents large policy challenges. International experience has demonstrated that resource-rich countries tend to under-perform compared with resource-poor countries and this tendency has been called the “resource curse”.
The key challenge is to sustain economic growth over a long period of time. Also, there is an obvious risk that Mongolia might revert to a high, but jobless growth path that was experienced in the past decade. The massive increase of mining production would be converted as a strong upward pressure on the exchange rate as well as upward pressure on domestic wage rates and on inflation, all of which would further undermine the already poor competitiveness of the tradable sectors of the economy and work against economic diversification and a more broad-based economic development of the country.
The changing situations and opportunities demand the rethinking of new development objectives for the country. Also, there is a need to formulate new trade policy objectives that will ensure equitable and stable economic growth. Therefore, the role of effective policymaking is very important.

Economic growth, trade, poverty and employment in Mongolia

As mentioned earlier, in the early 1990s Mongolian government opened up its market by liberalizing trade and denationalization of state properties. The combined effect of trade liberalization and privatization led to a dramatic increase in poverty, inflation, economic insecurity, and rising inequality in income distribution.
Economic growth, in the sense of expansion of material production, may be achieved through various means, each involving a distinct configuration of production and employment structures, and income distribution. Economic growth in Mongolia has gone through four distinct phases of development since its transition to market economy. (See Table 2)

    At the beginning of transition or between 1990 and 1994, with the entry into market economy, a set of relative prices were introduced that rendered unprofitable a large portion of the country’s economy. These unprofitable enterprises, which were built during the years of socialism without any consideration for economic efficiency, were allowed to go out of business, reducing output, employment and income. This led to a fall in aggregate demand and, through multiplier process, to substantial reduction in income. The downturn was exacerbated by the lack of managerial skills; shortages of capital, equipment, raw materials and fuel; questionable banking practices, corruption, slack financial oversight and banking services, coupled with other market distortions. Following privatization, many industrial and agricultural enterprises, including state owned livestock cooperatives – negdels, fell into inexperienced hands that ultimately led them to bankruptcy and thousands of people lost their jobs. Also, livestock privatization and the dissolution of negdels have led to a decline in the quality of infrastructure and services supporting herders, thus adding to their vulnerability. Alongside trade liberalization and privatization, the drastic economic decline created disturbing social problems as poverty and unemployment, which even today continue to be at an unacceptably high rate. (See Figure 3)

    Mongolians used a number of strategies to survive the uncertainties of the economic transition. Many responded to the massive economic changes through internal migration in search for better opportunities, working in the growing informal sector, trying to have fewer children, and working also in the agricultural sector. This was the first time that the Mongolians were faced with the problems of poverty and unemployment, which forced many urban residents to move to the countryside to engage in livestock herding. Mongolian traditional pastoral livestock sector helped to survive in this difficult period. Between 1990 and 1994, the number of agricultural workers increased by 30.1 per cent and many of them almost had no knowledge about agriculture18.  Consequently, agricultural productivity fell sharply.
Slight economic growth was observed between 1994 and 2001, however there was almost no improvement in the rate of poverty and unemployment during this period. The poverty headcount ratio which was 36.3 percent in 1995 fell marginally to 35.6 percent in 1998 and again rose to 36.1 percent in 2002. (See Figure 4) When macroeconomy experienced steady growth, the economy maintained its level of employment. In other words, economic growth failed to expand production and this growth process did not generate new jobs, that offers opportunities to all segments of the society to benefit from economic expansion. This ‘jobless recovery’ continued into the start of the new millennium.

    Mongolia’s economy returned to a relatively high growth rate since the transition to market economy and the average annual growth rate of GDP was 8.0 per cent during 2002-2014.  During this period, economic growth was in income generation briefly that helped reduce the rate of poverty quite rapidly. In current US dollar term, Mongolia’s GDP has increased more than 10 times compared with the 2002 level;  and household consumption expenditure has increased more than seven-fold. By 2008, GDP per capita, in US dollar terms, had recovered to the pre-transitional 1989 level.  This means that average standard of living in Mongolia returned to pre-transition level almost two decades later after the country went through the trauma of transition and other shock therapies.
However, despite the leading role played during this period by the mining sector as the engine of growth, this growth has been rigid for job creation. There are several reasons, including, first, the growth of output has not concentrated in labor-intensive sectors; second, more capital-intensive techniques are used, especially in the growing mining sector; and, third, the terms of trade were more convenient for capital-intensive mining sector. Therefore, over this time, on the one hand, faster growth has translated into poverty reduction, and on the other hand, unemployment has increased.
Even though, according to official statistics poverty today is still a much more widespread phenomenon in Mongolia than unemployment and very small share of the poor in Mongolia are unemployed. Most of the poor in Mongolia are ‘working poor’ instead of being unemployed, and so, there is a pending need to pay attention to the quality of employment.
As to distributional impact of mining, inequality between geographic regions and social groups has increased and the rapid mining boom has produced an income pyramid of population, with a small part of the population considered “wealthy”, while the rest of the population are in the “middle” and “poor” strata.  As indicated in the “Household Socio-Economic Survey 2012”, the consumption share of the poorest quintile of the population is equal to 7 percent of the country’s total consumption and the second poorest quintile is 12 per cent.  In contrast, the richest quintile has consumed 41.8 per cent and the second richest – 22.4 per cent, while the medium quintile is 16.3 per cent. The richest quintile has consumed more than 2/5 of total goods sold in the consumer market.
As indicated in the 2014 Household Socio-Economic Survey, 21.6 percent of the total population were living in poverty, which although is a decrease of 17.2 points from its peak in 2011 and by 14.5 points from the beginning of this period. During this period, unemployment rate has grown from 3.4 to 7.9 per cent.
Since 2014 Mongolia’s economic growth fell sharply. GDP growth rate in 2015 was 2.3 per cent and only 1.0 per cent in 2016. This resulted chiefly due to the sharp fall in the global commodity prices, including Mongolia’s main export products such as copper, coal, and gold.

(Final Part 2 to be continued in edition No. 12, 31.12.2017 of TMO)

1. Batnasan Namsrai., “Foreign trade: operational management and legal regulations” Ulaanbaatar 2003

2 CMEA or better known to the West then as COMECON, which was an economic organization from 1949 to 1991 under the leadership of the former Soviet Union that comprised the countries of the Eastern Bloc, including Mongolia. COMECON was meant to prevent countries in the Soviets’ sphere of influence from moving towards that of the Americans and South-East Asia.
3 The World Bank “Country meta-data of Mongolia” 2012
4 S. R. Osmani “Towards an employment-oriented pro-poor development strategy for Mongolia: A background paper” UNDP, 2007
5 S. R. Osmani “Towards an employment-oriented pro-poor development strategy for Mongolia: A background paper” UNDP, 2007
6 NSO “Mongolia in a market system” statistical yearbook 1989-2002, p. 94
7 NSO “Mongolia in a market system” statistical yearbook 1989-2002, p. 136, 190
8 NSO “Mongolia in a market system” statistical yearbook 1989-2002  p. 108

9 Authors calculation based on statistical yearbooks of respective years
10 Authors calculation based on statistical yearbooks of respective years
11 Authors calculation based on statistical yearbooks of respective years
12 The World Bank “Country meta-data of Mongolia” 2012
13 WTO “Trade policy review of Mongolia” 2007 p. 28
14 WTO “Trade policy review of Mongolia” 2007 p. 28
15 WTO “Trade policy review of Mongolia” 2007 p. 28

16  Authors’ calculation based on statistical yearbook of respective years.  
17 General Customs Administration of Mongolia “Foreign trade commodity statistics 2012”

18  Government of Mongolia and UNDP “Human development report of Mongolia 2003” p. 36

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