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Mongolia needs better roads, schools and hospitals: so why all this talk about saving for the future?

Gregory Smith's picture
Also available in: Mongolian

Mongolia’s mining revenues are set to soar in the coming years, but here people talk about the need to save for the future.

Surely building infrastructure, educating young Mongolians, improving healthcare and creating jobs is important? Surely by achieving these development goals Mongolia is providing for the next generation? These are great questions. Mongolia must do these things. But they in turn depend on efforts to prevent boom and bust and provide financial assets for future generations. Saving some of the revenues in good times is part of effective natural resource management.

Eric Parrado, former head of the Chilean ‘Economic and Social Stabilization Fund’, tells us that “if natural resource booms are well managed they can be a blessing” and that “an important general lesson is that governments should avoid temptation to spend significant temporary surpluses”. Eric was just here in Ulaanbaatar among international experts working with the Mongolian government to improve mechanisms to save resource revenues to (i) smooth the economy (a rainy day fund) and (ii) provide for future generations of Mongolians.

So why should Mongolia save? The main reason being reliance on non-renewable natural resources (which Mongolia’s geology provides in plenty) poses significant challenges to policymakers. These challenges are fourfold:

  • First, natural resource revenues are volatile and uncertain. Global prices can change to great extent, without warning and are almost impossible to project reliably.
  • Second, natural resources run out; they are exhaustible. The benefits must be made to last by transferring some (and not all) for future generations.
  • Third, Mongolia will be selling most of its copper, coal, oil and other minerals abroad. This has implications for the domestic economy in terms of how the non-mining sector competes and in terms of macroeconomic stability.
  • Fourth, the exploitation of natural resources can be a source of corruption and inefficiency. Mongolia needs to deliver value for money when investing and spending tax payers’ and mining revenues.

 

Back to the ‘save some money’ solution – In the good years government should run a fiscal surplus (spend less than is collected in revenues). This provides opportunity to save. The saved money can be used in the tough years preventing cuts to important areas of expenditure like education, health and infrastructure. This also reduces the need for government to borrow and incur associated interest costs. Also if savings become plentiful the government could spend only the profits from investment without reducing the financial assets themselves.

Without political backing, which in turn reflects public opinion in Mongolia, saving cannot happen. Mongolia has a stabilization account and a Fiscal Stability Law limiting budget deficits. But it requires saving into the account and some improvements to the design. There is also no merit in bypassing the stability law and procedures by spending money off-budget, as witnessed in 2012 and now in 2013, as it prevents the above mentioned challenges from being met.

Mongolia has a history of boom and bust. The graph below shows the ups and downs of the recent economic cycle. With the graph in mind it’s worth thinking about the insight Eric shared from Chile. During the period copper prices increased rapidly Chile saved off-shore and when copper prices fell at the height of the 2008 global financial crisis, Chile weathered the storm by spending funds saved in the good times. Expenditure on education, health and roads was largely maintained despite huge swings in mining revenues. Crucially Chile had public and political consensus behind their prudent approach.

Saving in a Sovereign Wealth Fund for rainy days and future generations, underpinned by fiscal discipline, is essential to avoid the resource curse and make the most of Mongolia’s geological endowment. Chile is joined by Norway, Timor-Leste, Botswana, Trinidad and Tobago –among others- in utilizing savings for success in natural resource management. No story is perfect and in each instance policymakers muddled through, enhancing the design of their savings instruments and improving institutions in an iterative and incremental manner. While there is no best practice, Mongolia can gather principles from these examples and inform its own policy.

Communicating the merit of the savings message takes hard work. Spending in the short-term wins elections and provides a much needed, but unsustainable boost to people’s lives. If Mongolia is to benefit from its mining revenues substantially, and over the decades to come, it cannot leave the challenges of reliance on mining revenues unchecked. By looking over the horizon, and into the years just ahead, Mongolia will have ample opportunity for improved roads, schools and hospitals; and for providing jobs for Mongolians.

However, there’s a choice to be made: short-term and unsustainable gains versus medium- to long-term sustainable benefits. It’s up to Mongolians to decide on the trade-off: which way is best for Mongolia?

Learn more about effective sovereign wealth fund management in Mongolia in a policy note I co-authored with my colleagues:
http://documents.worldbank.org/curated/en/2013/05/17713620/effective-sovereign-wealth-fund-management-mongolia-principles-apply

 

Comments

Submitted by Bryan Land on
The emphasis on volatility and making policy counter-cyclical is key. It is not just commodity price volatility one has to cope with. There are major output events that take place that may confound revenue projections. Especially if the export base is narrow. Take Mongolia's coal exports to China - not only have they commanded lower prices in line with international markets but a pronounced slow down in steel mill use of coking coal in China coupled with policy uncertainty around FDI in Mongolian coal resources brought about a sharp reversal in coal export trends. Expectations were of ever rising exports but instead they dropped off sharply - a double whammy ... lower prices and volumes! This feeds immediately into mineral royalty receipts and, with a lag, tax receipts (less profits to tax). Other sources of output uncertainty relate to infrastructure - delayed or unreliable power supply or transport bottlenecks will subdue output or delay expansions. All the more reason for saving for a rainy day!

Submitted by Ulrich Bartsch on
The article asks an important and interesting question in the beginning, but falls short of answering it: Surely building infrastructure, educating young Mongolians, improving healthcare and creating jobs is important? Surely by achieving these development goals Mongolia is providing for the next generation? Investing most of natural resource revenue makes sense, because resource revenue is natural assets converted into financial assets (cash). Spending cash on consumption means the nation's wealth diminished, as green growth accounting will tell us. However, investing cash in physical or human capital, or financial assets, preserves or even increases such wealth. The tricky part comes when the country has to decide the mix between investment in physical and human capital and (foreign) financial assets. A priori, investments on the ground in Mongolia would carry a much higher return than investments in, say, US treasuries. This has to be weighed against the potential for "overheating" the Mongolian economy, i.e. pushing demand for goods, services, and labor above the carrying capacity of the economy, thereby contributing to inflation, real exchange rate appreciation, and loss of competitiveness of non-resource sectors. And of course also against the institutional capacity of Mongolia to invest wisely and not waste the money on projects with low returns. The answer to the interesting and important question posed in the beginning would therefore have to involve an assessment of the current and future carrying capacity of the economy. We should not suggest to the Mongolian government too quickly to give their natural resource wealth to global capital markets and finance infrastructure in other countries, when they could just as well do so at home.

Submitted by Gregory on
Ulrich Bartsch many thanks for the help in trying to answer this tough question. I appreciate your insight into the debate and especially whether saved funds should be invested inside or outside Mongolia. To add in on this thread I’ve two things to throw in. The first is that the private sector (led by the mining sector) and the government are already scaling up investment in the Mongolian economy. My colleague Zahid tells us that: "government spending on new infrastructure in Mongolia has increased 35-fold in the past 10 years" and goes on to highlight the challenges that come with that. See: http://blogs.worldbank.org/eastasiapacific/node/3052. The second point reflects that saving outside is useful even if you don’t go to down the ‘invest outside and preserve the capital’ route. As Brian stresses in his comment above: "emphasis on volatility and making policy counter-cyclical is key". Saving outside for stabilization is often only a temporary measure. It helps calm things when it’s getting hot and can provide warmth later when needed. Money Chile saved abroad in 2005-06 was brought back in and spent in the domestic economy in 2008-09.

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