Financial crisis could provide Mongolia opportunity for reform

Image credit: rreichle at Flickr under a Creative Commons license.

Mongolia's steppes are especially beautiful in October. A light dusting of snow on the gentle rolling hills makes them look like a rumpled white blanket. A large share of Mongolia's population still lives a nomadic lifestyle, herding livestock from one grazing area to another and living in the traditional ger, Mongolia's version of the central Asian yurt.

In this beatific landscape, the financial crisis and collapse of global stock markets seem far away -- but Mongolia will be sharply affected. In recent years the government has introduced a host of programs that have made herders' lives less vulnerable and difficult: livestock insurance to protect herders from losses in the terrible freezes that occur every few winters; expansion of cell phone coverage throughout the countryside; and expansion of rural education. The global economic crisis, however, threatens the sustainability of these programs.

Mongolia is in many ways a typical developing country, depending heavily on resource-based exports -- in this case, copper and other minerals. The copper price has boomed in recent years, which has helped Mongolia grow faster and expand public programs. Yet the end of the global boom means the end of the commodity boom. Within a short time the copper price has dropped from over $8,000 per metric ton to under $4,000 today (see chart).

The classic advice to commodity exporters is to save much of the revenue windfall during the boom times, which Mongolia has done to some extent. The country has accumulated 12 percent of GDP, saving an average of 3 percent of GDP for the past four years. But it has spent more of the windfall -- some going to the very good programs noted above. But much of the spending increase has been unfocused, such as raising the government wage bill by 3 percent of GDP and introducing various giveaways to the public, amounting to 4 percent of GDP. Roughly speaking, we can say Mongolia saved about one-third of the windfall and spent the rest.

Now that its revenue is dropping sharply in line with copper prices, Mongolia will have some fiscal problems. This was one of the key topics at an economic policy conference I attended this week in the capital city of Ulaanbaatar. Mongolian President N. Enkhbayar opened the conference, which was also addressed by World Bank chief economist Justin Lin and former Russian Prime Minister Yegor Gaidar. (Read the presentations here.)

Much of the discussion among parliamentarians, government, and civil society reflected a sense that the global economic turmoil presents Mongolia with both challenge and opportunity. Gaidar spoke of the current troubles as a "window of opportunity for reform." During the boom, Mongolia’s decision-makers dithered about reaching agreement with the big international mining firms to develop world-class copper and coal deposits that are as yet untapped. Now, the global environment for mining is much less favorable, so to some extent Mongolia missed an opportunity. But Mongolia can still reach agreements that would be highly favorable to the country once prices rise again -- as they inevitably will some day. Cleverly structured contracts can ensure that Mongolia gets a fair share of future windfalls.

Some see this as a good time to enact fiscal rules that require a larger share of future windfalls be saved. That way, the country can have stable expansion of development programs that are insulated from boom-bust commodity cycles. The challenge for Mongolia is to use the country’s mineral wealth in a way that preserves and enriches the country’s unique natural and cultural heritage.