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

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