By Bolor Lkhaajav (Analyst of the Mongolian Institute for Geopolitical Studies)
April 3, 2018
Mongolia is a country with an abundance of natural resources. Its land-locked geographical position imposes some economic challenges but it helps Mongolia to distance itself from other regional security issues. Neighboring two politically, economically, and militarily powerful nations Russia and China- Mongolia’s economy is prone to any political and economic changes of these countries. As extractive institutions such as Rio Tinto, Centerra Gold, China Shenhua, and many other pursue Mongolia as a large market, good governance, short and long-term economic strategies are fundamental to build a strong Mongolia. Most importantly, Mongolia has all the tools to strengthen its economic outlook by looking at good-governance models and developmental model from regional and global actors. Hence, to build a stronger Mongolia, this research will address investment-led growth model’s opportunities and challenges. The research will also look at China as an example for solving an investment-led growth issues.
Mongolia, land-locked between two powerful nations, Russia and China, often face the need to balance in its foreign and economic policies without taking a pro-Russia or pro-China side. When we discuss Mongolia’s relations with Russia and China, we need to recollect the influence and leftovers of the two hundred years of Manchu Qing dominance and seventy years of Soviet influence in Mongolian political and economic sphere. It wasn’t until 1991 when Mongolians finally took full control of its politics and economy. As an emerging market, Mongolia’s economy has an abundance of potential, opportunities, as well as challenges to overcome both in domestic and foreign affairs. The World Bank estimated three hundred years of natural resource deposit in Mongolia in 2008. According to the CIA Fact Book, Mongolia’s soil is rich in oil, coal, copper, molybdenum, tungsten, phosphates, tin, nickel, zinc, fluorspar, gold, silver, and iron. Mongolia’s natural resource exploration started during the Soviet Union era but it increased since 2001. As exploration projects produced positive outcome, Mongolia’s natural resources attracted, investors, extractive institutions, and FDI in billions.
Mongolia’s Economic Opportunities: FDI
In 2015, Mongolia celebrated its 25th anniversary of the democratic parliamentary election. Since the 1990 democratic revolution, the government of Mongolia is going through a democratic transition in all its government branches. Mongolia’s foreign policy and economic outlook established a gateway to the global market using the third neighbor policy without excluding Russia and China. The third neighbor foreign policy allowed Mongolia to strengthen bilateral and trilateral economic ties with countries in East Asia, the Persian Gulf, and the Americas.
To further strengthen Mongolia’s economy, the Parliament of Mongolia passed an important Foreign Policy Concept in 2011, in a way to override irrelevant or detrimental government decisions. In accordance with the 2011 Foreign Policy Concept, number of bilateral agreements and economic partnerships were established. Take, for example, in 2015, a Memorandum of Understanding (MOU) and strategic Economic Partnership Agreement (EPA) was signed between Mongolia and Japan to develop the Tavan Tolgoi mining deposits, infrastructure, and railways.  This MOU illustrated the successful application of the third neighbor foreign policy, investment-led growth strategy, and government’s decision on diversifying the economy. Among multinational investors in Mongolia, Netherlands, China, and
Luxemburg are the leading investors in Mongolia (See Graph I).
Graph I. Foreign Direct Investments by countries, Invest in Mongolia Agency. 
The year 2011 saw the highest inflow of FDI in Mongolian history. The steady growth of
FDI indicated Mongolia’s application of investment-led growth model in its natural resources sector. According to the World Bank data, since 2005, 40% of the GDP came from FDI. The prima facie was that as long as FDI were financing the operational costs, introducing modern technologies, state imposed tax and tariffs and employment sides were covered. The long-term Investment Agreement between Ivanhoe Mines and the Government of Mongolia to construct and operate Oyu Tolgoi (OT) copper-gold mining is an example to demonstrate the mentality and dependency on the investment-led growth. Heavily criticized by the opposition parties and the public, the Government of Mongolia agreed to receive only 34% and gave Ivanhoe Mines 66% interest of OT. Following controversial OT’s investment agreement, public sentiment has changed towards FDI and investment-led growth strategy. The “OT 34%” became a popular slogan to force government to negotiate a better deal, a deal that is more beneficial to the people, to the country, not the investors. Economists often blame the popular movement for the slowing down for FDI, however, the Mongolian public and some MPs truly believe that if Mongolia continues to attract FDI, all agreements and deals must uphold international standard, abide by rules and regulations, filtered through the appropriate channels. In order to attract FDI in diverse sectors, government relaxed some of the regulatory policies, established investment friendly environment, and provided tax incentives in Free Economic Zones (FEZ).  As Mongolia’s economy continues to attract FDI, it is wise for the government to rebalance the flow of FDI into technology and innovation, public health, education, and other leading sectors. While investment-led growth often associate with FDI and extractive institutions, it is the government’s responsibility to allocate the diversification of these funds into human capital, not just products to be exported.
Mongolia’s Economic Challenges: Governance, FDI, and Labor Force
Mongolia’s economic challenges can be viewed from many different perspectives. Its geography, governance, corruption, population size, regional and global volatility, constant balance between Russia and China, neighborhood effect or a geopolitical restrains from China, all are reasonable perspectives. To put these perspectives in a greater context, we will look at Mongolia’s governance, political economy in FDI, and labor force separately. For Mongolia to have a stable economic growth, institutional issues must be addressed, foreign policy and economic strategies must support growth-led models while maintaining economic sovereignty and security.
The Importance of Governance in Policy Making
As an emerging market, Mongolia has a full potential to become the next Saudi Arabia of coal but geographical disadvantages and institutional issues impose some difficulties in achieving many of the opportunities. While global economic prosperities vary within geographical advantages/disadvantages, state’s role is fundamental in developing and implementing policies that produces economic growth. A two hypothesis was introduced in “Root Causes: A Historical Approach to Assessing the Role of Institutions in Economic Development” by Daron Acemoglu. He argued that, while geography can provide natural resources and trade possibilities via bilateral agreements and economic partnerships, human influences, good intentions and governance are key to economic prosperity. For example, Acemoglu touched on the Belgian colonization of Congo, slave plantation in the Caribbean, and forced labor systems imposed by institutions in Central America. On the other hand, even though Africa, Latin America, and Central America were gifted with natural resources, it was the extractive institutions and native elites (those in power) cooperated with the colonizers, which barred them from economic prosperity. Hence, per Acemoglu’s explanation of good governance, the Mongolian government must enforce good intention, policy, and decision making for the interest of the public v. political faction or oligarchs.
Since November 2011, the flow of FDI has dropped significantly, hurting the SMEs, employment rate, and created hostilities between political oligarchs (See Graph II).
Graph II. Annual Report. Bank of Mongolia, 2014.
The drop of FDI was caused by the fall of global commodity prices as well as politicization of the political parties and oligarchs on relaxing government intervention in regulating FDI and bilateral agreements. The quarrel also involved the 2010 National Security Concept, which specifically highlighted China as an economic security concern. As Chinese investments mostly target infrastructure, mining, and housing projects, the number of Chinese workers increased during the past decade. As of 2016, unemployment rate is at 8.6% and not improving, anti-Chinese, anti-foreign worker mentality is understandable.
In 2011, The World Bank’s Poverty Reduction & Economic Management Unit produced a policy research paper on Mongolia, to enhance the state’s role in FDI and public investments. The paper addressed critical issues such as government’s poor-quality of spending, principal-agent problems, politicization of SOEs and MPs, and the deep web of corruption involving
mega-projects and inadequate “build-neglect-rebuild” system. According to the Ministry of Finance, between 2005 and 2008, government expenditure on wages and salaries has increased from 5% to 11% while per capita GDP per household did not grow. Thus, mismanagement of the government expenditures, increase in wages and salaries for bureaucratic government officials has further deteriorated economic development progress and distorted the relationship between the public and the government itself. To rebuild the relationship, government must enforce tightly controlled fiscal policy and increase transparency.
Mongolia’s FDI and Labor Force
In 2015, Rand Corporation published a study on Mongolia’s labor force, “Improving the
Mongolian Labor Market and Enhancing Opportunities for Youth.” The study has addressed Mongolia’s labor market issues and provided policy suggestions to create an opportunity and incentive for the younger generation. According to the study, between 2002 and 2012, Mongolia’s labor-force participation was low as 63.4%, employment-to-population ratio was below average among the ages from 15-24 in comparison to other developing countries. Although 63.4% is substantial percentage, when the country population is only 3.2 million, unemployment becomes a leading factor for economic crisis. Mongolia’s educational trends were positive and didn’t influence the unemployment rate. The research concluded that, education is not the unemployment cause, however, shortage of career counseling, skilled workers training, and research in future labor-market were the main cause of unemployment. Consequently, local labor market is filled with foreign skilled and unskilled workers. To solve this issue, government must give incentive for local companies to hire domestic workers and hire foreign skilled workers when needed. Moreover, as Mongolia continues to attract FDI, government policies must support and reinforce diversification of labor force, train workers under the international standards as oppose to only in mining field. We can look China’s investment-led growth and labor market for an example.
A comparative study was done by Tomoyuki Fukumoto and Ichiro Muto, “Rebalancing China’s Economic Growth: Some Insights from Japan’s Experience.” The authors argue that since the launch of the “reform and the opening-up policy,” China has experienced huge economic growth but the growth was mainly driven by investments, which in the long-run created a disproportional job market and lack of high-skilled talents. According to Zeng Xiangquan from Renmin University’s Human Resource Department, “the shortage of workforce means labor cost will continue to increase and industrial transfer and technology will substitute workers.” China’s investment-led growth did not benefit households, as per capita income did not rise as fast as per capita GDP. We can conclude that exact same problem is facing Mongolia.
As a country with a vast amount of natural resources, Mongolia has all the tools to learn, implement, and execute a policy that produces economic growth and prosperity. Even though geographically challenged and sandwiched between Russia and China, Mongolia’s foreign policy concept has already established a gateway to the global market. The future of Mongolian economy is in the hands of the policy makers to solve all the issues mentioned above. As per suggestion, policy makers must stipulate a strategic economic growth that links all the developing sectors, health, medicine, technology and innovation. By creating an incentive to train high-skilled workers, local unemployment issue will be solved and labor market will not depend on foreign workers. Only then, FDI from the extractive institutions will turn into a long-term investment that the Mongolian people can benefit.
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