Mongolia Rising

Historically, there has been a strong correlation between an abundance of natural resources and governance issues. Historians and economists like to call this the “natural resource curse.” They suggest that having natural resources can harm the growth prospects of a country and of its citizens because of the over-reliance on an easily exploitable advantage. One doesn’t have to look much farther than the headlines for some obvious examples. Qaddafi’s brutal stranglehold on his people wouldn’t be possible were it not for the copious amounts of oil in his backyard that has bankrolled his oppressive regime. However, countries with growing appetites for natural resources are injecting money into resource rich countries to ensure their stability in an effort to try to break this mold. One prominent example of this phenomenon is the symbiotic relationship between Mongolia and China.Not many people think of Mongolia as an upcoming economic powerhouse. For much of its history it was an agrarian country known more for Genghis Khan and his merciless conquests than foreign investment or economic growth. However, Mongolia is just one example of a new breed of resource rich countries that have gained from rapidly increasing demand coupled with intensive foreign direct investment. Mongolia boasts rich mineral resources, including copper, coal, molybdenum, tin, tungsten and gold which are all vital inputs for a variety of products.

Mongolia’s resources have not been a secret, but the country lacked the proper infrastructure to efficiently extract its natural endowments. Due to weak domestic demand, it has not been economically viable to develop these resources. That has changed as countries such as Russia, China and Canada have poured millions of dollars into developing the local infrastructure and providing the human capital to properly exploit these resources. The most significant investment has been a 1000 kilometer super highway cutting through Mongolia from the Chinese border to the Russian border, designed to transport goods in and out of the country. These well-needed cash injections into the local economy has revitalized towns along the highway and spurred further growth and development.

However, the picture is not completely rosy. Mongolia suffers from a 11.5% unemployment rate and has 13.0% inflation according to the CIA World Factbook. This phenomenon is often referred to as “stagflation” and is notoriously difficult to overcome. Many suggest that unemployment is a factor of income inequality, a fairly common occurrence in newly liberalized countries, where the well-connected elite are able to capture the greatest opportunities.

One possible solution is a fiscal policy that favours education and other programs that open up more advancement opportunities to the general public. A more effective, progressive taxation policy may also help to alleviate this inequality and provide greater employment opportunities to the rest of the country. In return, this will spur further growth as a growing middle class, with better jobs and a steady stream of income, will boost aggregate demand.

Inflation is more difficult to control, since it is caused by large foreign inflows of cash and the resulting multiplier effect, both of which have driven the majority of GDP growth. Accordingly, the Mongolian central bank risks choking growth if it tries to contain inflation by raising interest rates.

Mongolia stumbled during the recent financial crisis when foreign demand for its resource exports took a hit. A subsequent poor crop yield hurt its agricultural sector, which still makes up a significant portion of its GDP. These effects are mostly cyclical, and while they have undoubtedly stalled economic growth, they are relatively minor blips in the bigger upward trend that the country can look forward to.

What does Mongolia’s development mean for similar resource heavy countries like Canada? Depending on how effectively Mongolia’s various institutions can manage its growth, Mongolia can steadily erode Canada’s competitive advantage, especially due to its closer proximity to China. While other countries may have comparable or even superior natural resources, Canada’s central advantage is its highly developed, stable, and flexible economic and political institutions. These include everything from liquid and efficient capital markets to well-developed human capital to enduring political stability. Investors can be confident that money invested in Canada won’t be funneled to fuel civil wars, bankroll dictators or eroded through transaction costs. In the long run, as counties like Mongolia are able to develop and replicate these valuable institutions, they will provide an increasingly attractive alternative to high wage, high regulation countries like Canada. Such a shift is not likely in the immediate future, and may never happen if the government cannot effectively manage its growth.

In the near term, Mongolia and its new mining companies seem to share a positive outlook. Canadian companies have already started to invest in Mongolia, and many analysts have declared Mongolia as the new ‘Asian Tiger.’ Whether or not Mongolia can live up to this venerable title remains to be seen.

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