Investment in institutions and people builds resilience to economic shocks
As Asian and European finance ministers meet here in Ulaanbaatar this week, one of the challenges they face is how to support commodity exporters that are feeling the full brunt of prolonged low commodity prices.
Countries like Mongolia, which heavily relies on copper, coal and other mineral exports, have seen a weakening of mining export earnings, sluggish economic activity and a widening budget deficits.
Within the East Asia and Pacific region, Mongolia is not alone. Other countries, especially net exporters of energy commodities such as Lao PDR and Papua New Guinea, have also been hit hard by the prolonged slump in global commodity prices, whereas they were among the fastest growing countries in the world only a few years ago. But the familiar boom-bust cycle of commodity exporters is not inevitable.
Commodity exporters like Mongolia can boost their resilience to commodity-price swings by strengthening institutions to provide more options to manage economic downturns. The principles of macroeconomic management—using natural resource revenues efficiently and cautiously, managing debt effectively, using the exchange rate as a shock absorber and tool for boosting competitiveness—are well known. The challenge is to institutionalize them so that they can be effective – and available when they are needed.
Indeed, following the global financial crisis of 2008-9, Mongolia developed important institutions to keep fiscal affairs under control. Expansionary policies during the boom times, combined with a sharp adjustment in commodities prices and falling investment, has made it a challenge to make those institutions effective.
Even with the best macroeconomic management, however, deeper issues need to be addressed. Any economy heavily dependent on a small number of sectors will face risks. In the longer run, Mongolia and the other net commodity exporters, need to find ways to diversify their economies. While this is easier said than done, the experience of some countries in the region provides useful examples.
Heavily reliant on oil revenues in the past, Malaysia took advantage of its diversified resources, invested heavily in land development and boosted the production of rubber and palm oil, but broader diversification was needed. The government also focused on technology and infrastructure development in areas such as energy, communications and transport. It supported those developments with policies that reduced the cost of labor, liberalized skilled immigration and expanded enrollment in polytechnic institutes, among others, to create skills to make the country more globally competitive.
Indonesia, meanwhile, diversified its exports by supporting agriculture and low-wage manufacturing. When oil prices began to fall in the 1980s, the government restructured and reduced public spending, limited real exchange rate appreciation and liberalized trade policy. These changes have helped Indonesia emerge as an industrial exporter.
Those success stories show how a country like Mongolia can navigate the current downturn and plan for a longer-term shift toward a more diversified economic base. At the same time, every country has its own characteristics, and diversification should build on a country’s comparative advantage. Mongolia’s ample potential for commercial agriculture and livestock export is a real opportunity to diversify the economy, if supported by appropriate institutions, such as export-related finance.
At the same time, Mongolia’s landlocked geography and low population density raises the premium on getting the fundamentals right: ensuring a labor force that is well-educated and healthy, giving firms the confidence that they can invest and do business in a clean and efficient business environment. The business environment has been improving, with reforms in permits and inspections showing results, and education and healthcare are also improving.
Indeed, from this perspective there is cause for optimism about Mongolia’s longer term prospects. Despite a rapid expansion of the school age population, enrolments have been steadily increasing. Similarly, Mongolia has made great progress in improving health care and reducing maternal and infant mortality, for example.
No long-term vision can take root, however, until the shorter-term challenges are sorted out. Countries hit by the fall in commodity prices, like Mongolia, need to stay the course on policy adjustments, exercising restraint so they can build resilience to external shocks, and secure the foundation of stability needed for a return to strong growth.