Masaryk University Faculty of Economics and Administration

Field: Studies in European Economy, Public Administration and Culture

ECONOMIC TRANSFORMATION IN

Bachelor Thesis

Bachelor thesis consultant: Author: Ing. Aleš Franc, Ph.D. Baljmaa Zorig

Brno, 2013

2 Masaryk University Faculty of Economics and Administration Department of Economics Academic year 2012/2013

SUBMISSION OF BACHELOR THESIS

For: ZORIG Baljmaa

Field: Studies in European Economy, Public Administration and Culture

Topic: ECONOMIC TRANSFORMATION IN MONGOLIA

Ekonomická transformace v Mongolsku

Principles for the elaboration

The goal of the work, problematic area, procedure and applied methods The goal of this work is to analyze and empirically appraise the synchronic changes, which took place in Mongolia during transition period. Also how it impacted the current economy and society of modern-Mongolia. The work will be written in the following methods: 1. It will be summarized at the beginning and the complete summary will be done in the end of the work supporting the previous one. 2. Relevant empirical data are collected and classified in this work 3. Comparison between economic system before and after the 4. Figures and tablets are included in order to demonstrate the changes and situation better

3 Size of the graphical works: approximately 20 tables and graphs

Size of the work: 35-45 pages

List of recommended literatures: NAYA J. Seiji; TAN L.H. Joseph. Asian Transitional Economies: Challenges and Prospects for Reform and Transformation. Singapore: Institute of Southeast Asian Studies, 1995. 305 pages. ISBN 981-3055-09-X.

KOLODKO; Grzegorz. From Shock to Therapy: The Political Economy of Postsocialist Transformation. : Oxford University Press, 2002. 457 pages. ISBN 0-19-829743-2.

LAVIGNE, Marie. The Economics of Transition: From Socialist Economy to Market Economy. Hampshire: Palgrave Macmillan Publishing, Second Edition, 1999. 328 pages. ISBN-13: 978-0-333-75416-0 paperback.

Tutor of the work: Ing. Aleš Franc, PhD.

Date of submission of the bachelor thesis: 07.01.2013

Datum of consignment of bachelor thesis and insertion to IS is stated within the valid schedule of academic year.

––––––––––––––––––––––––––––– –––––––––––––––––––––– Head of economics department Dean

In Brno 07.01.2013

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Name of the author: Baljmaa Zorig Title of the bachelor thesis: Economic Transformation in Mongolia Title of the thesis in Czech: Ekonomická transformace v Mongolsku Department: Economics Tutor of the thesis: Ing. Aleš Franc Ph.D Date: 2013

Annotation

This diploma thesis engages in one of the important events in Mongolian economic and political history, which took place in 90s after fall of the Soviet Union. The introductory chapters cover the main definition of transformation and the situation before implementing reform and changes in Mongolia. The other chapters discuss the current changes, which held during the transformation and its economic-social impacts on the country. The last chapters summons up all the considered issues and conclusions to give a final touch to this thesis.

Anotace Tato diplomová práce zkoumá jeden z nejdůleţitějších události v Mongolských ekonomických a politických historii, která se konala v devadesátých letech po pádu Sovětského svazu. Úvodní kapitole se dotýkají hlavní definice transformace a předešlé situace před implementací reforem a změn v Mongolsku. Ostatní kapitole se baví o nynějších změn, které se staly během transformace a jejich ekono-sociální důsledky v národu. Poslední kapitole zahrnuje všechny povaţované výstupy a úsudky z předešlých kapitolech.

Klíčová slova Transformace, šoková terapie, privatizace, Mongolsko, centrální plánování, volný trh

Keywords

Transformation, shock therapy, , Mongolia, centrally planned economy, free market

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Declaration

I, hereby declare that I have written this thesis alone by myself and that I enclosed in reference all relevant resources that I have used to write this thesis.

In Brno 2013

Signature

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Acknowledgements

Special thanks to my tutor Ing. Aleš Franc Ph.D for assisting me in writing this bachelor thesis. I am very grateful for him to his thoughtful comments and valuable suggestions that were great support in preparing the final version of the thesis.

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8 Table of Contents

Introduction ...... 10 1 Characteristics of Mongolia ...... 12 2 Economic situation before transformation in Mongolia ...... 16 2.1 The First Period: Before Soviet Union ...... 16 2.2 The Second Period: During the Soviet Union (The Mongolian People’s Republic) ...... 18 3 Theoretical background of transformation ...... 21 3.1 Goal of the transformation ...... 21 3.2 Strategies of the transformation ...... 24 3.2.1 Shock therapy ...... 24 3.2.2 Gradualism ...... 26 4 Transformation in Mongolia ...... 30 4.1 Liberalization ...... 30 4.1.1 Price liberalization ...... 30 4.1.2 Foreign Market liberalization ...... 32 4.2 Privatization ...... 35 4.2.1 First Phase in Mongolia ...... 37 4.2.2 Second Phase in Mongolia ...... 38 4.2.3 Impact of the privatization process ...... 39 4.3 Stabilization ...... 41 4.3.1 Fiscal reform ...... 41 4.3.2 Monetary reform ...... 47 5 Post-transformation ...... 52 Conclusion ...... 54 LIST OF APPLIED SOURCES ...... 57 ABBREVATION ...... 61 LIST OF FIGURES AND TABLES ...... 62

9 Introduction

The transformation is an eminent phenomenon and an immensely vast evolution, which occurred in more than twenty countries around the world. Significantly, it was a transition from one world to another: from communism to capitalism.

For countries with a centrally planned economy during the late 90s, this process marked an essential change. Some economists predict that if the transformation had not taken place in 1990s, the socio-economic situation persisting in the nations would have been even worse. The reason was imminent. Communism was a system, which had been prevalent for over seventy “successful” years until it had started to collapse. Sooner or later, countries had realized and were taking the necessary steps, which would lead to a more efficient new economic system in order to replace the old ineffective one.

Since 1960, the system of a centrally planned economy started exhibiting signs of experiencing a downfall. Countries like Yugoslavia and began with undertaking partial changes to the system but it failed to contribute towards boosting economic efficiency. Year after year, the old system proved to be incapable of resulting in sustainable . Consequently, by the late 1980s, all communist countries acknowledged a complete collapse of a centrally planned economic system.

The transformation entailed the enormous task of changing the entire nation in a certain amount of time with as fewer burdens as possible being placed on nation‟s economy and society. However, in accordance with the individual, social and political background of the communist countries, the final outcome might have diversified, although the same strategies and paths were selected. Differences can be attributed not only to the geographic and cultural backgrounds, but also to the mentality of the people residing in the nation.

Mongolia was one of the many post communist countries. It faced the same challenge as other post-socialist nations of switching from a centrally planned to a capitalist economy. It certainly differed from the other countries and that is the reason why I highlight the different characteristics of Mongolia in the first chapter. Despite the odds, Mongolia had almost entirely followed the same path undertaken by other satellite countries. Its chosen strategy called “shock therapy” was well known among the European post-communist countries that made their way to the free market, following the motto “the quicker, the better”.

The trigger to the transformation resulted in an ever-increasing dissatisfaction regarding the current political system, which started from the mid 1980s in Mongolia. It affected every aspect of people‟s everyday lives. There was a continuous persistence of insufficient amount of in shops; therefore, the government had to start implementing the ratio system. Furthermore, citizens did not have the right to vote. The people of Mongolia could not tolerate the old system anymore because of which they adopted a strong positive tendency towards the change. This attitude of the people assisted in

10 making it easier to adapt to the changes during the time of the transformation. On the other hand, among the countries in Central Europe, an equally strong positive tendency was not seen. This was might be due to the fact that the majority of the population was holding back on to the values, which they had inherited from Communism during the past 70 years.

Nevertheless, the main purpose of this thesis is to evaluate the process of transformation that took place in Mongolia and measure it with the evaluative criteria such as Magic Quadrangle. Since there are relatively few updated articles relating to Mongolian transformation for the non-Mongolians in English, I decided to write one. I will also lay stress on the ups and downs of the transformation from a Mongolian point of view. But mostly it will be an overall point of view of mine on transformation and in the end there will be a comparison of current socio-economic situation with other transitional countries.

The thesis begins with highlighting the characteristics of Mongolia. The next chapter defines the background theory of transformation as put forward by famous authors. Adding few examples of other countries‟ successful experiences implementing the strategies and paths. This is followed by an analysis of the economic and social impacts on the Mongolian society before and after implementing the changes in the system. The last chapter summarizes the facts and presents my own analysis in order to conclude the thesis.

11 1 Characteristics of Mongolia

This chapter provides a brief introduction to Mongolia. It is reasonable to point out some significant aspects of the current economy, society and . This will contribute towards understanding the fact that every transitional process varies in relation to a country‟s natural endowments.

According to the year of 2012, Mongolia has a land area of 1.6 million square kilometers and consists of a population of around 3,180,000. 1 Half of the country‟s population is under the age of 20 years. It has been 20 years since the transition started off and resulted in the transformation to a free market economy, which makes Mongolia a very young nation in any case.

Mongolia is a landlocked country between and , both of which are economically and geographically large, powerful countries of the world. Mongolia, being a relatively small country, has always been dependent on its enormous neighboring countries. Mongolia, Russia and China were under a communist regime and experienced reforms from a centrally planned economy to a market-oriented one. The two neighbor countries, Russia and Mongolia, started the reform when the Soviet Union had collapsed. During the existence of communism, Mongolia was directly controlled by Soviet Russia. Even now, after the breakdown of the Soviet Union, the Russian Federation is still a locomotive power to the Mongolian economy. Mongolia imports more than 90% of its product consumption and a considerable amount of electricity from Russia.2 The figure below shows how Russia plays the significant role in the imports.

Since Mongolia does not manufacture most of its consumption final products, it imports mainly all kinds of machines, equipment, electronics, and food products from different part of the world, mostly from China. However, China is an entirely different case, which still has the communist political regime but with a liberal market economy and surprisingly, its implementation of a mixed system made China one of the most developed countries. It has acquired an essential place in the world economy and is currently a main partner of the Mongolian economy. As displayed in the chart below, the bulk of the export goes to the “Land of Big Experts” (a nickname for China). The total amount of Mongolian export to China is estimated to be 3 070 million USD by 2012. 3 The main export items are generally raw materials and .

1 [27]Central Intellegence Agency. . 2 [31]National Statistical Office of Mongolia. Monthly Bulletin of Statistics. 3 [28]MONGOL BANK. Monthly Bulletin of Statistics: Trade Balance.

12 Figure 1-1: Mongolia’s Foreign Trade Balance

Export, by country0% (2012) Import, by country (2012) 3 231.6 mil.USD 5 245.8 mil.USD Others 3% Russia 2%

China 29% Others 44% China Russia 95% 27%

Source: Monthly Bulletin of Statistics, Mongolbank, Trade Balance (2012)

Thanks to the gift of the nature, Mongolia is rich in natural resources, which contribute towards most of the export products. Ever since the mid 1960s till today, natural resources have played an immense role in the Mongolian economy with the help of massive investments from the Soviet Union during times of communism. Nowadays, the mining business is booming at a breakneck speed, resulting in many foreign and domestic investors striving to acquire the biggest shares.

Currently, the deposit that is demanded the most is Oyu Tolgoi. This infamous mineral deposit also-known-as Turquoise Hill is the world‟s largest undeveloped - mine in the middle of the desert in Mongolia. Shares of 34 % of the mine belong to Erdenes Oyu Tolgoi LLC, which is wholly owned by the Mongolian government and the greater shares of 66 % belong to a Canadian company Turquoise Hill Resource that most of its shares are owned by Australia-based Company Rio Tinto, the mining giant.4

A profit from the mining sector is the core of the state budget and the government is taking it into account and making more investment friendly policy to attract more foreign investments to Mongolia. The Ministry of Mineral Resources and Energy of Mongolia estimates the total amount of Oyu Tolgoi‟s reserve up to 2.3 billion tons of ores, 26 million tons of copper concentrate and 800 tons of gold. For this year, it plans to mine 43 million tons of ores, 317 thousand tons of copper, 14.77 tons of gold and 59.07 tons silver.5 The value of the mineral products exported is approximately 4 299.4 million USD, which is 89.2 % of overall export in Mongolia. The chart shown below clearly shows that the mining sector is a fundamental aspect of the GDP of Mongolia.

4 [32]OYU TOLGOI. Home Page. 5 [30]THE MINISTRY OF MINERAL RESOURCES AND ENERGY. Oyu Tolgoi the copper-gold mineral deposite.

13 Agriculture,forestry and fishing Mining and quarrying Figure 1-2: GDP, by sector (2012) Manufacturing Electricity, gas, steam and air conditioning supply Water supply; sewerage Wholesale and retail 0.33% 0.34% Transportation and storage 1.66% 15.38% 14.01% Accommodation and food service 4.65% Information and communication 3.89% 18.91% Financial and insurance activities 1.09% Real estate activities 0.86% Professional, scientific and technical activities 6.00% 9.89% Administrative and support service 3.80% 6.00% Public administration and defence 2.62% 1.73% 5.80% 1.67% Education 0.92% 0.43% Human health, social work Arts, entertainment Other services Net taxes on products

Source: NATIONAL STATISTICAL OFFICE OF MONGOLIA. Monthly Bulletin of Statistics. September, 2012.

Since it possesses rich natural resources, Mongolia lists among the top ten rapidly boosting economies with a GDP growth of 6,9 percent. It ranks seventh amongst the top ten countries attaining the highest GDP growth by the end of 2011.6 Outlook of high price of mineral products in world market and its large mineral reserves give Mongolia the potential to grow rapidly and raise living standards significantly. However, international experience shows that mineral rich countries often catch the “Dutch disease” if the nation doesn‟t have immune system against it. The “Dutch disease” is an economic term, which originated from the when it discovered the bulk of natural gas. A rapid growth in the exportation of natural gas results in an appreciation of the Dutch guilder. Consequently, other non-mineral products became less competitive in the world market.

Corden and Neary (1982) explained these impacts of “Dutch Disease” of booming mineral sector through resource movement effect and spending effect. Resource movement effect refers to movement of mobile factors into the booming mineral sector and away from the traditional lagging sectors like agriculture and manufacturing. In case of Mongolia, this effect in capital of booming sector might be negligible comparing to the labor force because capital is primarily imported from elsewhere. The spending effect happens when the extra revenue from booming sector pushes up the demand for labor in

6 [33]Info Mongolia.

14 that sector. Also draws attention from other sectors. Overall, growing foreign investment in the booming sector appreciates the domestic currency and as a consequence it weakens the competitiveness of the country‟s export, which causes the other sectors to shrink.7

However, building immunity to Dutch Disease can alleviate this situation. This occurs when the government steps in to offer support to the non-mineral sectors in order to boost their level of competitiveness in the world market. Another approach to reduce this unpleasant situation is to minimize the overflow of foreign direct investment to the mining business. Special funds of cultivating part of the foreign investment are established in various mineral rich countries, but its effect differs in countries.

Nevertheless, actions speak louder than words. Being aware of the threats of the Dutch Disease, developing countries still cannot resist the easy inflow of money, which can be used for various purposes such as reducing the level of the nation. Mongolia, too, is starting to be infected with the Dutch disease to become “Minegolia”. During the past few years, it has been an important of discussion amongst the Mongolians. With its natural resources, many think Minegolia can become a country like Kuwait. In my opinion, establishing the economy based on natural resources will simply be an absolute advantage until the reserve completely runs out. It is essential to create opportunities of comparative advantages in our economy as a “cure-all” pill for all kinds of diseases.

7 [26]Page 827.

15 2 Economic situation before transformation in Mongolia

Mongolia has an extremely rich and extensive history. However, people from all around the world know Mongolia especially because of its Great Emperor, Genghis Khan from the 13th century when the was at its zenith. But I would like to lay more stress on the latter part of history, which can highlight the economical, social and historical background of Mongolia in a better manner.

This chapter covers the brief historical events as well as the economic and social situations before the start of the transformation. I divided the period before and after Mongolia became part of the Soviet Union in chronological order.

2.1 The First Period: Before Soviet Union

The first period outlines a brief history of Mongolia before the era of Communism.

Mongolia was once known as “Pax Mongolica” during the Golden Era of the Mongol Empire. With its supportive economic unification, political and military strategies, Mongolia went a long way in amusing the world. The Mongol Empire contributed endless efforts in developing world trade by regenerating the “Silk Road”, which was connecting the European market to the Asian market. But after the death of the Great Emperor, the glorious days of the Mongol Empire came to an end. Consequently, the Mongol Empire was rapidly deteriorating after undergoing a century of Golden Era. Ever since then, the nation has never reached its peak of the Golden Era.

The nation was continuously weakening until the end of the seventeenth century when the ruler, Manchu Qing Empire came to throne. Throughout history, Mongolia had decayed at its lowest economy level for more than two centuries under the Manchu domain. The people of Mongolia had no rights whatsoever as free men and socio- economic life was in an acutely poor shape with a feudal regime from 1691 to 19118. Unfortunately, there were no recorded macroeconomic indices to show the extent of the atrocious state of the economy under the Manchu Empire until the Russian analyst Ivan Mikhailovich Maisky came into the limelight. Maisky first recorded and analyzed the Mongolian economic indices. Due to his research, Russia‟s contribution to imports was only 5 % of the total import, but China‟s imports were 95 %. This proved how China utterly restricted Mongolia with its foreign politics and the Mongolians were banned to trade abroad. Also, its banknote lost its store of a value and people were bartering with tea instead of money. 9

8 [10] Page 165. 9[10] Page 48.

16 The entire land of Mongolia belonged to the Emperor of the Qing dynasty but the Emperor‟s faithful Mongolian feudalists possessed it with his faith. The land and almost half of all the livestock belonged to feudalists, who represented only 7.8% of the total population. The rest 92.2% of the population were bondsmen who were desperately on breadline. Owners of the land were exploiting bondsmen who were working for them. Bondsmen were not motivated to work which is why agriculture was heavily lagged behind.10 Animal husbandry, which is the core sector of economy, was also extensively unproductive. The Manchu dynasty tried every single method to keep the Mongolians underdeveloped for as long as they could and indeed, they did succeed. There were no schools, communication systems or healthcare systems and illiteracy spread throughout the population. 11

This state of continuous hardship and struggle in Mongolia lasted for around 200 years. It finally came to an end when the Chinese Empire collapsed and the Manchu dynasty was subverted. With the help of the Russian army, Mongolia declared its freedom from the Manchu Dynasty in 1911. Unfortunately, as a stagnated country with a very weak , it was impossible for Mongolia to regain its freedom. Moreover, in Russia, the Bolshevik Revolution was hitting off in 1918 and China used this unstable situation to invade Mongolia back and therefore, sent its troops to Mongolia. However, the Red army from Russia beat the Chinese force and on the 14th of March 1921, Mongolia declared its de-facto independence.

The economy at this point was based mostly on nomadic pastoralism. A coalmine, an electricity-generating station, a few small gold mines and several skin- and wool- processing plants, all of which were owned by foreigners, represented the industrial sector.12 The revolution implied that Mongolia must start building a new society. It was an irreversible shift from the old primitive feudalism to a new independent era.

To build a strong independent country, the government needed to democratize the whole nation, to strengthen the new state authority, to build up the independency and to completely decimate feudalism instantly. However, building the nation alone itself was not an option at that time. After the October Revolution in the USSR, the Bolsheviks party had won and wanted the revolution to spread throughout the world. Its influence spread around the world at a fast pace after World War 1 took place. Since many capitalist countries experienced extensive losses from the war and middle-class workers were rioting against the rising level of poverty, the new phenomenon “communism” was a means to ease the unpleasant social situation of the countries.

In the past, Mongolia had frequently turned to Russia for assistance. As a result, Mongolia decided to follow Marxist-Leninist politics under the pressure of the Soviet Union and started to build communism.13

10 [9] Page 53. 11 [9] Page 50. 12 [2]Page 262. 13 [7]Page 216.

17 2.2 The Second Period: During the Soviet Union (The Mongolian People’s Republic)

The second period began since the formation of the communist country until the fall of the Soviet Union.

First of all, as a de-facto independent country, Mongolia ratified its new Constitution in 1924 and declared itself “The Mongolian People‟s Republic” (MPR). It officially chose the “non-capitalist” path and started the transition process from feudalism to communism. The first step that needed to be employed in order to build the MPR was to obliterate the feudalist system and to implement the basic institutional framework. The government set up the basic institutions such as the Mongolian State Bank. It made basic economic arrangements like the state monopoly in foreign trade, unified taxation, currency reform and the state budget. 14 All of them were absolutely new to the country.

Another essential institution for the socialist country was the “Mongolian Economic Central Planning Organization” which consisted of economic goals to improve the stagnant and underdeveloped . 90 percent of Mongolia‟s national income was attributed to pastoral activities and the remaining 10 percent was affiliated with natural resources. 15 It was necessary to boost the background of the agricultural sector immediately, and to improve mining and basic industrial plants for processing main raw materials like leather, meat and wool. The much needed qualified workers and new technologies were brought forward by the Soviet Union. With the assistance of the Soviet Union, the economy started to develop from its lowest point.

According to the Soviet model, all land was nationalized but livestock remained in private hands at the beginning and central planning had started. 16 The planning organization renewed the plan every five years. The First Five-Year Plan started in 1948 as soon as World War II came to an end. The main target of the first plan was to improve the efficiency of agriculture since a food shortage persisted after the war. 17Although the national economy was not directly affected by the war, impacts of the war affected the balance of the Mongolian economy.

The Second Five-Year Plan aimed at creating an industrialized country from a pastoralist-based economy. The leader of USSR, Lenin, believed that heavy industry was the key to rapid economic growth.18 Even after World War II had taken place, USSR continued to emphasize more certain aspects of the industry like mining, timber processing and consumer goods production. Due to the heavy investment in the industrial sector, which had started from 1940, the sector had started to boom and its production

14 [9] Page 53. 15 [10] Page 296. 16 [10] Page 322. 17 [9] Page 54. 18 [11] Page 546.

18 doubled only in a decade‟s time. By 1970, its production was 13 times larger than it was initially. This is represented in the table below.

Table 2-1: Development of the total amount of industrial products in the MPR Indicator 1921 1930 1940 1950 1960 1970 Production (in mil. tugriks)* 0,1 1,0 125 243 677 1719 Growth index – – 100 1,9x 5,4x 14x

Source: Tamchyna. 1974 *The price of industrial products in 1967

As a satellite country of the Soviet Union, the MPR joined the Council for Mutual Economic Assistance (CMEA) in 1962.19 The CMEA was an economic organization under the Soviet Union, which aimed at providing mutual help in the economic sphere between the member countries. Becoming a member country of the CMEA proved to be advantageous to Mongolia. The country was able to export raw materials and import consumer goods and technical machinery with preferential prices. 20 It was also beneficial for USSR and for the members of the CMEA. Mongolia became their supplier of rich natural resources. As in return, to contribute to the growth of the demanding sector of mining, Mongolia received technical and financial support in the form of new equipment, technology and loans from USSR and the CMEA.

As a result, with the aid of enormous investments, Mongolia discovered more new mineral deposits and its production level reached its peak and compared to other products, it achieved the highest growth rate. Mining became the core sector of the economy, which generated more than 40% of total export turnover. According to the table below, Mongolia had reached its goal of switching from an agricultural economy to a rapidly industrialized one.

Table 2-2: Growth and Structural Changes in Mongolia’s Economy during the Industrialization Period

1960 1970 1980 1990 Growth Rates (in percentages at 1986 fixed prices) Gross industrial product 100 261.1 604.2 1,218.1 Gross agricultural product 100 128.2 123.2 179.6 Gross livestock product 100 113.3 191.2 154.2 External trade turnover 100 120.6 416.2 694.1 Structure of GDP (percentage of GDP at factor cost) Industry 14.6 22.6* 29.3* 33.8 Services 62.7 52.1* 55.7* 6.0 * As a percentage of national income. Sources: (1993) and information provided by the State Statistical Office, Mongolia.

19 [2]Page 264. 20 [2]Page 265.

19 Apart from the economic planning and the booming industrial sector, there were affirmative changes in the infrastructure. For example, Mongolia experienced a significant positive change in the literacy rate of its population. In 1940, more than 20% of population knew how to read and write. This marked an extremely profound change in comparison to the situation before the revolution when illiteracy level was almost zero. The government laid more emphasis on the basics of free education and healthcare system. 21 Moreover, it brought the cultural heritage back to the society and focused on intangible sectors like sport, arts, and science. This enlightenment of the population was a great achievement succeeding the acceptance of the “non-capitalist” way.

Communism steered Mongolia away from its harsh feudalist times and helped in evolving into an enlightened and refreshed nation. It would be incorrect to generalize that communism resulted in disastrous consequences for the people of Mongolia. The Five- Year Plans of a centrally planned economy not only aimed at economic growth but also placed emphasis on factors such as social development, increasing living standards, cultural development, and scientific and technical development. Due to its strictly maintained policy on education, the education level of the population profoundly improved. Everybody was treated equally. That was one of the principles of the communism.

But another principle of communism was a state-directed economy, which had quotas for almost everything, for example, agriculture, industry, investment, capital construction, domestic and foreign trade, telecommunication, transportation, labor resources, wages and retail sales. The purpose of the quotas was to provide everybody with equivalent shares, and everybody had to work equally. Unfortunately, this principle failed when the centrally planned economy became heavily capital-intensive and the products could not meet the demand since it was not competitive in the world standards. Even though the quota and the production growth were significant, people refrained from purchasing products, which were available in only a few varieties. Furthermore, it was resulting in the production of unqualified and unnecessary products for which the cost exceeded the revenue. During the 1980s, government expenditure exceeded 60 percent of the level of GDP. Under the prevailing conditions, the only way to maintain economic growth was to obtain ever-increasing financial assistance from the USSR and CMEA.22 The subsidies and heavy investments in inefficient sectors were one of the reasons underlying the failure of communism. More detailed reasons can be found in the following chapters.

21 [8]Page 98. 22 [2]Page 264.

20 3 Theoretical background of transformation

The word “transformation” is the term used most widely to define the tremendous change in the late nineties, which took place in all communist countries. As I mentioned earlier, the “transformation” was an absolutely new concept, which took place in over 28 countries all around the world: especially in and Europe. Changing such a system was an extensive and challenging process, which all post-communist countries had to encounter.

However, economists have failed to study the entire process of transformation perfectly. Its definition takes varying forms as the views of authors differ from each other since there is no “correct one”. For example, the author of the book “From Shock to Therapy” and the former Finance Minister of Grzegorz W. Kolodkom interpreted the term „transformation‟ as „a process involving a fundamental shift leading from the late socialist centrally planned economy based on the dominance of state ownership towards a free market, with the private sector playing the key role”.23

On the other hand, a Czech author Zdislav Šulc defined the term “transformation” as a change of economic mechanisms that takes place in the economic structure of system as well as in the regulative components correspondingly.24

With relevance to Šulc‟s definition, the transitional economy is considered as an in-between or a mixed economy because it is impossible to completely change the economy from centrally planned one to a free-market at one time. There will always be a remnant of the regulative components from planned economy while building the institutional framework of the new economic system. Therefore, they exist together as mixed. Due to the presence of both the economic systems, their features and functioning collides with each other and creates unstable economic situations, which is an aspect of the transitional economy. Theoretically, it will reach the beneficial state of the market economy when all the elements of the system are completed. If it is incomplete, the economy fails to reach its beneficial point and will resultantly face the negative impacts. 3.1 Goal of the transformation In the late 1960s, economic growth declined significantly among transitional countries. Some attempts were made to employ reforms to relieve the regulations of the market in Yugoslavia and Hungary. However, the reforms were not sufficient to improve economic efficiency. Initially, this triggered a few countries implement a serious change called the “transformation” in their economic systems in the 1980s. Later on, this phenomenon of adopting the course of transformation spread across other countries, even to remote nations like Cuba and North Korea. This action is known as the “demonstration effect”. 25 Although it started in the 1960s, by the end of the 1980s all communist

23 [1]Page 1. 24 [3]Page 25. 25 [1] Page 3.

21 countries recognized the thorough deterioration of the centrally planned economic system.

Its downfall can be attributed to two prerequisites. Firstly, a state-directed economy is inadaptable and inconvertible with any economic changes in a short period of time. Since it is directed by the state, there was no competitiveness and economic initiatives towards the profit motive. Because the system was not based on earning profits, if a factory earned any profit, it would directly be added to the state budget. This ruined business initiatives. Secondly, it had an excessively low level of productivity. Although adopting a centrally planned economy implied certain benefits, it failed to achieve its economic goals overtime. The centrally planned production could not compete with world standards. It was producing unqualified and unnecessary products, which resulted in the cost exceeding the revenue. All losses were subsidized by the government. With such a dysfunctional system, even the technology used in production was unable to stand at par with that of other capitalist countries.

Transforming one system into a completely different and distinct system is a highly time-consuming and challenging process. The transformation aims at three main matters26:

1. Building the new framework (institutional and structural changes): Institutional changes are the changes, which stimulate the free market economy by improving the private sector and increasing the level of competitiveness. It contains withdrawal of state ownership, creating private ownership instead, and land reforms, passing laws against monopolies, and building basic institutions like the tax department, the bank system and the judicial system. Carrying out these massive changes requires time and money. But the economy of the transitional countries was heavily corrupted. Therefore, the World Bank together with the IMF supported them through “Structural Adjustment Loans” (SALs), which were given to those countries that were implementing structural changes such as price liberalization and reduction of import duties.

Moreover, this World Bank‟s supportive policy aimed at solving two problems in borrower countries. The first problem arose when the price of crude oil increased drastically during the period 1979-1980 and it resulted in an imbalance in foreign trade of most countries, which had no crude oil reserves. SALs were given to countries facing a huge trade deficit. In return, borrower countries had duties to increase the amount of export turnover and to devaluate the currency. The World Bank outlined the second problem as a compulsion to make structural adjustment, especially to stimulate the percentage of export in the GDP of borrower countries. The loans, which were given to the transitional countries failed to increase the economic growth as planned. Consequently, the World Bank aimed at structural adjustment and encouraged them to participate in the world market due to structural adjustment policy.

26 [24] Page 123.

22 Economists approve of the fact that complete structural adjustment policy is based on two main parts, namely, the stabilization and structural adjustment. Structural adjustment policy usually begins with a stabilization policy with a fiscal, monetary and an exchange rate policy and then followed by structural adjustment. The government should mobilize the resource, allocate the resource to the public sector, liberalize the market and reform the institutions in order to implement structural adjustment. Further detailed policies and arrangements are shown in the table below. The structural adjustment policy was implemented by the World Bank and IMF.

Figure 3-1: Structural Adjustment Policy

Source: Rolph Van Der Hoeven, Fred Van Der, Structural Adjustment and Beyond in Sub- Saharan Africa. 1994

Surprisingly, the impact of the SALs by World Bank on the borrower countries was generally negative. Negative impacts were mostly seen among the African countries and the World Bank was heavily criticized with regard to its structural adjustment loans. There were multiple criticisms of SALs. Among them was national sovereignty. The World Bank was dictating the nations with their policies and as a result it was threatening sovereignty of national economies. Critics agree that the World Bank wasn‟t acting in nation‟s best interest; furthermore it misjudged the state owned enterprises. The World Bank wanted to remove state owned companies through privatization all at once. But it miscalculated the sudden impacts of privatization when the state owned companies were providing nation‟s most of the job and low price of products.

2. Free market economy: A transformation from a centrally planned economy to a free market economy needs several amendments. These could include aspects such as a reduction of government intervention in the economy, a change in the role of government in the economy,

23 providing the individuals with the power to decide but not infringe the liberty of others, elimination of bureaucracy, price liberalization and free foreign trade. Basically, a market economy is based on the equilibrium of market demand and market supply. The price of goods in a free market is determined solely by the market, not by the government. Therefore, when the government sets a level of supply that fails to meet the level of demand in a centrally planned economy, its profit is not as high as it is in a free market. Unlike a planned economy, a free market stimulates the economic initiatives of individuals towards profit.

3. Macroeconomic and financial stability Its main purpose is to keep rising at a low level after price liberalization takes place. The government should maintain strict fiscal policies and the central bank should implement relevant monetary policies. 3.2 Strategies of the transformation Transitional process from a centrally planned economy to a market economy varied depending on a country‟s individual socio-economic situation, tradition, culture, geographic location and its historical and national characteristics. Despite these varying characteristics of the countries, they all shared common problems, which were brought forward by the planned economy such as low productivity rates, shortage of products, high inflation rates and rising levels of foreign debt. Thus, post-socialist countries shared the same goal, which was not only to transform to a market economy but also had to overcome the problems resulting from the transformation. However, they differed significantly in the methods implied, the priorities and the time spans during the transformation. So far there are two widely known main transformation strategies due to the transition tempo: shock therapy (big bang) and gradualism (incrementalism). 3.2.1 Shock therapy

In the 1990s, the economist John Williamson,27 together with a group of financial specialists and economists from the World Bank, International Monetary Fund (IMF) and US Treasury Department, coined the strategy “shock therapy” with an intention to transform the post communist countries in a short period of time. This strategy was also fairly known as the “Washington Consensus”, which was a standard reform package promoted for those post-socialist countries. Necessity of this strategy occurred when the Cold War came to an end and the Berlin Wall was demolished, bringing the communist era to an end. At that point, post-socialist countries were desperately in search for a way to recover from the last decade of a persistent stagnant economy.

Shock therapy is essentially a method in which the new government eliminates any action, which is taken backwards towards the past, and avails political social consensus in order to enforce imperative measures. These measures would have an immediate impact on reducing the standard of living, along with promising a rapid

27 [25] Page 15.

24 recovery.28 This is why it is vital to have stabilizing policies at the same time based on the monetary theory of Friedman in order to refrain from a high inflation rate and a disruptive balance of payments situation. Also, a huge reduction in the state budget and money supply takes place during the time. Shock therapy is a macroeconomic-based reform that takes precedence over microeconomic level of reforms. Proponents believe that this method can be carried out with low transitional costs and saves considerable time.

Unfortunately, this method has drawbacks. Reforms in particular sectors simply fail to change the system over a night. For example, banking is a sector that needs a longer time to adapt to the changes. Other than that, the World Bank and the IMF were providing post-socialist countries with SALs to increase their economic growth and to improve their living standards. By offering assistance, lenders were not just suggesting them to follow the “Washington Consensus” but were more likely enforcing them to follow the strategy. Most post-socialist European countries such as Russia and Mongolia carried out the shock therapy.

Poland is a classical example of a country, which implemented the shock therapy. There are few reasons, which explain how Poland recovered in such a quick manner by implementing shock therapy. An essential reason was that in comparison to other socialist countries, Poland had already started its reform in the 1980s. This made it easy for the Polish economy to adapt to the changes and consequently, recover.

Like any other transitional country, Poland also faced the inflationary pressure and Balcerowicz‟s29 government responded by implying monetary and fiscal restrictions. Consequently, the inflation rate decreased significantly. During the year of 1990, the budget deficit was reduced by 2.5% of GDP, which was 10 times lower than its original level. Economic development during the first half of the 1990s was characterized by a decline in the role played by the government. The share of government expenditures in GDP decreased from 72% in 1989 to 45% in 1995.30 Slowly, balance between market and government was achieved in many economic sectors. The government ensured the macroeconomic stability successfully.

The figure shown below represents economic growth of transitional countries, which followed the shock therapy. Poland‟s GDP growth was significant compared to other countries. On the other hand, Mongolia‟s GDP growth wasn‟t big as Poland‟s but it gradually improved; yet other countries were facing ups and downs of economic growth.

In the case of Mongolia, shock therapy has been implemented since a long time and by 2002, the economy reached its previous level of 1989 (after a period of eleven years).31

28 [5] Page 119. 29 Leszek Balcerowicz, the economist, ministry of finance during the transformation who is well known for his “Balcorowicz plan”, which implemented shock therapy 30 [34] Page 69. 31 [12]Page 1001.

25 Table 3-1: Growth of GDP among countries with transitional economies (1990=100)

Countries 1992 1993 1994 1995 1996 1997

Bulgaria 83 82 82 84 75 87 Hungary 85 85 87 89 90 94 Poland 95 99 104 112 118 126 Mongolia 83 80 82 87 89 93 Russia 81 74 65 62 60 61 Romania 79 81 84 90 93 87 Source: Статистический ежегодник, 1998, Госкомстат России.

Although the growth in GDP was significant, there are few negative aspects affiliated with this strategy. As mentioned earlier, reforms in a particular sector take time. The judicial system, for example, cannot be established over just a night‟s time. The entire law system has to be renewed and new laws have to be adopted which are based on the free market economy. Furthermore, it also requires qualified human capital like lawyers and workers in each specific field. 3.2.2 Gradualism

Gradualist strategy tends to support an alternative policy in opposition to the shock therapy. The Gradualism or the Ad hoc Incrementalism reforms were usually symbolic, apart from some exceptions. These reforms were mainly based on abiding by old rules and informalities during the reform.32 An advantage of this method was the higher probability of not having to face an economic decline during the gradual advancement of liberalization and stabilization in the long run. However, on the other hand, the entire process will cost more than using the method of shock therapy. Although a consistent theory of gradualism was never prevalent, Hungary attempted to implement gradualism but never accepted that they followed the method. However, the gradualist strategy was followed mostly by Asian countries. In comparison to Central and Eastern Europe, Asia‟s reforms focused more on creating long-term market development rather than a radical and rapid one. Supporters of this strategy believed that there would come a time when price liberalization and the rapid transforming process would be an eminently huge burden on society and economy. Priorities mostly revolved around developmental parts: full employment, improvement of agricultural production, exports based economic growth, development of industry and replacing imports with domestic output.33

Eastern Asian countries like China and Vietnam are significant examples of countries implementing gradualism successfully. However, they were following the “third way” between capitalism and socialism, which was creating a decentralized free market environment with a strict political system. It is because most Asian countries did not take into account the advice presented by the World Bank. They strongly believed in

32 [6]Page 296. 33[2]Page 10.

26 their government. Additionally, the government had a strong opinion regarding changes. Their strategy was to reform a particular sector or to make several adjustments and observe the effect of the changes. If that change proves to be positive, the method will be used further. This is why people of the nation trust their government and therefore, the government does not want to disappoint them. The role of the government is therefore essential. However, it is more important to maintain the reforms, which are implemented by the same government. Otherwise, there might be a danger of progress being culminated or the implementation of reforms entailing different perspectives.

China is so far the most excellent model country, which has successfully transformed its economy to that of a free market. Its economy growth was much higher than any other transitional countries and currently; China‟s economy is one of the biggest economies in the world.

The transitional method of the Chinese was partial and was based mainly on results of experiments. Although the method and realization of the reforms varied in different sectors and geographical areas, in the end all the results were controlled and checked by the government. The transformation had started in China since more than 20 years, but it was always partial. For example, the progress of liberalizing markets, creating the private ownership and structuring the market economy is still incomplete, although today they have many state owned factories and many product prices set up by government. China managed to increase the annual growth of its GDP by more than 10 % from 1980 to 1994 and it was the fastest growing economy in the world during that time with a growth of 7.8% of GNI per capita every year.34

Besides focusing on industrialization, the Chinese reform laid stress on developing the agricultural sector and carried out land reforms. The land was not privatized but farmers were provided with the permission to use it. They sold fixed amount of their produced products at a fixed price to the government and the rest was sold in the market. Hence, there were two types of prices, which were set up by the government and the market. Alongside this, the government increased the fixed price of products, which they purchased from farmers. This new method encouraged farmers to earn more and in this way, the agriculture was blooming. Taking this into account, it was proven that there was a reduction in the price gap between centrally planned and market economy without curtailing any negative effects on the economy.

Changes in infrastructure were also taking place. Regional disintegration was implemented by providing more authority to the lower levels. Some regions were turned into China‟s “Special Economic Zones” (SEZ) which are geographical regions that have free market oriented laws rather than the nation‟s typical laws, in order to attract more foreign direct investment. Those regions were providing a friendly environment in taxation, exchange markets, laws for foreigners and multinational corporations. This new policy entailed significant benefits since China is one of the largest exporters in the world.

34 The World Bank.

27 Table 3-2: Poverty among Chinese people

Year Population Population (mil.) has income Population (mil.) has income per (mil.) per day lower than $1 day lower than $2 1990 1143 360.6 799.6 1993 1185 343.6 769.8 1996 1224 200.8 631.6 1998 1248 201.2 620.8 1999 1258 218.4 623.6 2000 1267 194.4 567.4 2001 1276 183.0 529.6 2002 1285 167.4 495.2 2003 1292 152.2 460.7 2004 1300 133.2 415.7 Source: Shahing Yusuf and Kaori Nabeshima, “China’s Development Priorities”.

With the help of the table shown above, a crucial conclusion can be drawn. Chinese reform has been implemented successfully and the number of people experiencing poverty drastically decreased since 1990.

However, it is still too soon to come to a conclusion regarding this part of economic history. As mentioned earlier, the theoretical background of the “transformation” is still constantly developing. It is impossible to determine which strategy would have worked better. However, considerable success and economic growth were observed among countries, which opted for the gradual method. As seen in the table above, China and Vietnam are in a better state than those countries, which opted for the shock therapy. The change in their real GDP growth has never seen a negative trend.

Table 3-3: Real GDP annual percent change in the developing and transition countries Country 1990 1991 1992 1993 1994 1995 1996 1997 1998

Albania -10 -28 -9,7 9,6 9,4 -0,9 19,8 -7 8 Bulgaria -9,1 -10,8 -8,4 -11,6 -3,5 -1,8 -8 -5,6 4 The Czech Republic -1,2 -14,2 -6,4 0,1 2,2 5,9 4,3 -0,8 -1 Hungary -3,5 -11,9 -3,1 -0,6 2,9 1,5 1,3 4,6 4,9 Poland -7,2 -7 2 4,3 5,2 6,8 6 6,8 4,8 Slovakia -2,5 -14,6 -6,2 -3,7 5,2 6,5 5,8 5,6 4 Belorussia -2,8 -1,2 -9,7 -7 -9 -10,4 2,8 11,4 8,3 Kazakhstan -4,6 -11 -5,3 -9,2 -12,6 -8,3 0,5 1,6 -1,9 Russia -3,6 -5,5 -18,6 -13 -13,5 -4,2 -3,4 0,9 -4,9 Ukraine -3,8 -10,6 -9,7 -14,2 -22,9 -12,2 -10 -3 -1,9 China 3,8 9,2 14,2 13,5 12,6 10,5 9,6 8,8 7,8 Mongolia -5,6 -9,2 -9,5 -2,9 2,3 6,3 2,4 4 3,5

28 Vietnam 4,9 6 8,6 8,1 8,8 9,5 9,3 8,2 3,5 Source: The World Economic Outlook Database September 2002

Mongolia did not learn a lesson from its neighboring country, China. It was consistently following the directions of the World Bank and the IMF and could not reduce its poverty level for decades. As seen in the conclusion drawn, there is no country, which is in a better state than China, which followed shock therapy. After decades since the transformation had started, the result achieved highlights which strategy is the most appropriate for transitional countries.

29 4 Transformation in Mongolia Mongolia was known as the “16th Republic” of the Former Soviet Union. The country was also a satellite state during Communism. After the fall of the Soviet Union and Communism, external shocks in Mongolia were enormous. Increasing economic difficulties, shortages of consumer goods, cessation of foreign aids and overall confusion and panic among the population exerted considerable pressure on the government to undertake steps towards transition as soon as possible. This unstable economic situation can be clearly observed in the figure below (during the beginning of the 1990s). The economy faced a decline of 9.2% of GDP in 1991 and that of 9.5% in the year of 1992, which indicates that the economy was experiencing the highest rate of downfall of its GDP. From 1994, the economy started to recover slowly once the transformation process finally began affecting the economy in a positive manner.

Figure 4-1: GDP growth rate of Mongolia, %

Source: National Statistical Office of Mongolia, Monthly Statistical Bulletin 2006.

Under the guidance of the World Bank, Mongolia followed the shock therapy. Mongolia was the only Asian country that opted for this method over the gradual method, which was chosen by most of the other Asian countries. The main fundamentals of the transformation are liberalization, stabilization and privatization. But these fundamentals need to be supported with an institutional backing. A strong fiscal position, balanced budgets, balance in current accounts, low inflation, high employment rate, liberal regimes toward international trade and capital flows; all these will contribute towards the growth of the economy only if they are supported by adequate organizations, good institutions, and respected and organized market rules. 4.1 Liberalization 4.1.1 Price liberalization

Liberalizing price and creating market equilibrium price are the fundamentals of the transformation. The first major move to deregulate fixed prices from the centrally

30 planned economy was in January 1991 by the 20th Protocol.35 The main purpose of this protocol was to boost productivity of industries, minimalize production cost, decrease budget deficit and create a free financial market. And before this protocol was implemented, the government approved the state budget of 1991 with 435 million tugriks, but in practice, the deficit was 2.8 billion tugriks, which was even greater than six times more than the planned amount. That implies that the transformation certainly cost more than what was expected.

According to this protocol, the price of gasoline fuel increased to 95%, the price of rose to 75%, that of electricity increased to 94%, the prices of main agricultural products were increased from 20% up to 280% and the prices of industrial products increased from 7% to 70%.36 However, 35 categories of retail goods, 10 categories of imported goods and 36 wholesale groups of goods remained under state control.37

On the day following the implementation of this protocol, there were no goods present in the markets because some people were aware of this protocol and purchased all the products before the prices increased. When this protocol was brought forward, there was a huge insufficiency of products. Consequently, those people who bought the products beforehand sold them at much higher prices to people and prices of common goods were increasing at breakneck speed. It was necessary for the increasing demand to meet the high supply, but at the same time, domestic industries were at stake and the price of imported goods increased after the free foreign trade. This triggered cost-push inflation. When the government doubled wages, stipendium, pension, and even tax payments in order to ease the unstable economic situation, the Mongol Bank had to increase the money supply. This resulted in a rise in the inflation rate. This situation is shown in the figure below, which displays how Mongolia faced hyperinflation during the year 1992 and 1993. At that time, the prices of common goods were increased to 425%38 and a rationing system was introduced in order to control the insufficient supply of basic consumer goods. However, the rationing system only lasted for a year or slightly longer.

Figure 4-2: Annual inflation rate, % 400 325.5 300 183.0 200

66.3 100 52.7 53.1 44.6 20.5 6.0 10.0 8.1 8.0 1.6 4.7 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Source: Mongolian Statistical Yearbook, 2004

35 Government implemented 20th protocol as a “Matter of some measures to transform centrally planned economy to market economy” in 15th January 1991. 36 [11] Page 875. 37 [2]Page 269. 38 [11] Page 879.

31 Many critics of the shock therapy claim that it was a faulty step to liberalize prices all at once at a time when there was a huge scarcity of food supplies. Inflation was persistent during the liberalization of prices but it was inappropriate for the economy to experience hyperinflation and indeed burden the population. One thing for which the government can be blamed is preceding the process of price liberalization in an incorrect order and for not considering the latter impacts of it in a careful manner. The ideal process to deregulate fixed prices should have taken a certain form. Firstly, prices of good, which are produced by domestic factories and cater to the demand, should be liberalized. Secondly, prices of goods, which are imported but can be substituted by local industries, should be liberalized next. However, prices of goods that are essentially to be imported can be liberalized gradually and slowly due to national currency, market price of imported goods and interest of retail traders. Thirdly, the government should have intended to implement price ceiling on certain essential products like transportation, electricity, communication, water supply and heating.

The former Prime Minister, who was responsible for the 20th protocol was heavily criticized for his ill policy of not giving considerable importance to the price liberalization process. The government was also blamed for relying too much on the invisible hand, in that it lacked information on price liberalization. If the process of price liberalization was given more concern and was carefully analyzed before its implementation, the society would certainly have not been burdened to this extent. Neither would have hyperinflation taken place. 4.1.2 Foreign Market liberalization

On the eve of the transformation, the foreign trade of Mongolia was heavily dependent on USSR and CMEA. The mutual foreign trade created more than 90 percent of total foreign turnovers. Trade among the CMEA countries was carried out only by the state-owned foreign-trade enterprises. Mongolia experienced a drastic decline in foreign trade because of the transformation of its economy and the collapse of the Soviet Union. Since the country chose to follow the market-oriented regime, Soviet Union stopped its substantial financial support and limited its trade with CMEA countries. This led to enormous external shocks in the Mongolian economy. Therefore, liberalizing the foreign trade to world market was an urgent matter. In 1990, foreign trade was liberalized.

Table 4-1: Trade Balance of Mongolia (in USD mil.) Indicators 1989 1990 1991 1992 1993 1994 1995 1996 1997 2000 2003 Trade -1116 -578.8 -140 -62.6 -8.7 -3.4 -22 -87.4 30.2 -140.2 -199.6 Balance Exports 795.8 444.8 346.5 355.8 365.8 367 451 423.4 568.5 535.8 627.3

Imports 1911.8 1,023.6 486.5 418.4 374.5 370.4 473 510.8 538.3 676 826.9

Source: Annual Report, 2003.

32 As seen in the table above, a huge deficit arose due to an external shock in trade balance during the beginning of the 1990s. However, the situation improved after deregulating the foreign trade. It is because the size of total import has decreased drastically in comparison with the increase in total export. Exports decreased by more than half between 1989 and 1991 and only gradually increased from 1992 onwards due to increase in exports of copper, animal skins, cashmere and leather goods. However, export revenues solely depend on price fluctuations of a few main export products. For example, in 2001, export of copper increased by 6.3% from the previous year, but more than 25 million dollars worth of revenue were lost due to decreased prices of copper during that year. Recent studies reveal that export products of Mongolia such as raw materials and mineral products are increasing but final products, which are exported, are decreasing.

On the other hand, import is increasing every year. But after deregulation of foreign trade took place, the number of imports fell drastically. The underlying reason can be its cessation of massive financial aids from the Soviet Union. Also, another point, which can be held accountable for this decrease is that imports were affected by the devaluation of tugriks which made importers recognize that it is more expensive to import to Mongolia.

Nowadays, 70 percent of all the imports consist of technical machineries, equipment, automobiles and gasoline. Most of the mechanical machineries are for mining, agriculture and for the electric power industry. Other types of import products include consumer goods, food products and electronics.

One characteristic of liberalizing foreign trade is the integration into the world market. Consequently, Mongolia became a member of the World Trading Organization (WTO) in 1997 and accepted all multilateral foreign trade agreements. This made foreign trade easier with the other members of the WTO. Becoming a member of the WTO brought forward more liberal trade policies for Mongolia, which reflected positively on the economy since Mongolia is highly dependent on external trade. In 1995, before entering the WTO, the total export of the country was USD 451 million. In 2003, it amounted to USD 627.3 million, experiencing an increase of 1.4 times.39 Furthermore, the country‟s main partners in foreign trade during Communism were USSR and members of CMEA. But currently, Mongolia is trading with more than 80 countries all around the world, especially with People‟s Republic of China, the USA, the EU, the Russian Federation, the Republic of , Korea and many other major trading partners.

Parts of this liberalization of the foreign market lead to the creation of an investor friendly environment. So in June 1993, the “generous” foreign investment law was renewed with more liberal provisions on ownership, simplified administrative procedures for registration and the approval of new investment in order to attract foreign investors.40 It granted generous tax concessions to projects concerned with fuel and energy development, mining, and mineral processing. This was due to the new law in the 20th

39 [21] Page 7. 40 [2] Page 279.

33 protocol, which stated, “If a foreign investment enterprise exports more than 50 percent of its production, then the firm has a tax exemption for 3 years and 50 percent tax relief in the following 3 year period”. The new law was certainly great news for investors all over the world.

Furthermore, on July 1, 1997, further foreign investment laws were adopted which abolished almost all custom duties affiliated with the investment process.41 As the result, foreign direct investment (FDI) in Mongolia increased by 5.8 times after the new amendments of law took place (see the table below). One distinctive matter observed in 1997 was the massive increase in FDI in Canada by 1337 times. One of the investors in the mining sector in Mongolia is Ivanhoe Mines Ltd., a Canadian mineral exploration and development company. When the Canadian company Ivanhoe Mines Ltd. found the gold- copper deposit in 2001 in the of Mongolia, it began the world‟s largest mining exploration project. The place where the deposit was found is called “Oyu Tolgoi”, and today, 18 drilling rigs and 200 people are working round the clock at the deposit. This deposit is the world‟s second-largest gold-copper deposit with a metal value of USD 46 billion at today‟s prices.42

Table 4-2: Foreign Direct Investment (in USD million)

1990-2003 1990-1996 1997-2003 Increase Total 1,114.7 164.5 950.2 5.8 times China 337.7 13.6 324.1 23.8 times Canada 133.8 0.1 133.7 1,337 times Rep. of Korea 83.3 9.2 74.1 8 times Japan 60.5 23.7 36.8 1.6 times USA 36.6 14.2 22.4 1.6 times Russia 34.0 14.1 19.8 1.4 times Source: WTO, Trade policy review: Report of Mongolia, 2005.

Although the Canadian investment has grown immensely over the decades, China accounted for over 70 percent of the overall registered FDI. China has been the largest investor since 1990 until now.

When talking about liberalization of foreign trade and foreign direct investment, foreign exchange system is always a significant aspect of the free foreign trade market. In fact, the reform of the foreign exchange system was the most complicated part of the transformation because of the heavy external dependence of the economy. Therefore, the government transformed the regime gradually, through a series of devaluations of the tugriks until in 1993, when a floating exchange rate was adopted. 43 Before 1993, Mongolia had a fixed exchange rate system. However, the exchange rate arrangements were de jure floating till March 2009. Before that, the exchange rate arrangement has

41 [20] Page 640. 42 [37] CNN Money. 43 [2] Page 279.

34 been a conventional pegged and later, stabilized arrangement. In 2009, the Mongol Bank held a foreign exchange auction allowing the determination of the exchange rate mainly by market forces and therefore, the de facto exchange rate arrangement classified to floating.44

The official exchange rate of the Mongol Bank is the middle point of the prior days‟ standard rates of buying and selling of transactions in the interbank market and also the transactions, which take place between banks and their clients.

Table 4-3: Exchange rate after liberalization of exchange rate

End of period Exchange rate tugrik against US dollar Change (%) 1993 396,51 4% 1994 414,09 14% 1995 473,62 46% 1996 693,51 17% 1997 813,16 11% 1998 902 19% 1999 1072,37 2% 2000 1097 0% Source: Bank of Mongolia, Monthly Statistical Bulletin, 2009.

During Communism, all foreign trades were conducted with transferable ruble45 between countries of CMEA and the exchange rate between tugrik and ruble was fixed by the International Bank for Economic Co-operation (IBEC).46 Furthermore, tugrik has been pegged to the USD at times in order to maintain a stable nominal USD exchange rate. After the liberalization of the foreign exchange system took place, the Tugrik depreciated till 1997 at a fast speed (see the table above). Moreover, a floating exchange rate stimulated the private sector due to easy access to foreign exchange. Market-defined exchange rate immediately raised the prices of commodities and depreciated the Tugriks. Ever since 1997, when the government abolished all custom duties in order to ease the fast depreciation of Tugriks, its pace decreased and the exchange rate has been currently stabilized. 4.2 Privatization On the eve of fall of Communism, Mongolia started to build hundreds of factories and industries with the help of Soviet Union to build the socialist country. Although industrialization and these establishments were never a part of Mongolia before Communism, this system was based on state ownership, which is unproductive and corruptive. It needed to implement reforms due to the ever-declining economic growth and increase in inefficiency. Even though government officials were deregulating the

44 [44] Page 3. 45 It was an artificial currency functioning as an accounting unit among socialist countries. 46 [2] Page 278.

35 economy and pushing the economic system to a more liberal and loosened state, the increase in economic growth was nowhere to be seen. Privatization is one of the main impulses in developing the private sector and also an inevitable part of the transformation process along with the price liberalization, economic stabilization, de-regulation and so on. The idea of privatizing has been initiated in Europe by Margaret Thatcher, the famous Prime Minister, in the 1980s in Great Britain. She mentioned in her speech, “Economy is not designed to be led by the government, and it is not just the government‟s job.”47 Her priorities were to privatize most of the state owned entities on a large scale such as power stations, railway stations, petrol stations and airlines. Therefore, centrally planned countries started to adapt the concept of “privatization” from Britain‟s model, but the method was not necessarily the same. There are three well-known methods of privatization that are widely used:

1. Share Issue Privatization – selling shares on the . The ideal country, which used this method successfully, was China. 2. Asset Sale Privatization – method used in German Democratic Republic. Selling an entire organization to a strategic investor, usually by auction or by using the Privatization Commission. 3. Voucher Privatization – distributing shares of ownership to all citizens. Poland was first to come up with the voucher privatization but put it into practice later in 1995. The Czech Republic (carried into effect for the first time), Mongolia, Russia and many other post communist countries used a voucher privatization method by distributing it to citizens.48

In case of Mongolia, due to insufficient cash accumulation to buy and privatize a state property and to provide all people with similar conditions for privatization, it was decided to choose the method of issuing vouchers49, which were distributed to citizens for free. This was because during that time, people‟s savings were only 1.5 percent of privatization value. Furthermore, Mongolia faced difficulty in finding investors who would be interested in state properties due to the lack of popularity and recognition among potential investors. Additionally, the government divided entities into three categories due to privatization:

Enterprises, which will remain state owned: in this category includes 21 companies, which are the most important, do not have to necessarily undergo privatization and have monopolistic characteristics, such as Mongolian Railway, Mongolian Airlines (MIAT), and State Pharmaceutical Industry. Partially privatized state owned enterprises, which include 42 industrial companies of infrastructure, mostly in agricultural sectors. Fully privatized enterprises, which can be fully competitive after privatization.

47 [4] Page 183. 48 [4]Page 184. 49[38]Government of Mongolia.

36 Furthermore, the privatization process can be divided into two phases, the period of 1992-1995, and the period after 1996.50 During the first phase, industries and small- medium enterprises were privatized. Livestock, housing and other remaining state owned entities were privatized after 1996, which was the second wave of the privatization process in Mongolia. 4.2.1 First Phase in Mongolia

Mongolia moved at a fast pace on private sector entry, with the first comprehensive privatization program among other reformers. 51 The privatization program started in July 1991 with the distribution of the vouchers and it was initially scheduled to be completed in mid-1993. 52 Before the important event took place in 1990s, apart from the agricultural sector, almost 100 percent of all other sectors were state owned.

State emitted two different vouchers: pink (red or violet in some books) and blue. Every citizen who was born prior to the approval of the Privatization of Law was entitled to have three pink vouchers, each with a book value of 1000 tugriks and one blue voucher with a face value of 7000 tugriks. 53 The pink vouchers were for privatizing small enterprises with a minimum of 50 workers. They were tradable so the market value could diversify from their original value even before the privatization. However, the blue vouchers were not allowed to be traded freely; they were allowed only in the secondary market, which was planned to be opened in 1994. 54 This was because the blue vouchers were for the privatization of bigger enterprises.

After 70 years of building socialism under the Soviet Union, people were not familiar with the entire new concept of privatization and private sectors. There is no doubt that a certain amount of vagueness existed among the population around the privatization process. That is why during the first phase of privatization, the participation was free of charge where vouchers were used to motivate citizens to take an active part in the privatization process and to increase their awareness regarding the benefits.

As a result, about 70 percent of all small-to-medium enterprises and agricultural entities were privatized and had been shifted to private hands by the end of the first round. The remaining voucher holders were planning to exchange these in the next round of the privatization, like housing and livestock.55 Small enterprises privatization included 1,600 small-to-medium enterprises and approximately 5,000 agricultural entities56 with a total value of 9.4 billion tugriks. Large enterprise privatization included assets of 450 large enterprises and 300 agricultural companies with a total value of 10.8 billion

50[19]Page 28. 51 [13] Page 25. 52 [2] Page 271. 53 [14]Page 10. 54 [14]Page 10. 55 [2] Page 271. 56 [18]Page 15.

37 tugriks. 57 Citizens could bid with their vouchers in the first round of the small privatization and the highest bidder could win at the auction. The privatization commission was found to organize the entire auction process. Moreover, large enterprises would also be privatized at the auction with blue vouchers. Large enterprises would have to develop privatization plans and attain approval for its implementation from the Privatization Commission. Then, the Commission would value their fixed assets, audit the balance sheet, and issue shares on the basis of net assets in order to convert them into joint stock companies. Ten percent of the companies‟ shares are granted to the employees, who would then be able to participate in the auction on an equal basis along with others. The remaining 90 percent are sold in batches at the . This process was similar to that of the small privatization by bidding but this time, it was carried out via brokers. Bidders could declare a price or a price range for the shares, and a time period during which their bids remain valid. Then, the brokers would continue collecting bids from all over the country, even from distance place by phone and then place it at the Stock Exchange. So the broker with the highest bid would win and would register the new owners with their ownership certificates.58 Individuals who were unable to choose a company or did not understand the process could invest in mutual funds operated by brokerage firms. After full privatization of a sufficient number of enterprises, secondary trading would begin. At that stage, foreigners would be able to buy shares.59

Meanwhile, it was necessary to build the legal framework and sound policies alongside the privatization process in order to deliver the whole process fast and complex. The Mongolian Stock Exchange was found in 1991 in order to implement the privatization policies around the voucher scheme. Furthermore, the new Constitution was ratified in 1992 and it guaranteed private property rights. After that, in 1994 three laws have been passed on corporate law, which were the fundamentals needed to flourish the private sector.60 4.2.2 Second Phase in Mongolia

In June 1997, the second phase of the transformation process started officially. The aim of this phase was to accelerate the privatizing process and to add new revenue resources to government budget.

From this phase, participants can use cash at the public auction, except for the vouchers from 1996 until 2000. During the previous period, it was permissible to bid with the vouchers only since inefficient amount of money was not present in private hands. But after 6 years of introducing the transition steps, people had more accessibility to cash and the economic was growing.

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38 During the second phase, livestock and apartments were privatized. More than 20 million livestock, which were the property of the partnerships, were privatized by distributing them back to their members (original owners) of cooperatives 61 . The estimation of total apartments that were privatized was roughly around 85,000. 62 Concurrently also the property rights on land were approved to be privatized by the new law since 1995.63 The government gained an experience from the previous privatization process during the last few decades and adopted new laws in order to build an investor friendly capital market. Due to the recent changes, which took place over the years, Mongolia‟s state owned capitals became more attractive among potential investors all around the world. For example, Gobi, the largest cashmere manufacturer in Mongolia, was privatized in 2007 in coalition with Japanese investors. But even up to now some main large-scale enterprises remained under state control. One of the examples is the Erdenet Mining Corporation, which is one of the biggest ore mining and processing factories in Asia. The corporation was founded as a joint venture with Russia. The State Property Committee of Mongolia holds its 51 percent of shares of the venture.64 Just like the Erdenet Mining Corporation, a few large enterprises like MIAT (the Mongolian Airlines) and Mongolian Railway are still under the control of the government. These are the enterprises, which remained stated owned after the privatization. 4.2.3 Impact of the privatization process

During the Communist period, public goods comprised almost more than 90 % of the GDP. This changed completely when privatization began in 1990s. In 1997, private business constituted more than 60 % of the GDP. Currently, Mongolia‟s private sector produces more than 75 % of the country‟s total output.

Figure 4-3: Percentage of private sector in GDP

Source: Mongolian Statistical Yearbook, 2005.

Similar to the objectives of other post-communist countries, the aim of Mongolia was to carry out the privatization process as quickly as possible. The operation was

61Cooperatives: Livestock were never fully nationalized under the Soviet Union, but rather they were controlled by government as a group of farmers. 62[29] State Property Committee 63 [16] Page 9. 64 [42] Erdenet Mining Corporation

39 carried out in a fine manner as planned by the government with the guidance of the Washington Consensus. The goal of the shock therapy was to privatize the state enterprises as soon as possible and to hand it out to the shareholders. Consequently, the productivity would increase immediately and the private sector would instantaneously boost the national economy. Unfortunately, the hasty privatization did not bring about positive consequences as anticipated by the government. Unexpected downsides were observed when factories started collapsing and thousands of Mongolians became unemployed after privatization. Poverty increased dramatically and people were feeling nostalgic about previous Communist times when everyone was perfectly equal and no gap persisted between the poor and the rich.

There were several problems related to the privatization process. Firstly, Mongolia handed out vouchers for free, regardless of the age of people. Czech Republic used the same voucher method, but sold it with a symbolic price to people over 18 years old. In this manner, the Czech government faced a surplus in the state budget during that particular period. The government of Mongolia could have done the same and it would have provided more responsibility and more business initiatives to those who buy the vouchers.

Secondly, there was a lack of foreign investment. Before 1990, Mongolian socio- economic relations were only with other transitional countries that isolated it from capitalist world. Also, the government allowed foreign investment only at the second wave of privatization with limited rights. Since the Mongolian population did not have sufficient money to invest in the enterprises, it would have been different if the government attracted foreign investors. For example, in the end of 1995, Hungary was the first country from the Soviet Block, which privatized most of its public enterprises and at the same time, attracted net revenue of 4.5 million dollars from foreign investors. Since 1997, its economic growth sustainably increased.65

Thirdly, the hasty privatization, which followed guidance provided by the Washington Consensus was a faulty system. The main goal was to privatize all the enterprises quickly so that there was no control after the privatization process. The government was focusing immensely on the process of privatization and neglected the essential implementation after the privatization. There were insufficient legal frameworks related to the privatization process and its post-privatization situation. This led to the persistence of management problems in many enterprises. Having too many owners for one specific firm becomes problematic. Since the voucher system allowed every bidder to own a share of the firm, this situation resulted in a firm with no dominant owner to take over the important administrative decisions after the privatization process. Even if there were dominant owners, most of the shareholders were not equipped with the sufficient knowledge required to efficiently manage a certain firm in a particular sector. Because of this, many owners misused firms and many important factories of the national economy, which later all went out of business. Others were taking abominable loans with a promise

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40 to payback in the future, but were unable to repay them due to outdated technology and inefficient knowledge. This placed a significant burden on the banking sector.

Examples of countries, which implemented privatization successfully are Poland and Hungary. They chose the method entailing gradual privatization, and did not follow guidelines offered by the Washington Consensus. Poland privatized state enterprises by lending them to the buyers. At the same time, the government implemented the “liquidation policy”. Following a careful and gradual process of privatization, many enterprises adapted the free market system and enabled it to function in a cost-effective manner.

However, the privatization process was unclear to the people of Mongolia. Many people were unaware of the full benefit of the vouchers; therefore, often, the vouchers became worthless. Furthermore, there was no organization that was continuously checking up on the privatization realization. Successful privatization can be attained by maintaining an adequate legal framework and ensuring institutional provision. Privatization in Mongolia cannot be measured as being successful. 4.3 Stabilization 4.3.1 Fiscal reform

In the centrally planned economy, taxes and other instruments of state revenue attained a secondary role in macroeconomic measurements while the state budget was based on centrally planned and controlled economic activities. Before the transformation, Mongolia‟s economy was extensively inefficient, so much that its state expenditure mostly exceeded its state revenue. For example, in 1989, Mongolia‟s deficit accounted for 20 percent of its GDP and during the entire time, the deficits were financed by preferential low loans from the USSR. This corrupted mechanism had been working until the fall of the Soviet Union. Thereafter, the real problem arose when the huge deficits were no longer covered by advantageous financial resources. As a result, the country needed fiscal changes in order to cover its huge state deficits. There were two solutions to improve the public finance: reduce the expenditures and raise the state revenue. 4.3.1.1 Reduction in government spending

The first step to reduce the deficit was to immensely reduce its government spending. From 1991, the government firstly reduced its subsidies in state-owned enterprises, which were working in the red and subsidiaries in imported goods. However, the biggest burden on government spending was current expenditures whose share in total expenditure was about 78 percent and around 52 percent of GDP before the transformation. Within the current expenditures, goods and services accounted for the largest categories by creating more than 40 percent. These included free food, wages, salaries, health, social security payments, subsidies and transfers to households and public sector. 66

66 [22] Page 15.

41

After the transformation and massive reductions, the percentage of current expenditure shrank overtime. But the 20th Protocol in 1991 adjusted wages and salaries by double the amount because of the increase in prices after the price liberalization. That meant increase in government spending.

Additionally, debt service also had a tendency to increase further as it can be seen in the table below. In 1997, debt service amounted to 7.8 percent of the total spending. This reveals the fact that over the years, the government had been spending more than it has earned.

Also, capital expenditures amounted to approximately 17 percent of total expenditures during the 1980s. But from 1986, their share rapidly increased because of greater investment in health, housing and educational sectors until 1993.67 At that time, capital expenditures were almost the same percentage as current expenditures. In 1994, the government made some changes in the structure of capital expenditures, such as introducing new social security law and health insurance systems. After some adaption, the percentage of capital expenditures decreased slowly. Despite the extensive cutbacks and changes, government spending still exceeded its revenue.

Table 4-4: Government Spending (in percentage)

1992 1993 1994 1995 1996 1997 Current Expenditure 70.4 51.4 59.6 58.6 61.4 65.3 Goods and services 43.8 34.1 41.3 43.0 45.5 41.3 Debt service 0.3 2.4 1.3 1.0 1.9 7.8 Subsidies 26.3 14.9 17.0 14.6 14.0 16.2 Capital Expenditure 29.6 48.6 40.4 41.4 38.6 34.7 Share of total expenditure in GDP 40.1 52.5 44.2 40.4 36.0 38.7 Share of current expenditure in GDP 28.2 27.0 26.4 23.7 22.1 25.3 Source: Ministry of Finance 4.3.1.2 Expansion of government revenue

The pre-reform fiscal system was based on two major revenue sources: remitted profits from state owned enterprises and turnover taxes.68 The amount of the income tax was mostly derived from enterprise income taxes. In statistics, every state owned enterprise had a different tax rate. An average state owned enterprise paid taxes equivalent to 60-70 percent of their profits.69 Apart from the enterprises, personal income taxes were levied on a few individuals who also faced different rates of taxes.

67 [22] Page 15. 68 [23] Page 44. 69 [2] Page 273.

42 The second major revenue source was from taxes on goods and services. Turnover taxes created almost half of the tax revenues in the 1980s. Turnover taxes had two components: the import price differential, which is the difference between the import contract price and the fixed domestic prices of the imported goods, and domestic turnover taxes.70 These two components played a significant role in tax revenue until 1991.

In 1991, the new Tax Law was introduced within the fiscal reform. Tax reforms were intended to find alternative tax revenues and reduce the government role in fiscal policies. We can observe the changes in the tax revenues in the table below, for example, excise tax quintupled after the tax reform because the new law introduced selective excise tax on gasoline, fuel, spirits and tobacco. Since then, tax revenue from excise tax on gasoline is seen to be rising in parallel with the increasing domestic demand for petroleum. Other significant changes included the replacement of import price differentials by an import duty at a uniform rate of 15 percent and new tax rates on corporate and individual income taxes.71

Table 4-5: Mongolian State Budget Revenue (at current prices) 1989 1990 1991 1992 1993 1994 1995 1996 1997 Total revenue & grants 5243.3 5328.7 6497.2 11916.4 54843.3 85459.3 140902.4 159954.6 212040.1 Current revenue 5243.3 5328.7 6055.2 11289.6 51816.4 82194.0 135683.6 155932.4 206001.5 Tax revenue 5075.7 4669.0 5145.8 10231.0 49810.1 67453.0 105509.7 120977.6 163971.1 Income tax 2385.4 2095.8 2585.9 5475.1 28439.7 32040.6 48537.2 45608.1 62620.0 Enterprise income tax 2331.2 2051.1 2485.9 5235.3 27167.1 29874.9 43236.2 39226.8 54878.8 Personal income tax 54.2 44.7 100.0 239.8 1272.6 2165.7 5301.0 6381.3 7741.2 Social security contributions 253.0 243.4 - - - 6275.4 15764.6 18473.5 21242.0 Taxes on property - - - - 6.1 - 54.0 - 78.4 Taxes on goods & services 2410.7 2311.6 2172.5 3120.5 14140.2 19528.8 28107.1 37231.0 63307.3 Value added tax 2410.7 1930.1 572.2 93.1 7139.9 11343.2 16254.2 21528.3 38133.8 Domestic VAT - - - - 3713.9 5810.8 7838.8 10687.2 19829.0 VAT on imports - - 572.2 93.1 3426.0 5532.4 8415.4 10841.1 18308.4 Excise tax - 381.5 1592.1 3019.2 6586.7 5329.1 8579.7 11120.2 20337.8 Special classified services tax - - 8.2 8.2 413.6 2856.6 3273.2 4582.5 4835.7 Taxes on foreign trade - - 294.7 1449.1 6578.8 7541.1 9571.5 13917.4 8790.6 Custom duties on imports ------9571.5 12874.6 7231.6 Custom duties on exports ------1042.7 1559.0 Other taxes and fees 26.6 18.2 92.7 186.3 651.4 2067.1 3475.3 5747.7 7932.7 Non-tax revenue 167.6 659.7 909.4 1058.6 2006.3 14741.0 30173.9 34954.8 42030.4 Capital revenue - - 9.9 11.6 0.0 672.7 134.0 - - Grants - - 432.1 615.2 3026.98 3265.3 5084.8 4022.2 6038.6

Source: “Mongolia in a Market System” Statistical Yearbook, 2004.

The New Coalition government was elected in the free election and it started implementing radical reforms in the public financial sector. One of the radical changes was to abandon most of the custom duties in foreign trade in May 1997.72 This implies that 15 percent of government revenues were removed and the government had to find

70 [2] Page 273. 71 [23] Page 44. 72 [23] Page 44.

43 other revenue resources as a replacement. The government introduced a new excise tax on cars and increased other items of tax revenues such as selective excise taxes, income taxes and value added taxes. However, the government tried to increase the elasticity of the tax system by adding items or by increasing the tax rates after the transformation. The main factor of total revenue depends profoundly on the mining industry, which contributes significantly towards the total revenue of the Mongolian economy. For example, as seen in the table above, total revenue of the government in 1993 was 5 times higher than in the previous year, reflecting the boom in mining sector. This was because in 1993, the government launched a program called “Gold” and the production of gold mining has been increasing rapidly ever since then. 73 Since that time, the government is focusing more on its dynamic sector by supporting new mining operations and implementing mining-friendly laws in order to attract more foreign investors.

However, the taxation system cannot be measured only by its total revenue. Also, the burden of taxation plays a significant role in the effectiveness of the taxation system in the economy. The burden of taxation is measured by the total tax revenue to GDP ratio. Figure 4-4: Tax burden of Mongolia

Source: Meeting of Ministers of Finance, Copenhagen, 2001.

In comparison with other socialist countries, Mongolia‟s population faced a lesser burden of taxation. For example, tax to GDP ratio of Czech Republic was 36.4% in 1997 and Mongolia‟s was only 19.7%. Mongolia‟s tax burden was below average in comparison to the burden of taxation among other transitional countries. Unfortunately, Mongolia‟s tax burden had a tendency to increase in percentage and failed to maintain its ratio. Its tax burden was 29% in 2001, which was 10% greater than 1997. However, the tax to GDP ratio of Czech Republic in 2001 was 37.7%.

Mongolia‟s tax to GDP ratio was over 32% in 2006; a high level for low-income countries. High corporate tax rates and absence of provisions for loss-carry forwards

73 [43] WCPA, IUCN.

44 tended to discourage investment. A new Tax Law, effective January 1, 2007, should have an impact: it lowers rates for corporate and personal income taxes, and for business, it introduces tax loss carry-forward provisions. However, tax administration continues to be a major problem. Tax inspections are frequent and rules are too often applied in an arbitrary manner. The result is rent-seeking by inspectors and additional costs and tax evasion for businesses.74 4.3.1.3 Debt

Although the government tried to minimalize its deficits by reducing government expenditures and expanding government revenue, Mongolia still faced increasing debts. As mentioned several times earlier, Mongolia received huge financial assistance, especially from Soviet Russia. Only a small percentage of it was from the CMEA.

Those financial assistances were in the form of trade loans (that is, loans provided by the Soviet Russia to balance bilateral trade), loans for turnkey projects with an interest rate of 2% p.a (that is, loans for building key plants including houses, agriculture, industries, infrastructure, telecommunication, apartments, transportation, power supplies, hospitals, schools, etc.), and loans for technical assistance (loans for purchases of equipment and materials to implement investment projects by Mongolia). With the assistance of those loans, hundreds of small and big projects were financed. The total amount of debt in 1990 was 10 billion transferable rubles. 66.4% of the total debt comprised of investment loans and the remaining 33.6% were compensation loans of foreign trade.75

Table 4-6: Long Term External Debt by Creditor Countries (in mil. of transferable ruble) Creditor countries 1982 1984 1986 1988 1990 USSR 4,524.2 5,689.9 7,035.4 8,451 10,288.1 Others 109.4 117 164.1 171.7 157.4 Source: Ministry of Finance and Mongolbank

As seen in the table above, debt size doubled from 1984 till 1990, only a time span of six years. There are a few explanations underlying the surge of external debt. Trade loans increased when imports were still greater than the exports of Mongolia. For example, the price of imports increased by twice of the original price but export prices increased only by 30 %. In the late 1980s, aggregate export was approximately 730 million dollars but on the other hand, total import was 1 billion dollars, which was comparatively 300 million dollars greater. 76 The differential was compensated by products from Russia. Loans for technical assistance and turnkey projects increased, mostly because the price of technical equipment and fuel were increasing drastically.

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45 Total debt at that time was a huge burden on the economy of Mongolia and was equivalent to approximately 10 times Mongolia‟s GDP as of 2001.77

From 1988, the Mongolian government started to negotiate with Russia regarding its external indebtedness. Mongolia wanted to cancel out most of its debt to Russia and wanted to pay small amount of debts when it was financially able to pay for it. Mongolia used economic facts and reasonable explanations for its negotiation. This negotiation started from 1988 and during that time, the amount of debt was increasing rapidly. Between 1997 and 2001, it increased from 60 % to 90 % of GDP, which was seen as a serious fiscal problem for Mongolia.

Finally in 2003, after a long period of negotiation, Russia and Mongolia came to an agreement, which stated that 98% of total debt (that was 11 billion dollars) would be cancelled and the remaining 2% (that was 250 million dollars) was to be paid by the Mongolian government. Due to this agreement, the long indebtedness with Russia successfully came to an end.78

Although the government settled its previous persisting debts with Russia, it is still facing some debts during the last decade. The largest part of the external debt is attributed to enterprises, citizens, direct foreign investment and donators. Amongst these, foreign direct investment has attained a large part of the external debt during the last few years due to Mongolia‟s booming mining industry.

Table 4-7: Mongolia’s external debt (in mil. USD)

Mongolian external debt 2008 2009 2010 2011 2012.Q1 (in mil. USD) Total 2 184 2 986 3 997 9 622 10 866 1. Government 1 602 1 818 1 767 1 927 2 535 2. Mongol Bank 1 246 264 268 269 3. Banks 366 341 484 685 554 4. Others 305 800 2 375 12 490 13 498 Source: Bank of Mongolia, 2012.

However, when the external debt exceeds its ratio to GDP over 40%, it proves to be a threat to national economy and its safety. As in the figure shown below, Mongolia‟s external debt to GDP is assumed to be over 40% in 2012. In the last decade, this ratio fluctuated around 30 %, which is still a high percentage.

Table 4-8: External Debt to GDP ratio 2005 2006 2007 2008 2009 2010 2011 2012* External Debt to 39.7% 31.7% 24.5% 24% 29.6% 27.5% 22% 41.5% GDP ratio Source: Bank of Mongolia, 2011.

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The government of Mongolia decided to issue its debt bond on the 25th of October in the year of 2012. Recently, it issued its 10-year bond at the world‟s stock market at yield of up to 5.25%, which is little less than the 10-year bond from at a yield of about 5.4%. The government‟s goal is to sell 5 billion worth of bonds and on its first launch, Mongolia sold 1.5 billion dollars worth of bonds. The money attained from the bond will be spent on mining investments and on other infrastructural projects. The government is planning to pay of its bond payments by generating tax revenue, especially from the mining sector.

This latest event reveals that Mongolia‟s debt has a tendency to grow further. The government should be aware of the danger proposed by external indebtedness. It should learn a lesson from countries such as Greece, Spain and . 4.3.2 Monetary reform 4.3.2.1 Financial sector

Until the late 1990s, Mongolia had a mono-banking system, which implied that the State Bank of Mongolia carried out all the central and commercial financial activities itself. The State Bank of Mongolia, which is currently known as the Mongol Bank, was responsible for accommodating the financing needs of the annual plan and the budget. There was an automatic adjustment in the quantity of money. This was done in order to reach targets of physical output given fixed prices and was dependent upon when and how the plan was actually exercised. Furthermore, since the State Bank was a central bank, its main responsibility was to issue national currency, control foreign exchange and allocate credits. Four hundred branches of State Bank were collecting deposits and giving credits. Credits were directly provided to state enterprises, cooperatives and individuals, which had a permission from the State Bank, regardless of their creditworthiness. Therefore, most enterprises, which are running in the red, continue undertaking another loan to pay off which they took previously.

The mono-banking system had come to an in 1992 and the two-tiered banking system was introduced in Mongolia with the Mongol Bank and other fifteen commercial banks, which were new. The new banking system inherited all the abominable loans. There was inadequacy in terms of the economical capacity and institutional supervisory as well as weak corporate governance in the centrally planned banking system, which persisted previously. The new banking system took over this and also managed commercial banks alongside.

The Mongol Bank inherited bad loans during the time of the State Bank and since then it was stood responsible to the government of Mongolia, the IMF, the World Bank and other international organizations. Moreover, new commercial banks took over all the bad credits related to citizens, companies and factories. For the newly established commercial banks, it was a question of whether they should accept those abominable loans in hope of termination in the future or wait till government annuls all those credits

47 in order to avoid placing burden on the banking sector. Eastern Europe and countries of the Soviet Union, including Mongolia all faced this distorted situation of bad loans.

During 1994, 1996 and 1998, the banking sector of Mongolia experienced systematic crises. In each of these years, there were significant bank insolvencies and several banks closed down. The government funded costly rescue plans. The 1994 restructuring program cost approximately over 2% of GDP. The rescue plan undertaken during 1996-98 was comparatively larger, costing about 8% of GDP.79 This was because the situation became worse in Mongolia from 1996 onwards and people could no longer place trust in the bank and bank runs took place all over the country. People formed long lines outside the banks in order to wait to draw out their deposits. Deposits of banks decreased 35 % in a significantly short time. 80 Consequently, it was vital for the government to take steps in order to ease the situation. The government delivered new bank laws and gave Mongol Bank the privilege of having superior power over commercial banks. It defined the Mongol Bank as an independent Bank of Mongolia that contributes its efforts towards improving the nation through monetary policy and controlling commercial banks through financial instruments in order to manage their credits, interest rates, and solvency. As a superior power, Mongol Bank started to take relevant actions and closed down three commercial banks, which were working relatively poorly. With the help of this newly enforced law, the banking system started to work efficiently since the new law began eliminating the flaws associated with the old system. Moreover, the Mongol Bank took guidance from international organizations like , for institutional supervisory and management of commercial banks.

Part of the reform program in the banking sector was issuing government bonds amounting to 47.9 billion (5.2% of GDP) 81 in order to replace distorted loans and compensate for commercial banks losses faced by costumers from bankrupted banks. Since Mongolia did not have any system entailing deposit insurance, the government compensated savings by issuing government bonds and the Mongol Bank intervened with more liquidity support. Additionally, the Mongol Bank superintended all the commercial banks several times in order to eliminate the flaws of the banking system, and to immediately shut down banks which are working inefficiently. Furthermore, the Mongol Bank was convincing the agency of special credits collecting, called the “Mongolian Asset Realization Agency”, to collect those overdue debts. This reform program proved to be considerably effective and since then, Mongolian commercial banks were not functioning as poorly as they did during the beginning of the transformation. As a result, the government successfully compensated 70 billion Tugriks of debts from bankrupted banks, which was equivalent to 40% of government revenue or 7% of GDP. 4.3.2.2 Monetary policy

Monetary policy is defined by the Ministry of Finance and is carried out by the Mongol Bank. The Bank of Mongolia was established in 1991. With the introduction of

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48 the new law in 1996; government established its legal grounds of the power, management, organization, activities, and the regulation of foreign currency circulation by entrepreneurs, organizations and citizens in order to establish mechanisms to sustain the exchange rate of the Mongolian currency. The Mongol Bank is mostly in charge of implementing monetary policies.

During the first half of 1991, Mongol Banks used expansionary monetary policies in order to finance the budget deficit as well as to cater to the needs of state-owned enterprises. This was because Mongolia has started experiencing large external and domestic deficits when the Soviet Union terminated their concessional long-term assistance, which was financing all the deficits faced by Mongolia during the period of Communism.

Table 4-9: State Budget Deficit, Money in circulation and Inflation State Budget Deficit Money in circulation Price of common goods, % 1990 - 737 - 1991 2,423 1,694 52,7 1992 356 1,839 325,5 1993 6,817 8,751 183 1994 15,194 18,767 66,3 1995 11,456 25,591 53,1 1996 15,039 41,704 53,2 1997 70,478 56,817 17,5 Source: Mongol Bank

The table above displays how currency in the economy on average grew by 9 percent annually during the period 1985-90, but increased substantially with 143 percent of an annual growth rate in a one-year period in 1991.

This gave rise to inflationary pressures. Price of common goods in 1992 increased more than 300 percent and almost 200 percent in the following year. As shown in the table, prices of common goods had increased 24 times in 3 years. As shown below in the table, inflation reached its highest point during the transition, at around 300 percent in 1992 and 1993.82

The upsurge of inflation which took place during the transition process had been stimulated not only by printing money in order to compensate for the deficits, but also by several other factors such as regression of productivity of economy, relaxation of fiscal policy, devaluation of tugriks and price liberalization.

Table 4-10: Mongolia’s inflation rate and money supply

1989 1990 1991 1992 1993 1994 1995 1996 1997 Inflation rate - - 121.2 321.0 286.4 87.6 53.1 44.6 20.5

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49 Money supply 6.5 27.0 53.5 31.7 251.0 79.5 32.9 25.8 32.5 (% change) Source: Asian Development Bank, 1997.

Factories and companies were facing deficits, which were subsidized by the government. However, when the transformation began, the provisions of subsidies were ceased. As a result, productivity of factories decreased rapidly after the transformation took place. Subsequently, income tax from the factories also reduced drastically. Within price liberalization, the government deregulated centrally controlled prices and prices were dramatically increased until they were the same as the market prices. Majority of the prices were doubled, and such immense increases in price affected the persisting inflation rate in Mongolia.

In 1992, an agreement was based on the Structural Adjustment Policy between the IMF, World Bank and Mongolia. Mongolia received financial assistance from the IMF due to its declining budget deficit and because of the reduction in the money supply due to expenditure on stabilization of the economic situation. Thanks to the measures affiliated with the structural adjustment program, printing money became a slackened process and the inflation rate declined.

Like many other former socialist economies, Mongolia experienced a sudden surge in inflation during the first few years of transition, followed by steady disinflation in subsequent years. Thereby, inflation rate decreased rapidly from 1994. It declined substantially from the 321% of 1993 to 44.6% in 1996. The rapid disinflation was due to the strict monetary policies, adaption of the floating exchange rate system and then liberalization of domestic prices. Until June 1997, the rate fluctuated around 60%. However, it decreased to 20.5% by the end of the year. In 1998, prices continued following a downward course.

Since the mid-1990s, the Mongol Bank has implemented a monetary aggregate targeting framework. The reserve money has been the operating target and the M2 has been the intermediate target.83 However, the Mongol Bank has not been rigorously abiding by its monetary targets in terms of practice (table below), and if seen from the perspective of an ex post, and in light of the observed inflation rates, it is appropriate for one to argue that this deviation from set targets does not seem unreasonable.

Table 4-11: Targeted and Actual Values for Monetary Aggregates, 1995-2006

M0 Growth M2 Growth Inflation Target Actual Target Actual

83 Mongol Bank.

50 1995 28.7 38.3 32.9 53.1 1996 36.5 31.7 25.8 44.6 1997 23.1 19.8 32.5 20.5 1998 18.7 4.4 -1.7 6.0 1999 49.9 10.8 31.6 10.0 2000 18.6 11.2 17.6 8.1 2001 11.1 8.2 13.6 27.9 8.0 2002 21.5 21.9 35.8 42.0 1.6 2003 13.9 14.5 15.2 49.6 4.7 2004 20.0 17.0 18.0 20.4 11.0 2005 15.0 19.7 20.0 34.6 9.5 2006 15.0 15.0 25.0 39.6 6.0 Source: Mongol Bank, 2012.

Data on monetary aggregates put forward that ever since the mid-2000s, the relationship persisting between reserve money and broad money has turned unstable.

In view of the complexities faced whilst conducting monetary aggregate targeting because of the current demonetization process and the volatility of the money multiplier, the Mongol Bank focuses on sustaining economic growth over the medium term. It also aims at maintaining CPI-inflation at a single-digit level. Medium term sustained growth is set up as the policy target so as to elevate the welfare of the people, ensure macroeconomic stability, and bring about improved opportunities for larger demand capacity. In the forthcoming years, it is expected that the economic capacity will increase and this will be followed by a growth in mining and infrastructure. Monetary policy will enable increases in money supply, which is consistent with this projected growth.

Nevertheless, it is essential to take into account that Mongol Bank would be unable to carry out this policy if the government plans on conducting an expansionary fiscal policy, specifically higher social transfers as general elections come nearer.

In conclusion, the negative effects of the transformation like declining productivity, decreasing government revenue and rising budget deficits were not generally unexpected. It would certainly take considerable time in transforming the inefficient banking sector into a healthy banking system. Despite the rugged start, which was taken in 1997, the Mongolian economy and its financial sector began recovering gradually and therefore, the gross product slowly began to increase within a period of around 4 years. The Mongol Bank carried out its duties by ensuring the supervision of the functioning of commercial banks and by annihilating banks, which were functioning in a distorted manner.

51 5 Post-transformation The problem with economic policy is that it is complex to measure the achievement and the power of the economy. But all the economic indicators are dependent on each other. That is why the “Magic Quadrangle” measures the successes of stable macroeconomics of a country. Through this standard evaluative criterion, I will try to show post-transformation economic impacts on Mongolia compared to other transitional countries. Magic quadrangle measures the nation‟s economy based on its GDP, inflation, and current account balance.

20 Figure 5-1: GDP annual growth rate, by transitional 15 country, %

10

5 2008 2009 0 2010 -5 2011

-10

-15

-20

Source: World Bank, 2012.

The first indicator of the magic quadrangle is GDP growth. As I mentioned in the introduction, Mongolia was among the fastest growing economy with 17.3% of GDP growth in 2011, thanks to the mineral boom. The average GDP growth rate of Mongolia since 1990 has been 4.5 % percent, which is quite good for the emerging market. In 2009, most of the countries experienced a drastic fall in their GDP growth because of the economic crisis of 2008. The same happened in Mongolia since the GDP growth was below zero. However, China, on the other hand, is facing a stable GDP growth even during the economic crisis. The stable growth can be explained by its gradual transformation strategy.

The next indicator is the unemployment rate. However, unemployment and inflation were both a new phenomenon to the country after Communism. Unemployment officially started being measured from 1991 when state-owned enterprises collapsed and shifted into private hands. The economic decline, which took place during the transformation naturally led to higher unemployment and worsened the living standards of the population. Unfortunately, unemployment has been affecting vulnerable groups of people overtime. According to data from The National Statistical Office of Mongolia, it can be seen that by September 2012, the number of registered unemployed reached 44 095 people. Younger population of ages ranging between 25 and 34 years creates 40% of

52 the total unemployment. It is certainly a tragic fact that a large number of young people, who should instead contribute towards building up the economy, are actually unemployed. Furthermore, brain drain is threatening our nation. Nowadays, there is a significant trend persisting among young people to work abroad, especially in Korea. Most qualified university graduates end up working in the heavy industry. But this situation can be changed if the government starts indulging in intensive policies, which focus on creating more jobs. Figure 5-2: Unemployment rate, by post socialist country, 2008, %

China 4.2 Czech Republic 4.4 5.5 Bulgaria 5.7 Russia 6.2 Ukraine 6.4 Azerbaijan 6.5 Poland 7.1 7.5 Hungary 7.8 Slovakia 9.5 Mongolia 14.2 0 2 4 6 8 10 12 14 16

Source: World Bank, World Development Indicators, 2010. Among most post socialist countries, Mongolia has the highest unemployment rate of 14.2 percent in 2008. This is a large number for a small nation, but hopefully the unemployment rate has a tendency to decrease. In 2011, the unemployment rate decreased to 8.7%. Even though was at dangerous level in 2008, due to the booming industry, the overall economy is noticeably improving.

40 Figure 5-3: Inflation rate, GDP deflator, %

30

20

2008 10 2009 0 2010 2011 -10

-20

-30 Source: World Bank, 2012.

53 The third indicator is the inflation rate. As shown in the figure above, Mongolia is amongst those countries with a high inflation rate such as Ukraine, Russia and Latvia. China, Czech Republic and Slovakia tend to have a stable inflation rate with the exception of the economic crisis.

As for Mongolia, the inflation rate was around 16 % in the year 2012. This rate was sufficiently above the inflation target of Mongol Bank, which was a single-digit level. Inflation is increasing due to demand side pressures. These pressures can be attributed to higher levels of government spending and by heightened food prices, especially that of meat. The Mongol Bank is focusing on improving the situation by using tight monetary policy. In order to be effective, it is necessary for this monetary tightening to be complemented by fiscal restraints. The Mongol Bank is decreasing the pace at which bank lending is taking place. This had been rising over 60 % in 2012. However, there is still a tendency for it to grow further, since the interest rate depicted by the central bank paper is still negative in real terms. Therefore, it can be said that more monetary tightening is required. However, unfortunately, government spending increased by 56 % in 2011 and is budgeted to rise by a further 32 % in 2012, and is fueled by rapidly rising resource revenues. A large part of government spending was directed towards increases in wages and salaries, large amounts of cash handouts to the general population and burgeoning of capital expenditures. It was possible for this pro-cyclical fiscal policy to result in another “boom-and-bust” cycle, especially because the global economy could face a substantial decrease in growth due to the continuing European sovereign debt crisis. This could possibly result in significantly rapid declines in mineral prices, and subsequently, in government revenues.

Table 5-1: Current account balance of transitional countries, in mil. USD 2008 2009 2010 2011 China 420 568 243 256 237 810 201 714 Czech Republic -4 773 -4 848 -7 601 -6 348 Estonia -2 216 682 549 476 Bulgaria -11 875 -4 256 -796 331 226 558 Russia 103 519 48 604 71 079 98 834 Ukraine -12 763 -1 732 -3 018 -9 006 Azerbaijan 16 452 10 174 15 040 17 144 Poland -34 957 -17 155 -24 030 -25 023 Latvia -4 492 2 283 723 629 Hungary -11 119 -193 1302 1 320 Slovakia -6 185 -3 161 -3 008 12 Mongolia -690 -341 -885 -2 760 Source: World Bank, 2012.

The last indicator is trade balance. Amongst those transitional countries, Russia, China, and Azerbaijan are facing surpluses in their current account balance. There is no doubt to this since China and Russia are the world‟s biggest exporters and importers.

However, all of a sudden, since 2011, Mongolia is experiencing an enormous trade deficit. In comparison with other transitional countries, the trade deficit has been

54 relatively less until the year of 2011. Since imports of mining-related equipment and fuel imports have increased, the trade deficit attained record levels of over 2 billion USD. Nevertheless, exports also rose significantly and reached 4.8 billion from 2.9 billion USD a year ago. This was almost completely supported by coal shipments to China. Furthermore, copper export has been revealing a poor performance since a significant period of time in comparison to coal export. The current account deficit increased to 35 percent of GDP from 14 percent in 2010, but was entirely funded by record FDI inflows of 5.3 billion USD or almost 62 percent of GDP on a four-quarter rolling sum basis, and foreign currency reserves remained high consistently. As a result, in the past few years, the Tugrik has appreciated in terms of both, nominal and real. This will undermine the competitiveness of the non-mineral trading sector of Mongolia.

Conclusion

The focus of the entire thesis is to evaluate the transformation process in terms of aspects of Mongolia from my point of view. The transformation is a complicated process and it is difficult to tell whether it is over or not. The more complex part is to conclude whether the country transformed successfully or not and whether it achieved the aimed economical level.

In the previous chapter, I tried to analyze the economic impacts after the transformation with basic measurements such as GDP growth, inflation rate, unemployment rate and current account balance. Mineral boom and rapid GDP growth created an overheated economy. This led to increase in inflation rates, but somehow unemployment rate has been decreased since the mining boom. However, there are other important measurements that those indicators fail to point out.

Despite the mineral boom and rapid GDP growth, thirty percent of the Mongolian population still lives below the poverty line. The correlation between unemployment and poverty is apparent. When there is a persistence of a large number of unemployed workers, there is a high probability of high level of poverty prolonging in the nation. Since the mid-1990s, one-third of the population has been living in conditions of extreme poverty. After privatization, many industrial enterprises collapsed and this caused many Mongolians to return to semi-nomadic pastoral agriculture. A huge part of the population‟s income depends on the agricultural sector and due to overgrazing and extreme climatic conditions over the previous years; there is an increased risk of poverty among the rural population. 84 After privatization, many immigrants from rural areas moved to the capital city with the hope of finding new jobs. Since most of them sold their homes and moved to Ulaanbaatar, they could not afford the expensive prices incurred to live in apartments and currently they are living in the suburban area of the ger85 area.

84 [16] Page 7. 85 Ger is a Mongolian nomadic easy-transportable yurt.

55 Figure 5-4: Poverty headcount ratio at $2 a day (PPP) (% of population), 2010

Azerbaijan 2 Kazakhstan 2 Latvia 2 Russia 2 Ukraine 2 Poland 2 Romania 4.1 Mongolia 13.6 21 Vietnam 48.4 0 10 20 30 40 50 60

Source: World Bank, World Development Indicators, 2010.

The government has been strongly criticized by the opposition due to the heavy transitional costs incurred by the society and that the reforms were not improving the social situation. Although the GDP of the country is increasing at fast pace, all the persistent unpleasant situations in the economy and society, such as conditions of high inflation, high unemployment rates and the increasing gap between the rich and the poor has resulted in feelings of nostalgia regarding the old, happy days when everyone had an equal share in public goods. 86

In my opinion, Mongolia, being a small nation, did not have any other option but to be a part of Communism. In fact, Mongolia did benefit from that era. However, during the period of transformation, the government did not fulfill its duty to improve people‟s living standard. Instead, the situation became much worse. Mongolia faced a high rate of unemployment, inflation, and poverty compared to other post socialist countries in the last two decades. Hyperinflation took place after liberalizing prices and the inflation rate is still high compared to other transitional countries. This shows the inefficiency of the Mongol Bank towards targeting inflation properly. Also, unemployment has been high during these two decades. These indicators were considerably bad until the situation was eased by the mining boom.

This shows how the government performed an extremely poor job and was not prepared for the impacts, which came about after the transformation period. The government of Mongolia blindly followed external guidance provided by international organizations such as the IMF and the World Bank. The government‟s decisions were clearly not directed towards the impacts and results after the changes were implemented. It seemed as if the main goal was to transform the economy as quickly as possible regardless of the impacts. For example, the government liberalized the prices all at once without careful considerations during the transformation. Because of that, the inflation

86 [2] Page 291.

56 rate reached its highest peak. The same reckless decision was made for the privatization process when the government carried out the whole privatization process as if it was just a handout of enterprises‟ shares to the population. The privatization process should have instead been carried out keenly and must be considered as being extremely essential for the national economy‟s future. The result of the poor privatization process was that most of the main factories had been closed down and Mongolia is unable to cater to its domestic needs of basic consumer goods, food products, and other essential basic supplies after the period of Communism.

The government only believed and trusted the pattern of shock therapy blindly. The situation after transformation indicated how the shock therapy transformed Mongolia into one of the lowest income countries in the world. People in the parliament were unaware of the risk of the transformation in that they mostly left it to the invisible hand of the free market. After all, the main aim of the transformation was to transform the economy with macroeconomic stability. A country with a high inflation rate, unemployment, persistence of poverty and yet with a high bureaucracy level in institutions does not seem to ensure macroeconomic stability, which I can say that the transformation failed to reach its aimed level. So I cannot conclude the transformation in Mongolia was a success story.

Fortunately, only with the rich natural resource, Mongolia‟s socio-economic situation has started improving from the bad transformation era in last few years. The mineral boom started accelerating the stagnant economy of Mongolia. With the help of the state revenue from the mining sector, the government is able to deal with poverty and unemployment. However, the mineral boom can cause the Dutch Disease (mentioned earlier), which would not bypass the Mongolians. A knowledge-based economy is certainly the gateway to get through harsh upcoming times.

57 LIST OF APPLIED SOURCES

Literature and online sources

[1] KOLODKO; Grzegorz. From Shock to Therapy: The Political Economy of Postsocialist Transformation. United States: Oxford University Press, 2002. 457 pages. ISBN 0-19-829743-2. [2] NAYA J. Seiji; TAN L.H. Joseph. Asian Transitional Economies: Challenges and Prospects for Reform and Transformation. Singapore: Institute of Southeast Asian Studies, 1995. 305 pages. ISBN 981-3055-09-X. [3] ŢÍDEK, Libor. Transformace české ekonomiky 1989-2004. Praha: C.H.Beck, 2006. 304 pages. ISBN 80-7179-922-X [4] National University of Mongolia; University of Manchester. Mongolian Economy: Handbook for The Transitional Economy. Ulaanbaatar: Admon 1999. 379 pages. [5] LAVIGNE, Marie. The Economics of Transition: From Socialist Economy to Market Economy. Hampshire: Palgrave Macmillan Publishing, Second Edition, 1999. 328 pages. ISBN-13: 978-0-333-75416-0 paperback. [6] ZAGHA, Roberto; NANKANI, Gobind. Economic Growth in the 1990s: Learning from a Decade of Reform. Washington: The World Bank, 2005. 364 pages. ISBN 0- 8213-6043-4. [7] BAABAR, B. History of Mongolia. Cambridge: The White Horse Press, 1999. 448 pages. ISBN 999-0-038-5. [8] ŢELEZNÝ, Teodor. Mongolská lidová republika. Praha: Nakladatelství Svoboda, 1985. 305 pages. ISBN 25-130-85 ?? [9] TAMCHYNA, Zděnek. Mongolsko. Praha: Institut zahraničního obchodu/ČTK- Pressfoto, 1974. 125 pages. 59-221-73 [10] NAMJIM, Tumur. Mongolian Economy. Volume 1. Ulaanbaatar: Academy of Mongolian Science, 2004. 174 pages. ISBN 99929-82-40-3 [11] NAMJIM, Tumur. Mongolian Economy. Volume 2. Ulaanbaatar: Academy of Mongolian Science, 2004. 174 pages. ISBN 99929-82-40-3 [12] NAMJIM, Tumur. Mongolian Economy. Volume 3. Ulaanbaatar: Academy of Mongolian Science, 2004. 174 pages. ISBN 99929-82-40-3 [13] VLČEK, Eduard MATES, Pavel. Dějiny státu a práva mimoevropských socialistických zemí. Praha: Státní pedagogické nakladatelství, 1984. 105 pages. 17- 184-84 [14] GELB, Alan; DENIZER, Cevdet. Mongolia - Privatization and System Transformation in An Isolated Economy: Policy research working papers series 1063. Country Economics Department, The World Bank, 1992. 44 pages. [15] CHENG, Kevin. Growth and Recovery in Mongolia During Transition. International Monetary Fond, 2003. 26 pages. ISBN: 978-1-45187-513-3 [16] HILLENBRAND, Bertelsmann. Bertelsmann transformation index 2003: towards democracy and a market economy. Verlag Bertelsmann Stiftung, 2005. 346 pages. ISBN 9783892047292 [17] HAHM, Hongjoo. The Development of the Private Sector in a Small Economy in Transition: The Case of Mongolia. Washington, D.C.: The World Bank, 1993. ISSN: 0259-210X. Page 64.

58 [18] BROADBENT, Kieran. Mongolia: Country Report and Development Prospects. Ottawa: University of Ottawa, 1994. Page 68. [19] G, Munkh-Erdene. Bodomj. Ulaanbaatar: Munkhiin useg Group, 2009. ISBN 999291836. 123 Pages. [20] GOYAL, Hari. A Development Perspective on Mongolia. Asian Survey, Vol. 39, No. 4 (Jul. - Aug., 1999), pp. 633-655. University of California Press, 1999. ISSN: 00044687 [21] Trade Policy Review: Report by Mongolia. . 15 February 2005. WT/TPR/G/145 (05-0551). 22 Pages. [22] Mongolia Country Economic Memorandum Towards a Market Economy. December 2, 1991. World Bank. Report No. 10108-MON. 181 Pages. [23] NIXSON, Frederick; WALTERS, Bernard. The Transition to a Market Economy: Mongolia 1990-1998. (ISSN 1523-9748 International Journal of Economic Development, 2000) [24] И.М. Албегова, Р.Г. Емцов, А.В. Холопов, Государтвенная экономичиская политика. МГУ, 1998. 320 стр. ISBN 5-8018-0012-3 [25] WILLIAMSON, John. Latin American adjustment: How much has happened? California: Institute for International Economics, 1990. ISBN: 0881321257. 445 Pages. [26] CORDEN, W. Max; NEARY, J. Peter. The Economic Journal: Booming Sector and De-Industrialization in a Small Open Economy. Vol.92, No. 368. Wiley- Blackwell, 1982. ISSN: 00130133. Pp. 825-848. [27] CENTRAL INTELLIGENCE AGENCY. The World Factbook. [online]. ISSN 1553-8133. [cit. 2012-03-21]. Available at: https://www.cia.gov/library/publications/the-world-factbook/geos/mg.html [28] MONGOL BANK. Monthly Bulletin of Statistics: Trade Balance. [online]. [cit. 2012-09-18] Available at: http://www.mongolbank.mn/documents/statistic/2012/09.pdf [29] STATE PROPERTY COMMITTEE. Government of Mongolia [online]. [cit. 2012-05-12] Available at: http://www.spc.gov.mn/eng/ [30] THE MINISTRY OF MINERAL RESOURCES AND ENERGY. Oyu Tolgoi the copper-gold mineral deposit. [online]. [cit. 2012-10-01] Available at: http://mmre.energy.mn/strategy/field/101/ [31] NATIONAL STATISTICAL OFFICE OF MONGOLIA. Monthly Bulletin of Statistics. [online].[cit.2012-11-07] Availeble at : http://web.nso.mn/download_data.php?type=bulletin&year=2012&file=bulletin_2012 _sep.pdf [32] OYU TOLGOI. Home Page. [online].[cit.2012-11-07] Available at: http://www.ot.mn/?q=en/about-us [33] INFO MONGOLIA [online].[cit.2012-11-07] Available at: http://www.infomongolia.com/ct/ci/3773 [34] TOMŠÍK, V. (1998). Makroekonomický vývoj České republiky, Maďarska a Polska v letech 1990-1996, Politická ekonomie. No. 1998/4. [35] From Plan to Market. World Development Report. 1996. The World Bank

59 [36] USAID FROM THE AMERICAN PEOPLE. Foreign Direct Investment of Mongolia. An Interactive Case Study. United States, March 2007, Nathan Associates Inc. Page 55. [37] GRAINGER, David. The Great Mongolian Gold Rush The land of Genghis Khan has the biggest mining find in a very long time. A visit to the core of frenzy in the middle of nowhere. CNN Money. [online].[cit.2012-12-01] Available at: http://money.cnn.com/magazines/fortune/fortune_archive/2003/12/22/356094/index.h tm [38] GOVERNMENT OF MONGOLIA. State Property Committee. [online].[cit.2012- 12-01] Available at: http://www.spc.gov.mn/eng/index.php?option=com_content&view=category&layout =blog&id=7&Itemid=28 [39] WORLD BANK. The World Development Report. 2002 [40] WORLD BANK. The World Development Report. 2004b [41] BANK OF MONGOLIA. Annual Report. 2002e [42] ERDENET MINING CORPORATION [online].[cit.2012-11-07] Available at: http://www.erdenetmc.mn/index.php?lang=en [43] WCPA, IUCN [online].[cit.2012-11-07] Available at: http://cmsdata.iucn.org/downloads/dauriamining.pdf [44] INTERNATIONAL MONETARY FUND. Staff Country Reports. IMF Country Report No. 10/52. Washington D.C. February 2010. [45] BOKROS, Lajos. čat k relativní prosperitě (Porovnání procesu transformace v ČR a Maďarsku). Finance a úvěr, 2001, c. 4. ISSN 0015-1920.

60 ABBREVATION

CMEA () Council for Mutual Economic Assistance MPRP Mongolian People‟s Revolutionary Party USSR Union of Soviet Socialist Republics IBEC International Bank for Economic Co-operation UN United Nations WTO World Trade Organization DUC Democratic Union Coalition Comintern Communist International SAL Structural Adjustment Loan IMF International Monetary Fund

61 LIST OF FIGURES AND TABLES

LIST OF FIGURES

Figure 1-1: Mongolia‟s Foreign Trade Balance…………………………………………13 Figure 1-2: GDP, by sector 2012………………………………………………………..14 Figure 3-1: Structural Adjustment Policy………………………………………………..23 Figure 4-1: GDP growth rate of Mongolia (in USD mil.)……………………………….30 Figure 4-2: Annual inflation rate, %……………………………………………..………32 Figure 4-3: Percentage of private sector in GDP………………………………………...40 Figure 4-4: Tax Burden of Mongolia…………………………………………………….44 Figure 5-1: GDP annual growth rate, by transitional country, %...... 53 Figure 5-2: Unemployment rate, by post socialist country, 2008, %...... 54 Figure 5-3: Inflation rate, GDP deflator, %...... 56 Figure 5-4: Poverty headcount ratio at $2 a day (PPP) (% of population), 2010………..57

LIST OF TABLES

Table 2-1: Development of the total amount of industrial products in the MPR……..…19 Table 2-2: Growth and Structural Changes in Mongolia‟s Economy during the Industrialization Period…………………………………………………………………..19 Table 3-1: Growth of GDP among countries with transitional countries.……………….26 Table 3-2: Poverty among Chinese people………………………………………………28 Table 3-3: Real GDP annual percentage in the developing and transitional countries….29 Table 4-1: Trade Balance of Mongolia (in USD mil.).…………………………………..33 Table 4-2: Foreign Direct Investment (in USD million).……………………………..…34 Table 4-3: Exchange rate after liberalization of exchange rate………………………….35 Table 4-4: Government Spending (in percentage) ………………………………………42 Table 4-5: Mongolian State Budget Revenue (at current prices) ……………………….43 Table 4-6: Long term external debt by creditor countries (in mil.of transferrable ruble).45 Table 4-7: Mongolia‟s external debt (in mil. USD)……………………………………...47 Table 4-8: External Debt to GDP ratio…………………………………………………..47 Table 4-9: State budget deficit, Money in circulation and inflation……………………..49 Table 4-10: Mongolia‟s inflation rate and money supply………………………..………50 Table 4-11: Targeted and Actual Values for Monetary Aggregates, 1995-2006………..51 Table 5-1: Current account balance of transitional countries, in mil. USD……………..56

62