Export Diversification and Inclusive Growth in Land-Locked Countries in Asia: Bhutan, Kazakhstan, Mongolia and Turkmenistan* Stephen Golub, Kazuatsu Shimizu and Anastasia Vasilyeva Swarthmore College Report prepared for the United Nations Conference on Trade and Development Revised November 2017 * We are grateful to Mussie Delelegnaregna for inviting us to prepare this report and Stephen O’Connell for comments. The views expressed here are our own and do not necessarily represent those of UNCTAD. 1 Table of Contents I. Introduction: the Paradox of Resource Wealth in the Central/South Asian Context .......... 3 1. The Resource Curse ........................................................................................................ 3 2. What can be done? .......................................................................................................... 5 3. The Central/South Asian Context ................................................................................... 7 References ......................................................................................................................... 10 II. Kazakhstan ....................................................................................................................... 12 1. Introduction ................................................................................................................... 12 2. Oil and Macroeconomic Policy .................................................................................... 14 3. Private Sector Development ..................................................................................... 15 4. Institutions and Governance ..................................................................................... 28 5. Diversification strategies .............................................................................................. 33 6. Conclusion .................................................................................................................... 42 References ......................................................................................................................... 43 III. Turkmenistan ................................................................................................................. 46 1. Introduction ................................................................................................................... 46 2. Dominance of Natural Gas............................................................................................ 47 3. Macroeconomic Management ....................................................................................... 50 4. Obstacles to Private Sector Development ..................................................................... 53 5. Institutions and Governance ..................................................................................... 64 6. Diversification Strategies .......................................................................................... 68 7. Conclusion .................................................................................................................... 76 References ......................................................................................................................... 76 IV. Mongolia ......................................................................................................................... 78 1. Introduction ................................................................................................................... 78 2. Converting Mineral Wealth into Development............................................................. 80 3. Macroeconomic Policy and Management of Mineral Wealth ...................................... 81 4. Private Sector Development ......................................................................................... 85 5. Institutions and Governance ......................................................................................... 94 6. Diversification Strategies .............................................................................................. 99 7. Conclusion .................................................................................................................. 106 References: ...................................................................................................................... 108 V. Bhutan ............................................................................................................................ 110 1. Introduction ................................................................................................................. 110 2. Macroeconomic Management of Hydropower ........................................................... 111 3. Obstacles to private sector development..................................................................... 119 4. Institutions and Governance ....................................................................................... 131 5. Diversification Strategies ........................................................................................ 134 6. Conclusion .................................................................................................................. 142 References: ...................................................................................................................... 143 2 I. Introduction: the Paradox of Resource Wealth in the Central/South Asian Context This document examines prospects for economic diversification and inclusive growth in four Asian economies characterized by high levels of natural resource dependence and challenging geographical and historical contexts: Kazakhstan, Turkmenistan, Mongolia and Bhutan. Diversification away from natural resources is not easy to begin with. A history of political and economic isolation and/or strong state control of the economy add additional difficulties. 1. Natural Resources: Blessing or Curse? One would expect natural resource abundance to be a great advantage in fostering prosperity in developing countries. In some cases, such as Botswana (Kojo 2015), revenues from natural resource exports have enabled rapid improvement in living standards. In practice, more often than not, natural resources have proven to be a “curse,” inhibiting rather than promoting economic development (Venables 2016, Collier 2007). The growth performance of natural-resource abundant countries has generally been lackluster, as Sachs and Warner (1995) were the first to point out. In the 2000s, the “Commodity Super- Cycle” of rising commodity prices driven by Chinese demand for raw materials, particularly energy, led to booming growth in many natural resource-importing countries (Gangelhoff 2015). Falling oil and other commodity prices since 2015, associated in part with a slowdown in China’s growth, has revealed the fragile foundation of this growth and the lack of structural transformation in many natural resource exporters, with many countries facing fiscal and balance of payments crises and sharp declines in growth. It is therefore important to understand how to make natural resources a blessing rather than a curse. There are a number of economic and political reasons for the failure to benefit from natural resources. From an economic point of view, natural resources are difficult to manage (Venables 2016). Extraction is often technically complex and beyond the capabilities of developing countries. Thus, many countries welcome foreign investment. Relations between multinational companies and national governments can be fraught, and in some cases developing countries may not bargain effectively. In other cases, developing countries are so wary of foreign involvement that they prohibit or dissuade foreign investment, thus reducing their ability to exploit and earn income from their resources. This is the case with Turkmenistan for natural gas and Mongolia for mining, as discussed below. Management of resource revenues, however, has proven to be the most significant problem. First, resource prices and revenues are highly volatile, making planning difficult. In principle, countries should save a large part of their income when prices and sales are temporarily high, perhaps into a stabilization fund and thus running current account and fiscal surpluses. Conversely, when prices are 3 below their long run level, countries can legitimately run fiscal and current-account deficits. In practice, however, even ignoring the political distortions discussed below, it is not always easy to determine when prices are above or below an equilibrium level and whether price changes are permanent or temporary. Second, booming natural resources tend to result in “Dutch Disease”: domestic currency appreciation and higher wages, harming other tradeable goods sectors, both traditional and non-traditional. For example, high oil revenues in countries such as Nigeria and Venezuela have crowded out agriculture and manufacturing (Ross 2012). This can be problematic for long run development because of the acute dependence that results on one or a few commodities. Third, even when windfall revenues are used for investment rather than consumption, the investments sometimes take the showcase monuments or inefficient public-sector enterprises that do not contribute to long-run growth. Finally, and perhaps most importantly, natural resource extraction and distribution is capital- intensive and not conducive to shared growth and structural transformation. Manufacturing