Report No. 26240-MOG From Goats to Coats: Public Disclosure Authorized Institutional Reform in Mongolia’s Cashmere Sector December 19, 2003 Public Disclosure Authorized Poverty Reduction and Economic Management Unit East Asia and Pacific Region The World Bank Public Disclosure Authorized Public Disclosure Authorized CURRENCY EQUIVALENTS (as of end January 2002) Currency unit = Togrog (Tg) US$1 = Tg 1100 FISCAL YEAR January 1 – December 31 WEIGHTS AND MEASURES Metric System ABBREVIATION AND ACRONYMS ADB - Asian Development Bank CMEA - Council for Mutual Economic Assistance FDI - Foreign Direct Investment FSU - Former Soviet Union GDP - Gross Domestic Product GTZ - Deutsche GeseLLschaft fur Technische Zusammenarbeit GmbH IDA - International Development Association NBFIs - Non-Bank Financial Institutions NCSM - National Center for Standardization Metrology NSO - National Statistical Office R & D - Research and Development SCM - Supply Chain Management SCMIC - Schneider Cashmere Market Indicators SFU - Sheep Forage Unit UNDP - United Nations Development Organization USAID - United States Agency for International Development WTO - World Trade Organization Regional Vice President: Jemal-ud-din Kassum, EAPVP Country Director: Ian C. Porter, EACTF Sector Director: Homi Kharas, EASPR Sector Manager Tamar Manuelyan Atinc, EASPR Task Team Leader: Vera Songwe, EASPR Table of Contents Executive Summary............................................................................................................................................i Chapter 1. Boom, Bust and Future Prospects ........................................................................................................... 1 The transition from command to market............................................................................................................1 The 1991-96 cashmere boom.............................................................................................................................1 The downturn in the cashmere industry, 1997-2002..........................................................................................3 Household incomes and cashmere production...................................................................................................4 Future prospects.................................................................................................................................................7 Chapter 2. Dynamics of Cashmere Supply................................................................................................................ 8 Cashmere supply, 1990-2000: Transition to a market-oriented system.............................................................8 Access to raw material, infrastructure and environment....................................................................................9 Infrastructure concerns.....................................................................................................................................10 Environmental impact and property right ........................................................................................................12 Cashmere supply and livelihoods ....................................................................................................................18 Reform options.................................................................................................................................................20 Chapter 3. Standardization and Quality Control ................................................................................................... 23 Quality developments in cashmere sector........................................................................................................23 Reform options: Grading and standards...........................................................................................................26 Chapter 4. Dynamics of Cashmere Demand and the Processing Industry ........................................................... 34 Overview of processing industry .....................................................................................................................34 Government policy stance................................................................................................................................37 Impact of tax on earnings.................................................................................................................................38 Increasing competitiveness of Mongolian cashmere sector.............................................................................43 Chapter 5. Cashmere Marketing and Distribution Channels................................................................................ 47 Procurement and distribution systems: From command to markets ................................................................47 Current marketing channels .............................................................................................................................49 Constraints to intra-industry integration and policy options............................................................................53 Luxury good marketing and foreign direct investment....................................................................................58 Increasing communication flows between herders and processors..................................................................58 Chapter 6. Engineering Public Policy Choices to Strengthen Cashmere Industry and Reduce Poverty........... 60 Introduction......................................................................................................................................................60 Public sector policy choices to mitigate market failures and market imperfections in cashmere sector .........63 Conclusion .......................................................................................................................................................65 List of Boxes Box 2-1: Goat Habit 12 Box 2-2. Pastoralism and Intensification 14 Box 2-3: Assessment of Land and Land Management in Mongolia 17 Box 3-1: Cashmere's Five Quality Factors 23 Box 3-2: Importance of Grading and Standardization 27 Box 3-3: Experience from the Australian Wool Corporation: Normative Classification 28 Box 4-1: Cashmere Production Steps 36 Box 5-1: Vertical and Horizontal Integration in Chinese Manufacturing 57 Box 6-1: Cashmere Policy Formulating and Advisory Institutions in Mongolia* 62 List of Figures Figure 1-1: Boom and Bust in the Mongolia’s Cashmere Industry, 1993-2002 1 Figure 1-2: Annual Growth of GDP and Agricultural Sector, 1990-2001 2 Figure 1-3: Real Growth of GDP, Livestock and Crop Production, 1996-2001 2 Figure 1-4: Exports of five main commodities in 1993-2002 3 Figure 1-5: Direction of Trade in 1992-2002 in percent of Export 3 Figure 1-6: Openness of Mongolian Economy, 1990-2002 3 Figure 1-7: Togrog REER Index, 1991-2000 Six-month moving average 2 Figure 1-8: Household categories 4 Figure 1-9: Share of household groups in total by number of livestock owned 5 Figure 1-10: Trends in demand for luxury fine fibers, 1996-2000 7 Figure 2-1: Increased preference for goats 8 Figure 2-2: Number of Goats by Region, 1990-2002 8 Figure 2-3: Mongolia Pasture Capacity Thresholds 13 Figure 2-4: Simulation of cashmere production with and without Dzud in US$ million 19 Figure 2-5: Simulation of cashmere production with and without Dzud per household in US$ 19 Figure 2-6: Simulation of cashmere production with and without Dzud in tons 19 Figure 2-7: Simulation of cashmere production with and without Dzud per household in kg 19 Figure 3-1: International Dehaired Cashmere Prices 1970-2002 (All prices quoted in Jan) 25 Figure 3-2: Income from quality improvement of raw cashmere in total cashmere export 25 Figure 3-3: Income increase from quality improvement by household with livestock 25 Figure 3-4: Share of quality breeds in Mongolia’s goatherd 29 Figure 3-5: Percentage of breeding female goats in total goatherd 29 Figure 4-1: Import trend of fine animal hair (not combed)-in tons, 1996-2000 34 Figure 4-2: The effect of the export ban and tax on compositions of cashmere exports, 1993-2001 38 Figure 4-3: Share of total export taxes in Revenue and GDP 40 Figure 4-4: Share of cashmere export taxes in Revenue and GDP 40 Figure 4-5: Nominal export tax burden on herders in percent 41 Figure 4-6: Taxes and Fees Across Supply Chain 42 Figure 5-1: Main Marketing Channels and Agents for Cashmere Products 48 Figure 5-2: Export Restrictions Benefited Traders/Dehairers 55 Figure 5-3: Share of top 5 importers of fine animal hair in world import 56 Figure 5-4: Value Chain-Mongolian Cashmere 57 Figure 5-5: Increasing vertical integration among firms 58 Figure 5-6: Distances from cashmere-producing regions to UB market 59 List of Tables Table 1-1: Cashmere’s Role in Mongolia’s Economy 1 Table 1-2: Cashmere export trends 3 Table 1-3: Survival of goat offspring following Dzud 3 Table 1-4: Livestock by main types, 1989-2001 4 Table 1-5: Share of households groups in cashmere production and average income 5 Table 1-6: Sources of livelihood by well-being category: soum center /1 6 Table 1-7: Sources of livelihood by well-being category: rural communities /1 6 Table 2-1: Fodder Production Systems and Evolution of Fodder Supply, 1990-2002 10 Table 2-2: Livestock watering facilities, 1990-2000 11 Table 2-3: Mongolia Pasture Capacity, 1995-2001 13 Table 2-4: Some Existing Conversion Rates (Sheep