Mongolia Growth Diagnostics Elena Ianchovichina Senior Economist Economic Policy and Debt Department...
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Transcript of Mongolia Growth Diagnostics Elena Ianchovichina Senior Economist Economic Policy and Debt Department...
Mongolia Growth Diagnostics
Elena IanchovichinaSenior Economist
Economic Policy and Debt DepartmentWorld Bank
Objectives Use the growth diagnostic
framework to identify binding “constraints” to growth in Mongolia
Rely on both direct and indirect evidence to identify “bottlenecks”
High cost of finance
Low return to economic activity
Low social returns
Low appropriability
government failures
market failures
poor
geography
low human capital
bad infra
-
structure
micro risks:
property rights, corruption,
taxes
macro risks: financial,
monetary, fiscal instability
information externalities:
“self
-
discovery”
coordination externalities
bad international finance
bad local finance
low domestic
saving
poor inter
-
mediation
Growth diagnostics
Problem: Low levels of private investment and entrepreneurship
Source: Hausmann, Rodrik, Velasco (2005)
poor naturalresourcemanagement
Is private investment in Mongolia low?
Gross domestic investment in Mongolia has been high by international standards
Averaged 35% of GDP between 1996 and 2005 But most of it was official foreign aid and loans
59% of investment in 2004 The bulk of private investment went into a limited
number of firms in mining and construction FDI was high and averaged 5.2% of GDP in 1996-2005 Domestic private investment was financed mainly by own
funds (72 percent in 2004), and not bank loans Domestic credit to the private sector has been growing at
high rates, but most of the loans have been short term and financed trade, not productive investments
What are the reasons for the low private investment outside mining and construction?
Is the cost of capital in Mongolia high?
or Is the rate of return on capital in the
sectors outside mining and construction low?
High cost of finance
Low return to economic activity
Low social returns
Low appropriability
government failures
market failures
poor
geography
low human capital
bad infra
-
structure
micro risks:
property rights, corruption,
taxes
macro risks: financial,
monetary, fiscal instability
information externalities:
“self
-
discovery”
coordination externalities
bad international finance
bad local finance
low domestic
saving
poor inter
-
mediation
Growth diagnostics
Problem: Low levels of private investment and entrepreneurship
Source: Hausmann, Rodrik, Velasco (2005)
poor natural
resourcemanagement
Are real interest rates high?Real interest rates are high, but have come down substantially…
0
10
20
30
40
50
60
70
80
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
%
Mongolia Cambodia Vietnam Kyrgyz Republic
Source: World Bank, SIMA
What is the reason for the recent fall in the real cost of capital?The fall in the real cost of capital was due to inflation rate increases rather than risk premium declines…
Source: World Bank, SIMA
-2
0
2
4
6
8
10
12
14
16
18
2001 2002 2003 2004 2005
Interest rate spread (lending rate minus deposit rate)
Inflation, consumer prices (annual %)
and Mongolia’s cost of capital is still high relative to other developing countries
Real interest rate
-6
-4
-2
0
2
4
6
8
10
12
14
Tur
key
Slo
veni
a
Bra
zil
Chi
na
Alb
ania
Hun
gary
Egy
pt
Rus
sia
Indo
nesi
a
Mor
occo
00
Cro
atia
Bul
garia
Est
onia
Mor
occo
04
Ken
ya
Cze
ch
El S
alva
dor
Slo
vaki
a
Phi
lippi
nes
Indi
a
Mol
dova
Alg
eria
Ban
glad
esh
Nic
arag
ua
Bos
nia
Om
an
Pak
ista
n
Ecu
ador
Pol
and
Rom
ania
Source: Ricardo Hausman, “A framework for Growth Diagnostics”, Kennedy School of Government, Harvard University, May 2006.
Mongolia
Why is the cost of capital still high?Cost of capital is high because of high bank deposit rates and risk premiums
0
5
10
15
20
25
Mongolia Azerbaijan Cambodia KyrgyzRepublic
Vietnam Uruguay
Deposit interest rate Interest rate spread (lending rate minus deposit rate)
Source: World Bank, SIMA
High cost of finance
Low return to economic activity
Low social returns
Low appropriability
government failures
market failures
poor
geography
low human capital
bad infra
-
structure
micro risks:
property rights, corruption,
taxes
macro risks: financial,
monetary, fiscal instability
information externalities:
“self
-
discovery”
coordination externalities
bad international finance
bad local finance
low domestic
saving
poor inter
-
mediation
Growth diagnostics
Problem: Low levels of private investment and entrepreneurship
Source: Hausmann, Rodrik, Velasco (2005)
poor natural
resourcemanagement
Why are bank deposit rates and risk premiums high?Is bad international finance the reason for the high cost of capital?
International finance has been good Mongolia’s official debt is primarily
concessional, long-term FDI inflows have been strong
Outlook As of now the spread on ‘B+’ Fitch rated
countries is 280 to 300 basis points Collateral can be used to bring down the
spread further down But, new tax law affecting mining may result
in a drop in FDI and outlook will change if there is a negative TOT shock
High cost of finance
Low return to economic activity
Low social returns
Low appropriability
government failures
market failures
poor
geography
low human capital
bad infra
-
structure
micro risks:
property rights, corruption,
taxes
macro risks: financial,
monetary, fiscal instability
information externalities:
“self
-
discovery”
coordination externalities
bad international finance
bad local finance
low domestic saving
poor inter
-
mediation
Growth diagnostics
Problem: Low levels of private investment and entrepreneurship
Source: Hausmann, Rodrik, Velasco (2005)
poor natural
resourcemanagement
Why are bank deposit rates and risk premiums high?Is bad local finance the reason for the high cost of capital?
Domestic saving increased due to strong growth and BOP position
Rising official reserves and commercial bank assets pushed the 2006 liquidity ratio to 600% and credit growth was highest since 1992
But, the cost of capital is high due to poor financial intermediation
High cost of finance
Low return to economic activity
Low social returns
Low appropriability
government failures
market failures
poor
geography
low human capital
bad infra
-
structure
micro risks:
property rights, corruption,
taxes
macro risks: financial,
monetary, fiscal instability
information externalities:
“self
-
discovery”
coordination externalities
bad international finance
bad local finance
low domestic
saving
poor inter
-
mediation
Growth diagnostics
Problem: Low levels of private investment and entrepreneurship
Source: Hausmann, Rodrik, Velasco (2005)
poor natural
resourcemanagement
Why are bank deposit rates and risk premiums high?Poor financial intermediation is responsible for the high cost of capital
Bank deposit rates are high due to intensive competition among financial institutions
Spreads are high due to a combinations of factors: Difficulty in assessing credit risk; High bank operating costs; Low profitability of banks’ non-lending
assets;
Are the high cost of capital and limited access to capital the reasons for the large number of firms without loans?
72.1%27.9%
With a loan Without a loan
All firms100%
4.0% 68.1%
Applied Did not apply
25.9% 42.2
Did not need a loanDiscouraged
Why?High cost of
Capital22.0%
Collateral
18.7%
Low returnTo capital?
42.2%
Lack Collateral
3%l
Why?
Why?
Low returnTo capital?
1%
Loan Maturity of
1 year27%
Loan Maturity >
5 years0.9%
Source: Mongolia Productivity and Investment Climate Survey (PICS) 2004.
Discrepancy between complaints and data
Cost of capital Whereas 56% of the firms in PICS complained that the
cost of capital is a severe obstacle to business growth Only 22% of the firms in the survey did not apply for a
loan because of the high cost of capital Access to capital
Whereas 42% of firms claim that access to credit was a severe obstacle
70% either obtained a loan (28% of firms) or did not need a loan (42% of firms)
Access to long-term financing is limited Collateral requirement is excessive due to problems with
assessing credit risk Conclusion: while the cost of capital is high, it is not the
primary reason for the small number of firms with loans
High cost of finance
Low return to economic activity
Low social returns
Low appropriability
government failures
market failures
poor
geography
low human capital
bad infra
-
structure
micro risks:
property rights, corruption,
taxes
macro risks: financial,
monetary, fiscal instability
information externalities:
“self
-
discovery”
coordination externalities
bad international finance
bad local finance
low domestic
saving
poor inter
-
mediation
Growth diagnostics
Problem: Low levels of private investment and entrepreneurship
Source: Hausmann, Rodrik, Velasco (2005)
resourcemanagement
poor natural
Is the rate of return on economic
activity in Mongolia low? Efficiency has improved Productivity growth was positive in 2004 Return to capital has been positive and
high compared to other countries
TFP growth estimates in 2004 (%) (Cobb-Douglas)
α=0.3 α=0.4 α=0.5 γ=1 (CRTS) 5.8 5.2 4.5 γ=1.2 (IRTS) 5.0 4.2 3.4 γ=0.8 (DRTS) 6.7 6.2 5.7
TFP growth estimates in 2004 (%) (CRTS CES)
σ=0.8 σ=1 σ=1.2 α=0.5 7.1 4.5 2.6
Source: Staff estimates
Not all sectors enjoyed high returns to capital
Returns to capital in manufacturing and transport were negative
Industries’ contribution to real growth in Mongolia (percentage points)
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Agriculture 1.2 1.6 2.5 1.7 -6.2 -6.2 -3.5 1.1 4.1 1.9 Industry -1.7 -0.9 0.9 0.0 -0.2 3.7 0.4 1.6 4.0 -0.1 Manufacturing -2.4 -1.4 0.3 -0.5 -0.4 2.2 1.2 0.7 -0.1 -2.2 Mining 0.6 0.6 0.6 0.5 0.6 1.2 -1.2 -0.3 4.1 1.7 Construction 0.1 -0.1 0.0 0.0 -0.4 0.3 0.4 1.2 0.0 0.4 Services 1.6 3.2 -0.1 -0.1 3.4 1.5 6.0 3.1 1.5 4.3 Utilities -0.8 -0.1 0.1 0.1 0.2 0.4 0.2 0.0 0.1 0.1 Transport 0.5 0.0 0.6 0.0 1.2 1.4 2.0 1.5 1.8 -0.3 Trade 0.3 3.2 -1.2 -1.6 1.3 0.1 2.7 1.4 -0.7 4.3 Other services 1.6 0.1 0.4 1.4 0.7 -0.3 1.1 0.2 0.3 0.3
Source: Staff estimates based on data from World Bank (LDB).
What are the reasons for low returns in Mongolia’s lagging sectors?
Are the low returns due to low social returns?
or Are the low returns due to low
private appropriability (i.e. low private returns)?
High cost of finance
Low return to economic activity
Low social returns
Low appropriability
government failures
market failures
poor
geography
low human capital
bad infra
-
structure
micro risks:
property rights, corruption,
taxes
macro risks: financial,
monetary, fiscal instability
information externalities:
“self
-
discovery”
coordination externalities
bad international finance
bad local finance
low domestic
saving
poor inter
-
mediation
Growth diagnostics
Problem: Low levels of private investment and entrepreneurship
Source: Hausmann, Rodrik, Velasco (2005)
poor natural
resourcemanagement
Is human capital a constraint to growth?
According to PICS 2004, shortage of skilled labor is not a concern, except for large firms
Skilled labor is abundant, and job creation for skilled workers has been limited Unemployment among workers with secondary
and tertiary education was 64 percent in 2004 But, quality of education is poor and there is
a mismatch between skills demanded by the market and skills workers bring to the market
High cost of finance
Low return to economic activity
Low social returns
Low appropriability
government failures
market failures
poor
geography
low human capital
bad infra
-
structure
micro risks:
property rights, corruption,
taxes
macro risks: financial,
monetary, fiscal instability
information externalities:
“self
-
discovery”
coordination externalities
bad international finance
bad local finance
low domestic
saving
poor inter
-
mediation
Growth diagnostics
Problem: Low levels of private investment and entrepreneurship
Source: Hausmann, Rodrik, Velasco (2005)
resourcemanagement
poor natural
Is poor infrastructure a constraint to growth in Mongolia?
Survey results: Infrastructure is not a constraint as service interruptions do not result in large production losses due to spare capacity
But, transport services are expensive and poor quality
Domestic market is small (low income, low population density) and remote (poor geography)
Transportation services for freight are limited, costly and unreliable
Majority of goods moved by rail and rail transport costs are very high
Transit times are long and uncertain due to complex transit procedures including customs and trade rules
High oil prices have put upward pressure on road and air transport costs
Rail transport costs are high
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0.80
0.90
1.00
Kazakhstan Uzbekistan Tajikistan Kyrgyz Rep. Mongolia-Exports
Monglia-Imports
$/T
EU
/km
Source: Staff estimates based on data from Broadman (2005) and World Bank (2006)
High transport costs coupled with long and uncertain transit times result in excessive trade
costs
Export costs
0
500
1000
1500
2000
2500
3000
3500
US
$ p
er T
EU
Source: Doing Business database
Excessive trade costs are a binding constraint to
growth Hurt Mongolia’s export competitiveness Hurt the growth of Mongolia’s
manufacturing sectors Prevent firms from:
Integrating with global manufacturing networks Expanding markets, and realizing economies of
scale Diversifying the economic base
High cost of finance
Low return to economic activity
Low social returns
Low appropriability
government failures
market failures
poor
geography
low human capital
bad infra
-
structure
micro risks:
property rights, corruption,
taxes
macro risks: financial,
monetary, fiscal instability
information externalities:
“self
-
discovery”
coordination externalities
bad international finance
bad local finance
low domestic
saving
poor inter
-
mediation
Growth diagnostics
Problem: Low levels of private investment and entrepreneurship
Source: Hausmann, Rodrik, Velasco (2005)
resourcemanagement
poor natural
Is poor natural resource management a constraint to growth in Mongolia? No, but… The quality of natural resources are eroding even
as their contributions to public and shadow economies are increasing
Natural resource degradation threatens Mongolia’s progress towards sustained long-
term economic growth; its costs – in terms of lowered labor and land
productivity, biodiversity, tourism and government revenue, as well as public health related expenditures – continue to climb;
reduces the options for future generations. Lack of data makes assessments of
environmental degradation challenging, but indirect evidence suggests that illegal wild life and logging trade, and mining activities are responsible for the increasing environmental costs
Threats to the environment come from three profitable activities ‘Illegal’ wildlife trade has led to dramatic population
declines; The loss of species: will force herders to either purchase meat or consume own
livestock hurting incomes of vulnerable groups limit the growth of industries relying on wildlife as an
intermediate input. ‘Illegal’ logging is unsustainable, and:
has lowered timber prices driving legal operators out of business;
has limited revenue from forest-use fees; raised the costs of forest management; has affected negatively non-timber forest products.
The environmental effects of mining are worse in Mongolia than in other countries due to its large and unregulated artisinal mining sector
High cost of finance
Low return to economic activity
Low social returns
Low appropriability
government failures
market failures
poor
geography
low human capital
bad infra
-
structure
micro risks:
property rights, corruption,
taxes
macro risks: financial,
monetary, fiscal instability
information externalities:
“self
-
discovery”
coordination externalities
bad international finance
bad local finance
low domestic
saving
poor inter
-
mediation
Growth diagnostics
Problem: Low levels of private investment and entrepreneurship
Source: Hausmann, Rodrik, Velasco (2005)
poor natural
resourcemanagement
Is macroeconomic instability a constraint to growth? No
Monetary and fiscal policies have insured macroeconomic stability in recent years
Absence of REER appreciation for now, but the threat of ‘Dutch’ disease is real if commodity boom persists
Fiscal performance improved due to the commodity boom and improved budget management, but the quality of fiscal adjustment deteriorated
Public capital spending and maintenance declined by 1.4% of GDP
Fiscal pressures will persist in the run-up to the 2008 elections
Heightened concerns about financial sector instability The incidence of NPLs increased from 8.3% in end-2003 to
10% in mid-2005 Macroeconomic stability depends on the stability of the
terms of trade
High cost of finance
Low return to economic activity
Low social returns
Low appropriability
government failures
market failures
poor
geography
low human capital
bad infra
-
structure
micro risks:
property rights, corruption,
taxes
macro risks: financial,
monetary, fiscal instability
information externalities:
“self
-
discovery”
coordination externalities
bad international finance
bad local finance
low domestic
saving
poor inter
-
mediation
Growth diagnostics
Problem: Low levels of private investment and entrepreneurship
Source: Hausmann, Rodrik, Velasco (2005)
poor natural
resourcemanagement
Is the tax burden too high and distortionary?Mongolia’s informal sector is large and growing, signaling indirectly that the tax code is a binding constraint to growth
The tax base is narrow 100 taxpayers provided over 90% of revenues
Tax administration is weak; rent-seeking and tax evasion are wide spread
The tax code creates: incentives to avoid paying taxes by staying small disincentives to start-up businesses
A planned overhaul of the tax code will address some of these problems
The windfall profit tax on copper and gold, introduced in 2005 may have a negative effect on FDI inflows in the mineral sector; has led to a drop in official sales of gold and may encourage illegal trade
Duty exemptions on imported inputs used in the production of exports likely to do more harm than good to the economy
Export tax on raw cashmere encouraged smuggling to China, not downstream processing
Is corruption an obstacle to growth? Mongolia ranks 9th out of 62 countries, in terms
of the share of firms reporting corruption as a major obstacle to growth
Corruption is perceived to be the number one obstacle to growth, according to PICS
Has worsened since 2001 according to Transparency International
Government procurement affected The process of obtaining permits is nontransparent The process of acquiring land is extremely
bureaucratic and costly, and is associated with corruption
Is contract enforcement an obstacle to growth ?
Mongolia’s institutions for contract enforcement are weak but improving and are not a binding constraint to growth
Crime has been on the rise In 2004 firm’s losses due to crime
added up to 1.6% of sales
High cost of finance
Low return to economic activity
Low social returns
Low appropriability
government failures
market failures
poor
geography
low human capital
bad infra
-
structure
micro risks:
property rights, corruption,
taxes
macro risks: financial,
monetary, fiscal instability
information externalities:
“self
-
discovery”
coordination externalities
bad international finance
bad local finance
low domestic
saving
poor inter
-
mediation
Growth diagnostics
Problem: Low levels of private investment and entrepreneurship
Source: Hausmann, Rodrik, Velasco (2005)
resourcemanagement
poor natural
Mongolia is the 37th least diversified economy among a group of 100
countries
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0.80
0.90
1.00
Mon
golia
Vietnam
Kazakh
stan
Kyrgy
z Rep
ublic
Cambodia
Uzbek
istan
Ghana
Urugu
ay
Herfindahl Index Hirschman Index
Source: Database on export diversification (PRMED).The higher the index, the lower the degree of diversification
Comparative advantage vs.
competitive advantage
Mongolia specializes in primary commodities in which it has comparative advantage – land and mineral intensive products
But is vulnerable to terms-of-trade shocks and environmental degradation, and uses its scarce resource – labor inefficiently
Value added per worker in Mongolia is low except in mining
0
1000
2000
3000
4000
5000
6000
7000
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
LC
U i
n t
ho
usa
nd
s
Agriculture Manufacturing Mining Services Total
Source: Staff estimates based on data from Mongolian Statistical Yearbook (2004) and Government of Mongolia
Dependence on primary goods has grown in the past few years
Two economic activities - livestock herding and mining - represented more than 40 percent of real GDP in 2005
Three commodities – copper, gold and cashmere – accounted for 67 percent of Mongolia’s exports in 2005
The vast majority of non-metal manufactured exports were textiles and apparel (76 percent)
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
1990 1995 2000 2004
Herf
ind
ah
l In
dex
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
% o
f exp
ort
s
Herfindahl Index Export share of five largest exports
Do Mongolian firms “innovate”? Diversification of the production structure requires
“discovery” of an economy’s cost structure Firms must adapt new technologies to local conditions and
“discover” which products they can produce at low enough cost to be profitable
Mongolia’s manufacturing base is narrow but this is not because firms do not attempt to export new products; every year in the period 2002-06
New exports were 30% of exports at the 4 digit HS level Of these, 70 to 80% were new manufactured exports But half of new exports were discontinued next year, and
manufactured exports represented a large share of these new exports discontinued the following year
The process of “self-discovery” has been hampered by limited access to new technology & knowledge and access to markets
Access to new technology is critical for diversification and sustained growth – examples from resource-rich countries
A leap from resource-based activities to high-tech industries is possible
Emphasis on access to technology and training has been critical to:
Finland’s Nokia A move from pulp and paper to a global leader in
telecommunications Alliances with American and European companies and research
institutions were critical Aggressive human-resource development programs
Australia’s Broken Hill Proprietary Company (BHP) A move from local mining to shipping and ship building, and
exporter of cutting-edge know-how on mineral detection and mining-related environmental knowledge
Emphasis on building mining expertise in Australia has been critical to BHP’s success
High cost of finance
Low return to economic activity
Low social returns
Low appropriability
government failures
market failures
poor
geography
low human capital
bad infra
-
structure
micro risks:
property rights, corruption,
taxes
macro risks: financial,
monetary, fiscal instability
information externalities:
“self
-
discovery”
coordination externalities
bad international finance
bad local finance
low domestic
saving
poor inter
-
mediation
Growth diagnostics
Problem: Low levels of private investment and entrepreneurship
Source: Hausmann, Rodrik, Velasco (2005)
poor natural
resourcemanagement
Coordination externalities
Firms need services requiring simultaneous, large scale investments in order to: expand output of existing products; improve quality; expand the number of exported goods;
Firms also need improved access to foreign markets and state-of-the-art technology
Negative coordination externalities in Mongolia
Large informal exports of raw cashmere to China are indirect signal that the government has failed to address coordination issues in the cashmere industry
Herders lack finance, information and infrastructure to improve raw cashmere quality
Processors lack incentives and are reluctant to form strategic links with herders;
Some of the consequences have been: Shortages of quality raw cashmere
force processors to operate below capacity an obstacle to FDI from luxury makers of cashmere goods
Environmental degradation Coordination of transit trade and logistics has been poor SPS restrictions on meat products in China and Russia have
eliminated meat exports from Mongolia to these markets Firms are not competitive in global markets as they do not have
access to modern technologies, market, and product quality information
The role of knowledge clusters Network organizations – or knowledge
clusters – are the main strategic competitive asset of the Swedish forest industry
The network of institutions is essential to: developing and maintaining international
competitiveness; dissemination of skills and research from
universities and research organizations to the industry
Undertaking multi-industry projects
Concluding remarks Mongolia has grown rapidly, but growth has been
unbalanced Private investment has flown into a small number of firms
operating in mining and construction Returns in manufacturing and other private sectors have
been kept low by: Costly and unreliable transport services and lengthy and
complex transit procedures, including customs and trade rules
Negative coordination externalities Mismatch of skills and poor quality of education Limited access to modern technology, market information
Natural resource degradation threatens Mongolia’s progress towards sustained long-term economic growth
Diversify sources for finance and improve financial sector intermediation