Research: The Mongolian Wolf Economy amidst the Russian Bear and the Chinese Dragon

Thought I would bring back a research paper from 2014: 

Introduction

Mongolians have a long tradition of using metaphors from the natural world. This is why, as their economy skyrocketed in recent years, Mongolians have started to refer to their economy as the “Wolf Economy.”  Similar to how four nations in Asia with notable high growth rate in the 1980s were termed Asian Tigers, Mongolia used the wolf as it symbolized strength, wit, and resilience to harsh climates and a readiness to pounce. Thanks to its mining sector, it has become one of the fastest growing nations in the world and has attracted multiple foreign investments and mineral contracts. However, because of old socialist ideals of nationalism, along with political propaganda and protests by angry and poor citizens, the government is finding it harder to negotiate with foreign investors.

Mongolia, located between China and Russia, is the world’s second largest landlocked country. Its location has been described as “strategic” because of its direct access to large markets for its exports, which further contributes to Mongolia’s economic growth.  However, Mongolia’s historical dependency on Russia for electrical power and oil, combined with its close proximity to China for its export demand and transportation along with its landlocked position, undermines Mongolia’s sovereignty.

In this paper, I will examine how this unique geographic situation influences Ulaanbaatar’s decisions in mining, which will ultimately impact its economic growth and state sovereignty. Through this research paper, I show that Mongolia’s situation between the two giants can bring about long-term consequences to its economy. However, the government’s response to its situation can contribute to building a sustainable economic growth. First, I will give an account of the brief history of Mongolia’s politics and economic structure and an overview of its economy and natural resources endowments. This will be followed by the consequences that have occurred due to mining as well as the current impact of mining on the economy. Next, I will provide some insight into Mongolia’s relations with China and Russia as well as the latest developments Mongolia has made with its neighbors and their potential impact. I will then examine how Mongolia may benefit from its ties with its neighbors as well as the possible long-term disadvantages of its situation. Last, I will conclude with possible solutions for Mongolia’s predicament.

Nation in Transition

Chinggis Khaan (better known to the west as Genghis Khan) founded the Mongol Empire – the world’s largest land empire in 13th century by unifying the Mongol tribes and embarking on conquests. Similar to most great empires, the Mongol empire weakened due to internal disunity and the strengthening enemies. From the 1630’s to the early 1700’s, the Mongols came under the rule of the Manchurians (Qing dynasty) and permanently lost Inner Mongolia to the Chinese. After the fall of the Qing, the Mongolians declared independence in 1911. Shortly after, with the help of the Russian Red army, Mongolian revolutionists chased out the Tsarist and Chinese forces and created the Mongolian people’s government.

In 1924, the Mongolian government renamed itself the Mongolian People’s Republic Party (MPRP) and chose Lenin’s communist system, becoming the first Soviet satellite state.  During the 70 years of state socialism under the MPRP, Mongolia’s economy went through tremendous socio-economic change as it “sought to develop the country through planned industrialization and collectivization.”  This transition caused rapid urbanization and rural-to-urban migration in the 1950s as the government established large-scale state-owned collectives to manage herders.

Large non-violent street demonstrations were led by the Mongolian democratic movement in 1989, resulting in the collapse of the socialist regime and forcing the resignation of the  MPRP, followed by the establishment of a representative multi-party democracy and market-based economy. The first elections for the Great Khural (Parliament) in 1990 formed a long-lasting coalition government by the two largest political parties: the Mongolian People’s Party (former MPRP) and the Democratic party, making Mongolia the first country in Asia to successfully transition from communist rule to a democracy.

However, Mongolia’s economy entered a crisis as the rapid transition from a socialist to a capitalist economy brought a deep recession. The government immediately adopted a policy of ‘shock therapy,’ described as measures “to quickly remove regulations and control while trying to hand as many activities over to the private sector,” such as liberalization of trade, floating exchange rate, abolition of state subsidies, privatization of state sector assets, guarantee of property rights and reform of fiscal and financial systems. Additionally, one third of the Mongolia’s revenue and the aid it used to receive from Russia was lost, resulting in a rapid increase in the poverty rate reaching 30% in just a few years during the shift to capitalism.

As Mongolia embraced a free-market economy and extensive privatization, many foreign corporations and investors sought out possibilities for investment and found an abundance of minerals under Mongolian soil, which alleviated the economic crisis. It is evident that since the 1990s the economy has grown tremendously. The annual economic growth was 6.4% in 2010, reaching its peak in 2012 to 17.5%, and has since been steadily maintaining a double digit growth due to the investment pouring into its mining sector. The International Monetary Fund (IMF) in 2013 predicted the Mongolian economy would continue to expand in the coming years, and recognized it as one of the fastest growing economies in the world.

Overview of Economy and Natural Resource Endowment

This transition to a free market economy did not eliminate Mongolia’s centuries old nomadic lifestyle based on traditional herding and agriculture; however, this lifestyle’s importance in the economy has shifted. Today, Mongolia stands as one of the most sparsely populated countries in the world, with a total of just 2.9 million people, and the 19th largest landmass country. Although herds were collectivized during the Soviet Era, it remains “one of the few countries in the world where a large portion of the population lives as nomadic pastoralists.” The fall of socialism in Mongolia caused the many newly unemployed to go back to herding. The country has doubled the number of herders and increased livestock to 45 million since the early 1990s.  Even though the number of its livestock is more than 15 times its total population, herding is not the largest financial contributor to Mongolia’s economy and growth.

Mongolia’s transition to a free-market economy has rapidly expanded the main exports of just livestock and animal products to mineral deposits. The minerals sector has become the main engine behind the growth of its economy. Minerals account for 30 per cent of gross domestic product (GDP) and more than 80 per cent of exports. Copper, gold, iron ore, coal, molybdenum and fluorspar are the primary outputs of the industry. Its untapped reserves have been calculated by a Mongolia-focused investment bank, ResBank, to have a combined worth of 1.3 trillion. Resbank noted “there are approximately 6,000 known deposits of over 80 different minerals in the country, including gold, copper, coal, uranium, molybdenum, tin and iron.” It further noted, since “only 27% of the country has been surveyed to a scale of 1:50,000,” so the country has vast potential for further discoveries. The deposits forecasted to be most crucial to Mongolia’s economic development are gold, copper and coal. Mongolia is estimated to have 163.2 billion tons of coal reserves and about 77.3 billion tons of copper in reserves.

The discovery of Mongolia’s resource wealth led giant multinational corporations rushing into the country in hopes of exploiting the reserves. Before this breakthrough in mining, Erdenet Mine and Concentrate, owned by Erdenet Mining Corporation (EMC) – a joint Mongolian-Russian venture- has been the major source of Mongolian copper export since the late 1970s. However, by 2012, “the total 3208 exploration and mining licenses are owned by approximately 1000 mining companies,” from which about 30 have a total revenue more than USD 4 million. In 2012, approximately $5 billion in foreign investment – equal to half of Mongolia’s GDP – poured into the country. Hannah Beech, Time Magazine’s South East Asia bureau chief noted in her article Hesitant Steppes in 2012, “A natural-resource boom has transformed the country, making it the fastest-growing economy on the planet this year.”

From the many mining projects there are two that are most notable and prominent. The first is Oyu Tolgoi (OT), a giant copper-gold mine discovered between the late 1990s to early 2000s, is four times bigger than Erdenet Mine and Concentrate and forecast to contribute about one-third of Mongolia’s GDP in 2020. OT is located about 80 kilometers north of the Chinese border and is estimated to have deposits of “37 million tons of copper and 1,431 tons of gold and is considered to be worth USD$350 billion,” amounting to 50 times the value of Mongolia’s current GDP. After six years of negotiations, the Mongolian government signed an investment agreement with the joint venture between Rio Tinto and the Canadian firm Ivanhoe Mines for the management of OT in 2009. The agreement gave the joint venture a 66% stake over OT’s production and the Mongolian government the remainder. The first copper concentrate for commercial production was produced in January of 2013 at the Southern Oyu open pit mine and sent its first shipment in July that year. The Hugo North division – a black rock cave mine- is planned to extract its first ore in 2015.

On the other hand, Tavan Tolgoi (TT) is considered the world’s largest unexploited coking-coal reserve and the second largest untapped reserve in the world. Located in South Gobi Desert just 200 kilometers from the Sino-Mongolian border, the reserve is believed to have some 7.5 billion metric tons of coking coal. TT is divided into six sections: Tsankhi (divided into East and West), Ukhaa Khudag, Bor tolgoi, Borteeg, and Southwest and Eastern coalfields. Initially, in 2011, the Mongolian government selected US-based Peabody Energy, China’s Shenhua, and Erdenet Mining Corporation as partners to develop the TT coal deposit, but in 2012 the government put the deal on hold. Today Erdenes MGL, a government-owned company, owns all of TT. From the six sections, the biggest is the Tsankhi section. Now, the East Tsankhi section is managed by a subsidiary of Erdenes MGL – Erdenes Tavan Tolgoi LLC (Erdenes TT). According to Invest Mongolia, an Asia Pacifics Investment firm, Erdenes MGL “is due to float on the Hong Kong, London and Ulaanbaatar stock markets sometime in the next couple of years.” The Australian based Macmahon Holding Ltd. was contracted in August 2011 to work as a miner at the east pit of TT mines. The government hopes to eventually contract the West Tsankhi to a consortium of international mining firms as well.

Consequences of Mining

The increase in trade and mining has given rise to different challenges that have impacted Mongolian society and environment. Improper or non-existent restoration of previously exploited mine lands are accelerating the pace of desertification that is already occurring due to global warming. According to Mongolian officials in 2012, about 70 percent of the country is suffering from desertification. Contamination from mining in turn affects the villagers near the mining areas and causes severe problems to their health. In 2008, a small village just 20 kilometers from the outskirts of the capital city was plagued with health problems arising from the exposure to mercury. Many women, elderly people and children suffered kidney dysfunction, desquamation, memory impairment and many other severe symptoms.

Despite the boom in the economy, one third of Mongolians are still living in poverty. The income distribution gap is vast, and many have not benefited from economic growth. Almost half of the 1.2 million people in the Mongolian capital, Ulaanbaatar, live in urban slums called the ger district. While many are forced to burn cardboard for heat in the winter and scourge for food to eat, others drive around in their new LandCruiser cars and dine at high-end restaurants.

An article in The Economist, “Mongolia: Change at the Top,” claimed that although Mongolia’s economy grew by 17.3% in 2012, thanks to its booming mining sector, the country’s standing went down from 116th place to 120th in 2011 on the Transparency International’s Corruption Index, ranking amongst the most corrupt countries in the world. The corruption scandal of Mongolia’s former president, Nambaryn Enkhbayar as well as the dismissal of Prime Minister Altankhuyag Norov for alleged corruption this November, sheds some light on the people behind the corruption statistics we see on the news. Both were charged for multiple cases of money swindling and twisting laws in their own interest, which attests to how the foreign investment that is rushing into Mongolia has been ending up in the private pockets of men in power.

Furthermore, the manufacturing industry is being neglected. Between 2001 and 2009, the manufacturing industry in Mongolia contracted from 30% to 20% of Gross Industrial Output (GIO), while mining grew from 50% to 70% of GIO.  This trend is regarded as a classic sign of impending ‘Dutch disease’, a term that refers to harmful consequences for a country’s economy due to dependence on a single natural resource.  Similarly, traditional agriculture and pastoralism are in danger of being lost as the government is neglecting these sectors. Jeffrey Reeves, an Associate Professor at the Asia-Pacific Center for Security Studies, noted in his article, Resources, Sovereignty, and Governance: Can Mongolia avoid the ‘Resource Curse’? that “as of 2009, a bumper crop year, Mongolia’s crop production covered less than 250,000 hectares, almost 300,000 hectares less than in 1990.” This decline is the result of a lack of investment in what the government increasingly treats as a “secondary industry.” The ongoing neglect has further led to over-dependency on foreign imports for goods ranging from food to petroleum. For example, during the international economic crisis in 2008-2009, Mongolia suffered a deep economic downturn due to a collapse in mineral prices. This decline in prices led to a corresponding decline in Mongolia’s economy and an increase in unemployment.

Stemming from these issues, public opinion has become very nationalistic in that the majority of the Mongolian people have turned against foreign investment and the exploitation of Mongolian mineral wealth. A report regarding OT’s activities noted the “deep sense of frustration, anger, and distrust felt by the community towards the OT project” as many felt that the  “company is abusing their power by not listening to the needs of the community” thus the herders and “other residents of the area are pessimistic of the benefits the mine will supposedly bring.” The government has tried to win back the support of the people by promising monetary handouts. In 2009, the Minister of Finance declared that each Mongolian citizen would receive a one-time incentive of 50 thousand tugriks, or $35, directly after the government signed an investment agreement over Oyu Tolgoi (OT) with Ivanhoe Mines. Such monetary handouts and promises of shares from mining projects for citizens have become common in the past six years, especially when elections are around the corner. The two main parties- the MPRP and DP -competed to promise even higher amounts to the citizens, hoping to gain votes. Although such monetary handouts and promises silence the people for a month or two, the apparent problems arising from mining have led to increasing resource nationalism.

Prices and Agreements: Impact on Economy

Despite the boost in economic growth in the past few years, Ulaanbaatar has had ongoing trouble negotiating with investors. Besides the nationalistic protests of the public and support from nationalistic politicians, the global fluctuation in metal prices has made it difficult for Ulaanbaatar to advance successful agreements regarding mining projects.  The main dispute has been with Oyu Tolgoi (OT) as the mine’s expansion has been stalled for about 16 months because its leading stakeholders have been unable to negotiate a fiscal framework with the Mongolian government. The dispute has been over the scale of management fees and taxation between Rio Tinto (the leading stakeholder of the OT mining project) and the government, which holds a 34% stake.

The problem arose when copper prices fell last year, down to 8% in the London Metal Exchange this year, and Rio Tinto raised its cost estimates for the mining project accordingly. Since the government is a stakeholder, it has to pay its share of the cost overruns to continue the mining at OT. However, there has been a deadlock in an agreement, as the Mongolian government imposed new and increased taxes on Rio Tinto and Ivanhoe mines. Not only were firms unhappy, but the new tax wasn’t taken lightly by investors, as shares for Ivanhoe alone fell 20% following the news.

Part of the disputes with investors is a consequence of a decline in Mongolia’s chief mineral export: coal. Coal exports in US dollars (USD) fell to $1.12 billion last year, from $1.9 billion a year earlier, whilst its volume fell to 18.3 million metric tons, from 20.9 million tons. The decline in exports coupled with the “fight amongst the foreign investors who” had fueled the mining boom has amounted to a credit crunch in Mongolia’s economy. Now, an article in the Economist said, the country is undergoing a “balance-of-payment crisis from which its hard-currency reserves have fallen by two-thirds; the currency, the togrog, is also sharply lower.” This past November, operations at the TT coalmine were suspended due to multiple “disagreements between the state owned mine operator Erdenes TT and Macmahon”; the main dispute was the delay in payments worth USD 22 million by the Mongolian government.

As the economy plunges and mining agreements are stalled, foreign mining investors are discouraged from doing business as they question the political environment in Mongolia. The Asian Development Bank (ADB) announced that Mongolia’s economic growth slowed to 5.3% in the first half of 2014, from 7.5% in the final quarter of 2013. According to ADB, the economy has been sharply decelerating, falling from 8.7% in 2013 to 3.8% in the first quarter of 2014 as the investment stimulus in the economy was withdrawn. The Foreign Direct Investment (FDI), reported the ADB,  “plunged by 62.4%,” which cut investments by 32.4%.

Despite Mongolia’s economic plunge occurring due to ongoing disputes with foreign investors, coupled with the decline in coal and copper prices, Mongolia has been able to avoid a full-blown crisis, thanks to its neighbor, China. For example, China offered a loan in August 2014 from China’s Development Bank that has helped increase Mongolia’s hard currency. The Chinese ‘Dragon’ has further extended several extensive foreign exchange swap arrangements as a lifeline to Mongolia.

Relations with China and Russia

The help coming from its neighbor should not be taken lightly. As an article from The Economist stated that there are two issues facing Mongolia’s mining situation: while the long-run issue is resource nationalism, the short run issue is Mongolia’s dependency on China and Russia. The question thus lies on how long and to what extent Mongolia can and should continue to rely on China and Russia’s aid in sustaining its economic growth and the effect on its state sovereignty?

In his book, The Race for What’s left, Professor Michael Klare of Hampshire College argued that “Mongolia’s key mining decisions are governed by its geopolitical situation rather than economic considerations.” The history behind Mongolia’s relations with China and Russia reflects the great influence they have on Ulaanbaatar today. Every ounce of coal, gold, copper or uranium must exit through one of Mongolia’s neighbors, Russia or China.

On one hand, Mongolia was historically under the influence of the Soviet regime during the communist era. In 1921, the Mongolian People’s Republic “modeled its economic and political systems after those of the Soviet Union”. Thus, anything that could be privately owned was nationalized and owned by the government. Non-state trade was prohibited and almost all-international trade was directed to the Soviet and countries of the Council for Mutual Economic Assistance (CMEA). Professor Young C. Kim of George Washington University, further noted, “Soviet aid financed much of Mongolia’s imports, investment, and government expenditure,” and as of November 1989, Mongolia’s per capita debt to USSR amounted $6,800. This massive aid made the Mongolian economy significantly dependent on the Soviet and its allies. But when Mongolia transitioned to a democracy in 1991, virtually all-Soviet aid stopped and the Soviet troops left Mongolian soil, and thus Mongolia  “plunged into an economic spiral.  

Although Mongolia has almost fully recovered from the economic downturns of the early 1990s, remnants of the 70-year influence of the former Soviet era left a legacy of dependency.  Klare highlighted an example of how the young democracy’s “legacy of ties to the USSR” is highly dominating the nation’s mining operations, as most of the copper exports are run by a Mongolian-Soviet joint venture, the Erdenet Mining Corporation (EMC) that was first established in 1978. Today, Russia provides 50% of Mongolia’s electricity, 90% of Mongolia’s petroleum, and owns half of Mongolia’s largest enterprises: Ulaanbaatar Railway, the Erdenet Copper Complex, and Mongolrosvetmet, a non-ferrous metal concern.

Economic dependence can be illustrated by the oil crisis last summer, when the Russian Federation had a shortage in its fuel production. This shortage resulted in extreme cuts in petroleum supplies to Mongolia. The cuts led to stagnation – not just in mining work, but in the lives of the people who were dependent on their petroleum-running cars. Another example occurred during the international economic crisis of 2008-2009, when Mongolia suffered a deep economic downturn due to a collapse of mineral prices in its biggest exporting markets- Russia and China. The decline in prices led to a decline in Mongolia’s economy and an increase in unemployment.

On the other hand, after the transition into a democracy, Mongolia’s ties with China were re-established and trade increased tremendously. In 2003, more than 600 Chinese businesses in Mongolia were established. As international institutions pressured Mongolia to privatize, many Chinese individuals and companies bid on Mongolian industries and service enterprises, which greatly increased Chinese economic leverage on Mongolia. Due to historical grudges that go back to the days of Chinggis Khan and the Qing Dynasty, the Mongolian public has a huge mistrust toward China. However, about 90% of Mongolia’s exports went to the People’s Republic of China in 2013 (CIA 2014) and Chinese investment is very high in Mongolia. Over 6,000 mining licenses have been issued to Chinese investors.

Currently, 95% of the products of Erdenes TT are sold in the Chinese market. The remainder of the output is used locally to generate electricity. Additionally, “in 2004, two-thirds of Mongolia’s flour, sugar and rice were imported from China”. Therefore, Mongolia remains very dependent on Chinese finished goods and its economic growth is highly dependent on China’s demand for Mongolia’s raw materials. Furthermore, Mongolia is reliant on the use of rail services inside China’s borders as well as the Tianjin port facilities for its exports and imports. Tianjin port, the closest port available to Mongolia, gives the traders direct access to international transport and distributes its goods and commodities.

Besides the prominent roles Russia and China play in the growth of Mongolia’s economy, the two powers use their leverage to exert influence on Mongolia’s domestic affairs. Since Mongolia relies heavily on China’s rail links, China has severed these rail links during times when Mongolia’s political actions were deemed inappropriate. For example, in 2002, when the Dalai Lama, the Tibetan spiritual leader, visited Mongolia, China responded by punishing the Mongolian government by stopping all train traffic to and from Mongolia during the Dalai Lama’s visit, thus limiting access to the Tianjin port. Reeves further noted, “Chinese dominance of Mongolia’s mineral sector directly affects the country’s sovereignty in that it limits the government’s ability to manage its domestic affairs exclusive of foreign influence and to stem the flow of cross-border activity”. Meanwhile, Russia can cut supplies or even shut off energy just as they have done previously to other countries in the region, such as Ukraine and Belarus. Unlike Kazakhstan, which can use non-Russian pipelines to export its oil and gas, Mongolia’s only option for exports to the north and west is through the Russian pipeline network. Thus, Moscow can use this clout to negotiate to its advantage.

Furthermore, Mongolia’s main exporting commodities from the mining sector – copper, coal and gold – are not as easily transportable as petroleum is, especially by coastal states. These raw materials have to be transported by train or trucks, which requires Mongolia to build roads and railways that connect them to the rest of the world. Unfortunately, all transportation infrastructures that would connect Mongolia to other countries are within China or Russia’s territories. In a recent article on Bloomberg, Moody’s Investor Services noted “apart from weak selling prices, land-locked Mongolia presents more challenges because in-land producers are geared towards selling to the Chinese market, compared with other seaborne producers that ship to more countries.” Therefore, Mongolia has a superior-inferior relationship with both China and Russia, not a complementary relationship. Because of Mongolia’s geographic situation, it has a very high economic dependence on China and Russia, which greatly affects Ulaanbaatar’s sovereignty as the Russian Bear and Chinese Dragon can influence the Wolf’s domestic and international decisions.

Revival of trilateral partnership with the two Giants

During these past few months, Mongolia’s relationship with China and Russia has become tighter, starting from the separate visits by the heads of states to Ulaanbaatar, which led to a trilateral summit held in Dushanbe, Tajikistan this past September. These meetings occurred at a time when Mongolia had been experiencing a rough decline in its economic growth, while Russia had been dealing with tough economic sanctions from the West, and China had been clashing with Japan, Vietnam and others over disputed islands in the South China Sea and East China Sea. Thus, looking further into the separate agendas of each country’s energy and economic security is necessary to better understand how Beijing and Moscow will impact Ulaanbaatar’s decisions regarding its mining and economy.

The main agreements made during the different meetings were cited “fruitful” by Chinese news agency, Xinhua. From the 26 economic agreements China signed with Mongolia, the most significant agreements made were a bilateral trade target of $10billion by 2020 (up from USD $6.2 billion in 2013) and the five new transportation agreements that highlighted access to the seaport and transit transport, including designating six Chinese seaports, including Tianjin, Dalian, and Jinzhou, for the transit of Mongolian exports to overseas markets.” President Putin’s visit on the other hand resulted in 14 bilateral agreements between Mongolia and Russia, mainly centered around Russo-Mongolian transportation projects, such as the “electrification and construction of a second track for the 1100 km (684 mile) rail from Mongolia’s northern border with Russia through the planned Sainshand minerals processing industrial zone in the Gobi to Zamyn Uud on the Chinese border.”Moreover, the three state heads of Russia, China and Mongolia agreed upon continued cooperation for transcontinental rail plans – Silk Road Economic Belt – during their first trilateral meeting at this year’s Shanghai Cooperation Organization (SCO) summit in Dushanbe between September 11-12. The “Silk Road Economic Belt” initiative, proposed by Xi, is a proposal to revive the ancient trade route linking China with Central Asia and Europe. Cooperation between the three nations, were evident as President Xi stated “China’s silk road economic belt initiative could be coordinated with Russia’s transcontinental rail plan and Mongolia’s Praire Road program.” He further noted that this will create a China-Mongolia-Russia economic corridor. According to Russia’s ITAR-TASS news agency, the three countries looked into rail development, highway construction, and a gas pipeline. The three nations also have agreed to plan more regular trilateral talks to further their cooperation.

Impact on Mongolia: Benefits?

Mongolia’s increased ties with its giant neighbors and new agreements of inter-governmental transportation infrastructure may prove to have several foreseeable benefits for the small nation. Firstly, increased transportation infrastructure will be beneficial to Mongolia’s economy as it will be able to expand its exporting markets to countries other than China and Russia. The many agreements to improve Eurasian transportation connections through Mongolia, made with both China and Russia, could benefit Mongolia’s ‘third neighbors’ as Mongolia reaches out to Japan and South Korea and diversifies its trade partners. Border cooperation and access to rail capacity in China, the opening of four new Mongolian ports for rail transport, and China’s agreement to have one third of all Mongolian goods transported on Chinese rails to be exported to third countries via Chinese seaports will allow Mongolia to export to markets beyond China.

Additionally, rail projects reflect how Sino-Russian rail cooperation and the trilateral cooperation between the three neighbors put Mongolia’s transport possibilities to greater use resulting in more efficient trade.  As Mongolia embraces compatible rail gauges with China, it will cut its exporting costs by an estimated USD $120 million.  Russo-Mongol joint efforts to build a section of the so-called western route pipeline across its steppe territories with Russia may be economically strategic. According to the Australian Business Review, “leading Australian companies already fear that the opening of Mongolia’s coal resources to the East Asian market would be a game-changer and could possibly push them out of the market.” This indicates the possible impact of the rail projects if it is successfully implemented.

Secondly, Mongolia can also benefit from its increased ties with Russia and China. The support of the landlocked nation’s giant neighbors are necessary for Mongolia to expand as well as build strategic ties with other potential alliances. When Mongolian President, Tsakhiagiin Elbegdorj, requested the support of China and Russia for Mongolia’s wish to join the Asia-Pacific Economic Cooperation (APEC) as a member-country, during the trilateral meeting, both neighbors accepted. Nadine Godehardt, Asia expert at the German Institute for International and Security Affairs (SWP), noted how “APEC would give Mongolia a chance to enhance cooperation with a range of other countries and partly pursue its long-term third-party neighbor policy.” Moreover, Mongolia needs to balance off China’s power over Mongolia’s economy by strengthening its relations with Russia. Even though Russia provides energy and goods to Mongolia, China is the dominant force in Ulaanbaatar’s foreign relations because of China’s dominating share of trade with Mongolia. Thus, increased transportation links between Mongolia and Russia may allow for more independence from China’s market and trade.

Long-term disadvantages

Despite the possible benefits of increased trade routes and ties with Russia and China, Mongolia faces some long-term disadvantages, as it will have to compete with the two giants’ trade monopolization as well as become more vulnerable to China’s market demand for mineral exports.

China and Russia’s push to integrate and increase its rail networks with Mongolia will give them monopoly power over transportation infrastructure. In Russia’s case for example, it is currently facing heavy economic sanctions from the West due to its actions in Crimea and eastern Ukraine and is now looking at its immediate neighbors, Mongolia and China, as major economic partners. Russia’s finance minister recently reported that the nation is losing about USD $90 billion to $100 billion per year due to oil prices falling by 30%. Thus, Moscow is under great financial pressure, since about half of its revenue comes from oil. As Russia is looking to move its exports to the Eastern market, Mongolia’s role in connecting Russia to countries such as India, Pakistan and South Korea among others, through the joint development of a western Mongolian railway, is crucial. For example, if Mongolia and Russia integrate their national rail systems, such as the lines between Mongolia’s Gobi Desert coal deposits to Russia’s Pacific coast, the two nations will be able to ship to South Korea and Japan. Since South Korea’s economy is growing consistently and 97% of its energy is foreign sourced, its market for energy will likely grow. This is good news for Mongolia, because South Korea’s “import of coal, already at 80 million tons a year, is expected to rise to 128 million by 2018.” However, “South Korea’s demand for natural gas is expected to increase 1.7% annually until 2035,” which means a potential significant energy deal for Russia, which Putin will most likely use to Russia’s advantage.

On the other hand, China is undoubtedly increasing trade route ties with its neighbors, including Mongolia, to rapidly increase its economic capacity and national security. Levi and Economy noted, “Chinese efforts to build pipelines that connect its markets to Central Asia are probably of greater importance to Beijing than oil and gas investment itself.” The Wall Street Journal, also cited that analysts said the new  “are designed to put China at the center of Asian trade and transport and secure more opportunities for major Chinese construction and engineering firms.” Earlier this month, President Xi announced that China will contribute USD $40 billion to new Silk Road Fund that will develop the “Silk Road Economic Belt” and the “21st Century Maritime Silk Road”. The “Economic Belt” and is planned to be a network of highways, railways and other infrastructure that will connect China to Central and South Asia, the Mideast and Europe. The “Maritime Silk Road,” on the other hand, is a route that will expand ports and industrial parks in Asia, the Mideast, Africa and Europe. Therefore, although China’s market is still interested in purchasing coal from Mongolia, it is increasingly becoming more invested in expanding its own economy through the new transcontinental trade routes. The personal agendas of Russia and China therefore will prove difficult for Mongolia, as the small landlocked nation does not have the capacity to compete with the large powers.

Another disadvantage Mongolia faces is how it will become more and more dependent on Chinese demand for mineral exports as more trade routes will enable Ulaanbaatar to increase exports to Beijing. Although Mongolia seeks to balance off China’s power by strengthening its ties with Russia, Ulaanbaatar’s economy relies on Beijing’s capital to boost its foreign exchange reserves. This is something which Moscow is unable to do with its current sanctions from the West. Despite China’s slowing economic growth in 2014 compared to previous years, its GDP growth this past year beat the estimates by analysts and remains to be the world’s largest global energy consumer. Today, Beijing still remains “by far Ulan Bator’s largest economic partner with bilateral trade reaching 6 billion USD last year.” Mongolia’s largest foreign investor is also China, as 50% of all foreign investment comes from the “Dragon.” In addition, Mongolia is now the third-largest exporter of copper concentrate to China, supplying 25 percent of its imports last month. As rail infrastructure between China and Mongolia develop and Mongolia embraces rail gauges compatible with China’s rails, Ulaanbaatar will be able to export double the amount of coal for the same price. This will be detrimental for Mongolia if demand from the Chinese market falls.

Unfortunately, China’s demand is expected to fall as there is a rapid increase in Chinese local coal production as well as plans to reduce China’s carbon emission. China is cutting back on its carbon emissions as it is the world’s leading energy-related CO2 emitter, and has released about 8,715 million metric tons of CO2 in 2011. The government of China plans to reduce carbon intensity (carbon emissions per unit of GDP) by 17% between 2010 and 2015 as noted in its 12th Five-Year Plan. This plan can explain China’s move to increased natural gas supplies from the Central Asian Gas Pipeline (CAGP) and its recent agreement with Russia to double its gas supplies. Economy and Levi emphasized that, “whatever the motive, increased pipeline-based supplies from Central Asia could raise the stakes and difficulty for any US (or Indian or Russian) effort to cut Chinese oil and gas supply lines during a future war.” In May of this year, Russia signed a $400 billion deal to supply natural gas to China for 30 years. It is evident that Moscow is assisting Beijing’s plans to replace coal with natural gas during the 30 year timeframe, which will negatively affect Mongolia’s coal export prices as China cuts back on demand.

Since China’s demand and investment in Mongolia’s mining sector remains crucial to Ulaanbaatar’s economic growth, the rise in coal production in the Chinese mining sector will prove to be detrimental to Mongolian coal exports outlook.  For example, in the Northern province of Shanxi, the output of washed coking coal rose as capacity expanded last year. The production of the “province’s mines has continued to increase this year, rising by 1.44% over the first five months of 2014, but jumping more than 12% month-on-month in May, taking production since the beginning of the year to 387m tonnes.”  As noted by Tania Branigan, in 2014, “new laws restricting foreign investment in strategic assets and an attempt to renegotiate the Oyu Tolgoi deal – along with the slowing of the Chinese economy, which has powered the Mongolian surge,” led to the decline of economic growth and the plummeting of foreign investments by 54% last year. Therefore, although the new transportation links may prove to be cost-effective for Mongolia’s trade with China, the increased long-run dependency on China’s market demand will prove to be detrimental to Mongolia’s economic growth.

Looking into the future: What Mongolia can do

The Mongolian state’s response to address its predicament is critical to the its future economic stability and growth. What can the Mongolian government do to contribute to building a sustainable economic growth? Terry Lynn Karl, a scholar in political science, deemed two main factors as catalysts for sustainable economic growth: increase in state economic capacity and increase in state institutional capacity. State economic capacity is to be achieved through diverse taxable structures and professionalized civil services, whilst state institutional capacity can be increased by more representative and equitable institutions,” which will help the state avoid the resource curse and move towards economic prosperity. I will demonstrate what actions the government can take to increase its state economic capacity (diverse taxable structures and professionalized civil services) and state institutional capacity (representative and equitable institutions).

In order to increase its economic capacity, Mongolia has to shift towards not just diversifying its markets but also diversifying its taxable structures by developing other profitable industries besides mining. Since mining output constitutes 80% of all exports, Mongolia has to look at other industries such as cattle and agriculture. Agricultural output constitutes about 20% of Mongolia’s GDP and employs more than 42% of the workforce. A Mongolian news agency, Business Mongolia, noted that “a majority of the jobs outside of the nation’s cities are connected to livestock farming and animal husbandry, such as in meat, wool, cashmere and leather production.” By investing in these different sectors Mongolia can use the new railroad networks to its advantage by expanding the exports of these diverse industries to more markets and thus, becoming less dependent on the demand of a single taxable structure and avoid the impending Dutch Disease.

According to the World Intellectual Property Organization, Mongolia is the world’s second largest cashmere producer, and provides about 25% of the world cashmere. An article in one of Mongolia’s online news quoted the Mongol Cashmere Organization, “current annual revenues of around US$180 million are dominated by sales of raw cashmere, which make up 80 percent of total exports. If the country had the capacity to refine all of its cashmere before exporting it, profits could rise to between US$480 million and US$520 million.” Therefore, the Mongolian state should invest in the cashmere industry in order to diversify its economy and develop another strong and competitive sector that will help its long-term growth.

In terms of cattle, Mongolia has a long tradition of herding and raising livestock. According to the Mongolian agricultural Ministry, Mongolia has about 45 million livestock, which is more than fifteen times the size of the total Mongolian population of three million. Despite such a resource, Mongolia does not export much meat due to not being able to meet international sanitation standards. More than 95% of its meat is sold domestically. As the demand for meat is relatively high in its surrounding area and even in the Middle East, Mongolia’s meat exports will increase tremendously, with increased investment in helping herders and farmers meet the international standards.

By investing in other sectors such as its cashmere and pastoral industries, Mongolia will be less vulnerable to price fluctuations of its natural resources. This strengthens the Mongolian state’s sovereignty as it becomes less susceptible to a decline on its internal and external balance of payments due to price volatility in the world.

Moreover, by spending investments from mining towards research and development of other sectors, the state will be able to create more competitive jobs and protect the state’s non-mining fiscal capacity as well as avoid widening income disparities. In the recent years, because of the mining boom, the demand for mining related labor increased, with promises of higher salaries. Although some lucky Mongolians jumped into this profession, many did not have the same resources that would have otherwise allowed them to enter this sector. Thus, inflation soared due to increased spending because of newly found wealth by elites and foreign investors; the poor becomes poorer as they can’t afford the commodities that once were three times cheaper. If such different sectors develop and become equal players in the Mongolian economy, more Mongolians would be able to work in these sectors and provide for themselves and their families. As more sectors are developed in the economy, Mongolia can become a stronger player in the world market.

Secondly, it is necessary for the Mongolian government to improve and reinforce the necessary institutions that would have the expertise to help the state better manage its mining, economy and investments. Odmaa Narantugalag, a economic policy consultant at the Ministry of Economic Development and UNDP in Mongolia, noted in her article in the Asian Journal of Public Affairs that “improving strong institutions capable of effectively managing the mining sector will help the state bring increased financial development and economic growth.” Karl also noted the example of how Norway handled its economic situation in the 1960’s when they found an abundance of oil wealth but exercised a restricted approach to oil based investment and spending and established the necessary institutions first, that helped them avoid the overwhelming nature of the boom and build a sustainable economy. Karl quoted Noreng on Norway saying, “they established the predominant role of the state through a reorganized Ministry of Industry and a great new state oil company (Statoil), an explicit role for private and foreign companies under state supervision, and a system of corporate taxation of the oil firms.” Mongolia can similarly set up the necessary institutions that will strengthen its sovereign power over its mining sector and economy.

Moreover, the increased institutional capacity will, give the state the expertise and management skills to develop human and technological capital that will contribute to future sustainable economic growth. This will increase state investments in future projects in the mining sector and other developing sectors. The increase in human and technological capital provides the necessary local labor and technology the state can utilize for future mining projects. Thus, the state is not dependent on foreign labor and technology, which correspondingly decreases the state’s dependence on foreign investors (especially China and Russia) and their expertise.

In addition, the increase in institutional capacity will improve the mining regulations and the state’s oversight over resource exploitation. Mongolia can move towards sustainable economic growth if the state emphasizes its ability to regulate the mining sector over developing the sector further. Last year, the government implemented laws and regulations for foreign investment that have been advantageous to the state further maintaining Mongolia’s economic growth. For example, the May 2012 Strategic Entities Investment Law by the Mongolian government, which requires government approval for foreign investments over 75$million in “strategic sectors” such as mining that would result in a 33% or greater foreign stake, targeted only state owned enterprises. This was aimed at the Chinese mining state-owned enterprise Chalco, which “was attempting to buy 60 percent share in South Gobi resources Limited, a subsidiary of the British Australian mining behemoth Rio Tinto, for nearly $1 billion”. Besides regulating potential resource exploitation, rules that propose higher proportions of local employment of the Mongolian people in the foreign investors’ projects will directly benefit the local economy. As the Mongolian state learns to sets clear lines and implement regulations, not only will they increase their sovereign power over their economy, but also build a sustainable economy.

Conclusion

Mongolia’s geopolitical situation between China and Russia inevitably influences how and why Mongolia makes certain decisions regarding its mining and ultimately its economic growth and sovereignty. The three nations recent revival of ties may have some perceivable benefits for Mongolia such as better and faster access to third nation markets beyond China and Russia as well as increased support from its giant neighbors in expanding its economy and participation in international forums. However, the possible benefits for the Mongolian state also come with long-term disadvantages. China and Russia’s personal agendas to expand their own economies through the monopolization of the new transportation routes will be challenging for Mongolia as it will have to compete with the powerful markets. Additionally, Mongolia’s increased dependency on China’s market demand will in turn, be detrimental to its economic independence as it becomes increasingly vulnerable to demand fluctuations.

To address its geopolitical disadvantages, the Mongolian state’s management of its mining industry and geopolitical ties are intrinsic to its development. The Wolf can develop measures that will build sustainable economic growth through investments in building economic capacity and institutional capacity. Mongolia can diversify its economy by investing in the growth of its pastoral and cashmere sectors, which will build its economic capacity and further strengthen Ulaanbaatar’s sovereignty. Mongolia can also set up the necessary improved institutions that have the expertise and management skills to develop human and technological capital that will contribute to future sustainable economic growth. Building its institutional capacity will also further strengthen its sovereign power over its mining sector and contribute to its long-term sustainability.

I believe further research on how a landlocked state’s geopolitical situation can affect its economic independence and growth need to be conducted to fully understand the complexity of situations similar to Mongolia’s. I may have simplified the research because this paper only focused on limited factors of economic growth and Mongolia’s relations with its neighbors. More detailed studies need to be done in the future to thoroughly examine the impact of Mongolia’s geopolitical situation and the effect on its economy by looking at other factors such as the direct ties of China with Russia and their specific bilateral agendas. The study of the impact of Mongolia’s geopolitical situation and its decisions to address the issues to build sustainable economic development is critical as the state’s response plays a primary role in shaping the environment for how all individual and corporate investors can be involved in the Wolf’s economy. Thus, one critical question that remains to be answered is whether, in the future, Mongolia will be able to balance its investors’ interests with China and Russia’s influences? Or will the small landlocked country have to ignore investors’ interests in order to ensure its economic growth and geopolitical stability?

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