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COMPARATIVE TRADE FLOW IN TRANSITIONAL ECONOMIES: THE CASE OF MONGOLIA

Altanchimeg Algaa University of Guelph [email protected] April 2018

Abstract

This paper examines international trade flow of Mongolia as a country with a small open economy in transition. Mongolia has unique features to worth of study. It is landlocked between Russia and China, yet it has a vast land with world's largest natural resource deposits. As China being the largest importer of coals and other resources, Mongolian trade with China is significant, comparing to any other countries. The result reveals that Mongolia should look for a regional niche to play active role in world market and diversify its export destinations.

Keyword: trade flow, economies in transition, Mongolia

One. INTRODUCTION

The beginning of the transition process towards market economy has significantly changed international trade patterns of all former socialist countries. The regime change was associated simultaneously with a collapse of the CMEA1 trade block and disintegration of the USSR. Intra block trade instantly became international trade, subject to the barriers that each countries have.

Country background

Mongolia is a vast and sparsely populated nation. But it is landlocked between Russia and China, making it not favourable for international trade aspect. It is population is little over 3 million, of whom about one third live in Ulaanbaatar city, the capital.

Figure 1. Part of world atlas

Mongolia's present per capita gross national income is estimated at about USD 3590 (2016), making it lower middle income country on the World bank scale.2 Mongolia is rich in natural resources, particularly in coal, copper and gold. Also it has unique

1 The Council for Mutual Economic Assistance (COMECON, CMEA, or CAME), 1949- 1991, was an economic organization compromising the countries of the Eastern Communist countries mainly along with other communist countries elsewhere in the world.

2 https://data.worldbank.org/indicator/NY.GNP.PCAP.CD?locations=MN 1

 

nomadic culture and untouched nature to show off. Mongolians are highly literate (over 90%) thanks to emphasis made in socialist era and enjoy a health status measured by life expectancy, infant mortality rate and other health indicators that surpasses conditions in most other lower middle income countries.

Investment analysts predicted that Mongolia could become one of the fastest growing economies and key investment target for global mining corporations. In 2011, the Citigroup defined Mongolia as one of Global Growth Generator countries, which being countries with the most promising growth prospects for 2010 to 2050.3

Two. THEORETICAL REVIEW OF ECONOMIES IN TRANSITION AND THEIR TRADE FLOWS

Definition of transitional economy

The breakdown of communist regime in the Union of Soviet Socialist Republics (USSR), Central and Eastern Europe and Asia at the end of the 20th century lead to market economy. The movement from centralized planned economy to market relation based economy has been termed transition and thus the economies that have adopted this process are called transitional economies. (Bitzenis 2016)

In particular, the transition process was associated with an explicit end-state, namely the establishment of a capitalist economic system. Hence, the transition involved, in essence, the introduction of private ownership and restructuring through the privatization of state enterprises; the establishment of market equilibrium through the abolishment of centrally administered commands; the liberalization of economic activity through institutional reform; a change in economic behaviour as a result of economic actors adjusting their behaviour in line with self-interest and the rules of market exchange; and the reduction of the state to the role of legislator and facilitator of economic activity. (Bitzenis 2016)

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Some theories suggest that the “transition” process is continuous, and that achievement of end state, which completes the transitional process, can never be achieved. This has led to the use of terms such as the transformational economy and developing economy. In addition, capitalism has different colours, so the question of what type of capitalism should be the goal complicates the process. (Marangos 2004). There is also such thing as market socialism, the capitalist economic system integrated into communist politics. China and Vietnam are vivid examples of this type.

An alternative term, the “integration-assisted transition”, has been introduced by Aristidis Bitzenis and John Marangos (2007), who argued that the goal of transitional economies was the participation in the globalization process and attempting to integrate their economies into the globalized system by opening their borders, liberalizing their markets, and attracting foreign direct investments with the assistance of international financial institutions and multinationals.

Trade flow in the transitional economies

The usual pattern of the world trade is that developing countries export raw materials to developed countries, and import manufactures goods from developed countries. Raw material can be described as primary goods, which are coal, copper, grains and fish etc. Manufactured goods are goods that have been made. Those include machinery and computers etc. According to this pattern developed and developing countries are interdependent. They rely on each to other to cycle their market flow. Developed countries need raw materials for their manufacturing industries, and developing countries need to have market for their goods.

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Figure 2. Pattern of world trade

developed countries

Not only trade between developed countries and countries with transitional economies have increased rapidly after opening transitional economies' market to the world, also trade between developing countries and countries with transitional economies showed a massive increase from 2000. (UNCTAD 2008).

The main commodities of exports from transition economies to developing countries are fuels, which include crude oil, natural gas and coal and base metals. Developing countries export mainly in the category of manufacturing sectors namely, textiles and clothing, electronic goods, cars and machinery. Agricultural and food products are also main export agents to transitional economies.

Trade flows between developing countries and transitional economies was largely driven by rising demand for energy, the search for new and large market, as well as geographical location, cultural affinity and historical relationships.

  manufactured goods

    developing countries (transitional economies included)

raw materials

   4

Three. EVOLUTION OF MONGOLIAN TRADE FLOW

Mongolian trade flow prior to the reform /1930-1990/

From 1930 to 1990s, Mongolia's predominant trading partners have been then communist countries.

Between 1930 and 1952, the Soviet Union was Mongolia's only trade partner. Mongolia started trading with China from 1953. In 1960, trade with China was accounted for 18%of total trade. Trade with other communist countries also began in the 1950's and intensified in the 1960s after Mongolia entered into CMEA. In 1966 trade with the Soviet Union fell to 60% of total trade, but it has steadily risen after that attaining 80% in the late 1980s.

In 1986, communist countries received 96.7% of Mongolian exports: CMEA countries absorbed 94.2% and other communist nations such as China and North Korea imported remaining 2.5%. Capitalist countries such as Japan and Britain imported 3.3% of all Mongolian exports. In terms of import, communist countries provided Mongolia with 98.3% of its imports, which are countries in CMEA supplied 96.7% and other communist nations 1.6%. Western countries provided 1.7% of Mongolian imports. (National Statistics Office, Mongolia, 2008). Efforts to expand trade with capitalist countries were hampered by lack of hard currency, which is result of political regime difference and bad international relationship.

Closer look at trade with Soviet Union, according to 1986 data, it totalled 1.5 billion roubles4, of which exports amounted to 400 million roubles and imports amounted to 1.1 billion roubles. The Soviet Union supplied Mongolia with food, consumer goods, industrial use of oil products, fuel, machinery and equipment in agriculture, mining and construction sectors. In return Mongolia supplied minerals, processed food items and consumer goods such as cashmere and wool products.

4 Currency of Russian Federation, then USSR 5

Table 1. Trade flow before transition

   Trading country

Hungary

Export commodities

Animal hides, fir, leather product, processed meat

Import commodities

Equipment and spare parts of light industry and food processing plants; telecommunication and laboratory equipment; medicine; textile; cosmetics;

Machinery and equipment for light and food industries; electrical equipment; chemical products;

Electronic and technical equipment such as colour television and power generators

Unspecified

    USSR Minerals, processed food Machinery and equipment for items, consumer goods agriculture; car, food, mining and such as cashmere and wool construction materials, fuels, consumer

products goods; apparel;

 Czechoslovakia Copper, tin and tungsten concentrates, fluoride, wool, leather, fur products;

Diesel generator, equipment for leather, footwear and clothing industries; equipment for cement plant; chemical products; medicine, heavy duty machineries; apparel;

East Germany

Japan

Yugoslav

Minerals, leather and fur products, carpet, wool products;

Industrial raw materials, cashmere, camel hair and wool products; Unspecified

 China Timber, wool, sheepskin, Textile (silk), fruit, light industry cashmere, fur; products;

    Mongolia-China trade amounted to US$ 33million in 1988. In 1985, Mongolia-Yugoslav trade totalled to US$ 8.2 million, Yugoslav exported US$ 5.4 million and Mongolia exported US4 2.8 million worth of unspecified goods. In 1988 trade between Mongolia and Japan reached to US$ 30 million, which is half of Mongolia's trade amount with non- communist countries.

Before 1990, insufficient information was available on the value of Mongolian trade with other countries, but types of commodities exchanged were known. Table 1 illustrates Mongolian main trading partners and their traded commodities before the collapse of socialist regime.

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Transition to the market economy and the crisis

Mongolia has resumed positive economic growth for a relative short period in its transition to market economy due to rapidly implemented privatization and market liberalization programme. Mongolia acted promptly to transform its planned economy to market economy, drawing new legal framework for privatization and market liberalization and establishing government bodies to implement these much needed duties.

Table 2. Macro-Economic Indicators of Mongolia, 1989-1994

   GDP growth 4.2 -2.1 -16.2 -7.6 -1.3 2.1 (% per annum)

Agriculture

Industry

Exports (mill. US$)

Imports (mill. US$)

Inflation (% per annum)

1989 1990

13.8 -0.8

11.4 0.7

796 445

1912 1024

- -

1991 1992

-6.9 -5.9

-12.3 -15.9

347 356

501 400

154.3 321.1

1993 1994

-2.5 -

-4.7 3.7

360 324

361 222

183.0 66.3

    Sources: National Statistical Office of Mongolia; World Bank (1992, 1994); UNDP (1995)

However, shortly after economic and political reform, by 1992 the Mongolian economy was in serious crisis with critical problems such as near shut down of power plants and food supply shortage. Over the period of 1990 to 1993 GDP contracted by in total of 25.2%. (see Table 2)

More comprehensive policy reforms were introduced from 1993 and onwards, particularly in banking and government finance sectors. By 1994, the Mongolian macro- economic indicators are substantially improved with a manageable inflation rate of 66.3%, while a positive growth rate of GDP was reported.

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As noted before, GDP declined sharply in the first phase of post reform years (see Table 2), which was fully due to the sudden collapse of the CMEA trade bloc and within country supply chain system which used to connect herders/farmers to consumers. Industry, the capital intensive agriculture sector and construction sector showed severe contraction as a consequence of import squeeze and the disarticulating effects of breakup of the previous centrally planned system which used to provide vertical integration of production sectors (ADB, 1994).

With price liberalization implemented since 1991, in conditions were the soft budget sector was still important, inflation spurted, causing macroeconomic destabilization, but also affecting through a rapid deterioration of the “barter terms of trade” the important sector of traditional livestock farmers (World Bank, 1994).

Factors that illustrate specific circumstances and complexity of the transition in Mongolia are: First, the dramatic import reduction from Soviet Union had a major impact on the economy. The Soviet aid that financed most of turnkey projects and essential imports during the 1980s (at the level of almost 30% OF GDP) was stopped suddenly in 1990. This event reduced the large trade deficit, but induced dramatic negative multiplier effect on industry and agriculture sectors.

Second, the Mongolian government promptly acted to reduce its budget deficit by cutting government expenditure and improving tax collection to overcome high rate inflation. However, the still sizeable budget deficit remained and they were financed by loans and aids provided by international financial institutions and donor agencies.

Third, the privatization implemented in the agricultural sectors is assessed successfully. However, it resulted breakdown of supply chain network, which is linkage between producers and downstream or upstream industrial trade sectors. Therefore it is regarded as nominal rather efficient.

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In reviewing the sequence and content of the macroeconomic reforms of Mongolia in the post 1990 period, privatization taken in all sectors of economy, based on textbook assumption that “with privatized assets (land, livestock and capital given free or through auction) rural producers will be integrated into new competitive and efficient markets that are supposed to emerge spontaneously ”. This overemphasis on property relations was noted by the first economic study of the World Bank on Mongolia (World Bank, 1992). This observation was not made to criticize privatization, but to emphasize the importance comprehensive reforms in other arrears that were crucial for the success of privatization.

Another study financed by UNDP processed even further investigation and stated that privatization had failed on every account, as it did not bring about “allocative efficiency”, had brought renewed “monopoly powers” in markets and had a “zero or negative effect on aggregate rate of savings” (UNDP 1994). This critique was not illustrated on the second World Bank study, describing that privatization programme was an important achievement that increased efficiency in key sectors of the economy. (World Bank 1994) Nonetheless, privatization was often a complex mixture of transfer of ownership shares to workers of enterprises and continued state ownership, while privatization and price liberation were insufficiently complemented by improvements in rural marketing (ADB, 1994).

The privatization of livestock to its herders free, brought a positive incentive to overcome the underdevelopment of this sector, but the absence of market distribution system and proper incentive structure seems to be causing retrenchment by the herders.

The external trade figure in Table 2 shows the huge and rapid reduction of imports. As the country had been strongly import dependent on the CMEA, the collapse of this captive external trade system had brutal consequences for the domestic economy. The drastic import reduction (from an estimated 1912 million US$ in 1989 to 361 million US$ in 1993), particularly affected the capital intensive and import dependant industrial and agricultural sectors. As a consequence it depressed domestic supply of agro-industrial

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outputs, levels of processed agricultural Mongolian exports and most importantly the domestic supply of food staples.

The general contraction of the economy, in particular in a country as vast as Mongolia is, can also be noted from the major drop in road and railway transport volumes partly caused by severe fuel shortage. Total transport in million ton-km had been decreased by 45.3% by 1991 in comparison with the last normal pre reform year, 1980 (World Bank 1992).

After a severe slump in economic development, a near standstill in 1992 in energy sectors with a regular power failures and breakdowns of crucial heating systems during winter (average winter temperature is -25C during a day and -30C at night), in 1994 the first signs of economic recovery emerged with expanded volumes of copper production, new exports of mined gold and emergence of small and medium enterprises in some sectors.

Another factor, which was contributing to economic growth, was a sharp reduction of government expenditure as a share of GDP, while in 1990 budgetary expenditure still represented 51.9% of GDP. In 1993 it was estimated to have dropped to 28.3% of GDP. With the programme of privatization the existing tax base was eroded, although new VAT and income taxes filled at least part of the emerging fiscal gap.

With inflation in 1994 brought down to more positive level of two digits, and on the basis of the first recovery of GDP growth, the Mongolian transition to market economy is now recapped as rather successful.

Current trade flows and its challenges

Mongolian economy has evolved positively in recent decades. The economic growth of the country has been present and rather stable in recent years. GDP annual growth rate in Mongolia averaged 5.44% from 1991 until 2017, reaching an all time high of 17.50% in the fourth quarter of 2011 comparing to a record low of -9.30% in the fourth quarter of 1992.

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The growth in mining, processing industry, agriculture, construction and industry are among main sectors, which have had a positive impact on the social and economic development of the country.

The foreign reserves of the country increased to over 2 billion US$. The existing high level of currency reserves is thanks to the high prices of key export commodities such as copper, gold and coal on the global markets. Efficient management of the reserve will be crucial for the stability of the country's financial market and its trustworthiness a s well as the import of needed technology and equipment. The table below shows Mongolian key economic indicators from 1995 to 2010.

Table 3. Mongolia: Macro-economic Indicators

1995 2000

6.4 1.1

5.5 4.6 -1.5 -7.7

58.0 -78.7

473.3 535.8

415.3 614.5

9.8 53.7

151.5 202.1

2005 2010

2015 2017

   Output, Employment and Prices

GDP growth (%, per annum)

Unemployment rate (%)

Public Sector

Government balance (% GDP)

Foreign Trade

Trade balance (US$ million)

Exports of goods (US$ million)

Imports of goods (US$ million)

Foreign Direct Investment (US$ million)

Reserves, (US$ million), gross

7.3 6.1 2.4

 Industrial Production index 84 91 94 120.5 (1991. 2005 =100)

3.3 3.3 2.6 0

-119.5 -378.7

1064.9 2899.2

1184.4 3277.9

257.6 422

430.3 2091

7.5 7.3

  Domestic Public Sector Debt -- 8.7 3.2 -- (% GDP)

 871.8 1865

4669 6200

3797 4335

1200 -

  11

Memo:

Nominal GDP (MNT billion) 593 1038

Nominal GDP (US$ million) 1252 947

GDP per capita

Source: National Statistical Office of Mongolia;

2780 8255

2307 6690

900 3764

  In Mongolian economy international trade plays vital role. Mongolian international trade volume is increasing since its transition to market economy and has begun diversified in terms of destinations of its exports and the sources of its imports.

In 2017 Mongolia has traded with 132 countries and approached total trade turnover to 10536.12 million US$, consisting of 6200.66 million US$ of export and 4335.47 million US$ of import. External trade balance showed a surplus of 1865.20 million US$, largely due to increase of coal price in commodity market. Total external trade turnover increased by over 2 billion US$ comparing to 2016.

Figure 3. Mongolian Trade turnover for 2005-2017

Source: http://www.1212.mn/stat.aspx?LIST_ID=976_L14

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Import profile

Imports are rising in the long run as the economy expands; driven by fuel, transport equipment and machinery from developing countries. In 2017 Mongolia imported 4.3 billion US$ comparing to 3.3 billion US$ in 2016. Before 2016 Mongolian import has decreased from 6.3billion US$ in 2011 to 3.3 billion in 2016.

Figure 4. Import Profile

 Source: https://atlas.media.mit.edu/en/profile/country/mng/

Export profile

Exports are increasing in the long run too, largely driven by upward momentum in metal prices and coal imports by China and other developing countries. In 2017 Mongolia exported 6.2 billion US$ comparing to 4.9 billion US$ in 2016 largely due to coal price increase. However, Mongolia has suffered in its export due to unstable commodity price and its export has decreased from 5.8 billion US$ in 2014 to 4.6 billion US$ in 2015. Figure 5. Export profile

  Source: https://atlas.media.mit.edu/en/profile/country/mng/ 13

Trading partners of Mongolia

Trade is highly concentrated among a few partners because of its landlocked position. China is top import and export destination of Mongolia followed by Russia.

Over the years China has become Mongolia's single largest export market by far, while Russia's share has continuously declining. The United Kingdom, the United States, Canada, Republic of Korea and Japan are follow but with considerably smaller shares.

Figure 6. Major import partners

Source: https://atlas.media.mit.edu/en/profile/country/mng/ Figure 7. Major export partners

Source: https://atlas.media.mit.edu/en/profile/country/mng/

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Mongolia has been a member of the WTO5 since 1997, and has accepted all multilateral agreements. Since accession it has substantially liberalized its trade regime, reducing tariffs and loosening import-licensing requirements. Also upon accession, it agreed to remove a 30% export tax on raw cashmere by January 2007, but missed this target eventually removed it by 2009. This export tax was to protect domestic cashmere processing sectors from Chinese cashmere processing plants and to promote export of end product such as clothing and household items. Even Mongolia is the member of the WTO it is not yet a party to a regional or bilateral free trade agreement, customs union or a preferential trade agreement.

As of 2017, there is nearly 700 regional trade agreements notified to the GATT/WTO, half of which in force6. According to the WTO (GATT Article XXIV), free trade agreement should result in the elimination of “duties and other restrictive regulations of commerce” on “substantially all the trade between the constituent territories”. WTO rules stipulate that members entering into a free trade agreement should present a plan and schedule under which this elimination would normally be achieved within 10 years. Therefore entering into network of free trade agreements with its main trading partner is eroding Mongolia's preference of export tax on raw cashmere and others.

Mongolia is beneficiary of preferential schemes of Canada, the EU, Japan and US under the Generalized System of Preferences7. Mongolia is a member of the World Intellectual Property Organization, and has signed conventions and treaties on intellectual properties.

Many exports of developing countries qualify for duty free entry in the developed markets under the unilateral preferences of GSP. Furthermore, bound MFN tariff rates in the OECD countries are quite low and have been eliminated in many sectors of interest to developing countries.

5 World Trade Organization

6 https://www.wto.org/english/tratop_e/region_e/regfac_e.htm

7 The Generalized System of Preferences, or GSP, is a preferential tariff system, which provides for a formal system of exemption from the more general rules of the World Trade Organization

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Four. CONCLUSION

There has been dramatic growth in the general flow of international trade between transitional economy and developed economy in recent decades. This paper examined transitional process of Mongolia in international trade view as an example of former communist country and explored its trade expansion historically.

Before 1990 less than 10% of Mongolian foreign trade flows were outside the former communist countries. Nowadays more than half of Mongolian trade is with Asia Pacific region countries and industrialized countries around the world regardless of the political regime. This change in international trade pattern is accompanied by reform of trade and custom policies.

Mongolia has an excellent potential for economic growth since it is located in the Asia Pacific region. Intuition behind here is Mongolia is abundant of natural resources and buyers are located in the same region. Chinese economy is still expanding needing more raw material and minerals. Japan and Korea could provide capital for various technologies through investment. This is creates an excellent base for mutually beneficial economic cooperation.

On the basis of this study, following policy recommendations can be drawn. It is advisable to pay more attention on trade policy to diversify its export and import partners. Policy makers should consider the evidence supporting Mongolia's trade is dependent on its neighbours only because of its landlocked position. Development of export relations and opening new export markets are crucial in Mongolian trade development in order to halt this dependency of its neighbours.

Moreover Mongolian export commodities are mainly natural resources. These resources are limited. In order to maintain sustainable export income, Mongolia needs to build up its export potential of other commodities such as cashmere and wool products.

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