If not an SWF then what?

At the recent World Economic Forum’s “Strategic Dialogue on the Future of Mongolia” I heard a lot of talk about the need for the Mongolian government to shed its direct involvement in the economy, but also the recommendation to rely on a Sovereign Wealth Fund for investments to spur sectoral diversification. As I argue on the World Economic Forum’s blog, you can’t have both, economic liberalization and an active investment policy that selects winning companies/industries.

Yet, sectoral diversification beyond the mining industry is absolutely essential to Mongolia’s long-term economic and thus also its social and economic development. The case for such diversification is based on the recognition that a) natural resources are finite, and b) market oscillations in commodity prices makes dependence on resources an inherently risky state.

How to Achieve Sectoral Diversification

This is certainly not an area that I specialize in, so what I am offering here are some interested musings.

Clearly, a (neo)liberal world order has restricted the options for an industrial policy that are available to modern states, and it is an industrial policy that is really needed in the case of Mongolia to move beyond mining and its associated industries. In the days of classic developmental states like postwar Japan through the 1980s, states had access to tools such as control over credits, foreign currencies, etc. that allowed them to direct the economy. Some states were good at this (Japan and S Korea stand out as examples) while others imitated such strategies, but were not as successful. One of the main doubts about the success of developmental policies has always been that it assumes that the state and its representatives is able to “pick winners”, that is to pick sectors and firms that will be growing and successful.

Clearly, contemporary China is also pursuing developmental policies through its state-owned enterprises and somehow is able to mask subsidies under this set-up to be immune to WTO interdiction.

However, many observers would agree that the Mongolian state is not ideally situated to engage in an active industrial policy for two reasons: 1. a lack of policy analysis capacity, and 2. a close intertwining of business interests with government, or in more extreme cases, corruption.

What options might remain:

  • invest in basics
  • tax credits?
  • top-up venture fund for crowdfunding

Investments in Education, R&D, Applied Research

In the absence of an active industrial policy that targets particular technologies, sectors, or firms, many states strive to create the pre-conditions for innovation and the emergence of industries.

These preconditions include education and research, as well as the physical infrastructure to enable new industries.

In the Mongolian case this would suggest an increased focus for funding in education and research. The state universities are currently funded (almost?) entirely by tuition, though systems for research funding are under discussion or emerging. Stepping up such efforts now might lead to business opportunities in the long-term, especially when coupled with international best practice on supporting commercialization of research, etc.

Perhaps the role of the Academy of Science could be re-thought in this context. While largely a legacy of the state-socialist era when teaching in higher education and research were separated institutionally into the universities and the Academy and its institutes on a Soviet model, the institutes of the Academy could be re-invented as research institutes that focused specifically on applied research on the model of the German Fraunhofer Institutes.

Investment into applied research on minerals and minerals processing could be combined with similarly-structured efforts in other fields, particularly fields where Mongolia’s territory, location and climatic conditions might offer potential for future growth. Examples could be superconducting electricity transmission that would enable an alternative energy export industry for Mongolia (as partly envisioned by the Desertec Foundation [despite the horrifying terminology of “Greater East Asia”], see also Karl-Friedrich Lenz’ writings on Mongolia). Other examples might seek to capitalize on Mongolia’s cold temperatures as a condition for certain industrial processes.

Investments in Infrastructure

There are entire fields of research that examine the success of innovation incubators, industrial clusters and the like. A thorough search of these literatures would likely yield some lessons for the particular Mongolian context and how to provide the infrastructure that makes the emergence of new industries more likely.

From my point of view, some of the candidates for such industrial sectors that are often mentioned in discussions in Mongolia are highly implausible, though there’s always luck involved in these developments. Implausible scenarios (and thus areas where investment would not seem obvious to me):

  • Ulaanbaatar as a finance centre: Asia already has Hong Kong, Singapore, Tokyo, and whatever centres might emerge from China
  • IT industry: at such a generic level, there’s nothing about Mongolia that makes this more likely and the tiny domestic market and small number of potential entrepreneurs make this unlikely in my mind

Sectors that I find much more plausible:

  • organic agriculture/meat: the world is turning to healthier food and Mongolia is ideally positioned in this regard for super-organic production. This is a sector that definitely requires infrastructure investment
  • tourism: yes, but, this will always be specific niches
  • transport hub: railroads (keeping in mind the dreaded question of gauges), but I even find the airport as a hub between Europe and Asia vaguely plausible, though that requires massive and highly concentrated investment.

I’m certainly open to suggestions/discussions of other sectors or different views on the sectors I’ve mentioned here. I certainly also believe that investment into building research capacity on this question in Mongolia should be a priority NOW and not just in the medium or long term

Infrastructure investment could also come in areas where such investment aims to create commercial resources rather than bricks-and-mortar facilities. Stephen Kreppel has thus been involved in a national brand strategy for Mongolia that would ideally offer a Mongolian branding that would benefit any industry or sectors, as difficult as such unified messaging might be to achieve.

Tax Credits

A classic in the arsenal of policies that is acceptable under WTO rules, but Mongolian taxes (personal and corporate) are so low already that it’s unclear that there are massive incentives to be found in this area.

Crazier Ideas

With some of the excitement around crowdfunding and crowdsourcing theses days, perhaps these concepts could be adapted for industrial policies. Again, I’m mostly thinking out loud here, but could state investment not come in the form of matching grants to crowdfunded projects? In such a scenario the crowdfunding serves as the mechanism to “pick winners” relying on the distributed intelligence of the crowd rather than bureaucrats and simply super-charges such crowdfunding to enable commercial developments. Obviously, this is a bit faddish at the moment and might not be a permanent economic institutions, but the concept of crowdsourcing decisions about diversification opportunities may be applicable.

Thoughts? Ideas? Go ahead and use the Comment function below!

This entry was posted in Business, Development, Diversification, Economics, Foreign Investment and tagged . Bookmark the permalink.

5 Responses to If not an SWF then what?

  1. HF Mongol Khan says:

    “If not an SWF then what?”

    While Mongolian politicians, MPs and GOM ministers, get excited on OT, they miss several critical points (*). One of them that is LONG OVERDUE is a SWF.
    Even with just few pennies inside, this should have been created asap.
    With a bit of experience with SWFs, there are not many models for Mongolia. For NOW, there 2:
    • Khazanah,
    • Temasek at its beginning!
    That’s it case closed. No need to look any further.

    If nationalism is important (I let Mongolians decide for themselves), then a Mongolian SWF is a great way to settle many issues.
    • Before foreigners move in seriously across the economy, what about supporting local Mongolian groups, so that Mongolia has its own champions, supported by the SWF (like Singapore did with Temasek)?
    • For strategic mines, it’s simple. Each time GOM gets a 34% stake, BY-LAW it is awarded to the Mongolian SWF.
    • Each time, there is a change of control on one of these mines, the Mongolian SWF gets a right of first refusal to buy the stake (Indonesia / PT Semen Gresik / Cemex case for instance).
    Getting that moving is not rocket science; it just requires willingness to act, not talk.

    Later once Mongolia becomes an exporter of capital, the strategy may shift towards a KIA / ADIA / BIA / GIC type organization.

    I read the name Chile. For a long time, because of its current stage of development, that’s unlikely to be a model.

    And a SWF is to preserve the strategic long term interests of a country, no be nice and transparent (counterproductive) to the world, so communication from the SWF is M&A like, “need-to-know-basis”, GIC, KIA, ADIA, BIA type. Not more. Because Temasek and Khanazah have bonds outstanding they are held to more public disclosure, which is not ideal as far as those countries are concerned.

    (*) To be fair, I don’t know anybody with such a crazy-to-do list, not even the under-paid person from the Ministry Of State Owned Enterprises of another country I had dinner with years ago and I almost cried about his to-do-list trying to find CEOs for state-owned-enterprises)

  2. Gov. Skeptic says:

    There are too many obvious ideas for the development of the Mongolian economy and the diversification away from mineral exports. Much of this would happily be funded by foreigners if the terms of ownership are reasonable and the government acts effectively.

    Nonetheless an SWF is needed. All mineral royalties should go into the SWF. The government should privatize TT, their OT stake, and consider privatizing Erdenet, Khutul, and Mongolrostvetmet (though these last three would require Russian agreement) and put the proceeds from privatization into the SWF.

    The SWF should be absolutely independent from the government and use their cash to make investments abroad (for diversification) and capitalize + lend to the Development Bank. The Development Bank, as a JV of the SWF and the Gov., should be tasked with making loans on a commercial basis to viable large scale projects.

    Mongolia needs, as you mention, to find more non-mineral exports. If we interpret exports loosely to include things like infrastructure used for international transit and tourism consumed by international visitors (both of which contribute hard currency even if they are only consuming a service) there are some interesting ideas –

    General note – the Mongolian gov. should not have direct ownership in these projects and develop infrastructure through the BOOT model and permit private companies to do everything else.

    (1) Casinos in a special economic zone which excludes participation by Mongolian citizens. The GoM has shown itself to be against gambling by Mongolians (rightly so) but they should have no problem permitting the Chinese (who love gambling) to come to Mongolia and consume that service.

    If you build the casinos say 1 hour from Sainshand (I would say near Zuunbayan) you could set up direct access by train from Inner Mongolia and Beijing and get the casino companies to pay for/subsidize an international airport.

    (2) Build a railway in the West connecting Russia (and particularly the Elegest coal field) with Nariin Sukhait and Ceke. Russia and or China would love to build and finance this project for the government.

    This will create jobs and encourage non-mining developments in the south.

    Developing the West should be a major government priority.

    (3) Work with China to negotiate exports of Mongolian agricultural products for farms that meet high standards. Currently, the Chinese don’t want to touch the food produced by herders but they could probably be talked around to allowing meat of a know provenance with a clear chain of custody (+ refrigeration, etc.) to be imported.

    (4) Lease government owned forest land to private forestry companies. This will reverse deforestation (as the companies will have an incentive to properly guard the forest, something the gov. cannot do effectively).

    (3) and (4) will have the additional benefit of reversing or slowing the (terminal?) decline of the countryside which has been dependent on the herding economy.

    (5) Build a High Voltage Direct Current power line between, say, Choir (ie Dundgovi) and Beijing. Mongolia has a large amount of thermal coal which currently cannot be exported and essentially has no value. Foreigners (not just Chinese) will be happy to build coal fired power plants and renewable energy projects in the region if they can sell the power to China. I imagine China would be happy to build and own the power line and would be pleased to outsource pollution to Mongolia.

    (6) Scrap the Sainshand project (no loss here as there has been zero progress) and look at some of the serious counter proposals that have been made. The government needs to abandon the idea that they should own these projects and instead permit foreigners to build and finance them.

    (7) Put a better legal environment in place for the development of shale oil. Develop shale oil and build a refinery. Do not build a refinery in Darkhan. Somewhere between UB and Choir is probably the best location.

  3. HF Mongol Khan says:

    Disclaimer:
    I am not Mongolian, I don’t live in Mongolia, I don’t have business in Mongolia, I am just a passive minority shareholder in listed companies, mostly on MSE.
    (I am not from Malaysia, Singapore or China either)

    Mongolia needs a SWF NOW, not in 3-5 years!

    IPO of ETT, MIAT,…whatever… is not likely to happen before AT LEAST 1 or 2 years, combination of self-inflicted damages + commodity cycle +…assuming strong actions are taken now (which I doubt).

    However, local Mongolian groups need protection, help and support NOW…and it does not take a lot of $ to help them. Just political will, creating a framework for this.

    Otherwise if no action is taken quickly, more and more foreign firms will be moving in and will become dominant players in Mongolia and Mongolians will be sitting ducks.

    Then in 2016 before the elections we will see a surge of nationalism, by few miles much stronger that what we have seen…and accidents (South Gobi / Sefil like) will happen again for good reasons!!

    “The SWF should be absolutely independent from the government”:
    I pretty much disagree with that. The body ruling the SWF should be independent from the cycle of elections to avoid short term politically driven problems but I am totally allergic to the great transparency concept.

    First, it enables other market players (hedge funds) to read very well what’s the next move on the chess board, take advantage of it and that is detrimental to the SWF and to the nation. A SWF is there to protect the long term interest (may be some learning is needed in Mongolia) of a nation, not to be nice and transparent with the world. It however has to “respect the integrity of financial markets where it operates” that’s it, not more. “Need to know basis” for the rest.

    Second, for what I understand, Mongolia is a democracy where a majority elects a parliament and a parliament approves a government. If voters are unhappy, then next time, they elect others, until them, they’d better understand the concept of delegation. The Mongolian voter cannot check daily what his government is doing and approve his actions. That would lead to further short term driven actions, or inactions, that created recent problems.

    In term of SWF, Malaysia offers more examples. It has Khazanah for strategic stakes in Malaysian companies, supporting its own champions but it has also some state funds like EPF and PNB whose missions are different, more or less managing savings for the country, some kind of social security / retirement system.

    Singapore had Temasek for strategic stakes while GIC was building and managing a diversified portfolio.

    China has the NSSF collecting a cut from state-owned companies going for IPO and managing retirement funds while SAFE’s focus is related to strategic matters with Central Huijin the holding for banks. I don’t think CIC is a great success of any kind.

    Anyway, Mongolia needs several of those institutions for different purpose.

    Once $ start flowing in from IPOs of ETT, MIAT,…then those savings / retirements SWF will be needed.

    For now, the most pressing matter is the strategic one to protect national interests in Mongolia, the Khazanah / Temasek like!

  4. HF Mongol Khan says:

    …and by the way, if Mongolia had a SWF of that type in 2012 when Turquoise sold South Gobi to Chalco with a pre-emption right system Indonesian way, there would have not been any need for SEFIL…and the collateral damages that followed and cost so much in $, costs of opportunity and delays of all kind infrastructure wise.

  5. HF Mongol Khan says:

    SWF step one

    http://www.business-mongolia.com/mongolia/2013/11/06/shivee-ovoo-and-baganuur-shares-are-transferred-to-erdenes-mgl/

    That is step 1: loading the SWF with all the stakes in all the state owned companies.

    Please add to the list, MIAT and a bunch of others, MSE and MSCH&CD included as well as GOM stakes in ANY MSE listed companies and may be State Bank too (may be 51% for the fund, 1/3 for MoF and the rest for a state pension fund)!

    Step 2: Grant that SWF in the making with ALL the pre-emptive rights and 34% stakes GOM will be given by law.

    That would:
    a) Pro-actively deal with new South Gobi cases in a predictable manner (so that foreigners know where to stand)
    b) It would further reduce the risk of dilution of decision powers that may lead to potential abuses.

    Step 2: Take minority participations in local private groups adding some equity.

    For stakes above 66%, I would suggest only 66% goes into Erdenes MGL LLC (to be rename Chinggis Khan Sovereign Wealth Fund) and the rest would go into a retirement fund like EPF in Malaysia or NSSF (in China) where a % of IPO from state-owned-enterprise was given to NSSF.

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