Problems for Land-Locked Countries

Mongolia is one of the 48 countries in the world that are land-locked. About one quarter of the world's 205 countries are land-locked and these countries tend to have lower human development statistics compared to the rest of the world. Being land-locked is regarded as a disadvantageous because it can severely limit a country's access to global markets and global trade.  In general, coastal regions tended to be wealthier and more heavily populated than inland ones. Paul Collier in his book The Bottom Billion wrote, "If you are coastal, you serve the world; if you are landlocked, you serve your neighbors." Mongolia is no exception to these difficulties. The country has only two neighbors in China and Russia, and both countries have a very strong influence over Mongolia's economy. China for instance, controls the price of Mongolia's copper and coal exports and competitive pricing is restricted by Mongolia's limited access to international ports. China's recent growth has spilled across the border and is the main driver in Mongolia's mining driven development. 

With regards to the cross-boarder transit, there are international regulations that have been established in order to protect the rights of land-locked countries' to access global markets. In 1965 there was a 'UN Convention on Transit Trade of Land-locked States,' which granted special protections to land-locked countries with regards to access to sea ports and world trade. In 1982, there was a United Nations Convention on the Laws of the Sea, which protects the freedom of transit for land-locked states. Unfortunately both conventions are subject to bilateral, sub-regional or regional agreements. In other words, the rights of transit must be agreed upon with the transit neighbor in a formal trade agreement. In practice the protections granted in the UN conventions are not always honored by the transit country. The rights of transit of land-locked developing countries (LLDCs) remains an unresolved issue in international economic policy. Mongolia held a conference for LLDCs to discuss these trade issues in 2007. 

Mongolia is currently looking for ways to gain access to Korea and Japanese markets to sell its coal exports. The most direct route to these markets is through China and the port city of Tianjin, which has a free trade area. There is also the possibility of going through Russia, through Vladivostok, but it is not certain that Russia's rail network can support the quantity of coal that Mongolia is expected to export from its Tavan Tolgoi mine. Also, going through Russia will have significantly higher transit costs given the distance that needs to be traveled. Vladivostok can be reached from Mongolia by either going directly north to Russia and then circling around Manchuria, or by going Northeast and cutting through Northern Manchuria. Either way the distance that needs to be traveled by rail is significantly higher than the route through China to Tianjin. 

Mongolia will need to negotiate with China or Russia to set up some kind of transit agreement. China has no incentive to grant free transit because it already enjoys control over Mongolia's  coal exports. However, if Russia is approached first, it might be possible to pressure China into a more favorable agreement (Plan A). If China does not budge then plan B would be to secure a deal with Russia and accept the higher transit fees. The UN conventions will most likely help Mongolia's case at the bargaining table, but once again they hold little clout because they are not often followed and have no history of enforcement. Mongolia might also be helped by the World Trade Organization, of which Russia, China and Mongolia are members. However, it would be important to isolate Russia and China in negotiations in order to reduce the chance that they might collaborate to restrict Mongolia's export markets. 

DBM is currently raising funds for a railroad project that will run directly from Tavan Tolgoi to a Chinese border station. A later phase in the National Rail Project will connect TT with to the Russian boarder station.

Mongolian Sandwich

Being a landlocked country between Russia and China is a huge disadvantage for Mongolia.  Chinese and Russian influences are growing, sparking concerns among investors and the Mongolian people.  The Chinese already dominate Mongolia's exports, having bought 90 percent of Mongolia's exports in the first half of 2012.  According to Mine Web, Mongolia needs to expand its trade with China in order to ease its long-term dependence.

Dependence on Russia and China also poses a risk to the mining sector.  Mongolian mines rely on Russian and Chinese fuel, power and transportation to operate.  If a major disruption occurs in Russia or China, then Mongolian mines could shut down.  Furthermore, if Mongolia wants to export to other countries like South Korea or Japan it must rely on Chinese and Russian transportation.  In theory, Russia and China could coordinate their policies by limiting Mongolia's access to their railway networks in order to keep the Mongolian extraction economy under Russian and Chinese control.

Corruption is also a major issue.  Chinese and Russian businesses are viewed as some of the most corrupt in the world.  With their increasingly overbearing influence in Mongolia, it is not unlikely that corruption could spill across the boarder and into the Mongolian economy.

For these reasons, the Mongolian government has pursued a third neighbor policy, trying to build strong relationships with Japan, South Korea and the US.  In July, the government rejected a proposal that gave the development rights of the Tavan Tolgoi coal project over to Shenhua of China, Peabody of the United States and a Russian-Mongolian consortium.  The government is now trying to devise new deal that would include Japanese and South Korean partners.  This move, though disruptive to the launch schedule of TT, will probably pay off in the long term by promoting economic relationships with fellow democratic market economies in the region.

Dutch Disease in Mongolia?

How does a country like Mongolia convert its natural resource wealth into sustainable economic growth and prosperity?  In economics, Dutch Disease refers to the decline in manufacturing that tends to occur when natural resource extraction increases.  The increase in revenue from natural resources will make a nation's currency appreciate in value relative to foreign currencies, thus making it more expensive for other countries to buy the nation's exports.  This makes the manufacturing sector less competitive in the global market.  This phenomenon was first documented in the Netherlands after a large natural gas field was discovered there in 1959, thus the name Dutch Disease.

So how can Mongolia develop its manufacturing sector while its mining sector grows exponentially?  I don't think it should be difficult to manipulate the value of Mongolia's currency because Mongolia has only a few major export markets, namely China and Russia.  The Mongolian central bank could control the value of the Mongolian currency by deploying the same method that China uses to manipulate its own currency with its major trading partners.

Mongolian example:  China pays a Mongolian mining company 1m RMB (Chinese currency) for some amount of coal.  The mining company will go to the Bank of Mongolia and exchange the 1m RMB for however many Mongolian Tughriks.  The Bank of Mongolia could then use a healthy portion of that 1m RMB to purchase Chinese bonds, essentially injecting the RMB back into the Chinese economy.  This way the Bank of Mongolia will not accumulate an excess reserve of Chinese y, keeping the exchange rate between the Chinese and Mongolian currencies relatively stable.  This will keep Mongolian manufacturing competitive relative to Chinese competitors.  With Chinese consumption growing, Mongolian manufacturing should seek to export its finished goods to China.  This would allow Mongolia to develop a modern industrial economy as opposed to a undiversified extraction economy.

Mongolia's coal and copper resources are highly desired by Chinese companies.  This gives Mongolia a considerable amount of leverage when dealing with China.  For this reason, I think it is not unreasonable to think that this monetary policy would be tolerated by China.  Currently, Mongolian people are very weary of Chinese influence in their country.  In fact, in a poll asking who is the best partner for Mongolia, Mongolians put China last behind the United States, Russia, Japan and Korea.  But still, I think China remains the most promising partner for Mongolia, namely because of its proximity, its hunger for Mongolian exports and its increasing influence in World affairs.  What Mongolia needs is a trade agreement with China that acknowledges Mongolia's desire to develop its own domestic manufacturing, intended for sale in China.  Only then will both sides be equally served by the relationship and Mongolians can sleep soundly at night knowing that the big brother of Asia is not taking advantage of them.