Why we need to think beyond GDP?

Over the last few thousand years, humans have made significant progress in all walks of life despite occasional hiccups where they have faced wrath of the nature. Largely progress has been continuously measured in Gross Domestic Product (GDP) and its variants.  Despite emergence of wide variety of alternative measures of GDP, economists continued to rely on GDP to dovetail economic policies. It is widely known that GDP accounting does not value economic inequalities, quality of environment and non-market transactions such as leisure. Eventually this translates to conflict between goals of GDP maximization and promotion of social cohesion & protection of environment. Many developing nations including Mongolia imitated western development models of growth to achieve higher GDP despite recognition among policy-makers that such growth is not sustainable in the long run. In run for achieving higher GDP, countries exploited resources at a rate greater than natural regeneration rate leaving little resources for the future.  People took free ride on future to achieve short run welfare improvements. Mode of growth also resulted in worsening of the quality of life. This just not only raises economic concerns but also ethical issues. Are children tomorrow are less entitled to resources or clean environment?

GDP is a convenient way to aggregate different products and services produced in the economy and is often calculated as sum of aggregation of consumption of goods and services by households, firms, government and foreign sector. But can we think of GDP as perpetual income without eventually impoverishing ourselves. True income is defined as the maximum income that can be consumed in a given period without reducing the amount of possible consumption in future. In this context, if activities included in basket of GDP affect future well-being, then it is imperative to call for correction in GDP estimates to arrive at true income. This is not so counter-intuitive if we traditional look at how households/firms inherently make purchase decisions. A household who brought a car at million dollars will downgrade the value after a year due to usage of the asset. This is called as depreciation in technical terms. What we need therefore is to adjust GDP to depreciation of natural capital to arrive at true income. Often policy makers recognize natural resources as free gifts of nature and call for continual exploitation. As the events across the world has demonstrated, growth achieved by such means is only illusory and short-lived. Further, discovery of new technology or discovery of new resources will only extend the time-span of depletion. Therefore, it is imperative to estimate true income to measure the societal progress by making suitable adjustment to traditional GDP estimates.

Mongolia which adopted western development model excessively focussed on GDP yardstick without consideration for sustainability factors. Foreign trade remains the key component of GDP for Mongolia with exports primarily dominated by raw commodities such as coal, copper and gold.  Mongolia which showed high potential for growth in 1990’s is now grappling with serious crisis. GDP growth rate has been declining since 2011 at alarming rate. GDP growth rate fell from 12% in 2013 to 3% in 2015. Employment in the industrial sector remains low at 20% while contribution of the sector to total GDP is at 35% approx. (2013, 2014 & 2015 world bank estimates). Mongolian exports are mainly to China and export prices are more effected by Chinese market fluctuations rather than international market. Though, National security concept propounded in 2010 calls for economic diversification and human development it is counter-intuitive to see the continued dependence on China and also reliance on mining for growth. Mining contributed to 92% of exports, 70% tax revenue and 85%FDI in 2013 (NRGI, 2015). The revenues however from mining resources per-se are fraught with challenges such as rising extraction costs, volatile capital flows & global commodity prices and huge up-front investments. Amount of mineral rents are also declining now due to shocks in global market since global financial crisis and reduced demand from China. Uncertain domestic policy environment coupled by global uncertainties meant reduced FDI flow to Mongolia i.e. FDI fell from 43% (2011) to less than 1% (2015) of GDP.

Mongolia natural resource rents if invested in fixed capital formation in the earlier years then GDP growth should not falter. Infrastructure remains poor corroborated by the fact that fixed capital formation is on decline since 2011. Further private sector participation in capital formation is much less. The country shares only one rail border crossing with the neighbouring countries and construction seasons is relatively short due to long and cold winter. Only 14% of total roads are paved, which remain unchanged in length despite the doubling of vehicular fleet in last two decades. The city roads are with extensive cracking, potholes and subsidence. It relies heavily on air transport which is also impacted of strong winds, sand and snow storms.

All these concerns point at whether Mongolia endowed with large natural resources is also facing the problem of resource curse? There is no indication of resource curse as exchange rate depreciated from 2011-2015 and further there are no major changes in contribution of non-tradable to GDP or employment numbers of non-tradable goods and services over time period 2011-15 (Corden,1984). This is also consonance with findings from literature (Dodo Thampapillai, 2014). Depreciation in currency further is expected to strengthen the non-tradable sector such as agriculture more competitive.

If there is no resource curse, why is Mongolia growth faltering now? Our argument is that GDP yardstick needs correction before using it as tool for dovetailing economic policies. Mongolia revenues from mining needs to be reinvested in assets such as infrastructure, human capital and institutions that create future income flows and offset the current depletion of non-renewable mineral resources. GDP estimates without accounting for such natural capital depreciation will only overestimate the income and create a false sense of euphoria of high growth. Our research estimates the depreciation amount using the Hotelling valuation principle and User cost method (El-Serafy), which are the core methods for depreciation valuation in the literature. According to Hotelling principle, depreciation is set equal to the total rent for the year and assumes total rent to be reinvested in-order to guarantee consumption for future generations. El-Serafy, on other hand, calls for only part of rents to be reinvested to guarantee future consumption. El-Serafy method calls for setting aside a part of income (depreciation) aside every year and reinvested to create a perpetual stream of income both during life of the resource and after exhaustion of the resource. Our research estimates depreciation to be as high as 40% of GDP as outlined in table below: 

Depreciation (As % of GDP)

2011

2012

2013

2014

2015

Hoteling method

39.82%

30.58%

29.35%

24.94%

14.30%

El-Serafy method

11.76%

9.03%

8.67%

7.37%

4.22%

Mining revenues however if are reinvested in asset formation then depreciation calculated will be low. The election of new President Khaltmaa Battulga comes as opportune time as country charts new path for sustainable growth. Mongolia needs to dovetail economic policies based on true income and diversify the internal and external economy for better future of Mongolians.

Appendix-A

  1. Assumptions for Depreciation calculation

  2. Yearly production estimates are derived from Mongolian yearbook.

  3. World Bank commodity price pink sheet used for commodity prices.

  4. For coal cost data, estimates from MMC are used. Due to non-availability of miscellaneous cost data for coal for years 2014 and 2015, cost is assumed same as 2013 for cost of transport, logistics and administrative expenditure.

  5. Due to non-availability of crude oil cost estimates, cost estimates of Russia are used and assumed same throughout the period.

  6. Iron ore cost is assumed to be 19.5 USD per ton, Copper 5000 USD per ton and Molybdenum 11000 per ton, Gold 700 per ton and assumed same throughout 2011-2015.

 

 

Authors

KHULANGOO PUREVJAV

MPA

Director of Policy & Advocacy

 

 

  VENU GOPAL MOTHKOOR

Double Degree MPP-MPA Student at Lee Kuan School of Public Policy & London School of Economics and Political Science