Catching up on my reading after a break, I see that the excellent Bill Bikales has written a nice summary of the unfolding economic crisis in Mongolia, where the currency is plunging, borrowing costs are rising and boom-era debts are suddenly looking very doubtful:

The crisis traces back to 2012, when a new Mongolian coalition government took office facing extremely favorable economic conditions, including high mineral prices and strong demand from China. Gross domestic product had grown by 17.3% in 2011 and by another 12.3% in 2012, making the country a global leader.

Investment flowed into Mongolia as a result of an agreement with Rio Tinto to develop the massive Oyu Tolgoi copper-and-gold resource in the Gobi Desert. There was also strong interest in the equally massive Tavan Tolgoi coal deposit in that region, along with other coal, iron and copper deposits.

But the new government had won election by making highly populist promises, and this led to a contradictory agenda. On the one hand, the government attempted to renegotiate the already signed Oyu Tolgoi agreement, and in general started seeking better terms from foreign mining firms. This led to a quick drop in investment, growth and revenues. At the same time, the government rapidly expanded spending on housing, government salaries, social welfare and pensions.

The only way the government could finance the resulting large budget deficit was by borrowing. For the first time, Mongolia became a significant global issuer of commercial paper. Between 2012 and June 2016, the government raised $3.6 billion, roughly one-third of GDP, on global bond markets, paying high interest rates. There was also a massive buildup of domestic debt. In a throwback to the planned-economy era, the banking sector once again became a major financier of government programs. Total loans in the economy doubled in the first two years of the 2012 government’s term, and the money supply expanded at an extraordinarily rapid pace. Nonperforming loans began to build up. …

By 2014, international financial institutions expressed measured but clear concern about the deteriorating economic situation. The central bank slowed monetary expansion and budgets were tightened somewhat. This coincided with a continued collapse in foreign investment and a steady decline in global mineral prices due to China’s slowdown. As a result, Mongolia’s growth slowed sharply to 2.3% in 2015 and is likely to be zero or negative in 2016.

But the current economic downturn isn’t primarily due to a decline in global commodity prices. It is the result of the government borrowing heavily against future export earnings while taking actions that deferred the day when those exports would materialize. Instead of preparing for an inevitable cyclical downturn in commodity prices, the government took steps that magnified that downturn’s impact.

A sovereign debt default now looks very much like a live possibility for Mongolia. This sad narrative fits very well the best current understanding of the resource curse–which is not that possession of natural resources mechanically causes lower growth. There are enough countries that manage to do well while having large energy or mining industries (such as the US) so that attempts to find correlations between resource endowments and growth outcomes have had decidedly mixed results. Rather, the problem with having a big resource sector is that it exposes a country to the huge boom-bust cycles typical of commodity markets–and it is rare for countries to be able to make good decisions at either end of a commodity cycle. The temptations to make borrow too much and make bad investments in the boom days is particularly strong; note this sentence from a recent World Bank paper: “Credit growth has been most pronounced, and nearing the pace associated with past credit booms, in commodity exporting countries.” As Bikales shows, Mongolia has problems because it made bad decisions, not just because it had a mining boom. One useful recent summary of the literature on the resource curse is Cullen Hendrix and Marcus Nolan’s Confronting the Curse: The Economics and Geopolitics of Natural Resource Governance, who conclude:

Natural resources are neither discovered nor exploited in an institutional vacuum. Preexisting institutions are the key moderating factor. If these institutions are strong and the size of the mineral sector does not dwarf the rest of the economy, resource wealth provides additional capital for productive investment. Even if Dutch disease dynamics come into play, these resources can be invested in ways that promote intergenerational equity and the accumulation of long-term wealth. Under these circumstances, resource income is growth promoting, and the “curse” becomes more of a blessing. This condition seems to be the equilibrium path of Norway, the United Kingdom, the Netherlands, and the United States. If preexisting institutions are weak and the mineral sector is much larger than the rest of the economy (as in Angola, Nigeria, and Saudi Arabia), the resource curse dynamic emerges.

An interesting comparison is available just over the border in the Chinese province of Inner Mongolia, which is a huge coal producer and has experienced a similar boom-bust cycle along with commodity prices. Both Mongolia and Inner Mongolia are currently enjoying nominal GDP growth of less than 4%, down considerably from their recent highs–though Mongolia’s peak nominal growth rate neared 50% while Inner Mongolia was–only!–around 25%.

The province of Inner Mongolia of course does not have its own currency and does not borrow internationally, so it is not going to experience the same type of fiscal and currency problems as the independent nation of Mongolia. And while the governing institutions in the two places are quite different, neither place is exactly pursuing Norway-type best practices for managing their resource wealth. So there is also some evidence of the resource curse playing out in Inner Mongolia, essentially meaning bad economic decision-making during commodity booms. The famous “ghost city” of Ordos could be one supporting anecdote; however that example is probably overplayed, as Wade Shepard reports: “The real story consists of a mining boomtown building a new district on a long-term timeline in a period when hundreds of other cities across the China were doing the same thing.” On a macro level however it seems pretty clear that investment got even more out of hand in Inner Mongolia than in the rest of China, and is correcting harder: