Mongolia - Privatization and system transformation in an isolated economy

The authors examine the process of economic transformation in Mongolia, a huge, isolated, sparsely populated country. After identifying factors that led to formulation of a radical adjustment program in such an isolated country, they focus on Mongolia's innovative voucher privatization scheme, and the interplay between the speed of contraction in resource availability and that of the movement to a market economy. They show that the reform process was not smooth: that after the rapid formulation and implementation of major reforms, there was a marked slowdown, when reform timetables were revised and a more gradualist approach adopted. Later, reforms driven by the privatization program picked up momentum again. But one important lesson learned in Mongolia is that voters are likely to shy away from radical reformers when faced with growing shortages and a collapsing economy. In June 1922, the Mongolian People's Revolutionary Party (the former communist party) was returned to power in general elections, capturing 72 of 76 parliamentary seats. The authors identify factors related to speed versus caution: organization and institutional limitations; political considerations; whether a model of transformation exists; and a contracting resource envelope. Using a simple computable general equilibrium model, they analyze the impact of the cutoff of Soviet aid, which amounted to 30 percent of GDP, and of the disruption of trade. They conclude that preventing a decline in welfare of more than 20 percent - which is close to the decline in 1991 - would require aid flows of about 15 percent of GDP. Their model suggests that the rural sector is reasonably well insulated from external shocks, in sharp contrast with the urban sector. One response scenario explored by the model is that of massive reverse migration to rural areas. They point out that the more the resource envelope tightens and squeezes away the margin above subsistence, the harder it will be to sustain an orderly pattern of reform. In the extreme, this pattern may force the country to adopt a rationed wartime economy, despite intentions to shift to a market system.