Free Trade Agreement between Mongolia and US: Illusion or Reality

Free Trade Agreement between Mongolia and US: Illusion or Reality

The Paper Presented by Amarjargal Renchinnyam

At the Mongolia – US Bilateral Conference, Washington D.C

Feb 28-March 1, 2005

INTRODUCTION

FTA parades all over the world: the only country without FTA is Mongolia.

The substance of FTA has changed very significantly in the last 20 years. FTA is taking the form of comprehensive economic partnership agreement such as an agreement between Japan and Singapore. Comprehensiveness, flexibility, selectivity is the major substance of a new FTA.

Regionalism is an irreversible trend. According to the WTO’s 2002 annual trade report, RTAs could soon account for more than half of the world’s trade[1]. Many countries recognize that Free trade agreements (FTAs) offer a means of strengthening partnerships in areas not covered by the WTO and achieving liberalization beyond levels attainable under the WTO.

From the economic perspective, FTAs lead to the expansion of internal and external markets, the conversion to more efficient economic structures, and the improvement of the competitive environment. In addition, FTA help reduces the likelihood of economic frictions becoming political issues, and help expand and harmonize existing trade-related regulations and systems.

From political and diplomatic points of view, FTA is increasing the country’s bargaining power in WTO negotiations, and the results of FTA negotiations could influence and speed up WTO negotiations. The deepening of economic interdependence gives rise to a sense of political trust among countries that are parties to these agreements, expanding US global diplomatic influence and interests.

In promoting free trade agreements countries taken into consideration:

(1) Conformity with WTO agreements: First, the duties and other regulations of commerce should not be higher or more restrictive than a prior to the formation of the FTA. Second, they must eliminate duties and other restrictive regulations of commerce with respect to substantially all the trade and service. Third, they must ensure completion of FTAs in principle within at least a 10-year period.

(2) Impact on domestic industries: Countries cannot secure the advantages of FTAs without enduring some pain arising from the opening of its markets, but this regarded as a process that is necessary for raising the level of domestic industrial structures. Unavoidable issues emerge concerning various areas of regulatory control, including movement of people, as well as the opening of markets and the implementation of structural reforms in the economy.

All signs indicate that an East Asian FTA is inevitable. What remains negotiable is its nature.

The need for economic cooperation between Northeast Asian countries is increasing due to several factors.

1. These are the deepening of the economic interdependence among the North East Asian countries;

1. The need for the prevention of overlapping investment in major regional industries;

1. As a response to the formation of economic blocs in the world economy and the growing number of fields requiring the coordination of common interests such as the problem of trans-boundary pollution.

Shortly, based on criteria such as economic, geographic, political and diplomatic, feasibility, and time consideration FTA is an instrument of:

1. Trade and Economic policy
2. Political and foreign policy
a. support for democracy, liberty and freedom
b. push for economic reforms

Though Mongolia achieved economic growth under the process of transformation, its reaction to a widening spread and deepening of regional trading blocs has been lukewarm, due to lack of knowledge, experience, and remoteness.

Let me present a brief analysis of possible FTA between Mongolia and US.

The U.S. administration publicly committed itself to a free trade. In my understanding the main goals of the Bush administration trade policy are:

(1) To advance the competitive liberalization,

(2) To strengthen the rules-based multilateral trade system.

(3) Of course, it is not a secret that FTA is an instrument of US foreign policy.

As for Mongolia, unless we take a stance linking FTAs to economic reforms in Mongolia, we will not succeed in integrating it into regional and world economy and an improving international competitiveness of Mongolia as a whole.

Since 1999, the Mongolian government has been evaluating the potential gains by pursuing the establishment of FTA.

As I mentioned, regionalism is one of the most dominant trends in the world economy today. In line with the increasing trends towards the regional integration, Mongolia has investigated the establishment of FTA’s with major trading partners in the region. Mongolia’s new trade policy is aimed at promptly adapting to the changing economic environment, as well as resolving the country’s economic difficulties. Consequently, an ultimate goal of our economic policy is to integrate Mongolia into the regional and world economy.

Mongolia would like to see the U.S. as its first FTA partner because of United State’s global dominance and high complementarities in our trade structure and political relations. The United States shall be interested in the establishment of FTA with Mongolia due to its close linkage with neighboring countries like Russia and China, investment opportunities, as well as Mongolia’s growth potential through performing strong reforms in several sectors, including the financial sector. The political consideration will be not the least one.

U.S. POLICY TOWARD FTA

American support for Mongolian transformation to democracy and market system has been an important factor for its recent achievements. The current state of bilateral relations between two countries has been reflected in Joint Statement between the presidents of United States of America and Mongolia. It says that it is “a new era of cooperation and comprehensive partnership between their two democratic countries based on shared values and common strategic interests.[2]

United States wide assistance for Mongolia’s “progress toward becoming a mature and stable democracy and a private sector-led free market economy” should become a cornerstone of the “comprehensive partnership” between two. The United States has expressed a strong support for “Mongolia’s efforts to integrate itself into regional and international economic and financial structures”. And two Presidents “agreed to actively promote bilateral trade and investment and … expressed the hope that this would lead in due course to a closer bilateral economic and trade relationship.”

The political commitment made by President George W. Bush on FTA issue should be viewed as a direction to follow for respected government agencies.

US government position on FTA with Mongolia is and will be a reflection of a real political support for Mongolia. The successful conclusion of FTA would have a world-wide demonstration effect of America’s new foreign policy of no double standards.

Unlike some international organizations which attempt to “buy reforms” by offering some benefits, US is pursuing the policy of supporting economic and political reforms by encouraging countries to make a real progress on these issues. The clear signal for this is the US selection criteria for MCC and choice of FTA partner policy.

As we know, the United States is in the position to exert significant political and economic pressure on the region’s governments to implement difficult reforms. However, the new trend towards the FTAs is very much in line with the US current foreign policy.

From economic perspectives, the FTA between US and Mongolia would also provide support for US companies. The US companies would have the opportunity not only to work in Mongolia but also exploring the perspective markets such as China and Russia.

From the geopolitical point of view, the free trade development process in East Asia and South East Asia should be in the center of the US policy in the region. US-Mongolian FTA over time would help offset the potential leverage that China or Japan might gain through their own bilateral agreements with ASEAN.

The U.S-Mongolian agreement would also give to other Asian and transitional countries a good reason to continue to pursue an open, multilateral trading system and regional economic liberalization, if or rather when China or Japan pressure to do otherwise.

Once the FTA is concluded with Mongolia, there could be a centripetal force around the North East Asia like a domino effect due to both geopolitical and economic reasons.

There could be some critical issues associated with the establishment of FTA between our two countries:

1. How significant is Mongolia for US to establish a FTA?

1. Do we recognize the long term benefits for both countries?

1. Other nations might not appreciate this FTA or even complain about it.

MONGOLIAN POLICY TOWARD FTA

Today, Mongolia is the only member of WTO which has no FTAs with any country.

European former socialist countries were motivated for joining EU and NATO. By joining these respectable institutions these former socialist countries succeeded in all fields, including: economic, political, and technological. In order to join EU, these countries were motivated to introduce EU standards. The economic reforms have been painful for them but the interest for joining EU prevailed, therefore, for example, even the water standards meet now the EU standards. In Eastern Europe reforms were supported not only by governments but also highly understood and accepted by whole population. Because of these support and international commitments, the changes in governments did not affect the implementation of reforms in these countries.

In early 90’s in some areas of reforms, Mongolia was leading among post socialist countries. But today we are far behind the eastern European countries. The reason for this situation is that our reforms have been implemented partially or incomplete. There was no consistency in implementation of reforms. That is why I do believe that to push reforms in Mongolia FTA with US will be very important. In case Mongolia signs the FTA with the U.S., it will be an international agreement and Mongolia will be bounded to implement according commitments.

The trade between Mongolia and US has increased more than 5 times between 1995-2004 from 40 millions to 202 millions USD. However, it is only 0.67 per cent of US – Singapore trade[3]. Of course it is not big number and some may argue that it is too early to discuss FTA. Exactly because it is small number, exactly because we want to expand trade and investment between two, exactly because we want through FTA enhance and deepen the process of reform and structural changes in Mongolia, which will lead to positive social outcome – I would argue for FTA in a broad sense.

I believe that the FTA with the US would help Mongolia to:

– implement reforms no matter what party will be elected;

– reduce corruption;

– provide access to US and other market;

– bring more FDIs into the country;

– generate more employment;

– reduce poverty;

– introduce advanced new technology and new culture of organization production;

– integrate into regional and world economy;

– do structural changes;

– and enhance economic independence and security.

First, increased openness to trade offers better access to foreign knowledge which is likely to have positive effects on productivity growth. Second, trade liberalization appears to increase returns on both physical and human capitals, this in turn stimulates domestic and foreign investments. Finally, binding liberalization schedule under FTA and other international commitments can be a useful tool to ‘lock-in’ and accelerate liberal economic reforms.

FDI is the most crucial element in the Mongolia-US FTA. There are expectations that such an FTA would lead to substantial enhancement of capital goods and component parts sectors, although trade deficit of Mongolia vis-à-vis US in these sectors will expand.

Current general environment for FDI in Mongolia has a little advantage if compared to that of China, which is based on one of the largest markets in the world and low wages. It is therefore imperative that the Mongolia-US FTA be designed to contribute to the improvement in the general environment that can attract greater FDI into Mongolia.

With the increased FDI flow, the transparency in policy and institutional environment will be strengthened while market growth, productivity and business environment will be improved. In particular, foreign investors are likely to benefit from strengthened intellectual property rights protection and transparency of rules and regulations.

Given these considerations, Mongolia should concentrate its efforts on making strategic use of the Mongolia-US FTA and its elements that have positive effects on FDI in order to maximize these positive effects. The various elements of FTA are closely interconnected, and the functional synergy thus created would result in greater benefits (i.e., of economic cooperation and on FDI) than if separate bilateral agreements are made for each of the elements.

In case of concluding “pure” FTA, Bilateral Investment Treaty must accompany trade liberalization to maximize the synergy between the two aspects of liberalization. Mongolia, should sign a BIT with US as soon as possible, and this will become a strong basis upon which an FTA can be build. Further, to promote US FDI into Mongolia, it would be desirable to establish a common investment and development bank (IDB, Investment Development Bank).

I recommend to establish Mongolia-US FTA Business Forum (FBF), which would be a temporary institution to do the preparation work for establishment of FTA, and which could have a permanent working group for private sector engagement to facilitate more concrete cooperation between the two countries.

Our two countries are closely cooperating in applying information technology to traditional industries. We share a great experience of long term cooperation in science, technology and education.

Finally, to facilitate movement of human resources and technology transfer in both directions, it would be desirable to set up related exchange programs.

In 2003, I have analyzed the economic effect of the potential FTA between US and Mongolia by using a CGE model. The CGE model is a general equilibrium model that has the advantage of determining the re-allocation effects of the resources[4].

Mongolia is expected to gain more benefits from the tariff elimination between the two countries. The conclusion of a Mongolia – US FTA will provide Mongolian products with price competitiveness, enabling them to better compete with other countries in the US market.

According to my calculations, the FTA seems to result in Mongolia’s welfare improvements of up to 110 million US dollars. However, it does not consider service trade and market expansion effects. The actual improvement is expected to be even greater.

One of the main reasons why Mongolia considers the US as its first FTA partner is that there will be no negative economic effect on Mongolian economy. Export and import of agricultural products between our two countries are not significant. There are no areas of trade which could be considered as sensitive for talk.

The successful conclusion of the first FTA will be of a great importance for Mongolia because other FTAs will heavily depend on the first model. It is most likely that the preparations and negotiations for FTA will last from one to two years.

My study looks at the macroeconomic effects of the elimination of tariffs between the two countries. Some studies indicate that Mongolia’s GDP will show an additional 5~10% growth in the short-term and, if capital accumulation is considered, an additional double growth in the mid-term. In contrast, Mongolia’s trade balance will not be affected that much. Its balance with the world will decline by about $50 million in the short-term; however, it will improve substantially in the long-term after Mongolia’s competitiveness is strengthened. Furthermore, Mongolia’s welfare is expected to improve more in the short-term than in the long-term.

IMPLEMENTATION

The FTA between Mongolia and the US should be a comprehensive partnership agreement based on common strategic interests. With the help of FTA, Mongolia would be able to develop and harmonize a legal basis and make the following areas to be compliant with the US norms and standards: trade, tax, customs, water and food security, emission and copyright, and others. In order to implement standards we need, among others, free flow of labor, free flow of capital and mutual recognition of university diplomas. All above can not happen overnight, there should be a step by step approach, some issues we might resolve today some will be ready in 1or 2 years, and some in 3, 5 or even 10 years.

In 2007 we are going to celebrate 20 years of diplomatic relations – could be a good date for the benchmark. However, I do believe that our mutual relations have started a long ago. Our history says that Bogd khan in early 20^th century requested a political and economic support from the US. We also have had American businesses represented in Mongolia in 1920’s and 30’s. Those companies have worked according to free trade principles.

My vision of the step-by-step approach for development of FTAs with US and countries in the region.

Within the framework of concluded FTA, we need to standardize and modernize the differing trade norms of Mongolia, such as customs procedures, anti-dumping rules, the unification of product classification, rules of origin, etc, in order to lay the groundwork for economic integration. We should also implement a common incentive policy to accelerate the restructuring and cooperation of regional industries, to facilitate intra-regional trade and encourage political dialogue for stability in the region.

Beyond the sensitive nature of various trade items, there are a number of other issues of concern surrounding Mongolia’s FTA policy. The first issue to be considered is the need for public awareness about the potential benefits of FTA. Thanks to years of democracy and market economy, Mongolians already have the positive attitude towards trade liberalization.

It common that people in industrial countries think that trade liberalization will only contribute to the growth of imports. There is some fear that the complete elimination of tariffs will be applied as soon as FTA comes into effect, thereby requiring huge adjustment costs in some sensitive sectors in the short-term. The drawbacks of trade liberalization are usually exaggerated, while the benefits are often underestimated. Some even consider that an FTA with large economies will be a form of economic subordination. Therefore, the governments should strengthen the publicity activities on the pros and cons of preferential trade liberalization.

[1] http://www.wto.org/english/res_e/booksp_e/anrep_e/anrep02_e.pdf

[2] http://www.state.gov/p/eap/rls/ot/34490.htm

[3]US and Mongolia annual trade is equal to 3 day trade of US and Singapore.

[4]Unpublished Amarjargal Renchinnyam (2003), Economic Integration in North East Asia and Mongolia. Institute of Economic Research, Hitotsubashi University, Tokyo, Japan