Mongolia's Shadow Economy: Half as Large as the Official

UNCLAS SECTION 01 OF 02 ULAANBAATAR 000621 SIPDIS SENSITIVE SIPDIS STATE PASS USTR, PEACE CORPS, OPIC, AND EXIMBANK STATE FOR EAP/CM, EB/TPP, OES/IHA USAID FOR ANE CALISTA DOWNEY MANILA AND LONDON PLEASE PASS ADB AND EBRD USEDS E.O. 12958: N/A TAGS: ECON PREL EAID MARR SOCI MG SUBJECT: Mongolia's Shadow Economy: Half as Large as the Official One SENSITIVE BUT UNCLASSIFIED - NOT FOR INTERNET DISTRIBUTION. ¶1. (SBU) SUMMARY: According to a USAID-funded analysis, the informal economy in Mongolia is about 45% to 50% the size of the formal economy. This contrasts with the current official estimate of just 11% from the National Statistics Office (NSO). Using a new estimate based on a large sample survey of households, Mongolia's per capita GDP in 2004 would have been US$845 -- higher than the reported US$644, but still within the World Bank's low income category. The new estimate of the informal economy has not yet been officially accepted by Mongolia's government, but will carry implications for all numbers and policies based on economic size, as well as for thinking about tax administration and other issues. END SUMMARY. Turning "Guestimates" Into Estimates -------------- ¶2. (U) The existence of a large informal economy in Mongolia has long been known, but the exact size has been disputed. Some observers have asserted that the "shadow" economy is equal to the size of the formal one. Mongolia's NSO currently adjusts its official GDP estimates by incorporating shadow economic activity in three sectors: retail (non-automobile),restaurants, and land transport (taxis). This adjustment amounted to only about 11% of total GDP in 2004. ¶3. (U) To get a more accurate assessment, the USAID-financed Economic Policy Reform and Competitiveness Project (EPRC) worked with the NSO and the Open Society Forum to fund the Informal Sector Household Survey (ISHS),a national sample survey of 13,900 households. The IRIS Center of the University of Maryland designed and administered this survey. IRIS interviewed a sample of more than 2% of Mongolia's 596,400 households about their production and employment activities, their attitudes, and their finances. The objective of the ISHS was to obtain estimates of the size, scope and distribution of informal economic activity not counted in the nation's estimated GDP. ¶4. (U) These projections were reported in IRIS's 2005 report "The Size and Character of the Informal Sector and Its Shadow Economy in Mongolia" and in a May 2006 EPRC/USAID report "Mongolia's Informal Economy-Projections, Analysis and Policy Implications from the ISHS." The first report generated estimates of the size of the informal sector relative to Mongolia's gross domestic product (GDP); the second report generated estimates of the size of household income-national, regional, mean and median. A subsequent report from EPRC/USAID compared the two sets of estimates by converting the EPRC/USAID estimates of household income into their equivalent gross value added (GVA) to compare the two sets of estimates with Mongolia's GDP. The Findings: Economy Half Again As Large -------------- ¶5. (SBU) The two sets of estimates supported the conclusion that the informal economy in 2004 was about 45% to 50% the size of Mongolia's formal economy, a much larger portion of the economy than the NSO's limited adjustment suggests. These findings are in line with a 2002 IMF publication citing typical ranges for shares of the shadow economy as a percentage of GDP for different groups of countries. The range for developing countries was stated by the IMF to be 35-44% (as opposed to 21%-30% for transition economies, and 14-16% for OECD countries). The new figures for the size of Mongolia's informal economy indicates the 2004 GDP estimate of 1.9 trillion MT (about US$1.61 billion) is too low. This GDP figure implies a per capita income of US$644 (including the current 11% adjustment for the informal economy); the new estimates derived from the ISHS would imply a per capita income of US$845. Nonetheless, Mongolia would remain classified as a "low income" country in the World Bank's country classification. Implications ULAANBAATA 00000621 002 OF 002 -------------- ¶6. (SBU) These figures are not yet for public distribution; EPRC is now working with NSO to ensure official acceptance of the sharply higher figures for the informal economy and to discuss how to release the findings to donors and others. Official approval for these more accurate appraisals is essential, since a better estimate of the informal economy is needed in the larger effort to bring Mongolia's national accounts in compliance with the United Nations Standards for National Accounts (SNA-93). These revisions could have implications for a broad range of GoM policies. Ratios that use GDP as a denominator would need to be substantially revised for Mongolia; these include debt ratios, tax ratios, foreign assistance as a percent of GDP, etc. In addition, the potential impact of recently enacted tax laws may need to be examined, as well as a reexamination of strategies for tax enforcement. One aim of the new tax laws is to help bring more of the economy into the official sector, with the better tax compliance ameliorating the effect of reduced tax rates, while also increasing the transparency of Mongolia's economy. SLUTZ