As is generally accepted, a good public investment system needs to do two things<sup>5</sup> :

- To achieve allocative efficiency, that is to distribute resources as per national priorities, and to shift resources from less productive sectors and less effective activities to more productive and effective ones.  In other words,  ̳spending in the right areas‘;

- To achieve operational efficiency, or to implement programs and deliver services at the lowest cost per unit of output, or conversely, to get the most output for a given set of inputs

As detailed below, Mongolia‘s system is falling short on each of these objectives.

# _2.1. Low allocative efficiency_

There are two main aspects to this problem in Mongolia. First, the capital budget is fragmented with a portfolio skewed towards a large number of small projects spread across sectors and regions and an underfunding of large infrastructure investments that are critical for economic growth. Second, there is a gross neglect of maintenance and capital repair leading to the ―build-neglect-rebuild‖ scenario. Underlying these expenditure patterns are institutional weaknesses — public investment projects are not guided by well thought out strategic priorities, there is little in the form of economic appraisal in the planning and budgeting process, and capital budgeting is not done under reasonably disciplined sector ceilings and therefore there is no incentive for ministries to prioritize.

The vast majority of projects in the public investment portfolio in Mongolia are small and geographically targeted which has resulted in considerable fragmentation of the capital budget into a large number of small projects. To take the example of the 2008 capital budget, the total project portfolio for new investments of roughly $900 million was spread out over 758 projects, implying an average project allocation of $1.2M. However, the median project size was much lower. As Figure 2 shows, 66% of projects were less than $400,000 in size (500 million MNT), and another 28% were under $4 million. If one considers $8 million (10 billion MNT) as the threshold for a ―large project‖, then only 2% of the portfolio was made up of these large projects. In terms of cost, these large projects accounted for 40% of the portfolio.

This focus on smaller projects has come at the expense of a relative neglect of large, critical infrastructure investments. This is evident in the inability of policy-makers to increase electricity generation capacity, particularly for Ulaanbaatar, resulting in a near crisis situation of power shortages. Specifically, the need for a new Power Plant # 5 for Ulaanbaatar has been on the agenda for the past decade but has been repeatedly delayed. More significantly, the government has been unable to effectively plan for the huge infrastructure investments on roads, power supply, and water supply, estimated at roughly $5 billion, to effectively develop the Southern Gobi mines.

**Figure 2:  Distribution of investment projects by size, 2008**

<!-- Start of picture text --> 2% are<br>larger than<br>$8M<br>28% of<br>projects are 758 total<br>between<br>projects<br>$400k and<br>$4M in size<br>66% of the<br>projects are<br>less than<br>$400k in<br>size<br><!-- End of picture text --> _Source_ : Ministry of Finance

> 5 Based on World Bank (1998)

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