Such high fragmentation also reduces allocative efficiency for other reasons. First, these projects, given Mongolia‘s geography (small population and low population density) tend to be uneconomic. Second, fragmentation likely results in duplication and wasted resources. Third, it likely increases the costs of the public investment portfolio as it forgoes some economies of scale. Fourth, the large number of small projects taxes the limited human resource capacity of the line ministries that prepare and implement these projects, and of the Ministry of Finance that has to screen and approve them to be financed from the budget. It is therefore likely that a portfolio with many smaller projects will be of poorer quality than a portfolio of the same size with fewer, larger projects.

Another stark objective indicator of the misallocation of resources in Mongolia is the gross underspending on capital maintenance and repair in relation to the country‘s needs. Due to years of neglect, the state of disrepair in the energy and roads sectors is approaching crisis proportions. The electricity sector has immediate capital repair needs estimated by the Ministry of Fuel and Energy of about $130 million (or 2.5 percent of GDP), and 60% of the national paved road network is in poor condition and in need of capital repair and rehabilitation, at an estimated cost of $520 million (or roughly 10 percent of GDP). As against these large needs, and as shown in Figure 3, left panel, capital repair spending increased very little in nominal terms during the boom years, as compared to expenditures on transfers, wages and salaries, and new domestic investment, and declined as a percentage of new investments (from 10 percent to 6.5 percent) and of estimated public capital stock (from 4 percent to below 2 percent) between 2003 and 2010.<sup>6</sup>

**Figure 3: Spending in capital repairs and maintenance did not benefit from the expenditure boom and has declined as a share of new investments and capital stock**

<!-- Start of picture text --> Trends in capital repairs<br>Main government expenditures<br>3,000 12<br>Capital repair<br>2,500 10<br>2,000<br>8<br>1,500<br>As percent of new<br>1,000 6<br>investments<br>500 As percent of public<br>4 capital stock<br>0<br>2003 2004 2005 2006 2007 2008 2009 2010 2<br>budget<br>Wages and salaries Subsidies and transfers 0<br>Purchase of goods and services Doemstic investment 2003 2004 2005 2006 2007 2008 2009 2010 bud.<br>Capital repair<br>Billions<br><!-- End of picture text --> _Source_ : Ministry of Finance, World Bank staff calculations. Public capital stock calculated using perpetual inventory methodology specified in Harberger (2007).

There are both technical and political reasons for this under-prioritization. As elaborated on below, there is no economic analysis of projects during budgeting and no requirement that the future recurrent costs of projects be specified and be part of the appraisal process. The deeper political reasons are discussed in the next section.

Ideally, budgets generally, and public investments specifically, need to be guided by policies that are grounded in a strategic framework based on sound analysis. The requirement therefore is both that national and sectoral planning documents be of good quality, and that the public investment program be, as much as possible, linked to the priorities as established in these documents. While there are numerous

> 6 The Government does not have an asset register and therefore capital stock is not measured.  For the purposes of this report the public capital stock was estimated using the methodology in Harberger (2007).

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