Teaching Comparative Government and Politics

Thursday, September 25, 2008

Sovereign Wealth Funds: money talking

At the junction of economics, international relations, and comparative politics, are the rapidly-growing new version of state capitalism: sovereign wealth funds (SWFs). These are not parastatals, set up as government utilities or as instruments of nationalism and import substitution.

Investopedia, a Forbes Digital Company, defines sovereign wealth funds as, "Pools of money derived from a country's reserves, which are set aside for investment purposes that will benefit the country's economy and citizens. The funding for a Sovereign Wealth Fund (SWF) comes from... budget and trade surpluses... The types of acceptable investments included in each SWF vary from country to country; countries with liquidity concerns limit investments to only very liquid public debt instruments."

Traditionally, investment in the U.S. by other states concentrated on safe and liquid U.S. Treasury Bonds. So, for instance, Japan, China, and the UK own over 50% of US Treasury bonds (national debt). That is the kind of investment Milton Friedman described back in 1980.

But the newer SWFs often diversify their investments and look more like American overseas investment.

The Council on Foreign Relations (CFR) notes that, "Creating funds to manage government wealth is not a new phenomenon. But over the past five years, wealth accumulated in existing funds has ballooned and the number of new funds has spiked. The International Monetary Fund (IMF) estimated in September 2007 that sovereign wealth funds, or SWFs, control as much as $3 trillion, and that this tally could jump to $12 trillion by 2012. The sheer size and rapid growth of these funds increasingly commands the attention not just of economists, but also political analysts. [emphasis mine] Some argue that these funds will help nations dependent on natural resources to diversify their economies, but others worry about abuses of power and urge greater transparency at SWFs."

The CFR article notes that, "SWFs typically seek riskier investments and a higher rate of return. Ostensibly, they are run purely to increase the wealth of the state, not to pay off any specific debt." So, "China’s SWF recently purchased stakes in the U.S. financial firms Morgan Stanley and the Blackstone Group. Dubai’s SWF has bought up shares of several Asian companies, including Sony."

The Economist recently quoted former American treasury secretary Larry Summers as saying that a “signal event of the past quarter-century has been the sharp decline in the extent of direct state ownership of business as the private sector has taken ownership of what were once government-owned companies. Yet governments are now accumulating various kinds of stakes in what were once purely private companies through their cross-border investment activities.” Summers added, “Governments are very different from other economic actors."

Sebastian Mallaby, the director of CFR’s Center for Geoeconomic Studies, says finance ministries in the past have typically invested currency reserves in U.S. treasury bills and other risk-free bonds issued by wealthy countries. SWFs provide countries with a broader range of investment options.

According to the CFR report, "The major looming factor is how SWFs will be used in practice. Will governments use them simply as financial tools and eye investments from a purely financial standpoint, or will SWFs emerge as an implement of political muscle?"

The Economist speculated "Russia and China may be exceptions, in that both their governments have been willing to use the companies they own to pursue political goals and might well try to do the same with their sovereign-wealth funds."

Are oil-exporting countries importing political power? How will they use that power?

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