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That's because governments tend to be terrible at managing money
that is best left in the hands of private citizens. And locking
away billions of dollars in wealth can have pernicious economic
side effects.
Maybe that's why sovereign wealth funds are
popular with dictators and semi-authoritarian regimes, which
don't have to answer for the consequences when they make poor
economic gambles.
That may explain
why they have been developed mostly by authoritarian regimes in
semi-developed countries, where citizens don't have a chance to
demand smarter economic policies.
Singapore's
autocratic rulers need a reserve to pay off dissatisfied subjects
to maintain power when economic times get tough.
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The truth
about Sovereign Wealth Funds
Anders
Aslund
Foreign Policy
29 Jan
08
http://www.foreignpolicy.com/story/cms.php?story_id=4056
Worried
about oil-rich foreigners taking over your economy? You shouldn't
be. In reality, it is citizens of unaccountable, paternalistic
regimes who stand to lose most when rulers play games with their
national wealth.
The Arabs, the Chinese, and the Russians
are about to buy up large swathes of Western economies. Or so the
scare story goes. A frenzy of recent activity, including Dubai's
purchase of an undisclosed amount of Sony shares, Abu Dhabi's
acquisition of $7.5 billion worth of Citigroup, and China's $3
billion stake in private-equity firm Blackstone, has many
commentators fretting about so-called "sovereign wealth
funds"—investment entities set up by governments to
manage their surplus savings. According to an estimate by Morgan
Stanley, sovereign wealth funds have poured some $37 billion
since April into (mostly Western) financial institutions. One
hyperventilating observer of these developments even bemoaned the
onset of a "sharecropper economy" in the United States.
In truth, such funds are nothing for Americans or
Europeans to fear. If anyone should worry about them, it's the
people whose governments are amassing them. That's because
governments tend to be terrible at managing money that is best
left in the hands of private citizens. And locking away billions
of dollars in wealth can have pernicious economic side effects.
Maybe that's why sovereign wealth funds are popular with
dictators and semi-authoritarian regimes, which don't have to
answer for the consequences when they make poor economic gambles.
Sovereign wealth funds are nothing new, but they are
growing larger. They emerged in the 1970s in oil-producing
emirates, such as Kuwait and Abu Dhabi, as a way to accumulate
current account and budget surpluses during the oil boom. Now,
Abu Dhabi boasts the largest fund, sized at $600-700 billion, and
other countries have followed its lead. Norway established a fund
for its excess oil incomes in 1990. Singapore has accumulated two
large funds that, unusually, are not based on oil income. And
more recently, China and Russia have instituted large sovereign
wealth funds of their own. Today, such funds hold as much as $2.5
trillion in assets, according to Ted Truman, a senior fellow at
the Peterson Institute for International Economics. Some
economists forecast they will grow to $12 trillion by 2015, an
amount that roughly corresponds to the size of the entire U.S.
economy.
The motives of the funds vary, and they don't
always make sense. Consider Abu Dhabi and Kuwait, which wanted to
save their oil endowment for future generations, an admirable
goal. But today these two bureaucratized emirates look like poor
cousins in comparison with freewheeling Dubai, which has much
less oil. Because the rulers of Abu Dhabi and Kuwait centralized
their nations' wealth in the hands of the state, their state
sectors stifled their economies. Abu Dhabi's fund may be
impressive, but the entrepreneurial emir of Dubai has done a far
better job of putting sustainable wealth in the hands of his
citizens.
Another motive for the rise of sovereign wealth
funds is to form a buffer against volatile commodity prices. In
the 1970s, major oil exporters adjusted their expenditures to
their enlarged oil revenues, but after 1980 the international oil
prices plummeted, landing them in crisis. Learning this lesson,
oil producers such as Russia have established "stabilization
funds." It may sound like a good idea, but the Russian
deputy minister of finance responsible for foreign assets has
just been arrested and accused of embezzling $43 million. Why
trust the state with your money if the risk of theft is
excessive?
A separate but related trend is the enormous
currency reserves that Russia and especially China are amassing
thanks to persistent large current-account surpluses. After the
Asian and Russian financial crises of 1997-98, these governments
realized that they could not rely upon the International Monetary
Fund (IMF) to bail them out but needed sufficient reserves of
their own. These reserves have since reached $450 billion in
Russia and $1.44 trillion in China, corresponding to one third of
Russia's GDP and half of China's.
But the low returns on
international reserves make this arrangement costly. It is much
more economical to reinforce the multilateral financial regime
led by the IMF. Ballooning reserves, moreover, are a result of
undervalued exchange rates, which are only tenable in the medium
term. In the long run, inflation will eat up the competitive
advantage. By purchasing foreign currencies and issuing domestic
currency, central banks are boosting the money supply and
inflation, which is becoming a major concern in China and Russia.
Both countries would be better off letting their exchange rates
appreciate to reduce inflation, which would slow their
accumulation of reserves.
In short, sovereign wealth
funds are often a lousy bargain for the countries that have them.
That may explain why they have been developed mostly by
authoritarian regimes in semi-developed countries, where citizens
don't have a chance to demand smarter economic policies. Take
Singapore, whose economy depends on trade rather than a declining
resource such as oil, and yet has locked up billions of dollars
of its wealth in a fund since 1960. The government there has
exceptionally managed to maintain its authoritarianism after the
country became wealthy, but authoritarian regimes are more
vulnerable to economic downturns than democratic systems.
Singapore's autocratic rulers need a reserve to pay off
dissatisfied subjects to maintain power when economic times get
tough.
In democracies, the politics work differently. The
only democratic country with a large sovereign wealth fund is
Norway. Since the Norwegian fund was established in 1990, every
incumbent government has lost elections because the opposition
has promised all kinds of popular expenditures from the abundant
fund. Democratically, it is difficult to defend an excessive
public reserve fund.
Certain international reserves are
always needed, and exporters of commodities with highly
fluctuating prices require larger reserves as a safety net.
However, sovereign wealth funds are something different. They
reflect a paternalistic—and economically illiterate—notion
that the ruler knows best while citizens are so irresponsible
that they cannot be entrusted with their own savings. It would be
more economical and democratic to cut taxes and let citizens save
and invest themselves.
Editor's Note: The
original version of this article characterized Singapore's rulers
as "unelected." Technically speaking, they are elected,
but neither freely nor fairly. Freedom House rates Singapore as
only "partly free."
Anders Aslund, a
senior fellow at the Peterson Institute for International
Economics, Washington, DC, has just published the book Russia's
Capitalist Revolution: Why Market Reform Succeeded and Democracy
Failed (Washington: Peterson Institute, November 2007).
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