Tuesday, December 4, 2007

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Should you fear the sovereign wealth fund?

Over at Foreign Policy, economist Anders Ňslund says that sovereign wealth funds pose greater problems to home countries than host countries:

[S]uch funds are nothing for Americans or Europeans to fear. If anyone should worry about them, itís the people whose governments are amassing them. Thatís 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 thatís why sovereign wealth funds are popular with dictators and semi-authoritarian regimes, which donít have to answer for the consequences when they make poor economic gambles....

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 nationsí wealth in the hands of the state, their state sectors stifled their economies. Abu Dhabiís 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....

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 donít 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. Singaporeís unelected 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 paternalisticóand economically illiterateónotion 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.

posted by Dan on 12.04.07 at 10:30 PM


His article deals with more about government and taxes being bad. Since SWFs are government funded, they are also bad. He does it by taking a few negative and in most cases misleading examples from these funds and damns all SWFs by association.

These funds need to be more transparent and accountable but for the most part these investment funds are quite good for their citizens and for the world's economy.

posted by: Patrick Flaherty on 12.04.07 at 10:30 PM [permalink]

There hasn't been enough experimentation with these sorts of funds to derive and accurate conclusion. The nations cited as being underdeveloped have many more problems than wealth funds. Besides this, these funds serve the purpose of keeping the currency from appreciating and protecting against big dips in energy prices.

posted by: Tony Trepanier on 12.04.07 at 10:30 PM [permalink]

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