Posted by: oliviaclemens | October 22, 2008

Sovereign Wealth Funds and Global Competition

A host of nations have what are called ‘sovereign wealth funds’ (SWFs) designed to regulate fiscal imbalances or serve as a currency reserve as in a central banking role or more ambitiously serve the purpose of investment return which can include acquiring interest in private ventures.  Central banking role is the more conservative and traditional role that SWFs served but some have accumulated reserves (usually US dollars) so quickly the last few years as a result of commodity price inflation that they have sought out other opportunities to expand their portfolios.

This might be good news in the sense that many of these SWFs are in nations with commodities that are prone to exhaustion such as oil or natural gas so that a SWF’s investment in other enterprises provides the sponsoring nation a source of future income as its ability to sell commodities declines from extraction of the resource.  But it really is bad news for the global economy.  Sure, SWFs have played a role in bouying the financial sector that has caught the subprime fever; witness the Abu Dhabi Investment Authority (ADIA) investment of US$7.5 billion in Citigroup. However even this source of additional liquidity for Citi is at a premium.  ADIA gets an 11% annual dividend for its investment.  That is about three times the traditional dividend payment for a shareholder of common stock in a financial institutional.  Similar deals have been struck by other SWFs to assist private companies in the ongoing crisis.  As I will detail later, the development of SWFs poses a challenge to the global economy, both as a potentially integrative and as a polarizing and competitive factor.

A major concern is that SWFs might be used as economic devices to influence political decisions.  For example, it is suspected in some circles that SWFs might buy controlling or significant interest in natural resource companies that provide commodities relevant to national security concerns.  SWFs could conceivably be used to advance a state’s industrial policy by promoting “national champion” firms into overseas markets, eroding the ability of host enterprises to compete effectively, or by purchasing controlling stakes or outright ownership of host nation firms.

In autumn of 2007 the Abu Dhabi Investment Authority acquired Canada’s PrimeWest Energy Trust for US$5 billion.  This of course led to lively discussion in Ottawa as to what steps Canada should take to protect its oil and gas industry from foreign acquisition.  The issue is quite serious as these Canadian Royalty Trusts pay generous dividends and account for the bulk of Canadian oil and gas reserves – some are even leaders in extracting oil from shale and sand deposits which are estimated to exceed the reserves of Saudi Arabia.  Today, Primewest Energy is a privately owned entity that goes by the name of TAQA North Ltd. that of course pays no dividends.

This pattern is repeated in other forms across the globe as suspicions arise as to the transparency (there is none) of the motives SWFs have and how they might exercise their interest in, or sometimes complete ownership of (as in Primewest) native enterprises.  Recall in 2007 the controversy over ADIA’s desire tgo acquire interests in US port facilities and the refusal of selling shares in Occidental Petroleum to the Chinese SWF.  While SWFs have not done much more so far than delisted publicly traded companies from various exchanges, they do have the potential to exercise monopolistic control over various sectors of a nation’s economy.  For example, the purchase of 100% interest in Prime west cost ADIA just US$5 billion a year ago when Canroys were trading at 100% premium compared to today’s post-meltdown prices.  With its reserves and today’s depressed share prices , ADIA could conceivably afford to buy out the remaining Canroys and assume a dominant position in Canada’s oil and gas industry.

The issue is growing in importance and there have been changes in responses to the operation of SWFs.  Back in February 2008, the European Union’s Trade Commissioner Peter Mandelson welcomed investment of Chinese SWFs in European industry while also calling for “…a code of conduct and principles governing the behaviour of these wealth funds, which provides for transparency and good governance.”  Just 8 months later, French President Nicolas Sarkozy bolted from the EU position and encouraged European governments to set up sovereign wealth funds of their own to buy stakes in European companies while prices were at discount after the recent melt-down so that EU nations could prevent takeovers by what Bloomberg reporters characterized as “overseas predators.”

Oddly though, SWFs have traditionally come from ‘ginormous’ currency reserves generated by production and trade taxes from the selling of commodities, usually oil and natural gas.  That is how the middle eastern and Russian SWFs originated.  The Chinese SWF came from the huge reserves in dollars that have accumulated from the stunning trade imbalances with the US and Europe.  Traditionally, the Chinese have invested these reserves in US treasuries and other debt instruments.  But declining US interest rates and disappointing bond returns have led to an interest in better returns such as might be obtained in equities.  European nations do not really have a similar situation.  Rather, their SWFs would likely come from government taxes on their own citizens.  This would add to the tax burden that is already carried on the shoulders of European citizens.

While President Sarkozy of France has been deliberate about advocating European SWFs, even if they come from additional public taxes, here in the US we have been developing a sort of ‘stealth’ SWF that is now concentrated in our financial institutions.  And yes, like any European SWF, the stealth American SWF is supported by theissuance of additional public debt – namely the series of US government purchases of interest in AIG and other troubled firms and of course the recently authorized US$700 billion ‘rescue bill’ to shore up the banking industry.  We are on the hook for about US$1 trillion dollars as of this writing.  Hopefully our own under-the-radar foray in SWFs meets with greater success than has that of the Chinese SWFs which are reported to have lost billions of dollars in value on several ventures.

In any event I see this as a troubling sign.  Inevitable perhaps in a competitive global economy where monopoly counts for something; especially over resources, technology, or processes that are necessary to sustain advanced industrial societies.  While I generally oppose government intervention that comingles private and public ownership and I am a staunch proponent of free enterprise, responsibly regulated but not so much that competition is strangled, it may actually be an adaptive response by our usually inept government to shelter some key industries, even if it raises the public debt to even less acceptable levels.

Frankly, a nation that relies on the goodwill of other nations whose perpetual benevolence are suspect is only imperiling its future viability as a great power.  A nation that trusts its access to technology, natural resources, or to administrative processes to others is extraordinarily vulnerable to the caprice of foreign powers.

That said, I do see the emergence of SWFs as accelerating global competition, apprehension, and potential conflict.  SWFs might be the modern form of mercantilism, but with the peculiar twist of actually leveraging free market policies to their advantage – and advantage gained at the expense of a potential host’s capacity to act independently on the world stage.  So long as SWFs exercise that power with beneficence they will contribute to a more integrated, interdependent, peaceful, and prosperous world.

A panglossian view of how nations behave would welcome the advent of SWFs.  But a realist perspective would look upon the concentration of wealth in state entities that have shown a capacity to behave rapaciously with wide-eyed suspicion.  Fortunately, President Sarkozy by intent and President Bush by happenstance, have taken the first steps to insulate core state enterprises from serving the interests of potential adversaries rather than the public of their host nations.



  1. Nice Site layout for your blog. I am looking forward to reading more from you.

    Tom Humes

  2. A friend of mine just emailed me one of your articles from a while back. I read that one a few more. Really enjoy your blog. Thanks

  3. This is a really interesting article Liv. Im so glad we have you aboard.

    I was for the Dubai ports deal and generally am cool with investment from wherever. But you make a very good point about the market distorting power and potential security risk, that gives me pause.

    I dont like the idea of defensive Western SWF’s either, they would have a similar distorting effect on the market by giving the government a stake in particular businesses or industries.

    I used to be a big advocate of Social Security privatization, that would basically create a massive American SWF. After reading your article (and yes considering the Wall Street collapse) I dont think I can support that anymore. Can you imagine how much bigger the bailout would be if the government owned a stake in many (most?) publically traded American companies? The pressure to save them would be irresistable!

    Again welcome aboard, your post was great, its challenging and makes you think.

    Maybe we can get a followup about SWFs in the developing world? Im very interested in that, im curious what China already has, and how they have used it so far to influence policy in these countries.

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  5. […] going to leave the economic repercussions to people better in economics than me (perhaps our own econ expert will weigh […]

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