(August 8, 2012) — Ill-conceived sovereign wealth funds (SWFs) are handicapping their countries’ national development, a paper by a professor with the HSBC Business School, located in Beijing, China, argues.
There is a split between older, more objective-driven SWFs and newer ones that are created with broader ambitions in mind, the paper by Christopher Balding asserts. SWFs came from humble beginnings, he explains, and were originally tasked with mundane goals like smoothing out foreign reserves of commodity dependent countries, and limiting inflation and currency pressures. Instead, he says, a new generation of SWFs, which has aspired to allow governments to “dominate the global economy and diplomatic circles,” has had the effect of fostering corruption and hamstringing national development.
“Most original sovereign wealth funds were making valuable economic policy innovations to prevent inflation and macroeconomic instability,” Balding contends. “Most new sovereign wealth funds are being used to distort markets hindering national development. The landscape is dominated by vanity funds that seem better suited for the purpose of joining a sovereign country club rather than funds designed to solve difficult policy and development questions. The highest quality ‘innovations’ in sovereign wealth funds come from some of the oldest funds but are lessons well learned.”
Balding lists three points that he says a SWF should respect to function properly. First, only countries with a “predictable and dedicated” source of capital, such as the oil wealth that fuels many Middle Eastern SWFs, should consider setting up a fund. In the absence of natural resources, a SWF can result in “incredibly distortionary policies” that are needed to fund them. Second, SWFs should be engineered with strict capital withdrawal rules so as to prevent them from becoming “little more than political slush funds.” Balding singles out Russia’s SWF in particular as a fund that was used by its government as a vehicle for significantly higher public sector spending. Third, SWFs should be as independent as possible from their governments. By doing so, SWFs can be insulated from political meddling and thereby accomplish their intended purpose.
“Too many sovereign wealth funds in recent history have been created to join ‘the world’s most expensive club,’ rather than with a sound purpose or for economic policy solutions,” Balding argues. “While sovereign wealth funds can be useful, they can also exacerbate some of the worst tendencies of existing situations.” The structure of SWFs is absolutely critical, he concludes, and if a fund is to function well it must “avoid political influence, coordinate macroeconomic policy, create sound investment mandates, and establish a framework for capital withdrawals.”
To read the paper in full, click here.