Office of the Prime Minister,

Sovereign wealth funds invite considerable debate, as some view sovereign wealth funds as valuable sources of wealth that governments can access in times of need or for important but expensive large public investments, while others view them as potential sources of corruption and dangerous mismanagement. As an advisor to your government, I strongly urge that, despite criticisms leveled at sovereign wealth funds from some, if they are targeted correctly they can be extremely useful for society.

Ian Bremmer, cited in Mussachio and Staykov (2011, p. 3), defines sovereign wealth funds as “state managed pools of excess cash that can be invested strategically.” In essence, sovereign wealth funds are akin to a large pool of money that governments can decide how they want to allocate. Increasingly, governments- both developed and developing countries- have established sovereign wealth funds. They set sovereign wealth funds up for various reasons and in various ways. For example, oil rich countries in the Gulf region, such as the United Arab Emirates or Saudi Arabia understand that the oil wealth they have relied upon to grow their economies will dry up in the long-term. Thus, they have used the flood of money acquired to establish sovereign wealth funds that can then be used larger economic development, which can provide a strong economic foundation when their oil wealth dissipates. A sovereign wealth fund allows countries that anticipate economic challenges in the future to create a sort of rainy day fund. But this does not have to be the only purpose of a sovereign wealth fund. Think, for example, if you want to establish a massive sustainable energy program across the country that can both produce jobs, strong economic growth, and improvements in energy and infrastructure. These would incur significant costs, and if a sovereign wealth fund is already in place, either resources from that fund can be directed toward a sustainable energy program or, given the long time horizons of sovereign wealth funds, a sovereign wealth fund completely devoted to a sustainable energy program can build up over time. Sovereign wealth funds can both fuel growth and mitigate risk. I will outline some of the criticisms against sovereign wealth funds, but will aim to show you that there is nothing to be afraid of so long as the funds are managed properly.

Criticism is less targeted at sovereign wealth funds themselves and more so at the poor management of them. The global economic recession of the mid-2000s is an example, as foreign sovereign wealth funds invested in western financial institutions just before the crisis hit the United States (Mussachio and Staykov 2011, p. 7). Another criticism is that sovereign wealth funds are prone to much greater risks if they fail. At the same time, this is also part of the value of sovereign wealth funds and why we should increase investments in them. These funds have more room to invest in areas that are risky and may not be funded by private interests. Of course, sovereign wealth funds should not engage most of their investments in high-risk areas, high-risk in the short term can still be of immense benefit in the long-run, especially for sustained economic development.  Because some sovereign wealth funds tend to take on a significant amount of debt, they could be vulnerable to defaulting. But again, these criticisms, as well as criticisms of the nefarious motivations that are sometimes behind investments, are issues of management not of the sovereign wealth funds themselves.

Your government should not be afraid of sovereign wealth funds so long as they are managed with smart, strategic investments, and strong measures of accountability that ensure the fund will not be corrupted. We should look to other countries as models. Norway, for example, provides among the most transparent sovereign wealth funds in the world (Mussachio and Staykov 2011, p. 23). Although, transparency may reduce the amount of returns because it can put the spotlight on short-term risks, and in turn put more scrutiny on hedge fund managers, which results in less effective long-term investments (or a lack thereof), transparency fosters a culture of accountability on sovereign wealth funds and reduces risk as a result. There is far more upside in using sovereign wealth funds to make good on public investments that improve the lives of citizens. One can make criticisms on the tax system, for example, arguing that it is often used for corrupt purposes or rates are set in such an inefficient manner that governments and private interests should be afraid of their implementation. But the investment mechanisms of taxes and sovereign wealth funds are crucial vehicles for financial and economic growth and stability. Certainly, sovereign wealth funds pose a unique sort of risk. This is why an established set of objective, principals, and values that buttress the creation of our government’s sovereign wealth fund is crucial for our fund to be as successful as other countries, such as the UAE and Singapore. In fact, your government should be afraid of not establishing sovereign wealth funds, so long as it is done with transparency, accountability, and practical investment strategy.

Concerning the risks that arise in establishing sovereign wealth funds, however, I must advise that we develop adequate regulatory bodies and enforcement measures that will ensure the fund is prevented (as much as possible) from political and/or financial corruption. In doing so, there should be a special agency within the Department of Finance that oversees the sovereign wealth fund. The Minister of Finance would appoint the leader of the agency, and the agency would be composed of bipartisan ministers. Broad powers would be given to the agency so that if, say, a Prime Minister or Minister of Finance was trying to use the sovereign wealth fund for corrupt means, the agency could block this from happening.

There is also the bigger problem of transparency in the international context. If other countries are buying our country’s assets but are using that to fund a sovereign wealth fund that is not working in a way that is align with our principals, then we could not allow that country to buy our assets. Although this would make us lose money, sovereign wealth funds are only as good as they are managed. The same standards of transparency and regulation should apply, to the extent possible, on other countries that buy our assets to support their sovereign wealth fund. It may also be beneficial to work with other countries in establishing an international regulatory body, similar to the World Trade Organization or the rules that undergird free trade agreements. While acknowledging that sovereignty is above all the most important value to preserve, and countries should be given as much freedom in how they diversify their investment portfolios as possible, there should be room to create mechanisms that limit poor management of sovereign wealth funds. Because mismanagement can have significant affects on the global market and the economy, if couple large countries hedge risks in an irresponsible way through their funds, then other economies are exposed. Thus, it is in the international interest and our own domestic interest to work with other nations to set up (even regional agreements to begin with) foundational rules and enforcement mechanisms on things like transparency and protectionism, among others.

Beyond the ethical and transparency concerns, regulation of sovereign wealth funds should be fairly limited. Because of the long-time horizons and huge capital that sovereign wealth funds sustain, investments should be given greater latitude to engage in more risky investments. Public projects and policies that are invested through the funds make them extremely valuable and influential. Thus, we should give sovereign wealth funds some latitude in how the diversification of its investments, as long as it does not violate our country’s interests.

Overall, sovereign wealth funds are not something to be afraid of, and instead should be advocated by our government. They will help to generate wealth in the event of future shocks to the economy, direct our resources toward areas of national interest, while ensuring that future generations will be better off.

References

Staykov, Emil and Mussachio, Aldo. (2011). Sovereign wealth funds: barbarians at the gate or white knights of globalization? Harvard Business School, 5-66.

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