Singapore Democrats

Anders Aslund
Foreign Policy

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."

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