The rapid growth in government owned and managed Sovereign Wealth Funds (SWF) over the last several years has raised a variety of questions about their potential political and economic impact on recipient nations.  Many of these concerns have been overdrawn, others represent reasonable fears. 

With investable funds now estimated to be close to $4 trillion, SWFs are a significant factor in global capital markets. While this amount equals only about 2 percent of all internationally invested funds, it can still have noticeable impacts on the nations and the economic sectors in which the funds are invested.

In 2007 and early 2008, a good part of these SWF investments bolstered some of the troubled American and European financial institutions, as shown in the table below. Almost $45 billion from SWFs has helped shore up banks hard hit by the subprime crisis over the last year. 

Global investments, per se, are not at issue. International capital flows benefit both exporting and importing countries. Foreign investment often offers the citizens of the countries supplying it attractive opportunities to earn rates of return higher than might be available at home. For the people in the importing nations, foreign capital funds can provide the opportunity for undertaking investments and experiencing economic growth greater than their more limited domestic savings would permit. 

What has raised a red flag is some minds is the fact that SWFs are under the control of foreign governments. Critics have pointed out that they represent a reversal of trends in the post-communist era: that they involve a new form of investment socialism – a return to state-ownership and direction of economic resources. 

The fear is that the investing governments will use their funds not only to earn attractive rates of return, but to influence the political and economic policies of the host country. In the extreme, the fear is that vital sectors of a country’s economy could be in the stranglehold of a foreign government. 

These concerns have been reinforced by the practice of many SWFs not to publically report on how much they are investing and in what foreign countries and industries. Nor do many of them even have public statements outlining their general investment strategies. This lack of financial transparency becomes even more bothersome since the SWFs most likely not to supply such public information are often controlled by non-democratic and authoritarian governments such as those in the Middle East, China, or Russia. 

However, the general consensus among economists and financial analysts who closely track SWF investment patterns does not back up these fears. So far, the experts say,  these funds have placed their capital in companies and sectors of the host country that offer sound and stable long-term financial returns. Especially in Western recipient countries, there has been no hint of any attempt to use the financial clout of SWFs to gain political leverage. 

Particularly since the Western economies are so large, and competing sources of funds are so wide and versatile, any attempt by SWFs to pursue non-monetary goals could not maintain traction for very long. The International Monetary Fund estimates the total value of capital markets in North America and the European Union, respectively, to be $62 trillion and $80 trillion.

Furthermore, Western governments have a huge spider’s web of regulatory rules and procedures that make any such attempt extremely difficult, if not impossible. 

In addition, the growing sensitivity of governments and groups in recipient countries to potential misuse stemming from SWFs has resulted in a major push for international standards of transparency. On September 3, The Wall Street Journal reported that the International Monetary Fund was brokering an agreement among SWFs for the establishment of a set of 24 rules and procedures for investing their funds. Formal agreement over these rules is scheduled for a meeting in October. 

But it is the power of global competition that will continuously nudge SWFs, regardless of the political character of the government that owns them, to follow normal business practices. This will prompt them to increase their degrees of transparency while maintaining legitimate investor confidentiality and privacy. 

The crucial element has to do with the openness of the market where investors are trying to put their funds. The more open the market in which they invest, the more SWFs must tend to match the best practices of their rivals if they are to find long-term financial partners with whom to do business. 

Free and open markets assure, in the long run, that good investment practices tend to drive out bad. 

If there is a legitimate basis for concern, it involves SWF investments in underdeveloped countries that have corrupt governments that heavily regulate their economies. In this climate,  those who do well are those who grease the palms of people in high political office and in the layers of the bureaucracy. 

For example, the Chinese government has attempted to make significant inroads into Africa in search of oil supplies and other essential raw materials for its growing economy. The Chinese use direct investments either in the form of foreign aid or through their SWF to arrange long-term contracts to have exclusive access to these raw materials. 

In 2002-2003, China’s trade with Africa totaled $18.5 billion. By 2007, it had jumped to $73 billion, an almost 300 percent increase in four years. But projects to improve roads, modernize or build new plants and equipment in various commercial sectors, or the promise of funding schools and medical facilities have often failed to either materialize or match expectations. 

Given the nature of too many of these African governments, the money “invested” or given in “aid” has frequently followed the same path as similar aid and government-to-government investment deals made by Western governments. They have lined the pockets of African political leaders and increased the size of their off-shore bank accounts 

As a consequence, in a number of sub-Saharan countries, Chinese investment has generated among other segments of the population resentment against perceived Chinese imperialism and arrogance. 

In the United States,  the likelihood of SWFs using their financial resources to influence or manipulate the politics is virtually nil in practically all imaginable instances, given the size, openness, and rules governing financial and commercial activities. 

The danger is that misplaced and exaggerated fears about SWFs may act as a reinforcement and catalyst for growing trade protectionism. This would merely succeed in serving special interest groups mostly concerned with keeping out their real or potential foreign rivals. 

That would not serve the interests of the American people. Nor would it serve the gains from trade that all receive when goods and capital freely flows around the world searching out the best way to improve the human condition through commerce and competition.

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