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For some time now, the large flow of capital from the developing to the industrialised world has been the principal irony of the international financial system. In 2007 this flow will total well over half a trillion dollars, a figure that will be comfortably exceeded by the build-up in reserves and sovereign wealth funds (SWFs) in developing countries.
Indeed, Morgan Stanley has estimated on reasonable assumptions that there is now close to $2,500bn (£1,200bn, €1,800bn) in SWFs and that this figure will increase to $5,000bn by 2010 and $12,000bn by 2015.
Inevitably, and appropriately, countries possessed of publicly held foreign assets far in excess of anything needed to respond to financial contingencies feel pressure to deploy them strategically or at least to earn higher returns than those available in US Treasury bills or their foreign equivalents. Even without this pressure, SWFs are now growing at a faster pace than the global rate of new issuance of traditional reserve assets.
There is plenty of room for debate over how large these funds should become. (Does China really need a saving rate in excess of 50 per cent that all but forces hundreds of billions of dollars in reserve growth?) But on any plausible path over the next few years, a crucial question for the global financial system and indeed for the global economy is how these funds will be invested.
The question is profound and goes to the nature of global capitalism. A signal event of the past quarter-century has been the sharp decline in the extent of direct state ownership of business as the private sector has taken ownership of what were once government-owned companies. Yet governments are now accumulating various kinds of stakes in what were once purely private companies through their cross-border investment activities.
In the last month we have seen government-controlled Chinese entities take the largest external stake (albeit non-voting) in Blackstone, a big private equity group that, indirectly through its holdings, is one of the largest employers in the US. The government of Qatar is seeking to gain control of J. Sainsbury, one of Britain’s largest supermarket chains. Gazprom, a Russian conglomerate in effect controlled by the Kremlin, has strategic interests in the energy sectors of a number of countries and even a stake in Airbus. Entities controlled by the governments of China and Singapore are offering to take a substantial stake in Barclays, giving it more heft in its effort to pull off the world’s largest banking merger, with ABN Amro.
To date most of the official commentary on the issue of SWFs has been framed in terms of traditional arguments about cross-border capital flows. US and UK officials have raised concerns that focus only on the desirability of reciprocity and transparency and on how to treat sectors that trigger national security questions. Others, particularly in continental Europe, have been less positive and have emphasised nationalist considerations about the benefits of local ownership and control.
What has received less attention are the particular risks associated with ownership by government-controlled entities, particularly where the ownership stake is taken through direct investments. The logic of the capitalist system depends on shareholders causing companies to act so as to maximise the value of their shares. It is far from obvious that this will over time be the only motivation of governments as shareholders. They may want to see their national companies compete effectively, or to extract technology or to achieve influence.
We have seen the degree of concern over News Corp’s attempt to buy The Wall Street Journal. How differently should one feel about a direct investment stake of a foreign government in a media or publishing company?
Apart from the question of what foreign stakes would mean for companies, there is the additional question of what they might mean for host governments. What about the day when a country joins some “coalition of the willing” and asks the US president to support a tax break for a company in which it has invested? Or when a decision has to be made about whether to bail out a company, much of whose debt is held by an ally’s central bank?
All of these risks would be greatly mitigated if SWFs invested through intermediary asset managers, as is the case with most institutional pools of capital such as endowments and pension funds. The experience of many endowments and pension funds suggests that this approach is in most cases likely to produce the best risk-adjusted returns.
To the extent that SWFs pursue different approaches from other large pools of capital, the reasons have to be examined. The most plausible reasons – the pursuit of objectives other than maximising risk-adjusted returns and the ability to use government status to increase returns – are also most suspect from the viewpoint of the global system.
None of this is to propose policy. That can come only after the investment policies of SWFs have been much more extensively debated and many details have been clarified. But it is to register a cautionary note about the debates over SWFs so far.
Governments are very different from other economic actors. Their investments should be governed by rules designed with that reality very clearly in mind.
The writer is Charles W. Eliot university professor at Harvard
Top economists debate Martin Wolf’s and Lawrence Summers’ columns in the FT’s Economists’ Forum