Thursday, December 04, 2008

Do sovereign wealth funds make economic or political decisions

Should we worry about Sovereign Wealth Funds?


  • A SWF is any government-controlled fund that manages and invests government savings, regardless of the revenue source.
    • The Future Fund is a SWF.
  • Sources normally include
    • Proceeds from natural resources (Oil)
    • Foreign exchange reserves
    • Budget Surpluses
    • Superannuation / Pension
    • Acquisition of distressed assets (?)
    • SWF tend to have "illegitimate" origins.


  • State Owned Enterprise
    • Wholly owned and controlled entity
  • Publicly Listed Firms.
    • Government ownership/control of listed firms is common.
    • Classic LLSV (1999) paper -- "Corporate Ownership around the World" -- 18.33% of the world's largest listed firms are controlled by government at 20% level.
      • For High Anti-director Rights economies -- 13.75%
      • For Low Anti-director Rights economies -- 22%
      • Australia -- 5% (Telstra)
      • Other studies that replicate the LLSV paper for larger samples and different economies find even higher levels of government control of listed firms.
  • LLS (2002) look at government ownership of banks
    • Development Hypothesis
      • Alexander Gerschenkron -- Bank finance is important in economies with under-developed financial systems
    • Political Hypothesis
      • Government controls banks to capture private benefits of control and to direct those benefits to supporters and friends
    • In a sample of 92 economies (including Australia) LLS find that the evidence tends to support the Political Hypothesis
    • Government ownership tends to be higher in economies with "under-developed financial systems, interventionalist and inefficient governments, and poor protection of property rights".
  • Simon Johnson and Todd Mitton looks at government and business relationships in Malaysia
  • Raymond Fisman looks at Suharto family business relationships in Indonesia
  • Both find that political interference is high (leading to value discounts) and evidence of crony capitalism
  • Adam Smith was suspicious of joint-stock companies and government interaction.
    • “They have, accordingly, very seldom succeeded without an exclusive privilege; and frequently have not succeeded with one. Without an exclusive privilege they have commonly mismanaged the trade. With an exclusive privilege they have both mismanaged and confined it.”
  • Similarly Ludwig von Mises is suspicious
    • "those who really are in power always manage business in their own interests, whether this coincides with the shareholders' interests or not"
  • Government involvement in business is not in the interests of either consumers or the firms themselves.
  • Where do SWF come into that equation?


  • Diversification away from commodities (Oil)
    • Intergenerational equity
  • Higher returns on forex reserves
  • Distressed assets
  • Superannuation / Pension
    • Puzzle -- why not more SWF?
  • But not any argument about "commanding heights", market failure.


  • Bryan Caplan's biases
    • Anti-market bias
    • Make Work bias
    • Anti-foreign bias
    • Pessimistic bias
    • Bias against SWF combines at least two if not three biases.
  • Dislike of foreigners
    • Variation of the old "White Australia Policy"
      • Grades of Foreigner
    • Selling the Farm
      • Entrepreneurship is a non-renewable resource ... and we have already used it all up.
      • Cultural Cringe -- Foreigners take advantage of Australians
      • Do foreigners take advantage of Australians?

Market model cumulative abnormal returns (CARs) for domestic and foreign offers
for the 51 days surrounding the announcement day for target firms.

Market model cumulative abnormal returns (CARs) for the 51 days surrounding the
announcement day for target firms partitioned by country specific.

  • Political Concerns
    • Lack of information about Objectives
    • Lack of Accountability
    • Political Risks*
      • Investments in large well-known iconic firms
      • National Security
      • Strategic Interests
      • Reversing two decades of privatisation

*Suspicion of government is good.

  • What are SWF Objectives?
    • Promote Economic Development
    • Industry Policy
    • Macro-economic Stabilisation
    • Social Objectives
    • Diversification
    • Savings
  • That is a combination of activities that
    • Governments already undertake
    • Large investors already undertake
  • Are SWF unaccountable?
    • In their home economy SWF are subject to their domestic legal/constitutional framework
    • In any foreign economy they are just as accountable as is any other large foreign investor
      • Foreign government have no/few sovereign powers outside their home jurisdiction
      • Any investor can be expected to act in their own best interests subject to the laws of the land
  • Political Objections
    • National Security and Strategic Interests
      • We already have institutions whose job it is to manage national security issues
      • What precisely is the concern?
        • Tom Clancy's Debt of Honor
    • Investment in Iconic firms
      • Well-known phenomenon in international investment
      • Foreign investors face asymmetric information problem
      • SWF probably face more political risk
    • Reversal of Privatisation
      • Except foreign government control rather than domestic government control


  • Good Corporate Governance lies at the core of concern about SWF
    • Mechanisms that prevent large shareholders from expropriating the wealth of small shareholders
    • SWF are simply large shareholders
    • Michael Jensen identifies four mechanisms for good corporate governance
      • Capital Markets
      • Legal/political/regulatory System
      • Product and Factor Markets
      • Internal Controls
  • As long as SWF obey the law of the land, they are no different from anyone else
  • The problem with government is the exercise of sovereign power -- foreign governments have no sovereign power here.


  • To the extent that they exist and are ultimately controlled by politicians, SWF make political decisions
  • That does not matter
    • All investors should act in own best interest
    • Domestic legal/regulatory framework inhibits coercion and market manipulation
  • Domestic government however can use force and can intervene in m arket processes

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