Issue #12, Spring 2009

Seeking SWF

In this time of global financial crisis, America needs a sovereign wealth fund of its own.

There are many reasons to feel uncomfortable about Barack Obama’s proposed near-trillion-dollar stimulus package (and the $700 billion bailout that preceded it last year). There are serious questions–about whether the cost is ultimately bearable; whether the timing is too late to be truly counter-cyclical (and thus have its intended effect); whether it will crowd out private investment or create perverse incentives to eligible firms; whether this or that sector or taxpayer should receive aid; whether the right safeguards and oversight are put into place; and, of course, whether the government should play such a role in the private sector in the first place.

This last, most fundamental question partly stems from the fact that the U.S. Treasury is the wrong public institution for such a job, and the federal government’s fiscal budget is the wrong account from which to draw such funds. For one, the annual budget process is not an appropriate mechanism for deciding long-term capital investments; it is like paying for college out of your weekly paycheck. And two, there is a distinctly undemocratic, non-transparent, and potentially corrupt aspect to the control that the executive branch can exert in directing such investments.

But what if the United States had–as a number of other rich countries already do–a sovereign wealth fund (SWF)? Then neither Treasury Secretary Timothy Geithner nor Federal Reserve Chairman Ben Bernanke would have to cross this invisible–yet important–line to bail out private firms or otherwise jump-start the economy beyond bread-and-butter monetary policy efforts. We wouldn’t have to worry about drawing down short-term funds for long-term projects. The U.S. sovereign wealth fund could do it all.

By sovereign wealth fund, I mean a national mutual fund of stocks, bonds, and real estate holdings, including investments in private firms, established in the hopes of realizing profits as well as public goods that may or may not produce a direct revenue stream but which are important to the long-term productivity of the U.S. economy. In other words, the fund would bring in profits for “shareholders”–i.e., American citizens–but also provide a source of investment funds for business. Not only would it make sense from an accounting perspective to make long-term economic investments via such a fund, but the establishment of such an institution would have other salutary effects on American society, including the reconceptualization of the distinction between public and private capital, democratizing long-term decision making, spreading investment knowledge, and raising our dismal private savings rate. In short, the creation of a sovereign wealth fund is a key step in turning the United States into an “Investor Society.”

Rethinking Fiscal Policy

If we are going to spend an unprecedented sum of public funds to stimulate the economy–while also boosting future productivity through targeted education, environmental, health, and infrastructure investments–we should also take this historic opportunity to rethink the very dichotomy between the public and private sectors. Indeed, one way to think about the distinction between the role of a central bank or Treasury Department and that of a national investment fund is the way we think about personal checking versus saving accounts: We don’t solve problems with the latter by dipping into the former. The current stimulus plan is like using your overdraft line of credit to prop up your retirement savings account. America has been running its books as if there were just one big checking account to deal with both capital investments and trips to the candy store.

This approach to fiscal policy is largely a legacy of John Maynard Keynes and the quest for full employment. In the standard, industrial model of Keynesian economics, job growth is what drives the economy, and consumption, in turn, is what drives job growth. As a result, most politicians are obsessed with jobs as the main avenue to economic security, the idea being that we need to create more and more jobs that pay higher and higher wages, and, in turn, find the right people to fill those jobs. This was, many assume, the underlying justification for long-gone efforts like the Works Progress Administration, but also enduring programs like Social Security.

But in fact, the social insurance programs that are the most lasting legacies of the New Deal were really intended to be stopgaps on the way to the full employment that was going to be achieved through careful counter-cyclical monetary and fiscal policy in the Keynesian tradition. Little did policymakers of the 1930s know that unemployment insurance, welfare, farm subsidies, and, of course, Social Security would be the programs that took root and grew, or that the full employment of all able-bodied workers would remain a pipe dream even in the best of times.

This jobs-jobs-jobs bias has led politicians to tilt at expensive fiscal windmills, particularly during recessions. Mainstream progressive politicians are right about the fact that productivity gains are not equally distributed to workers. (And, in fact, profits have been rising as a percentage of national income while wages have been declining.) But these progressive leaders are misleading themselves and taxpayers when they say they can fix the problem by scuttling trade deals or cutting tax rebate checks, all in an effort to boost jobs. In a globalized economy where wages are always lower somewhere else, keeping manufacturing jobs here is a losing battle.

Instead, we should focus on de-linking–to the maximum extent possible–economic security from the vagaries of the labor market by helping average Americans become part of an investor class. That is, we Americans should be thinking about ourselves as an “Investor Society,” as global capital managers. Yes, this may take a feat of imagination to envision during a period of recession and a bearish stock market, but, in fact, the downturn is an opportunity to take stock of our fundamental policy strategies.

With the current consumption-based approach to social and economic policy, there will always be a disconnect between the macroeconomic health of the U.S. economy and the economic fortunes of the typical American family. That’s because technology-induced productivity growth often results in a windfall for the few at the top and little or no increased income rewards for those at the bottom. By contrast, if everyone were an investor, national productivity gains could instead be distributed in the form of dividends. When productivity went up, we could actually work less and take more time off when our kids were born or our parents were ailing, for instance. Such a work-deemphasizing approach would represent nothing short of a whole new economic policy–one better fit to a post-industrial knowledge economy and a fragile global ecosystem threatened by our consumerist culture.

A pipe dream? Hardly. Many other countries already enjoy such benefits. Qataris, Norwegians, and Emiratis all enjoy standards of living similar to ours without having to work much (or fret over the existence of jobs). In fact, most of the Persian Gulf countries import foreign labor to perform necessary jobs without the controversy over immigration that Americans perennially endure here. Granted, all these countries owe many thanks for their wealth to worldwide demand for oil and natural gas. But America has plenty of wealth, too–after all, we are the largest, most productive economy in the world. (Singapore, meanwhile, has built a significant sovereign wealth fund with practically no natural, extractable resources.) The difference is, we are squandering that wealth while foreign investors–such as the Chinese–buy up our capital stock with weak dollars that we use to finance our ongoing trade and budget deficits.

The Rise of Sovereign Wealth Funds

The ongoing controversy over the Federal Reserve and Treasury Department’s unprecedented bailouts for private firms has missed a larger trend in global finance: The rise of sovereign wealth funds. Today trillions of dollars of global equity are controlled by these financial behemoths, which have been around since the 1950s, even if the name “sovereign wealth fund” was only coined in 2005. Asset values are obviously volatile, but best estimates put the total assets controlled by such funds at around $2.4 trillion (between one and two percent of total global equity), with another $6 trillion controlled by national pension accounts and other similar entities. The Abu Dhabi Investment Authority is generally considered the largest SWF, with equity totaling around $750 billion. Abu Dhabi is joined by Norway, Singapore (which has two such funds), Russia, China, Taiwan, and Kuwait–which holds the oldest sovereign wealth fund in the world–to round out the “big seven,” though countries as diverse as Azerbaijan, Ecuador, Nigeria, and Brazil have also created such entities.

These funds invest both at home and abroad and, like a family savings account, provide a buffer against economic shocks. In fact, a little-known wrinkle of the last year and a half of bad economic news has been the role these funds have been playing in propping up U.S. companies. Long before Citigroup received monies from the Treasury, the corporation was kept afloat by funds from the Abu Dhabi Investment Authority; later, the China Investment Corporation came close to purchasing a 10 percent stake in the firm. Most of the other notable U.S. financial companies that have received bailout money have also gotten infusions of foreign cash via these government investment funds, including Morgan Stanley and Merrill Lynch. In other words, the American taxpayer–via the Troubled Assets Relief Program (TARP)–is now indirectly protecting Chinese investors.

As a result, most of the public debate in the United States regarding sovereign wealth funds has been between the private sector and government free traders who want to attract foreign investment, and isolationist or protectionist politicians who fear a loss of national economic sovereignty. Private foreign direct investment is one thing, the latter half argues, but ownership stakes held by secretively administered equity funds and controlled by non-democratic foreign governments are quite a different animal. Indeed, if political scientist David Stasavage is right that democracy’s roots lie in the need for the government to borrow funds from the governed, trading the franchise in return for credit, so to speak, then the reliance on foreign government funds to sustain the economy can plausibly be thought of as dilution of the power of American voters.

Foreign ownership of U.S. assets is nothing new. Since before America’s founding, entities from the United Kingdom collectively have had the single biggest foreign ownership of U.S. based equity. (One-fifth of all overseas dividends from U.S. companies go to Great Britain.) But today’s sovereign wealth funds are scarier to some Americans than “Mother England” ever was, since they do not represent countries with which we share a “special” relationship, a common language, culture, and a dominant racial majority.

These somewhat jingoistic concerns have led several Western countries to hold hearings and even pass legislation in an attempt to limit foreign control over domestic firms. French President Nicolas Sarkozy has railed against foreign investors, while the German parliament even passed a law requiring the Foreign Ministry to review any major acquisition of a German firm by a non-European government. And after the United States held hearings on the reach of SWFs, the “big seven” even held a summit to adopt voluntary limits and regulations to stave off statutory barriers.

But rather than spite ourselves with a twenty-first-century version of the Smoot-Hawley Tariff Act, why not step onto this global financial playing field ourselves? If the United States had such a fund, perhaps our concerns over foreign ownership would be mitigated by the knowledge that we are buying up foreign firms just as other countries are purchasing stock in ours.

What Would It Look Like?

Americans may be justifiably skittish about a quasi-public, quasi-private financial entity in the wake of the collapse and nationalization of the mortgage giants Fannie Mae and Freddie Mac, which occupied a similarly ambiguous niche. However, an American SWF would represent a somewhat converse arrangement. Fannie Mae and Freddie Mac privatized profit to their common stock holders while socializing risk, thanks to the loan guarantees by the federal government. A sovereign wealth fund, on the other hand–to the extent that it is managed without corruption–would socialize both risk and reward. Of course, this assumes that proper oversight and safeguards can be instituted in order to prevent cronyism in the deployment of capital reserves. For instance, the Freedman’s Savings Bank, created in the wake of the emancipation of African American slaves after the Civil War, failed during the Panic of 1873 largely because the (white) board of directors put the ex-slaves’ savings into their friends’ companies (mostly railroads).

Initially, such a fund would necessarily be created with debt, so it would, in practice, represent no more than an accounting sleight of hand, much like Social Security when it was first created. But this isn’t new debt–it is already a fait accompli in the current fiscal environment; the creation of the fund could be accomplished by an act of Congress that redirects TARP and other stimulus funds from the Treasury to this new public authority. (Of course, a corresponding law would be needed to draw a sharp line between the activities of the Federal Reserve and the SWF to prevent the Fed from playing the same role of investing in private companies and gaining equity as it did, for example, in the case of AIG.) However, over time this fund would diverge from the rest of the federal budget in terms of its revenue stream, outlays, and management model. It would be run like any other mutual fund: by a board of directors elected by shareholders–who, in this case, are the American people.

Much of the equity in a U.S. SWF could be directed to a new investment agenda at home. For example, it could be through this fund that we bring capital to underserved communities. Or it could be the basis of an investment agenda in green technologies, as some environmentalists have championed. And, yes, it might even invest in foreign firms.

Existing Models of Governance

Issue #12, Spring 2009

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