26 October 2011


'Maximizing Autonomy in the Shadow of Great Powers: The Political Economy of Sovereign Wealth Funds' (Columbia Law and Economics Working Paper No. 395) by Kyle Hatton & Katharina Pistor argues that -
Sovereign Wealth Funds have received a great deal of attention since they appeared as critical investors during the global financial crisis. Reactions have ranged from fears of state intervention and mercantilism to hopes that SWFs will emerge as model long-term investors that will take on risky investments in green technology and infrastructure that few private investors are willing to touch. [W]e argue that both of these reactions overlook the fact that SWFs are deeply embedded in the political economy of their respective sponsor-countries. This paper focuses on four countries that sponsor some of the largest SWFs worldwide: Kuwait, Abu Dhabi, Singapore and China. Each of these countries has been governed for decades by elites whose grip on power has been tied to the economic fortune of their country and their ability to pacify, or at least balance against, foreign powers. We argue that for these four countries, both the motives for establishing SWFs and the strategies they employ can best be explained by an “autonomy-maximization” theory.

In a world where uncertainty - both economic and political - looms larger as a concern in the wake of the global financial crisis and political upheavals, such as the revolutions in Tunisia, Libya, and Egypt, elites use an increasingly diverse array of tools to protect their autonomy within the global system and hedge against unexpected turmoil. SWFs serve ruling elites by concentrating substantial resources, which can be used to pay-off domestic adversaries, to insure the economy against major downturns and thereby mitigate public discontent, to signal cooperation to major foreign powers, and to increase legitimacy in the global arena by presenting governance structures familiar to the West. We employ a comparative case study analysis to highlight the critical importance of these political economy dynamics in the establishment of SWFs, their governance structures, and their behavior in both normal times and during times of crisis.
The authors conclude -
A widely accepted definition of SWFs holds that these entities are government-owned and controlled, and have no outside beneficiaries or liabilities beyond the government itself, so they are responsive to the expressed interests and objectives of the government. There are competing conceptions of what constitutes “governmental interest” in a democratic society, but a discussion of public choice vs. public interest politics is beyond the scope of this paper. This paper suggests that in countries without electoral democracy, such as China, Singapore, Kuwait, and Abu Dhabi, the government is comprised of ruling elites, who are not directly accountable to the public in general: it is easy to see how “governmental interest” becomes tied to the interests of the ruling elite. Indeed, the internal governance structures of the SWFs themselves ensure that SWF management is directly accountable to the ruling elite in each sponsor country. Consequently, it is unsurprising that SWFs can be, and are, wielded to advance the interests of those elites. First and foremost among these interests is the maintenance of their privileged position.

The task of maximizing autonomy is, however, complex. The privileged position of ruling elites in non-democratic countries is dependent on domestic stability, security of the state against foreign rivals, and the maintenance of substantial autonomy relative to superpowers to which they might otherwise be vulnerable. Without domestic stability, elite status is fragile and will last only until the next coup or mass uprising; a foreign invasion would topple existing elites or at least subsume them into a hierarchy with foreigners at the top. Finally, as autonomy relative to superpowers decreases, the ability to direct state action toward benefiting the elite is restricted and domestic legitimacy may be threatened.

SWFs are well-suited toward serving an autonomy-maximizing function in the domestic arena. The creation of a SWF ensures that wealth stays under the control of the ruling elite rather than passing into the hands of the population as a whole. In the Gulf, the extraction and sale of oil could transform a royally monopolized resource into dispersed wealth, but concentrating the resultant revenues into a SWF ensures continued royal control. In Asia, export led growth could increase the purchasing power of the domestic population, but sterilizing the returns by concentrating them in a SWF protects against destabilizing currency crises and the rise of new wealthy classes who might challenge the existing elite for political control of the state.

Further, once accumulated in a SWF, wealth can be strategically deployed in the domestic market to protect the status of elites. It can be used to “buy off” potential political rivals, expand the institutional space for political allies (increasing the benefits of aligning oneself with the existing elite), and to fund social programs that satisfy the needs of the population as a whole for the foreseeable future. Finally, SWFs ensure that domestic stabilization strategies can be maintained even in the face of shocks to the system like oil price or production declines or falling trade volumes. Collectively, these effects substantially improve domestic stability. SWFs are equally well-suited to maximizing autonomy in the international context by improving state security and mitigating the impact of volatile global markets on the domestic economy. First, administering wealth through the public sector rather than funneling it to the private bank accounts of the ruling class (as is done in a substantial number of resource-rich countries) legitimizes the sponsor-state government in the eyes of the international community.

In terms of the particulars of administering the fund, SWF investment decisions can also be made to directly induce potential threats to state security not to attack or to convince a third party to guarantee the security of the state. Even without such a direct bargain, deploying capital in other countries creates economic ties that discourage confrontation, and to create relationships that provide leverage in times of crisis.

SWFs can also be used to maintain substantial autonomy relative to superpowers that might otherwise exert pressure to limit the sponsor-country’s range of viable domestic policy choices. This is relevant in particular for small countries that cannot effectively maintain their own external security. First, SWFs diversify the revenue stream of the sponsor-country, insulating against the effects of changes in the terms of trade or other exogenous shocks, such as commodity price fluctuations. Maintaining foreign-currency-denominated assets also decreases vulnerability to currency crises, which effectively increases the range of available domestic policy choices in the long term. Further, SWF investments can be directed toward injecting capital or liquidity into the economies of superpowers during their own periods of crisis, with the expectation that this assistance will be remembered during future interactions. SWFs can also be used to fulfill unspoken “dollar-recycling” obligations that, if unmet, might lead to interventions by western countries. Finally, SWFs can also be used to secure access to natural resources or markets for primary exports, ensuring the long term viability of current industrial policy in sponsor countries and providing insurance against protectionism in developed countries.

More recently, SWFs have become an important force in global financial relations, not primarily because of their size, which is still dwarfed by private investment vehicles, but because of their ability and willingness to invest at times when private investors take flight. These investments have given rise to a series of interpretations. Some have stressed the potential danger that these ‘neo-mercantilist’ organizations may pose to the capitalist system. Others have painted a more positive picture by suggesting that SWFs could help enhance global social welfare by investing their resources to spur development in less developed countries, or to invest in green technology in an attempt to save the planet from climate change. In contrast, this paper suggests that these investments too are best understood as part of a general strategy aimed at autonomy maximization. SWFs have invested widely in the global financial system, and are as such dependent on it. Their willingness to step in when private investors took flight is therefore not without self-interest. In addition, by helping to stabilize global finance they were able to either confirm existing relations of reciprocity or establish similar relations. As discussed in the case studies, for the Gulf States the financial crisis created an opportunity to reciprocate the security umbrella the US has offered them in the past. For China, the crisis created an opening to position itself not only as a challenge to US dominance, but as a relational player.

The actual context in which SWFs were established and operate, we suggest, is crucial for understanding their role and the attractiveness of various investment opportunities at any given point in time. Modeling SWFs according to the standard accounts of state control over economic activities, which are derived primarily from the historical experience of the West, misses these critical aspects—and is therefore bound to miss the critical determinants of SWF behavior both domestically and internationally.