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by David Sharp, Founding President of the Australian Adam Smith Club (Melbourne) and author of Economic Simplicities

The Australian government’s appointment of David Gonski as head of the Fortune Fund and his acceptance of the position has lead to considerable public comment. He had originally been retained to write a report on the choice of an appropriate person for the position. Having prepared such report, apparently favouring the appointment of the former Treasurer, Peter Costello, the government had instead offered him the role, which he then accepted. The ensuing furore has led many people to want to know more about the nature and purpose of such a fund.

What are They?
Broadly speaking, a Sovereign Wealth Fund (SWF) is a fund owned by a state, which is used to invest in a variety of assets within the state, and/or internationally, for the ultimate benefit of the state and its citizens. Such funds can take a variety of forms, and can be dedicated towards a singular or limited purpose, or alternatively, be intended to be used widely or generally, making profits for the benefit of the state and its citizens Australia’s Fortune Fund is an example of the former, being set up to provide for the otherwise unfunded superannuation liabilities of the Commonwealth government. Singapore’s Temasek is an example of the latter.

Some analysts have distinguished state funds held by central banks as performing a separate function, and hence not properly to be regarded as a SWF, or as forming a part thereof. Typically reserve funds held by a central bank are used on a short term basis for currency stabilization and for ensuring banking system liquidity. Conversely a SWF is thought ideally to wish to maximize returns by investing long term. However there is a great deal of overlap and the distinction has become increasingly blurred.

History
SWFs began to appear post WW2. The first such fund is thought to be the Kuwait Investment Authority, which was set up in 1953 to husband and invest the surplus revenue of the oil rich state. Typically the early SWFs were set up in states heavily reliant on a dominant extractive resource, such as oil, the extraction and sale of which provided much immediate income, but which resource was subject to foreseeable exhaustion. Another early SWF was that of Kiribati (formerly the Gilbert Islands), which was established in 1956, using part of the wealth generated from the mining of phosphates. In such circumstances, a fund enabled the government to stabilize its economy, and protect it from violent fluctuations inherent in volatile markets. Given that such resource was likely to be subject to eventual exhaustion, it also provided for some degree of intergenerational equity, enabling future generations to share in the wealth. Depending on its primary purpose a SWF can thus be described as stabilization or a saving fund.

In the last two decades there has been a steep increase in the number and size of Sovereign Wealth Funds. It is estimated that in 1990 SWFs held approximately US$500 billion in assets, the overwhelming bulk of which had been funded by the exporting of commodities, particularly oil and gas. By the end of 2011 this amount was estimated to have grown to US$ 4.8 trillion, of which US$2.7 trillion was held by the SWFs of commodity exporting nations and US$2.1 trillion by the SWFs of non-commodity exporting nations. This is an overall tenfold increase. By comparison, Australia’s Future Fund, as listed by the Sovereign Wealth Funds Institute, comprised US$73.2 billion.

Particular noteworthy is the number of developed nations and states which have established SWFs. They include France, Ireland, Norway, New Zealand, Russia and Canada, as well as Australia. Various states and provinces have also set up SWFs, such as Alaska, Alberta, New Mexico, Wyoming, Quebec and Texas. Western Australia is considering one. They also exist in emerging nations such as Brazil, China, Singapore, South Korea, Malaysia, and Chile

In 2008, in order to meet criticisms, and allay fears of their potential ability to disrupt the global economy, the worlds main SWFs, prompted by the IMF, met and adopted a self-regulating Code of Conduct called the Santiago Principles.

The Rationale
The rationales for creating SWFs are many and varied. Apart from the purpose of funding particular specific programs such as, in Australia’s case, unfunded Commonwealth superannuation liabilities, education, the creation of infrastructure, and so forth, they include constraining government spending, stabilizing fluctuations in the economy, ensuring intergenerational equity, better management of the national wealth, protection against so-called Dutch Disease, (i.e. a spike in the value of a major export driving up the nation’s exchange rate, causing distress to the rest of its economy), providing a vehicle for saving, or simply creating a national profit making enterprise. A particular purpose, espoused by Malcolm Turnbull in his support for the setting up of an Australian SWF, is economic nationalism; i.e. as creating a source of national pride.

Some Arguments Against
There is considerable political, academic and professional criticism of SWFs. In Australia such critics include academics Robert Carling and Stephen Kirchner and finance journalist Terry McCrann. Various criticisms include:

  • Funds held by SWFs in effect constitute excess taxes, and should be returned to the taxpayers, who will know better how to use them.
  • Governments will always find reasons and ways to access and deplete SWFs.
  • Purchases by foreign SWFs of a nation’s assets pose a threat to national security.
  • Experience shows that stabilization funds rarely achieve such purpose.
  • Funds held publicly, such as by a SWF, will always be managed less efficiently and less effectively than those held by a similar but private organization
  • SWFs loom as easy and attractive prey to the criminal, the corrupt, and the incompetent, as witness the dissipation of Nauru’s SWF.