NBR Analysis: Volume 19

Introduction

3 Introduction Eric G. Altbach Eric G. Altbach is Vice President for Economic and Trade Affairs at The National Bureau of Asian Research. He can be reached at . [This page intentionally left blank.] 5 altbach The explosive growth of sovereign wealth funds (SWF)—together with the increase in resources available to other government-linked investors such as central banks, public pension funds, and state-owned enterprises in recent years—has spurred intense discussions about the implications for the international financial system. The debate over SWF investments in particular has likely been fueled, at least in part, by a growing anxiety over globalization even in many of the most developed economies, including the United States and Europe. An ongoing reassessment of the costs and benefits of investment liberalization—which parallels a similar debate over trade—has led to a variety of new policy proposals for more rigorous investment screening and review procedures and for legal mechanisms to block foreign investment. Some observers have argued that many of these policies, if implemented, would have the effect of raising new barriers to cross-border investment flows. As has been the case in debates over the benefits of trade in many countries, China has been a central focus of attention and concern. The activities and plans of the newly established Chinese sovereign wealth fund, China Investment Corporation (CIC), have received heavy publicity and growing scrutiny. This is a major concern for China, as the country is now generating the world’s largest current account surplus and must seek international investment opportunities to recycle this surplus productively. The United States too has a critical stake in managing this issue properly. U.S. multinational firms depend on the open investment environment overseas that the U.S. government has done so much to promote. Beyond this interest in maintaining investment opportunities for U.S. firms abroad, the United States now runs the world’s largest current account deficit, which reached nearly $740 billion in 2007. To fund this deficit, the country must attract foreign capital at the rate of more than $2 billion per day or risk a number of painful economic consequences. The Context for the Current Debate over SWFs The sudden furor over SWFs has struck some experts as odd, as the funds have been in existence since the 1950s, particularly in the Middle East. It is clear, however, that SWFs are now in a period of dramatic growth. While estimates vary, SWFs currently account for 1–2% of global financial assets, and may be growing by as much as $1 trillion per year. If this rate of increase continues, SWFs may account for 4% of global wealth within a decade. The rise of SWFs, moreover, is just one dimension of a broader shift of financial resources into emerging economies in the Middle East and Asia that has been fueled by soaring oil prices and rising Asian current account surpluses. In Asia, China is the big story. China’s current account surplus has grown dramatically in recent years, topping $370 billion in 2007; the country’s accumulated nbr analysis 6 foreign exchange reserves are estimated now to exceed $1.7 trillion. The desire to earn higher returns on these swelling reserves than that provided by fixed-income sovereign debt has led China and Russia to follow in the steps of the Middle East countries and entrust some of these resources to sovereign wealth funds to invest more aggressively in a broader range of foreign assets. The controversy that has accompanied this shift of financial power from developed economies in the West to both commodity exporters in the Middle East and exportoriented economies in Asia is not, then, all that surprising. A number of issues are often cited by those who seek new reviews or restrictions on the activities of SWFs. The first is the possibility that government ownership will affect the role that SWFs play in the global financial system—i.e., whether they will behave as other players in the market do or will instead have unique characteristics. The second is the lack of transparency of many SWFs with respect to investment objectives, strategies, holdings, and in some cases even governance. The third concern is the potential risk to national security that SWFs could pose if these funds choose to utilize their ability to mobilize significant resources in order to purchase ownership stakes in foreign firms and thereby acquire technology, information, or...