Founded in 2016, Ceteris Paribus is A student-led economics and finance publication at Davidson College.

Natural Resources in Sovereignty Wealth Funds

by Austin Gray

Although experts concur about the size, importance, and potential flaws of sovereign wealth funds, they do not agree about the goals of these funds. Some believe the funds serve primarily as royal kickback schemes while others claim they are giant political slush funds. Others see them as the last, best hope for oil states to escape the resource curse, and others see them as beneficent national trust funds. This disagreement exists because sovereign wealth funds perform all these functions. Some focus on just one of these tasks, while others strive after all the goals at the same time.

It seems relatively clear that a primary goal of sovereign wealth funds is to save and manage responsibly resource revenues for their country. In “Rise of the Fiduciary State: A Survey of Sovereign Wealth Fund Research,” the authors, William Megginson and Veljko Fotak, point out that from their analysis of announcements of new funds, a primary goal appears to be channeling the windfall from oil, gas, or minerals into a long-term savings fund to spread the benefits of the resource windfall over time. This goal is sustainable and makes sense given how quickly a country could mine or literally burn through a resource – putting the resource revenue into a sovereign wealth fund preserves and protects the payoff. Norway’s sovereign wealth fund concisely says on the front page of its website that “[w]e work to safeguard and build financial wealth for future generations.”

The announcement of Saudi Arabia’s massive new sovereign wealth fund gives weight to the role of sovereign wealth funds in fighting resource curses. Deputy Crown Prince Mohammed Bin Salman, another of whose titles is chairman of the Council for Economic and Development Affairs, crowed in an interview that Saudi Arabia would shake off its dependence on oil by 2030, or even 2020. A large part of Prince Mohammed’s goal is the same conservation of the revenue stream discussed above, but he also talks at length about the importance of diversifying into non-oil industries. Thus today’s Saudi example serves as evidence that funds can aim to spread their capital across industries as well as across time. In the same way banks devised interest rate swaps to diversify their revenue streams, the Saudis will be swapping shares of Aramco for shares of non-Saudi, non-oil firms. The Saudi example – stabilizing oil rent revenue from volatile commodity prices, diversifying across industry, and sustaining into the future – is not new, but highlights the importance of all these goals with its boldness and sheer size.

Megginson and Fotak also claim that the same states that created sovereign wealth funds to smooth their consumption over time also created the funds in order to set up a transparent and accountable system of management for their wealth. The lack of transparency of many funds belies this claim. Although they claim sweepingly that these new funds are modeled off of the Norwegian management and transparency practices, they include in this list funds from Iran, Nigeria, and Russia. In a rating of accountability and transparency by the Peterson Institute, these Iranian, Nigerian, and Russian funds received respective scores of 18, 14, and 50 out of 100. Norway received 100.

Oftentimes, these funds start shortly after the discovery of a significant deposit of natural resources. This claim is unsurprising, but it reminds the reader that the original source of these funds is still natural resources. Although transparency and accountability are laudable goals, and it would be wonderful if all funds mimicked Norway’s diligent transparency, it is important to remember that many of the countries launching these funds do not have the same record of democracy, pluralism, and political inclusivity as does Norway. Transparency and accountability are traits that allow the fund to be governed for and by its people – they are traits, however, that are quite unfamiliar to many of the world’s most autocratic states. As the examples of Iran, Nigeria, and Russia point out, undemocratic states control some of the largest reserves of natural resources and thus some of the largest sovereign wealth funds. In fact, lack of transparency in fund management helps explain some of the disagreement over political goals of funds. According to “Maximizing Autonomy in the Shadow of Great Powers” by Kyle Hatton and Katharina Pistor, opacity also helps explain sovereign wealth funds’ unique autonomy. Hatton and Pistor’s case studies “confirm that SWFs are used to maximize the autonomy of their sovereign sponsor and that this objective is quite consistent with each country’s behavior prior to its formation of SWFs.” Given this claim, autocratic sovereign sponsors would set up opaque, unaccountable funds whereas democratic sovereigns would set up transparent, accountable funds.  

It is clear that sovereign wealth funds derived from resource wealth occupy a unique niche in international finance. They hold unparalleled autonomy, both political and financial. When this autonomy is paired with lack of transparency, however, some risk comes into play. It could be ventured that some of this lack of transparency is natural and is merely a symptom of the political culture of countries not accustomed to the transparency we hold dear here in our popular system of government. However, concern over the potential for corruption and incompetence is also valid given the lavish spending habits of certain royals and the disastrous headlines from funds such as 1MDB in Malaysia. There is some risk in play for those dependent on sovereign wealth funds. However, with the clock ticking in what could be one of the last decades of the oil era, the diversification attempts of sovereign wealth funds are probably the last, best hope to escape the oil curse.

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