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Monday, July 30, 2007

Larry Summers: Funds that Shake Capitalist Logic

Larry Summers argues there is reason to be concerned about how the sovereign wealth funds. i.e. the build-up of foreign reserves and other assets in the hands of developing countries, might be used:

Funds that shake capitalist logic, by Lawrence Summers, Commentary, Financial Times [free - I think]: For some time now, the large flow of capital from the developing to the industrialised world has been the principal irony of the international financial system. ... Indeed, Morgan Stanley has estimated ... that there is now close to $2,500bn in [sovereign wealth funds] SWFs and that this figure will increase to $5,000bn by 2010 and $12,000bn by 2015.

Inevitably, and appropriately, countries possessed of publicly held foreign assets far in excess of anything needed to respond to financial contingencies feel pressure to deploy them strategically or at least to earn higher returns than those available in US Treasury bills or their foreign equivalents. ...

[A] crucial question for the global financial system ... is how these funds will be invested. The question is profound and goes to the nature of global capitalism. A signal event of the past quarter-century has been the sharp decline in ... government-owned companies. Yet governments are now accumulating various kinds of stakes in what were once purely private companies through their cross-border investment activities. ...

To date most of the official commentary on the issue of SWFs has been framed in terms of traditional arguments about cross-border capital flows. US and UK officials have raised concerns that focus only on ... reciprocity and transparency and on ... national security questions. Others, particularly in continental Europe, have been less positive and have emphasised nationalist considerations about the benefits of local ownership and control.

What has received less attention are the particular risks associated with ownership by government-controlled entities, particularly ... direct investments. The logic of the capitalist system depends on shareholders causing companies to ... maximise the value of their shares. It is far from obvious that this will ... be the only motivation of governments as shareholders. They may want to see their national companies compete effectively, or to extract technology or to achieve influence.

We have seen the degree of concern over News Corp’s attempt to buy The Wall Street Journal. How differently should one feel about a direct investment stake of a foreign government in a media or publishing company?

Apart from ... what foreign stakes would mean for companies, there is the additional question of what they might mean for host governments. What about the day when a country joins some “coalition of the willing” and asks the US president to support a tax break for a company in which it has invested? Or when a decision has to be made about whether to bail out a company, much of whose debt is held by an ally...?

All of these risks would be greatly mitigated if SWFs invested through intermediary asset managers, as is the case with most institutional pools of capital such as endowments and pension funds. ...

To the extent that SWFs pursue different approaches from other large pools of capital, the reasons have to be examined. The most plausible reasons – the pursuit of objectives other than maximising risk-adjusted returns and the ability to use government status to increase returns – are also most suspect from the viewpoint of the global system.

None of this is to propose policy. That can come only after the investment policies of SWFs have been much more extensively debated and many details have been clarified. But it is to register a cautionary note... Governments are very different from other economic actors. Their investments should be governed by rules designed with that reality very clearly in mind.

    Posted by on Monday, July 30, 2007 at 12:15 AM in Economics, Financial System, Policy | Permalink  TrackBack (0)  Comments (13)

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