State Funds May Not Bolster Freedoms

February 11, 2008; Page A2

Free traders have long argued that expanded trade is a force for political freedom abroad, and point to South Korea and Taiwan as proof.

In both places, exports boosted living standards for millions of workers, while expanded imports and foreign investment helped to break up entrenched elites. Autocratic governments eventually gave way to democracies.

But will sovereign-wealth funds do the same for democracy? Fans of the trade-produces-political-change argument doubt so.

Nine of the 10 largest state-owned investment funds are arms of countries lacking full democratic rights — China, Singapore, Kuwait, United Arab Emirates, Saudi Arabia, Qatar, Algeria and Libya. (Norway is the notable exception.) “The more that earnings go into government hands, the more that’s a setback for political reform,” says Arvind Subramanian, a former International Monetary Fund senior researcher.

In many of the nations with sizable wealth funds, the money stuffs the pockets of rulers who spend on patronage or repression. A few years back, Dubai, a part of the U.A.E., gave government workers tradable vouchers, valued at more than $100,000, for discounts on condominiums being erected in massive construction projects, says Marcus Noland, who studies Arab economies at the Peterson Institute for International Economics in Washington, D.C. “The short-term effect is that you buy people off,” he says.

The spectacular growth of sovereign-wealth funds — government investment funds whose assets total $3 trillion — is the latest example of global economic integration. Asian and Middle Eastern investment funds have been bailing out the brightest lights of Western capitalism, including Citigroup Inc. and UBS AG. The Asian funds are flush with trade surpluses; the Middle Eastern funds, oil money.

But the free flow of capital — represented by sovereign-wealth funds — and the free flow of goods and services produce different results back home. Trade, especially in manufactured goods, requires the growth of a vast web of companies run by managers who need to be free of government control to operate efficiently. The firms employ millions of workers, whose pay and benefits are at the upper end of local standards.

The result can be broad gains in living standards. Initially, that bolsters undemocratic regimes. China, for instance, is still firmly autocratic, though ordinary citizens have more personal freedom and access to information than they did in Mao’s walled-off economy.

Over time, though, a growing manufacturing economy creates a middle class that seeks political rights. Despite decades of strongman rule, South Korea made a quick transition to democracy after troops refused to fire on prodemocracy demonstrators in 1987.

Sovereign-wealth funds, by contrast, are small government agencies. The financial gains pour into government treasuries, in the case of Saudi Arabia, the bank accounts of ruling families. The economic gains are far more concentrated in the governing elite than are the gains from a manufacturing boom.

Longer term, the funds could help produce some political liberalization — even if that falls well short of full-throated democracy. To operate profitably, the funds need educated professionals who travel abroad and study other cultures. Foreign expertise is needed, too, further boosting cultural interplay.

The funds were designed, often with the help of the World Bank and IMF, to modernize developing nations, especially those receiving gushers of oil money. Investing the money abroad gave the countries a financial cushion when oil prices plunged. Walling off receipts in investment pools kept the money somewhat removed from rapacious rulers, although undemocratic leaders in Azerbaijan, Kazakhstan and elsewhere sit on the funds’ investment boards.

In Kuwait, the Kuwait Investment Authority, established in 1953, operates relatively independently and has helped to encourage political openness. Although the country is firmly ruled by the Al Sabah family, a fractious Parliament grills government leaders about the authority’s goals and performance.

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So far, the lesson that other Gulf states have taken from the Kuwaiti experiment is the less public debate, the better. “Most principalities look at Kuwait’s Parliament and see it as independent, an obstruction and a nuisance,” says Paul Salem, a Gulf state expert at the Carnegie Endowment for International Peace.

The IMF’s efforts to create codes of “best practices” governing sovereign-wealth funds, though, could help bolster those who want more political freedom. If funds are run in a transparent fashion, citizens could keep a sharper eye on how well a country’s money is being spent — and have the information necessary to ask informed questions.

The IMF negotiations are stalled now, with the funds unable even to agree on a definition of transparency. But the political bargaining may sharpen over the coming months as the funds seek to avoid a backlash in the U.S. and Europe. The funds complain about foreign pressure, but it could do them some good.

Write to Bob Davis at [email protected]

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