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     May 23, 2008
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SOVEREIGN WEALTH FUNDS, Part 2
Prosperity and harmony - or just greed
By Hossein Askari

Part 1: The forgotten issues

Given their significant level of oil and gas revenues for over three decades, there can be little debate that the oil exporting countries of the Persian Gulf have failed economically. Their average annual per capita economic growth was negative from 1975 to 2002 and has only become positive and high since 2002 because of booming energy markets, underscoring their continued dependence on oil and gas.

At the same time, depletable oil and gas reserves, the underlying source of all wealth in the region and the birthright of all current and future citizens, has resulted in anything but equity among the

 

citizenry. While oil has supported government revenues, economic failure and social injustice has become all pervasive.

It is time for a change while oil and gas reserves last. Comprehensive sovereign wealth funds, or SWFs, will afford these countries the means to achieve superior economic and social results. SWFs will take easy money away from the hands of governments and of rulers, military expenditures, waste and corruption are likely to be reduced and there will be better chance of adopting and implementing rational economic policies.

At the same time, equal annual real payouts to each citizen today and over time will support equity across generations, while promoting more rational consumption patterns because citizens will be free to do what they wish with their income instead of governments and rulers spending it on their behalf and to preserve their own power. In this way SWFs could have an all-encompassing impact on economic developments and on the lives of citizens in the Persian Gulf.

Looking at the spectrum of countries, we saw in Part I of this article that in Kuwait, Qatar and the United Arab Emirates, such funds would make each and every family rich beyond belief while limiting the benefits of the ruling classes. In Saudi Arabia, and to a lesser degree Iraq, payments from an SWF could make a significant contribution to the income of average families while again reducing the benefits of the rulers in Saudi Arabia and the emerging elite in Iraq.

In the case of Iran, the payment, though smaller, will make a difference for the average family and reduce corruption and the take of the elite. All of this will be most effective if it is supported by an effective income tax system and a period of transition as government oil revenues are reduced.

These changes, though at first blush purely financial in nature, will go a long way towards promoting more democratic governance and social harmony in the region that is today in social turmoil. Rent seeking rulers and their "hangers on" would have less incentive and ability to keep a tight grip onto power, possibly opening the door to democratic reform. The disenfranchised masses would reap equitable direct benefits from oil and gas revenues and might become less militant. Such a change would be a breath of fresh air in a region of absolute rule and general dissatisfaction.

We now turn to some of the operational, social and economic issues surrounding SWFs. The operational features are needed to make comprehensive SWFs deliver the hoped for results.

Ownership: Unambiguous confirmation of ownership is a critical element for the long-run success of SWFs. There must be no doubt that these funds belong to the country and thus to its citizens, and are not even partially the private treasure chest of rulers or senior government officials.

Administration: The operations of the SWF must be totally transparent. A Fund needs to have clear independence and authority with respect to investment decisions and general management. The SWFs administrators must have direct reporting lines to the governing board, and their employment/succession, performance and compensation be determined solely by such a board. The administration of the SWF and the formal processes it adopts should not be a part of the civil government structure, be reliant on any government entities nor have any connection to ruling families and elites. Accordingly, the government will not have real or ostensible authority over the SWF's management.

Governance and control: A fundamental concern with the establishment of an SWF is its governance structure. There needs to be integrity among those who can influence strategy and financial performance. The governance body (possibly a board of directors not dissimilar to a modern corporation) should be comprised of individuals with a balance of skills, experience, and independence appropriate for the management of the SWF. Mandatory and periodic disclosures with respect to the SWF's balances, investment policies and results, flow of funds, material matters, and even personal financial disclosures of the board members would instill public confidence (and international confidence, see below) and minimize potential malfeasance. Further, the rights of citizens, the SWFs beneficiaries, need to be clearly articulated and upheld. Effective internal control mechanisms must be put in place to ensure the proper functioning and governance.

Beneficiaries: It seems reasonable that only citizens should be the beneficiaries of any payout from the SWF as the oil belongs to citizens of all generations. The definition of "citizen" is itself a complex topic. For instance, in most countries a non-citizen spouse of a citizen could elect for citizenship status. If that were the case, would the spouse who was recently granted citizenship be entitled to the same payout from the fund in the same manner as the indigenous? What about extended families of the spouse? A pertinent question is whether payouts should be given to adults only? If payouts are given to all citizens regardless of age, is it reasonable to assume that a minor would be sufficiently responsible? Should the payment then be made to the parent or the guardian of a minor? If yes, then such a policy could encourage population growth (and the more children one has the larger the share of the fund's payout).

On the other hand, if the first payment (representing the accumulated annual payouts from the prior 16 or 18 years) to a citizen is set contemporaneous to the attainment of adulthood, would that expectation of such a financial "windfall" create moral hazards and result in unintended waste? For the purpose of our illustrative calculations reported in Part I, we assumed that annual payouts are made only to those over 18 years of age.

Moral hazards and conditionality: Given the moral hazard issue identified above, one could argue for instituting compensating factors that would serve to minimize unintended consequences. Specifically, the first payment from the SWF could be tied to some socially acceptable (or desirable) criteria. For instance, for those in 18-to-30 age bracket, the first and subsequent payouts could be made conditional to the citizens' achieving a minimum level of educational proficiency, or indeed, for having a history of productive and legal employment if not attending school. Such a condition would encourage literacy amongst the populace and could support economic growth. Another condition that could be attached to a citizen's right to receive current and future payouts from the SWF is the maintenance of a clean civilian record. Depending on the nature of the offense, a felon may forfeit his or her right to further payouts from the fund (The money that would have been paid out to felons may instead be re-directed to law enforcement bodies and also to

Continued 1 2  


A blow for Asian wealth funds
(Apr 16, '08)

Are the levees starting to break?
(Jan 18, '08)


1. Bernanke takes one more gamble

2. Hopes fade for a Tiger homeland

3. Ducking and diving under B-52s

4. Bush's Middle East policy in tatters

5. Golden experience to relish

6. A red herring

7. Bollywood demi-gods go blogging

8. Muck and menace in Maliki's Iraq

9. Myanmar's killing fields of neglect

10. The day free markets died

11. Robert Rubin's poisoned chalice

(24 hours to 11:59 pm ET, May 21, 2008)  

 
 


 

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