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The Sovereign Wealth Trust Fund: The Walking Stick on the Pilgrimage to Sustainable Growth

02/25/2013 11:16 am ET | Updated Apr 27, 2013
  • Bettina Strickler Graduate student, Columbia University School of International and Public Affairs

Recently the media has highlighted raising controversy surrounding the activities of Sovereign Wealth Funds (SWFs). Potential investments by the Chinese SWF in U.S. assets have been blocked, supposedly due to concerns over national security. People fear politically motivated investments and accuse SWFs of insufficient transparency in their actions. While these concerns are valid (and very applicable to some players in the market), condemning SWFs all together would be fatal for some countries that desperately need them to support and stabilize their economy.

Think about this: Why do commodity-exporting countries succumb to the so-called resource curse? Why is it that despite all the resource abundance, countries like Nigeria have not been able to capitalize on this? The perplexing question has a simple answer. It is poor, or even, wicked revenue management. That's why a sovereign wealth fund (SWF) should be the tools of choice to overcome the resource curse.

The resource curse or the paradox of plenty refers to the empirical fact that many countries blessed with natural resources have failed to convert those resources into tangible development. Even if governments overcome the problem of efficient revenue collection, unexpected detrimental macroeconomic effects that jeopardize growth are luring just around the corner.

Academic literature and practitioners have come to the conclusion that this gap can only be bridged when the revenue streams are monitored, channeled and their administration kept simple. This is where the sovereign wealth fund comes into play.

A SWF will facilitate revenue collection, thus decrease their deviations and it will provide macroeconomic protection for a country that is suddenly flooded by large sums money and does not know how to handle that. A well-structured SWF is the single most important ally for sustainable development and growth for a commodity producer in the developing world. It allows a country to convert its depletable resources into financial assets that generate recurring revenues over time. Also, it provides protection against commodity price fluctuations and can, if needed, spur development through earmarked funds. Placed beyond the domestic economy the SWF will protect the country from the appreciation of its currency, which would in turn render its export industry non-competitive.

But is this enough? What about countries that followed international advice, set up a SWF and still fell victim to the resource curse?

While establishing a sovereign wealth fund is a step in the right direction, it is not the panacea for sustainable growth but rather a precondition. The structure of the fund and its embodiment in a legal system will be crucial for success.

The benefits of a SWF for commodity revenue management can be increased and solidified by the legal enshrinement of such a SWF as a trust fund.

Under the common law legal system a trust constitutes a relationship that emphasizes the rights of the beneficiaries -- here the people of a country -- and reaches a protection of them through a solid legal basis. The establishment of a sovereign wealth trust fund will be beneficial for development and political stability. First, the investment of the trust fund abroad will shelter the domestic economy from detrimental macroeconomic effects of commodity exports and, second, the nature of the trust itself provides a legal guarantee to act in the citizens' best interest.

A trust fund offers the highest legal standards available and will lighten some of the concerns that have been expressed vis-à-vis the investments of SWFs. In the past some SWFs have had limited access to certain financial markets due to a lack of transparency and governance standards. A SWF set up as a trust fund will have access to the best financial markets, due to its high standards, and thus be able to compete with the private sector. This will eventually increase its return on assets.

Some might say that the creation of a trust fund is an unnecessary complication, a legal obstruction. The trust fund, however, increases chances that the purposes of the SWF are ever present and that highest governance standards are maintained. Really, when dealing with such large amounts of money not enough caution can be exercised and no effort should be considered excessive.

The sovereign wealth trust fund not only makes for sound revenue management, it also puts the interests of the people first. Its high legal standards will help to legitimize revenue management and ultimately to enable sustainable growth.