Sovereign wealth funds in resource economies institutional and fiscal foundations

S OV E R EIGN
WE ALT H FU NDS
IN RESOURCE
ECONOMIES
INSTITUTIONAL AND
F I S C A L F O U N DAT I O N S

KHALID ALSWEILEM
MALAN RIETVELD


SOVEREIGN WEALTH FUNDS
IN RESOURCE ECONOMIES



SOVEREIGN
WEALTH FUNDS
IN RESOURCE
E CONOMIES
Institutional and Fiscal Foundations
Khalid Alsweilem
and Malan Rietveld

Columbia University Press
New York


Columbia University Press
Publishers Since 1893
New York Chichester, West Sussex

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Copyright © 2018 Columbia University Press
All rights reserved
Library of Congress Cataloging-in-Publication Data
Names: Alsweilem, Khalid, author. | Rietveld, Malan, author.
Title: Sovereign wealth funds in resource economies : institutional and
fiscal foundations / Khalid Alsweilem and Malan Rietveld.
Description: New York : Columbia University Press, [2018] | Includes
bibliographical references and index.
Identifiers: LCCN 2017006011 (print) | LCCN 2017022373 (ebook) | ISBN
9780231544993 (ebook) | ISBN 9780231183543 (cloth : alk. paper)
Subjects: LCSH: Sovereign wealth funds. | Natural resources.
Classification: LCC HJ3801 (ebook) | LCC HJ3801 .A47 2018 (print) |
DDC 333.7— dc23
LC record available at />
Columbia University Press books are printed on permanent
and durable acid-free paper.
Printed in the United States of America
Cover design: Lisa Hamm


Contents
Acknowledgments
ix
List of Tables and Figures
xi
Introduction
1
PART O N E
An Institutional Perspective on Resource Economies

and the Role of Sovereign Wealth Funds
c h a p t er o n e
The Most Disadvantageous Lottery in the World:
Historic Controversies Around Natural Resources
and Economic Prosperity
11
c h a p t er tw o
Getting to Denmark: Institutional and Political
Problems of Resource-Dependent Economies
32
c h a p t er t h r ee
Guardians of the Future Against the Claims of the Present:
Sovereign Wealth Funds as an Institutional Response
to the Resource Curse
59


vi Contents

c h a p t er fo u r
To Be Boring: Institutional Lessons from the Modern
Monetary Consensus for Sovereign Wealth Funds
88
PART T W O
Rule-Based Fiscal Policies for Sovereign Wealth Funds
c h a p t er f iv e
It’s (Still) Mostly Fiscal: Simple Fiscal Rules for Accumulating
Windfall Resource Revenues in a Sovereign Wealth Fund
115
c h a p t er s ix

Integrated Fiscal Rules for Sovereign Wealth Funds: Spending,
Saving, and Stabilizing Resource Revenues
136
c h a p t er s e v en
Governing the Fiscal Rule: The Design and Institutional
Infrastructure of Fiscal Rules for Resource Revenues
156
PART T HR E E
The Governance of Operationally Independent Sovereign
Investment Institutions
c h a p t er eig h t
Public Footprints in Private Markets: Institutional Arrangements
in Delegated Sovereign Investment Management
175
c h a p t er n in e
Shadows and Siren Calls: Rules and Contracts in Delegated
Sovereign Wealth Fund Investment Management
206


Contents vii

c h a p t er t en
Summary
231
Notes
243
References
253
Index

271



Acknowledgments

T H E AU T HOR S would like to thank a number of colleagues for
their invaluable contributions, support and generosity in sharing their
thoughts on sovereign wealth funds, fiscal rules, and the management
of resource revenues. We started working and researching these topics
together in 2013 as part of a research project at Harvard’s Kennedy
School of Government. We thank Ricardo Hausmann and Eduardo
Lora of the Center for International Development, as well as Gary
Samore and Graham Allison of the Belfer Center for Science and International Affairs, for their assistance in facilitating our research and
for encouraging the engagement of ideas and expertise between scholars from these two centers at Harvard’s Kennedy School. We also wish
to thank Katherine Tweedie and Hendrik du Toit of the Investment
Institute at Investec for their support of that project, as well as Angela
Cummine of the University of Oxford for her contribution to the
research.
We have benefited enormously from talking to several renowned
experts and practitioners in the field of sovereign wealth management,
institutional economics, and the fiscal challenges around the management of resource revenues. In this regard, we thank in par ticu lar
Gordon Clark, Martin Feldstein, Jeffrey Frankel, Scott Kalb, Leonardo
Maugeri, Adrian Orr, Francisco Monaldi, Meghan O’Sullivan, Patrick
Schena, Martin Skancke, Ng Kok Song, Ted Truman, John Tichotsky,
Craig Richards, Adam Dixon, Ashby Monk, Samuel Wills, Håvard
Halland, and Amadou Sy. Professor Stanley du Plessis, the dean of
Commerce Faculty at the University of Stellenbosch, offered invaluable and detailed comment on large parts of this book.

x

Acknowledgments

Fi nally, we thank Bridget Flannery-McCoy and Ryan Groendyk,
our editors at Columbia University Press, for supporting the publication of this book and for their effort in producing the final
manuscript.


List of Tables and Figures

Table I.1:
Table 1.1:
Table 3.1:
Table 3.2:
Table 5.1:
Table 5.2:
Table 5.3:
Table 9.1:
Figure 1.1:
Figure 3.1:
Figure 3.2:
Figure 3.3:
Figure 5.1:
Figure 5.2:
Figure 5.3:
Figure 5.4:

Sovereign wealth funds
Historic commodity super cycles, 1788–2015

A typology of sovereign investors
Comparing resource- and reserves-based
sovereign wealth management
Key features of simple accumulation rules
Saudi oil revenues and average oil prices,
2000–2013
Key indicators of the moving-average rule,
2003–2013
Established tradable risk factors in addition to
market volatility
Developing country growth and resource
exports, 1970–2008
Number of new sovereign wealth funds
by decade
The cumulative total returns on financial assets
and oil, 1928–2008
Levels of institutional analysis for sovereign
wealth funds
Increasing fiscal dependence on oil
Oil price– driven cyclicality in capital spending
Annual returns on globally diversified portfolio,
2004–2013
Total assets under a moving-average rule with
investment returns

3
18
64
70
119

121
127
220
20
60
72
84
122
123
126
128


xii

Figure 5.5:
Figure 5.6:
Figure 5.7:
Figure 6.1:
Figure 8.1:
Figure 8.2:

List of Tables and Figures

Annual transfers to the fund based on
reference-price rules
Accumulated assets under a medium-saving
reference-price rule
Actual versus budgeted total government
spending

Counterfactual versus actual spending for
Saudi Arabia
Institutional structure for delegated sovereign
wealth fund management
Roles and responsibilities in determining SWF
(sovereign wealth fund) investment policy

129
130
132
150
184
189


SOVEREIGN WEALTH FUNDS
IN RESOURCE ECONOMIES



Introduction

T H I S BO OK OF F E R S an analysis of sovereign wealth funds as
institutions for managing resource revenues. The increasing appeal of
sovereign wealth funds is reflected not only in the growth in assets
under their collective management, a number for which credible estimates vary between $6.5 trillion and $8.3 trillion (as of the end of 2015),
but also in the proliferation of new funds. While the origins of the oldest
sovereign wealth funds can be traced back to the mid-nineteenth century,
and many of the largest and most famous of these funds emerged in
the Middle East during the oil boom of the late 1970s, a significant

acceleration in the establishment of new funds has occurred over the
past decade
Despite their increasing popularity and prominence, the literature
has struggled to arrive at a satisfactory definition of sovereign wealth
funds. This reflects, in part, the diversity of the sovereign wealth fund
landscape, which features institutions with a variety of funding sources
(notably, resource revenue windfalls and excess foreign- exchange
reserves) and operational models, as well as a myriad of objectives,
including macroeconomic stabilization, saving, income and wealth


2

Introduction

diversification, and the funding of developmental projects. In this
book, the focus is firmly on sovereign wealth funds that are funded
through natural resource revenues, although we argue for the importance of clearly distinguishing within this group between funds that
serve different functions. These include macroeconomic and fiscal stabilization, income generation or savings, and, as is increasingly popular,
a range of strategic and developmental functions (table I.1 provides a
list of sovereign wealth funds, with their inception year and main source
of funding).
Most important, we argue, the full— and most fruitful— embrace of
the sovereign wealth fund model by resource economies requires more
than the mere establishment of a portfolio of financial assets funded
from resource revenues. Rather, the sovereign wealth fund model is best
understood as a component of a credible, countercyclical rule-based
fiscal framework for resource revenues. The sovereign wealth fund
model contributes significantly to improved economic per formance if
it is embedded in a system of rules that govern the flow of resource

revenues into the fund and the flow of assets and income out of the
sovereign wealth funds (variously designed). Finally, the principal–agent
relationships involved in the delegated authority around the management of sovereign investment institutions require another set of rules
and institutions that are the subject of the final part of the book.
The case for the analysis of the sovereign wealth fund model through
an institutional lens rests in part on the increasing support in the literature on the resource curse for the importance of institutional quality
in determining whether resource wealth promotes or undermines
economic growth in the long run. We argue in this book (in line with
recent scholarship on the resource curse) that the understanding of
“institutions” in this context remains rather general. A more fruitful
line of inquiry focuses on the cluster of institutional and policy reforms
located around the management of natural resources. We present the
sovereign wealth fund model as exactly this kind of institution.
A dominant question in the debates around sovereign wealth funds—
which is also reflected in the literature on the relationship between
institutions, growth, and economic prosperity more generally—pertains
to the sequencing of institutional reforms. One argument suggests that
targeted institutional reforms are either unlikely to occur or succeed
in the context of weak general institutions. An alternative view is more
sympathetic to the potential contribution of incremental institutional


ta ble i. 1
Sovereign wealth funds
Government

Fund authority

Texas

Texas Permanent School
Fund
Permanent University Fund
Land Grant Permanent Fund

1844

Kuwait Investment
Authority
Revenue Equalization
Reserve Fund
Public Investment Fund
Severance Tax Permanent
Fund
Permanent Wyoming
Mineral Trust Fund
Abu Dhabi Investment
Authority
Alaska Permanent Fund
Alberta Heritage Savings
Trust Fund
Montana Permanent Coal
Trust Fund
State General Reserve Fund
Brunei Investment Agency
International Petroleum
Investment Co.
Alabama Trust Fund
Louisiana Education Quality
Trust Fund

National Trust Fund
Government Pension FundGlobal
Pula Fund
Sovereign Fund of the
Gabonese Republic
Macroeconomic Stabilization
Fund
State Oil Fund
National Development Fund
Revenue Regulation Fund
Kazakhstan National Fund

1943

Oil and public
land
Public lands
Minerals and
public land
Oil

1946

Phosphates

1971
1973

Oil
Oil and minerals

1974

Minerals

1976

Oil

1976
1976

Oil
Oil

1978

Minerals

1980
1983
1984

Oil
Oil
Oil

1984
1986

Oil and gas
Oil

1988
1990

Oil
Oil

1996
1998

Diamonds
Oil

1998

Oil

1999
1999
2000
2000

Oil
Oil
Oil
Oil

Texas

New Mexico
Kuwait
Kiribati
Saudi Arabia
New Mexico
Wyoming
Abu Dhabi
Alaska
Alberta
Montana
Oman
Brunei
Abu Dhabi
Alabama
Louisiana
Malaysia
Norway
Botswana
Gabon
Venezuela
Azerbaijan
Iran
Algeria
Kazakhstan

Inception

1876
1898

Source of funding


ta ble i. 1 (continued)
Government

Fund authority

Mexico

Oil Revenues Stabilization
Fund
Heritage and Stabilization
Fund
Mubadala Development
Company
Fund for Future Generations
Qatar Investment Authority
National Welfare Fund
National Oil Account

Trinidad and
Tobago
Abu Dhabi
Equatorial Guinea
Qatar
Russia
Sao Tome and
Principe
Ras Al Khaimah

Venezuela
Timor Leste
Chile
Bahrain
Dubai
Libya
Mauritania
Malaysia
Chile
Papua New Guinea
Mongolia
Ghana
Ghana
Nigeria
North Dakota
Australia
Angola
Kazakhstan

R AK Investment Authority
National Development Fund
Timor-Leste Petroleum
Fund
Pension Reserve Fund
Mumtalakat Holding
Company
Investment Corporation of
Dubai
Libyan Investment
Authority

National Fund for Hydrocarbon Reserves
Terengganu State Sovereign
Fund
Social and Economic
Stabilization Fund
Papua New Guinea Sovereign
Wealth Fund
Fiscal Stability Fund
Ghana Heritage Fund
Ghana Stabilization Fund
Nigerian Sovereign
Investment Authority
North Dakota Legacy Fund
Western Australian Future
Fund
Angola Sovereign Fund
National Investment
Corporation

Inception

Source of funding

2000

Oil

2000

Oil

2002

Oil

2002
2003
2004
2004

Oil
Oil
Oil
Oil

2004
2004
2004

Oil
Oil
Oil and gas

2006
2006

Minerals
Oil

2006

Oil

2006

Oil

2006

Oil

2006

Oil and gas

2007

Minerals

2011

Oil and gas

2011
2011
2011
2011

Oil and minerals
Oil

Oil
Oil

2011
2012

Oil
Minerals

2012
2012

Oil
Oil


Introduction 5

ta ble i. 1 (continued)
Government

Fund authority

Inception

Leading non–resource-based sovereign wealth funds
Singapore
Temasek Holdings

1974

Singapore

1981

Malaysia
New Zealand
Australia
South Korea
Vietnam
China
Brazil

Government Investment
Corporation
Khazanah Nasional
New Zealand Superannuation
Fund
Future Fund
Korea Investment
Corporation
State Capital Investment
Corporation
China Investment
Corporation
Sovereign Fund of Brazil

1993
2003
2004

2004
2006
2007
2008

Source of funding

Fiscal
appropriation
Foreign exchange
reserves
Various public
revenues
Fiscal
appropriation
Fiscal
appropriation
Foreign exchange
reserves
Various public
revenues
Foreign exchange
reserves
Various public
revenues

reform. Our inclination is toward the latter view. A generally supportive institutional context increases the prospects that sound institutions
for the management of resource revenues will endure. However, sovereign wealth funds and fiscal rules for resource revenues can— and, we
argue, have— contributed to ameliorating a number of the common afflictions associated with the resource curse. Often, what Rodrik (2008)
describes as “second-best institutions” set in motion a series of positive policy and institutional reforms— and we suggest that sovereign

wealth funds can do this in the case of resource revenues.
Also of relevance to this discussion is evidence that the emergence
of resource revenue windfalls tend to be associated with a subsequent
deterioration in institutional quality. This raises the possibility that
targeted reforms around the management of resource revenues, particularly in new resource producers without an inherited institutional
structure that has been shaped by a long history of resource production, can contribute to avoiding a dynamic that might other wise result
in a further deterioration of institutions. Finally, it is far from the case
that economies with other wise sound institutions are in some way


6

Introduction

inoculated from the emergence of weak institutions for the management of resource revenues. This book identifies aspects of the institutional arrangements for sovereign wealth funds and resource revenues
in locations such as Norway, Alberta, Chile, Alaska, and Wyoming that
require reform—or at least have room for improvement.
As with most institutions, sovereign wealth funds are not “one-sizefits-all” solutions. Yet we show in this book that there is significant
scope for tailoring sovereign wealth funds’ functions and their consequent saving and spending policies to meet local requirements, based
on the economic (and political) realities. Criticisms of sovereign wealth
funds underestimate the degree of nuance and variation in the sovereign
wealth fund model, as well as the extent to which resource-based sovereign wealth funds are designed to directly and indirectly address common afflictions associated with the resource curse— particularly those
of an institutional or political economy nature. In line with Rodrik’s
notion of “second-best institutions” and the idea that sovereign wealth
fund models themselves evolve and mature over time, we discuss fiscal
rules and investment approaches that may be considered suboptimal
but have the advantage of simplicity and can serve as intermediate steps
toward more complex institutional arrangements.
The fledgling academic literature on sovereign wealth funds has
already underlined the critical importance of institutional arrangements (or “governance”)—notably, spending and savings rules, mechanisms for transparency and accountability, and rule-based investment

strategies—to the effectiveness of sovereign wealth funds (see, for example, Bacon and Tordo, 2006; Humphreys and Sandbu, 2007; Das
et al., 2009; Monk, 2009; Ang, 2010; and Frankel, 2012). We devote
significant attention to these issues in the book, and argue in particular that the institutional arrangements or governance of fiscal rules, as
distinct from their design, are often overlooked in discussions about
sovereign wealth funds. Even the best-designed rule-based fiscal framework for resource revenues and sovereign wealth funds can be undermined by weak institutional arrangements.
Our discussion of sovereign wealth funds’ fiscal rules reveals a wide
range of institutional mechanisms through which this is achieved, ranging from constitutional mandates to legislative statues to presidential
decrees to elements of custom (or informal institutions). Three models
that have achieved some measure of success and durability provide valuable insights into the specification and governance of fiscal rules for


Introduction 7

managing resource revenues and sovereign wealth fund assets and income. Norway emerges as an example where the fiscal rule is governed
through consensus and custom, Chile as one that champions the contributions of technocratic expertise, and the American state endowment
model as one in which the fiscal rule is hardwired into the Constitution (albeit in an incomplete manner). We regard these three models as
viable conceptual frameworks that can be tailored to fit with local requirements and realities.
The final section of the book focuses on the institutional aspects
of the sovereign wealth fund model that pertain to the investment function, particularly various layers of delegated investment authority typically involved in investments of sovereign wealth funds. The section
considers why and how to achieve a degree of operational independence
from government for an investment management authority, how to
clarify the roles and responsibilities of the various principals and agents
involved in the delegated-authority model of investment, and how the
governance and performance of the investment authority is strengthened by an embrace of rule-based investment policies.
Having made the case for operational independence in the management of long-term sovereign investment portfolios, the institutional
question considered in this section deals with a familiar tension in public policy: balancing the desire for assigning operational independence
to a technocratic institution (in this case, the investment authority of
the sovereign wealth fund) with a degree of government control and
oversight of such delegated authority. While the case for operational
independence rests on compelling foundations in the case of sovereign

wealth funds—including improved investment performance, addressing fears of a regulatory backlash from recipient countries, a desire to
escape from public-sector pay scales to attract and cultivate internal
human capital, and the political ring fencing of assets—the analysis indicates that independence is typically (and appropriately) a matter of
degree. Independence is never absolute, and the exercise of discretionary powers by delegated sovereign investment authorities should be
constrained by clearly articulated rules and demands for transparency
and accountability.
This book argues that sovereign wealth funds can play a highly
constructive role in the management of resource revenues. We reach
this conclusion with the important caveat that the sovereign wealth
fund model requires these funds to be embedded in a rule-based fiscal


8

Introduction

framework and institutional framework. The potential contribution of
sovereign wealth funds alone to addressing or avoiding the resource
curse should not be overstated. Nevertheless, when accompanied by
well-designed and governed fiscal rules, as well as a clear institutional
structure for the management of agency relationships that arise from
delegated authority, the sovereign wealth fund model is a promising
targeted institutional response to the widely understood problems of resource economies.


pa rt one

An Institutional Perspective
on Resource Economies and the
Role of Sovereign Wealth Funds