2009 Oxford Business & Economics Conference Program
ISBN : 978-0-9742114-1-1
The Emergence of Sovereign Wealth Funds as Contributors of Foreign
Direct Investment
Ruth Rios-Morales1 and Louis Brennan2
Abstract
In the current world economy, sovereign wealth funds (SWFs) are hastily attaining
significance as global financial players. SWFs embody the largest concentration of
capital that the world has ever known (Redicker & Crebo-Redicker). We argue that by
engaging in foreign direct investment (FDI), SWFs can play a role in sustaining the
global economy. This paper examines the potential impact that SWFs encompass as
tools for economic growth. It is widely acknowledged that FDI has the potential to
sustain long-term economic development through job generation and enhancement of
exports. The paper also examines the role of national governments in the management
of these colossal funds and the recently established Santiago Principles related to issues
of transparency and best practice code of conduct.
1
Ruth Rios-Morales (PhD), Lecturer at LRG, University of Applied Sciences Switzerland, CH 1630
Bulle, Switzerland. Tel. 00 41 26 919 7878, Fax 00 41 26 919 7878, e-mail: ruth.riosmorales@glion.edu
2
Louis Brennan (PhD), Associate Professor at the School of Business, Trinity College, Dublin 2, Ireland.
Tel. 00 35 31 896 1993, Fax 00 35 31 679 95 03, e-mail: brennaml@tcd.ie
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1. INTRODUCTION
Amidst the economic and financial turmoil, sovereign wealth funds (SWFs) have
emerged as significant financial players. SWFs have delivered some support in the
initial stages of the global financial crisis triggered by the subprime mortgage meltdown
by providing some element of financial relief to a number of financial institutions.
Although these capital injections were welcome by market players, SWFs have
garnered the concerns of policymakers. Two main reasons account for such concerns:
the large magnitude that these funds represent and the role of national governments in
the management of these large funds (Rios-Morales & Brennan, 2008).
SWFs represent the largest concentration of capital that the world has ever known
(Redicker & Crebo-Redicker, 2007). At present, these funds surpass the amount of five
trillion dollars (UNCTAD, 2008); this figure is nine times larger than what private
equity funds represent. However, trends also reveal that SWFs are growing faster than
private equity funds. It is expected that by 2015 SWFs will have attained the level of 12
trillion dollars (UNCTAD, 2008). The second concern of policy makers highlighted
above, is related to the issue of transparency and accountability. The lack of
transparency of nations with surpluses has propelled a debate about the potential risks
and opportunities for host nations (Johnson, 2007). Parallel to this debate, strong
feelings of protectionism in some western countries had emerged to defend national
sovereignty (Siebert, 2007). In response, the International Working Group of Sovereign
Wealth Funds launched the Santiago Principles in October 2008. These principles aim
to address such apprehensions.
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The aim of the Santiago Principles is to provide a clear understanding of the
management of SWFs so that policymakers and market players can welcome these
funds and use them as tools of economic growth. FDI by SWFs can become the avantgarde of the global economy. It has been widely accepted that foreign direct investment
is an important element of economic development in the new global economy
(Blomstrom, 2001; Addison & Heshmati, 2003; World Bank, 2004; Lall, 2005). In the
present global system, states are playing a central role in the determinants of
international business activities (Dunning, 2006) and emerging and developing
economies are becoming important investors increasing their role in the global
economy. A large number of SWFs have their origins in emerging and developing
countries (UNCTAD, 2008).
The remainder of this paper is organized as follows: The next section presents a review
of exiting literature on the topic of SWFs integrated with scholarly research on the topic
of FDI. Section 3 focuses on the emergence of SWFs and the establishment of the
‘Santiago Principles’. Section 4 analyses the data on FDI and the potential role for
SWFs in sustaining FDI. The implications of the emergence of SWFs are presented in
section 5. Finally some conclusions are drawn in section 6 of the paper.
2. RELATED LITERATURE
The unprecedented emergence of SWFs as financial players has impelled a debate
among policymakers, market players and scholars regarding the potential risks and
benefits that these funds can convey to the global economy (Johnson, 2007). While the
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role of SWFs has been widely acknowledged in this highly volatile global financial
system dominated by risk aversion, liquidity pressures and asset write-downs (RiosMorales & Brennan, 2008), the extant literature has tended to focus on the concerns
highlighted above.
In the debate around the potential risks and benefits of SWFs, the main concern has
been the lack of transparency in the administration and investment strategies of these
colossal funds. A large number of publications have underlined the danger that SWFs
may cause if they remain unregulated (Truman, 2007a; Green & Torgerson, 2007;
Redicker & Crebo-Redicker, 2007), suggesting that SWFs can act as vehicles of future
global instability (Redicker & Crebo-Redicker, 2007). A number of publications have
emphasised the need to establish an international code of conduct in order to avoid
protectionism that would be detrimental to the globalization process (Truman 2007a,
200b). In contrast to the above perspective, Jen (2007a) and Kern (2007) have
underlined the variety of economic and financial benefits that SWFs present. Beside the
benefits that SWFs encompass as investors, the IMF (2008) argues further that SWFs
can help to avoid extreme economic cycles, transfer across generations surpluses of
current accounts and enhance revenues of investors’ nations (IMF, 2008). Nonetheless;
this international institution has being prominent in raising the importance of
establishing an international code of conduct (IMF, 2008).
The potential risks that have been attributed to SWFs, have been addressed by the
launch of the Santiago Principles in October 2008. Thus, there is a need to focus on the
potential benefits that SWFs can bring to the global economy. Although much has been
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written about SWFs in recent times, the body of scholarly research on this topic is
rather scant. In assessing the role of SWFs as important contributors of FDI in the
global economy, the existing substantial body of literature on FDI provides evidence
for the significance of FDI as a method of economic growth. However, research on the
topic of SWFs as contributors of FDI is limited. Nonetheless, the work of Green &
Torgerson (2007), Jen (2007b), Siebert (2007), UNCTAD (2008) and Plotkin & Fagan
(2009) offer a basis for seminal work to support our argument that by engaging in FDI,
SWFs can sustain the global economic growth. According to the World Investment
Report 2008 SWFs have only invested 0.2 percent of their total assets in FDI. About 80
percent of this investment has taken place during the period 2005-2007. The report also
reveals that 73 percent was invested in the developed world mainly in the United
Kingdom, the United States and Germany (UNCTAD 2008). Since these funds already
represent five trillion dollars (UNCTAD, 2008) and are estimated to reach the sum of
12 trillion dollars by 2015, (Redicker & Crebo-Redicker, 2007), SWFs have the
potential to serve as major funding sources in the global financial system (Fernadez &
Bris, 2009).
Important research has been conducted on the topic of FDI as a contributor of economic
growth. The large body of literature is not unanimous in acknowledging that FDI is a
direct contributor of economic growth. However, research shows that FDI has the
potential to contribute to long-term economic development (Blomström, 2001; Addison
and Heshmati, 2003; World Bank, 2005; Lall, 2005; Dunning, 2006). Researchers also
acknowledge the fact that FDI will have a positive impact in the economy of a country
when the infrastructure of the host country is ready to receive the so-called spillovers of
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FDI (Borensztein et al., 1998, Willem te Velde, 2001). Spillovers of FDI can benefit
the domestic economy by bringing technology, know-how, managerial skills and
production networks (Blomström, 2001). Hermes & Lensink (2003) found that FDI has
a particularly positive impact in economies with well-developed financial markets.
The participation of SWF in FDI is novel and to date no theories have been developed
to analyse and forecast the impact of these new financial players on FDI. However, the
Investment Development Path Theory (IDP) of Dunning (1998) offers a basis for
examination. The IDP suggests that the magnitude of countries investment is correlated
positively with the rate of economic growth. The IDP hypothesizes that with increasing
economic development measured by GDP per capita, conditions for inward and
outward investment in a country change. This is reflected in the country’s NOIP (Net
Outward Investment Position) defined as the difference between outward and inward
investments, which is hypothesized to evolve from being highly negative in the early
stages of development to becoming positive and eventually fluctuating around zero
once the country is fully developed and industrialized. Dunning divides the economic
development of countries into five stages. At the first stage, a country’s outward FDI
(OFDI) is negligible or non-existent but attracts a small amount of inward FDI (IFDI).
In the second stage, the rate of economic growth continues to increase, while the rate of
IFDI is higher than that of OFDI. At the third stage, countries exhibit a growing NOIP,
due to an increased rate of growth of OFDI and a gradual slowdown in IFDI while GDP
continue to grow. At the forth stage, the GDP rate increases from the pervious stage
and outward FDI continues to grow rapidly. In the final stage, NOIP tends to fluctuate
around zero reflecting high levels of IFDI and OFDI. This is explained by the
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neutralisation of the asymmetries among positive and negative balances, given that
inward and outward FDI have gone through a vast growth in previous stages (Buckley
& Castro, 1998). At this stage, the relationship between the NOIP of an economy and
its level of development becomes less stable (Dunning & Narula, 1998).
The IDP model gives special attention to the government role in FDI (Dunning &
Narula, 1998). This theory focuses on the role of government and economic
development in determining the pattern of competitive advantages of foreign investors
relative to those of local firms (ownership advantages), relative competitiveness of
location-bound resources and capability of the country (locational advantages), and the
propensity of foreign and local firms to utilize the ownership advantages internally
rather than through markets (internalization advantages). With a country’s development
and government interventions the configuration of these advantages changes and
reflects on the NOIP of the country (Dunning & Narula, 1996). While Dunning
suggests that the IDP of countries differ with each other mainly due to the pattern and
efficacy of government interventions, the theory should take this into account (Dunning
& Narula, 1996). Since the establishment of SWFs, and in many cases their operation,
represent a government intervention, they may impact on the IDP of their countries of
origin.
3. THE EMERGENCE OF SWFs AND THE SANTIAGO PRINCIPLES
Sovereign
wealth
funds
are
special-purpose
government-owned
investments,
accumulated from surpluses of current accounts and reserves (IWG, 2008). A number of
these most important funds were established over the second half of the last century.
Kuwait pioneered the establishment of SWFs, launching its SWF in 1953 (Roy, 2007).
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Among the older and largest is Singapore’s Temasak Holding which was created in
1974. Alaska established its SWF in 1976 while Abu Dhabi investment Authority, the
largest SWF, was also launched in 1976 (see Table 1).
In Table 1 we can observe that a larger proportion of SWFs were established in recent
years. This extraordinary growth in the number of SWFs has been the result of the rapid
accumulation of foreign assets in some countries (IWG, 2008). Among some of the
largest SWFs is the China Investment Corporation (CIC) which was established in 2007
and holds US$200 billion. China has accumulated surpluses from exports sales revenue.
Given that China has reserves of US$1.5trillion (Jen, 2007b), it is likely that the CIC
will increase its assets.
Table 1: The 20 Largest Sovereign Wealth Funds
Name of Funds
Year founded
Source
Billion US$
Abu Dhabi Investment Authority
1976
Oil
875
Singapore Investment Corporation
1981
Non-commodity
330
Norway Government Pension Fund-Global
1990
Oil
322
Saudi Arabia Various Funds
n/a
Oil
300
Kuwait Invetsment Authority
1953
Oil
250
China Investment Corporation
2007
Non-commodity
200
Hong Kong Monetary Authority Investment Portafolio
1998
Non-commodity
140
Stabilisation Fund of the Russian Federation
2003
Oil
127
China Investment Company
2003
Non-commodity
100
Singapore Temasek Holdings
1974
Non-commodity
108
Australia Government Future Fund
2004
Non-commodity
50
Libya Reserve Fund
n/a
Oil
50
Qatar Investment Authority
2000
Oil
40
US Alaska Permanent Fund
1976
Oil
40
Brunei Investment Agency
1983
Oil
35
Ireland National Pension Funds
2001
Non-commodity
29
Algeria Revenue Regulation Fund
n/a
Oil
43
South Korea Investment Corporation
2006
Non-commodity
20
Malaysia Khazanah Nasional
1993
Non-commodity
18
Kazakhstan National Oil Fund
2000
Oil, gas and metals
18
Source: Deutsche Bank Research, "Sovereign Wealth Funds, State Investment on the Rise", September, 2007
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Currently, there are about 70 SWFs held by 44 countries with assets that range from
US$20 million to US$875 billion (Beck & Fidora, 2008). About 30 percent of total
SWFs have originated from accumulated current accounts surpluses of non-commodity
sources (Rios-Morales & Brennan, 2008) and about the same percentage are held by
Asian and Pacific countries (Johnson, 2007). However, oil producing countries remain
the largest holders of SWFs (see Table 1). The accumulation of large current accounts
surpluses has been a trend observed in a number of countries; remarkably the majority
of these countries are emerging and developing nations (Rios-Morales & Brennan,
2008).
The rapid growth in the number of SWFs and the establishment of large SWFs by China
and Russia has provoked concern and anxiety in some western countries (Betts, 2008).
Although the Anglo-Saxon governments were receptive of SWF investment (Jen,
2007b), other western countries voiced strong apprehension based on the prospect that
SWFs could be used to seize control of strategic companies in sensitive sectors for their
own political purposes (Siebert, 2007; Betts, 2008). The argument of financial
protectionism became an issue for the International Financial Institutions (Thompson
Financial, 2007).
Given the significance of the possible impact that protectionism could have in the global
economy, the International Monetary Fund (IMF) called states to a dialogue in October
2007 (IMF, 2008). Twenty-six countries that hold SWFs voluntarily played a role in the
creation of an institutional framework around the governance and investment operations
of these funds. A year later, the General Accepted Principles and Practices (GAPP) -
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Santiago Principles were launched with the aim of fostering trust and confidence among
recipient and investor countries. These principles aim to support a healthy global
economy with a financial system based on free flows of capital that complies with
applicable regulatory requirements and transparent management (IWG, 2008). The
purpose of the GAPP is to reflect appropriate governance and accountability of
investment. The GAPP consists of 24 principles that cover four key areas:
1) Legal and institutional framework
2) Objectives and coordination on macroeconomic principles
3) Governance structure and code of conduct
4) Risk management framework
The launch of the GAPP is expected to dispel some of the prevailing apprehension
about SWFs. It is expected that the Santiago Principles will support further investment
by these well-established institutional investors and continue to contribute to the
economy of recipient countries (IWG, 2008). SWFs are long-term investors (Gilson &
Milhaupt, 2008; UNCTAD, 2008). It is widely acknowledge that long-term investment
is one of the best methods of economic development. Long-term investments endure
business cycles, convey diversity to the markets and provide support during economic
volatility (IWG, 2008). The Santiago Principles therefore facilitate a platform for a
more efficient flow of foreign direct investment.
4. FOREIGN DIRECT INVESTMENT AND SWFS
There has been a vast increase in global inward foreign direct investment (IFDI) flows
since 1970. Enhancing the investment climate has been a policy priority for many
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governments. Particularly over the past two decades, there has been strong support from
governments for foreign investment. A large number of countries have implemented
industrial policies and macroeconomic measures of liberalisation, deregulation, and
improved the availability of infrastructure and skilled labour force. These are essential
policies to support making FDI an instrument of economic development (Rios-Morales
& O’Donovan, 2006).
After a steady expansion of IFDI over the 1990s, it reached a peak in 2000. FDI flows
declined for the three subsequent years (see Figure 1). In 2004, world FDI increased
slightly due to the increased flows to developing countries while FDI into developed
countries continued to fall. The recovery in FDI has since continued and in 2007 FDI
reached higher levels than those obtained in 2000 (sees Figure 1). Developed countries
continue to be the dominant contributor group to FDI flows. Developed countries also
continue to be the major destination of inward FDI. However, developing countries
participation in FDI is increasing steadily. The contribution of emerging and developing
countries to FDI has been noteworthy in recent years. These countries have also been
important recipient of FDI. In fact, the strong performance of IFDI in 2007 mirrors the
strong performance of multinational corporations particularly in developing countries
(UNCTAD, 2008).
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Figure 1
ISBN : 978-0-9742114-1-1
Global Inward FDI Flows
(Millions of US dollars)
2 000 000
1 500 000
1 000 000
500 000
World
Developed economies
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
-
Developing economies
Source: UNCTAD, 2008
The emerging and developing countries are surging as important contributors and
recipients of FDI. In Table 2 we observe that emerging and developing countries have
obtained higher levels of inward FDI as a percentage of GDP than the developed
countries. During the period 1990-2007, inward FDI stocks as a percentage of the GDP
in these countries were at an average level of 20.83 percent, while the developed
countries obtained an average level of 14.71 percent. The average real economic growth
rate has also been higher in emerging and developing countries than the rate obtained by
the developed world. During the period 1990-2007, emerging and developing countries
obtained an average rate of real GDP growth of 4.75 percent. Developed countries real
GDP growth for the period 1990-2007 is 2.6 percent. However, the level of outward
FDI stocks as a percentage of GDP from developed countries continues to be higher
than the level from emerging and developing countries. The average level of outward
FDI from developed countries is almost double that obtained by emerging and
developing countries during the period 1990-2007 (see table 2).
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Table 2: Inward and Outward FDI stock as a percentage of Gross Domestic Product and
Real GDP Growth, 1990-2007
In the light of Dunning’s IDP model (1998), we first examine the correlation between
inward FDI stocks as a percentage of GDP and the rate of real GDP growth. We also
examine the correlation between outward FDI stocks as a percentage of GDP to the rate
of real GDP growth. For developed countries, the correlation coefficient between
inward FDI stocks as a percentage of GDP and the rate of real GDP Growth is close to
zero (-0.0070). Outward FDI stocks as a percentage of GDP correlated to the rate of real
GDP growth is also around zero (-0.0045). Dunning (1998) suggest that when countries
obtained such correlation figures close to zero, these countries have reached the final
stage of the IDP. Buckley & Castro (1998) explained that such countries have gone
through such a vast development in previous stages that at the final stage countries have
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managed to neutralised asymmetries in balances. By contrast the correlation coefficient
between inward FDI stocks and economic growth for emerging and developing
countries is high as is the correlation coefficient for outward FDI stocks and economic
growth (see Table 2). According to the IDP model, these results are consistent with the
fact that emerging and developing countries are at earlier stages of the IDP.
Since high correlation coefficients are found for emerging and developing countries,
this suggests that inward and outward FDI may have an influence on the real economic
growth of this group of countries. According to the World Investment Report 2008,
inward FDI flows are set to decline, indicating that emerging and developing world
would suffer the most. However, SWFs can play a role in sustaining FDI. In order to
estimate the figure needed to sustain FDI, we used forecasts for FDI for 2008 from
UNCTAD (2008). This indicates that in 2008, FDI would have declined by 31 percent
or US$568 billion. On this basis, we can measure the proportion of SWFs assets needed
in order to neutralize such a decline. Our estimation suggests that by allocating just over
11 percent of their total assets of US$5 trillion to FDI, SWFs could have averted the
forecast decline in FDI.
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Figure 2
ISBN : 978-0-9742114-1-1
World Inward FDI, 1990-2010
(Millions of US
dollars)
2000000
Forecasted
Period
1500000
1000000
500000
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
-500000
Source: UNCTAD, 2008
5. IMPLICATIONS OF SWFs IN THE GLOBAL ECONOMY
The emergence of SWFs has two main implications for the global economy. Firstly,
SWFs are potentially significant sources of investment. Although investment figures
from SWFs in FDI are modest thus far, the potential that these funds have as investors is
enormous. In the present global economic scenario, with an expected decline in FDI
flows, developing and emerging countries are in an especially vulnerable situation.
Table 2 shows the high dependency that developing and emerging countries have on
inward FDI. Over the period 1990-2007, the magnitude of inward FDI represented 20.4
percent of GDP. In Table 2 we also observe that developing and emerging countries
have obtained nearly twice as high the rate of real GDP growth than their developed
economy counterparts. Since FDI has had a positive influence on the higher rate of GDP
growth for emerging and developing economies, a reversal of the growth trend in FDI is
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likely to have an adverse impact on these economies. To avoid such an impact, SWFs
have a role to play by contributing more prominently to FDI.
Secondly, SWFs are changing the world economic order. Despite the fact that some
SWFs have been established long ago, the surge of SWFs as investors is novel. In recent
years, states have used surpluses of current accounts to invest in the global financial
market. This new phenomenon has been label “New Mercantilism” since the public
sector is gaining involvement in corporate activity (Gilson & Milhaupt, 2008). The
widely promulgated notion that the public sector is not an efficient administrator of
resources is being ignored by the countries of origin of SWFs.
6. CONCLUSIONS
SWFs have gained significance in the present global economy, mainly due to the lack of
confidence of investors in the financial markets. SWFs have been acknowledged as
potential funding sources for the global financial system (Fernadez & Bris, 2009). This
paper proposes that by engaging in FDI, SWFs can play a very important role in
sustaining the global economy, especially to developing and emerging countries that are
vulnerable to FDI decline. SWFs are large and tend to be long-term investors,
characteristics that are compatible to FDI. The funds’ features can also facilitate better
endurance to volatility and market pressures. Our findings suggest that only 11 percent
of SWFs investment in FDI is needed in order to counteract the future decline of FDI.
Although much political controversy has surrounded the topic of SWFs, the recently
established Santiago Principles related to issues such as transparency and best practice
code of conduct can provide a clear understanding of the managements of SWFs.
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Policymakers and market player should therefore welcome these funds and use them as
tools of economic growth.
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19
2009 Oxford Business & Economics Conference Program
ISBN : 978-0-9742114-1-1
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