SOVEREIGN WEALTH FUNDS, Part I The forgotten issues by Hossein Askari and Noureddine Krichene
Articles on sovereign wealth funds (SWFs) have become all the rage. The size of
a number of these funds is touted to be an important force in international
finance - a potential force for stability or instability.
Some pundits are sounding the alarm bells. Some countries, especially the
United States, want to establish rules and regulations defining and limiting
the global policies, practices and operations of SWFs. Although SWFs of
Singapore (US$330 billion), China ($300 billion) and Norway ($300 billion) are
the list, those of Abu Dhabi ($875 billion), Saudi Arabia ($300 billion),
Kuwait ($70 Billion) and Qatar ($60 billion) have received the most attention.
Yet, in the case of these Persian Gulf funds there is little attention afforded
to the three most basic questions. questions here, with the management of these
funds examined in a follow-up article.
First, some background. SWFs in these countries are financed from oil and gas
revenues and are intended to provide a buffer and a source of income when oil
and gas boom tapers off. With oil and gas prices at record levels, the size of
these funds can be expected to increase rapidly over the next few years. This
will be especially the case for Abu Dhabi and Qatar given their growing
revenues and small indigenous populations, and thus their inability to absorb
Given that oil and gas revenues have been the source of these funds, the
ownership of these SWFs must therefore mirror the ownership of oil and gas
reserves. In the case of these countries, current and future generations of
citizens own the oil and gas reserves. Accordingly, all citizens, both current
and future generations, should benefit from revenues (royalties) arising from
mineral resources. Besides already enjoying a minimal tax burden, current and
future citizens should expect higher incomes from economic growth supported by
natural resource depletion.
How does this translate into policy? The task for these governments is clear.
First, governments must take control of all minerals on behalf of the
citizenry, and especially on behalf of future generations who have little say
today. Second, governments must make sure that they do not waste depleting
mineral resources because they are the birthright of all citizens and must be
used productively. Third, as minerals are depleted, governments must make sure
that they use their revenues in such a way that all citizens today and for all
future time receive similar real benefits.
One way to achieve the goal of equal benefits for all individuals and
generations could be for the governments to use the revenues to fuel rapid
economic growth, accompanied by economic justice (avoiding significant income
disparities) as oil and gas (the birthright of all citizens) have funded
economic prosperity. This is easier said than done.
All of the major oil exporters of the Persian Gulf experienced negative per
capita average annual growth from 1975 to 2002, despite their significant oil
and gas revenues: Kuwait (-1.2%), Saudi Arabia (-2.5%), the United Arab
Emirates (-2.8%), and Iran (-0.4%). The only region that fared worse than the
Middle East during this period was the sub-Sahara.
While the considerable rise in oil prices since 2002 has undoubtedly generated
economic growth and increased gross domestic product and GDP per capita (even
reversing the long-term negative trend from 1975), their sub-par economic
performance shows that revenues have been wasted and the direct connection of
recent economic growth to oil revenues clearly underscores the continuous
dependence of these countries on oil.
Even if they could achieve stellar growth rates, governments would still have
to make sure that citizens received equitable benefits from oil and gas
depletion, not an easy task. Although the quality of the data is poor, the
strong indication is that the available measure of income distribution (Gini
coefficient) for the Middle East and North Africa regions consistently lags
behind those of other country groups. Any objective pair of eyes would also
support this conclusion.
It would seem that the current system in these countries has failed and that
their poor economic performance and their income distribution provides plain
testimony and justification for change. The majority of the people in these
countries have suffered the devastation brought on by ongoing sub-par economic
performance, warfare and poverty. So what can be done to prevent further waste
of these nations' oil and gas wealth? Can future oil revenue be used to benefit
all citizens? Here is where sovereign wealth funds, or SWF, come in.
Given this reality, it would seem that the best way to achieve this goal is to
find a mechanism to distribute an equal real payout from current and future oil
and gas revenues to each and every citizen, living today and for all time. This
may sound an impossible task but it can be readily approximated and updated
yearly to reflect changes in the oil and gas markets and country populations
(the beneficiaries). It would avoid wasteful government expenditures, be they
subsidies or military expenditures.
Individuals would be in a position to spend their money as they wished, the
most efficient way to transfer benefits to the citizenry. Governments would be
forced to become more efficient if the SWFs were made even more significant by
gradually taking away oil and gas revenues from governments and placing them
directly into SWFs.
A number of countries and states (within countries) have adopted funds for
future generations. To varying degrees, these funds generally take but a small
percentage of revenues of exhaustible resource depletion; their operations are
generally opaque; and in some cases there are no rules for the portion to be
saved, and in cases where there are rules, the rules for the portion to be
saved, its management, and/or its distribution are highly imprecise.
The de-linking of oil revenues from government coffers may avoid other problems
normally associated with the exploitation of depletable natural resources, such
as high level of military expenditures. Military expenditures, in turn, could
be associated with a number of other adverse developments.
Civil wars and conflict are more likely if military expenditures are high; and
the risk of civil war is higher if natural resource endowment is double the
average. Civil wars in turn lead to higher military expenditures, capital
flight, loss of social capital, slower economic growth, and more poverty and
refugees, an almost impenetrable vicious circle.
We believe that a fund that in time takes all revenues away from the government
should be an integral and primary component of any template to manage natural
resource depletion. Iran has in fact passed a law to wean the government from
oil and gas revenues over a period of 10 years, a law that the government has
In estimating what SWFs could achieve for Persian Gulf citizens, we have been
very conservative. We have taken the average of oil and gas revenues for the
years 2001-2005, a projected growth in oil and gas revenues of 4.5% per year, a
rate of return on safe investments of 6% per year and historical population
growth rates of 2% per year, and have estimated in a model what the real annual
payouts, defined as increment in real per capita income to each citizen over 18
years of age, would be if future oil and gas revenues were invested in country
Commentators have failed to look at what SWFs could achieve for the citizens of
these countries. They just look at their size and even very rarely look into
implications for the rest of the world where these funds may be invested.
Broadly speaking, the absolute payout figures and as a percentage of GDP per
capita are very impressive and could make a tremendous difference in income of
the average citizen. But there are significant variations between the six
countries (we have added Iran and Iraq into the mix as their citizens could
also benefit from an SWFs). Based on our results, the six countries fall more
or less into three categories: (i) Iran, (ii) Iraq and Saudi Arabia, and (iii)
Kuwait, Qatar and the UAE.
Iran has the lowest payout figures. In the case of Iran, the annual payout to
every citizen over 18 would be nearly 40% of today's GDP per capita. Although
Iran's population is large (more than the other five countries combined, while
Iran’s ex-patriot population is relatively small), its oil output is less than
twice Kuwait's or the UAE’s. Iran's payout potential could improve dramatically
(more than double over a decade) if it began to exploit more aggressively its
natural gas resources, as has Qatar. But still these estimated annual payouts
to every citizen are dramatic in affecting their quality of life, while
promoting economic equity.
Iraq is a unique case. It is a country that has gone back to the 1950s and is
essentially starting all over again. It appears poorer than Iran because it has
little in the way of modern infrastructure but it is likely to be richer than
Iran in terms of per capita endowment of oil. In our opinion, our estimated
payout figure of 160% of per capita GDP (in part because its GDP per capita is
low today), though dramatic, is still an underestimate if Iraq can move towards
peace and improved governance. Iraq could approach the category of a Saudi
Arabia in terms of oil revenues per capita, while learning from the past
economic policy mistakes of Iran and Saudi Arabia.
For Saudi Arabia, the payout potential is significantly higher than that of
Iran or even Iraq (given Iraq’s current status and Iran’s slow exploitation of
its natural gas resources). Although for Saudi Arabia our estimated payout as a
percentage of GDP per capita is on the same order as that of Iraq's (170% of
per capita GDP), it is much more in absolute terms because of Saudi Arabia's
significantly higher GDP per capita; given their high GDP per capita, this is
the case for all Gulf Cooperation Council Countries (GCC). The annual payout in
Saudi Arabia would dramatically improve the lives of citizens, as Saudi
economic growth faltered during 1986-2000. At the same time such a SWF would
provide a better guarantee of economic benefits to future generations.
Kuwait, Qatar and the UAE are in another league. Simply said, they are rich
beyond belief. Their annual payouts, even under the most conservative
assumptions are just staggering. Our calculations do not include their existing
investments in their SWFs.
In the case of the UAE the numbers are simply huge. Most of these funds do not
belong to the entire UAE, only to the Emirate of Abu Dhabi. The entire
citizenry (of all ages, not just over 18) of Abu Dhabi is about 250,000. They
are all effectively multi-millionaires based on their existing foreign
investments alone (if you believe the $875 billion estimated size of the Abu
Dhabi fund). Our estimated annual payout for citizens of the UAE is nearly 600%
of current GDP per capita (a GDP per capita figure that is already about the
highest in the world along with Qatar’s). If the income from existing
investments were added to current (and projected) oil revenues, then the annual
payouts for the citizens of Abu Dhabi would again increase significantly.
Qatar, with its rapidly growing gas revenues and citizenry of about 200,000, is
likely to be in the same fortunate position as Abu Dhabi. Today, our projected
annual payout figure for citizens of Qatar is over 1,000% of current GDP per
capita. Kuwait still has significant foreign investments, even though it spent
a large portion for its liberation and reconstruction. Our estimated annual
payout is 650% of GDP per capita.
In the case of Kuwait, Qatar and the UAE the issue is not so much that citizens
of these countries are likely to starve any time soon. Instead the issue is
that the wealth of nationals should be preserved for them and for future
generations in an optimal, equitable and transparent manner. This depleting
wealth should not be seen as the birthright of rulers to use in order to buy
loyalty, to waste on grandiose projects and military hardware, and to support
shortsighted economic policies.
Looking at the spectrum of countries, in Kuwait, Qatar and the UAE, such SWFs
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
can 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 still make
a significant difference for the average family and reduce corruption and the
take of the elite.
Careful consideration needs to be given in each country, on a
country-by-country basis, to the management of SWFs and to designing a system
that affords appropriate incentives to individuals to live productive lives and
to contribute to national economic and social prosperity. In our next article
we will look into management issues of these SWFs.
Hossein Askari is professor of international business and international
affairs at George Washington University. Noureddine Krichene is an
economist at the International Monetary Fund and a former advisor, Islamic
Development Bank, Jeddah.