Sovereign Wealth Funds: power vs principle

Fred Halliday
5 March 2008

The world's financial press has a new obsession to succeed the "sub-prime mortgage" craze of autumn 2007: "sovereign wealth funds", those state-backed investment bodies whose accumulating assets (often fuelled by the high energy prices of the 2000s) are roaming the globe in search of businesses to invest in, partner - and perhaps devour.

The enormous capital assets of these funds, and their potential influence on western markets and business, make the focus (and to a degree the fear) understandable; but some at least of the reporting and discussion about these new behemoths in the western media has a bias towards misunderstanding.

Fred Halliday is professor of international relations at the LSE, and visiting professor at the Barcelona Institute of International Studies (IBEI). His many books include Islam and the Myth of Confrontation (IB Tauris, 2003), 100 Myths About the Middle East (Saqi, 2005), and The Middle East in International Relations: Power, Politics and Ideology (Cambridge University Press, 2005)

Fred Halliday's "global politics" column on openDemocracy surveys the national histories, geopolitical currents, and dominant ideas across the world.The recent articles include:

"A 2007 warning: the twelve worst ideas in the world" (8 January 2007)

"Sunni, Shi'a and the "Trotskyists of Islam" (9 February 2007)

"Al-Jazeera: the matchbox that roared" (25 March 2007)

"The Malvinas and Afghanistan: unburied ghosts" (4 May 2007)

"Palestinians and Israelis: a political impasse" (4 June 2007)

"Crises of the middle east: 1914, 1967, 2003" (15 June 2007)

"Lebanon, Gaza, and Iraq: three crises" (22 June 2007)

"Yemen: murder in Arabia Felix" (13 July 2007)

"Eternal Euzkadi, enduring ETA" (3 August 2007)

"Cyprus's risky stalemate" (26 August 2007)

"Islam and Europe: a debate in Amsterdam" (1 October 2007)

"Justice in Madrid: the "11M" verdict" (5 November 2007)

"The mysteries of the US empire" (30 November 2007)

"The assassin's age: Pakistan in the world" (28 December 2007)

"Islam, law and finance: the elusive divine" (12 February 2008)The world's sovereign wealth funds (SWFs) are believed already to command assets worth around $3 trillion ($3,000,000,000,000) this figure is higher than (for example) the GDP of the United Kingdom. But the SWF phenomenon represents a major change in the world's financial and investment markets in a way that goes beyond even considerations of this epic (and often suddenly acquired) scale of riches. For its significance lies also in the intellectual and policy context of its emergence: namely, that after three decades of policy, propaganda, and hype about "freeing up markets", "reducing the role of the state", and "promoting the private sector", the SWFs embody a massive and unstoppable shift of influence back to what are in effect state-owned entities. Take that, neo-liberalism! The cunning of history has done it again.

The power the sovereign wealth funds have been suddenly seen to wield has panicked the world's older financial elites into flailing responses: an attempt at the World Economic Forum in Davos to negotiate a code of conduct with representatives of SWFs; Australia's consideration of stricter disclosure requirements; and the European commission's proposed "code of practice" (released on 27 February 2008) that is designed to guide investments from SWF countries in European and United States markets. A closer look at the last of these in particular highlights how far there is to go to before a strong, democratic response to the SWF's rise is developed.

Europe's pipedream

The European commission's code enjoins the SWFs annually to declare the origin and disposal of their assets; to abstain from using investments for political purposes; and to make their management structures transparent. The commission - keen to show that Europe believes in "open" capital markets, concerned to avert possible controls on capital inflow by key European states, and faced with the refusal of SWFs to sign a firm undertaking on these matters - thus opted for a "wish list". The commission's code appears naive and unworkable at best, deceitful (designed to fool domestic political audiences into thinking that something is being done) or complicit with unaccountable entities of enormous power at worst.

But it is worse: for the European commission, and western governments in general, are in no position to lecture the rest of the world on correct behaviour in such matters. The European Union itself proclaims open markets yet practices protection, in regard both to agriculture and significant areas of European trade and industry (over airlines, or France and Germany's gas and electricity giants energy companies, for example, open markets are forgotten (see Sarah Laitner & Ed Crooks, "Energy groups to escape split of assets" [Financial Times, 27 February 2008]).

As for the "good practice" now recommended to the SWFs - of not using their economic power for political purposes - this is something that western states have been doing from time immemorial. Economic activity and state interest have, after all, permeated the international market for as long as it has existed; the policy of sanctions against Cuba by the United States or Iran by the United Nations are current examples, while the history of oil companies in Latin America or the middle east in the past century is replete with many more.

Moreover, the European commission's proposals suggest a lack of awareness of the kinds of states and societies from which the SWFs are emerging. A state-owned investment fund will behave no differently to the states of which it is an appendix. Where there is no clear distinction between state and private interests and (a very condition of authoritarian and secretive political control) no clear evidence on who takes decisions within these SWFs or on what criteria - as is the case to a great extent in Russia, the Arab Gulf states, and China - it is not clear what the value of such a "code of practice" can possibly be.

The Gulf states in particular remain - for all the superhighways, skyscrapers, "knowledge cities" and glitzy conferences - controlled by secretive ruling families whose members regard the state, and its revenue, as theirs. An Arab ambassador recently put it to me that the minister of finance is, in effect, the private accountant of the ruler. No-one knows what the state's (or ruler's) income is. Oil revenues provide the basis of an informed guess; but when it comes to the often equally large income from capital invested abroad, and who controls it, there not even broad estimates exist.

The Gulf's other face

The new power of state corporations is most obvious in the energy market. The control by the state and its associated companies of production and distribution of key energy resources is in the middle east (as in Russia and China) a key source of state power. In this environment, the rise of the SWFs has international implications for inter-state as well as business relationships.

A powerful state may establish a degree of order in business and state affairs. But in the middle east and Russia (to name only these areas) the very nature of the "originating" state guarantees that there will be problems - for three basic market and regulatory preconditions for a sustainable working model are absent:

* there is no free press; hence no independent investigation or reporting on economic matters; the least that would happen if a Gulf Arab or Russian paper did print independent reports is that the advertising would dry up

* there is no rule of law; hence those with power in such countries are free to break contracts, renege on commitments, reappropriate assets, and even pilfer state funds, as they see fit. This is not going to change in the near future - indeed, the availability of new oil and gas revenues may only make it worse

* there is no independent parliament or political structure. The Russian elections of December 2007 (parliamentary) and March 2008 (presidential) show that legislatures count for little; of what remains, intimidation, forcible exile, imprisonment, or, more congenially, bribery, solve the rest. As for the Gulf states, all talk of a "transition" to democracy is nonsense: the rulers and their associates continue to make all the major decisions.

Also in openDemocracy on global finance:

Ann Pettifor, "Debtonation: how globalisation dies" (15 August 2007)

Tony Curzon Price, "The end of gentlemanly capitalism" (13 August 2007)

Christopher Harvie, "Gordon Brown vs Scotland: the balance-sheet" (17 September 2007)

Tony Curzon Price, "Gordon Brown: between rock and hard place" (18 September 2007)

Robert Wade, "The financial crisis: burst bubble, frayed model" (1 October 2007)

Avinash D Persaud, "The dollar standard: (only the) beginning of the end" (5 December 2007)

The requirement of the European commission's code includes the publication of statistics and data. Many western accounting practices are far from perfect in this respect, but in the middle east the situation is on another level of unreality: it is no exaggeration to say that no official and business statistics - on oil output or revenue, on state income or expenditure - are reliable.

The idea that a "code of practice" can address such systemic conditions is unreal. The kinds of practice Russia has engaged in - tearing up contracts with foreign firms, appropriating the business of figures like Mikhail Khodorkovsky of Yukos Oil - is evidence of the state's controlloing ambition; while the conduct of Saudi Arabia in relation to the al-Yamamah arms deal with Britain in the late 1980s - and the investigation into the bribery associated with this deal, which was abandoned in 2006 - reveal the way the House of Saud is used to doing business. The ideas of "transparency" and "accountability" beloved of western NGOs and progressive business advocates look irrelevant in this context (see Michael Hopkins, "The politics of responsible business", 8 June 2007).

The west's illusion

The notion of western-style controls regulating the policy and behaviour of, for example, Arab Gulf states is revealed too in the irrelevance of the idea of "insider trading" in the region. Such a concept has no purchase - all trading, contracts, and deals are based not on public accounts or commercial law (let alone on transparency) but on personal contacts. This was emphasised to me over three decades ago by the wise Iraqi economist, Mohammad Salman Hassan: "In the Arab world no contracts are institution to institution, state to state, or enterprise to enterprise. All are person to person. On this they rely."

For some western banks and businesses starved of funds, and facing the credit-crunch sparked in autumn 2007 by the "sub-prime" mortgage crisis in the United States, all this may appear good news. Their balance- sheets have (as the financial journalists say) "lots of holes to be filled". But these institutions - and western governments - which wish or are obliged to deal with SWFs have a clear choice here (see Ann Pettifor, "How debtonation dies", 30 August 2007).

They can enter agreements with SWFs (and other economic-political bodies in authoritarian states) with their eyes open - aware of the arbitrary adminstrative practices, occult financial sources and political interests involved. Such an approach is possible, many have followed it over the years.

They can also choose to leave the sovereign wealth funds to invest elsewhere; and to wait for the time - on present showing a pretty long way away - when both the SWFs and the wider political-financial systems of these countries meet better western criteria.

This is the choice. What western banks and businesses - and governments - should not do is to fool their publics, and possibly even themselves, about the realities of business, politics and influence in authoritarian states. The indulgence (or worse) towards money-laundering and fake accounting in the west, as well as the venality of many of those involved at the highest levels of business and power, may give a clear signal as to which path is the more likely. But at some point a dysfunctional global financial system needs bold action based on principle with long-term purchase, not mere calculation of short-term benefit. The SWFs are not going away. It is time to relearn for the old phrase about speaking truth to power.

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