The middle ground is rapidly disappearing on the question of sovereign wealth funds, as highlighted in two distinct views in Tuesday’s FT. First, Jeffrey Garten, Juan Trippe professor of international trade and finance at the Yale School of Management, asks how Merrill Lynch, Citigroup, Morgan Stanley and other big banks could turn to foreign governments for financial lifelines with so little public controversy. Perhaps, he says, it is because the “dangerous broader context of what is happening – the rise of ‘state capitalism’ – is not sufficiently recognised.”Indeed, the reality may be that the era of free markets unleashed by Margaret Thatcher and reinforced by Ronald Reagan in the 1980s is fading away. In place of deregulation and privatisation are government efforts to reassert control over their economies and to use this to enhance their global influence. It is an ill wind that blows.
Just look, says Garten, at the “quantum increase of regulation nationally and globally”. The issues of product and food safety will spawn new and highly complex trade regulations. The blizzard of energy and environmental legislation is mind-boggling. The subprime debacle will probably lead to new rules for every type of institution that securitises debt, he warns.
Evidence of the rise of state capitalism can also be found in increasing public sector ownership of natural resources, notes Garten. “Government-run energy companies from Saudi Arabia, China, India and Brazil now own more than 80 per cent of the world’s reserves. Russian and Chinese government entities also look poised to seek global domination of aluminium and iron ore”.
Finance is being taken over too, warns Garten. “Beijing’s state-controlled banks are now moving into the US and taking large stakes in important banks such as South Africa’s Standard Bank. Last year sovereign wealth funds in the Gulf and east Asia invested more than $60bn in foreign financial institutions and the amounts are rising rapidly”.
These trends are hardly surprising, Garten adds. “Since the mid-1980s the world economy has been on steroids, resulting in exceptional growth and wealth creation. Now governments are reacting against the excesses of free markets” – even after turning a blind eye towards dangerous financial imbalances.
The very countries that had little history of free markets accumulated massive reserves, while the US accepted big deficits and became hungry for money from anywhere it could find it. In a world economy in which international institutions are weak, governments backed by huge reserves have discovered they have significant leverage in markets. That is especially true in downturns, such as now.
The implications worry Garten. While prudent regulation in selected areas can be justified, the new zeitgeist is likely to produce too much government intervention, too fast – and less productivity, less innovation and less growth.
Greater regulation will open up new chances for trade disruption. Beyond that, trade and finance will “become more politicised as governments leverage the companies they control as instruments of foreign policies,” he warns.
Unfortunately, the trend is unstoppable, says Garten. But, he suggests, officials from market-friendly finance ministries could acknowledge the momentum behind the rise of state capitalism to demand their own governments produce impact statements that spell out all the costs of new laws and regulations. They could commission reviews in the IMF and WTO of the implications of growing government intervention. Think-tanks, too, should gear more research to state capitalism, he suggests.
On foreign investment by state-owned companies or SWFs, the US and the EU need to set common standards for transparency, ownership and reciprocity. The rules should be enforceable – “not milk-toast, voluntary guidelines”.
In the late 18th century, capitalism was replacing feudalism. In the 20th century, freer markets won the day. Now, concludes Garten, the world is flirting with another big transformation in the philosophy and rules of global commerce. “Unlike the changes of the past, this new trajectory does not represent progress”.
An FT editorial on Tuesday, however, says the role of SWFs in bailing out investment backs is not only welcome but “will be necessary if the US economy is to avoid a prolonged slump”.
A populist backlash against SWFs may follow, the FT warns, particularly from US politicians who argue that the funds will try to gain influence over US companies and are potentially susceptible to “non-economic” interests.
The main flaw in this argument, says the FT, is the “absence of any proof to back it up”.
Because they lack transparency, there may be problems with the way sovereign wealth funds operate. But they have every financial incentive to be good stewards of the assets they buy. Their investment may even be an opportunity for US firms, as China’s investment in Barclays, the UK bank, promises to be.
Rather than regard sovereign wealth with suspicion, the US would do better to embrace it as a much-needed shot in the arm.
The recycling of capital from countries that have trade surpluses with America is essential to prevent it sliding into recession. The alternative would be a higher cost of capital for US banks. Further capital injections are, moreover, “likely to be greeted with enthusiasm by markets”, the FT adds.
There are other advantages. For the banks, sovereign wealth may be a more benign presence on the shareholder list than many hedge fund managers. The funds gain from diversifying narrow portfolios. Most want to avoid controversy and may bypass sensitive sectors. But America’s banks will need to show they are deserving. A public backlash would serve nobody’s interests.
True, perhaps, but just how America’s banks will show they deserve the supposedly “no strings attached” capital from SWFs is anybody’s guess.