Public Footprints in Private Markets

Sovereign Wealth Funds and the World Economy

Robert M. Kimmitt

From Foreign Affairs, January/February 2008

Summary:  The massive growth of sovereign wealth funds -- pools of capital controlled by governments and invested in private markets abroad -- should not cause alarm. But it does raise legitimate questions for the United States, pointing to the need for new policy principles for both the funds and the countries in which they invest.

ROBERT M. KIMMITT is Deputy Secretary of the U.S. Department of the Treasury.

Even in the wake of some high-profile controversies -- such as the Chinese national oil company CNOOC's attempted purchase of a U.S. oil company or Dubai Ports World's possible takeover of operations at U.S. ports -- the vast majority of foreign investments reviewed by CFIUS continue to be processed expeditiously and without controversy within a 30-day investigation period. In 2006, there were approximately 10,000 mergers and acquisitions in the United States. Of these, 1,730 were cross-border transactions, and only 113, or roughly 6.5 percent, came before CFIUS. None of these transactions was blocked.

Congress passed a new CFIUS law in the summer of 2007 that mandates additional scrutiny and higher-level clearances for transactions involving foreign government control. However, this additional scrutiny comes in the context of provisions for greater certainty for investors, more accountability from the U.S. administration, and better communication between CFIUS and Congress. It also reinforces the disciplined approach that allows CFIUS to focus its attention on the very small share of cases that raise genuine national security concerns.

There are also non-national-security issues associated with the potential increase in foreign public ownership of private firms. First, the U.S. economy is built on the belief that private firms allocate capital more efficiently than governments. Second, foreign governments could conceivably employ large pools of capital in noncommercially driven ways that are politically sensitive even if they do not have a direct impact on national security. Examples would include investment decisions made to promote a given foreign or social policy. Third, there is the potential for perceived or actual unfair competitive advantages relative to the private sector. For instance, a government could use its intelligence or security services to gather information that is not available to a commercial investor. With a sovereign guarantee, a SWF could also obtain or extend financing (if needed) at interest rates that a commercial investor could not. It is also possible for a SWF to take an indirect approach by channeling foreign exchange through domestic SOEs, which in turn invest abroad.

FIRST, DO NO HARM

How should the United States and other recipient countries of SWF investments respond to their increased importance? First, they should take care to do no harm. They should recognize that SWFs have not caused significant financial-market disruption and that the overwhelming majority of SWF investments do not involve partial or complete control of firms. And even for investments that do involve control, there is little evidence of any ulterior foreign policy motives in practice.

Recipient countries should also maintain their unequivocal support for international investment. President George W. Bush reaffirmed this long-standing U.S. policy in his "Statement on Open Economies" on May 10, 2007, the first such statement in 16 years. The benefits of market-driven free investment flows are many. There are static gains as U.S. businesses are able to expand by tapping international capital. From a macroeconomic perspective, investment inflows help finance the country's current account deficit. There are also important dynamic gains from the resulting business competition. Prices of goods and services decrease, their availability and variety increase, and the productivity and efficiency of domestic businesses rise.

The U.S. economy benefits significantly from inward and outward foreign direct investment. U.S.-headquartered multinational companies that invest abroad have contributed strongly to overall productivity growth in the United States and thus to rising U.S. living standards. U.S. multinationals accounted for over half of U.S. productivity growth between 1977 and 2000 and for half of the increase in U.S. productivity growth between 1995 and 2000. During this five-year period, productivity at U.S. multinationals surged, growing six percent annually.

Research also shows that foreign-owned firms in the United States employ 4.5 percent of the work force and account for 5.7 percent of output, 19 percent of U.S. exports, 13 percent of research-and-development spending, and 10 percent of all U.S. investment in plant and equipment. These firms also pay more than 30 percent higher compensation (wages and benefits) on average than do their counterparts in the rest of the U.S. economy. And 30 percent of these jobs are in manufacturing, compared with fewer than 10 percent of all U.S. jobs.

The biggest threat to the benefits of foreign direct investment would be a slide toward investment protectionism. As Treasury Secretary Henry Paulson has noted, protectionism, in both investment and trade, would undermine U.S. growth and job creation. And this is not just a U.S. concern: there is also rising protectionism in Europe and other industrialized countries and in emerging markets. Often this investment protectionism is masked by claims of national security concerns or driven by individual firms that might lose out in a given deal.