Monday, June 11, 2012

Christopher Balding: Singapore Government builds its SWF not through shrewd investments

TR Emeritus, June 11, 2012 (source)

People in around the world, though especially in Asia, talk about sovereign wealth funds as if they are the same the world over. However, there is one very significant dividing line in the type of sovereign wealth funds and it has profound implications for both economic policy and political theory.

The first sovereign wealth funds were created by oil rich Gulf states to invest their structural surplus in European and North American financial markets. By taking their long term structural current account surplus and investing foreign markets, the oil exporting Gulf states were limiting inflationary pressures and currency appreciation. So far, export focused Asian countries with sovereign wealth funds like China and Singapore have been following the same policies.

There is however one major difference between the oil rich Gulf states that first created sovereign wealth funds and the manufacturing focused east Asian states that followed in their foot steps. When an oil exporting country takes oil out of the ground, sells it, and deposits the proceeds in their sovereign wealth fund, there is no net change in wealth. Just because the oil is in the ground rather than sold with money in the bank to show for it, does not make that country any more or less wealthy. In fact, they would probably become more wealthy by keeping oil in the ground rather than selling it now.

The financial term used is that the country is “monetizing” (turning oil into money) their existing national wealth. Everyone focuses on the size of Abu Dhabi’s sovereign wealth fund, but Abu Dhabi is not any wealthier because their sovereign wealth fund has money in the bank rather than oil in the ground. A good comparison would be Bill Gates. If Bill Gates sells some of Microsoft shares turning them into cash, he is no more wealthy with cash rather than shares of Microsoft. His portfolio allocation has changed but his wealth is unchanged.

Countries like Singapore however do not have pre-existing national wealth in the form of assets like oil to turn into money. So where does Singapore get its “national wealth”? From the financial capture of the economic productivity of its population. As I have covered at length in the previous postings, Singapore has run a long term structural budget surplus but the relative enormity needs to be put into some perspective. Let me give you a a couple of ways to think about how much the government of Singapore has been “capturing” from its own population to use for its own wealth purposes.

1. From 1990 to 2012, the average government revenue to government expenditure ratio according to the IMF averaged 2.2. In words, that means that for every $1 SGD it was taking in from its people, it was only spending 45 cents! Less than half of all government revenue was actually spent on the people.

2. Consider the concept of “financial capture” or how much of the economy the government uses for its own purposes. If we add net government borrowing, government revenue, and the increase in foreign exchange reserves, the government since 1990 has on average captured 44% of GDP. This average 44% of GDP has been saved in vehicles like foreign exchange reserves, GIC, and Temasek. In other words, the government was capturing for its use and control 44% of the Singaporean economy every year since 1990.

3. It then becomes reasonable to ask how well did the Singaporean government did with that 44% of GDP the captured every year. To answer this question, let’s use a narrower definition of economic capture. Instead of using total government revenue which may include dividends and the like from Temasek or GIC, let’s use the operational government surplus representing only ongoing revenue from taxes and fees minus expenditures for government operations. From 1990 to 2010 alone, the government of Singapore captured in the form of operational government budget surpluses, foreign exchange increases, and borrowing $980 billion SGD. According to public Singapore records detailing their balance sheet and MAS reserves, Singapore controls assets of……$993 billion SGD. Given the Singapore governments 21 years of economic capture from 1990 to 2010 and their resulting assets under management, that would give them an annualized rate of return of .0007%. In other words, Singapore has returned less than 1/10th of 1% annually since 1990.

4. The enormous difference reveals itself in very real ways. While there are very real problems with excessive redistribution and a lack of entrepreneurial spirit in oil rich countries, the political philosophy of economic capture versus monetizing natural resource wealth reveals itself in how the state treats its own people. Here is a figure that illustrates the difference of how economic capture treats its people.

Comparing SWF state spending on health and education

According to the World Development Indicators from the World Bank, when we compare Singapore to other major SWF countries with more than a few years in existence, the differences are stark.

Singapore ranks last in education spending and last in public health expenditure. The government of Singapore is capturing the financial benefits of its citizens productivity and not providing the public goods and services its people have every right to expect.

Whereas oil rich states have enormous sovereign wealth funds because they won the geographic lottery, Singapore created enormous sovereign wealth funds by capturing the economic productivity of its people.

The government of Singapore has built sovereign wealth funds not through natural resource wealth or shrewd investments, but capturing the financial wealth of the people of Singapore. The people of Singapore work for the government.

Christopher Balding

*The writer is a professor of business and economics at the HSBC Business School at the Peking University Graduate School. An expert in sovereign wealth funds, he has published in such leading journals as the Review of International Economics, the Journal of Public Economic Theory, and the International Finance Review on such diverse topics as CDS pricing, the WTO, and the economics of adoption and abortion. His work as been cited by a variety of media outlets including the Wall Street Journal and the Financial Times. Prof Balding received his PhD from the University of California, Irvine and worked in private equity prior to entering academia.
The article first appeared on his facebook page:

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