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Imagine you receive the news tomorrow that an unknown, distant family member has passed on and left you a bequest of a million dollars. What to do? Spend it immediately on luxury consumption – a round-the-world trip, perhaps – or invest it offshore and live off the returns, thereby smoothing your consumption and protecting the wealth for your own and your children’s futures?
There is another option, though: immediate investment in yourself, say by enrolling at Harvard for an MBA, thereby boosting your personal future income. Also, more educated parents tend to have more educated (and healthier and connected) children, thus boosting the prospects of future generations.
The third option, in a nutshell, is what three new papers in the Journal of African Economies suggest for developing countries that have jumped on the sovereign wealth fund (SWF) bandwagon.
SWFs are state-owned investment funds designed to preserve the high returns from non-renewable resources, like oil, for future generations.
A quarter of the world’s economies still depend on non-renewable resources, and more than half of them now have some type of SWF, including many recently established funds in Africa: consider, for example, Ghana (2011), Angola (2012), Nigeria (2012) and Senegal (2012). Others, like Kenya, Tanzania and Mozambique, are finalising SWF policies. And these funds matter: SWFs are a quarter of Algeria’s GDP, 40% of Botswana’s GDP and over 100% of Libya’s GDP.
There is good reason why countries are turning to this type of investment fund. SWFs have many good properties, as the experience of Norway since 1990 has shown. They convert temporary resource revenue into a permanent investment income. Best to keep it offshore, too, so as to avoid domestic inflation, real exchange rate appreciation and the contraction of other traded sectors (also known as Dutch disease).
And why invest locally when all profitable investment opportunities would presumably have been financed already at the world interest rate if the capital account is open? For these theoretical reasons, and because of the practical successes of SWF across the world – Norway, Chile, Saudi Arabia – many African countries followed suit.
But the authors of the three Journal of African Economies papers question this logic. They argue that many African countries do not have open capital accounts, meaning that there are still many profitable opportunities to invest in within Africa.
Why then send precious investment funds abroad when the highest returns can be reaped locally? To return to our earlier metaphor, why invest your long-lost family member’s bequest in stocks on the JSE, when you don’t even have a high school education yet? Invest in yourself first!
In Africa, the focus should be on infrastructure. One set of authors, Rabah Arezki and Amadou Sy, argues for three stages of financing infrastructure with the help of SWFs: First, involve development banks, who are often more informed about viable investment projects, in the first phase of large projects, which is often the riskiest. Second, offload more mature projects to arms-length institutional investors like SWFs. Third, develop an African bond market to facilitate this offloading.
The maintenance of infrastructure in Africa is of particular concern, and SWFs can play a role here. Arezki and Sy calculate that at least one-third of Africa’s investment needs are in maintenance, and suggest bundling construction and maintenance services in private-public partnerships as one way to overcome this (by making sure builders have an incentive to minimise maintenance costs).
South Africa does not have an SWF, although the idea of a supertax on mining profits has been mooted before. If we did decide to go this route, as many of our neighbours seem to be doing, the question becomes: who gets to choose how the funds are spent?
Anthony Venables and Samuel Wills, another set of authors, argue that it should be done through the usual budgetary process; in SA’s case, that will be through Treasury. Another author, Joe Amoako-Tuffour, argues instead for a more independent SWF that takes direct positions in investments. Whatever strategy is followed, it is important to remember an additional reason for SWFs: to minimise the misuse of resource rents by politicians.
There is no better example of this than the second smallest nation in the world: the Pacific island of Nauru with a population of 10?000. In their paper, Samuel Wills, Lemma Senbet and Witness Simbanegavi note how the island, made up almost entirely of phosphate, was the richest country in the world in the 1960s.
Two-thirds of the phosphate revenues were invested in a trust, which peaked at $100 000 per person. In 2004, after some questionable investment decisions that included a cruise ship that never left port and a Lamborghini for the police chief (to drive on an island of 21km2), the fund had only $3?000 left per person.
The lesson is that we do not live in a world of benevolent dictators. Politicians make bad decisions often, and state-owned investment funds should be structured to avoid their misuse. But going to the extreme and parking all resource returns offshore is also not the answer for many African countries.
Investing in local infrastructure, and its maintenance, may provide far higher returns for future generations – if the possibility of misuse can be curtailed.
Johan Fourie is associate professor in economics at Stellenbosch University.
This article originally appeared in the 8 September edition of finweek. Buy and download the magazine here.
