Among the big ideas that have been suggested to support the UK’s economic recovery is the creation of a sovereign wealth fund. As reported in the Daily Mail, officials are understood to be 'actively considering' a £25bn taxpayer-backed fund. “Under the plan, the Government would buy shares in key businesses outside of London as part of Prime Minister Boris Johnson's agenda to strive to 'level up' the entire country after lockdown ends.” Lord O'Neill, who is pushing this idea hard, has dubbed it the ‘Good Bank’ – but is this a good idea?
Levelling up is an unusual justification for the creation of a sovereign wealth fund. Traditionally, they’re used by commodity-rich nations to invest surplus income, diversify income streams and accumulate savings for when the commodity revenues dry up. It’s a way of counteracting Dutch Disease, whereby an increase in the economic development of a specific sector (e.g. the discovery of large oil reserves) can lead to a decline in other sectors as they sap talent and resources. With high government borrowing and North Sea oil production in steady and perhaps terminal decline, the traditional justifications don't make sense for the UK.
Even when they are started for the traditional reasons, sovereign wealth funds aren’t a surefire bet, but a few have performed well. Singapore’s GIC, the Abu Dhabi Investment Authority, and Norway’s Government Pension Fund Global are envy-inducing. But due to the logic of their creation, their remit is nothing like the proposed ‘Good Bank’. Singapore's GIC, for example, is diversified across multiple asset classes, invests purely overseas, and is mandated to beat inflation.
GIC is run with strict investment discipline, as chief executive Lim Chow Kiat explains:
“So the team have to make a proposal that what they are going to do will be better than the beta that they have. Their job – their key performance indicator, their bar – is to do better than what they have foregone. There is a cost to it: the opportunity cost of foregoing beta and the riskiness of the investment. It’s not enough that you do better than beta. You have to deliver something risk-adjusted to account for the additional risk you have taken on.”
In Boulevard of Broken Dreams, Josh Lerner argues that sovereign wealth funds face the same problems as other government schemes to promote venture activity: “the temptation to invest too locally without considering broader options, a failure to assess performance, and pressures to invest in the ‘pet projects’ of political leaders and their associates.”
Lerner cites the example of the University of Rochester to illustrate the point that goals are often in conflict – for example, between supporting local economic growth and running a successful fund. In the early 1970s it had the third largest endowment in the country, after Harvard and the University of Texas. However, the administrators decided to invest locally in companies such as Kodak and Xerox, which suffered in the 1970s and 1980s. As a result, the university had to dramatically downsize in the mid-1990s. “In this case, the goal of supporting local businesses ran counter to the goal of buffering the university against financial shortfall,” says Lerner.
Looking at successful sovereign wealth funds around the world, it’s easy to think that imitation is the best policy. It’s particularly galling for some, as perhaps the UK could have used its bonanza from North Sea oil, or even its prizatizations, to endow what might now be a significant fund. However, there is a question of whether North Sea oil and privatizations helped fund tax cuts that had a greater positive impact on the economy than a fund would have.
For GIC’s Lim Chow Kiat: “[T]he unique thing is not what most people see. The most unique thing is the governance arrangement. The government makes it very clear and is very disciplined about that – to leave GIC alone to just focus on making money. It is hard for a lot of governments to do that.”
At the extreme, a fund buying shares in key local businesses risks corruption, as Malaysia’s domestic-focused 1MDB scandal shows, but more likely it would be a sub-optimal allocation of resources like the University of Rochester. The UK already has a flourishing venture capital industry and UK Research and Innovation has a budget of £7 billion to fund innovation. There’s a lot the government can do to support more innovation – opening up pension funds to venture capital would be a small change with potentially large consequences.
Sovereign wealth funds are a nifty policy solution for countries with surplus income and large oil reserves. They might also be a useful way for countries like Turkey, Romania, India and Bangladesh, who are creating a new breed of sovereign wealth funds whose role it is to support the growth of their investment industries, while potentially circumventing red tape and other local political challenges – although the jury is still out. The UK has neither the surplus income, nor the local problems that couldn’t be better circumvented through established institutions like Innovate UK and British Business Bank. A sovereign wealth fund shouldn’t be applied crudely to the UK without first considering if there are better policy levers and established institutions to meet our stated goals.