Sovereign wealth funds: Should governments invest in private businesses?

President Trump recently signed an executive order to study creating a sovereign wealth fund for the US government. If the proposal comes to pass, it will create new problems without solving any old problems.

What are they? Sovereign wealth funds are a way for governments to own the means of production. They typically invest proceeds from state-owned natural resources into private businesses. My colleague James Broughel writes in a very clear explainer piece at The Dispatch that “More than 100 of them exist today, managing an estimated $13 trillion in assets.” Norway has the largest sovereign wealth fund, now worth $1.7 trillion after earning a 13 percent return last year.

More than 20 US states have sovereign wealth funds, most famously Alaska, which gives each of its residents an annual check from the returns, usually between $1,000 and $2,000. Trump’s executive order seeks to create a federal sovereign wealth fund. It is unclear at this point what the fund’s objectives or investment strategies would be, or if Congress will have a say.

Politicization. This is the most obvious problem with sovereign wealth funds. Though not a significant problem in Norway, you can bet your biscuits that Donald Trump would politicize a federal sovereign wealth fund if he succeeds in creating one. The federal government owns more than a quarter of US land and holds vast oil reserves and other natural resources that could provide capital for the sovereign wealth fund. Trump could potentially have a multi-billion-dollar tool to reward friends and punish enemies.

TikTok. For example, Trump has already floated using a sovereign wealth fund to buy TikTok. The Biden administration ordered Chinese-owned TikTok to find an American buyer, or be banned from the US. Trump paused the ban shortly after taking office, and wondered aloud about buying a 50 percent federal stake in TikTok.

While a sovereign wealth fund investment stake could save the platform, one wonders for how long. A US government-owned social network is unlikely to appeal to teenagers, and the privacy concerns are obvious and ongoing. Still, a Trump-directed investment would buy TikTok’s loyalty to Trump—which itself may limit TikTok’s appeal. And if TikTok displeases Trump somehow, he could yank away the lifeline.

It is not a stretch of the imagination to see Trump using a sovereign wealth fund to invest in Tesla, or tech companies whose CEOs he has tangled with in the past, or American manufacturing companies in need of help, like US Steel. He could then use those investments to extract favors. Politicization could also take more covert forms if this is too unsubtle.

The golden rule of politics. A forgotten rule of politics is to never give yourself powers you wouldn’t want your opponents to have. Republicans are failing this test right now on sovereign wealth funds, among other issues.

Republicans who are okay with Trump politicizing a sovereign wealth fund are unlikely to be so sanguine when Democrats next take power and politicize the sovereign wealth fund for their purposes. Progressives might use a sovereign wealth fund as part of whole-of-government initiatives to discourage fossil fuel use, subsidize industries they like, disinvest from industries they don’t like, or promote equity and climate policies that conservatives dislike.

To be fair, Norway and Alaska’s sovereign wealth funds are relatively apolitical. One cannot say the same of many Gulf countries, such as Saudi Arabia, which invests some of its funds in glamor projects like professional soccer teams and LIV golf. Critics argue these distract public attention from the country’s human rights abuses and mistreatment of women. Malaysia’s sovereign wealth fund, The Wall Street Journal reports, “channeled billions of dollars to support the lifestyles of a Prime Minister and his cronies.”

Why create one? Another good rule of thumb is to not enact a policy unless it helps to solve a problem. Trump shouldn’t create a sovereign wealth fund just to have one. It must have a purpose. And it needs to be better suited to that purpose than alternative policies. Let’s apply that standard to sovereign wealth funds and fiscal policy.

Deficits. Most countries with sovereign wealth funds have budget surpluses. The investments give governments somewhere to put the extra money. This would not be the case in America, which last ran a federal surplus in the Clinton administration. Projections show large and growing deficits as far as the eye can see. American sovereign wealth fund proponents instead see it as a deficit reduction tool, as well as a way to boost domestic saving rates.

The argument goes that money from federally-owned land and oil reserves can earn a higher return than they do now if the profits were managed under a sovereign wealth fund. The extra funds can help close annual spending deficits.

Let’s assume that this works as advertised. It still avoids the root problem of overspending. Sound policy works in part by choosing the right tool for the job. The right way to address overspending is not to hand some of the means of production over to Washington, it is to spend less.

Shoring up entitlements. This argument is similar to the deficit reduction argument. Social Security and Medicare have more than $73 trillion in combined unfunded liabilities over the next 75 years. They are the single largest driver of America’s long-run debt. The programs have structural deficits that will get worse over time, due to their pay-as-you-go structure.

Once again, reformers must choose the right tool for the job. If the root problem is Social Security and Medicare’s unsustainable pay-as-you-go structure, then the solution is to change that structure. A personal accounts model, such as more than 30 countries use, would solve the problem permanently.

A sovereign wealth fund, even one large enough to cover unfunded entitlement liabilities, would leave the structural pay-as-you-go problem untouched. It would also create new problems, such as increased federal ownership over vast swathes of the economy.

Likely uses of the funds. Congress is unlikely to actually spend sovereign wealth fund investment returns paying down entitlements. More likely, it will find new spending projects instead. It has already done this with the Social Security trust fund, which consists entirely of IOUs from previous government spending binges, which taxpayers will eventually have to cover.

Well-meaning sovereign wealth fund designers can put up all the guardrails they want. Spending advocates, who are just as well-meaning on behalf of their favored programs, will find ways around those guardrails. Congress has the power of the purse. If it creates the rules around a sovereign wealth fund, it can also change them. So can presidents, unless courts stop them, which is no guarantee.

The national debt. Let’s assume that the previous arguments about deficits and debt are wrong. Suppose that Washington somehow pays down the entire national debt and runs a surplus going forward. A sovereign wealth fund is still inappropriate policy.

Governments should have rainy day funds they can dip into during a downturn, or to help deal with a crisis, like an earthquake or a pandemic. Because of the risk of politicization, those rainy day funds should not be invested in private businesses, and instead should stick to government bonds. America’s national political climate is not Norway’s. Republicans and Democrats both have long track records of cronyism, and of tying strings to grants and investments.

Some fiscal hawks might argue that such surplus revenue should be returned to taxpayers, especially if a rainy day fund is well stocked, as in the Alaskan model. The federal government’s poor financial shape means this would likely be generations away, even under ideal conditions.

If the goal is to increase private investment, private investors have a much stronger incentive than government agencies to be alert to investment opportunities, rather than listen to lobbyists’ overtures. Because private investors put their own money at risk rather than taxpayers’ money, they also tend to be more prudent. Markets are a profit and loss system, and private investors tend to do better on both fronts than government investors, especially in the long run. Politicians rarely think beyond the next election cycle, which is one reason the entitlement crisis hasn’t been solved yet. Most private investors have their eye on retirement, or on passing along wealth to children and grandchildren.

It’s too early to tell if a federal sovereign wealth fund is on the way. Between the incentive problems, knowledge problems, and better alternative policies, it should die on the drawing board.