When Sovereign Funds Don’t Work

Some resource rich countries are so corrupt that setting up a commodity fund for managing resource rents is pointless.

I’ve been saying this for years now: when it comes to resource rich countries using sovereign wealth funds to successfully manage resource revenues and overcome the resource curse, strong institutions and good governance are indispensable. In short, governments should not be setting up a sovereign fund if they do not already have the necessary institutional ingredients to actually make it work. As evidence of this, I’d like to direct your attention to a neat new paper by Antony Goldman entitled “Poverty and Poor Governance in the Land of Plenty: Assessing an Oil Dividend in Equatorial Guinea”.

The Goldman paper is well worth reading, as it depicts a dire governance situation in Equatorial Guinea and, in so doing, offers a useful case study of a failed (or, at least, failing) sovereign fund. Here’s a bit of background: the country is rich in natural resources — GDP per capita is above $11,000 — but these riches are enjoyed by only a small proportion of the country. Indeed, three quarters of the population apparently live in poverty. Here’s an interesting blurb to describe why this is the case:

“Equatorial Guinea’s management of natural resource revenue has earned it international notoriety. Allegations of a local elite with an apparent taste for multimillion dollar mansions abroad and wasteful spending at home have dominated reporting of the country since the oil boom began...Money is managed by a tight-knit group of family and ethnic group members, but governance is filled with intrigue and unexplained changes...The government has developed a recent track record for savings, but there are no safeguards on those funds or mechanisms to ensure that they last...There is little evidence of what goes into the Malabo government’s plans for managing oil and gas revenues. Neither the President nor the ruling party make substantive public disclosures about the budgeting process.”

That’s pretty bad. But none of the this stopped the country from (or the international community from pushing the country towards) setting up a sovereign fund:

“Equatorial Guinea has a Fund for Future Generations (FFG), but there is little transparency about its management. At its creation, the government pledged to deposit 0.5 percent of annual oil revenues into a special account at the regional central bank, the Banques des Etats de l’Afrique Centrale (BEAC). In 2008, the World Bank confirmed that the government had been following through on its promise (Toto Same 2008), but now the government’s statistics on money held at the BEAC appear to present global figures rather than a breakdown, suggesting that the money could be spent without safeguards – and that the rhetoric behind the initiative is designed to satisfy an external constituency while the substance of policy and practice on the ground effectively remains little changed.”

This was the same problem we saw in Chad — the international community pushed the idea of a sovereign fund to ensure inter-generational savings, but the institutional and governance frameworks required at the local level to make such a policy effective simply did not exist. As we now know, some resource rich countries are so corrupt that setting up a commodity fund for managing resource rents is pointless. So here’s my takeaway from all of this: An SWF isn’t a mechanism to bypass weak institutions and poor governance at the local level. Rather, it should be the manifestation of these effective institutions and good governance.

Anyway, for some more details, here’s blurb from a paper I wrote on this topic:

“One would hope that a SWF could be set up such that it is insulated from instability just as one would hope that the fund could help underwrite political and economic stability. But it is important to reinforce that establishing a SWF and sustaining its capacity over the long term confronts the same problems already constraining economic growth and development. The prevailing institutional and political reality cannot be ignored. For example, political elites and interest groups may try to use the fund for their own gain or clientelistic activities. For resource-rich African countries, the scope of challenges in this regard is wide. Such prevailing conditions may even constrain the establishment of a SWF not to mention the employment of the fund for development goals. For example, the ruling elite may find it useful to establish a SWF, but only as a means of maintaining its power or financing pet projects.”