Sovereign wealth funds are more fashionable than ever. In Latin America, some countries – Chile, Trinidad and Tobago and Venezuela – have had theirs for some time. Brazil – with reserves of over $250bn – joined them last year. In 2011 Peru, Colombia, Panama and Bolivia took moves towards creating their own.
All these countries have abundant reserves and face the challenge – the Andean countries in particular – of managing the raw materials boom. Their investments and exports are highly concentrated in sectors offering little value added or job creation. Hence their desire to use their present abundance to take a leap forward in production and diversify their economies, an issue that remains pending. Sovereign wealth funds may be strategic vehicles to this end – as long as the institutions are nurtured by first-rate professionals and processes.
Felipe Larraín | Finance Minister of Chile
This is precisely what was masterfully achieved by Chile. In the middle of the last decade it created two sovereign wealth funds with stringent rules and top-level human and institutional capital, making Chile a worldwide reference for SWFs on a par with Norway. Chile’s funds are governed by a strict fiscal responsibility law, adopted in 2006. This requires an amount equal to 0.5 per cent of GDP of the previous year’s surplus to be allocated to the first fund (the pension reserve fund); the next 0.5 per cent of GDP of the surplus is used to capitalise the central bank; and whatever surplus remains goes to the second sovereign wealth fund (the economic and social stabilisation fund).
Several lessons can be learnt from this successful Latin experience. The first is that this sort of instrument is inseparable from serious fiscal policy. The second is that very rigorous regulatory and institutional frameworks are needed, especially in emerging countries. Lastly, it is equally essential to provide the institution with the right human capital. In the Chilean case, both in the previous government and the present one, we are talking of professionals and economists of great value, starting with the two finance ministers who supervised (Andrés Velasco) and supervise (Felipe Larraín) the funds, together with those directly in charge of them in the previous government (Eric Parrado) and the current one (Ignacio Briones) – all of them with doctorates in economics, long academic careers and ample professional experience.
However, the Chilean funds are not strategic funds, i.e., aimed at encouraging business development and diversification. Some emerging countries such as the Emirates, Singapore and Malaysia created strategic funds with the clear aim of contributing to business development and production diversification. One might imagine Chile equipping itself with a third sovereign fund for this purpose. The beauty of the Chilean model is that it potentially offers the right structure of incentives to do so: the present three successive layers for fiscal surplus allocations could be joined by a fourth for a strategic fund. This would only be activated if the first three items are fulfilled. Therefore it would only be activated above a significant level of fiscal surplus. The strategic fund could then operate as a fund of funds, pushing production diversity towards technology sectors or even mining industry suppliers, for example.
In fact it is remarkable that, although it is the world’s leading producer and exporter of copper, Chile has no world-scale multinational supplying that industry with vehicles, diggers or explosives. They are all foreign: Caterpillar and Joy Global are listed in New York, Komatsu in Tokyo, Atlas Copco and Sandvik in Stockholm, Boart Longyear, Leighton and Orica are Australian, the Weir Group is Scottish and Hatch is Canadian. They are all large-scale creators of high value-added jobs. Coldelco, the world’s biggest producer of copper, employs just under 20,000 people – a great deal fewer than the Swedish multinationals Sandvik (44,000 employees) and Atlas Copco (30,000 employees). Its income is seven times lower than that of Caterpillar, which also employs almost five times more people than the Chilean multinational.
Latin America’s abundance of natural resources is undoubtedly a blessing. On average, more than 50 per cent of the region’s exports are linked to raw materials. Having raw materials is not a curse; it all depends what you do with them, as shown by the cases of Norway, Australia and Canada. In the end, the question we must ask a country that has lithium, for instance (as do Chile, Argentina and Bolivia), is: Where do you want to be in the value added chain? In the market of lithium as a raw material, estimated to be worth a little over $1bn a year? Or the lithium battery market, estimated at a little over $25bn? Or even the electric car market, which will use lithium batteries and is estimated to be worth $200bn?
Part of the answer to this question may lie in the creation of strategic funds. The experience of other countries, particularly in the Arabian Peninsula and southeast Asia, can serve as a model in this regard. In the case of Latin America, Brazil has, through the BNDES, effectively operated with an instrument of this sort, producing giants such as Vale and Petrobras in raw material industries, but also investing in cutting-edge industries such as the case of Embraer in aviation. Today, countries like Peru and Colombia, heavily dependent on raw materials, are adding their voices to the debate about whether or not to create sovereign wealth funds. They could look to Chile to design strategies but also further afield, to the Emirates, Singapore and Malaysia, and think of a model that would enable them to set up a strategic fund – something that Chile itself should consider too.
Javier Santiso is professor of economics at the ESADE Business School and director of the ESADE Centre for Global Economy and Geopolitics (ESADEgeo)
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