WIESBADEN – State-controlled investments from overseas – so-called sovereign wealth funds (SWFs) – are now the subject of intense debate. The United States and France have made their fears known. In Germany, too, the debate centers on SWFs’ political and economic significance for the country’s future.

The problem has been exacerbated by the growing wealth of a number of countries, some of them formerly run by socialist or communist regimes. China, Russia, India, and the Gulf States have integrated their wealth into the global economy, to the immense benefit of world trade.

The openness of Germany’s markets makes them especially attractive to global trade. This openness will not change, yet there are some who now call for new safety fences – in other words, for protection.

For example, Russian investors are interested in taking a massive share in the German-French aerospace company EADS, which is already 5%-owned by a Russian bank. For many, this proposal has underscored a change in investors’ behavior. But what, exactly, has changed?

SWFs have been around for years. Among the first countries to invest their considerable state-owned funds were Kuwait, the United Arab Emirates, Norway, and Singapore. They invested, and still invest, their budgetary surpluses worldwide in government bonds and state-owned enterprises. Industrialized countries like the US and Japan also have so-called “reserve funds.”

Some of these funds are huge. In the UAE, the Abu Dhabi Investment Authority has estimated capital assets of $875 billion, making it probably the world’s largest state-owned investment company. In July 2007, another rich UAE fund, Dubai International Capital, bought 3% of EADS, after taking a stake of almost 2% in the automotive manufacturer Daimler in January 2006.

The Kuwait Investment Authority, also a state-owned fund, holds 7% of Daimler. Singapore possesses two SWFs – Temasek-Holdings, with capital assets of roughly $100 billion, and the Government of Singapore Investment Corporation, with approximately $330 billion. Both funds are invested worldwide, including with the port operator PSA.

Some funds are subject to considerable restrictions. Japan limits its state investments overseas to bonds, mostly those issued by the US. Until recently, China, which holds foreign currency reserves of more than $1.2 trillion (the world’s largest), followed this policy, too. But a $3 billion investment by the Chinese SWF in the US investment firm Blackstone suggests a more worryingly strategic investment policy, one that appears aimed at advancing its own industrial interests in certain markets.

Russia, where the line between state-controlled and privately controlled companies is often blurry, has demonstrated this strategy in Europe. Indeed, Russian investments in aerospace, telecommunications, and, most of all, in the energy sector, are the main source of concern for Germany.

Are state-controlled investors now aiming primarily for strategic rather than purely financial returns? Because SWFs’ resources are so substantial, it is advisable to take precautions to avoid becoming a target of politically motivated market manipulation, or becoming economically and psychologically dependent on foreign governments’ decisions.

Most Western countries already have instruments to deter foreigners from making unwanted investments, not only in defense industries, but also in other sectors. But, while Germany’s Foreign Trade and Payments Act protects against takeovers in the defense industry (though the law needs strengthening) elsewhere Germany has no system for examining investments by SWFs that may be strategically motivated.

The International Monetary Fund now encourages more transparency by foreign investors, and has plans for a code of conduct. The EU Commission also favors voluntary agreements aimed at strengthening transparency. Some SWFs now seem willing to engage in constructive dialogue.

But assessing potential threats is not easy. Most investments are seen to benefit a country’s economy, if not its security. We in Germany need to distinguish one from the other. Bills have been drafted that amount to amendments to the Foreign Trade and Payments Act and related regulations. While strengthening the act, they seek to avoid affecting the openness of the German economy.

Under proposed new legislation, if a foreign investment in a German company amounts to more than 25%, an assessment can be made of whether public order or safety might be threatened. In my view, this would address the concerns about SWFs, while not generally impeding investment because it would apply only in a very few cases.

Germany has also drawn up a plan to protect its industries that is modeled on US regulation. Since 1988, the US president can prohibit foreign direct investment if it is seen as a threat to national security. An additional control was introduced last year, so now all direct investments in which a foreign government is involved are scrutinized by the Committee on Foreign Direct Investment.

The principle of reciprocity should clearly apply to transnational investments. Germany is open to foreign investors, but in return we Germans demand the same market access abroad. Much remains to be done in this area even in Europe, as Germany’s own experiences with France and Spain demonstrate. In China and almost all Middle Eastern countries, foreigners are restricted to minority shareholdings and must contend with high import duties and numerous non-tariff barriers.

Protective measures must remain the exception rather than the rule. We Europeans must accept the challenges of global competition, and transnational investments are the basis of thriving economic development at home and abroad. Nevertheless, we must not allow ourselves to become the passive economic playthings of other nations, or of big state-owned enterprises. We must play an active part in shaping globalization, and that means crafting appropriate rules.

Copyright: Project Syndicate, 2008.  
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