The human rights potential of sovereign wealth funds.

Author:Keenan, Patrick J.

When World Bank president Robert Zoellick called for sovereign wealth funds to invest one percent of their capital in Africa, (1) he was expressing what has become the conventional wisdom in two distinct ways. First, many scholars and policymakers have come to believe that poor countries are better served by private investment than traditional public development assistance. (2) For example, in 2006 private capital displaced official development assistance as the dominant source of finance for African states, and all indications demonstrate that states are unlikely to significantly increase official development assistance in the near future. (3) Indeed, Zoellick's suggestion echoed a similar call from the Organization for Economic Cooperation and Development. (4)

The second way that Zoellick's call reflected the conventional wisdom is the implicit assumption that a large infusion of wealth would benefit the people of Africa. If wealthy countries were to heed Zoellick's call, there would be an influx of up to $30 billion in new equity investment in Africa. (5) At first blush, this might appear to be a pure benefit likely to lead to economic growth and improvement in the welfare of people located in the world's poorest countries. But history has shown that infusions of wealth from wealthy countries to developing countries have not had their intended effect. For example, states that receive substantial revenue from the sale of natural resources like oil, gas, or minerals have often fared worse than similar states without such resources. (6) In many countries, development assistance has had very little impact on economic growth and many of the biggest recipients of foreign aid are less well off now than they were two generations ago. (7) There are compelling reasons to be skeptical over whether increased investment in Africa by sovereign funds promoted by Zoellick, even if heeded, will do much good, and some reasons to think that such investment might actually do harm.

In this Article we propose a mechanism designed to increase the likelihood that greater sovereign investment in Africa will actually benefit the citizens of recipient states. We take as our starting point an important facet of Zoellick's proposal. He suggested that one-percent of investments from sovereign wealth funds be channeled through the International Finance Corporation, (8) the branch of the World Bank responsible for private sector investment in the service of the World Bank's mission of reducing poverty. (9) Zoellick argued that the IFC's "access, knowledge, and capital" could "help other investors over the initial hurdles of investing in new equity opportunities in Africa." (10) Toward this end the IFC announced in December 2008 that it would create a "Sovereign Funds Initiative" to enable the IFC "to raise and manage commercial capital from sovereign funds for equity investments in some of the poorest developing countries." (11) The IFC has not yet released details about the new initiative, but it is at least an indication that the IFC is attempting to put Zoellick's words into action. The IFC has an extensive record of investing in Africa and providing advisory services for private investors, (12) which suggests that the IFC could add value to the investments of others by, for example, helping to identify viable projects or avoid untrustworthy partners. But the real potential of the Sovereign Funds Initiative to do good (or harm) depends in part on how it shapes the incentives and constraints facing the recipients of its investments.

Zoellick's proposal and the nascent Sovereign Funds Initiative have the potential to provide real benefits to poor people in Africa if structured appropriately, but must first resolve an important and difficult problem: additional wealth can reduce welfare. To describe this problem we use the term unconditioned wealth, by which we mean wealth owned or obtained by states unaccompanied by strong political or market conditions. (13) Examples include the massive influx of investments from China into Africa, typically free of social or political conditions, windfall revenues from the sale of natural resources, and development assistance delivered without meaningful oversight or attention to the uses its recipients make of it. (14) Without such conditions, wealth whether in the form of revenue from the sale of natural resources, development assistance, or sovereign wealth funds--can be used in ways that either do not meaningfully contribute to economic development or that actually reduce social welfare. (15)

In this Article, we propose that the World Bank transforms its Sovereign Funds Initiative into what we will call the "Multilateral Sovereign Investment Agency" (MSIA). The MSIA would be an investment vehicle through which sovereign funds would channel at least a portion of their assets under management. The management would then use these funds to make equity investments in enterprises in Africa. Our objective in proposing the MSIA is to learn from history. African states have received influxes of wealth many times before, but this wealth has not produced meaningful economic development or improved the lives of ordinary people. If the World Bank's new program is structured in a way that reflects the best available understanding of why previous influxes of wealth have done so little good, it has the potential to be a meaningful development tool and not just another abortive attempt to increase the amount of wealth flowing into Africa without considering the effects of that wealth on the welfare of people living in recipient states.

In Part I of this Article we situate our proposal in a broader theoretical framework. We show that infusions of wealth have not significantly contributed to economic development. To do this we rely on recent econometric studies of the efficacy of development assistance and the history of resource-dependent economies to show that transfers of wealth, standing alone, have not sparked economic development or enhanced welfare. After surveying the evidence, we show why wealth transfers have been ineffective: those transfers have not generated the incentives necessary to ensure that newly-attained wealth is used to benefit ordinary citizens rather than support the regime that happens to be in power. Resource wealth, development assistance, and, increasingly, investments from sovereign funds can all suffer from this malady. Wealth, regardless of the source, is unlikely to benefit citizens unless someone has the capacity to hold the managers of the wealth accountable if they waste or steal it. This accountability can come from an engaged citizenry that votes out of office politicians who mismanage the economy, or from financial markets that reward well-managed firms and punish those who are poor stewards of shareholder investment. Although this is not a new problem, the conventional approaches to managing it are inadequate because they assume a model of state decision-making that is inconsistent with the capacity, functionality, and will of many developing states. Many of the states most in need of development assistance or foreign investment simply do not adequately fulfill their legal duty to protect human rights, are led by unaccountable rulers, and have economies in which transparency is rare and corruption is common. (16) To fill this gap, we argue that, especially in the case of fragile or dysfunctional states, the protections to which citizens are entitled can be provided through transnational mechanisms designed to mitigate the problems associated with investment in these locations. Our proposed MSIA is an attempt to fashion a real-world solution, based on the best available research on wealth and developing states, to the problems that can come from investment in places where regimes use wealth to protect themselves, not enhance the lives of their citizens.

In Part II we describe our proposal in more detail. We argue that the MSIA could be created within the existing framework of the World Bank Group and sketch the broad outlines of MSIA. We deliberately do not attempt to specify every detail of the proposed new entity. Such operational details are certainly important, but must flow from the institution's theoretical framework rather than precede it. Many of our institutional design principles are drawn from the venture capital literature. Venture capital firms receive funds from outside investors and then invest those funds in very early stage businesses. (17) The venture capital market has evolved in such a way as to efficiently link capital with promising entrepreneurs. (18) We draw on this literature to better understand three main issues: the importance of actively seeking investment opportunities rather than passively awaiting applications, the need for investors to provide management assistance in addition to financial capital, and the potential for investors to help encourage ethical practices and compliance with the law. The venture capital model is useful primarily because it demonstrates how institutional design features can manage the incentives and interests of outside investors, fund managers, and portfolio companies in a way that can produce wealth for all.

In Part III we consider ways to implement our proposal and anticipate several possible complications or objections. Although there are many possible objections, we focus on three: that our proposal amounts to a return to ineffective and offensive conditionality; that our proposal does not account for the history of exploitation and abuse associated with corporate activity in Africa; and that our proposal is simply implausible.

Separate and apart from the roadmap provided above, a couple of brief clarifications and a statement of our normative premises are in order before moving on. First, sovereign funds (19) are asset management vehicles that invest public funds. In contrast to currency reserves...

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