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BW Businessworld

Invasion, Yes Invasive, No

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Of course, protectionism will surely be heard about when the Congressional races become more prominent after the summer. Such local contests often feature arguments about closing factories and unfair foreign competition. Unemployment has just begun to rise. By summer, it could be a lot higher.

On the other hand, primary campaigns in previous elections have been more protectionist than the general election, because in primaries candidates fight for their party’s core supporters, which pushes them towards extremes. So if there is little or no protectionism now, the danger may be about to pass.

There are three likely explanations for the absence of protectionism. One is that in the party most prone to populism, the Democrats, Hillary Clinton and Barack Obama are such charismatic figures that populists such as John Edwards had no chance.

The second is contained in an even more recognised phrase: subprime. If the US slides into recession, it will be due to the billions of dollars lost by banks in the subprime mortgage market. Unlike in earlier slumps, there is no point in blaming foreigners. The problem lies at home.
Moreover, part of the solution is coming from the countries that protectionists expected to gain popularity by attacking: China, other Asian countries, and the Arab world. Their state-run investment funds, known as ‘sovereign-wealth funds’, have provided more than $70 billion in new capital to the big Wall Street commercial and investment banks.

My former employer, The Economist, described this as “the invasion of the sovereign-wealth funds” in its 19 January 2008 issue. These huge funds, which economists at Morgan Stanley reckon command total assets of $2.9 trillion, may be saviours today but soon enough, says The Economist, rich-country politicians will start to attack them for gaining too much control over strategic investments and for harbouring political motives. Protectionism may be silent today, goes this argument, but tomorrow it will be noisier than ever.

The Economist has influential company. Larry Summers, who was Treasury Secretary under Bill Clinton, wants sovereign-wealth funds to be regulated in a special way. Last September, I attended a debate about this between Summers and Jose Angel Gurria, the former Mexican finance minister who now heads the OECD in Paris.

In the debate, Gurria took the position of an economic liberal: open capital markets were vital for global prosperity, and it would be counter-productive to place obstacles in the path of such investment funds. All that was needed was a code of conduct. Nonsense, said Summers, it would be naïve to rely on codes and transparency. In his view, such funds cannot be relied upon to act like normal, profit-seeking investors. They might want to secure foreign technology for national strategic interests, for instance.

The Economist did not argue for special rules covering sovereign funds, but it did agree that these funds are likely to provoke a backlash amongst rich-country politicians.

So, what are the public-policy implications of these funds’ rise? If oil and commodity producers continue to build up vast balance-of-payments surpluses and if China continues to accumulate foreign-exchange reserves, these funds are going to get bigger.

This issue needs to be sliced up in two ways. The first: for whom might these funds be a problem? The second: what type of behaviour would merit special rules? If you look at the recent rescue of Wall Street banks, the “for whom” question matters greatly. For the US government and for taxpayers, the rescue is not a problem; it has saved them huge sums. The problem is really one for the banks’ shareholders and creditors, for these investments have diluted shareholders’ rights and in some cases established preferential claims on the cash flows of the banks.

The “what behaviour” question is also illuminated by the bank rescue. All the investments in those banks are minority stakes. Only if the sovereign funds were to buy controlling stakes could their behaviour become an issue.

The right conclusion is that sovereign-wealth funds require no special rules as long as they buy only minority stakes. Only when they take controlling stakes should they be given special scrutiny or be subjected to special rules.

The author is a former Editor of The Economist.
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Businessworld Issue 25 Feb-3 Mar 2008