The economic effects of sovereign wealth funds in oil exporting countries
By Dr. Salem Boubakri and Dr. Ahlem Trabelsi
Oil price volatilities have attracted the attention of several researchers since the first oil shock of 1973, because of their damaging macroeconomic and financial effects that undermine economic growth. Several empirical studies have focused on analyzing the effects of oil price volatilities on the real economies of developed countries, particularly the United States (Kilian and Vigfusson, 2011a; Herrera and Karaki, 2015, among others).
The literature on oil dependent economies highlights the harmful effects of oil price volatility. When governments are dependent on natural resources, their revenues will fluctuate accordingly, complicating development planning. Indeed, resource revenue volatility can lead to inefficient spending of revenues and an uncertain investment environment that dampens the level of investment and impedes economic growth. Oil price volatilities also lead to insufficient investment and a higher probability of debt crises due to overspending following a revenue windfall and incurring debt when revenues decline (Bauer, 2013). Therefore, government expenditures become procyclical, aggravating the impact of oil price volatilities on the investment climate. Mohaddes and Raissi (2018) argue that volatility in commodity terms of trade are associated with lower accumulation of physical capital, lower total factor productivity and, consequently, fewer possibilities for technological progress and weaker growth.
Several empirical studies have focused on the change in the relationship between oil price volatilities and GDP growth. Hamilton (2003) highlighted the asymmetric effects of negative and positive oil shocks. Mork (1989) showed that oil price increases have a proportionally greater (and negative) impact on economic activity in OECD countries than the corresponding positive economic impact of oil price decreases. The intensification of the asymmetric response of economic output to oil price shocks has been confirmed in several studies. Kilian and Vigfusson (2011) noted that several empirical studies support the hypothesis of asymmetric effects in the transmission of positive and negative oil price shocks to real economic growth. However, many of the studies quantifying these asymmetric responses are based on an empirical framework such as a VAR model or dynamic correlations that do not provide a valid and accurate answer to the central question of asymmetric effects.
Recently, new econometric tools have been used at a global level to explain the oil price decline in June 2014 by measuring the impact of oil price shocks on real economic cycles as well as at a specific scale. Indeed, recent empirical results showed significant progress in terms of: (i) quantifying the asymmetry in the relationship between oil price volatilities and real economic activity in the United States; and (ii) increasing recognition of the importance of using non-linear models. However, many uncertainties remain in terms of modeling and the potential role of the transmission channels from the oil market to the economy.
Our contribution in this study is to quantify the effects of oil market volatilities on real GDP in some net oil exporting countries through the transmission channel of sovereign wealth funds (SWFs) growth. Many oil exporting countries have established SWFs to mitigate the volatility of oil prices and provide a buffer to sustain government spending during periods of falling oil prices.
SWFs were originally created as stabilization funds to absorb economic shocks. Therefore, they can play an important role as a transmission channel between the oil market and the real economy. Mohaddes and Raissi (2018) argue that SWFs reduce the uncertainty arising from fluctuations in commodity prices and their impact on resource revenues. They explain that SWFs can help the government to stimulate the economy by increasing public capital expenditure when private investment is low. Koh (2016) shows that government expenditure volatility is lower in countries with stabilization funds, thus implying that resource funds tend to dampen fiscal procyclicality.
SWFs can also be used to mitigate the negative consequences of natural resource curses. SWFs are particularly interesting, as their investment targets aim to maximize financial returns to ensure permanent revenues for the country and respond to economic development needs (Bernstein et al., 2013). These funds represent an investment opportunity, especially in energy exporting countries, in which they can have multiple goals. Indeed, countries relying on energy commodity exports can create SWFs to diversify reserve portfolios, generate greater returns, and fight the effects of “Dutch disease” (Corden and Neary, 1982).
The theoretical literature on the resource curse contains many mechanisms that may explain why higher natural resource revenues may lead to less economic growth and why resource rich countries generally have worse economic development than countries with fewer natural resources. For instance, Torvik (2002) shows that more natural resources generate a negative multiplier effect that results in lower income through rent seeking. Indeed, as natural resources increase, investments in firms become less profitable, encouraging more investors to seek rent rather than taking the risk of investing. Torvik (2009, 2018) has used resource curse theories to discuss why natural resources induce prosperity in some countries but stagnation in others. He argued that there is a robust negative correlation between the share of resource exports in GDP and economic growth, and there may be a causal effect between resources and growth. However, we still do not know the extent to which resource abundance causes slow growth.
Kilian (2017) investigated the impact of the United States’ fracking boom on Middle Eastern oil exporters, especially Saudi Arabia. He demonstrated that the Saudi Arabian government has dealt with the decline in oil prices (i.e., since June 2014) by relying on its financial reserves in SWFs. However, during an extended period of low oil prices, the precautionary savings in the SWFs would be exhausted and no alternative measures, such as fiscal retrenchment, appear to be in place.
To sum up, we point out that the challenge with SWFs is that they reduce economic distortions, which undermine their benefits. There are concerns about (i) their management, strategies, and transparency, (ii) the efficiency of their investments, (iii) the profitability of foreign investments on the domestic economy, and (iv) the most important issue, their capability to dampen the effect of oil price volatilities on the real economy.
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 Based on the classification of the Santiago Principles proposed in October 2008, SWFs can be classified in five categories that have their origin in either commodities or other assets. In our study, we are only concerned with SWFs resulting from commodity exports.
 For a complete literature on description, rules, and macroeconomics effect of SWFs, see Truman (2008), Mohaddes and Raissi (2018) and more recently AlKathir et al. (2020).
Illustration : Alexey Hulsov, 4 avril 2020, Pixabay Licence (libre d’usage).