In praise of foreign investment: best practices for the sovereign wealth funds.

• Author: Kimmitt, Robert M.

International investment in the United States fuels the U.S. economy by creating well-paid jobs, importing new technology and business methods, and providing healthy competition that fosters innovation, productivity gains, lower prices, and greater variety for consumers. President Bush reiterated the longstanding U.S. commitment to open investment in his May 10, 2007, "Statement on Open Economies," where he affirmed that "[O]ur prosperity and security are founded on our country's openness."

Sovereign wealth funds have attracted significant attention recently, due in large part to their rapid growth in number and size. This growth undoubtedly brings with it implications for the international financial system. However, it is troubling that these developments have also stimulated protectionist pressures that threaten the important open investment policies that allow for greater prosperity throughout the world.

Sovereign wealth funds, as large pools of government-controlled capital invested cross-border in private markets, do raise legitimate policy questions. While greater vigilance is appropriate, it is necessary to ensure a clear understanding of sovereign wealth funds, and consider carefully the implications of their growth, before prescribing a policy response.

WHAT IS A SOVEREIGN WEALTH FUND?

The U.S. Treasury has defined sovereign wealth funds as government investment vehicles funded by foreign exchange assets, and managed separately from official reserves. Sovereign wealth funds generally fall into two categories: commodity funds, which are established through commodity exports, either owned or taxed by the government; and non-commodity funds, which are typically established through transfers of assets from official foreign exchange reserves. Large balance-of-payments surpluses have enabled non-commodity exporting countries to transfer "excess" foreign exchange reserves to stand-alone funds.

It is important to distinguish sovereign wealth funds from other sources of sovereign investment, as many have often confused the activities of sovereign wealth funds with those undertaken by state-owned enterprises or other entities. While there are similarities among these entities, there are some important differences.

* International reserves are external assets that are readily available to and controlled by finance ministries and central banks for direct financing of international payment imbalances. Reserves are by definition generally...