Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday 1 February 2013

Safe Assets and Sovereign Wealth Funds: Norway, the UK and Oil

Miles Kimball was ahead of me in thinking about the safe asset problem. It was interesting that we seem to have reached similar conclusions thinking about very different things. He focused here on the immediate problem of what the Fed was buying as part of QE, whereas I was in a fictional (and perhaps utopian) world centuries ahead when the government owned net assets rather than net debt. A sovereign wealth fund can be helpful in both cases: the monetary authority can ask the fund to make the decisions about what assets to buy, and the fund can provide the assets to either match against government debt or help reduce the need to raise taxes to pay for government spending. A short list of his posts on this issue can be found here. They are especially relevant for the UK if you are worried that all the Bank has been doing with QE is buying Gilts.

The discovery of a finite natural resource is an ideal experiment in teaching macro. It uses the intertemporal consumption model to illustrate why current account deficits (pre-extraction phase) and surpluses (extraction phase) can be optimal things for economies to have. I’m afraid I use the discovery of North Sea oil as my example, and luckily there is still enough there that no student will ever say to me ‘so there was once oil under the North Sea?’ [1] But my excuse for showing my age is that it also allows a very nice contrast between what happened in Norway and what happened in the UK, and a nice way to throw Ricardian Equivalence into the teaching mix.

For anyone who does not know, Norway invested (and continues to invest) most of its tax receipts from North Sea Oil into a Sovereign Wealth Fund (which used to be called the Petroleum Fund, but is now rather misleadingly called the Government Pension Fund.) It was not a token exercise - its assets are around $654 billion, which is larger than Norway’s GDP. The UK, mostly under the Thatcher government, decided instead that it was better to give this money to the people, so it cut taxes using its receipts from North Sea Oil. Under Ricardian Equivalence, where agents who care about their children as themselves also internalise the government’s accounts (which include any oil fund), what the UK and Norway did will have identical effects.

They will have identical effects, because those receiving the tax cuts will invest much of the proceeds so that when the oil runs out, they (or their children) will be able to carry on as if nothing had happened because they can consume the returns from those assets instead of revenues from the oil. It is a classic example of consumption smoothing: saving or borrowing to smooth out the impact of variations in income. We know people do sometimes try and consumption smooth, because most save for their retirement. Yet did UK consumers save the proceeds from oil to create their own personal equivalents of Norway’s oil fund?

The data is not very promising. While the UK ran some current account surpluses in the early 1980s, there were also deficits, and by the late 1980s there were only (large) deficits. We almost got back to current account balance in the late 1990s, but have had large deficits ever since. No obvious sign of saving the revenues from oil there. Looking at our net foreign asset position is initially a little more hopeful, as it’s positive value increased in the first half of the 1980s, but that disappeared for good by 1990, and the UK is now a net debtor. Perhaps a more detailed study might come to different conclusions, but I do not know of any that does.

Nor did the government set a very good example. It should at least have been running down its net debt position while North Sea oil revenues were at their peak, so that it could reduce the need to raise distortionary taxes once the money ran out. Net government debt did fall in the second half of the 1980s, but it went straight back up again in the early 1990s, suggesting this was just a cyclical effect.

What has this got to do with safe assets? Only this. One of the arguments against establishing a Sovereign Wealth Fund is that, even if the fund is nominally independent, governments cannot be trusted not to interfere, and so it is better to give the money to the people. Miles Kimball discusses this ‘libertarian’ view here, and I alluded to the ‘communism by the back door’ idea at the end of my earlier post. That, presumably, was part of the justification for not establishing an oil fund in the UK in the 1980s. I suspect if you asked most people who were born in the UK in the decade after North Sea oil started flowing whether the UK or Norway made the better decision, they would say Norway. In Norway, I suspect they would say Norway too.[2] The evidence seems to suggest they would be right. So in this case at least, not setting up a Sovereign Wealth Fund for ideological reasons was a mistake.

[1] How to use resource revenue is a critical issue for many developing countries, and is discussed in many places by my colleagues at the end of my corridor, including here.

[2] Of course many would not have a view, but I cannot help feeling that strengthens the case for a Fund. Interestingly it seems
that it is the right in Norway that want to spend more of the Fund today, and the left that (financial crisis aside) want to stick to their 4% rule.  


  1. 1. It is imho an illusion that:
    a) governments will be pro-saving (effectively that is what a SWF is). Political science indicate that politicians are having mainly a next election focus.
    Norway looks an exception. The other countries with SWFs have relatively stable semi- or whole dictators running the show. Unless you consider state pensionfunds as a SWF.
    b) 2/3th of the people live from paycheck to paycheck. In countries like in the West where you would have a split of the proceeds rather on numbers than on wealth (which seems reasonable as such)'saving' will therefor not work.
    Unless you would find it perfectly acceptable that large percentages of the aged live below a lot of levels. They will spent and lateron be compensated otherwise one way or another (basically assuming a save-assumption (and subsequently a future minimum level of income assumption) leading to more future spending (and very likley taxes).

    2. There is option 3. Dutch variety (probably the one we see most in practice. That the windfall is used for shorter term spending. Not so much lower taxes, but more gov spending.

    3. Option 3 is probably an even bigger risk than the UK-option. First of all it happens more often. The only Western country now in the position to establish a SWF (Australia)for instance is going Dutch.
    Plus it gives the population a false sense of security. At least all in the UK knew what they had to do and say 1/3 or so actually did it (at least 1/3th). But the 2/3th can more easily (still extremely difficult)be confronted with this.

    4. In practice we see a mix, also in Norways. Norway's government is also spending much more than it would have done without oil.

    5. The problem with so many of these things is how to keep governments under control financially. Basically they have say a 2 year focus and are effectively supported by large parts of the electorate in that (the majority that lives from paycheck to paycheck). While a lot of decisions are very long term. Say financing of pensions decisions now will have effects more than 1/2 a century from now.

    6. Basically it is the problem with all rebalancing, Keynesian stuff being a large part of it. There is always a good reason for stimulus, but there is never a good reason for the opposite (for politicians at least).
    And that goes through the whole political system. The RE bubble was not only a miss by regulators and the financial sector. Risks should at least have been very clear for the people on charge.
    It looked to be also very convenient for a lot of people in charge. Keep the bubble alive keeps the voters happy as it gives them a false sense of wealth and a false sense of growing spending power and gets politicians reelected.

    7. A main problem with eg Keynsian policies. The idea behind it sounds very reasonable only the execution is often rubbish. Basically similar like having bankers being accountable for a small part of potential losses but being entitled to a much larger part of the gains. Leveraging risky behaviour. Uncontrolled (and most is) politician behaviour is simply leveraging risky behaviour as much as pre crisis the rules timulated risky banker behaviour.

    8. Problem being how to make a 'system' that works. You need democratic legitimation. Which limits the possibilities of an unelected expert forum. But it should also avoid the negatives of short-term focus (by politicians) and even shorter term than that focus by the majority of voters. You run a country aground otherwise.
    Focus in macro is way too much on the mechanism and not how it should work in practice.

  2. I would suspect that what Norway did also had an additional benefit that the UK missed. By exporting all that capital (generated from the North Sea), Norway also mitigated some of the affects of the Dutch disease. Also, having oil, Norway tried to go up the value chain by not just producing oil, but also refining it and creating heavy industries that help extract it (the country has some of the most superb engineering firms for deep sea drilling). The latter technological spillover from oil production was promoted and nurtured by the government - something that would never happen in the UK or US where ideology trumps reason.

    The UK missed all these opportunities. I would suspect that oil (and the financial sector) produced the Dutch disease, helping to explain why the UK does not have a mittalstand when it used to be a country of shopkeepers. It also explains the deindustrialization of the UK. It also explains why the country was so reliant on finance - an industry that employs few, but adds a lot of value to aggregate GDP (which means median income families are probably worse off than his counterparts on the continent). Ultimately, this type of inequality of wealth also generates inequality of power - hence why Osborne's austerity drive, influenced by the wealthy, was really a premise to shrink the state than rather have any concern for the real economy.

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