Sovereign Funds: How the Communist Party of China Finances Its Global Ambitions, by Zongyuan Zoe Liu (Belknap Press, 288 pp., $39.15)
Sovereign wealth funds (SWF) have long been an anomaly in market economies. In 2008, the U.S. Treasury Department defined SWFs as “government investment vehicles funded by foreign exchange assets, which manage those assets separately from official reserves.” Such funds blur the traditional distinction between the state, which serves as market regulator and guarantor of rule of law and property rights, and the marketplace, in which private actors freely compete within parameters established by law and morality.
Countries’ reasons for creating such vehicles vary. Norway established its Government Pension Fund Global to invest tax and license revenue generated by its oil sector and grow its national pension funds. Other nations have used SWFs as instruments for pursuing industrial policy at one remove from direct government control.
These funds’ intrinsically political character raises questions about their marketplace operations. As state-owned entities, they will not have the same incentives and priorities as private actors. For example, SWFs are less likely to prioritize profit-maximization, and may not even be required to do so. Some, for instance, primarily function as another macroeconomic tool for governments to try and smooth the business cycle’s ups-and-downs. SWFs are also subject to political pressures, encouraging investment based on the regnant government’s current needs, which may not be the same as pursuing long-term economic growth.
Then there are concerns about these funds being weaponized by their government owners. What happens if a SWF decides, at the behest of its controlling government, to use its stake in a publicly traded corporation in another country to pursue specifically political goals in that nation? And what if the SWF’s owner also happens to be an authoritarian regime that does not consider itself bound by Western norms of government accountability and transparency? And what if that same government uses the SWF to serve geopolitical ends that clash with other states’ national-security interests?
Into this discussion enters an important new book, Sovereign Funds: How the Communist Party of China Finances Its Global Ambitions. Its author, Zongyuan Zoe Liu, Maurice R. Greenberg Fellow for China Studies at the Council on Foreign Relations, analyzes Beijing’s use of SWFs to leverage its own domestic and potentially geopolitical goals.
The word “leverage” is key. One of Liu’s central contentions is that China’s use of SWFs differs significantly from that of other governments. Indeed, she gives Beijing’s funds their own designation—Sovereign Leveraged Funds (SLF)—to underscore the distinction.
Liu notes that other SWFs are “primarily commodity-based funds established in oil-rich states.” China, by contrast, is one of the world’s biggest commodity importers. Why then, Liu asks, does China have its own sovereign funds in the first place? What are they being used for?
To answer these questions, Liu uses a straightforward approach: “follow the money, find the politics.” Forensically, she studies financial statements and similar documents, exploring “the capital structures and asset allocations of China’s sovereign funds.” Doing so, she contends, reveals “the politics that steered the flow of capital into China’s sovereign funds and the geopolitical motivations that drives the funds’ asset allocation.”
This is where leverage enters the picture. According to Liu, the funding schemes that bankroll China’s SLFs are based “on a series of complicated transactions, including debt-issuances and other forms of implicit financial leverage.” The funds, then, are a “political-economic innovation,” as they are capitalized by Beijing’s use of its own financial and political assets, instead of, say, taxes on commodity exports.
Politics and financial engineering are thus central to China’s SLFs. As Liu notes, their operations are shaped by negotiations across Beijing’s numerous bureaucracies—entities that do not necessarily act harmoniously. Foreign observers regularly underestimate the factionalism and rivalries within the Chinese Communist Party and China’s state apparatus. But whatever their masters’ conflicts, SLFs potentially give Beijing the option to exercise significant soft power in global markets, such as by using their equity-voting rights in firms located in strategic sectors (e.g., semiconductors), to influence decisions about where, for example, to locate production facilities.
China initially created its SLFs in response to the 1997 Asian financial crisis and revised them further after the 2008 financial meltdown to allow for greater diversification of investments and reduce the opportunity costs associated with low-yielding U.S. government securities. In both cases, Beijing considered the funds as tools for bringing national financial markets under greater state control and shielding them from turmoil.
SLFs provide more for China than risk management, however. Beijing has gradually applied the SLC model, Liu explains, to the working of its state-owned enterprises. Under Xi Jinping, SOEs have become Beijing’s capital-investment vehicle of choice to drive industrial policy and its Belt and Road Initiative (BRI). “In effect,” Liu observes, Xi’s “state-owned capital investment companies are SLFs mandated to focus on financing development in state-prioritized strategic industries like civil aviation, energy and mineral resources, nuclear power, and global shipping and logistics.”
While industrial policy is conceptually flawed and is proving dysfunctional in China, Western governments must nevertheless decide how to deal with Beijing’s SLFs in global markets. Certainly, the U.S. dollar’s status as the world’s reserve currency gives America a grip on what Liu calls “the plumbing of the global financial system” that China cannot presently match. She also argues, however, that Beijing’s SLFs could give it “an asymmetrical capability” in global markets, should it decide to deploy the funds aggressively as a form of soft power.
Part of the way forward, Liu suggests, is for Western states to recognize that China’s sovereign funds are not the same as other countries’ funds. Those nations, she says, must understand that Beijing has not yet deployed its SLFs to punish rivals, let alone as “crass geoeconomic power plays.” At the same time, Western policymakers should acknowledge that Xi’s efforts to recentralize CCP control over the economy in defense of national security have “eroded the autonomy of Chinese sovereign leveraged funds.”
This doesn’t mean that Western states should simply ban Chinese sovereign funds from operating in their markets. Doing so, says Liu, would “jeopardize the open market ideal of capital mobility in the West” and deprive companies of access to large sums of investment capital. Nonetheless, Liu also believes that a relatively open stance can be harmonized with Western governments’ Foreign Direct Investment (FDI) screening frameworks, which identify investments that constitute a national security risk.
What constitutes a national security problem can be slippery to determine. Sectional interests regularly deploy bogus claims to undermine domestic and foreign competitors. Could policymakers even achieve FDI harmonization, given Western states’ often differing assessments on national security?
Liu suggests that Western states may respond to China’s use of SLFs by developing their own “funds designed by the state, capitalized by the state, staffed by the state, and ultimately carry the implicit goal of achieving a state-prioritized economic agenda.” Such funds could, she posits, allow Western governments to enhance their own financial statecraft. Skeptics question, though, why Western SLFs wouldn’t fail like other state-run economic ventures. These enterprises often fall prey to rent-seeking, take excessive risks due to state backing, and support politically trendy but economically unviable causes.
Western governments should be cautious, then, about creating SLFs. However, policymakers must consider these funds’ role in China’s economy and their use in advancing Beijing’s political agenda abroad. As geopolitical competition heats up, America and other Western nations must develop appropriate policy responses. Ignoring this would be a dereliction of duty.
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