Madelaine Drohan recently provided an excellent commentary on why SWFs are created and why resource-rich Canadian provinces should follow the SWF trend:
Why is this a good idea? If done right—which means sticking to commitments to put money in, investing it wisely and resisting temptation to raid the fund—this use of non-renewable resource revenues fulfills at least three important purposes: it ensures that future generations will benefit; it stabilizes government revenues; and it dampens the impact commodity price movements have on a currency (when fund assets are invested abroad) and on wage and price inflation (when assets are invested in neighbouring provinces or countries).
This isn’t a new idea. Kuwait used its petroleum revenues to set up a sovereign wealth fund in 1953. There are now about 45 such resource-backed funds around the world, and more are being created all the time.
Norway sets the gold standard. Since 1996, it has put almost all of its revenues from oil and gas into a separate savings fund, drawing only on the income for government spending. Its fund is now worth more than $600 billion. Alberta, which started its fund 20 years earlier, has a mere $16 billion set aside because it quickly lost the will to make regular deposits. Quebec, which began in only 2006, has saved even less.
The brief commentary also responds to several objections to SWFs:
There are four main objections to such schemes. We need the money now. We should pay down debt first. Future generations already benefit from current spending on education and health. And, politicians are never able to resist temptation and will surely raid the fund. These are valid objections, but none is insurmountable. True, setting revenues aside is not an attractive idea at a time of deficits and debt. The solution is to do it gradually, setting out a time frame for putting an increasing share of resource revenues into a fund. Norway, for instance, set up its resource fund in 1990, but only made the first deposit in 1996. Political temptation can be curtailed by erecting sturdy barriers against raids. The Canadian Pension Plan Investment Board, which has never been raided, can serve as a model.