Natural Resource Management and Policy

Series Editors: David Zilberman · Renan Goetz · Alberto Garrido

Ole Bjørn Røste

Norway’s
Sovereign
Wealth Fund
Sustainable Investment of Natural
Resource Revenues
Natural Resource Management and Policy

Volume 54

Series Editors
David Zilberman, College of Natural Resources, University of California,
Berkeley, CA, USA
Renan Goetz, Department of Economics, University of Girona, Girona, Spain
Alberto Garrido, ETS, Technical University of Madrid, Madrid, Spain
There is a growing awareness to the role that natural resources, such as water, land,
forests and environmental amenities, play in our lives. There are many competing
uses for natural resources, and society is challenged to manage them for improving
social well-being. Furthermore, there may be dire consequences to natural resources
mismanagement. Renewable resources, such as water, land and the environment
are linked, and decisions made with regard to one may affect the others. Policy and
management of natural resources now require interdisciplinary approaches including
natural and social sciences to correctly address our society preferences. This series
provides a collection of works containing most recent findings on economics,
management and policy of renewable biological resources, such as water, land,
crop protection, sustainable agriculture, technology, and environmental health. It
incorporates modern thinking and techniques of economics and management. Books
in this series will incorporate knowledge and models of natural phenomena with
economics and managerial decision frameworks to assess alternative options for
managing natural resources and environment.

More information about this series at http://www.springer.com/series/6360

Ole Bjørn Røste

Norway’s Sovereign Wealth

Fund
Sustainable Investment of Natural Resource
Revenues
Ole Bjørn Røste
Department of Sociology and Political Science
Norwegian University of Science and Technology
Trondheim, Norway

ISSN 0929-127X ISSN 2511-8560 (electronic)

Natural Resource Management and Policy
ISBN 978-3-030-74106-8 ISBN 978-3-030-74107-5 (eBook)
https://doi.org/10.1007/978-3-030-74107-5

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Acknowledgements

I want to thank an anonymous reviewer for very useful comments, and editor Johannes
Glaeser for discussion and suggestions regarding the outline.
Further, I thank MA student at NTNU Isak Riksheim for assistance with figures,
and Monica Janet and her production team for their thorough effort.
Any remaining errors or weaknesses are the sole responsibility of the author.
All views presented are those of the author.

v
Contents

1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.1 The Government Pension Fund Global (GPF-G) is
a Norwegian SWF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
1.2 The Risk-Return Trade Off in Investments . . . . . . . . . . . . . . . . . . . . . 8
1.3 Investments Abroad . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
1.4 Investment Management Performance . . . . . . . . . . . . . . . . . . . . . . . . . 12
1.5 Is the GPF-G Sufficiently Sustainable, Ethical and Profitable? . . . . . 15
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
2 Natural Resource Sustainability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
2.1 Non-renewable Natural Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
2.2 The Rationale for a Petroleum Fund: A Windfall Gain . . . . . . . . . . . 30
2.2.1 The Tempo Commission . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
2.2.2 What is the Fair Share of Future Generations
in Resource Wealth? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
2.2.3 Time Transformation of Income Through Global
Capital Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
2.2.4 Constraints on Investment by the GPF-G . . . . . . . . . . . . . . . . 49
2.2.5 The Goals and Constraints of SWFs . . . . . . . . . . . . . . . . . . . . 52
2.3 Petroleum Wealth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
2.3.1 Windfall Resource Gains—Some International
Experience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
2.3.2 The 1970s and 1980s: Expectations Followed
by Increased Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
2.3.3 The 1990s: Expansion of the Petroleum Wealth . . . . . . . . . . . 64
2.3.4 The 2000s: SWF Growth and Professionalization
of Wealth Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
3 The Economics and Politics of SWFs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
3.1 Limiting Spending: Norway’s Fiscal Rule . . . . . . . . . . . . . . . . . . . . . . 81
3.1.1 Implications of the Low-Yield Environment Since
2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86
vii
viii Contents

3.1.2 Investors Chasing Incremental Yields . . . . . . . . . . . . . . . . . . . 88

3.2 How to Spend Petroleum Wealth—Procurement Versus
Handouts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
3.2.1 How the Wealth is Spent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
3.2.2 Effects of the SWF on Income Distribution . . . . . . . . . . . . . . 92
3.2.3 Could Transfers Strengthen the Public’s Involvement? . . . . . 92
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
4 Investment in Practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
4.1 Geography and Asset Class Allocation . . . . . . . . . . . . . . . . . . . . . . . . 97
4.1.1 Asset Classes, Factors, and Financial Risk . . . . . . . . . . . . . . . 99
4.1.2 Political Risk Across Asset Classes and Space . . . . . . . . . . . 114
4.2 The Management of Large Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118
4.2.1 How Investment Markets Work . . . . . . . . . . . . . . . . . . . . . . . . 118
4.2.2 The Time Horizon of the GPF-G . . . . . . . . . . . . . . . . . . . . . . . 122
4.2.3 Implications of Size for an Investment Fund . . . . . . . . . . . . . 126
4.2.4 Large Size Tends to Dampen Returns . . . . . . . . . . . . . . . . . . . 129
4.2.5 Stylized Facts of Active Fund Management . . . . . . . . . . . . . . 130
4.3 Asset Allocation, Management Style, and Returns . . . . . . . . . . . . . . . 133
4.3.1 Liquidity Needs and Types of Funds . . . . . . . . . . . . . . . . . . . . 133
4.3.2 Is Cash Still King? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137
4.3.3 ‘Best-Practice’ Factors in Financial Management . . . . . . . . . 139
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143
5 The Ethics of Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145
5.1 The Ethics of Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147
5.1.1 Ethics Based on What One Could Do . . . . . . . . . . . . . . . . . . . 149
5.1.2 Ethics Based on What One Should Do . . . . . . . . . . . . . . . . . . 151
5.1.3 The Ethical Regulation of the GPF-G . . . . . . . . . . . . . . . . . . . 152
5.1.4 Practical Aspects of Ethics Work in Relation
to the GPF-G . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154
5.2 Implications for SWFs of Socially Responsible Investment
(SRI) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157
5.2.1 The UN Global Compact . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158
5.2.2 The OECD Guidelines on Corporate Governance . . . . . . . . . 160
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162
6 Risks and Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163
6.1 Slumps, SWFs and the Elusiveness of Financial Risk . . . . . . . . . . . . 169
6.1.1 Demands on Liquidity in a Slump . . . . . . . . . . . . . . . . . . . . . . 170
6.1.2 Finance Is not Physics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171
6.1.3 The Elusiveness of Financial Risk . . . . . . . . . . . . . . . . . . . . . . 171
6.2 Geopolitics and Risks of Expropriation and Confiscation . . . . . . . . . 179
6.2.1 Geopolitical Risks Facing SWFs . . . . . . . . . . . . . . . . . . . . . . . 179
6.2.2 The Political Economy of ‘Envy’ – Confiscation
and Expropriation Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181
Contents ix

6.2.3 Could Envy Trigger Confiscation of Assets by States? . . . . . 183

6.2.4 Point-Source Risk in Real Estate . . . . . . . . . . . . . . . . . . . . . . . 189
6.2.5 Real Estate: Composition, Liquidity and Political Risk . . . . 191
6.2.6 Gearing and Institutional Quality . . . . . . . . . . . . . . . . . . . . . . . 192
6.2.7 The Real Estate Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194
6.3 Immigration: Wealth Dilution or Enhanced Economic
Growth? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195
6.3.1 The Influx of Asylum Seekers of 2015 . . . . . . . . . . . . . . . . . . 196
6.3.2 The Costs of ‘New Countrymen’ . . . . . . . . . . . . . . . . . . . . . . . 199
6.3.3 Asylum Seeker or Migrant? . . . . . . . . . . . . . . . . . . . . . . . . . . . 201
6.3.4 Some Societal Implications of Immigration . . . . . . . . . . . . . . 202
6.3.5 Distributional Implications of How Resource Wealth
Is Spent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206
7 A Sketch of an Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209
7.1 What Could Possibly Go Wrong? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 218
7.1.1 Historical Price Data Cannot Be Forward-Looking . . . . . . . . 228
7.1.2 Investment Opportunities in Emerging and Frontier
Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229
7.1.3 Geopolitics Could Trump Financial Market Logic . . . . . . . . 231
7.1.4 How Corruption and Malfeasance Limit Investment
Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232
7.1.5 Financial Investments and Non-developed Countries . . . . . . 233
7.1.6 Operations-Size and Costs: Economies of Scale
or Dilution of Focus? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 234
7.1.7 Considering the Future . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237
7.1.8 Why the Wealth Was not Squandered . . . . . . . . . . . . . . . . . . . 238
7.2 Did Norway Escape the Resource Curse Altogether? . . . . . . . . . . . . 241
7.2.1 Resource Curse? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 243
7.2.2 Or Just the Contours of a Curse? . . . . . . . . . . . . . . . . . . . . . . . 244
7.2.3 Creativity and Ample Public Funding . . . . . . . . . . . . . . . . . . . 246
7.2.4 A Brief Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 248
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249
8 The Future of the GPF-G . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251

Appendix 1: Cash Flow into the GPF-G, 2000–2020 . . . . . . . . . . . . . . . . . . . 257

Appendix 2: Covariation of Asset Class Returns . . . . . . . . . . . . . . . . . . . . . . 259
Chapter 1
Introduction

This introduction outlines some of the topics covered, and foreshadows some of the
discussion.
The book consists of six parts—parts I—VI, named Natural Resource Sustain-
ability (I), The Economics and Politics of Constrained Spending (II), Investing in
Practice (III), The Ethics of Investment (IV), Risks and Uncertainty (V), and The
Sketching of an Evaluation (VI).
Norway is a country rich in natural resources, most notably till this date hydro-
carbons, that is oil and natural gas. It has been seen as important since the first large
oil find, of Ekofisk in 1969, to bring these natural resources to market and spend the
states’ share of the oil revenues wisely.
Norway has a significant hydrocarbon endowment. It was first discovered and has
later been extracted under the seabed on its continental shelf and in its economic zone
of the North Sea. Over time, oil and gas have been discovered throughout Norway’s
economic zone, from the North Sea to the Barents Sea. This has had a strong impact
on the evolvement of GDP per capita in Norway for several decades. A significant part
of the income has been saved, in the early years informally as increased infrastructure
investments, and since about 1998 also in large financial claims on the rest of the
world in a large fund, mainly in equities and fixed-income instruments—more widely
referred to as stocks and bonds, respectively. Few would doubt that Norwegian are
richer in monetary terms than they would have been without the resource richness.
When one owns a lot of one specific natural resource, with a volatile price history,
which also makes up a large fraction of one’s total wealth, it makes sense to diver-
sify. Related to this, is that transient natural resource wealth can be converted into
renewable financial wealth.
This book is mainly about the Fund created to store a large fraction of the wealth
in financial assets, that are listed and traded internationally. The name of this Fund
is Government Pension Fund—Global, abbreviated to GPF-G, although it is not

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 1

O. B. Røste, Norway’s Sovereign Wealth Fund, Natural Resource
Management and Policy 54, https://doi.org/10.1007/978-3-030-74107-5_1
2 1 Introduction

directly linked to pension liabilities.1 In accordance with standard usage, this is a

Sovereign Wealth Fund, in the continuation abbreviated to SWF. A SWF is a state-
owned investment fund that invests in real and financial assets such as stocks and
bonds, or unlisted real estate, and precious metals, sometimes called alternative
investments.2
By design, the GPF-G is a general-purpose macro fund, which aims at strength-
ening public finances in later time periods. The name has been chosen to remind us
of the large financial pension obligations of the state, and thus also to promote an
important premise of public debate of no freely available cash that can be spent. It
may thus be instructive to compare the value of the Fund and the known remaining
resource value with the value of the net present value (NPV) of the central govern-
ment’s future pension obligations. The Fund attained a value in October 2019 and
into 2020 of some 10.000 billion kroner, or some three times Norway’s mainland
GDP. This could cover most of the value of future pensions. The unexploited part of
the hydrocarbon endowment, however, has remained of an approximately unchanged
value during the most recent years. What exactly the oil money will be used to buy
is not clear. The comparison with future pension payments suffices to illustrate that
the Fund may be made available for several different purposes. In spite of the Fund’s
name, it is not reserved for the purpose of financing pensions.
The book also covers the context of the fund, including some of the history behind
its inception, in 1990, after some twenty years as an oil country, and the political
compromises needed in a democracy for the transformation of wealth into the future.
The first deposit in the fund was made in 1996. An important part of the motivation
for the Fund is a widely shared view that future generations have rights in relation
to the value of the non-renewable natural resources that are or can be exploited.
Resource richness is one possible departure point to arrive at a SWF. A govern-
ment must run fiscal surpluses in order to save money. If the savings are to be invested
abroad, the country must also have a surplus on its current account. The government
can influence the current account balance with its policies, but it cannot not control
it as precisely as its own fiscal balance. Indeed, even the latter may not be entirely
under government control.
Funds accumulated in this way can be stacked away in a fund. It is also in prin-
ciple possible to construct a SWF through borrowing, that is by inflating the public
sector’s balance sheet. This, however, would entail costs that could easily outweigh
the benefits that the Fund might give rise to. Borrowing is therefore of lesser prac-
tical relevance than net saving. Saving could be painful, compared to the option
of spending the funds right away. Thus, discipline, or the willingness to restrain
oneself with a view to improved future outcomes, is needed. In democracies, and at
the macro level, this discipline requires sound institutions that make it possible to

1 A much smaller government owned fund invested in Norwegian and Nordic stocks, formerly known

as Folketrygdfondet, had its name changed into the State Pension Fund – Domestic, abbreviated to
GPF-D.
2 Alternative investments may also be, for instance, private equity funds or hedge funds. By historic

convention some large funds, including the very large U. S. Social Security Trust Fund, are not
considered as SWFs.
1 Introduction 3

prioritize the long term over the present. The situation is not too different from the
familiar one facing individuals who may strive to save. In less democratic political
systems, it could be sufficient that a ruling elite, in the limit one person, adopted and
implemented the required policies for this.
Since the start of the natural resource curse literature in the mid 1990s, resource
wealth has by many come to be seen as a curse rather than a blessing with regard
to economic growth, or in moderate versions as a mixed blessing. Despite a volu-
minous literature on why resource-rich countries do not seem to have an advantage
with regard to growth this issue may still not be fully understood. What stands out,
however, is the advantage implied by high institutional quality: Institutions must
be robust to challenges that countries with resource wealth have to overcome. A
policy stance that might be stable without resource income, may thus become desta-
bilized with the temptations, revenues and political pressures that tend to follow from
resource richness. I rely on the definition of institutions of Douglas C. North (1994:
360) in what follows: “Institutions are humanly devised constraints that structure
human interaction. They are made up of formal constraints (e.g., rules, laws, consti-
tutions), informal constraints (e.g., norms of behavior conventions, self-imposed
codes of conduct), and their enforcement characteristics. Together they define the
incentive structure of societies and specifically economies”.
Frankel (2012) reviews the natural resource curse literature, discusses proposed
channels of causation, and proposes a list of policy measures to address the associated
pitfalls—with emphasis on macroeconomic stability. The list includes transparent
commodity funds. In Frankel’s view, commodity abundance is best viewed as a
double-edged sword, with benefits and dangers. The relevant policy question for a
country with natural resources is how to make the best of them. The term natural
resource curse had been coined by Auty (1993, 2001).
Norway is one of not too many cases, where one appears to have planned for
long time horizons, and avoided to squander the resource wealth.3 There are more
examples in which resources have been quickly depleted, with nothing left to show for
sold-off resources, particularly from less developed countries. An important question
is whether something universal can be learnt from the Norwegian experience as
regards advisable approaches to future resource management, including potentially
to set up of SWFs for resource-rich countries at lower income levels.
To shed light on this question, and address some key decisions, the Norwegian case
is discussed, from the beginning in 1969 when oil was discovered at what became
the North Sea Ekofisk field.4 Production started on that major oil field in 1971.
Conditions regarding royalty payments, tax regime etc. were initially tailored to suit
the international oil companies, and therefore very generous early on. Norway thus

3 Other examples of successful resource management may include Botswana, Chile, Australia and
Canada.
4 The first drilling started 19 July 1966, when Exxon moved the platform Ocean Traveler from the

Gulf of Mexico to the North Sea. The year before, Exxon had been awarded 12 out of a total of 78
blocks which made the company the largest license owner on the Norwegian shelf. Traces of oil
were found in the second well, but this finding was developed only after 32 years, as part of the
Balder field.
4 1 Introduction

managed to get a large field into production quickly, but was also fortunate enough
to change the very generous regulations before the uncovering of other large oil
deposits.5 This can perhaps be interpreted as a fortunate combination of skills and
luck.
The price of crude oil is also important in relation to the tax regime. The original
tax regime in the early 1970s was predicated on an oil price of about U. S. dollars 2
per barrel. The offshore fields of the North Sea were only marginally profitable. In
1975 the oil price reached 12 dollars per barrel and the fields became very profitable.
Although price decreases do occur, and also limit the government’s ability to tax, the
situation has since mainly been one of high profitability.
Today the largest fraction of the petroleum wealth is held in the large SWF, which
is invested abroad in its entirety. The main reason for this, is that hydrocarbons have
been exchanged for financial assets, including American technology stocks which
approximately doubled in value between 2010 and 2020.6 Although there are more
of other financial investments that did not fare that well, the value of the remains
of the hydrocarbon deposits underneath the seabed is much smaller than the Fund.
The transformation from a natural resource into claims on the world´s productive
capacity, in the form of equity and fixed-income securities, appears to have gone
remarkably well. This may be counted as a second fortunate combination of skills
and luck.
For a long time, it was believed that there were not good prospects for finding oil
on Norway’s continental shelf. Indeed, according to a public statement by Norges
Geologiske Undersøkelser (Norway’s Geological Survey) in 1958, one could disre-
gard the possibility that there could be coal, oil, or sulfur on the shelf along the
Norwegian coast (see, e.g., Hannesson 2001).7
With a story that may almost look too good to be true, it is important to remind
both Norwegians and others that successful results can never be taken for granted
in delicate undertakings like this. There are many examples of unsuccessful time
transformation of funds, with and without SWFs.
It might be premature to ask whether, and if so when, the luck will run out. Still, it is
pertinent to be aware of the risks posed both in relation to the wealth accumulated in
the Fund to date and the remains underneath the seabed. To this author’s knowledge,

5 According to a news article on E24.no, in the event of the 50-year anniversary for the start of
test drilling, there had been much discussion on the prospects for oil and gas exploration off
the coast prior to this. See https://e24.no/energi/nordsjoen/50-aar-siden-startskuddetfor-norsk-(…),
published 19 July, and accessed 20 July 2016.
6 See interview with then Managing Director of the NBIM, Norges Bank’s investment arm, Yngve

Slyngstad, in daily Aftenposten on 28 February 2020, p. 19: “Han tok Oljefondet fra olje til tech.
Det har gitt en fenomenal gevinst” (He took the Oil Fund from oil to tech. This has resulted in a
phenomenal reward—this author’s translation.).
7 According to a statement by Norway’s Geological Survey, in 1958, “one (could) disregard the

possibility for there being coal, oil, or sulfur on the continental shelf along the Norwegian coast.”
However, Erik Pontoppidan the younger (1698–1764), a professor and the bishop of Bergen, had
written in 1752 that discoveries of oil and other resources (petroleum, sulfur etc.) could be expected
in the ocean as well as on land. Cited also by Øystein Olsen (2008), then Managing Director of
Statistics Norway, in a speech - translation from Norwegian by this author.
1 Introduction 5

there is no known example of a large financial fortune that has survived over a long
time span. This may be in part because large funds are rare due to the obvious
difficulties of accumulating them, but also because financial and liquid wealth is
highly visible and accessible, and thus also vulnerable. It is always easier to spend
than to save. This could be due to both insufficient self-restraint and pressures from
others8 : Good spending ideas are easy to come by. One can also expect persistence
and creativity from players who want to access and consume the funds. One important
reason is that those who make such suggestions, typically also hope to gain from
them in some way if they are adopted.
The remains of resources below the seabed are also at risk due to the still high costs
of extraction—although technological improvement in this domain as elsewhere is
a one-way street—where improvements may be uneven but still quite certain over
time. In theory, extraction costs could increase in spite of technological progress.
This, however, may be dominated by technological progress and hence not likely
over long time spans. The best available and most cost-efficient technology, which
is almost always used, usually improves over long time spans.
Further, there is a possibility that one or more alternative sources of energy can be
developed that will lead to an accelerated replacement of oil and gas.9 Even if fossil
fuel and traditional bio fuel still accounts for about 90 per cent of the global energy
consumption, some new, low-carbon alternatives—mainly solar and wind energy,
grow fast. Still, they account for just a few percentage points of the world’s energy
consumption. This means that potential pitfalls and opportunities for an owner of
sizeable, not-yet available hydrocarbon deposits may be of interest.

1.1 The Government Pension Fund Global (GPF-G) is

a Norwegian SWF

A fundamental idea behind the construction of the GPF-G is a deeply felt obliga-
tion to share the benefits provided by the nonrenewable natural resource petroleum
with future generations. If only the real return of the Fund is consumed over time,
according to the prescribed use of resource revenue by the fiscal rule,10 the real

8 On self-restraint and fiscal rules in relation to fiscal stabilization, see e.g. Bayoumi and Eichengreen

(1995) and Millar (1997), whose data are mainly from states and provinces in the United States
and Canada. Budget rules seem to contribute to stabilizing public expenditures without impacting
much on the volatility of GDP.
9 In the earlier literature, the concept of so-called back stop technology has been applied. Since crude

oil could be made synthetically, there would be an upper bound for crude oil prices reflecting its
costs of production. Today, alternatives to fossil fuel, or greener alternatives, carries much more
interest, as the climate problem due to green-house gas emissions makes continued large-scale
use of hydrocarbons as an energy source much more uncertain. This may be the most important
uncertainty today.
10 The Norwegian fiscal rule from 2001 is a spending rule. It allowed for up to 4 per cent of the

value of the fund at the previous year end to be spent in the budget, a rough approximation to the
6 1 Introduction

value of the Fund, and hence its international purchasing power, will remain intact.
However, for the not-yet exploited resources, it is very difficult to know what he
future value of oil will be. In any event, with currently known uses and technology,
and remaining natural resources, the real value of the Fund as a percentage of GDP
is likely to decline. In this scenario, it is bound to play a decreasing role in public
finances over time. This argument seems robust unless GDP growth would stag-
nate—which is possible but not likely. For instance, at an average rate of 2.5 pct.
growth per year, real GDP would double in less than 30 years, which could cut in
half the size of the Fund as a fraction of GDP assuming that the real return of the
SWF—administratively approximated to 3 pct. per year—is consumed. Similarly,
positive population growth would diminish the size of the wealth per capita. This
could be due to significant immigration and/or high birth rates in excess of death
rates. In Norway there has been substantial net immigration over the latest years.
The population has thus increased in spite of low birth rates.
A key decision in resource extraction is the speed of extraction, i.e. the rate of
transformation from natural resource into financial assets. At the one extreme one
could assume that the petroleum resources would always be of value and should be
shared in kind with future generations. This, however, could be wrong and expose
the future generations to a risk that the resource could become valueless, due to for
instance new affordable energy sources. At the other extreme one could extract all at
once (or in practice at a high rate constrained by the practical difficulties of moving
the resource sufficiently swiftly from deep underneath the seabed to the market).
This latter strategy—which is arguably not too different from the one Norway has
applied—runs the risk of not benefiting from future price increases due to scarcity—
in the event that the resource would not become valueless: One might thus assume
that the non-renewable resource would become increasingly scarce given continued
extraction and a fixed physical supply, which would increase prices.11
For Norway, as for other investors, what may seem most difficult for the future is to
be able to invest at a rate of return, at acceptable risks, that can sustain continuous high
spending through the budget. In the low-interest rate environment that has prevailed
internationally since the financial crisis of 2008/2009, a given real return target like
the Norwegian one of 3 pct. (4 pct. prior to a downward revision in 2017), would
implicitly require a much higher weight in the asset classes that imply the highest risk,
and therefore the highest ex ante expected return. This is typically equity or stocks,
and within a fixed-income allocation credit and maturity (duration) risk. In practice,
however, it has been difficult to achieve much through such strategies in an investment
grade fixed-income setting. However, also several so-called alternative investments

expected real return from the Fund. This return estimate was revised to down 3 per cent in 2017
due to, inter alia, very low interest rates.
11 This kind of assumption is reflected, inter alia, in Hotelling’s (1931) rule, which states that a

resource owner should let the resource stay in the ground if it’s price would increase more than
the owner’s discount rate. This strategy would maximize the return from a non-renewable resource.
Frankel op. cit. points out that the resource supply may be elastic within a range and tend to increase
with the resource price. Even if e.g. crude oil deposits are fixed, more of the deposits is likely to be
found and brought to market in time periods when the price of oil is high.
1.1 The Government Pension Fund Global (GPF-G) is a Norwegian SWF 7

have become targets of yield-seeking investors. One problem with this development
is that for a well-diversified fund, increased expected returns do imply higher risk
levels. One danger is that the increase in risk may not be well enough understood,
particularly in relation to new types of investments. This could potentially lead to
capital losses that should or could have been avoided—particularly in an environment
where many may be forced, simultaneously, to aim for higher yields. Investors may
base their decisions on risk—return tradeoffs that are reflected in historical data from
times when there was, inter alia, no urge to act aggressively to enhance yields.12
To pursue incremental returns by changing the asset class composition of the
holdings thus imply increased risk. These risks are likely to be particularly high, and
potentially underestimated, in the current, still, low-interest-rate environment which
despite signs of hikes ahead in the United States’ federal funds rate target seems
to last for some time. Investors are in general tempted to assume increased risks to
be better able to comply with demands from the owners, in the case of SWFs the
political leadership of sovereign states. Political demands to spend more money, and
faster, may be democratically legitimate and yet suffer from the same problem linked
to myopia that individuals may suffer from in their private decision-making: Instant
pleasure might be so tempting that it may be bought at a too-high price in terms of
future pain—here foregone future consumption. It is therefore difficult to save, even
for those who should be able to afford it.
It is particularly this rather mechanical way of arriving at a willingness to absorb
more risk by many that makes this author a bit skeptical as to whether it would
be worth to assume much more risk to enhance returns. When actors reluctantly
change behavior to avoid painful adjustment to lower consumption, by increasing
risk, there may be reason for concern—and more so if many participate without very
sophisticated decision-making. The collective assessments of risks could well be
insufficient, or of a lesser quality, with a severe, undue, optimistic bias. This may
also be important due to an embedded agency problem: If the investments turn bad,
investors who move as in a herd can point to each other—and express that “we were
all surprised” —so as to minimize and/or avoid ex post blame and responsibility.
This is another reason to be skeptical about the actual or true increase in risk with
regard to the future—as opposed to what could perhaps be concluded from careful
analysis of historical data collected from earlier times of sometimes very different
circumstances.

12 An example from some years back, is the hedge fund Long-Term Capital Management L.P.

(LTCM), a hedge fund based in Greenwich, Connecticut, which applied absolute-return trading
strategies with high financial leverage. It was a prestigious fund, established in 1994 by the former
vice chairman and head of bond trading at the investment bank Salomon Brothers, John W. Meri-
wether. Members of its board of directors included Myron S. Scholes and Robert C. Merton, who
shared the 1997 Sveriges Riksbank’s prize in the memory of Alfred Nobel (‘the Nobel prize’). The
prize was awarded “for a new method to determine the value of derivatives”. The annualized returns
of the LTCM after fees exceeded 21 per cent in the first year, and came in at 43 pct. in the second
year, and 41 pct. in the third year. However, massive losses were made when spread bets went wrong
after the 1997 Asian financial crisis and the 1998 Russian financial crisis. In 1998 it lost 4.6 billion
dollars in less than four months. Sources: Wikipedia.org and Nobelprize.org, accessed 28 and 29
February 2021, respectively.
8 1 Introduction

In 2001, new guidelines for fiscal and monetary policy were established in Norway,
with a new sharing of responsibilities between these two macroeconomic policy
fields. Fiscal policy had earlier allowed for discretionary decisions. From 2001 on it
became subjected to a fiscal rule which allowed for use through the budget of up to
4 pct. of the value of the GPF-G at the end of the previous year. As mentioned, the 4
pct. figure was an administrative approximation to the real return on the investments
in the SWF. It was adjusted down to 3 pct. in 2017. However, even at 3 pct. the fiscal
rule allows for spending of some 300 billion kroner annually sine 2019, due to the
sharply increased size of the GPF-G. For 2021, this maximum spending of resource
revenue and financial return on the investments (referred to as “resource revenue”
for simplicity in the continuation) will pay for almost 20 per cent of the expenses
in the state budget in a normal year. These some 300 billion kroner were available
without any taxation. The situation in most other countries is less fortunate—one
most often has to pay a sizable interest bill on the respective state’s debts before any
money from taxation can be spent in the state budget.
It is not possible to know what the future real returns will be. However, the recent
history may suggest that 3 pct. could be a better approximation than 4 pct. There had
been a downward trend in return since before the fiscal rule’s inception in 2001, which
was strengthened by the financial crisis of 2008 and 2009. When considering this the
former administrative approximation at 4 pct. may have been too high. At the same
time, this particular number which could in principle have been changed frequently
with changed expectations, was kept unchanged for a long time in part because it has
served as a well-communicated demarcation line regarding what would constitute
responsible budget policy. Further, frequent changes could also have canceled each
other out. This could for instance have been true if accurate estimates for real return
tended to evolve around a given level, or even a given trend, that was relatively stable
over time. Then a simple rule could suffice, with no need to revise the real return
expectation over long time intervals.

1.2 The Risk-Return Trade Off in Investments

After the financial crisis of 2007/2008, expected yields at given risk levels had
declined. So, one would have had to increase risk to maintain the old real-return
target of 4-pct. Several players, including the central bank since 2012, had argued
for a reduction from 4 to about 3 pct.13 A recent government commission had even
advised to apply a real return estimate of 2 pct.14 The fiscal rule is an upper bound

13 See the manuscript for The Annual speech by Central Bank Governor Øystein Olsen (2012) on
16 February.
14 See the report of the Thøgersen commission, NOU 2015: 9. The view of future equity returns is

conservative in relation to historic equity returns for the United States, where the Standard & Poor’s
500 stock index has yielded about 10 pct. nominally over the latest sixty four years since the index
was extended to 500 shares in 1957. If similar returns could be expected for the future, a 43 pct.
equity allocation could suffice to secure an expected real return of 3 pct. p.a. even if we assume the
1.2 The Risk-Return Trade Off in Investments 9

on the consumption of oil and gas resource revenues through the budget. However,
behavior since 2001 suggests that actual spending has tended to be set near this upper
bound. In earlier years there was even a tendency to overspend in relation to this
“ceiling”. These excesses, however, had limited consequences due to a very strong
growth of the GPF-G in the period, due a fortunate combination of high production
volumes of oil and gas and high prices, at least until the sharp oil price decline of
2014. Overall, fiscal policy became more rule-based, even if the fiscal rule was not
binding and is prescribed to be used with flexibility. There may, however, be limited
flexibility on the low side due to domestic politics constraints.
Consider next monetary policy. One lesson from the increased capital mobility
of the 1990s was that Norway´s previous fixed-but-adjustable exchange rate regime
could not be sustained due to destabilizing currency speculation. After a period
of a regime that aimed at a stable exchange rate, from about 1998, an inflation
targeting regime was formally adopted in 2001—as in many other countries in the
2000s. This made monetary policy more discretionary, since the former obligations
to stabilize the foreign exchange market was abolished—even if the exchange rate
remains an important variable for the small open Norwegian economy. Fiscal policy
thus became more rule based, and monetary policy less rule based, than previously.
Further, the fiscal-rule-real-return estimate became a fixed parameter of key macroe-
conomic importance. It would determine what a sustainable use of resource income
could be.
A further, linked, change of the 2000s was an increased risk tolerance for the GPF-
G. The strategic benchmark was changed to approximately 60 and 40 per cent equi-
ties and fixed-income securities, respectively.15 From the inception of the Fund, the
proportions had been the reverse, with 40 per cent equities and 60 per fixed-income
securities. The strategic allocation to equities set by the Ministry of Finance was
further increased in 2017, to 70 per cent.16 Although these changes in isolation
imply a higher risk tolerance, the change was also motivated with practices by other

yield from real estate and on all debt to average zero. However, there may be good reasons to expect
lower overall returns going forward than in the post-World War II period, also in the United States.
There may be stronger reason to expect lesser equity returns in some other locations. Furthermore,
prudence should usually be applied in such estimates, as it may be most costly to err on the upside.
15 The initial benchmark was more conservative, with 40 and 60 per cent, respectively, in equities

and fixed-income securities. From the summer of 2007, the weights with respect to equities and
fixed-income were reversed, to 60 per cent equities and 40 per cent fixed-income. Two years were
allowed to phase in this large change. The new allocation in addition allowed for up to 5 per cent
in unlisted real estate, as a component of the fixed-income allocation. The maximum per cent
was increased to 7 per cent in February 2020. Further, there is a limit of 2 per cent for unlisted
infrastructure. A neutral equity allocation of 60 per cent was attained again in August 2009, due to
purchases of 1.010 billion kroner worth of shares, of which 641 billion were fresh funds and 369
billion kroner were obtained by selling fixed-income securities. Source: nbim.no, “Fra 40 til 60
prosent aksjer”, accessed 11 April 2020.
16 This was done in response to a recommendation from a government commission, which advocated

an equity allocation at 70 per cent. However, the chair of the commission, Knut Anton Mork,
dissented. In his view a 70 per cent equity share was too high in view of the increased risk implied.
His advice was, instead, to reduce the equity share in the strategic benchmark to 50 per cent. See
the Mork Commission’s report, NOU 2016: 20.
10 1 Introduction

similar funds (referred to in some official documents as a “peer group of funds”) and
a view that the time horizon of the GPF-G is very long. Regardless of why it was
chosen, the new strategic benchmark should make it easier to attain the new 3-pct.
real return expectation. In the current low interest rate environment, however, this
measure could still be insufficient to secure returns in line with the return target.
Further, there have been signs of an economic revival in the U. S. since 2018. Thus,
the Federal Reserve increased the short-term interest rates in the U. S. somewhat
from 2018, arriving at a fed funds target at 2 ¼ -2 ½ per cent in December that year.
However, these interest rate increases were reversed in 2019. In early 2020 the fed
funds target was again at 1.75 pct., the same as in the spring of 2018. It had then
risen continuously from about zero in November 2015, where it would soon return.
Other large central banks, notably the ECB and the Bank of Japan, has so far kept
their money market rates low due to low growth. In February/March 2020 the world
economy was hit by the outbreak, first in China but before long in several other coun-
tries of a new feared virus, the new Coronavirus (SARS-CoV-2) which may lead to
Coronavirus disease (Covid-19). It is still too early to overview the full consequences
of the disease outbreak, which are no doubt very serious. In March 2020, the World
Health Organization (WHO) declared the Covid-19 outbreak a pandemic. The begin-
ning of the end of a long period of low interest rates since 2008–9 was postponed,
and the Fed Funds target range in the United States was lowered to 0–0.25 per cent.
The positive shape of the U.S. Treasury yield curve in 2018 had turned flat,
and then negative in March 2019—which is often interpreted to signal weak times
ahead. This trend continued till the Federal Reserve cut interest rates several times
throughout 2019. The Covid-19 crisis by itself contributed towards an inverted, or
negative, yield curve through the first quarter of 2020. Since, the curve has stayed
quite flat, with both short-term and long-term yields below 1 per cent. Elsewhere,
yield curves often tend to follow the United States, particularly for long maturities.
Short-term interest rates are heavily influenced by monetary policy, and expected to
remain at about zero through 2023. In this environment of protracted low interest
rates, investors may—depending on how the world stock markets will continue to
perform, need to hold much equity to aim for a 3 per cent real return. The allocation
to equities at 70 pct. of the GPF-G in this author’s interpretation signals a willingness
to assume this high risk.
In addition to an increased allocation to equities in the strategic benchmark, overall
risk also increased somewhat through allowance for new investments like unlisted real
estate and infrastructure within the 40 per cent fixed-income allocation, where up to
7 per cent could be allocated to real estate (5 per cent till February 2019). Investments
in unlisted equities has not yet been approved, although there is a possibility to invest
in equities that will be listed later, that is prior to an initial public offering (IPO).
Unlisted infrastructure was also considered, and a limit of up to 2 per cent was adopted
in 2019. These alternative investments may be attractive in view of their combined
expected-returns and diversification properties, but demanding with regard to staff,
oversight and information flows, not least for a Fund owned by the public. Alternative
investments are wanted in the main because they offer higher yields. Inclusion of these
would imply an increase in risk which is compensated by higher expected returns,
1.2 The Risk-Return Trade Off in Investments 11

and a somewhat better diversification, that is a higher ex ante expected return at

a given risk level. The disadvantage for a large publicly owned fund, seems to be
mainly reduced oversight and increased complexity in the fund management.
Two distinct forces are at work in relation to risk and return with respect to the
composition of the portfolio. First, the investment in new asset classes, or even new
investment vehicles within existing ones, could enhance diversification and hence
increase the return for a given level of risk. This effect, however, is strongest when
one diversifies early on, typically from a fixed -income portfolio with low or moderate
credit risk into one that also contains a sizable allocation to equities. Second, one
could implement more direct high-yield strategies. This would increase risk and
expected return, and lead to increased fluctuations in realized returns. In the context
of the current low interest rate environment, mainly the second strategy has been
important in practice.
Furthermore, one could have further adjusted the real return expectation down-
wards (from 3 per cent per year). However, this would be painful mainly because
it would require reduced fiscal spending. The Norwegian case might illustrate the
importance of this political difficulty: The SWF has grown strongly in recent years, so
3 pct. (and even 2 pct.) leads to a significant injection of funds into the budget—with
a Fund at about 10.000 billion kroner, about 300 billion kroner, or 30 billion euro.
By comparison, the state budget totaled 1.280 billion kroner, about 128 billion euro
for 2019. This large injection of public funds is called the budget impulse. In 2019
and 2020 about 1/5, or slightly less than 20 per cent of central government expen-
ditures, were covered without tax collection. This situation appears quite stable. It
marks a stark contrast to the public finances of many other industrialized countries,
in particular across South Europe.
The experienced opposition, for a long time, to a downwards revision of the real
return estimate, seems to reflect that it is hard to let go of additional possibilities to
spend public funds even at the very high level that has long prevailed in Norway.
Nonetheless, even before the 2017 revision of the return target to 3 pct. the spending
for 2015 and 2016 approached that new target. This is a typical situation when
changes are slowly made and implemented in Norway. It could make it possible for
officials to claim that there is stability, sometimes even when important changes are
made. The could dampen public debate, and hence perhaps also potential critique.
The establishment and operation of SWFs is a trend, even for some countries
without investment needs linked to natural resource wealth. Since most of the quite
new SWFs are due to current account surpluses, they also reflect per definition
imbalances in global trade. There were just two SWFs in 1950s, and about ten in the
1980s. Many new entities have been established since the 1990s. They are mainly
operated by central banks, and the main purpose seems to be higher returns for
investments with a long-term horizon.17 It may be useful to start out with some
elaboration on the most common situation behind the creation of a SWF—where a

17 Seee.g. Gieve (2008), who cited Deutsche Bank and Morgan Stanley on the occurrence of new
SWFs. In that author’s view, the growth in SWFs is positive to the extent that it increases liquidity for
some investments that central banks would not undertake, and could lead to both improved returns
on investments and more available fund for various purposes, and thus also an improved global
12 1 Introduction

non-renewable resource is extracted and where the owner—either of the resource

directly—or of significant tax and royalty incomes that will not persist for the long
term—decides to put resources away for the future. This could reflect either ‘rainy
day savings’, as for individuals in the short term, or an aim to see to that also future
generations will benefit from the resource income. A much quoted example, is that
of the Kuwait Investment Authority (KIA), reportedly the oldest SWF in the world.18

1.3 Investments Abroad

Traditionally SWFs have invested their funds abroad, for a variety of reasons—which
include inter alia the sterilization of foreign exchange intervention, where interna-
tional currencies are purchased and there is a relative lack of investment opportunities
domestically.19 Whereas there may be economic arguments to invest also domesti-
cally, this is a much more demanding task than investing abroad, considering that the
role of the government is usually both to own the SWF on behalf of the population, or
taxpayers, and to undertake many projects with uncertain returns aimed at long-term
domestic economic development. Thus, this book focuses on the investment of funds
owned by a government, that are invested in financial markets abroad. This has thus
far also been the task of the Norwegian SWF—the GPF-G.

1.4 Investment Management Performance

As in other domains of public policy, evaluation is important also as regards invest-

ments. One should evaluate achievement, or what is achieved compared to what
one could have achieved, with prevailing or alternative policies. This is essentially
a counterfactual question, to which it is by design difficult to get a precise answer.
It is nonetheless important enough for many to be willing to try to get as precise
an answer as possible. Evaluation in this domain is usually associated with bench-
marking, on several levels. Clearly, performance is wider than financial performance
within an applied framework, which is the aspect most often referred to and discussed.
Although it is much more difficult, it is important to challenge the assumptions behind
a chosen framework, among the in principle available alternatives. To benchmark is

efficiency in capital allocation. Central banks have traditionally invested in long-term government
bonds of OECD countries, particularly U. S. Treasury bonds. The yield on such bonds dropped
from about 5 per cent annually in 1995 to about zero in 2008, which was still the yield late in 2020.
18 This institution, formally established in 1982, traces its roots to the Kuwait Investment Board,

established in 1953, eight years prior to Kuwait’s independence. Source: kia.gov.kw, accessed 1
December 2018. Policy challenges for that country, including how to save for future generations,
were discussed by Chalk et al. (1997).
19 See for instance The World Bank (2014).
1.4 Investment Management Performance 13

in this context to compare with reasonable evaluation standards, where various yard-
sticks may be applicable. To contribute in this direction, the Norwegian government
has hired international experts on several occasions, with various mandates, who have
utilized different techniques and methods. I will comment briefly on the implications
of some of this work.
Ang (2010) referred to “the four benchmarks for SWFs”: i.e. (i) the legitimacy
of the Fund construction—that is why the funds that are put aside are not rather
spent as they accrue; (ii) recognition of the implicit liabilities in relation to the SWF,
given its role in fiscal and other government macro policies; (iii) a performance
benchmark that Ang sees to go hand in hand with the structure of the SWF; and
(iv) considerations related to the equilibrium long-term benchmark of the markets in
which the SWF invests and long-term externalities that affect the SWF. Only item
(ii) is related to the term benchmark as it is most often used—that of performing in
line with the markets that the SWF is allowed to invest in, with adjustments for any
actively assumed deviation that implies risk exposure. However, for a given state all
four items are of central importance to the establishment and operation of a SWF
over time. Thus, these items will be discussed here, with reference to the Norwegian
case. The arguments should, however, be relevant also in other settings, including to
SWFs that are run due to current account surpluses due to other sources than natural
resources riches, as in some South East Asian states.
In addition to the comparisons of what is achieved to what could have been
achieved, the historical background of the Norwegian SWF is also covered. This may
serve as a case study and be of help in assessing factors that have been critical in what
has, at least till now, been deemed a rare success in natural resource management that
implies actual significant savings for the future. The future is unknown, and therefore
always open to debate. It is approached here through a discussion of strategy, in
view of insights from, in particular, implications of uncertainty in investments. The
political context of foreign government investments, including geopolitics, is also of
high importance in practice, and is thus briefly discussed and commented upon.
Towards the end the prospect of investments within Norway is evaluated. As of
yet there are no such investments on behalf of the GPF-G (although a fraction of
some hundred billion kroner, about 3 per cent the overall pension fund, is denoted
GPF-D, D for domestic, and organized separately. The source of this fund consists of
accumulated surpluses over time in Norway’s social security budgets. That entity is
allowed to invest inter alia in Nordic listed equities. However, there have been signals
that some of the players in public policy want to make the GPF-G invest in Norway.
The SWFs of some other states have increasingly undertaken domestic investments.
However, the traditional arguments for keeping the GPF-G invested only internation-
ally still appear strong for a small open economy like Norway. Further, important
considerations linked to transparency and accountability appear to strengthen this
position.
Although the decision of where to invest is often framed as one of prospective
risk-adjusted return, difficult control questions arise. Particularly a would-be dual
role of the government within Norway would favor investments abroad. It is much
easier to get a handle on whether the investment is worth undertaking when the funds
14 1 Introduction

are used and the revenue produced by external entities. If the state were to operate as
both owner/investor and borrower/user of funds there could be risks of deliberately
produced returns below competitive market rates on investment, and linked to this,
possibly also issues related to the abuse of political power, including corruption.
Issues could also arise related to the quality and/or truthfulness of financial reports
produced under such circumstances. The control regime surrounding a SWF should
therefore probably be more restrictive if a significant share of investments is made
domestically. Hence, investments abroad could provide as a welcome simplification,
helpful in safeguarding both the interests of the citizens who own the fund’s invest-
ments, and the taxpayers who would have to foot the bill in the event of possible
significant shortfall in realized returns.
There have been political pressures from the far right in Parliament to allow for
domestic investments on behalf of the GPF-G. The future of the Fund will depend on
the combined influence of several key factors, not least political pressures regarding
the spending level, that is the relative degree to which the investment’s returns should
benefit the generation that currently governs, and generations of the future. The
current policy framework reflects an aim to transfer a large fraction of the resource
wealth accumulated in the SWF forward to future generations. This aspect of the use
of funds may be politically vulnerable, in particular to populist advances.
In the fall of 2017, a government commission headed by former Central Bank
Governor Svein Gjedrem recommended that the GPF-G should be separated from
Norges Bank, of which the manager NBIM is currently the largest branch, to become
an independent unit. The main reason cited was that both monetary policy and fund
management are large, and highly important and demanding tasks, and that it is
demanding for the same board to professionally oversee both these key activities. In
combination with the policy on asset class composition, which has thus far aimed at
extensions into alternative assets, this is a highly important grand design decision.
There seems to be very little debate on such large and important decisions, and more
debate on easier-to-evaluate decisions that relate to the actual management within
the chosen framework.
For instance, there has been some debate on the fund’s active management of, in
particular, equity investments compared to the alternative of passive management,
which is favored by much of the theory in this domain—cf. the efficient market
hypothesis in various forms. Most of this debate has been quite recent. Although
informed debate that can shed light on the effectiveness of management is welcome,
it is currently most relevant in relation to a small part of the SWF. In relation to the
strategic benchmark, most of the management is of a passive nature. This means that
the ‘risk budget’ expressed as allowed relative volatility has not been binding. The
strategic allocation to various asset classes is therefore of a higher order of magnitude
for financial return. This is of high importance, and some are afraid that this Fund
is turning in the direction of more active management, despite lackluster results of
that to date.20 Active investors participate in a zero sum game, in which a huge bill is

20 See,
for instance, a debate article by B. Espen Eckbo of the Tuck School of Business, Dartmouth
College, in Dagens Næringliv online. Source: dn.no, accessed 28 April 2020 (“The Question We
1.4 Investment Management Performance 15

run up that must be footed by some participants. The costs of active investments, or
the price discovery process, has been estimated by French (2008) to at least 10 per
cent of the market capitalization. That author found that the typical investor, under
reasonable assumptions, could have increased his average annual returns by 67 basis
points over the 1980 to 2006 period by holding a passive market portfolio. Passive
managers could free-ride on price efficiency created by active investors.
In line with French’s results, Malkiel (2013) found that the high fees for active
financial management could not be justified either on grounds of superior returns for
investors or by benefits in promoting price discovery and market efficiency.21 This
applied across the board for various types of equity and fixed-income investments in
the United States. For instance, the expense ratio charged large institutional investors
for active management of equity funds increased from about 47 basis points to 55
basis points from 1996 to 2011 (p. 101). The most appropriate choice for an investor
would thus seem to be to invest passively, by following an index rather than trying to
beat the market on timing or security selection. This choice is highly cost efficient:
It is available for all investors at fees below 5 basis points, and perhaps for even less
for very large investors. In spite of some active management, index management has
been the main approach followed in the investments on behalf of the GPF-G. This
may change, however, as the new Managing Director of NBIM from 2020, Nicolai
Tangen, has expressed intentions of more active management. In that respect, there
may be arguments in both direction. If more active management is implemented, it
will come with its own set of risks that the GPF-G has thus far not been very exposed
to. One thing that seems more certain, is that a more active management could make
it difficult to establish the correct management fee for NBIM.

1.5 Is the GPF-G Sufficiently Sustainable, Ethical

and Profitable?

The title of this book indicates that the GPF-G needs to be sustainable, which might
also be interpreted to include ethical, and profitable. The last concern, of profitability,
has always been well considered. Ethics, and in particular sustainability, may be seen
as somewhat newer, even if these dimensions have always been relevant for investors,

Should Ask the New Head of the GPF-G”). Eckbo warns against a tendency of an increased appetite
for active mandates – inter alia in unlisted stocks, property, and international infrastructure projects,
by the management of the GPF-G, fronted by the departing chief executive in 2020, Yngve Slyngstad.
His replacement, Nicolai Tangen, has made some statements that indicate a continued, and perhaps
increased, appetite for active mandates. There may thus be more of this.
21 Between 1980 and 2006, the financial services sector in the United States grew from 4.9 to 8.3

per cent of GDP. Scale economies in investing seemed to benefit only investment managers, as
expenses for clients rose over time. In Malkiel’s view, «[t]he major inefficiency in financial markets
today involves the market for investment advice, and pose the question of why investors continue
to pay fees for asset management services that are so high. It is hard to think of any other service
that is priced at such a high proportion of value» (p. 108).
16 1 Introduction

in particular for states as investors that operate SWFs on behalf of their population.
Developments linked to requirements for ethics’ standards and sustainability have
accelerated over time, in particular during the latest decade.
Ideally, the answer to the above title question should be yes, yes, and yes. I
will argue throughout this book that this may be a defensible position, at least in
the main. However, to my experience one can usually benefit from rethinking and
reconsideration with new knowledge, also in these domains. I thus try to extend and
refine the thinking along these three dimensions for this SWF.
With regard to sustainability, at least the management of the resource revenue—
when viewed through the rear view mirror—does appear sustainable. An important
qualification for the future, however, seems to be that the extraction of oil and gas to
fill energy needs is seen by many as non-sustainable in view of the colossal global
climate challenges. This is, however, quite new. It would be rather unfair in this
author’s view to direct critique against Norway with the benefit of hindsight for
having extracted much of its hydrocarbon deposits and brought them to market. A
new situation, where extraction appears as less sustainable and ethical than before,
could lead to reduced profitability and call for more caution in the future.
Further, the investments also need to be ethical, as they appear in the main to be.
Keeping in mind that the GPF-G invests broadly in the capital markets and own shares
of more than 10.000 companies, it appears as paramount to avoid investment in the
ethically speaking worst cases. The impression of this author is that the Fund has
demonstrated a capacity to act when needed judged from that principle. One could
perhaps also demand an active approach in the direction of desired developments
from a large player like the GPF-G. Some have demanded this in Norwegian public
debate. This could, however, be difficult to satisfy through the investments.
Furthermore, the GPF-G appears as a success story in terms of the returns. One
important reason for this, is that one has chosen to stick to the applied strategy also
through some very difficult times in 2008–2009. After the financial crisis, the stocks
owned by the GPF-G fell in value with about 40 per cent and the fraction held in
stocks had thus declined. Very large amounts—at the time more than 1.000 billion
kroner, or about 10 per cent of the fund’s value in 2020 was invested in stocks to
continue to stay exposed as intended to this central asset class. Later, at a time when
the exposure has increased to the upper limit of 60 per cent in stocks, one adopted
a new strategic benchmark with 70 per cent stocks. This implied that one did not
need to reduce the weighting of stocks in the holdings. After this move, stock prices
continued to rise through 2019, which became the second best year for the Fund with
returns near 18 per cent. From 12 February to 13 March 2020 the FTSE Global All
Cap stock market index declined by 34 per cent due to the pandemic. In the second
quarter, however, there were positive news from several countries and massive policy
interventions. At the end of June 2020, this index was down by only 7 per cent since
the beginning of 2020.22
There may, as admitted by the managers of NBIM, be a sizable element of good
luck in the overall return to date. Movements in value can be very large in both

22 Global stock market development according to Norwegian Ministry of Finance (2020).

1.5 Is the GPF-G Sufficiently Sustainable, Ethical and Profitable? 17

directions. When looking ahead, it is important to consider that a fund investing

about 70 per cent of its capital in stocks, is bound to experience good and bad times.
Some may argue that the history suggests that this approach will be highly successful
if one sticks to it. This author hopes that this will prove true, but is more skeptical
than some others. The reason for this is that the future is unique and open, and as
such cannot be owned or controlled by anyone. Rules of thumb based on historical
prices are very crude tools that may serve us well when they are used with care. They
suggest that it is risky not to accept any risk, but provide no guarantees. Economic
developments will determine the returns.

References

Ang, A. 2010. “The Four Benchmarks of Sovereign Wealth Funds”, unpublished manuscript,
Columbia Business School, NYC, NY.
Auty, R. 1993. Sustaining Development in Mineral Economies: The Resource Curse Thesis. NYC,
NY: Oxford University Press.
Auty, R. 2001. Resource Abundance and Economic Development. NYC, NY: Oxford University
Press.
Bayoumi, T., and B. Eichengreen. 1995. “Restraining Yourself: The Implication of Fiscal Rules for
Economic Stabilization”. IMF Staff Papers 42 (1): 32–48.
Chalk, N, M. El-Erian, S. Fennell, A. Kireyev, and J. Wilson. 1997. Kuwait: From Reconstruction to
Accumulation for Future Generations, Occasional Paper No. 150, International Monetary Fund:
Washington DC.
Frankel, J. 2012. “The Natural Resource Curse: A Survey”, in Beyond the Resource Curse, ed. B.
Shaffer, and T. Ziyadov, 17–57, Philadelphia: University of Pennsylvania Press.
French, K. 2008. “Presidential Address: The Cost of Active Investing”, Journal of Finance 63 (4),
accessed through Wiley Online Library – onlinelibrary.wiley.com – on 28 April 2020.
Gieve, J. 2008. “Sovereign Wealth Funds and Global Imbalances”. Bank of England Quarterly
Bulletin 48 (2): 196–202.
Hannesson, R. 2001. Investing for Sustainability: The of Management of Mineral Wealth. NYC,
NY: Springer.
Hotelling, H. 1931. “The Economics of Exhaustible Resources”. Journal of Political Economy 39
(2): 137–175.
Malkiel, B. 2013. “Asset Management Fees and the Growth of Finance”. Journal of Economic
Perspectives 27 (2): 97–108.
Millar, J. 1997. “The Effects of Budget Rules on Fiscal Performance and Macroeconomic
Stabilization”. Staff Working Paper 1997–15, Bank of Canada: Ottawa.
North, D. 1994. “Economic Performance Through Time”, American Economic Review 84 (3):
359–368 (Nobel lecture).
Norwegian Ministry of Finance. 2001. Stortingsmelding No. 29 (2000–2001). Retningslinjer for
den økonomiske politikken, Oslo.
Norwegian Ministry of Finance. 2020. Meld. St. 32 (2019–2020). Forvaltningen av Statens
Pensjonsfond Utland i 2019 (The Management of the SPF-G in 2019), Oslo.
Olsen, Ø. 2008. “Norge og Oljen i et 100-års Perspektiv”. Speech at Samfunnsøkonomenes
jubileumskonferanse, Oslo: Statistics Norway.
Olsen, Ø. 2012. Address by Governor Øystein Olsen to the Supervisory Council of Norges Bank
and Invited Guests on 16 February. Oslo: Norges Bank.
The Gjedrem Commission. 2017. Norwegian Public Report. Oslo: Ministry of Finance.
The Mork Commission. 2016. Norwegian Public Report. Oslo: Ministry of Finance.
18 1 Introduction

The Thøgersen Commission. 2015. Norwegian Public Report. Oslo: Ministry of Finance.
World Bank. 2014. Overcoming Constraints to the Financing of Infrastructure: Sovereign Wealth
Funds and Long-Term Development Finance: Risks and Opportunities. Mimeo prepared by staff
of the World Bank Group for the G20 Investment and Infrastructure Working Group, February
2014.
Chapter 2
Natural Resource Sustainability

The literature on the management of non-renewable natural resources makes us aware

in particular of the risk of overconsumption by early generations, and thus a too
early depletion of the resource wealth.1 This is perhaps the most obvious risk once
the resources become marketable. In many settings marked by weak institutions,
however, it may not be possible or realistic to bring the resources to market. A
complex chain of events must take place before one can have hope of transferring
wealth to future generations.
Savings may be advocated, both for the possible event of a rainy day, as for indi-
viduals, and in order to share the resource wealth with future generations. For the first
purpose a comparatively small resource stabilization fund suffices. The spending of
non-renewable resource revenue analytically amounts to spending from a fixed stock
of wealth, to put it simple. The resource wealth is finite, both physically and finan-
cially. Thus, a stream of consumption larger than the return from the resource—the
so-called permanent resource income—cannot be sustained over time. Any sustain-
able approach to the spending of wealth from non-renewable resources must thus
explicitly take the future into account.
A simple and conservative way to approach this issue, is to restrict consumption
to the return from the resource. In forestry, for instance, this can be envisaged as
consuming a timber volume that corresponds to the volume growth, typically on an
annual basis. This would approximate the permanent income model, which can be
useful to assist the thinking around this problem: In a broader context, it will be

1 One contribution to this literature, is Hannesson (2001). The task may be most demanding for
capital-scarce developing countries. Interestingly, van der Ploeg and Venables (2011) find that in
that instance incremental consumption should be skewed towards the present generation. Savings
should be directed to accumulation of domestic capital, public and private, rather than foreign
assets. Their theoretical result would be strengthened in the event of distortionary taxation, and if
consumers are constrained with regard to borrowing against their expected future revenues—both of
which can often be expected in countries with poorly developed institutions. That savings may not
be well-worth in very poor countries, could perhaps count as good news in the context of revenues
spent.
© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 19
O. B. Røste, Norway’s Sovereign Wealth Fund, Natural Resource
Management and Policy 54, https://doi.org/10.1007/978-3-030-74107-5_2
20 2 Natural Resource Sustainability

sustainable to use or consume up to the permanent income.2 However, there may be

uncertainty related to the size of the permanent income—which is the usual yardstick
for measuring the stock of wealth in individual cases. An important problem under
this line of reasoning, is that budget spending is continuous in time, whereas the
permanent income from a resource endowment will only be known with certainty
ex post, that is after it has been extracted. As a practical matter, one thus needs to
approximate the permanent income as one goes along. The Norwegian fiscal rule can
be understood as an example of such approximation. One important modification of
the permanent income model in Norway, is that the initial stock of resource wealth
would be left untouched: Only the real returns made from investing are spent. This
approach is therefore a conservative approximation to the spending of the permanent
income. As all initial resource wealth is saved rather than consumed, the time horizon
becomes infinite. The relative economic significance of the Fund may, however,
decline.
Rainy-Day Savings
The desire to keep a buffer of capital for a rainy day may be a rationale to establish
a SWF. It is clear that in order to satisfy this need one would need only a small fund,
for which the return on capital would not be very important. The capital of the
GPF-G can be used as rainy-day savings, too. There are examples of this in relation
to the financial crisis in 2008 and the Coronavirus pandemic of 2020. The main
purpose with the GPF-G, however, is to share the substantial resource revenues with
future generations. This is a much taller task, that requires much larger savings and
investments by the SWF. For that purpose, it is imperative to stack away enough
funds and to ascertain that one is likely to earn a respectable return in view of the
risks taken. The GPF-G has thus grown sharply from its inception, to become the
largest SWF in the world.3
The rationale for rainy day savings, is just that economic fluctuations may cause a
downturn or standstill in the economy. It may then, depending on the circumstances,
be rational for a government to spend resources from reserves to sustain a given
consumption pattern. This could be particularly useful as a response to temporary
negative income shocks, but in principle also to some extent to ease the initial pain
from permanent negative shocks. One problem of importance for policy, is that one
can rarely know on impact the size or duration of a given shock. In part due to this, it
is customary to treat shocks as temporary, at least early on. If the shock in question
is temporary, it may also be possible to reduce the effect of the shock. However, if
the shock turns out to last longer, one could end up regretting that much resources
were spent trying to counter the initial negative impulse. The utility of that action
may be limited to a reduction of discomfort in the short-term, mainly for agents

2 The permanent income is somewhat larger than the stream of real returns, since in the model one
also consumes the stock of wealth together with future generations, assuming a finite time horizon.
This and some other technical issues make the model less suited for exact implementation.
3 See “Top 89 Largest Sovereign Wealth Fund Rankings by Total Assets” compiled by the Sovereign

Wealth Fund Institute (SWFI), swfinstitute.org, accessed 16 September 2020.

2 Natural Resource Sustainability 21

whose economic activities are severely affected by the shock. Depending on the
circumstances, the resources spent for countering the shock could perhaps have been
more wisely spent in response to other needs and challenges.
It is common to treat negative shocks, at least in countries with ample resources
that apply macro policies meant to be countercyclical. To alleviate large negative
income shocks that may lead to recession or depression is potentially very useful—
even if it may not be obvious that it can be easily achieved. In view of the potential
serious consequences of such negative shocks, it may be seen as worse from a public
policy standpoint not to try and alleviate them. One may thus easily accept the
risk of failed stabilization policy. It could still relieve some pain. Forgiveness could
also be available later if one did try to do one’s best. A downturn in the whole
economy is always severe, and the costs of recessions can be high in terms of lost
production possibilities and income. In democracies, the citizens, or tax payers, own
the resources applied, and the state operates as an agent handling the resource wealth
on behalf of the citizens, also for this purpose.
An item of physical wealth, including a stock of a specific quality of crude oil, can
in theory be valued at the market price at a point in time i.e. with delayed delivery—in
a standard fashion, and modified by future prices to the extent these deviate from the
spot price. The market price is simply what the highest bidder is willing to pay for the
respective wealth item at a point in time. In the simplest, albeit somewhat unrealistic
form, market prices are uniform into the future. If future oil prices increase with a
factor similar to the discount factor for oil income, the present value of the wealth
or resource would then simply be the quantity times the price per quantity unit—a
seemingly naïve approach.4 This sum is the value of the resource wealth. Its spending
should be divided equally on all time periods from the present to infinity. This amount
can be consumed without exhausting the wealth. The former physical resource will
have been transformed into an income stream, in the form of interest, dividends etc.
from investments in financial markets. Even if this framework is too simple to be
taken literally, it captures the essence of the problem and therefore can meaningfully
assist the thinking as regards adequate mechanisms for wealth transformation into
the future.
Future Generations: Is There an Aggregate Bequest Motive?
This second consideration to be made in relation to revenue spending, is intergen-
erational. It is an accepted normative standpoint that the resource wealth should also
benefit future generations. If the resource revenue is consumed quickly, its financial
value will be bounded and not too difficult to calculate. However, it may be less clear
what proportion one should ideally transfer, or what monetary value one should apply
for resources that exhibit volatile price development.
One could decide to transfer forward to future generations for instance the real
value of that resource stock, by consuming over time only the real return. However,
this strategy will depend on attachment of value to physical resources. To clarify, we

4 This
author remembers the late Jan Mossin pointing out in a lecture at The Norwegian School of
Economics and Business Administration, that this approach that he associated mainly with non-
economists, is correct in that instance.
22 2 Natural Resource Sustainability

know what the oil price is today, including the value per unit of deposits of uncertain
quantities underneath the seabed. However, it is impossible to know what the oil
price will be in the future. The resource value could, for instance, increase due to
more acute scarcity of a limited resource. Development of better exploration and
extraction technologies could make scarcity less acute and thus have the opposite
effect. These possibilities may sum up the experiences with oil and gas thus far.
The resource price could, however, also decrease for other reasons. In particular,
other energy sources could replace hydrocarbons as an energy source. There are now
signs of an increased pace in the development of greener, more sustainable, energy
sources. Delayed extraction from undeveloped resource deposits, and thus delayed
conversion of hydrocarbons into cash, implies a financial exposure to the resource
price. This price risk can be managed through asset diversification, as the case of
Norway may exemplify.
If the extraction costs are fixed and the market price for a resource to be extracted
rises with the discount rate, the value of the resource wealth will be fixed. However,
both the extraction costs and the market price for resources, and also the demand
for the resources at given prices will evolve over time. Thus, it cannot be known
early on what the present value of a resource endowment will be. All such estimates
are bound to be very uncertain, and more so if the extraction will depend on the
pace of the development of new technologies, as has typically been the case in
Norwegian waters. The net present value concept avoids this difficulty by relying
on the combined expectations of market players, as embedded in market prices. The
genuine uncertainty due to expectations however, cannot be avoided.
Technological Progress in Hydrocarbon Development.
The technological aspects of offshore oil exploration and extraction have become
more visible over time. In the 1970s one could have guessed at but not known with any
certainty the developments that would follow. However, since technology can only
improve over time, not deteriorate, the early value estimates for a resource might be
downwardly biased in such cases—irrespective of the additional uncertainties linked
to oil price developments, and even if this ‘problem’ is acknowledged.
In the Norwegian case, sharp increases in market prices of petroleum combined
with immense technological improvement has inflated both the physical size of the
resources that can be profitably exploited, and to an even greater extent, due to price
increases, the financial value of the proceeds. Both technological and economic
factors account for a large extension of the time horizon for extraction. An example
of this lies in the history of the second test well, drilled in 1966, with only traces of
hydrocarbons. As mentioned in the introduction, that location became a part of the
Balder field 35 years later. With time technology improved, and the oil price rose.
Extraction of this resource deposit thus became not only economical, but highly
profitable.
Due to such developments, Norway’s physical output from the oil and gas industry,
measured in million barrels per day, is still substantial in 2020. What was thought to
last for a few decades has lasted for five decades, and will still go on for some time.
The limits currently seem to lie in the perceived sustainability of oil drilling as such,
more than in limited natural resource deposits. Further, with much larger wealth from
2 Natural Resource Sustainability 23

non-renewable natural resources than anticipated early on, intergenerational aspects

have gained in importance. The not-yet born are, nonetheless, not well represented.
The current generation has to look after their interests, too. In any event, it has become
more difficult to spend the resource income without due consideration of the future,
even if it is recognized that the resource endowment represents a windfall gain. The
still-new, important climate-related concerns in relation to oil and gas extraction,
seems to underscore this. This quite-new problem in terms of consideration in policy
circles, suggest that the rate of extraction of fossil fuel resources could slow down
earlier than technological development and the resource deposits would suggest.
Sharing of the wealth with future generations may appear straightforward, but is
really not. One reason is that one cannot know in advance the price profile over time of
a natural resource. Thus, there will be uncertainty as to the real value of the resource
that will be realized. Even if the future price developments were known with certainty
in advance, technical distortions and unforeseen events could potentially lead to a less
than optimal extraction profile. Further, even if the extraction profile had been known
with certainty, the price developments would be uncertain. The product of the two
would hence also be uncertain. The cash profile reaped through the resource markets
depends on an uncertain physical quantity, which will react, albeit imperfectly, to
price fluctuations, but not least on the future prices of the resource—that in the
example of petroleum would be set by the interaction of participants in international
commodity markets.
Fundamentally, both the amount extracted of a natural resource, and the market
price the extracted resource could fetch, would depend on the demand for that
resource. Resource demand will again be a function of the available profitable
uses and various technological developments and alternatives, but also the macro
economy. The demand at any price for a natural resource, depends on all of this—
which is determined simultaneously. This sheds light on the erratic price history of
crude oil, and also underscores that the price could decline as a result of the devel-
opment of non-fossil alternatives of greener fuel, in particular when combined with
taxes.
Hydrocarbons are Valued Mainly as an Energy Source
Hydrocarbons are mainly a source of energy. The high demand linked to energy
provision implies that energy prices from alternative sources play a major role in price
formation. The broad picture seems to be that energy consumption globally goes up
over time, but that this rise is slowed by cost increases. For fossil fuels, an additional
important constraint lies in sources of renewable energy that become more popular
over time—alternatives that are friendlier to an increasingly challenged environment
and atmosphere in terms of CO2 and other green-house gas emissions. In this domain,
results from international cooperation have emerged slowly, even if concerted efforts
among states has gained momentum in the latest years, as reflected for instance in
the Paris agreement of 2016. A new sense of urgency has made the environment an
acknowledged concern very recently. This indicates that the future value of fossil
fuel deposits remains uncertain, and potentially much more so than the volatility in
historical energy prices could make one believe.
24 2 Natural Resource Sustainability

The resulting uncertainty could be exploited by the current generation to argue

in favor of a higher rate of extraction, if not necessarily of spending, than otherwise
warranted. However, once the funds become visible in a publicly owned account, it
will become more difficult to curb proposed spending programs that refer to the, in
principle, available funds.
Nonetheless, uncertainty with regard to the future may not be the most serious
challenge in terms of restraining oneself and avoiding excessive spending early on.
Wishful thinking may present larger problems. Undue optimism can result in over-
spending compared to a realistic real return approximation. In the late stages in a
resource SWF’s life cycle, when the bulk of the resource value has been invested in
financial markets, market uncertainties may dominate over uncertainties with regard
to the time profile of resource extraction. It may be difficult to reveal if the market
expectations are too optimistic and easier to argue that less of a resource can be
exploited, as the information needed to assess the latter question is often concentrated
to some key players.
The Scarcity Value of Hydrocarbons
A brief note on the scarcity value of natural resources may be called for: It is not
by itself the non-renewability that creates high demand. Even if non-renewability
contributes to a scarcity value, scarcity by itself is insufficient for economic value. It
must also be possible to put the scarce resources to profitable use, that is, productive
use, without considerable negative side-effects. There are several well-known exam-
ples of once valuable nonrenewable resources, where the quantity has been fixed over
a reasonable time horizon in a human-life context, that have deteriorated sharply in
value due to the development of new technology and alternative energy sources. A
case in point is peat, also known as turf.5 Other examples are pelt, as explained by
Hannesson (2001), and coal.6 This may illustrate the price risk associated with gas
and crude oil deposits. Market prices for benchmark products convey the economic
value, even if every resource is unique and the future is unknown. Note, however, that
new and potentially valuable uses could surface in principle at any time. A natural
resource deposit may thus contain an option value, to be realized if and when new
profitable uses surface and instigate resource price increases. Although it is difficult
to know the value of the real option provided by leaving natural resources untouched,
it could be of a significant value.
Norway’s Savings Record: Almost Too Good to be True?
When looking back to take an inventory of the main events that allowed the great
success of the GPF-G—at least in a financial context—to take place, there are traces
of both luck and hard work. First, it was fortunate that there were significant resource
deposits on the continental shelf: The view of Erik Pontoppidan the younger (1698–
1764), Bishop of Bergen, prevailed over the much more recent one of Norway’s

5 See the discussion in Hannesson (2001).

6 For instance, the once affluent district Charle roi in North Belgium has fallen behind compared
to other districts; Brussels, Antwerp, Liege and Gent. Today it is marked with social problems and
high unemployment.
2 Natural Resource Sustainability 25

Geological Survey (1958). Second, it was fortunate that the developments in inter-
national maritime law were such that resource deposits within a 200 nautical mile
economic zone became the property of the coastal states. This principle determines
property rights in most instances—i.e. when other widely applied principles would
support another result. The 200 nautical mile economic zone principle today appears
undisputed in prescribing ownership. For Norway, which has a very long cost line,
this has no doubt been a very good principle. Third, it was fortunate that Norway in
the 1970s had already developed strong institutions that were both democratic and
favorable with regard to economic growth and development. The newfound riches
therefore did not become easy targets for corruption, as in so many other locations.
Forth, it was fortunate that the resources were in such high demand internationally, for
energy provision, while the bulk of it was extracted. As with some other human activ-
ities, we have become much more aware of the negative side effects of this recently,
in terms of not least climate gas emissions. This suggests a slow-down, if not an end
to crude oil in energy provision. Development of greener alternatives appear more
acute than before, and it is thus likely that the volume of oil extraction will decline in
the short to medium term, and in particular in the long term. In this author’s view, the
substantial negative side effects from extraction of oil and gas, modifies the degree
of success somewhat also for Norway. However, the responsibility for the use of oil
and gas may mainly reside with the end users.
The fortunate circumstances could thus end. Today, there is an increasing
consciousness that hydrocarbons we extract and bring to market lead to destruc-
tion of environmental values. The oil industry is contributing to a gigantic negative
external effect: The consumption of oil and gas leads to huge emissions of climate
gases that may cause irreparable environmental damage, that it may be costly to
ameliorate after the fact. Often the best option may be to let conditions improve
with time without exposure to pollution. The social value of our undertakings in this
domain have in any event, due to large negative external effects, been lesser that the
private value for those who demanded the oil and gas.
The GPF-G has attained a valuation in excess of U. S. dollars 1,000 billion, or 1
trillion, in 2020. In the future the revenue from resource extraction is likely to decline.
An increase in fees and taxes linked to consumption seems likely, perhaps also for
production. If this is correct, the income to this Fund will mainly be from the financial
returns on the capital. This was intended, since the logic behind the financial saving
is the depletion of physical resource deposits. The process may however be speeded
up, which could make the Fund more vulnerable with regard to price volatility in the
international capital markets it invests in. Other things equal, this could make the 70
per cent allocation to stocks questionable, and perhaps shorten the time horizon. A
high allocation to stocks is also a high-stakes game: It increases the likelihood that
the GPF-G can continue to grow, subject to high future returns from equity, but also
that of a major setback. (Figs. 2.1, 2.2, 2.3 and 2.4).
26 2 Natural Resource Sustainability

5000
4500
4000
3500
3000
2500
2000
1500
1000
500
0
-500 Gross returns Fresh funds Weaker Withdrawals Management
krone costs
exchange rate

Fig. 2.1 The GPF-G’s evolvement over time, measured in kroner. Source Norwegian Ministry of
Finance, Meld. St. 2 (2019–2020), National Revised Budget for 2020

Sources of change in the GPF−G: The krone exchange rate

Accumulated Currency rate

1300

1100

900
Billion 2020−kroner

700

500

300

100

−100

−300

−500
1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Year
Source: Revised National Budget for 2020.

Fig. 2.2 The impact of the krone exchange rate, annually and accumulated. Source Norwegian
Ministry of Finance, Meld. St. 2 (2019–2020), Revised National Budget 2020
2 Natural Resource Sustainability 27

Sources of change in the GPF−G: Supply of fresh funds

Accumulated Net fresh funds
3500
3250
3000
2750
2500
2250
Billion 2020−kroner

2000
1750
1500
1250
1000
750
500
250
0
−250
1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Year
Source: Revised National Budget for 2020.

Fig. 2.3 The impact of the supply of fresh funds, annually and accumulated. Source: Norwegian
Ministry of Finance, Meld. St. 2 (2019–2020), Revised National Budget 2020

Sources of change in the GPF−G: Returns

Accumulated Returns
5000

4500

4000

3500
Billion 2020−kroner

3000

2500

2000

1500

1000

500

−500

1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Year
Source: Revised National Budget for 2020.

Fig. 2.4 The impact on the GPF-G from returns, annually and accumulated. Source Norwegian
Ministry of Finance, Meld. St. 2 (2019–2020), Revised National Budget 2020
28 2 Natural Resource Sustainability

2.1 Non-renewable Natural Resources

Taken literally, there is no such thing as a non-renewable resource. If we allow for

enough time for a resource to be reproduced, all resources, even petroleum, may
be renewable. For practical purposes, however, and particularly in relation to public
policy related to resource management, the concern has been primarily for the present
and the very near future, with an emphasis on the former. Thus, I follow here the
usual convention of labeling resources that take long to renew in the perspective of
the length of a human life as non-renewable.
Despite reservations about what kinds of current consumption of nonrenewable
resource wealth that might be sustainable, the view that resources belong also to
future generations seems reasonable, and appears to be normatively well-founded.
It is also clear that the not yet born generations are at a disadvantage when it comes
to having their wellbeing represented in political processes, compared to the current
generation with voting rights and a relatively eager desire to spend publicly owned
funds. Politicians who want to be (re)elected, must thus please the current genera-
tion. Nonetheless, since there appears to be a bequest motive, in the sense that it is
considered to be fair to share the resource wealth with future generations, the advan-
tage of the current generation in representation in decision-making with important
implications for the future, may pose less serious problems than it might appear like
on first sight. Still, it most likely implies that it will be difficult to save in perceived
difficult times for the current generation.
There are two quite different types of risk in relation to caring for the future
generations: First, and most obviously, the resources may be depleted and the wealth
spent mainly by the current generation. It would clearly be a bad outcome if future
generations were thus deprived of their rightful share in the resource wealth. A
solution to this problem could be for the current generation to restrain itself, for
instance by establishing a SWF or by transferring capital to a fund to be shared
with future generations. The second, less obvious, risk is that a once valuable resource
may become worthless due to technological developments. As explained above, in
relation to the account of Hannesson (2001)—the resources may decline in value.
There are, for instance many examples of peat that became valueless due to the
proliferation of new energy sources. It is not possible to know today with certainty
which valuable resources that may in the future lose the bulk of their value. There must
be a middle way, between extracting and consuming the full worth of the petroleum
resources and saving the resources as oil and gas in the ground. One could extract
and sell a part, and invest part of the proceeds in international financial markets.
Nonetheless, this approach would be of little help in arriving at how much it is
reasonable to respectively extract, consume and leave undeveloped. One should keep
in mind that future oil prices are unknown: Resources left in the ground undeveloped
could therefore at least in theory either become valueless or appreciate extremely in
value. The risk associated with this uncertainty, could complicate decisions on what
fraction, if any, to leave undeveloped. A risk-averse resource owner could extract at
a high rate, to invest the proceeds in other assets.
2.1 Non-renewable Natural Resources 29

Caution should perhaps lead us to extract or spend less of the physical resource in
the locations with resource deposits. A resource like oil, with multiple known uses,
could perhaps retain its value. This seems to have been the situation thus far in relation
to the Norwegian hydrocarbon deposits, in spite of some large price fluctuations.
The peat example cited above may in this interpretation, that emphasizes the many
industrial uses of petroleum—where new ones may be added, not be well-suited to
guide policy. Nonetheless, this example pin-points an important risk with regard to
technology that cannot safely be disregarded. The optimal profile of oil extraction
over time would depend on assumptions which can be verified or falsified only in
retrospect.
The problem is more complex than the one sketched here, as other factors of
importance also vary over time. One example of this is the extraction technology,
which is likely to be developed further—although at uneven steps, to make it increas-
ingly economical over time to extract a given resource endowment. Even if this could
also apply to deposits that have been fully exploited under technology that could be
utilized further, it could in isolation also be an argument to wait in order to be able
to extract resources more economically.
Various new techniques make it possible to squeeze more water or oil out of a
rock, which in this context might be likened with a sponge. This however, would
not by itself imply that it is better for one single supplier to a market to wait: Other
suppliers may also have resources that become increasingly marketable with new
technology, due to some aspect(s) of technological change. It is thus possible that the
development of alternative technologies may result in large increase in supply for a
resource at given prices.7 This type of uncertainty, that typically applies in relation
to real options, cannot be avoided.
It will be risky to save the resource as such in the ground, undeveloped, and it
is often possible to extract resources early, and invest the proceeds for the future in
financial markets. This is the approach Norway and some others have chosen: To
extract the resource at a rather high rate, and save and invest most of the proceeds.
This choice has in part been related to economics in extraction costs—where there
may be some minimum economical scale that may be quite large when it comes to
extraction of oil and gas resources underneath the seabed. However, if one extracts
more early on, to attain a large-enough scale, there is no guarantee that it might not
be possible to extract resources more economically also at a smaller scale in the
future. Consider, for instance, the quite recent significant improvements in floating
production technology, which has made redundant many large installations made of
concrete. Flexible and low-cost extraction technologies have increased dramatically
in importance over time, and made ever smaller projects economical. That even these
kinds of development may be difficult to predict over time, adds to the complexity
of extraction decisions for hydrocarbon deposits underneath the seabed.

7 This may explain why the hypothesis of Harold Hoteling (1931) doesn’t seem to work well in
practice. This rule tells us that the price of a scarce resource is likely to increase gradually over time
and that the rational resource owner will take that into account in his extraction decisions. With
offshore oil and gas, the story is more complex. For instance, there are decision lags. It is thus not
possible to deplete all oil or gas completely at a point in time.
30 2 Natural Resource Sustainability

The most important challenge ahead for this kind of activities seems to be the
colossal external effects involved in terms of climate gas emissions, most notably
CO2 , when the extracted resources are used—typically for energy provision including
as fuel for cars and other means of transportation. One argument is that as long as
there is demand for hydrocarbons for that use internationally, some producers will
bring them to the market. Since the Norwegian off-shore installations are powered by
electricity from renewable energy sources, mainly hydro-electricity, Norway could be
seen as behaving in agreement with a new and stricter standard regarding extraction
activities. A big problem, however, is that most environmental degradation due to
fossil fuels are linked to their use subsequent to extraction. Another, perhaps obvious,
problem is that electrification of the installations will allow more natural gas to
be sold—some of which will fuel European power plants. This use will clearly in
isolation generate more emissions of CO2 .
This is controversial, however. It is also possible to argue normatively, that a
country that has already produced a lot of hydrocarbons and is in part due to this
comparatively well off, should exhibit self-restraint with regard to supplying more.
Further, the main problem with emission of green-house gases is as mentioned caused
by the burning of extracted hydrocarbons, not by the production. This is important in
emission accounting, as only the emission due to extraction will be in the producing
country. The bulk of the emissions is attributed to the consumers of oil and gas. If
less hydrocarbons were brought to market, there would be reduced green-house gas
emissions also in extracting countries, but not by very much. It has been suggested
that the shares of producers and consumers in CO2 emissions could be about 10 and
90 per cent, respectively.

2.2 The Rationale for a Petroleum Fund: A Windfall Gain

The idea of establishing a SWF in which to invest the revenues from oil and gas is
not new. In the two first decades, the additional funds from this source were spent in
the ordinary state budget. It was not until 1990 that the State Petroleum Fund was
formally established, based on a proposition from finance minister Arne Skauge of
the conservative government of Jan P. Syse. It still took six years before the Fund
was formally established, and the first 2 billion kroner vas transferred to the SWF
account at the central bank in 1996. At that time there was an increasing and quite
widespread recognition that something should be done in view of sharply increased
revenues due to higher oil and gas prices and large new discoveries of oil and gas
deposits. The social democratic government of Gro Harlem Bruntland had wanted
to put forward a similar proposition to parliament in 1986, but had postponed this
move due to tactical considerations in macroeconomic policy, linked to the wage
negotiations of that year. After these wage negotiations, however, this government
Brundtland resigned. According to economic historian Lie (2013), they were afraid
that establishing a fund at the time could have been interpreted as a signal that the
government saw the sharp oil price decline of 1986 as temporary.
2.2 The Rationale for a Petroleum Fund: A Windfall Gain 31

Finance minister Skauge’s decision was taken in 1989, after a phone call to the
deputy leader of the parliament’s finance committee, Sigbjørn Johnsen of the labor
party, who later became Finance minister. The GPF-G was made possible by favorable
institutions and some strong personalities in economic policy circles—particularly in
the administration, but also amongst politicians. In assessing who were responsible
for establishing the GPF-G, author and journalist Skredderberget (2015) emphasized
the agreement across the political blocks, that included the labor party and the conser-
vative party, and also some key actors in addition to the persons already mentioned.
Jens Stoltenberg played an important role in the early phase of the SWF.
It has been considered as good public policy as of late to nudge individuals to save
more for their future or retirement, because it has become increasingly recognized
that individuals often lack the self-restraint needed to forego immediate consumption
to save for the future.8 Another way of contributing towards the goal of increased
savings for the future, could be for the government to save on behalf of its citizen-
taxpayers. The case for this may look particularly strong in the event of income from
the sale of non-renewable natural resources accruing to the state. This is discussed
further in Chap. 3, in relation to some results from the work of Richard Thaler on
bounded rationality. The Swedish Royal Academy of Sciences awarded Thaler the
2017 ‘Nobel Prize’ in Economics for this work.9

2.2.1 The Tempo Commission

Of particular importance with regard to the practical approach of a would-be Norwe-

gian SWF was the report of the Tempo commission, chaired by former Central Bank
Governor Hermod Skånland.10 Partly in response to dissatisfaction with the working
of Norway’s Social Insurance Fund (Folketrygdfondet) established in 1967, a mech-
anism was proposed whereby the funds were first earned due to industrial consid-
erations in relation to the resource extraction rate, and then transferred into a fund
that would invest these proceeds in international capital markets. Finally, the money
would be transferred back, through the covering of the ‘non-oil deficit’ in the state
budget. The transfers back into the Norwegian economy could then come at a pace
and in proportions that were subject to financial and economic considerations. This

8 Nudge is also the first part of the title of the 2008 book Richard Thaler coauthored with Cass
Sunstein of Harvard Law School. The rest of that book title is Improving Decisions about Health,
Wealth and Happiness. The book advocates paternalism of a libertarian kind in policy, based on
research in psychology and behavioral economics.
9 Formally, the name of this prize established only in 1969 to strengthen the position of economics

in society is Sveriges Riksbank’s Prize in Economic Sciences in Memory of Alfred Nobel.

10 An earlier official document of great importance is Norwegian Ministry of Finance (1974), Meld.

St. 25 (1973–1974)—a royal resolution clarifying that a certain amount of the petroleum revenues
had to be invested to the benefit of future generations, and that additional domestic investment could
probably add little to future consumption.
32 2 Natural Resource Sustainability

is how resource stabilization funds work. Later, this framework has become known
as ‘the Fund mechanism’.
For the Social Insurance Fund, no such disciplining mechanism was established.
As a consequence, it became difficult after only a few years to set aside funds for
capitalization of that Fund. The political understanding then became that Norway´s
social insurance scheme should receive funds continuously through the budget, under
a pay-as-you-go approach. Consequently, the social insurance fund, known today as
the GPF-D—D for domestic, as opposed to G for global—corresponds only to a
miniscule fraction of the global Fund, i.e. the GPF-G.
Since the first major oil find in the North Sea in 1969, the extraction of resources
and spending of revenues have been analyzed and debated in the context of public
policy. Some of the most important parameters in this context have been the extraction
rate—which under assumptions of future market prices for petroleum, exploration
and extraction costs, and the specifics of the petroleum tax regime, could be translated
into a cash profile from the resources. There would also be savings, both in cash for
investment in capital markets and undeveloped resources underneath the seabed. The
state would run budget surpluses, before an adjustment for oil, due to the resource
revenue on the income side of the budget.
The appointment and work of government commissions is an important tool
in public policy-making in Norway. Commissions are used to arrive at informed
and professionally sound decisions in diverse domains. Such recommendations are
usually robust to critique from other experts, and presumably well-founded. Govern-
ment commissions have over the years played an important role also in the context
of oil and gas development. The so-called Tempo commission is a case in point. As
the name suggests, it was particularly concerned with the rate of extraction of the
petroleum resources.
The work of government commissions to formulate public policy can be visual-
ized as follows: First, the government decides, whether there will be a commission.
Second, its mandate as well its chair and other members are decided upon. Within
this framework, there will be quite few surprises for the government regarding what
the likely outcome would be from the process. The use of commissions may also
be portrayed as a method of ascertaining that political decisions do not have any
clear pitfalls from a professional or academic standpoint, and further that it will be
acceptable in a wide social context. These aims are secured through the appointment
of members external to the government, often university professors, business leaders,
or other experts. Most commissions work with a short time horizon. At the end of
the group’s work, a report is filed with the government which usually arranges a
public hearing based on the recommendations. Various professional organized inter-
ests, in particular, the large labor market organizations may have important roles as
commission members and/or in the hearings stage. Finally, the government presents
regulation proposals, including proposed changes, before Parliament.
On other occasions, similar commissions may be used as an instrument to
strengthen the authority and legitimacy of important public policy decisions with
2.2 The Rationale for a Petroleum Fund: A Windfall Gain 33

respect to various organized interests. The aim may be to arrive at binding, unani-
mous decisions. As mentioned it is common, in particular, that the main labor market
organizations are represented among commission members.
The final outcome of such processes is influenced by inputs and later interactions
through the mentioned stages. As regards recommendations, the members and their
professional standards are important. Further, the mandate, time frame, members
and other personnel resources may influence on the outcome. The relevant decisions
behind all this is taken by the government. In some instances, how the work is
organized might be highly suggestive of what the final advice will be. The Tempo
commission may, however, be an example with a more independent role for the
appointed experts. As already mentioned, The Tempo Commission was headed by
former Central Bank Governor Hermod Skånland, in 1983 the central bank’s Deputy
Governor.
The commission analyzed broad societal and economic consequences of Norway’s
quite new petroleum sector after a period of strong growth: A main concern was,
for economic stability reasons, to avoid that the uncertainty one faced about the
petroleum revenues should translate into a corresponding uncertainty for aggregate
demand, and thus the activity level in general as measured by GDP. A particular
concern of the commission was to dampen the tendency for boom—bust cycles
due to changing prospects over time for the petroleum sector. To achieve this, one
had to separate the income from oil and gas and its use from one another in the
budget. Although primarily a task for budget policy, techniques could be prescribed
to simplify this task.
The commission thus advocated, already in 1983, the creation of a Fund for
resource revenues with transfers into and out of this Fund as an integral part of the
budget. As mentioned, this practice later become known as ‘the Fund mechanism’.
The Fund could in principle serve either of two functions. First, it could work as a
buffer in relation to variations in future government revenues from resources. Second,
it could be intended for saving, with or without resource revenues. The commission,
however, left it to political consideration to decide whether there should be a build-
up of such a large Fund that the return from it would constitute a separate factor in
budget policy. A Fund of the type of the current GPF-G was clearly not in the cards.
The size of the Fund was explicitly identified as a political decision, that was
interpreted by the commission as outside their mandate. Further, it was stated that the
establishment of a Fund did not need to result in the creation of a new organizational
unit. The book keeping could be handled as a central government krone account with
the central bank. One only had to negotiate an agreement subject to which the state
would receive a return on its krone-denominated account that corresponded with the
returns made on international investments denominated in foreign currencies.
Furthermore, the commission noted that under certain assumptions on future
resource prices, return on real and financial capital, and the size of the resources,
one could arrive at optimum solutions on production levels, i.e. the extraction rate
and the use of revenues that would presume that income and its use could be sepa-
rated from one another to a much greater extent than what would be needed to avoid
34 2 Natural Resource Sustainability

prospective petroleum related boom—bust cycles, that could in part be fueled by too
high expectations of economic outcomes due to the newfound wealth.11
A political decision, nonetheless, was to implement a Fund that became very large,
and where the anticipated returns has later become a key element of the budget policy.
For operational management, the central bank established a separate wing within its
organization to perform fund management, Norges Bank Investment Management,
NBIM. There has been a strong growth in the number of staff in this wing of the
central bank.12 Today, the NBIM is by far the largest wing of the central bank, with
about 60 per cent of the total central bank staff.13
In retrospect, it would appear as artificial to apply the theoretical possibility of
a fund without a new organizational unit for evaluation purposes. The main reason
for this decision is the very large size the Fund has attained since its inception. Few
could have expected that the fund would by the year 2020 exceed 1,000 billion, or
1 trillion, U.S. dollars. With that size one needs a large, professional organization.
Elsewhere, practices of the investment industry exhibit an ample appetite for the
hiring of investment professionals, who must thus be expected to create value.

2.2.2 What is the Fair Share of Future Generations

in Resource Wealth?

As mentioned, strong norms do suggest that at least some of an endowment of non-

renewable natural resources should be left for future generations—either as crude
resource deposits or as financial capital, or a mixture of the two. The squandering
of resource wealth by a current or early generation, is also a well-known problem—
not least in developing countries with weak institutions. This pattern is likely to be
considered as unfair by many, because future citizens or residents would not have a
chance to benefit from the resource wealth. This seems to be the case, even if it would
be difficult to establish anything that can approach a legally binding norm that would
require saving the proceeds from sales of non-renewable resources. In any event, any
such claims would have to be derived from the earlier generations. In principle, thus,
the early generations will always be able to extract and consume the resource wealth
with a view only towards their own needs. Apart from technological development,
the constraint that bars this from happening rests within a current generation where
some do care for future citizen-residents.

11 The source for this and the two previous paragraphs is The Tempo Commission (1983), a.k.a. NOU

1983: 27, pp. 9, 10, and 15.

12 Indeed, the operations have become so large in scale and scope that a recent government commis-

sion recommended that fund management should be separated from the bank. See NOU 2017: 13
(Sentralbanklovutvalget).
13 According to the annual report of 2018, Norges Bank (2019) employed 953 staff, of which 601

(63 pct.) in the NBIM.

2.2 The Rationale for a Petroleum Fund: A Windfall Gain 35

It may perhaps be seen as more unfair to consume all of a specific resource endow-
ment than to consume its equivalent in cash. The latter can be achieved by borrowing
towards the resource wealth. One reason is that undeveloped resources may be used
more profitably in the future. In such instances, an undeveloped resource stock may
carry a significant real option value. This may be important in relation to undeveloped
petroleum, due to the numerous applications for this resource, including industrial
ones. However, as mentioned above, there is also the theoretical possibility that, due
to for instance the evolvement of new technologies, the natural resource might have
a financial value only within a limited time frame. Technological progress remains
a big unknown factor, that may work as a double-edged sword, regardless of how
one approaches the intergenerational consumption-savings problem: Technological
progress can render a resource valueless for specific applications, but might also
result in innovations that open up for novel profitable applications, or known appli-
cations that can be performed more efficiently, or applications that one might not
have thought of. Specifically, as one has seen in the North Sea and the Norwegian
Sea, technological progress can lead to sharp increases in the fractions of oil deposits
that can be economically extracted from oil and gas reservoirs underneath the seabed.
One could argue that the generation currently in charge should, based on norms of
equity, share non-renewable resources with future generations. In a democracy, this
would require that the parties and voters considered it to be important to save beyond
their own time horizon to the benefit of future citizens. This could as mentioned
be likened with a kind of aggregate bequest motive, based on solidarity with future
citizens or residents in the territory. This kind of motive could be much more fragile
than a bequest motives within most families. Within a family there may be a strong
feeling of identity that may make it simpler, although usually not trivial, to put aside
financial capital for the future.
The main factor that can prevent a depletion of natural resources by the generation
currently in charge thus seems to be self-constraint within that generation, motivated
at least in part by solidarity with future generations. This condition could be difficult
to satisfy in practice. It may thus be reasonable to expect failure, in the form of
resource squandering, in many instances.
For a country, perhaps in particular a multi-ethnic or otherwise heterogeneous
society, this task would be more demanding. In relation to this problem, mainly due
to the lesser identification with members of the society, including in the future, and
uncertainty also as to who they would be—e.g., whether one considers residents or
citizens. It thus seems problematic to presuppose a general bequest motive. It might
also be problematic that the political system, and/or other relevant systems, do not
have built-in mechanisms that emphasize the wellbeing of future generations: They
are not yet around, and can therefore not vote. Under uncertainty, and without a
binding norm, the current generation may therefore to a large extent do as it pleases.
Their choices are still likely to be sensitive to their expectations regarding the future.
The best unborn members of future generations could hope for, is sympathy among
those who vote and rule today. However, it is also possible that they will not need
36 2 Natural Resource Sustainability

sympathetic actions, or transfer of financial wealth, due to the possibly of a superior

future economic situation due to growth.14
The Norwegian fiscal rule, of spending up to 3 pct. of the value of the SWF at the
end of the previous year (4 pct. until 2017), may serve to illustrate the weighing of
such concerns—even if the main concern that has dampened spending of petroleum
wealth thus far seems to have been a limited absorption capacity of the domestic
economy. Spending and use of funds above the absorption capacity can lead to infla-
tion, which based on past experiences could be expected to be costly to eradicate.15
Thus, self-restraint through the use of a norm that political parties have agreed to
respect, constrains the current generation’s consumption of income, including income
due to resource wealth. The arrangement works, but it has not yet been put to any
tough test.
Even if one accepts that future generations have rights linked to a natural resource
stock, it can be difficult to determine the extent of these rights, that is what fraction
of a given natural resource endowment that belong to future generations. The peat
example of Hannesson, op. cit. illustrates how the value of physical resources may
decline dramatically, for reasons that cannot be well understood ahead of time. In
other examples, the value could increase. In addition to the highly uncertain future
value of physical resource deposits, continued technological progress and economic
growth may render future generations well-off compared to the earlier ones. The
latter argument is likely to apply with greater force to relatively poor countries in
emerging economies.
What share to set aside for future generations, must be decided-upon by the current
generation. The solution could in view of this become biased to favor that generation
at the expense of future ones. The possible aggregated, fragile bequest motive referred
to above, could work to alleviate a bias towards over-spending towards the well-
known needs of a generation currently in charge.
The fiscal rule has long been a key parameter of budget policy in Norway. The
rule can be defended both due to the economy’s limited absorption capacity with
regard to injection of fresh funds, and a view that future generations should receive
a fair share of the resource wealth. In public debate the former concern has received
most attention, perhaps due to a difficulty in knowing what share of the wealth to
set aside. The large and increasing size of the GPF-G, and the framework which
aims at recurrent spending up to the real return, shows that the concern for the future
is highly important. Without such a fiscal rule, more money could be spent by the
current generation without explicitly considering the future generation’s rights to
the resource endowment. There has been some debate over the years in relation to

14 As outlined above, this requires real economic growth at a higher rate than the population growth,

which has been realized since the industrial revolution but which cannot be taken for granted for the
future. Many thus believe that real GDP growth will remain below the 2–3 pct. per annum interval
realized in the West during the recent decades.
15 Inflation entails real costs when economic agents need to take it into account in their decisions.

There is a large literature on the sacrifice ratio, defined as the output loss likely to result from
needed disinflation policies in view of historical data from disinflation periods. See, e.g. Ball (1994);
Leitemo and Røste (2008) and the references in these works.
2.2 The Rationale for a Petroleum Fund: A Windfall Gain 37

spending in excess of the allowance in the fiscal rule. The norm is important, but has
become less of a constraint over time due to the very strong growth of the Fund. In
earlier events of overspending, growth of the Fund fixed the problem. It therefore
never became necessary to apply explicit corrective measures. The fiscal rule was
still of use. There could have been more overspending were it not for the spending
norms embedded in the fiscal rule—that has required good arguments for increased
spending. If more funds had been spent in earlier years, the returns could have been
much lower.
The future generations could have a right to either a fraction of the unextracted and
unrefined resource or to the income stream that it might give rise to, or—perhaps more
realistic—a combination of the two. The first possibility is easy to understand and
communicate as it is concerned solely with physical entities. However, as discussed
above, the financial value of a physical resource may change dramatically. One
possibility is that it may become valueless before it can be extracted. Responsible
management requires that the uncertain future price development is considered.
The second possibility is less straightforward. Future resource prices are likely
to vary in ways that cannot be understood or foreseen in advance. This is typical for
commodities markets. One should also keep in mind that some deposits are easier
to exploit than others, and that the ease of extraction of various deposits in terms
of costs, may change over time with the evolvement of better and more economical
extraction technologies. Further, there may be additional profitable applications of a
natural resource over time. Particularly this latter possibility could render it respon-
sible to leave some resource deposits undeveloped. This argument assumes a stable,
tranquil environment. Uncertainty regarding possible later development of what is
left undeveloped, may significantly shorten the time horizon and speed up extraction.
An adopted resource extraction path must be economically sustainable. One
approach to sustainability could be the extent to which a resource income would
extend the ability to consume by the members of a society, contemporaneously and
in the future. One could think of this approach as an aim to spend only the real,
permanent income. With given social preferences, an optimum path could be derived.
Constraints that cannot easily be avoided could, however, distort this picture. There
could inter alia be constraints given by physical factors of nature, for instance on the
fraction or subset that can be economically and/or physically exploited up to a given
point in time. A second type of constraint could be linked to how the wealth can
be shared with future generations. Ideally, the latter should depend on what would
benefit both the current and the future generations. To get a good handle on this,
could, however, be difficult.
One important problem in relation to the second possible restraint, is that extrac-
tion of petroleum resources has resulted in environmental degradation and strong
impulses to the real economy from both extraction activities per se and the spending
of the resulting wealth. There has also been a tendency towards inflation linked to
later fiscal spending, reflected inter alia by CPI increases. This could be a cost for
the current generation, but perhaps less of a cost for the future. It would depend inter
alia on the time profile of inflation rises, and expectations formation, as well as the
sacrifice ratio associated with inflation reduction.
38 2 Natural Resource Sustainability

Inflation may appear as less important on impact, since it only leads to upwards
price adjustments, typically of both prices and wages. It still reflects serious problems.
A view that a doubling of both prices and wages would have no real effects, is wrong.
The reason is, as mentioned, that inflation may lead to needs for costly disinflation
policies in later time periods. Such policies translate into foregone output compared to
in instances without disinflation needs. The reason that such policies are still needed,
is that inflation tends to feed on itself if it is left unchecked. Such developments could
reduce both growth and macroeconomic stability.
Thus, specific low-inflation policies may be needed to stem decreases in GDP.
This means that there is a risk that some of the real income that otherwise would
have accrued, may be lost due to future anti-inflation policy. Inflation is clearly an
unwanted effect of resource extraction and the consumption of wealth due to natural
resources. To avoid it, one must usually exhibit some self-restraint in the spending
of resource income. This could be particularly important in small, open economies
where disturbances due to inflation may be amplified through the exchange rate.
Figure 2.5 The Price of Oil 1980–2020
Figure 2.6 Quantity of oil (bbls) produced by Norway and her world market share
1970–2020

Brent diff.Brent−Dubai diff.Brent−WTI

120 24
110 22
100 20
Real prices in 2015 U.S dollars, GDP deflator

90 18
80 16 Difference in real price per barrel ($)
70 14
60 12
50 10
40 8
30 6
20 4
10 2
0 0
−10 −2
−20 −4

1980 1990 2000 2010 2020

Year
Source: IMF, World Economic Outlook Database, April 2020.

Fig. 2.5 Exhibits the price for Brent Blend and the difference between this price and the price for
West Texas Intermediary (WTI) and Dubai Fateh (DF) respectively, in real U.S. dollars (2015, GDP
deflator)
2.2 The Rationale for a Petroleum Fund: A Windfall Gain 39

4.50% 4.500

4.00% 4.000
Norwegian production in percent of world production

3.50% 3.500

3.00% 3.000

Thousand barrels daily

2.50% 2.500

2.00% 2.000

1.50% 1.500

1.00% 1.000

0.50% 500

0.00% 0

1970 1980 1990 2000 2010 2020

Year
Source: British Petroleum Statistical Review of World Energy 2020.

Fig. 2.6 Exhibits the Norwegian production of crude oil (million bpd, right axis) and Norway’s
share in world production of crude oil (percentage, right axis) since 1970

An argument against significant time transformation of the wealth to benefit future

generations can be illustrated by the history of economic growth in industrial nations
since the industrial revolution: Till this day, members of future generations have been
better off economically than their ancestors. This is mainly because they have been
able to stand on the shoulders of the members of earlier generations with respect
to technology. It is therefore likely, though not at all certain, that future citizens
will produce more real output per capita than the members of earlier generations.
If this possibility based on extrapolation—often a risky undertaking—should hold
true, relatively big sacrifices would be required today to set aside enough resources to
make a real difference for the future generations. The yardstick of future satisfaction
from this resource transfer will be the relative ease with which the same wealth could
have been produced later on. Technically, the utility of incremental wealth cannot be
compared between different subjects. The same could apply between generations.
However, absent an agreed-upon metric for that purpose, we stick to the reasoning
that it could be a bad idea to save for by-today’s-standards very rich future citizens.
If the society of the future were to be highly affluent, a fixed resource transfer today
might not make much of a difference. The reverse should hold true in a less wealthy
future setting. All aspects of the future are uncertain, but it is likely that income and
productivity could increase. Efforts to save today might thus be less valued later-on
40 2 Natural Resource Sustainability

Brent price Gas Oil

Brent real price in 2015 U.S dollars, GDP deflator

200 100

150 75
Mill Sm3

100 50

50 25

1980 1985 1990 1995 2000 2005 2010 2015 2020

Year
Sources: IMF, World Economic Outlook Database, April 2020 and Oljedirektoratet

Fig. 2.7 Exhibits the Norwegian production of crude oil and natural gas and the Brent crude oil
price. Sources: IMF and The Norwegian Oil Directorate

than expected today. This argument seems to have had some merit since industri-
alization, which was largely completed in the decades after 1900 in Norway. This
transformation has dramatically changed production and industrial use of energy,
and later data and information processing. Another, less readily measurable aspect
of the transformation, is institutional development (Fig. 2.7).
North (1958: 537), argued that developments in transport technology had been an
essential feature of the growth of the Western world of the previous two centuries.
Reduction in the cost of carriage had enabled specialization and division of labor
nationally and internationally to replace the relatively self-sufficient economies that
dominated the Western world about two centuries earlier. Further, Shiue (2002) found
in a case study of China in the eighteenth century that market integration in time,
through storage, was also important for growth. For our purpose here, it is also impor-
tant to consider possibilities for market integration in time due to financial markets.
Furthermore, in later works of North, much of the growth differentials between
nations is attributed to different institutions (e.g., North 1990, 1991, 1994). Rodrik
et al. (2004) found through replication and extension of studies that highlighted the
role of trade and integration, respectively, that once one controlled for institutions
the effects of both trade and integration vanished in studies that regressed economic
growth on these two factors.
2.2 The Rationale for a Petroleum Fund: A Windfall Gain 41

Regardless of the true mechanisms that cause growth, which may be intricate and
involve many different variables,16 it may be difficult to achieve. Thus, growth cannot
be taken for granted. The past record should make this clear. The high growth rates
of Western countries since World War II have been recorded over a brief period.17 A
more demanding environment for growth can therefore lie ahead, for several reasons.
One possibility is that growth could be dampened due to various constraints, linked
e.g. to global warming and the environment. In that event, transfers toward the future
could also become more appreciated than we would typically expect today, as the
transfers would be spent by less well-to-do future citizens-residents. When the future
is uncertain, it does make sense to be more careful than one would otherwise be.
Technology optimists may not believe in constrains on growth.18 In any event,
it might be inappropriate to assume economic growth at the previously experienced
growth rates. In the agrarian societies of earlier times, there was no marked tendency
for GDP growth to outpace population growth, to sustain large increases in GDP per
capita over time. In spite of variations in income, upwards and downwards, the trend
was quite flat. Thus, GDP per capita never took off as it did later, in the industrial
age. This fundamental change in the growth rate, has been attributed to improved
total factor productivity over time—due to improved ideas and practices, on how
to best accomplish efficient production. While the past may be analyzed in detail
to largely confirm this pattern, one cannot know what growth rates one can achieve
in the future: Growth might rise, decline, or remain constant. As of late, there have
been some signs that corporate earnings have slowed in the United States recently
compared to before the 2008 financial crises, and that one should perhaps expect
lesser real GDP growth than the mentioned 2–3 pct. per annum interval that seem to
have applied to many high-income countries.19
Some attribute the productivity gains in the industrial age mainly to an ‘energy
revolution’, whereby biofuels and muscle power were replaced by engines running
on fossil fuels. If this covers a large fraction of the “growth miracle” there may be

16 Sala-i-Martin (1997) provides an overview over the difficulties in finding the “true” model in
empirical work. The typical growth regression had seven independent variables. In that author’s
paper six right-hand-side variables were used in a very large number of regressions—due to the many
candidate variables (62 in the literature). Three were accepted a priori: Income, life expectancy, and
the primary-school enrollment rate—initially, in 1960, to reduce endogeneity problems. The main
finding is that many variables can be found to be strongly related to growth.
17 On this, see, e.g., North (1994): “In fact, most societies throughout history got ‘stuck’ in an

institutional matrix that did not evolve into the impersonal exchange essential to capturing the
productivity gains that came from the specialization and division of labor that have produced the
Wealth of Nations. (…) Societies that got stuck embody belief systems and institutions that fail to
confront and solve new problems of societal complexity” (p. 364).
18 Technology optimism may be understood as a measure of risk seeking or risk aversion—see,

e.g., Hochschild et al. (2012), citing Hjörleifsson et al. (2008), who see it as underestimation or
neglect of uncertainty in favor of a widely shared speculative promise. In spite of technological
path dependencies and knowledge accumulation, we cannot know ahead of time what the future
will bring or that particular concerns regarding the future are unfounded.
19 Expected global growth rates, by contrast, are likely to be higher than 2–3 per cent. p.a. due to

the relatively high growth rates of successful emerging market economies.

42 2 Natural Resource Sustainability

reason for caution now that fossil fuels are increasingly viewed as non-sustainable.
God ideas may solve this situation too, but it would seem difficult to be able to fill
the potentially large gap left by fossil fuels without incurring high costs and, thus, a
drain on future growth. This, however, is a bit speculative.
In view of uncertain growth, a good response could be to leave some of the
petroleum resources in the ground. Since the resources may, at least in theory, also
become less valuable, one could be well advised to transfer some resource income
from earlier times into the future, through the use of investment funds. The disadvan-
tage of this solution is that it may become more difficult to save, and more tempting
to spend assets that are liquid and have an undisputed monetary value.
The disadvantage of leaving the future generation’s share in the ground, unde-
veloped, is that it is uncertain what the future value will be of natural resources,
for instance petroleum under the seabed. It is also possible that foregone opportu-
nities of economical extraction could result in increased costs later on due to scale
effects. There are, moreover, numerous possible scenarios that could imply quite
different price developments for petroleum, and, thus, genuine uncertainty. One way
to reduce this uncertainty, is to extract a part of the resources and channel the asso-
ciated proceeds into financial investments. At least if we would be able to restrain
ourselves from consuming, and hold on to the funds at the bank as well as to the
resources.
An old saying holds that what is out of sight is out of mind. Although numerous
professionals and experts, and politicians, would not forget about the resources even
if they were left in the ground, known resource deposits per se could attract less atten-
tion than funds deposited with a bank or invested through financial markets. The true
spending possibilities could perhaps, at least partly and temporarily, disappear from
the public’s consciousness. A net effect could thus be reduced spending and increased
savings for a while. A price to pay could be a less favorable asset diversification, at
least if a large fraction was left as undeveloped natural resources. With moderately
sized deposits left undeveloped, overall diversification could improve: A portfolio of
both financial investments and some crude natural resources, with somewhat uncor-
related returns in relation to stocks, and/or some bonds, could produce a higher
expected risk-adjusted return on the overall capital stock. Further, there would be a
real option value attached to the undeveloped deposits, in view of potential new prof-
itable uses in the future. The fraction of the initial hydrocarbon deposits that can be
left undeveloped declines with extraction. In November 2020, NBIM communicated
that about one third of the resource wealth was due to expected future government
revenues, whereas about two thirds had been invested in the global capital markets.
Proponents of greener energy carriers tend to claim that the era of massive use of
hydrocarbons as an energy base is about to end. New technologies, and Pigou taxes
aimed at reducing negative externalities, combined with other restrictive measures—
particularly aimed at reducing green-house gas emissions, makes it less attractive
than before to explore and extract hydrocarbons. It is still uncertain, however, if or
when it may become unprofitable to extract oil and natural gas. Increased scarcity
of oil and gas deposits ready for extraction, and a to date steadily increasing energy
demand, could over time work to counter the restrictive effect. Further, even if energy
2.2 The Rationale for a Petroleum Fund: A Windfall Gain 43

(a) Coal Crude oil Natural gas Traditional biofuels

55.0%

50.0%

45.0%
World power consumption (per cent)

40.0%

35.0%

30.0%

25.0%

20.0%

15.0%

10.0%

5.0%

0.0%

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020
Year
Sources: Smil (2016) and British Petroleum Statistical Review of World Energy (2020).

(b) Hydropower Nuclear Other renewables Solar Wind

2.75%

2.50%

2.25%
World power consumption (per cent)

2.00%

1.75%

1.50%

1.25%

1.00%

0.75%

0.50%

0.25%

0.00%

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020
Year
Sources: Smil (2016) and British Petroleum Statistical Review of World Energy (2020).

Fig. 2.8 Exhibits world enregy supply by sources, since 1900. Panels a shows the main sources over
times coal, crude oil, natural gas and traditional biofuels—which includes firewood. Over time the
share of fossil fuels has increased, and traditional biofuels declined. Panel b shows corresponding
figures for some additional energy sources: hydropower, nuclear energy, as well as solar, wind and
other alternative energy sources. The alternative sources are on the rise, from a low level. Panels
a and b show the relative share of the various energy sources in World supply. Panel c shows how
the volume of energy consumed has rise over time, measured in tWh
44 2 Natural Resource Sustainability

(c)
160.000
150.000
140.000
130.000
120.000
110.000
100.000
90.000
tWh

80.000
70.000
60.000
50.000
40.000
30.000
20.000
10.000
0

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020
Year
Sources: Smil (2016) and British Petroleum Statistical Review of World Energy (2020).

Fig. 2.8 (continued)

consumption per capita could in isolation decline with more efficient use of energy,
prospective growth in formerly poor countries contributes towards increased energy
demand. In addition, other uses of oil and gas than as an energy source could increase
in importance, including in numerous industrial uses. The latter includes inter alia
plastics and asphalt in road pavements and construction. Nonetheless, energy provi-
sion is important. The balance between supply and demand in the oil market will
thus be dramatically altered if that demand were to fall sharply. Figure 2.8a, b and c
shows the composition of energy supply on sources measured in percentages (Panels
a and b) and TWh (Panel c). Sources: Smil (2016) and British Petroleum Statistical
Review of World Energy (2020).
The scenario of an increased use of greener alternatives to hydrocarbons as energy
source, could therefore signal a dramatically changed situation with regard to the
future demand for oil and gas. In any event, this reasoning should suffice to illustrate
the high uncertainty from a financial standpoint attached to saving by leaving unde-
veloped resources underneath the seabed. If the resources were to become valueless
in the future, the optimum financial strategy today would clearly be to extract as
much as possible, as quickly as possible. From a purely financial perspective, it
could be immoral not to do so—even if the verdict could be different if this strategy
resulted in foregone greenhouse gas emissions globally, and this latter element was
also considered. It now appears increasingly problematic not to consider green-house
2.2 The Rationale for a Petroleum Fund: A Windfall Gain 45

gas emissions. The perhaps most important point in this context, is who should pay
for oil extraction constraints. The default solution seems to be that the producer pays
the bill in terms of foregone petroleum revenues. An intermediary position, of split-
ting of the bill, could be difficult to administer. That solution could, however, make
it easy to convert a significant part of the stock of non-renewable natural resources
into financial wealth. In spite of expected opposition to such initiatives, it would be
relatively straightforward to administer them if agreements were made. Further, to
pay someone for abstaining from an unwanted action would not be new. However,
due to views on the origin of problems it could be difficult to arrive at voluntary
agreements.20 The solution to this could also be that it becomes too costly to extract
offshore oil resources.
This latter mentioned strategy above of high extraction speed may by coincidence
if not design approximate the extraction rate path Norway has followed. It seems to
have worked well. The same could apply for the future, although this remains a more
open question. If the rules of the game were to turn restrictive, the required adaption
could imply that a fraction, as mentioned estimated to one third, of the resource
wealth had to be left unextracted. Although new uses of hydrocarbons could emerge,
this could take a long time. It is mainly large quantities of oil and gas demanded for
energy uses that has made extraction from underneath the seabed profitable.
A related argument against a low extraction rate, could be that human progress has
thus far in history depended on making the most out of what nature has had to offer,
and that it could entail new significant risks to adapt differently to the environment.
Technological progress can make it reasonable to expect new opportunities—to the
extent that we can uncover and implement them in this sector. However, a tendency
for this happen to date cannot guarantee that our past pattern of behavior, if repeated,
will produce desirable results for the future—a future with a more vulnerable envi-
ronment than previously. Technological progress could expand our capabilities to
economically extract non-renewable resources compared to what we have seen thus
far. In could also become possible to produce smaller quanta. The implications for
the environment of the use of hydrocarbons, in its most common uses, could take
longer to change to the better. In this overall picture, the old approach of simply
disregarding systemic environmental effects appears increasingly unsustainable. In
view of the high stakes involved, caution seems appropriate.

20 One reason could be norms that those causing problems should end their associated actions

without payment. In association with that norm, it could be invoked that money was made as a large
bill was ran-up. It could also matter that the resources within the coastal states’ economic zones
was made their property, and that much of the proceeds from resource extraction has been saved
and invested. The bargaining position of an offshore oil producer might be better if the wealth has
been wasted. The cited arguments could be difficult to maintain legally, but possible to maintain
politically. International law applies elements from both law and politics.
46 2 Natural Resource Sustainability

2.2.3 Time Transformation of Income Through Global

Capital Markets

A country abundant in natural resources like oil and gas will usually possess a total
portfolio of assets that is highly exposed to price development in erratic resource
markets. Depending on the stock of other assets, and/or liabilities, there could be
a strong case for diversifying the wealth by transferring parts of it into other asset
classes, typically equity and fixed-income instruments.21
The value of a basket of different assets will be less responsive to price develop-
ments in oil and gas than the resource deposits would be. This implies that the financial
risk will be reduced for a portfolio comprised of several asset classes, compared to
before a diversification. In particular, the portfolio would thus become more robust in
relation to a significant fall in the resource prices. Another way to express the diver-
sification effect, is that expected returns will increase for any given risk level. Since
the returns between commodities and financial assets are far from perfectly corre-
lated, overall risk declines when commodities are exchanged for financial wealth.
In principle, it would be possible to exploit the lowered risks through a portfolio
adjustment that increases the holdings of assets associated with high risk and high
expected return. Following the diversification, one could thus either maintain the
initial risk level at a higher expected return, lower the risk level for an unchanged
expected return compared to before the diversification, or pursue a combination of
the two. Compared to just holding one asset, in the example of undeveloped crude
oil, diversification represents a free lunch. The advice seems to be for most, if not
all, holders of resource wealth to sell off some resources and invest the proceeds
in other asset markets. How this is done could, however, be the difference between
success and failure.22 Another potential pitfall, is that resource wealth may become
more vulnerable after extraction. If resource wealth can be raided, it could constitute
a defense to keep the resources in the ground.
Once the resources are exploited, other types of risk than financial risk increase.
Keeping the resource undeveloped in the ground, therefore need not imply that one
is irresponsible. First, consider Hotelling’s (1931) argument. If the return in terms of

21 This presumes that the discipline to not spend the wealth when it becomes more easily available

is strong enough in view of temptations to increase current spending—as outlined above. This, of
course, needs not to be the case. Particularly countries with weak institutions or rampant corruption
could gain from making the resource endowments less available for consumption, at least if there
were prospects for the institutional setting to improve. There is strong evidence that the exploration
of valuable resources under rampant corruption, or more generally, with weak institutions, leads to
a high risk of illegitimate expropriation or theft of the resources or the revenues.
22 For instance, there is some evidence that it may be very difficult to extract the value from oil and

gas by auctioning off un-exploited blocks of the seabed for extraction. One reason is that the bidders
would be careful due to the possibility of asymmetric information—in particular one would ask
oneself if the seller could possess privileged negative information. Further, extraction underneath
the seabed is demanding both with respect to technology and capital, which could severely limit the
group of potential buyers. Oil exploration and extraction are highly capital intensive even on land,
and much more so offshore. It could therefore be better in most instances for a state to first explore
the resources, and also extract and bring them to market, before they are sold.
2.2 The Rationale for a Petroleum Fund: A Windfall Gain 47

future price increases for a resource can be expected to be higher than the returns in
financial markets, the resource owner may be well-advised to postpone development
and sale. An important corollary to this argument in relation to hydrocarbons under-
neath the seabed, is that the costs of extraction are likely to decline as more knowledge
and experience is accumulated over time. Thus, the resource owner could gain from
saving the crude resource even if the price development for the resource in isola-
tion should not outperform the relevant opportunity cost of capital market returns. A
caveat to Hotelling’s argument is that a window of opportunity for exploitation might
be wasted. Particularly in some countries with weak institutions, it may be most prof-
itable to leave the resources in the ground—if not in anticipation of price increases
due to an increased scarcity value, so to guard the wealth from other dangers, like
theft, embezzlement, and the like. Often, the resource wealth could be best protected
against such risks if they are left undeveloped. Further, the argument presupposes
strong property rights—so that one can know that the resources left undeveloped
can be developed later when the time is ripe. Unsecure rights, will lead to haste in
extraction. Furthermore, Hotelling’s argument does not consider diversification.
Second, to develop the resource and bring it to market involves its own important
risks. Much like a kid may be wise in hiding a bag of candy from other kids, the
resource owner may benefit from the comparatively low attention a crude resource
deposit may attract, compared to that linked to any viable storage of the equivalent
wealth in other assets. It does not matter much if one thinks of deposits with financial
institutions, ownership of financial instruments like stocks or bonds, or other wealth
items. One strategy that could stir up unpredictable responses, could be the acquisition
of ‘lighthouse assets’ like high-rise buildings in NYC—known as sky scrapers. To
many, these are both highly visible objects and powerful symbols of capitalisms. For
private owners who can afford it, such assets allow them to come across as someone
highly important in public opinion. These pieces of ‘loud’ real estate objects might be
enviable for some, and could possibly be labeled conspicuous investment—inspired
by Thorstein Veblen’s (1899) concept of conspicuous consumption, where a main
point was for the buyer to signal affluence to others.23
When resource deposits are safe from theft, investment of the saved proceeds may
also best be taken care of through the world’s financial markets. Through the effect
sketched above, this approach can provide much better risk-return characteristics
than simply saving the real commodities in kind: With improved diversification,
there will be a higher expected return for each risk level. From this perspective,
financial markets are well-suited for time transformation of wealth. If the investor
should want to change the investment strategy, smooth changes may be applied over
time to the weights of various assets or asset classes. This can also be relied upon to

23 Veblen referred in his book The Theory of the Leisure Class (1899) to two characteristics of

consumer goods: Their serviceability—that gets a job done, and their honorific aspect, which
may display high status. The consumer may derive utility from both characteristics. An honorific
aspect might also apply to the choice of a sky scraper in New York City as an investment vehicle.
The same objective (investment) could usually also be achieved through low-profile investments. A
counterargument may be that the sky scraper is a specific kind of investment, with certain properties
that cannot easily be mimicked through a basket comprised of other similar asset types.
48 2 Natural Resource Sustainability

alleviate some of the risk linked to the cash profile that a given extraction strategy
might result in. The financial markets are large enough to accommodate large flows
of funds that might be unevenly distributed over time. It is also reasonable to assume
that financial savings are likely to produce significant real returns over time, which
will add to the savings. For crude resource deposits, meaningful returns may not be
available. Nonetheless, the processes required to invest through financial markets,
would lead to increased attention and awareness of the funds to be invested.24 This
may be particularly risky in societies of weak social underpinnings.
What is much less certain is, as already mentioned, that the owner of the resource
wealth is willing and/or able to demonstrate a sufficient degree of self-restraint to
avoid consuming the income right away, rather than saving it. A second, important
qualification, is that we know much of how financial markets have behaved under
ordered peace-time conditions within limited time spans, and considerably less about
what could happen in times of severe stress. For instance, under the financial crisis
that started in 2007/2008, there was a tendency for some funds to become closed—so
that investors were unable to access their holdings. The reason was that one wanted
to avoid the sharp decline in value one expected would have followed from not
barring the investors’ opportunity to withdraw funds. This could create an unstable
situation with strong incentives for participating investors to (with)draw first. Many
investments still lost most, or in some instances all, of their value. For the investor,
the difference vis-à-vis open investments were that they did not have the possibility
to withdraw their money during the process towards zero or near-zero value. This was
probably a surprise to many. There may therefore be some not well understood risks
attached to financial investments for many, linked both to possible unknown future
circumstances, and the behavior of financial institutions and counterparties, that
one may overlook too easily when considering investments in vehicles of financial
markets.
Overall, one could hope to save up to the net cash flow from resource activities.
For an owner, the amount of net cash received is the difference between incurred costs
and income at various points in time. The government would often instead collect
various taxes levied on the extracting companies. Usually a petroleum tax system
is tailored to the aim of confiscating most of the economic rent from production,
i.e. the surplus from the activity compared to other similar activities where resource
wealth is not involved. For subsea oil extraction, comparison with profit margins in
construction industries on land may approximate neutral profit rates, not influenced
by rent. This land-based industry is typically less profitable than the oil industry.
Confiscation of all rent by a fiscal authority is not feasible. There are needs both to
attract firms and to keep the operations going over time, under competition from other
countries and their tax systems. Profit margins in the offshore oil and gas industry
are therefore much higher than under close-to perfect competition on land. Perfect
competition is a theoretical and limiting concept, which can provide a contrast to

24 It is important, however, to recognize that this depends on institutional quality in several different

layers of the SWF operation—which increases the complexity and makes this form of asset
management less straight forward.
2.2 The Rationale for a Petroleum Fund: A Windfall Gain 49

activities that are highly intensive in capital and newly developed technologies. This
combination creates barriers to entry for many, and thus less competition.
For a host country both costs and incomes depend to a large degree on the extrac-
tion strategy: It determines the effort at extraction over time, and the physical quantity
of the resource brought to market. Another factor that impacts heavily on income is
the oil price, or more precisely the prices of oil and gas of various qualities. Oil and
gas prices are notoriously difficult to forecast. This implies that after an extraction
decision, the net cash flow profile and hence the net present value of an oil extraction
project are governed by stochastic processes. This hampers planning and makes it
difficult to arrive at any detailed production schedules. However, continuous extrac-
tion and sales over time imply an indirect hedge against crude oil price fluctuations,
since price bids may be hit as they evolve. One must nonetheless be prepared for
surprises. ‘Good luck’ is always welcome, and it seems that Norway has benefited
from some good luck also in this respect.
What is meant by financial assets is here essentially stocks (equities) and bonds
(fixed-income securities). These are claims on the world’s productive capacity, issued
by business firms and governments. Investors often prefer to own investments that
are listed by and traded through regulated exchanges. This will also add to the trans-
parency of an investment operation. In spite of the strong focus on equities and
fixed-income, it is not uncommon to invest a fraction of a SWF in other real or
financial assets that may be less liquid. As mentioned, unlisted real estate and infras-
tructure projects are examples. Further, it may be attractive to invest in companies
that have specific plans to ‘go public’ and have their shares listed on an exchange in
the near future.25
Irrespective of the asset class, financial investments come with several other risks
and perils, which are important to understand. These risks include, inter alia, a signif-
icant risk of fraud and/or embezzlement. Otherwise, wealth could well be squandered
financially, after having been established and channeled into the financial markets.
One consequence of this may be painful downward adjustment of consumption for
the future, another is regret of having invested. This could inflict trauma and/or
stigma, and be worse than not being able to save in the first place. In democracies, it
is therefore important that all related to the investments is highly transparent.

2.2.4 Constraints on Investment by the GPF-G

Investments on behalf of the GPF-G and similar SWFs need to be ethically sound.
First, what one may label ‘the usual reasons’ constrain investment behavior to be
ethical, with a view to long-term returns. This is independent of the sustainability
of the activities that did produce the invested surplus. However, if these operations

25 Inrelation to the GPF-G, the manager has put forward several proposals to allow investment in
unlisted equities that have been turned down by the Ministry of Finance, most recently in September
2020. What is allowed, however, is investment in companies where the board has decided that the
company shall go public.
50 2 Natural Resource Sustainability

are viewed as unethical, investment goals could become more difficult to fulfill.
For instance, various behavior aimed at punishing unethical behavior may make
such undertakings less profitable. A second possibility is that fund managers could
become less motivated if the activities that gave rise to the proceeds saved and invested
failed to satisfy general ethical standards. Third, the GPF-G like other SWFs is fully
owned by and operated on behalf of a sovereign state. This means that any potential
‘tarnishing’ of the reputation of the SWF as an investor could also stick to the
government and state as owners. This concern applies with particular force to SWFs,
and may imply higher costs of perceived unethical investment behavior for SWFs
than for other investors. A positive ethical image is therefore for multiple reasons a
needed prerequisite for a SWF in order to achieve good results.
With respect to ethics of investment particularly issues linked to operations in
foreign countries may come to mind. However, ethics becomes a broader concept
for a SWF. It includes not least the agents that are funded through the investment
activities, either with equity capital or loans. Their activities should at least not be
seen as largely unethical. In the context of the GPF-G, ethics has also been related
to the fractions of the resource wealth that are saved and spent respectively. The
former element of ethics is discussed in Sects. 5.1 and 5.2 of Chap. 5—The Ethics
of Investment. The latter element of ethics is discussed here. It concerns behavior of
relevance to future generations of yet unborn citizens. In view of the discussion above.
Attention must be paid to this issue, even if is difficult to identify clear principles or
arrive at any fraction of the petroleum wealth that the future generations deserve to
receive.
It is also important to note that sustainability with respect to the future could
be an elusive concept. As explained above, resources that are left un-exploited, for
instance due to a careful extraction strategy, might lose their financial value due to
developments in technology and/or demand. At the other extreme, one could think
of extracting all instantly or very quickly, to convert the proceeds into financial
wealth to be invested in the world’s capital markets. If the resource prices later
soared, one could clearly regret that all was extracted early. There could be only
limited comfort in expert financial management of proceeds from a time when the
resource price was low. One could, of course also adopt an intermediate position
on the rate of extraction. In any event, the wealth than can be transferred to future
generations will depend on the extraction profile over time, which is partly determined
by earlier generations. The current generation can extract more or less of the resources
that are left. Transformation of resources into the future, would depend on both
extracting more than one consumes at the prevailing resource price, and a willingness
to live below ones means to benefit future generations. The evidence discussed above
suggests that to restrain oneself may be as difficult for states as for individuals. To live
below ones means in order to save and invest for the future is not easy. One obvious
risk, is that too much is extracted and spent compared to what is invested and left
undeveloped. A less obvious risk, as we have seen, is that it may be suboptimal to
leave a large fraction undeveloped.
2.2 The Rationale for a Petroleum Fund: A Windfall Gain 51

The rate of extraction, together with production costs and resource prices, gener-
ates the cash profile which determines the opportunity set as regards future genera-
tions. One possibility could be that future generations could be entitled to a specific
fraction of the overall net present value (NPV). However, a simpler measure could
be needed, as the NPV evolves over time with both interest rates and, in particular,
resource prices. These difficulties notwithstanding, the most obvious risk from the
perspective of the future generations is that either all, or too much, of the wealth will
be spent too soon. From advertising that target consumers, one is often exposed to
the seductive argument why wait? It could perhaps be tempting for public officials
too, to aim at instant gratification if the alternative could appear as a reduced ability
to spend later on. This could apply also if there were an intergenerational bequest
motive on the aggregate, which is possible but not obvious. Self-restraint might come
to resemble a tax levied for not consuming, which could be expected to trigger an
instantaneous urge for consumption. One might still arrive at some sort of rule of
thumb, in relation to how much to set aside and when for future generations. The
most obvious characteristic of such a rule, is that it needs to be simple, in order
for it to become both well understood and easily communicated. In a democracy,
this would probably be a necessary but not sufficient condition for saving to invest
towards the future.
The decisions on how to proceed, once the fraction of current spending of resource
wealth has been decided upon, and thus also the fraction to be set aside for the future,
could also carry weight in an ethical context. The justification of a given fraction could
in particular depend on how the money would be consumed. For instance, it could
be channelled through the state budget—as either regular spending or investments in
e.g. education and/or infrastructure. Further, it could be important to what extent the
funds should be used to provide the citizens or residents with goods and services, or
investments for more goods and services later on, as opposed to establishing a room
for tax relief or direct handouts. The two latter alternatives would stimulate private
consumption and/or saving. Norway has relied heavily on the first alternative—i.e.
that the public authorities have procured goods and services for residents and citizens.
The composition of government spending is such that some groups could receive
more than others—in Norway in particular those who are large consumers of subsi-
dized public services—particularly in health and education, including pre-school
child care. Families with several children, for instance, receive large benefits. Tax
relief is usually preferred by the wealthy, who pay the most taxes. Strong egalitarian
norms long worked against this way of spending resource wealth. Tax relief was,
however, much less palatable for the former labor-center governments than for the
conservative coalition government since the fall of 2013. A strongly communicated
policy priority of tax relief under the current government increased the use of this
channel of indirect spending. Nonetheless, the changes in policy thus far have not
been very aggressive.
A strategy of direct handouts appears not to have been formally considered by
Norwegian authorities. This may in part reflect a very strong belief in the impartiality,
good faith, and skills, of public administrators compared to make good choices for the
citizens. In Norway, the government is widely believed to know what the needs are
52 2 Natural Resource Sustainability

and how they can best be addressed in an economically efficient way. Further, even
the Alaska Permanent Fund—which is famous for handouts to residents of Alaska,
restricts the amounts that are to be redistributed—a fraction of the earnings—to the
population in relation to the announcement of the fund’s real returns.26 Furthermore,
there is a requirement for residents to file an application in order to be able to receive
their SWF return check. Receipt of some of the returns thus requires activity on
behalf of citizens and residents. Usually, one would think that this procedure would
exclude some of the formally entitled who might be less motivated or forget to apply
in time. For instance, poor people and others with few resources, would most likely
be overrepresented among those who do not apply to receive the return they are
entitled to.
Interestingly, the discussion of payouts of Hannesson (2001) suggests that citizens
will be more interested in and concerned with management of the state’s investment
activities on their behalf if at least some of the return from the Fund is redistributed
to the ultimate owners (i.e. to citizens and residents). It is likely that such an interest
could provide the owners with incentives to demand high-quality, low-cost manage-
ment. The last point may not have received the attention it deserves in Norway. The
reason for this could, however, be a desire to avoid divisive arguments over which
groups who would qualify more or less as recipients of the resource proceeds.
If one decides to establish a SWF, several important organizational issues arise:
For instance, how large a fund should one aim for, how would one decide on the
amounts to be put aside in the fund, and how would one acquire the necessary
skills, knowledge and capacity for this task. The latter concern could be a restraint in
determining which organization should manage the SWF. It could also involve several
aspects resembling business decisions of the type “make or buy?”. The outcome
of such considerations could be strongly influenced by views and debate on the
appropriate size and scope of government activities. For instance, the minimalist
approach with regard to organizational issues of the Norwegian Tempo commission
would be insufficient for the establishment of a SWF of a large size and high technical
sophistication. Views have changed in later years regarding both the size of the GPF-G
and the way this fund is managed, which are two highly important and interconnected
issues to consider in relation to organizational design.

2.2.5 The Goals and Constraints of SWFs

The idea of a SWF is meaningful only to the extent that a country is willing to
run fiscal surpluses. This may be easiest to accomplish under centralized decision
authority. Under democratic rule that require regular elections with competing parties
or candidates, it may be more attractive to gain votes and build coalitions through
promises to increase public spending. It may be much more difficult to suggest

26 Like other U. S. states, Alaska is constrained by federal guidelines that restrict the payout of

resource revenues accrued to the Alaska Permanent Fund. See, e.g., Alsweilem and Rietveld (2018).
2.2 The Rationale for a Petroleum Fund: A Windfall Gain 53

significant savings, and the party or candidate who does is likely to become less
popular and perhaps to experience difficulties in upcoming elections.
It may become more difficult in democracies to convince the voters of the idea
that one should pay higher taxes to be able to spend in a distant future, and also in
more difficult times. The usual problem in this domain is a tendency towards fiscal
deficits—which also leads to increasing levels of government debt. Creation of a
SWF requires one to be able to pursue policies that achieves the opposite of the most
popular policies. Resource revenues may make this possible.
Under less democratic, or autocratic, rule the consistent running of current account
surpluses would require a long-term horizon for the ruler or rulers. This could stabi-
lize expectations about the future, specifically the expectations that either the rulers
themselves, or their prescribed followers subject to some dynastic succession rule,
would stay in power for the long term (see, e.g., Olson 2003b). It would then be in
their interest to care for the society within a long-term horizon, in a limiting case like
in a democracy. Including in this instance, with increased emphasis on the future,
significant savings would require a long time horizon that cannot be taken for granted.
An exception to the difficulties to save in democracies could be the income earned
from non-renewable natural resources, often labeled “windfall gains”. Since there
are many examples of how such incomes have been consumed in a fashion that has
in retrospect be seen as too quick, decision-makers can with relative ease appeal to
norms that would slow down the rate of consumption of such exceptional incomes.
Norway may be a case in point. To sell the idea that the resource income should be
saved and invested, it was in earlier times common to point to countries like Britain
and the Netherlands. These two countries—where resource income formed a much
smaller fraction of GDP—spent this income as it was earned. After a while, any
returns earned, and the initial windfall gains, were spent and reduced to phenomena
of the past.
The underlying decisions were made in democratic settings, in which it may be
particularly costly for decision makers to curb spending to prioritize the future. It
may look bad not to be able to save from such ‘extra incomes’ as this would also
imply unwillingness to live on the income that could have been realistically expected
without the extra, unexpected income.
Other countries of significant resource wealth that have chosen to save for the
future, like oil producers on land in the Middle East, are not particularly democratic.
In these countries it has therefore been relatively easy to arrive at decisions which
implied saving and investment of a share of the resource related income. The impor-
tance of the relative degree of democracy in this context, relates to the costs and
benefits experienced by government decision makers when current consumptions
is lowered compared to what could be sustained without saving for the future. The
difference of political regime type should matter most when the resource income is
only moderate. In some countries the hydrocarbon resources have been so large that
it would represent a comparatively small sacrifice in terms of consumption to save
a large fraction. Norway may be an intermediate case in this respect. The resource
incomes are large, so it is important to save and invest a fraction. Still, these incomes
were not dominant in the economy.
54 2 Natural Resource Sustainability

According to IMF (2008: 5) there are five types of sovereign wealth funds—of
which two are of particular interest for the purpose in this book: first, stabiliza-
tion funds where the main objective is to insulate the budget and economy against
commodity price shocks, and second savings funds for future generations, which aim
to convert non-renewable resources into a more diversified portfolio of assets and
mitigate Dutch disease. The three other types, reserve investment corporations, devel-
opment funds, and contingent pension reserve funds, are of lesser interest. However,
the objectives of these various categories of funds may be multiple, overlapping, or
changing over time. In Norway, the GPF-G shall benefit future generations, and also
provides a stabilization function. It also provides a structure for disciplined recur-
rent spending of amounts deemed appropriate. There was never a stabilization fund.
Prior to the GPF-G, foreign exchange reserves were large, and the task of managing
official reserves became more concerned with returns, and increasingly took part in
activities that may typically be associated with reserve investment corporations. The
categories of funds, may thus be better suited to label bundles of activities that go
together, than to pin down the characteristics of actual funds in operation.
Some countries that have established SWFs do not have ‘extra’ resource incomes.
China and Singapore are examples. These two countries are different, but may have in
common seen from West Europe a culture of top-down management in governance,
including in economic affairs. Decisions may then be taken for, more than by, the
people. This could in theory enhance the decision quality in relation to objective
needs the decisions are meant to fill, if such needs can be meaningfully determined.
In our context, it simply means that it will become comparatively easier for a nation
to save for the future, even if this could lead to some unpleasant consequences early
on. In any event it will be necessary to run persistent current account surpluses to
sustain savings through the international capital markets.
A not so pleasant implication, is that one would need to export products that
could be wanted at home, either directly as consumption goods, or indirectly through
utilizing the country’s productive capacity to produce other goods and services for
domestic purposes. Instead, goods are produced for export, and a part of the proceeds
from these activities is invested in foreign countries. One could thus end up producing
and exporting goods to foreigners in return for claims on the foreign sector—which
may domestically resemble selling wanted goods for deferred payment.
The establishment and later successful running of a SWF is neither for all nor
straightforward. To invest internationally one needs to run a current account surplus
in order to get started. The sources of this are most often resource-related high
incomes that cannot be sustained over (very) long time intervals, since the resources
will become gradually depleted. Then it makes sense to save and invest. To decide
explicitly on deliberate, substantial savings, however, could be difficult in democra-
cies. The required self-restraint may not be present for either deciding to save and
invest or sticking to that decision, or both. Political processes, including elections
ahead, may lead to challenges both in relation to obtaining surpluses and stacking
them away. It is always possible to point to many problems, most of which can be
fixed by additional spending.
2.2 The Rationale for a Petroleum Fund: A Windfall Gain 55

In real world examples, basic institutions may be lacking, to make it difficult to

arrive at the sizable current account surpluses needed to build an asset position in
international capital markets. This may be either because the resources may be ille-
gally or unofficially extracted, or because the foreign currency incomes from resource
sales are spent to pay for imports. One example of the latter could be Venezuela,
which has very large offshore oil reserves, but also civil unrest and constrained
public finances. It could appear as impossible, at least near-term, for that country to
pursue the strategy that, e.g., Norway has pursued in relation to resource wealth.
If one assumes that an agreement to save for the future can be attained, democracies
could however have good possibilities of carrying this out in a fashion that would
benefit most citizens, even if savings might not be accomplished according to plan.
Especially for old individuals, it may be uncertain whether they can count on being
around to consume later. Hence, the interests of many could be better served by
spending than by saving and investing. Further, the less stable the political setting,
including in the surroundings, the lesser reason could there be to curb spending and
consumption to achieve better expected future outcomes. In that situation, which
apply to many non-democratic societies, a future not-planned-for might emerge.
The societies best fit for saving and investing, whether democratic or not, are stable
societies.

2.3 Petroleum Wealth

In 1966, the American oil company Exxon found traces of hydrocarbons on a loca-
tion of the Norwegian sector of the North Sea. This first discovery, which was not
economical to exploit at the time, 35 years later became part of the Balder field. The
first large discovery, as mentioned, was made in December 1969. Another American
oil company, Phillips Petroleum, had drilled several dry wells at location that later
was named the Ekofisk field, also in the Norwegian sector of the North Sea. The
company had asked for permission to pack up and leave for Christmas, but Norwe-
gian officials had insisted that they first completed the project. Then they struck oil,
big time.27
This uncovering of what turned out to be a very large oil and natural gas field
opened new perspectives for future oil and gas extraction on Norway’s continental
shelf. The 1970s were marked by optimism, although considerable uncertainty as to
the quantity of resources and, not least, the costs of extraction, and also the delineation
of the exploitable physical resources. How much could be exploited profitably, and
what would it mean? The associated economic prospects remained uncertain.
The technological challenges and uncertainties in extraction of hydrocarbons
under the seabed were large at the time, and added significantly to the uncertain-
ties about the economic value of the newfound resources. However, such endeavors
into the technically unknown are attractive in one sense: Technical and other key

27 See Hannesson, 2001.

56 2 Natural Resource Sustainability

knowledge accumulates over time, and is rarely if ever lost.28 The experience with
North Sea oil and gas extraction illustrates well that it can be reasonable to hope for
significant improvements that imply cost reductions when experts become dedicated
to work intensively to solve such problems. One key element of this, is the economic
incentive linked to success, often warranting the employment over time of technical
experts in specialized organizational units. High economic rents that allow for this
also account for overwhelming efforts in bringing the extracted resources to market:
Large installations that dwarf the Eiffel tower have become common and numerous.
These gigantic, highly visible, installations of concrete, are nonetheless less needed
than before. Much smaller, more flexible ones are increasingly applied, at the seabed
and the ocean surface. The description here is superficial in view of the true techno-
logical complexities, but may still suffice to illustrate how technologies can improve
and costs be reduced, in new approaches to solve demanding tasks. This process has,
as mentioned been catalyzed by very high financial returns from oil extraction, which
include the resource rent discussed above that the state may confiscate the bulk of
through a particular petroleum tax regime.
Newly discovered resource wealth represents a windfall gain, at least if we
abstract from the production costs. This implies an ability to spend without producing
first, which could pose a strong temptation, difficult to resist for most political and
economic decision-makers. In isolation, this points to the importance of establishing
institutions that would promote saving rather than just consumption. The inclination
to consume appears to be strong and ever-present. In order to get the highest possible
benefits out of resource wealth, it is necessary to overcome strong temptations to
consume the windfall gains as soon as this becomes possible. With well-developed
credit markets, this might even be long before the resources are brought to market.
However, there may also be costs associated with the restraint on consumption
that one could have to undertake to save through a SWF. In democratic systems,
leaders that prioritize saving over spending may risk to become unpopular.29 There
are usually many unresolved tasks that require funding. There could thus be a risk
that fiscally responsible politicians may be voted out of office. Particularly in rela-
tion to this difficulty, the idea that non-renewable natural resources also belong to
members of future generations may come in handy in helping to fend off some
of the claims for increased immediate public spending. This viewpoint can serve
as a normative narrative, where norms related to equity may justify self-restraint,
and make it possible to build support for otherwise unpopular fiscal decisions. This
could also create an environment that facilities the establishment of institutions that

28 A perhaps sobering analogy is the atomic bomb: Once it was invented it could never be de-

invented. For better or for worse, someone can always from then on profit from the knowledge on
how to exploit nuclear chain reactions.
29 Indeed, leaving resources aside, there seems to be a tendency towards deficit spending in democ-

racies. Thus, it is common to have public debt of a considerable size relative to GDP. The Maastricht
criteria, established among EU countries prior to the launching of the euro, addressed this issue
by requiring participants to inter alia maintain a debt to GDP ratio below 60 per cent. Since the
financial crisis from 2007/8 this ratio has increased in industrial countries, in several instances to
levels above 100 per cent of GDP. The Covid-19 pandemic has increased public debt further.
2.3 Petroleum Wealth 57

promote saving, protecting natural resource wealth from desires for instant gratifi-
cation. However, since future generations could become richer than the current one
due to compounded economic growth, there are limits to this rhetoric.
In the words of former Norwegian Prime Minister Jens Stoltenberg, the 4-pct.
restriction in force from 2001 (from 2017 3 pct.) on the spending of oil revenue
through the budget implied that one was only logging the growth of the woods. This
metaphor visualized the concept of real returns, and communicated that the use of
the real return of the GPF-G was judged as sustainable, since the equivalent of the
resource value adjusted for real returns in financial markets were still to be transferred
to future generations. In principle, the fiscal rule implies a very long time horizon
for the GPF-G: To never spend the capital, only the real returns, technically implies
an infinite horizon. However, the set-up has been arrived at by extracting and selling
the oil and gas resources quite aggressively—and saving the bulk of the proceeds.
For many countries this would represent a high-risk strategy, with a sequence of
very demanding task. The most demanding task for all countries may be the one
towards the end, of saving and investing the bulk of the proceeds. However, there
are numerous non-trivial tasks to be completed before this becomes relevant. Some
implications of the needed sequencing of events are discussed towards the end of
this book.
There is a large amount of financial risk embedded in any choice of a specific
profile of resource extraction over time. In the Norwegian case, there has been five
decades of extraction, and an important element of what one may call good fortunes.
There may also be a large risk in physical terms, implied by draining reservoirs
of oil and gas with the use of early technologies which leads, at least initially, to
low fractions of reserves being exploited, compared to the possibilities later on,
under more advanced technologies. This important and complex issue, of mainly
engineering, is outside the scope of this book. In addition, it is difficult to feel
completely confident that the funds will be transferred forward in the promised
or intended fashion, even if there may be no reason to doubt that this has been
the intention. For instance, the situation could change so that it might not benefit
decision-makers to enforce their own prior decisions.
The above statement was true with regard to transfers into the future as long as
the real return on the investments overshot the 4 pct. mark. Thus, for a while after
the financial crisis of 2008 it was not true. The take-out from the Fund had also for
some years exceeded the 4 pct. chalk mark relative to the value of the GPF-G at the
close of the previous year. This, however, was corrected automatically and swiftly
as the Fund grew sharply over the latest decade or so. High oil prices and increased
production volumes of oil saved the day. In 2017, the real return estimate was revised
downwards, to 3 pct. In spite of the low-interest rate environment, the real returns
are likely to overshoot spending as long as it conforms to the fiscal rule. However,
since the real return on financial assets varies sharply from year to year, this may be
difficult to get a handle on. In particular, one cannot know that the real return will
exceed spending in any given year.
A premium on planning for the future and constraints on recurrent spending,
may explain why many resource-rich countries have set up SWFs. It might also
58 2 Natural Resource Sustainability

contribute towards explaining why some countries that have set up SWFs based on
a current account surplus in traded goods, rather than from sales of non-renewable
resources. This is not common in the Western hemisphere and does, as mentioned,
not appear as a frequent choice for democracies. It could be difficult to sell to political
constituencies in a Western democratic setting that one should run current account
surpluses from regular trade in goods and services, to use the net proceeds to invest
in claims on foreign countries. Under less democratic rule, however, a relative lack of
competitive pressures in politics could increase forgiveness for unpopular decisions
that leaders might regard as wise.
One example of a country that has accumulated very significant international
investments without windfall gains from resources, is Singapore. Some other Asian
countries have made similar arrangements in later years. The aim here is limited
to illustrating that it may be easier to take unpopular decisions that imply to save
when these decisions are not dependent on successful election campaigns—not to
characterize political regimes and governance styles of the world. The latter, clearly,
would be demanding, and would require more information and nuances.

2.3.1 Windfall Resource Gains—Some International

Experience

Some of the challenges one must cope with to successfully manage resource wealth
are due to implications of the resource extraction per se. For instance, Boccara (1994)
observed for the Franc zone countries in Africa, like Cuddington (1989) for some
other countries, that a boom in fiscal spending typically persists after a boom in
resource income ends. In his view, this was due to liquidity constraints and costs of
reversing public policy30 : There is a typically pressures from political constituents
to both to keep spending, and to avoid to divest and fire people. Further, credit may
be more available due to increased state revenues during booms. Fiscal policies
should be made with the constraints in mind, which may often be easier said than
done. Further, evidence for Mexico, where oil revenues accounted for about one
third of export revenues, is available in Everhart and Duval-Hernandez (2001). The
latter authors recommended the establishment of a stabilization fund to absorb the
‘shocks’ from spending and revenues alike, which was established in 2000. By design,
only positive surprises with regard to total state revenues including from oil triggered
deposits into this fund.31 A stabilization fund could alternatively introduce a liquidity
constraint, by separating the revenues from the budget during a boom, but would not

30 Boccara, op. cit., found the same tendency for the Franc zone countries in Africa that Cuddington

(1989) had documented for Colombia, Cameroon, Kenya, Nigeria and Jamaica: “.. there has been
a tendency to overspend (…), which has considerably reduced realizable welfare gains. (…) The
ratchet effect of increased government spending during booms (…), is common.” (pp. 154–155,
quoted by Boccara, op. cit.).
31 In spite of “windfall receipt from oil production [of] about 18 per cent of GDP between 2000

and 2012, only trivial amounts remained in the balance of the oil stabilization fund”, according
2.3 Petroleum Wealth 59

in or by itself suffice for expenditure smoothing.32 The reason is that fiscal authorities
can borrow, and often easily during a resource boom with a burgeoning fund.
Additional to this, and more relevant also for industrial countries with stronger
institutions, is the ‘Dutch disease’ mechanism,33 see Corden and Neary (1982), and
Neary and van Wijnbergen (1986). If the booming sector in an open economy is
of an extractive kind, as natural gas in the Netherlands, minerals in Australia, or
oil in oil exporting countries like the United Kingdom and Norway, the manufac-
turing sector could experience a ‘de-industrialization’ pressure. One mechanism is
increased wages and costs, which reduce the competitiveness and thus the size of
the manufacturing sector. There are two types of events that can trigger this mech-
anism, either major new resource finds or a sharply increased resource price for a
resource-producing country.
First, there is a spending-effect, with improved terms of trade, increased aggregate
demand, and real exchange rate appreciation. Second, there is a resource-movement-
effect: Demand increases across the board, not only for items that can be imported. For
the non-tradable items, prices rise. Resources are moved, e.g. from the manufacturing
sector to the production of services.
Gylfason (2001) indicated four main transmission channels from abundant natural
resources to stunted economic development in a cross-national study with data since
1965: Dutch disease, rent seeking, overconfidence, and neglect of education. He
found with regard to education that natural capital could crowd out human capital,
to slow down development. The share in GDP of public expenditure on education,
expected years of schooling for girls, and gross secondary-school enrolment, were
all inversely related to the share of natural capital in national wealth.
Gould (2010: 16–17) discusses recent developments of extractive industries and
SWFs in the Pacific region. That author finds the mixed record of Kiribati, Nauru,
Timor-Leste, and Papua New Guinea illustrating: Utilizing resource revenues to
create development outcomes is difficult, and what works in one country will not
necessarily work in another. Further, a SWF should be considered in the context of a
wider macroeconomic and fiscal framework as the opportunity cost of establishing
a SWF can be significant. Pacific island countries have been indebted and have
faced high borrowing costs. Thus, it has often been better to retire debt than to
invest in new assets. Alternatively, windfall resource revenues could be added to
the foreign exchange reserves in countries with managed exchange rates, to assist
currency interventions and possibly prevent a balance of payment crisis. Finally, the

to an IMF country report on Mexico; No. 13/333, November 2013, International Monetary Fund,
Washington DC.
32 Because oil prices are volatile and no-one knows what future oil prices will be, oil revenues

are unpredictable. Nominal commodity prices, including the price of oil, have exhibited extreme
volatility (see, e.g., Deaton, 1999). Smoothing of the budget is thus he best one can hope for in
relation to a stabilization fund. See Davis et al. (2001).
33 In the late 1950s, a large gas field was discovered in Groningen, Holland. Extraction led to

high export revenues and improved welfare, but also some de-industrialization. This situation was
referred to by The Economist in 1977, in the first printed usage of the term Dutch disease, as «internal
health and external ailment» (Rudd, 1996).
60 2 Natural Resource Sustainability

state may have the capacity, at least if resource revenues accrue gradually, to spend
the revenue effectively as it is earned: The social return from government spending
could exceed the financial rate of return of a SWF.
If a SWF is established, it should according to Gould, ibid., have a clear, widely
agreed purpose. The experience from the Pacific shows that that SWFs can serve
different goals, from reducing the impact of revenue volatility to increasing inter-
generational equity. In addition to guidelines governing the amounts that can be with-
drawn annually to finance the budget, other fiscal rules, such as limiting borrowing
against the SWF or the building up of substantial public debt, could help to preserve
the value of the state’s resources (Davis et al. 2001). Further, SWFs should be inte-
grated with the national budget, which would allow policymakers to consider the
respective state’s resources in their entirety. Furthermore, the SWF should be held
offshore if resource extraction its thought to be temporary, or where the revenue
could adversely interfere with the conduct of monetary policy. The latter is also
likely to increase the investment options. Finally, professional investment manage-
ment is necessary to ensure that the SWF achieves solid returns, diversifies risk and
is not open to manipulation: “The state should set a clear investment policy that
reflects its risk appetite, including a target rate of return. (…) investments should be
in financial instruments rather than local projects to reduce the chance that the SWF
will act as a second arm of expenditure policy” (op. cit.: 17).
Although the context is different in Norway, most of the lessons seem to apply
there as well. They have been addressed through various public policies, including
economic policy. Not least, there is wide consensus on the integration between the
SWF and the state’s budget, whereby the resource income is quarantined in relation
to other resources, until it is spent through explicit and regular decisions by Parlia-
ment. All investments are made offshore and by competent investment professionals,
subject to clear guidelines. Borrowing by the state is not an issue, as central govern-
ment debt across maturities is so small that it is difficult to construct a sovereign yield
curve. However, households have run-up net debts of several times their disposable
income. Non-financial corporates and local government are also indebted. Wind-
fall gains tend to make all in a territory more creditworthy, not just the state. Hence,
indebtedness that may hollow out a net asset position on behalf of the central govern-
ment may result from borrowing by others—either other official legal subjects than
a SWF, or the public, i.e. firms and/or households. In democracies, the ultimate
beneficiaries in relation to property owned by the state and the business sector are
households. Households may be more impatient than policymakers.
Nauru, formerly known as Pleasant Island, is a phosphate rock island in the Pacific
Ocean. It is discussed e.g. by Hannesson (2001: 46–50) and Cox (2009), in addition
to Gould, op. cit., and warrants a further comment. It exemplifies what can go wrong
with a windfall gain, including with savings, investments, and boom-bust cycles.
This micro state has about 10.700 inhabitants on 21 km squared, the world’s second
smallest state in population after Vatican City, and the third smallest in area, after
Vatican City and Monaco, and the world’s smallest republic. From the end of World
War II, it was governed by a UN trusteeship. The governments of the United Kingdom,
Australia, and New Zealand were jointly responsible for ruling the island. Phosphate
2.3 Petroleum Wealth 61

mining that benefited particularly Australia and New Zealand was carried out by the
British Phosphate Commission. Terrible associated environmental degradation has
not to date been remedied to this author’s knowledge.
Nauru became independent in 1968, and applies the Australian dollar as legal
tender. Thus, the nominal exchange rate is not affected by economic misery, and one
indicator of worrisome management is missing. Further, the exchange rate or interest
rate cannot be used to stabilize the economy. An important implication is harder
budget constraints. There has been severe overspending, failed investments of
resource incomes, and also reports of corruption and fraud. Public funds were gener-
ally spent with lackluster results. One was not able to develop an alternative economy
to mining. Connell (2006) suggested that Nauru might be the first ‘failed state’ in the
Pacific. The end of mining due to resource depletion, combined with budget deficits,
led to indebtedness and then repossession of international assets. Briefly, Nauru was
a tax heaven and, reportedly, an illegal money laundering center. Most things are
imported, property rights are not well respected, and much of the land lies idle. The
government employs most who participate in the labor market, and there is almost
no private sector. Since about 2001 Nauru has accepted aid in exchange for hosting
a controversial offshore Australian immigration detention facility.

2.3.2 The 1970s and 1980s: Expectations Followed

by Increased Uncertainty

The 1970s saw the establishment of the organization of oil producing countries,
OPEC, which in 1973 managed to dramatically increase the price of oil by cutting
back on supply. OPEC has since played an important coordinating role among oil
producers, and aimed at influencing the pace of oil extraction with a view to price
developments. In 1979, the revolution in Iran with the ousting of the Shah, lead to a
sharp increase in the oil price. In view of this, the situation for countries with much
oil to bring to market was more promising than before around 1980.
Within NATO, Norway is less free than other oil producing countries to coordinate
its policies with OPEC. Norway’s relations with OPEC have thus been limited, in
spite of large shared interest for a very large oil and gas exporter. However, in periods
with downwards pressures on oil prices, there has been some limited cooperation
aiming, in particular, to stabilize oil prices.
The decade started with optimism on behalf of the oil and gas industry, at high
oil prices in historical terms. The high prices may by themselves have appeared
as supportive of an optimistic view in relation to future price developments. This
situation was fueled by the above-mentioned oil price increases, and lasted to 1986.
In that year, the oil price plunged from about 20 to below 10 dollars per barrel, a
level it later stabilized around.34 There was a big gap between the prior price of

34 Unlessotherwise specified, prices refer to the common benchmark oil Brent Blend. Prices are in
nominal terms unless otherwise specified. In part, and mainly due to substitutability, variations in
62 2 Natural Resource Sustainability

about 20, and the new at about 10 dollars. New fields and current projects alike
became less economical. It was not until the mid-1990s that the price significantly
rose above 20 dollars. The difference between scenarios of oil prices of 10 and 20
dollars, respectively, was particularly important for offshore oil production where
marginal costs were much higher than on land in the Middle East. Extraction costs
in the Middle East could be below U. S. dollars 3 per barrel.
The more sobering outlook of future incomes from oil and gas from about 1985 led
to some critique against the way the resource revenues were spent in Norway—where
there was no SWF yet. All oil and gas revenues were spent through public budgets
as they accrued. A government commission, The Perspective commission (1988)
chaired by Erling Steigum of The Norwegian School of Economics and Business
Administration, claimed that too much was spent. Further, the low reported savings
rates in the national accounts represented an overstatement of savings for 1986, as
the reduced value of the stock of petroleum reserves was not reflected in the figures.
For this Commission, the situation called for action to curb spending. With regard
to the time horizon for the spending of resource revenues, it stated, inter alia, in its
report:
Norway is about to empty the oil reserves without an increase in either financial claims on
foreign countries or tangible investments outside the oil and gas industry. The swift extraction
of resources in combination with large deficits in Norway’s external accounts, implies that
one does not currently take due account of future generations.

and further,
There appears to be broad agreement in Norway that it would not be right to live on our
future descendants, passing burdens on to the future. (NOU 1988: 21, p. 13 - this author’s
translation.)

Few would disagree with this. However, it was less straightforward to assess what
the fair share of the future generations should be, and thus on how to proceed. One
was also reminded, to an increasing extent, of the environmental consequences of
oil and gas extraction. A particularly dramatic event, was a oil and gas blow-out in
1977 on the Bravo oil platform in the North Sea that a notorious Texan, known as Red
Adair, was hired to stop. There have also been many other incidents over the years to
remind us of the particular risks associated with the oil and gas industry—both in the
extraction and in later stages of production. Another incident that stands out, was the
wrecking, in 1989, of the VLCT ship Exxon Valdez in the Prince William sound just
off the coast of Alaska. The oil spill was large, but not amongst the largest to date.
It was more than other things the vulnerability of the surrounding area as a habitat
for inter alia salmon, sea otters, seals, and miscellaneous bird species that made
is grave. Despite this major incident, perhaps the biggest man-made environmental
ocean catastrophe on record, and some smaller setbacks, the volume of extraction,
and the optimism with regard to the future of the oil industry, increased when the
price of crude oil climbed above its lows.

the oil price may also crudely measure value development for other petroleum products, such as
natural gas, including liquid natural gas—LNG.
2.3 Petroleum Wealth 63

With licensing to international oil companies, the state’s revenues from oil were
mainly royalties and taxes. There was after a while also some income from the State’s
Direct Financial Interest (SDFI), which was established as a separate legal entity in
1985.35 The latter incomes were less important in the 1980s, but increased in size
over time. As mentioned, prior to the GPF-G from 1996 under the petroleum law
of 1990, all state revenues were spent through the annual budgets. However, not all
was consumed. Notably, large sums were spent on projects undertaken to improve
infrastructure. Even if these projects showed up in the accounting as spending, a large
fraction of it was in essence investment. It is not difficult to argue that these projects
too produced returns, but much less trivial to account for the size of these returns.
The accounting in public budgets was crude and counted funds used as spending.
This is so for reasons of both ease and flexibility. The underlying reality, however, is
that much was invested also before the Fund. However, the new framework centered
around the SWF makes it easier to track investments and returns.
There has been a noteworthy debate on spending patterns since the establishment
of the GPF-G and the introduction of the fiscal rule in 2001. For instance, labor-
center so-called “red-green” governments have been criticized by conservatives for
not spending the oil money in a fashion that will results in economic growth. For
instance, much money was spent on projects in health care and pre-school primary
education (kinder gardens), which was formally classified as current spending. The
responsible governments, where the labor party was the leading coalition partner,
argued that the “spending” was in reality invested and that this kind of projects,
not least schooling and education, sharply improved the society’s future productive
potential. It is easy to agree, but also easy to see that keeping track of domestic
investment may pose problems.
Thus, although the argument may have substantial merit, the accounting frame-
work of the state budget has been too simple to adequately separate spending from
investment for the future. There is always a danger that lax accounting standards
could lead to ill-founded reclassification from consumption to investment, to pave
the road for current spending to count as investments. It is common to assert that the
resource revenues were wisely spent also before the establishment of the SWF, but
not very easy to show why this is so. In this respect the SWF is an improvement.

35 The State’s Direct Financial Interest

(SDFI) is administered by Petoro, with 64 employees, which
aims to maximize the revenues from the state’s ownership. This gives rise to about 1/3 of Norway’s
cash flow from oil and gas which is transferred directly into the GPF-G—amounting to 96 billion
kroner in 2019. The portfolio consisted at the end of that year of 200 production licenses, 35
producing fields, and 16 pipelines with landing facilities, and 14 licenses with a net surplus agree-
ment. Prior to 1985, the tasks were handled by Statoil, which was partly privatized in 1981. Source:
petoro.no, accessed 25 September 2020.
64 2 Natural Resource Sustainability

2.3.3 The 1990s: Expansion of the Petroleum Wealth

Towards the end of the 1990s, the oil price stabilized at about 40 dollars per barrel—
the same nominal price as at the outset of this decade. Within most of the decade, it
remained closer to 30 dollars, and also dipped below 20 dollars per barrel. Further,
as always, the oil price was highly erratic. The value of the export of oil and gas
increased, and this increase accelerated into the 2000s, when oil prices climbed as
high as about 120 before stabilizing at around 100 U. S. dollars. The dot-com-bubble
around year 2000, and the Great Recession from 2008 onwards dampened the price
increases somewhat. In the 2000s, large volumes of natural gas were also brought to
market—a new trend that continued into the latest and current decade of the 2010s.
Following the international economic slump of 1990/1991, stabilizing the macro
economy was a main priority of the Norwegian government. The downturn became
particularly marked in Norway due to delayed effects of large excesses in the 1980s,
which led, inter alia, to bailouts that made the central government owner of several
major banks. It has been stated later that the misfortunes were due to an unfortunate
combination of bad policies, bad banking and bad luck. A part of this was due to
lack of experience with the market economy, as both the credit markets and property
market as regards residential housing was deregulated only in the 1980s.
In the labor market, a tripartite agreement, or social pact—The Solidarity Alter-
native—was entered into by the main labor organization (Landsorganisasjonen i
Norge) and The Confederation of Norwegian Industries (Norsk Arbeidsgiverforening,
from 1989 Næringslivets Hovedorganisasjon). The name is due to The Employment
Commission (1992). The main goal was to get out of the crisis, through increased
economic activity and reduced unemployment. The ability to pursue expansive fiscal
policy was strengthened by the resource revenues from oil and gas. This was the
main contribution of the central government. Further, Norway pursued a fixed, and
from 1994 stable, exchange rate vis-à-vis European currencies.36 The labor orga-
nization’s contribution was to refrain from wage claims on behalf of its members.
The effect on average wage growth was strong, as the wage negotiations between
the largest confederation of trade unions, LO, and the one of employers, NHO, func-
tion as a benchmark for many more than their members. Wage rises were thus kept
in check for a while to stimulate job creation. The stable exchange rate vis-à-vis
the most important trading partners resulted in a direct correspondence between the
achieved wage restraint measured in local currency, the krone, and competitiveness
in international markets.
This framework for macroeconomic policy was effective for roughly a decade,
from about 1987 to 1997. By the end of this period expansive fiscal policy was
no longer needed. Further, wage restraint appeared as less needed due to improved
business conditions. It also became more demanding to stabilize the exchange rate,

36 In practice, the exchange rate was stabilized vis-à-vis the euro’s predecessor, ther European

Currency Unit (ECU). This covered the bulk of Norway’s trading partners, apart from Sweden,
Britain, the United States, and Japan.
2.3 Petroleum Wealth 65

through interest rate setting, under a higher and increasing capital mobility inter-
nationally. Another element that contributed to a silent and unofficial end to the
arrangement, was a new conservative-center government from 1997 with less well-
developed channels to labor organizations, in particular to LO, than the previous
labor-dominated governments. Further, there were increasing difficulties in keeping
the exchange rate steady under the increased capital mobility during the late 1990s.
In the new setting that evolved, it must have seemed less obvious to labor union
representatives than before that wage restraint would lead to immediate and lasting
improved cost competitiveness in international markets.
An important reason for the establishment of a SWF in 1990, was a perception
by some government officials and politicians that significant wealth might else have
been squandered, due to increasing political pressures to increase spending: The
new arrangement implied that public revenues were channeled through the GPF-G,
which subsequently covered the non-oil deficit.37 The perceived need for money to
spend was linked to increasing expectations, which could appear as ever-increasing
and unbounded. Under the new framework it would no longer suffice to propose
increases in government expenditures, without specifying the financing. The ability
to cover deficits is bounded by the real return expectation, and the size of the Fund
at the end of the previous year. As mentioned, establishment of the GPF-G was
formally approved by Parliament in 1990. However, it was not until 1996 that the
first funds accrued to the Fund—in that year a modest 2 billion kroner.38 From 1998
on, additional funds were transferred at an increasing rate.
A further important change occurred in 2001, when it was communicated that the
real returns represented an upper limit for spending under normal cyclical conditions,
and the government’s real return expectation for the SWF was set to 4 pct. This was
communicated as a fiscal rule, clarifying that expected real return, or less, could be
spent through the budget, with reference to the value of the GPF-G at the end of
the previous year. It was thus visible that additional, unfunded spending would be
passed on to future generations in the form of a reduced SWF.
The Fund mechanism was implemented, whereby the government’s resource
income first accrued to the fund, to be invested in international capital markets.
In this way the resource income was only indirectly available for the government to
finance the annual non-oil deficits. The democratic implementation of this institu-
tional framework, suitable institutions for long-term financial planning, and a portion
of good luck, may distinguish Norway from many other states. Many have been
unable and/or unwilling to shield off resource wealth from political pressures towards
spending sooner rather than later. This author views Norway’s framework as a neces-
sary, but not sufficient, condition for spending resource income wisely. It does not
suffice, since it could be instantly changed. Such is the logic of public finances under
democratic rule.

37 In
the budget documents, this procedure is referred to as “The fund mechanism”.
38 Thenew creation was named The Petroleum Fund. Later the name changed to The Government
Pension Fund Global, GPF-G. There is also a much smaller domestic counterpart—the Government
Pension Fund—Domestic.
66 2 Natural Resource Sustainability

Further, the fiscal rule is not, and never was, meant to be a straitjacket: In a
given year there could, subject to the business cycle, be either increased or reduced
spending. Not surprisingly, self-restraint proved difficult, e.g. in the 2000s before the
Fund gained a very large size. In this period, the day was saved by a combination of
high oil prices and increased extraction—which accelerated the growth of the Fund
in spite of government expenditures in excess of what the fiscal rule allowed and that
in isolation looked too high. The situation was thus stabilized.
The growth of the Fund has been intimately linked to fiscal policy: The non-
oil deficit is financed through the GPF-G, which must satisfy the mentioned fiscal
rule—that is a 4-pct. rule from 2001 and from 2017 a 3-pct. rule. This means that
accumulation of the fund, except for from the Fund’s returns, must stem from a fiscal
surplus. In this way one has avoided to create a mirage of a fund, that could have
reflected increased government debt.39 It is reasonable to expect the latter constraint
to imply, and also facilitate, a higher degree of discipline than the alternative.
By the year 2000, a robust framework had been implemented to carry out savings
for the future. The framework also shaped the spending decisions for the following
decade, when the price of oil rose sharply to record levels, in excess of U.S. dollars
100 per barrel over long time spans. The extraction rate also increased. International
conflicts and other factors that impacted on the balance between supply and demand in
the petroleum markets also played important roles. One could supply large resource
quantities at high prices. Since about year 2000, the returns from the Fund also
increased steadily due to compounding. All of this made the GPF-G grow sharply.
The typical picture elsewhere may be one of scarcity of funds and expensive
servicing of significant government debts. This stylized situation leads to well-known
pressures, not unlike those that a comparatively poor individual might experience
upon the receipt of an above-average wage check. According to an old Norwegian
expression money may in this situation “burn in the pocket”. Incremental income
may thus not be saved, although this could be wise.
By comparison, the outcome that Norway has achieved in relation to its incre-
mental resource revenues appears attractive. There has been some interest expressed
in the factors that makes it possible to save collectively, and of whether collective
saving could be facilitated for other countries, with other institutions, institutional-
ized environments, and challenges. Although it is difficult to give advice for other
settings, the framework—‘fund mechanism’—that separates the income stream from
the budget is important. Further, one could delay spending when possible. What is
more or less possible, would then depend on the acuteness of the problems money
can solve.
To a large extent the success in terms of ability to save collectively, through mecha-
nisms linked to government institutions, may be attributed to a favorable institutional
setting in Norway ahead of time. However, the establishment of the Fund was also

39 This is not to say that such, often costly, constructions have no value. Such arrangements may be

entered-into by less wealthy countries despite the costs, if they are viewed as providing flexibility.
They may also be used as vehicles for forced saving, analogously to the use individuals may make
of, e.g., home loans where down payment represents savings of funds that could alternatively easier
have been spent.
2.3 Petroleum Wealth 67

facilitated by other factors, including the timing: It took place at a time when resource
revenues had attained a high level and were still increasing—which continued for
several years due to a combination of increased prices of oil and extraction at a high
rate. The latter was a high priority of the respective governments. That the inter-
national environment was ripe for absorbing the high output in periods of high oil
prices, was good fortune. The high-rate extraction activities were demanding but
profitable, even if the oil companies paid a large fraction of the economic rent in
royalties and taxes. The large official proceeds could later be converted into financial
wealth by a competent organization built explicitly for that purpose. In its entirety
the success was due to a combination of a willingness to succeed, appropriate skills
and good luck. Still, it could not have been realized without effort. Several required
elements cannot be taken for granted, perhaps particularly not by small states.
Several fortunate factors, some of which could appear as coincidences, thus made
it possible for this small state to stack away an increasingly large part of the resource
revenues into a fund constructed mainly for resource transfers into the future, to
benefit future generations. Given its large size and the self-imposed constraint of
consuming only up to the estimated real returns, the Fund will remain important
for a long time. Nonetheless, it is likely to decline from its current peak level of
about 3 ½ times Norway’s mainland GDP. The reason is a combination of expected
future GDP growth—which would increase the denominator in that fraction—and
a possibility that the real value of the Fund may already have reached a level close
to its peak. The latter could be likely because the bulk of the exploitable physical
resources may have been extracted, due to extraction costs and because oil drilling
appears less sustainable than before. Even if the Fund should grow further in real
value, spending through annual budgets will dampen the rise.

2.3.4 The 2000s: SWF Growth and Professionalization

of Wealth Management

Macroeconomic stabilization policy has been popular and extensively used in

Norway, compared to in many other countries. This has been so particularly in relation
to governments where the labor party has played a major role. The 2000 years were
no exception. In the red-green three-party alliance in office from 2005, the labor party
was the dominant coalition partner.40 The idea that the government should counteract
cyclical movements in demand, however, has a significantly wider appeal. Also, the
conservative government in office since 2013 has referred to the same principle to
justify a high rate of spending of public funds. This argument was also used to moti-
vate an expansionist budget policy following the oil price slump from 2014, which
hit hard in South West and West Norway, where most of the oil-related industry is
located. This positive attitude towards stabilization policy may represent a departure

40 The parties in these coalition governments were the labor party, the agrarian party, and the
socialist left party.
68 2 Natural Resource Sustainability

from traditional conservative economic policy, which emphasizes budget discipline

as a prerequisite for keeping taxes low.
The mentioned tripartite agreement—The Solidarity Alternative—negotiated
between the main labor market organizations and the government, was effective
from about 1987 till about 1997. It carried a name that could be interpreted either
as a reference to needed solidarity to justify intervention by the state and organized
labor, or that the required quantity of solidarity was secured, or both. This arrange-
ment ended when unemployment declined and the focus of organized labor changed
from fear of unemployment to seeing to that they received a fair share of the profits
from production. Increased resource revenues during the international boom of the
late 1990s played a large role in capitalizing the GPF-G.
Until year 2000, the Fund was very small. It since grew rapidly. The 2000s were
also marked by increased professionalization in the management of the SWF. The
thinking along the lines of the earlier Tempo commission, of a fund without a need
to set up new organization was left soon after the inception of the GPF-G. This must
be understood in the context of the large size the Fund was to attain, just a few years
after it had been established.41 Sharply rising resource revenues contributed both to
perceived organizational needs and good abilities to fulfill them. As mentioned, a new
organization in the form of a separate wing of the central bank was created—NBIM.
At the time it may have been difficult to think of any other approach. The central
bank was already an experienced international fund manager with large investments
of official foreign currency reserves in international bond markets. With regard to
NBIM, there was an expressed commitment to excellence and expert management
from the start. Today, this organization employs a staff of about 550, and is larger
than the other parts of the central bank combined. The bank as a framework for the
SWF has therefore been under some pressure. Among the options that have been
addressed to remedy this, was to separate the NBIM, i.e. the investment wing, from
the rest of the central bank, as advised by a recent government commission.42 This
radical secession measure was, however, not implemented.
Savings and investments on behalf of the government increased both in the
2000s and the 2010s. Improved terms of trade and better government finances made
increased savings quite easy to accept for the public. In international trade, Norway
was well positioned to benefit from China’s development and increased presence in
international markets: The prices of natural resources such as oil and natural gas
were bid up, and manufactured consumption goods, that were of increasingly higher
quality, could be imported at cheap prices.43 Norway were thus able to buy more

41 As mentioned above, the Tempo commission saw size as a political decision, outside its own
mandate, and did not recommend saving for transformation of income into the future, to the benefit
of future generations.
42 The Gjedrem Commission (Sentralbanklovutvalget), headed by former Governor of Norges Bank,

Svein Gjedrem, NOU 2017: 13.

43 An example of a country on the ‘wrong’ side of the China trade is Mexico, a commodity exporter

that was seen as losing from China’s rise in world trade. This also led to larger firm-size in manufac-
turing by hurting small firms the most due inter alia on how the market for intermediary products
worked (Ivacone and Winters, 2013).
2.3 Petroleum Wealth 69

imported goods for the proceeds from her exports. Apart from a steady demand for
raw materials at increasing prices, the China-trade effect and import of labor from
Eastern EES and EU countries also contributed towards keeping consumption prices
low. So the terms of trade improved. Cheap imported manufactured consumer goods
were available from Asia, and cheap labor from East and Central Europe. Together
with the international low interest rate environment since the outset of the finan-
cial crisis in 2008, this development which implied low ‘imported’ inflation set the
stage for low interest rates in Norway. The comparatively lax monetary policy stance
underpinned demand and promoted growth for a prolonged period.
Since 2001, the monetary policy framework has aimed at low and stable inflation,
which in practice meant inflation of about 2½ per cent per year. However, for long
periods the inflation rate stayed significantly below this target. Further, the above
mentioned trade effects that kept inflation low also impacted on fiscal policy. The
lack of any serious inflation threats seemed to pave the way for quite high spending
through the budget, made possible by resource revenues. Thus, for some years neither
high spending nor low interest rates lead to inflation above the target, or even fears of
such developments. Since about 2009 the Great Recession amplified this sentiment.
Both inflation and inflation expectations remained low. One could have returned to
the more normal situation before 2007/2008, were it not for the pandemic of 2020:
There were some signs of this, with increasing interest rates in Norway compared to
in her surroundings. However, although inflation has not been a great concern lately,
it is highly likely to return as one before too long.
In the United States, interest rates were increased through 2018 when funds were
also drained from the money market with a view to reverse, over time, the extraordi-
nary liquidity supply known as quantitative easing since 2008. However, these moves
were reversed, both with respect to interest rates and liquidity. Factors that dampened
expectations of interest rate increases in the early spring of 2020, included the U. S.
presidential election held in the fall, which seemed to restrain the Federal Reserve.
However, this became unimportant. When the Covid-19 pandemic hit Western coun-
tries from the spring of 2020, many large economies experienced combined negative
aggregated supply and aggregate demand shocks of yet unseen magnitudes. It was
imperative to ease fiscal and monetary policy. GDP growth turned sharply negative in
many countries, in particular for the first quarter and half of 2020. Later developments
were more positive, due not least to progress in relation to development of vaccines
against the new disease. In this respect there were very positive news in November.
Wide-scale vaccination will take place throughout the spring of 2021 in developed
and high-income countries. Although the world had never been better scientifically
prepared than before this pandemic, the crisis became colossal. Forecasts by The
World Trade Organization (WTO) in the spring suggested that world trade could
diminish by about up to 1/3. The United Kingdom and several countries of South
Europe lost about 10 per cent of GDP in 2020.
Fiscal policy was loosened and official interest rates cut to near-zero across the
industrialized countries. Towards the end of 2020 many market-based interest rates
were still negative, including for long-dated maturities. Interest rate hikes do appear
distant. It will take time to know the full consequences of the Covid-19 pandemic,
70 2 Natural Resource Sustainability

and we are unlikely to get rid of this disease soon. In spite of this, the developments
as regards vaccines are likely to have a tremendous positive economic effects.
International asset markets have been resilient to an extent that has surprised many.
For instance, international stock markets that were very hard hit initially recovered
throughout the spring and summer. Towards the end of the year there were several
all-time highs registered on key stock market indices. The crude oil price also rose
some, to a level of about 50 dollars at the close of 2020. These trends continued into
2021.

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Chapter 3
The Economics and Politics of SWFs

In the following (or: what follows) the rational for the establishment of SWFs is
discussed. The main idea behind a resource fund is to stack away wealth in earlier
periods for consumption in later periods. Such time transformation of wealth could
be useful for smoothing a state’s budget. This could be either short-term, as in rainy
day savings for individuals or household, of for the longer term, for instance for
handling challenges of a structural type. One has a cash surplus at time t 0 that one
wants to convert into goods and services later, at t 1 , t 2 ,…T, where T is the time
horizon, which may approach infinity. This becomes more attractive if one earns a
good return in the meantime.
Much research suggests that it is common for individuals not to always behave
in their own long-term interest. The reason is primarily temptations to spend to
achieve immediate satisfaction, or instant gratification. One important aspect of such
problems, that have shifted into to a center-stage position in economics in recent
years, is that individuals save too little if left to themselves. This is an important
example of bounded rationality.1 The work of the 2017 ‘Nobel Prize’ winner in
Economics, Richard Thaler, may inform public policy in this common circumstance,
not least as regards retirement savings.2

1 Bounded rationality first surfaced with Herbert A. Simon (1956), in a Psychological Review article;

“(…) organisms adapt well enough to ‘satisfice’, they do not in general ‘optimize’” (p. 129), “A
‘satisficing path, (…) that will permit satisfaction at some specified level of all its needs”. The theme
was also discussed in Simon (1947)–Administrative Behavior and Simon (1957)–Models of Man.
For Simon, limited data processing abilities and time made satisficing a better approximation of
behavior than optimizing according to theoretical models.
2 The motivation for the 2017 Sveriges Riksbank’s Prize in Economic Sciences in memory of Alfred

Nobel, awarded to Richard Thaler, is available on the web site www.nobelprize.org (downloaded 30
October 2019). A further motivation mentioned there, is that of liberating the intellectual legacy of
Adam Smith—as there had been a tension between the views on human rationality in the two books
he published—The wealth of nations, Smith (1776), well-known for the invisible hand rendering
socially desirable the outcomes based on individual self-interested actions, and The theory of moral
sentiments, Smith (1759), in which human life is described as a struggle between the passion of
immediate satisfaction and “an impartial spectator”—our long-term oriented and rational self. The
© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 73
O. B. Røste, Norway’s Sovereign Wealth Fund, Natural Resource
Management and Policy 54, https://doi.org/10.1007/978-3-030-74107-5_3
74 3 The Economics and Politics of SWFs

According to the Swedish Academy of Sciences, Thaler’s work on the conse-

quences of bounded rationality, limited self-control, and people’s sense of fairness
has brought key insights from psychology from the fringe of economics to its very
center. In addition to informing public policy, it had been crucial in building the new
field of behavioral economics, and unified social science. It may be seen as good
public policy to nudge individuals into saving some more than they would else have
done. Several approaches may be utilized for that purpose, the most obvious of which
may be to attach some tax relief to long-term individual savings. Many countries have
done this, often in combination with a role for the authorities in pension schemes or
tax incentives to promote individual retirement savings.3
Savings by the State with Windfall Gains
A more radical approach could be for the government to save on behalf of all,
say through SWFs. In this way, one can save on behalf of all citizens or residents. In
this context the administrative entities of the state may be utilized to attain, on the
aggregate, the rationality linked to long-term savings decisions that individuals tend
to lack. An important caveat, is that draconian savings policies may be unpopular,
so that its proponents may be voted out of office in democracies. This illustrates
the political limits to the SWF approach, in particular when it cannot be linked to
windfall gains as in the case of resource incomes. The resulting long-term savings
can be used to pay for fiscal deficits and allow for higher spending in later time
periods. A particularly strong case for applying this approach may exist if there are
significant temporary incomes for the state from non-renewable natural resources.
There seems to be a strong norm that one should be able to capitalize on wind-
fall gains, and thus also have something to show for them in the future. This may
seem irrational as surpluses from windfall-gains do not differ from other available
funds. A reason for the apparent strong norm, may be the ease with which a political
opponent can emphasize in later time periods how some specific resources may have
been squandered. The responsible players during a specific time period subsequent
to a resource find may thus more easily be put on the spot than their colleagues of
other time periods.
In spite of this, long-term savings may not easily be undertaken. Also states seem
to suffer from problems similar to those individuals may face, of saying no to the
immediate pleasure instant spending might offer. In line with this, there is a well-
known tendency for states to run fiscal deficits, thereby passing some of the bill for
current spending on to future citizens-residents and tax payers. It may therefore, as
many states have experienced, be challenging to set aside significant resources. This
step seems to require institutions in place that facilitate the application of a long-
term perspective in savings decisions. Such institutions are scarce both in history
and across space. Chances for them to be at work are best in stable democracies.

tension has been referred to as the Adam Smith problem and most have found Wealth of nations
to be more positive with regard to selfish interests than Theory of moral sentiments. This view is
however not obvious. See Paganelli (2009) for an opposing view.
3 In the United States, the popular 401(k) plans are a prime example of the latter. See, e.g.“Thank

Richard Thaler for Your Retirement Savings”, Bloomberg News 10 October 2017. According to
this news item “[i]f you have a 401(k) plan at work, there’s a good chance that you’re saving more
for retirement because of Richard Thaler.” Source: www.bloomberg.com, downloaded 31 October
2019.
3 The Economics and Politics of SWFs 75

In principle, the investments and their return could be used for any type of govern-
ment spending. In the Norwegian case, pensions have informally been identified as
a target for savings. The reason for this is that pension payments constitute a large
part of government expenses and are set to rise over time, and more so than most
other budget items. Pension liabilities have a time profile not too different from
that of investment return. This budgetary item is therefore well-suited to signal the
opportunity cost of increased government spending. In addition to pointing that out
in debates on public spending, it is usual to say that money will be taken from our
children.
The resources that generate the income from petroleum to be saved are non-
renewable. Hydrocarbon deposits stem from decomposition of organic materials
from earlier geological time periods. Once the resources are developed and brought
to market, or consumed, they will be ‘gone forever’. Renewability does in this context
require time periods so long that they are difficult to grasp. In relation to human
lives, the required time can be approximated by infinity. For all practical purposes,
the creation of petroleum was therefore a one-off event.
Savings Without Windfall Gains
The term Sovereign Wealth Fund (SWF) is wider than the one of resource fund. In
addition to savings out of resource-based temporary income, it may include savings
of more ordinary income such as taxes. A fiscal surplus may have a counterpart in
savings in a fund on behalf of a sovereign state. There will typically also be a current
account surplus if a fiscal surplus is due to taxation of incomes from abroad, in which
case there will be a situation of twin surpluses.4
If the fund is invested abroad, as is often the case for large financial investments—
particularly for small states and with incomes denominated in foreign currencies—
the investments will also be denominated in foreign currency. Foreign currency may
be bought against local currency by the authorities to settle purchases linked to the
investments as they are made. If such purchases are not made, a surplus supply of
foreign exchange and drainage of liquidity will lead to an appreciated exchange rate
and an upward pressure on short-term interest rates. It is common to see to that there
is sufficient liquidity and to tolerate some fluctuations in the exchange rate.
Purchases and sales of foreign currency with respect to a SWF is therefore linked
to exchange rate management. In particular, the timing of large transactions is sensi-
tive. In a market context, the flows of foreign reserve are more important than the
accumulated net position. This is important because exchange rate management may
be a source of political controversy, at least for large states with significant foreign
trade. It may be somewhat easier to get away with this type of economic manage-
ment for smaller states that trade less internationally, and thus keep a lower profile
as competitors in international markets. In the Norwegian case, it is this author’s
impression that one has emphasized to separate purchases of foreign exchange from
any active exchange rate management. A further impression, is that there are few if

4 That
there will also be a current account surplus, follows from conventions in national accounts
book-keeping.
76 3 The Economics and Politics of SWFs

any such efforts. In spite of this, net flows of a considerable size could influence on
the exchange rate level.
The approach of the GPF-G appears to be an accumulation of claims on the world’s
productive capacity—that can be tapped into when needed at later points in time. One
may think of this as hedging of future needs for imports. Purchasing power in terms
of goods and services has been the main consideration in the structuring of the Fund.
It is difficult to know with any precision what goods and services one would need to
import long ahead of time, and from what countries. However, that would not matter
so much as long as one could maintain international purchasing power. Acquisition
of a fraction of world productive capacity could in this context be a good operational
adaption to uncertainty. Even if future imports may be of a slightly different origin
and product composition on average, one could expect to secure enough income to
foot the bill.
The main economic motivation to establish and operate a SWF is outlined above.
In principle, at least two types of political issues may arise in this context. First, in
relation to national politics, highly important questions are whether to save, and if
so, how much and under what framework. Clearly, both ability and willingness are
needed for a SWF to be established. Ability, measured by any objective standard
will vary between countries. Nonetheless, significant incomes from resource wealth
could in isolation be interpreted as a strong indication of ability. Note, however, that
even if there is an undisputed ability to save, the willingness to do so can never be
taken for granted. Many countries have spent most or all of the incremental incomes
from oil and gas as they have accrued, and hence accumulated no savings. Still,
there are numerous examples, particularly from the recent years, of states that have
established SWFs. As mentioned above, some countries have also established SWFs
without ‘windfall’ natural resources incomes.
For the countries that have higher abilities by objective standards, particularly
weak institutions could jeopardize one or more of the serially dependent steps
needed to arrive at a good solution for the long term. Under such circumstances,
one cannot realistically expect to be able to consume prior savings at later points in
time. Spending of the resource income could thus appear as appropriate for decision-
makers in view of the involved risks that the resources may else be illegitimately
confiscated or detracted. This seems to be a major obstacle to savings. It may still
be uncertain whether problems linked to weak institutions lead to lacking ability or
willingness, or both, with respect to adopting a long time horizon. The main point
is that even if thinking in terms of economic optimizing may point to a long time
horizon, several uncertainties and political factors may work to shorten the feasible
or even advisable investment horizon.
Second, with respect to international politics SWFs do not operate in an empty
space. Indeed, these entities are closely watched by many different players, including
governments of foreign states.5 In a way not too different from that of individuals

5 See, e.g., the Foreign Affairs article by Kimmit (2008), titled Public Footprints in Private Markets,

and International Working Group of Soverign Wealth Funds (2008), Soverign Wealth Funds Gener-
ally Accepted Principles and Practices, a.k.a. the “Santigo Principles, in particular nos. 17 and 22
on transparancy and disclosure and risk management,” respectively.
3 The Economics and Politics of SWFs 77

who may be interested in the savings of each other, governments of states may
closely watch other states. Political concerns might thus arise abroad about invest-
ment decisions that are made and their expected implications. For instance, foreign
governments may be uncomfortable with financial undertakings of foreign states,
or entities that these states control, both on their own turf and in some instances in
third countries. The entities controlled by foreign states may position themselves
strategically to control some scarce resources, or be strong competitors for business
firms of other countries.
Foreign governments may also expect, wrongly or correctly, that the goals of
investments in a SWF may differ from the pure economic ones that may be stated
officially, and that one would usually expect from private investors. There are no
good alternatives to judging the facts, and the goals of SWFs may thus be analyzed
and understood in terms of the applied investment style over time. The way an
operation is run, for instance in terms of the extent of diversification and concen-
tration of the investments, have implications for what can realistically be achieved
through the investments, and may contain important information in particular for
foreign states. Monitoring of the investments could thus be important in avoiding
misunderstandings.
The Norwegian GPF-G owns a fraction of most listed companies in the markets
where it is invested, and is comparatively open with respect to its holdings of assets.6
This reduces its strategic possibilities in spite of its large size. At the outset, this
appeared as water-proof in communicating that one had pure financial objectives.
Since the Fund has grown to become the world’s largest SWFs, however, it could be
easier for doubters to think that the average investment size might render holdings
less trivial for targets. When one also considers that the Fund is owned by a small
state, with a quite low international profile with respect to geopolitics, the goals
would probably without difficulty be interpreted as financial by most observers.
There would in view of this also be little reason to doubt expressed statements of
purely financial goals.
Funds owned by the governments of greater powers may by contrast be more secre-
tive, and may also concentrate their investments in fewer, key holdings. Their asset
positions may also be concentrated to industries considered to be of strategic impor-
tance, commercially or militarily. With a lesser degree of diversification, compared
to just buying a proportion of outstanding securities in the markets, one could also
expect such entities to hold large stakes in individual companies. Such operations
could be meet with suspicion with regard to an expected possibility of covert opera-
tional goals. Thus, possible suspicion in relation to the true goals may cause problems
in relation to income transformation across time periods. However, such problems
could be alleviated by increased diversification and openness in relation to why a
particular SWF has been established. The uncertainty can therefore often be avoided,
at least in part. Fortunately, openness and diversification are also associated with other

6A rough estimate of up to 2 per cent of the value of all listed shares in market economies globally
is owned by the GPF-G. This figure varies by region and has steadily increased with the Fund’s size
over the latest years.
78 3 The Economics and Politics of SWFs

good things, such as higher risk-adjusted returns on the investments, and often also
increased political legitimacy.7
In sum, both national and international politics may constrain the use of investment
vehicles like SWFs. For this to be a viable strategy, there must be consensus at home
on both the objectives and the instruments to be used. International politics may also
constrain what financial or other goals, if there should be any, that can be achieved
through a SWF. A suitable political framework is therefore required to succeed. In
addition to the usual economic and financial risk that international investors face
there may, depending on the asset classes applied and investment regions selected,
be risks of de facto confiscation or expropriation. The latter possibilities could apply
with particular force if small states were to acquire ‘point-source’ assets pegged
physically to distant locations in less developed countries, where foreign ownership
might be less respected than in developed countries more nearby, and international
law possibly insufficiently enforced.
Whereas great powers may be met with suspicion, linked to their perceived goals
in the international investment markets, states of lesser power could probably more
easily risk to become victims of predatory activities of other strong players, including
states. This is due to little power in a largely anarchic setting of states. It means that
small states could become more dependent of international agreements than large
states with respect to safeguarding the investments made in some foreign countries.
SWFs of stronger states, economically and/or militarily, might in addition rely, at
least implicitly and indirectly, on the potential for sanctions by their state against any
abusive behavior. Such measures may not be available for small states.
An important, and often neglected, part of the risk of international investments is
due to this limited ability by small states to command stable conditions and enforce
agreements, including international treaties. In relation to investments, this seems to
make some asset classes particularly risky. Location-specific ‘point-source’ invest-
ments in foreign territories are cases in point. The risks associated with such invest-
ments are likely to apply with particular force to small, distant state investors with
limited military capabilities. It could follow that Norway should be careful, in partic-
ular regarding location and the acquiring of physical property. Although risk is bound
to increase in a phase where holdings in this, for the Fund, new asset class are built,
the risks seem to have been capped. In particular, one has chosen prime locations. As
mentioned, this may imply some other, a bit less serious, problems linked to visible
wealth.
Implications of International Investment Law
An important reason why there are investment treaties is, like in some other
domains, that many states have seen it to be in their best interest to contribute towards
a safer environment for international transactions. If many participate, either globally
or within a limited area, they can achieve this together. An important related point
is that it is imperative to counteract confiscation and expropriation risk, that may
keep capital from being transferred to areas where it is much needed from a technical

7 Inpractice, Sharpe ratios and information ratios are calculated to assess the risk-return trade-off,
see e.g. Norwegian Ministry of Finance (2020a, b, c).
3 The Economics and Politics of SWFs 79

standpoint and could represent an effective contribution towards growth and material
progress. In principle, it should be in the interest of most countries to undertake some
costly measures to alleviate a situation which prevents profitable investments from
being made. This could inter alia constrain some short-term myopic acts of home
governments in undeveloped countries, that may curb the inflow of investments from
foreign countries.
Treaties have traditionally been important in safeguarding international invest-
ments, especially for small states. Until recently, the number of international treaties
on investments was small. In the latest two–three decades, however, this number has
exploded. It has been difficult to regulate international investments within the frame
for international trade negotiations of the WTO through multilateral agreements.
However, governments of many countries have still concluded numerous, mainly
bilateral treaties. A large number of treaties thus regulates international investments.
One important implication of the proliferation of new treaties is that the regulation
has become fragmented and therefore less predictable. Often, the same facts can
be brought before different international tribunals, or tribunal-like conflict solving
bodies, that can both apply different principles and interpret the principles that they
do apply differently. The field thus experience problems of predictability in spite of
the abundance of treaties. The problems are often linked to vagueness and uncertainty
as to what actually applies to specific cases, depending on in what context these are
considered, more than to lack of regulation. Due to this vagueness, international
investment law seems to imply plentiful opportunities for forum shopping, which
implies to channeling legal processes into the preferred, ‘optimum’ forum from the
viewpoint of a litigator. This may imply less certain ex ante expectations of the merits
of any case, which could also limit the set of wise options for particularly small states
with few power resources to draw on in other issue areas. Uncertainty of applicable
law may thus be one extra reason to remain cautious.
As states are sovereign at home, international law can usually not be enforced
by a higher-level authority. Supranational arrangements are few and far between
in international relations. What one can hope for is still that the states value their
reputation enough to live up to commitments through the treaties they have ratified,
and value the effects a good reputation may have on their ability to make or receive
international investments. While this might in principle suffice to constrain oppor-
tunistic behavior, this may not always be the realized outcome. The latter may be
influenced also by activities in other domains. In particular, issue linkage may poten-
tially increase in the enforceability of binding international treaties. Predictive state
behavior may therefore be more easily achieved if states are parties to a large web
of influences and transactions. This may open-up for linkages and thus also quid pro
quo across issue areas.
International law might to some extent protect international investments in spite
of a limited enforcement ability. However, since enforcement is unlikely if a state
sees it in its self-interest to break a treaty regulation, the protection of investments
provided by international treaties and conventions can in practice depend on the type
and location of the respective investments. The protection provided by international
law might thus, from the perspective of a prospective investor serve to magnify the
80 3 The Economics and Politics of SWFs

difference both between ‘good’ and ‘bad’ recipient states and secure and less secure
investments: For states that respect international norms, also in the field of invest-
ments, the regulations of importance in this field might underscore and strengthen
their intentions to keep promises and respect agreements. Other states, that may inter
alia have breached international norms or regulations in other fields, could appear as
less likely to keep promises or respect agreement that they at some point may want
to renege on. States may therefore be considered as more or less good, in relation
to the expected ex ante likelihood that they are likely to respect international regu-
lations that formally restrain their actions. States may be ‘good’ because they have
stakes linked to keeping their promises, or ‘bad’ because they have few such stakes
to consider. Perceived trustworthiness may therefore at least in part depend on the
web of agreements within which the respective states might be intertwined.
There is little doubt that such international agreements provide value and serve
an important function in many international investment projects by reducing the ex-
ante perceived uncertainty. Since reducing uncertainty is essential for the volume
and direction of investments, this is also important for economic growth.
Nonetheless, overall the limits of international law in regulation of the behavior
of states and their agents remains an important obstacle in relation to volumes and
growth of cross-border investment. Great powers can sometimes do as they please
rather than what they have committed to. In spite of this, there may be costs linked to
reputational damage. Enforcement of international agreements may be sufficiently
weak, however, for no-one to be able to compel the behavior of others to conform
with a statutory regulation. Thus, even if all were to agree with respect to the content
of certain standards, no-one could force unwilling states to comply.
The best one can hope for is perhaps that reputational effects of ‘defection’, or
behavior deemed parasitic, will be over time be perceived of as potentially costly in
relation to future activities of common interest among states. This mechanism can
potentially promote cooperative behavior.
In terms of the political risks of investment, it should be clear that physical assets
located in areas where agreements may be comparatively less respected, would appear
as particularly risky. Whereas the debt obligations of such countries, that trade inter-
nationally, would also be risky there would in the latter case be a potential loss
of access to the capital markets. The value of this potential loss may be judged as
significant enough to constrain opportunistic behavior.
The corresponding loss in terms of a potential seizure of, say, a ‘point-source’
property in the same state’s territory, could become much less significant. In the view
of international investors, this type of loss could be avoided simply by not investing in
that country, which would probably be the default inclination by most international
investors. Further, decisions of this typed depend on micro judgements of factors
that could be more or less transparent due to circumstances specific to each case.
A combination of factors could thus apply to investments within specific countries,
that could make is easier to get away with wrongdoing and more advisable to stay
out. Even if there is a first time for all acts, including the investment in new regions,
investors can often spot early on many areas to keep out of, before any ill-advised
commitment of funds.
3.1 Limiting Spending: Norway’s Fiscal Rule 81

3.1 Limiting Spending: Norway’s Fiscal Rule

There are many variations of the application of rules in fiscal policy. Regardless of
the specific outline, the aim is usually to constrain oneself to avoid temptation due to
myopia. Myopia might result in disregarding, or at least not paying sufficient attention
to, any long-term consequences. The need for a constraint in fiscal policy applies at
the level of the state. Politicians may be tempted to spend too much resources early
on in order to impress their constituencies. Although some do understand that today’s
deficits will show up as tomorrow’s taxes, which will usually also be a bit higher due
to interest payments, many in the respective electorates may not consider the future
sufficiently. One may therefore have problems with fiscal deficits in democracies, as
the literature suggests, due to different mechanism, some of which have been well
documented empirically—see e.g. Hahm et al. (1995) and Persson et al. (2007).8
The stylized fact of a tendency towards deficits, may in consequence resemble the
simpler well-known phenomenon that individuals typically save too little for their
retirement if left to themselves (e.g., Thaler and Sunstein, op. cit.): At a later date
they may thus regret their own spending choices of earlier years. The latter problem
may be alleviated through ex ante public policy which could nudge, or even force,
individuals to save more either by themselves when for instance stimulated by tax
incentives, or by the state on behalf of them in a SWF. Further, social policies may be
applied ex post towards groups that are not performing sufficiently towards saving
for their own future. For the first problem, of states, however, such amelioration
strategies are not available. States must either constrain themselves or live with
relative hardship later on.9 How can states approach this problem? In discussing this,
we draw on insights from analogies to the same problem at the individual level, that
may also lead to insufficient savings for the future.
Agents could want protection ahead of time, with regard to changes in their prefer-
ences at later points. They may themselves be able to address this through precommit-
ment—for instance by introducing costs to changing their mind later on (Elster 1979,
2000). Elster applied the term self-binding. Another solution to such problems could
be government policy that would lower the relative attractiveness of later unsound

8 Wyplosz (2005) argued that the often-applied fiscal rules may not suffice to address fiscal deficit
problems. The rules may be either too lax or too strict, and are thus often ignored. Wyplosz suggested
instead that the size of the deficit could be made a task for Accountable Fiscal Policy Committees,
that could operate in a similar fashion that independent inflation targeting central banks decide on
their key interest rates. This could in principle remove the deficit bias and allow a committee to
exercise fiscal discretion in the short run to stabilize the economy, and deliver long-term debt sustain-
ability too. This, however, would require governments to delegate authority in fiscal policy which
might neither be realistic nor advisable. At least in settings where monetary policy is delegated,
this could be tantamount to technocratic rule and weak economic policy accountability. Political
constituencies differ on preferred fiscal policy, and it may be easier to sort out differences without
bad consequences than in monetary policy. It may therefore be argued that vote competition over
fiscal differences is mainly good in democracies.
9 One exception to this could be that tax payers of other countries come to the rescue. Although this

cannot be excluded, it would probably not be a strategy worth relying on even for poor developing
countries receiving aid.
82 3 The Economics and Politics of SWFs

decisions, by nudging agents to do what is believed with reference to research to be

in the agent’s best interest (Thaler and Sunstein, op. cit.).10
In our context here, the problem is that the agents could need protection against
overconsumption of public funds in early time periods that could squander their
resource wealth. More generally, fiscal policy could become too loose with budget
deficits and associated debt accumulation over time. Any such excesses will have to
be paid for in later time periods, and in part by future generations. This would be
an opposite situation from the one that is widely recommended in academic studies,
and the one the Norwegian authorities have tried to establish.
In the Norwegian resource wealth case the problem is elevated from the individual
level to the state. This has some implications that distinguishes the problem from
that of individuals who save too little. First, there may in part be an opportunity for a
‘free lunch’, if one saves less, on future Norwegians. This important difference may
make the problem worse for the state than for individuals. However, this effect is
reduced by strong norms and an approximate bequest motive. The reason for this,
is widespread solidarity with the children of the generation in charge, which may
perhaps also apply to yet unborn, future countrymen. The future tax payers who will
foot the bill under deficit spending, will therefore in part be protected by social norms.
Given the temptation to spend for immediate satisfaction, however, and bearing in
mind that the same problem also applies to individuals, the implied protection is
likely to be imperfect at best.
Another phenomenon that can render the normative protection of future citizen-
tax payers incomplete, is a common tendency to expect or assume that there will
be economic growth of a few percentage points yearly, on average, over the time
period before extra debts will be paid off. This has, apart from some recessions of
quite short duration, been the situation in industrialized countries throughout the
post-World War II era. It may be human to assume that this trend will continue.
Even if there may ex ante be scant relevant evidence to convince us of this, it can be
verified that one would not have been penalized for assuming this in the past, through
the rear view mirror. If it holds true for the future, income growth in a country over
time will contribute to make the future citizen-tax payers wealthier than the current
ones, and hence less severely affected by any excessive spending today. However,
this ‘truth’ of future promised growth is very fragile. Much like structural models
that may generate profits in financial markets only for a while, it is likely to break
down sooner or later. However, the breakdown may take more time to show up in
the form of faltering growth. The changes in economic growth rates are linked to
long term structural changes in the macro economy, that take place over long time
spans. Therefore, abrupt and sustained changes in national economic growth rates
are less likely than abrupt changes in returns from specific trading rules in financial
markets.11

10 A game theoretic approach to precommitment is provided by Thomas Schelling (1960).

11 Thisis not a restatement of ‘natural’ growth rates in industrial countries of 2–3 per cent per year.
We do not know what future growth rates will be, which also lowers the signal/noise ratio in relation
to observed growth.
3.1 Limiting Spending: Norway’s Fiscal Rule 83

The Norwegian fiscal rule of 2001, formulated by the Stoltenberg I government,

specified that only the real return of the investments in the GPF-G should be consumed
over time.12 Thus, the international purchasing power of the Fund would be kept
intact. An administrative estimate of this real return was, as mentioned, initially
set to 4 per cent of the Fund at the close of the year preceding the budget year.
In 2017, the annual return estimate was lowered to 3 per cent. This very rough
estimate of future returns was and is uncertain. It still has served as an important
demarcation line with regard to responsible policy, in Norwegian krittstrek, ‘chalk
mark’, that determined how large the non-oil deficit could be. This was important also
in anchoring the expectations of other agents in relation to fiscal policy. This specific
spending allowance has become more important over time due to its importance in
budget policy, where up to 1/5 of the budget is paid for without taxation.
For several years in the 2000s there was overconsumption in relation to the 4-pct.
rule, so that more resource income was used than the fiscal rule suggested would
be sustainable. This situation was not corrected by a decline in spending, as would
normally have been the case in other contexts. Rather, a large increase in resource
income, due mainly to increased oil and gas prices, made the GPF-G grow larger
year by year, so that the equivalent of 4 pct. of the Fund also increased sharply. The
large size of the GPF-G made spending cuts unnecessary. What had appeared as
unsustainable spending could therefore be sustained without spending cuts. In later
years, however, that approach would have been more difficult since the size of the
Fund has grown at a slower rate. The challenge today could be more linked to not
spending all the funds that the fiscal rule technically does allow. Even at a high level
of spending, corresponding to about 16 per cent of the expenses in the state budget
in 2019, and an expected 20 per cent in 2021, it could be difficult to hold back in
relation to pressures for even more spending (Fig. 3.1).
The differing views on what could be accepted as sustainable use of oil wealth
should be understood in view of the genuine uncertainty involved in the forecasting
of future returns. Actual policy has showed some flexibility, with spending in 2016
of about 2.8 percent of the Fund’s value at the close of 2015. From 2016 to 2020
the spending was lesser than the revised 3-pct. spending cap. However, this must
be understood in relation to a sharp increase in the size of the GPF-G up to 2015.
With the large size that the GPF-G has attained, even a use of ‘oil money’ below
3 pct. of the value of the Fund at the close of the previous year implies a strong
impulse to the economy from public spending. This impulse should not be very
strong during normal times—reflecting a still limited absorption capacity of the
economy. A strong spending impulse could in principle spill over to interest rate
setting, to produce higher short-term rates and currency appreciation. In the years
prior to 2015, spending did not deviate much from the revised fiscal rule of 3 pct.,
from 2017. As mentioned, during the latest years about 1/6, or 16–17 per cent of the
state budget expenses was paid for from the GPF-G, which has since increased to
about 1/5.

12 Norwegian Ministry of Finance (2001), Stortingsmelding No. 29 (2000–2001).

84 3 The Economics and Politics of SWFs

Norway's use of 'oil money' through the state budget

Oil−adjusted deficit Structural oil−adjusted deficit
500

450

400

350
Billion 2020−kroner

300

250

200

150

100

50

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
Year Source: Revised National Budget for 2020.

Fig. 3.1 Resource Revenues and Fiscal Stabilization: the oil-adjusted budget deficit. Source
Norwegian Ministry of Finance, Meld. St. 2 (2019–2020), Revised National Budget 2020

If we look some years back, the fiscal rule framework has been applied flexibly
and in some instances broken. This author’s conjecture is still that the fiscal rule has
contributed to curb resource wealth spending. Despite some difficulties, the fiscal
rule and debate related to it have probably constrained actors eager to spend, at least
on the margin. There are many examples of critique of politicians by economists
with reference to high spending in relation to the fiscal rule, which has at times
attached some political costs to not respecting this rule. The fiscal rule has become
an important normative standard, which it implied at least some costs not to live
up to in times when it was less than fully respected. This rather simple and crude
framework for use of public funds may therefore function as social capital, that
facilitate collective endeavors. The simplicity and crudeness may be advantageous
in terms of communication to the public, as it is easily understood, and thus for
refinements of policy over time consistent with this framework.
In early 2013, all parties in the Norwegian Parliament, except for the Progress
party, had accepted as binding the spending cap in the fiscal rule. This position was
adjusted when that party took part in the new conservative Solberg government after
the 2013 general election. As a junior partner, that party adjusted a position that had
been successful in gaining popular support.
According to Alsweilem and Rietveld, op. cit. chapter seven, the literature on the
governance of fiscal rules is not very optimistic on what can be obtained in terms
3.1 Limiting Spending: Norway’s Fiscal Rule 85

of improved outcomes. In their view, fiscal rules should be evaluated in relation to

the Koptis and Symansky (1998) criteria list, as articulated by Kyle (2014). That is,
(1) Well defined, (2) Transparent intentions and implementation, (3) Adequate with
regard to the target-variable, (4) Consistent both internally and with economic policy,
(5) Simple—and thus easily understood, (6) Flexible—with adequate escape clauses,
and (7) Enforceable—with clear mechanisms and various roles for institutions.
One preliminary observation, is that rules that are simple also often tend to be well
defined, flexible and enforceable. Simplicity is also likely to enhance transparence,
and make intentions clear. Further, it would be difficult to make and maintain simple
rules that are not adequate with regard to a target variable, or not consistent with
economic policy. Norway’s Fiscal rule happens to fit very well into this frame-
work, and most observers and analysts seem to agree that it satisfies them well,
including Alsweilem and Rietveld, op. cit. This author also agrees, and will highlight
in particular the simplicity and political institution building around the rule.
According to Alsweilem and Rietveld, “the savings rules tend to be better devel-
oped and more clearly articulated than spending rules” (p. 159). In Norway, all oil
and gas income that accrues to the government is first deposited in the Fund (‘the
fund mechanism’). It is also clear that up to 3 per cent can be spent in the state budgets
under normal cyclical conditions, and further, that the fiscal rule is not intended to
be used mechanically, in particular without cyclical adjustments.
Populism is widespread and frequent also in Norway. Many have wanted to spend
in fashions not compatible with returns-based spending in the past. Today this may
be simpler: Some 300 billion kroner is no doubt a large chunk of money. As this
author sees it, the public policy culture that was dominant at the time of the large
oil finds of the late 1960s, and for several decades to follow is very important in
the Norwegian case. Modest social democrats of the labor party ruled the country.
Further, an influential economics profession, particularly at Oslo, made the policy
stance more ‘frugal’.
Furthermore, some strong individuals strongly influenced economic policy,
including but by not limited to the former Central Bank Governor Hermod Skån-
land, and former Prime Ministers of the Labor party Gro Harlem Brundtland and
Jens Stoltenberg. To this list, a few bureaucrats of lower public profiles could be
added. None of the mentioned contributions were in isolation sufficient for the
applied policy stance of savings and investment. In combination, however, they made
possible the approval by other political parties and their constituencies. This sphere
of interest of politicians, bureaucrats, and academics, who emphasized collective
actions and outcomes dominated economic policy formulation. This was important
for the outcome.
This task was probably much simplified once a policy stance was formulated which
strongly emphasized common interests and the future. It was possible to coordinate
thoughts and actions around two main principles. With others in the driver’s seat
from the outset in the late 1960s, this result with emphasis on common interests
and the future could have been more difficult to attain. In Norway, the institutional
and political scene in 1969, at the time of the large initial oil find, were sufficiently
favorable for a long-term view to be adopted in relation to newfound wealth. It is
86 3 The Economics and Politics of SWFs

more difficult to know wheter alternative arrangements could have produced the same
result. The dominant labor party at the time probably facilitated coordination within
a group whose participation was required to secure an outcome that emphasized
the future. One important factor, is that the political constituents of the labor party
followed the party’s leadership. This may have been different within other parties at
the time, and almost certainly more recently.
The Progress party accepted the fiscal rule as binding, as the last of the parties
represented in Parliament from 2013, to become a constituent of the Solberg govern-
ment.13 For the junior partner in a government comprised of two parties, this conces-
sion was unavoidable. Hence, the relevant aspects of economic policy became shared,
even if the social democrats had formulated the fiscal rule, and even if the Progress
party broke out of the government in January 2020. In the meantime, two remaining
parties in the government’s basis in Parliament took part in the cabinet. Seven years
of rule by a conservative coalition government does not seem to have changed the
landscape by much—even if there has occasionally been criticism of ‘high spending’.
This could be because a high spending rate is permitted according to the fiscal rule.
With a Fund larger than 10.000 billion kroner, 3 pct. amounts to the sizeable sum of
some 300 billion kroner.

3.1.1 Implications of the Low-Yield Environment Since 2008

Structural factors seem to have pressed the expected returns on financial investments
down since the financial crisis. First, several of the world’s leading central banks
have since 2008 adopted activist monetary policies at or around what in earlier days
appeared as the zero lower bound of interest rates. Under the new type of expansionist
monetary policy, called quantitative easing, or QE, it has been common that short-
term official interest rates interest rates have been negative, and increasingly more
negative over time.14 Thus, money left idle at banks would not only earn zero interest,
but could even imply direct payable costs. In this way banks were nudged to lend
more to the public on the margin. The ‘ammunition box’ of monetary policy was
still almost exhausted, albeit at a lower interest rate level than in earlier times. The
effects of this type of new monetary policy have been small and uncertain. Else it
would most likely not have been new. In reverse, the effects appeared equally small

13 Former Prime Minister Jens Stoltenberg, like central banker Hermod Skånland an economist

educated at The University of Oslo, had expressed dissatisfaction with a situation where the Progress
party had money the rest of the parties didn’t have for increased spending in their communication
with prospective voters.
14 In practice, QE implies expanding the money supply by buying large quantities of bonds, including

bonds of long-dated maturities. This shifts the yield curve down and increases bank liquidity, to
make lending to the public more attractive. The lower bound of interest rates in practice appears a
bit elastic—negative rates around 1 per cent seem to have been possible to achieve and maintain
over time, at least over the five or so latest years.
3.1 Limiting Spending: Norway’s Fiscal Rule 87

and uncertain in the United States during 2018 when the Federal Reserve aimed at
gradually reversing QE in order to bring down the money supply.
Some years ago, one did not think of QE as realistic. However, the developments
since 2008 may have important consequences also for future monetary policy. It
also has wide-reaching consequences for what returns one can realistically expect
from a moderate-risk SWF. One important source of uncertainty in this context is the
run-up in price of real assets, including equities, since the financial crisis. In earlier
times, the expected and realized returns on the two main asset classes—equities and
fixed-income securities –were closer to one another. Then a situation emerged with
zero or even negative returns for short-dated fixed-income securities of high credit
quality. What might initially have appeared as an aberration, has become persistent.
Simultaneously, stock valuations and returns on equities have increased. As already
discussed, this has nudged or even pressured some investors to allocate more funds to
high-risk assets, in order to generate the average expected returns needed to achieve
their investment objectives.
This aggregate disturbance in financial markets is due to monetary policy and
unprecedented. It could have unforeseen effects for years to come. One type of
negative effect, could be stock market crashes due to run-ups in valuation in an
environment of cheap funding. Also an expected ‘normalization’ in interest rates, as
announced in some countries from about 2018, could have that effect—even if the
Covid-19 pandemic has made this scenario less likely for a while. The leading central
banks seem to be very sensitive to stock market developments, and could potentially
stabilize this market on the margin. It is less likely that the central banks would
have sufficient motivation and ability if stock-market valuations become excessive.
Another negative effect that may be likely, is that of cost shocks for investors who have
become accustomed to borrowing cheaply long-term. One can argue that investors
and other players in capital markets should be rational enough to be able to cope
with such possible developments. Still, many may be unable to do this. Others could
be able to act differently, but still find it tempting to continue.
In any event, this new type of behavior could impact on what ‘normal interest
rates’ might mean in the future: The main central banks are unlikely not to consider
negative consequences of their future rate hikes. The experience from the United
States since 2018 lends supports to this view.
The central banks have in performing QE operated along the yield curve by buying,
e.g., large quantities of long-dated fixed-income securities. They have thus at least
to some extent driven down long-term yields. As a result, the return from investment
in government securities is sharply lower compared to in previous decades. Due
to dwindling returns from fixed-income, the ‘new’ environment has made it more
difficult for pension funds and others to meet future obligations. The transformation
of funds across time, of SWFs, has also become more difficult and riskier. For quite
a while it has thus been necessary to invest in something else than fixed-income
securities to make significant returns. The ‘something else’ may vary in content.
However, one thing the compensating investments have in common is high risk.
Other things equal, for those invested in high-risk assets it is more likely that a
significant fraction of the capital may be lost.
88 3 The Economics and Politics of SWFs

Due to the low level of interest rates, some see the future interest rate development
over the long term as a one-way bet. To the extent that this is meaningful, even
government securities may have become riskier as investments, at least while we
wait for the turning point. It is mainly a question of when interest rates will rise
again. When they do, significant capital losses in fixed-income securities, including
government bonds, cannot be avoided. Equities may also be vulnerable, since the
interest rate level impacts strongly on valuations that investors base their decisions
on. Fixed-income securities other than government bonds have higher risk but are
typically priced in relation to the yield curve for government securities. Yield changes
over time will largely reflect the sum of changes in the government yield curve and
changes in a spread. Interest rate risk from government securities therefore spill over
to, e.g., corporate bonds that are in addition exposed to other types of risk, most
notably credit risk. Fixed-income as one of the two main broad asset classes has
become less attractive due to the near-zero yields. This has triggered investments
in the other main asset class—equities, usually marked by much higher risk. In this
author’s view, it is difficult to exaggerate the effect on systemic financial market risk.
A further effect, is that the low yields have made assets outside the main asset classes
attractive.

3.1.2 Investors Chasing Incremental Yields

To do better than about zero on average in a low interest rate environment, an investor
or a SWF must take on risks. This can be done in several ways. The easiest approaches
could be to increase the exposure to equities and/or to accept increased credit risk in
fixed-income investments. A corresponding problem with a sustained low-interest
rate environment, is that stocks may look attractive enough to investors with less
promising ‘stories’ than previously, and less successful efforts towards value creation
to underpin earnings expectations or future growth prospects. While low funding
costs would generally be good news for the prospects of building value in businesses,
it could thus also mean that there is a larger room for negative surprises when there
is little competition for funds. Another way to state this, is that equities may be
overvalued. This suspicion applies in particular to growth stocks that trade at high
multiples of earnings, due to expected future earnings growth. For dividend stocks
there is at least some return along the way.
In sum, cheap funding is likely to have wide-ranging economic implications.
For instance, with respect to investments in financial markets, expected real
returns have been adjusted downwards. One immediate consequence of this is that
future consumption has become more difficult to fund through long-term financial
savings—for individuals, business firms and governments alike. All these players
may therefore face pressures to increase the expected return on investments, which
would usually mean to assume more risk. Alternatively, one could save more than
before to meet future needs, or revise downwards the expected proceeds at the far end
3.1 Limiting Spending: Norway’s Fiscal Rule 89

of a savings plan. Over time, a combination of the two alternatives is likely—

with some increased risk and a lower expectation of the future purchasing power
one expects to secure through a savings plan. In the meantime, however, increased
risk-taking could lead to some further capital losses.
The prevailing yield situation implies that bank deposits and other investments
where the yields are heavily influenced by short-term money market rates, cannot
be relied upon to generate positive returns—at least for a while. Representative
short-term money market rates for the main currencies were negative by about ½
percentage point before the outbreak of the Covid-19 crisis. This forces investors to
accept some risks even to avoid outright losses. To achieve positive returns within the
asset class of fixed-income, this could imply acceptance of interest rate risk due to
longer duration, i.e. long maturities and/or small interest payments, and more credit
risk.
It has thus become easier to accept credit and liquidity risk. This implies that
default risk with respect to borrowers plays a more important role, and that it has
become less certain whether an investment can be realized without losses when the
funds are needed. This could perhaps also entail more volatile asset markets, less
able to absorb trades of large blocks of securities. Liquid and ‘deep’ markets may
be understood as public goods, indirectly created through numerous transactions by
investors differing, e.g., with respect to liquidity preferences and confidence in the
markets. The reduction in this quality subsequent to 2008, implies in isolation a less
attractive investment environment, even if many will accept the risks required to take
part. This could be a loss, since the public goods of liquid markets are less available.
However, the market that is left may also be the ‘only game in town’, and as such
remain attractive and heavily utilized.
Since inflation has been very low globally after the onset of financial crisis in
2008, the sharply reduced nominal yields has translated directly into expected real
returns. The supply of savings channeled through financial markets has still increased
compared to the situation in earlier years. This is due inter alia to changed regulations
which require pensions to be funded—i.e. that funds are needed to be put to work in
financial markets ahead of time with a view to meeting specific preset obligations.
This conservative and prudent approach would clearly depend on well-functioning
financial markets to perform well at producing the desired outcomes.

3.2 How to Spend Petroleum Wealth—Procurement Versus

Handouts

The aim one has in mind when accumulating a large fund, is to transfer wealth into
the future and make resource revenues available for future residents and citizens.
Since about year 2000, a sizable fraction of the Norwegian government’s income
from oil and gas revenues has been set aside to facilitate transfers into the future. The
fiscal rule prescribes spending only up to the real return on the wealth, allowed to
90 3 The Economics and Politics of SWFs

be consumed year by year through the state budget. The official estimate of the real
return on the Fund’s capital, is as mentioned set at 3 per cent per year. This is the
anticipated nominal return adjusted for declining purchasing power due to inflation.15
The real value of the capital earned by the government from exploitation to date is
thus intended to be kept intact in the Fund. Resources that have not yet been extracted,
in the ground under the seabed, are assessed to be worth about one half of the Fund.
That is, about two thirds of the wealth are kept in the Fund, and the remaining one
third is undeveloped. Although the fraction in the ground by definition declines with
extraction, the value of what is expected to remain is uncertain and have on several
occasions been adjusted upwards. Reasons for such adjustments have been both
technological progress that has made it economical to extract a larger fraction from
the hydrocarbon reservoirs, and the discovery or increased likelihood of additional
resource deposits that had not been counted. This observation serves to highlight
the high degree of conservatism exhibited from an intergenerational perspective, by
spending only up to the expected real return on the capital accumulated in the Fund,
i.e. the part of the resource wealth that has already been converted into financial
capital.

3.2.1 How the Wealth is Spent

In principle, current spending may take two main forms; either outright spending
on goods and services, or transfers. The latter is also referred to as handouts. The
spending may be either channeled to investment projects intended to serve the needs
of residents and citizens over long time periods, or used to foot the bill for spending
on smaller items within a shorter time horizon. The oil and gas wealth of Norway
has been used for both purposes—investment and spending.
Funds can also be used for transfers, which has been particularly important since
2013 for the conservative government currently in office. The transfer mechanism
applied has been tax relief, which implies that the resource income is spent in a fashion
that benefit the groups that pay much in taxes. This also has a partisan dimension, as
the individuals that this benefits the most belong to a wealthy subset of the population.
Transfers to the wealthy may by many be seen as socially unjust. Alternatively, one
could have made sizable and regular payments to citizens or residents, which is rare
but is done in relation to the Alaska Permanent Fund. Application of this latter method
of spending resource revenues has not yet been seriously discussed in Norway.
The capital and/or return from SWFs can thus either be spent to buy the population
goods and services, or by transferring funds to the citizens and/or residents—either
in the form of tax relief or direct pay-outs. That the state is the owner of a SWF
has important consequences for how its returns and capital can be spent, even if a

15 A composite consumer price index is used in this adjustment, consisting of the weighted average

of the currencies the Fund’s investments are denominated in, referred to as the Fund’s currency
basket.
3.2 How to Spend Petroleum Wealth—Procurement Versus Handouts 91

government acts on behalf of its citizens. In particular, the power associated with
decisions of how to use the funds rests with the state. Income will accrue for individual
citizens only to the extent that tax relief or handouts is decided. In Norway, the bulk
of the spending of petroleum wealth has been channeled through the public sector
expense budgets that together make up the state budget. These funds are spent in
the main to finance the provision of public services. The citizens can thus be said to
receive services instead of cash. Many individuals may experience that the resource
wealth is mainly spent on services for others, that they may themselves have a limited
desire for, and/or a low ability to consume.
The state provides certain kinds of services in certain volumes for certain groups.
Overall, this also implies that citizens or residents receive less than the monetary
value of the offered services. If possible, many would instead have opted to receive
the service production’s value in cash. Some may find that few public services are
tailored to their needs. There may be exceptions if the state is particularly able or effi-
cient in service production, and in deciding which services to produce. This govern-
ment provision function ascertains that the funds are spent towards useful goods and
services. However, it also implies that some will find the services offered unpalat-
able. For instance, they may be unable to access what is provided, either because they
may fail to qualify, or because they may be unable to use some services. There is a
deadweight loss accrued from public spending on behalf of citizen-residents instead
of cash transfers. To put things into perspective: Christmas gifts have been found to
imply a loss of about 20 per cent when the combined utility of the giver and recipient
is considered. The reason is that the recipient knows best what purposes he or she
needs to use scarce cash for. Joel Waldfoegel (1993) of the University of Minnesota
found a loss in the interval 10—30 per cent, which was considered to be smaller the
closer the social distance between the giver and recipient.16 The social distance may
be small for close relatives. It appears as less realistic that the state will be able to
provide with high efficiency based on the closeness criterion. The best argument for
state provision is rather likely to be one of control and of avoiding outright waste. It
could therefore, in isolation, be realistic to expect a large deadweight loss from the
production of goods and services by a state for a large and diverse group.
A more important implication may still be that some citizens are likely to receive
only a small fraction of the resource wealth that is spent. It is thus possible that the
recipients of public services may be content even if the service production should
be highly inefficient. The reason is that they get something out of this arrangement
that they could not else have taken for granted. It may thus not matter much that they
could have preferred to receive the cash spent instead.
The types of services to be provided by public authorities for free, or at subsidized
prices, to whom, and in which quantities, are important political questions. A main
political cleavage in Norway in this respect, seems to go between the labor party and
coalition partners on the left, and the conservative party and its coalition partners on
the right. One may illustrate their positions as follows: The parties to the left favor
spending on services that can easily be distributed to low and middle income families,

16 Christmas gifts may fare better if also other aspects than the implied value transfer are considered.
92 3 The Economics and Politics of SWFs

like publicly operated kindergartens. The parties to the right prefer tax relief. Tax
relief will accrue in the main to rich people who pay the most taxes. Apart from this,
or from that group, tax relief has good efficiency characteristics. We have seen some
of both strategies, and the latter mainly since the general election of 2013.

3.2.2 Effects of the SWF on Income Distribution

Overall, the Norwegian spending of resource wealth has to a large extent benefited
people of low and moderate incomes. Some have even argued that because of this
tendency, the GPF-G should be included on a per capita basis in the income distri-
bution—which would then become much more egalitarian.17 This would appear as
ad hoc, and be incorrect, according to Kalle Moene of the University of Oslo.18
This principle would also make the income distribution less egalitarian in most other
countries, who manage large public debts instead of net assets in a SWF. This debate
may illustrate that the accounting is far from perfect. In this author’s view the net
asset position of the central government is important, even if the spending decisions,
as Moene points out, rest with the state- in spite of some reasons outlined here to
be skeptical with regard to the efficiency of public spending. Compared to a situa-
tion without the SWF, many citizens can rest assured that the state will contribute
towards their future needs through public spending programs. That they could have
been more confident if they instead received the funds thus used, as transfers, seems
less important. In any event, this is an impression from the public debate thus far.

3.2.3 Could Transfers Strengthen the Public’s Involvement?

The way public resources are spent, including the spending of windfall gains from
resource wealth, can have a large impact on the way citizens view the financial rela-
tions between themselves and their government. Also, the attitudes towards invest-
ment activities of governments can be understood in this context. Involvement of the
citizens may lead to a feeling of contentment and ownership that could be benefi-
cial inter alia in the context of shielding the savings from pressures from numerous
sources to increase current spending.
In particular, the popular involvement and interest in the management of SWF
investments is likely to increase with the degree of direct pay-outs. See, e.g.,
Hannesson 2001: 78, who discusses the difference in this respect between The Alaska
Permanent Fund and The Heritage Fund of the Province Alberta of Canada. The
state government of Alaska distributes a significant return of its Fund to the residents

17 Thisview has been advanced in particular by Steinar Juel, a former chief economist of Nordea
bank in Oslo who has later joined the conservative Oslo think tank Civita.
18 Moene wrote a piece on this in the business daily Dagens Næringsliv, 7 May 2019.
3.2 How to Spend Petroleum Wealth—Procurement Versus Handouts 93

of the state, subject to an application process, whereas Alberta has used its Fund to
strengthen the budget of the province. For Alaska, this is subject to the constraints of
a framework allowed for states by the federal government of the United States.19 The
public of Alaska is much more interested in their Fund than the public of Alberta.
Strengthening of a large budget, as in Alberta, makes the returns from the fund appear
less important from the perspective of most citizens: Information on the fund and its
returns may then easily be disposed of: ‘It doesn’t concern me’.
Citizens or inhabitants who are only indirectly affected by the investment oper-
ations can probably also be expected to become less interested in the particulars of
these operations. However, even those most affected as recipients of large quantities
of public services, could experience the link to actual investment activities as indirect
and remote—probably even if an understanding was in place that linked the activities
to investments in world capital markets.
The way the fruits of investment are made available for their ultimate owners,
i.e. the citizens or residents, can be expected to be important for how the investment
activities are perceived by the public. The perceptions of how well investment activ-
ities are performed, could impact strongly both on the available funds for welfare
spending and the political legitimacy of the investment-savings operations linked to
a SWF that a government may operate.

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Hahm, S., M. Kamlet, and D. Mowery. 1995. “Influences on Deficit Spending in Industrialized
Countries”. Public Policy 15 (2): 183–197.
Hannesson, R. 2001. Investing for Sustainability: The Management of Mineral Wealth. NY, NYC:
Springer.
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Accepted Principles and Practices, ‘Santigo Principles’, Washington DC: International Monetary
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Koptis, G. and S. Symansky. 1998. Fiscal Policy Rules, Occasional Paper no. 162, Washington
D.C.: International Monetary Fund.
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Charles H. Dyson School of Applied Economics and Management, Cornell, NY: Cornell
University (Available through ecommons.cornell.edu).
Norwegian Ministry of Finance. 2020. Meld. St. 2 (2019–2020). Revised National Budget 2020,
Oslo.
Norwegian Ministry of Finance. 2020. Meld. St. 32 (2019–2020). Forvaltningen av Statens
Pensjonsfond i 2019 (The Management of The SPF-G in 2019), Oslo.
Norwegian Ministry of Finance. 2020. Meld. St. 1 (2020–2021). National Budget 2021, Oslo.

19 See, e.g., Alsweilem and Rietveld, op. cit.

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Paganelli, M. 2009. “The Adam Smith Problem in Reverse: Self-interest in the Wealth of Nations
and the Theory of Moral Sentiments”, Theory and Practice of Economic Policy. Tradition and
Change: Selected papers from the 9th Aispe conference. Milano: Franco Angeli.
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Democracies”. Quarterly Journal of Political Science 2: 155–188.
Rodrik, D., A. Subramaniam, and F. Trebbi. 2004. Institutions Rule: The Primacy of Institutions
over Geography and Integration in Economic Development. Journal of Economic Growth 9 (2):
131–165.
Schelling, T. 1960. The Strategy of Conflict. Cambridge, MA: Harvard University Press.
Simon, H.A. 1947. Administrative Behavior. NYC, NY: Macmillan.
Simon, H.A. 1956. “Rational Choice and the Structure of the Environment”. Psychological Review
63 (2): 129–138.
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Mathematical Essays on Rational Human Behavior in a Social Setting. NYC, NY: Wiley.
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Smith, A. 1776.An Inquiry into the Nature and Causes of the Wealth of Nations. London: W Strahan
and T. Cadell.
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191: 64–78.
Chapter 4
Investment in Practice

There are many approaches to the investment of surplus funds. Although the sources
of the current account surplus to be invested may impact on the choice of time horizon
of SWFs, these approaches are largely independent of the origin of the funds. The
surplus funds may either stem from the sale of non-renewable natural resources,
surpluses in international trade without sale of natural resources, or the borrowing
of funds internationally. In the latter case, the SWF may be seen as a mirage of the
debt build-up, and the maturities and duration of investments should be analyzed and
understood in relation to the debt obligations. In the event of surpluses stemming
from trade balance surpluses—regardless of whether they stem from processed goods
and services or sales of nonrenewable resources, the time horizon can be set subject
to the preferences of those who govern. However, proceeds from the extraction of
non-renewable resources could in isolation favor a long investment horizon.
The central aim of the investments may also vary in other respects: A country
investing its surplus from international trade, whether in natural resources or manu-
factures, needs to be able to transfer funds into the future and earn meaningful returns
in this process. In principle, this works like an individual’s saving. It is usually seen
as good to save, but one could want to save more for a good purpose and/or if the
returns on the investments are good. With borrowed funds, this may be different. The
funds were borrowed for a reason—usually linked to known or expected expenses
in the near future. As a rule, there is a negative carry on such arrangements, and the
borrowing is usually done at a higher rate than the investment of surplus funds.1
As outlined above, in the Norwegian case the 1983 Tempo commission did not
foresee a need to establish a new organizational unit to run a petroleum-related SWF.
That this still happened, must be understood in view of the size of the task which
increased due to a political decision to operate under an arrangement that resulted in

1 Higherexpected returns than borrowing costs would require more risk in the investment than the
borrowing. Liquidity is not an issue, since it is assumed that the borrowed funds will be at hand if
or when they are needed.

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 95

O. B. Røste, Norway’s Sovereign Wealth Fund, Natural Resource
Management and Policy 54, https://doi.org/10.1007/978-3-030-74107-5_4
96 4 Investment in Practice

a very large fund, which size has reached more than the triple of Mainland Norway’s
GDP. Although this fraction is likely to decline in the future, the scale of the invest-
ments of the GPF-G in terms of both value and its operational organization are likely
to remain large.
The way one structures the activities and the attitude towards risks of various kinds
go a long way towards explaining the returns one might expect to achieve—that is
the level and variation of returns that one should aim at.
This chapter identifies some key decisions that must be addressed by all SWFs,
and exemplifies based on the way some key types of decisions have been made and
implemented in relation to the GPF-G in Norway.
In theory one wants a broadly diversified portfolio, which can be envisaged as
trying to reap the sum of a risk-free return and various incremental return increases
associated with so-called factors. One can think of this as actively taking on risk
in relation to the various factors, in a setting where market prices determine which
securities to buy and sell to most economically to attain the desired exposure in
relation to the same factors. Note that since factors may be first empirically derived,
and then rationalized theoretically ex post, one cannot know their durability. In this
author’s view, there is no guarantee that factors will not vane and disappear with time.
It could, of course, be awkward to have to defend a construct that later disappeared.
In practice also other issues come into play, the most important of which may be
the jurisdiction where the activities that govern returns for an investment are located.
Location may be the sole most important factor to consider for all investments. This is
obvious for various real estate and infrastructure investments, which are pinned down
to the coordinates where a physical property and/or capital-intensive installations are
located. However, also for other investments location is key to returns. At a basic
level, this is linked to confiscation and/or expropriation risk. However, location is
also linked to cultural factors and business conditions. Real estate is an example of a
‘point-source revenue’, much like oil is a ‘point-source resource’. In both instances,
the exact location of the ‘point’ is likely to constrain economic opportunities.
Not all locations are safe for investments. In the event that one has invested in
locations that turn out to be unsafe, the investments may be lost. In such instances, the
investments may at best be considered as sidelined, if there is a realistic possibility
that their value can be kept up without committing significant new capital and possible
to get the values out at a later date. One possible source of such losses could be hostile
attitudes towards foreign capital owners. The problem may be local or national, and
the respective authorities may confiscate, consume, or redistribute the investment
capital. This can be done with or without explicit decisions towards expropriation, and
without official personnel being involved. For instance, legislation may be passed to
benefit someone in a national or local setting at the expense of investors, in particular
foreign investors. Alternatively, one could turn a blind eye on violent measures carried
out by agents that attempt to seize assets owned by foreigners.
Such events are very rare in locations considered safe-enough for investment.
They still represent important economic risks and events that are unrelated to market
forces, and that one cannot protect oneself against by adjusting one’s investment
market behavior. A large subset of such problematic issues can be labeled political
4 Investment in Practice 97

risk. Most of it can be related to actors that may change their behavior towards
an investor after significant location-specific or country-specific investments have
been made. For international investors, the last mentioned category may be the most
difficult to deal with, because few others are likely to be affected—which is also
likely to mean that it may be comparatively easy for any wrongdoers to get away
with abusive behavior.
These issues imply that an investor must make some shortcuts as regards asset
composition. Many of the risks one might get paid to assume are idiosyncratic—
as for instance the credit risk of a specific bank, counterparty or business firm, or
revelation over time of the ‘true’ type of government, or any another type of agent
one would need to trust in an area where one has invested. This may be revealed only
after the funds have been committed and/or transferred.
The type of problems discussed here is most relevant for emerging and frontier
markets. In mature investment markets, one can always judge by the track record of
the relevant authorities. Those who have been investment-friendly in the past have
an incentive to continue this—even if broken promises of not confiscating and/or
expropriating could result in immediate gains. A gain of this type could be small
compared to lost business opportunities associated with reduced trust needed in
future transactions related to investments. Valuable trust takes a long time to build,
but can be lost instantly in the event of negative news that one thus wants to avoid.

4.1 Geography and Asset Class Allocation

How could an international investor go about to acquire a share in the world’s produc-
tive capacity? This is a difficult but important question for SWFs. The asset class
allocation accounts for a large fraction of the variation in returns. It is more impor-
tant which asset classes an investor invests in than what the selection of investments
are within the represented asset classes. The reason is that asset classes are bundled
together based on their risk and return characteristics. Examples of broad asset classes
are bonds and stocks. More narrow asset classes can be various types of bonds or
stocks, e.g. based on issuer characteristics like firm size and sector/industry.
The opportunity to choose various baskets of investments based on such sub-
divisions implies that there may not be a need to directly replicate world capital
markets by investing in all markets according to how the market indices are composed.
However, if shortcuts are made based inter alia on empirical correlation of past return
patterns, there is a risk that these will be different in the future. Historical patterns in
returns data tend to break down sooner or later. Indeed, price data must in principle
be expected to deviate in the future even if it would be difficult to know how or why.
This can happen swiftly, in particular if some players, particularly large ones, try
to exploit them in trading or investment. From a risk/return viewpoint, investors are
therefore typically advised to hold a well-diversified portfolio of assets, i.e. to hold
the market.
98 4 Investment in Practice

A famous example of failed reliance on historical return patterns, is the mentioned

former hedge fund Long-Term Capital Management L.P. (LTCM), which ended up
being bailed out by the Federal Reserve in 1997. This fund applied absolute-return
trading strategies with high financial leverage, and had been established in 1994 by
John W. Meriwether, former vice chairman and head of bond trading at the investment
bank Salomon Brothers. Members of its board of directors included Myron S. Scholes
and Robert C. Merton, who shared the 1997 ‘Nobel prize’ “for a new method to
determine the value of [financial] derivatives”. Its annualized return after fees was
above 21 per cent in the first year, and came in at 43 and 41 pct. in the second and
third years. In its fourth year, massive losses were made when spread bets turned
sour due to the Asian financial crisis in 1997, and the Russian financial crisis the
next year. In 1998 LTCM lost 4.6 billion dollars in less than four months.2
Economic growth rates, and thus also returns for various assets, are usually highest
for a subset of emerging market economies (see, e.g., Olson 2003a). However, one
cannot know which ones ahead of time. Some other countries in this group usually
perform badly. To allocate significant investments to emerging or frontier markets is
thus a risky strategy that will pay off mainly if one invests in the right selection of
such markets. The approach can therefore imply high risk.
Although diversification is usually an argument for such geographical augmen-
tation of the investment universe, it is typical to commit only a small fraction of a
fund’s capital to such investments. It might therefore also be justified to leave them
out, to simplify fund management and instead reap savings related to staff, systems
etc. If one leaves out such country groups and modest underperformance results—
this may be defensible due to simplification, better oversight, cost reduction, and
risk reduction. There may also be large operational challenges and specific more rare
risks associated with the investment in unstable counties. These include most if not
all developing countries and emerging markets. Some elaboration on this view is
presented below.
Much investment is undertaken under what might be labeled a civilization assump-
tion—which can be thought of as expectations of inter alia strong property rights,
the rule of law, and an independent judiciary. In many countries, however, institu-
tional qualities of this sort may be lacking and out of reach for the foreseeable future.
This may be due to how governance systems actually function. Sufficiently high
expected returns to invest might be ruled out, unless something new and positive
should emerge. Although surprises may mainly be non-negative, such events could
take time. An implication is that it might not be attractive from an investor’s standpoint
to enter the respective markets even after the onset of new, positive developments.
In developing countries, capital is scarce for good reasons. The situation that face
private capital owners, may typically be such that they would want to export their
capital to secure their rights as owners, despite scarcity of capital locally. It wouldn’t
so much matter that scarcity should in isolation lead to high returns. The capital
may be exported because it is understood that it is unsafe in the original location, and
may be vulnerable to confiscation and/or expropriation. The soundness of investment

2 Sources: Wikipedia.org and Nobelprize.org, accessed on 28 and 29 February 2020.

4.1 Geography and Asset Class Allocation 99

projects, technically and fundamentally, is less important than this. Economic growth
models have been naïve in abstracting from this important constraint, mainly because
they were developed for industrial countries where the capital is safe.
Capital owners in poor countries who experience unsatisfactory institutions there-
fore often want to export their capital. The result could be very scarce capital, and,
technically, a high expected return on capital—that is in the event that the producing
capital is not stolen or confiscated.
Another important problem for an investor is inflation. In isolation it should be
possible to protect oneself against inflation through acquiring real rather than nominal
assets. Examples of the former are equities, real estate, and some inflation indexed
fixed-income securities. In equilibrium, the return of nominal assets should be consid-
ered net of inflation. However, inflation may come as a surprise, and lead to significant
capital losses. This may seem less important from the perspective of the latest decades
of low inflation internationally. However, inflation is likely to resurface. There could
thus be a considerable chance for surprisingly high inflation. This risk could be more
relevant in view of the competitive exchange rate management in large countries
following from the Great Recession from 2008. The monetary policy referred to
as quantitative easing, or QE, has been aggressive. This new situation highlighted
uncertainty for the future, and is an add-on to the usual risk implied by an unknown
future. Some observers have even likened the novel situation created by QE with
that of a supernova in astrophysics.3 With much attached negative determinism, one
can hope that this metaphor exaggerates. Still, there may be room for considerable
negative surprises that it will be difficult to prepare for. A key component that can
cause worries, is the money supply of large nations.

4.1.1 Asset Classes, Factors, and Financial Risk

It is customary to apply a benchmark viewed as neutral to judge the management

activities for SWFs and other large funds that invest in international capital markets.
This amounts to comparing the situation that one has realized, and on which there will
be book entries, to a theoretical situation that could have been maintained by instead
naïvely holding on to a representative set of assets. At a strategic level, it is usual for
owners of such funds to apply a benchmark in terms of the overall allocation of funds
to various asset classes. The manager will then be informed of what is expected in
terms of returns, and also usually of what the tolerance will be for deviating from this
strategic benchmark in order to, hopefully, enhance returns. The manager is thus left
with two important decisions to make: (1) The degree to which one deviates from the
strategic benchmark in the operational management of a fund, and (2) the selection
of specific assets—like individual stocks and bonds or pieces of real estate—within

3A supernova is powerful and luminous stellar explosion. Sooner or later it will collapse. The
original object, called the progenitor, either collapses to a neutron star or black hole or is completely
destroyed (Source: Wikipedia.org, accessed 30 January 2020.
100 4 Investment in Practice

the chosen asset class allocation. Item (1) may be closely linked to the rebalancing
regime, which may work like a high-stakes filter rule in trading: There is a fixed
tolerance for deviation from the strategic benchmark, and when a given threshold is
exceeded, large rebalancing transactions are triggered automatically.
This approach is much used in practice. It may, however, appear traditional consid-
ering developments in finance, see e.g. Ang, op. cit. That author claims that it would
make more sense to set up a benchmark for performance evaluation based on various
identified factors in financial studies, of so-called factor benchmarks. Factor theory,
according to Ang, op. cit., is based on the principle that factor risk must be compen-
sated in equilibrium—for investors to be willing to hold the assets—and that factors
are the driving forces behind risk premia. Several factors are typically present, with
varying strength, within an asset class or for a given asset in that class.
This author is a bit skeptical regarding the practicability of the factor approach
for benchmark construction. The reason is that the concept may not be concrete
and precise enough to guide decisions. Even if one can argue that the factors that
represent the risk which one may get paid for assuming in the markets, the factors
are based on historic price actions and thus distinct for subperiods and decoupled
from the future. The ex post return on a basket of actual assets that are traded in
regulated markets can be calculated precisely. The excess returns over the risk-free
rate will, however, vary over time for reasons that cannot be foreseen due to market
efficiency. The fraction of realized return that is due to each specific factor must
therefore remain indeterminate.
Without reference to a specific target excess return target, it would be difficult
for high-level investment committees to relate to say, how much illiquidity or credit
risk one should assume. It may also for this reason be more practical to relate to
tangible assets that represent bundles of the different factors, so that there would be
several factors bundled together in any one security—for instance a corporate bond.
However, both approaches may be used, which should lead us to expect at least some
use of factor benchmarks. Application of the ‘traditional’ or the ‘new’ approach may
be a matter of taste. Technically oriented investors may prefer the factor approach.
Examples of factors given by Ang, op. cit. are the following: inflation, real rate
risk, term risk (i.e., future changes in the shape of the yield curve), credit risk, growth
stocks (as opposed to value stocks), and illiquidity. The list is not exhaustive. These
are clearly factors that will impact on returns of assets and asset classes, and that
any fund manager should relate to in some way. It is clear that different types of
assets will be sensitive to various degrees with respect to changes in pricing for
the different factors. That factors are numerous (and the above list non-exhaustive),
could give rise to communicative challenges in applying this approach to risk. The
factor approach to a performance benchmark may therefore be best suited for use
by technical experts within professional organizations like SWFs, and less suited
for a government to communicate the risk-return policy of its SWF. The latter must
be easy to understand for both generalist politicians and their constituencies, and
non-experts concerned with public administration.
A fund manager or guardian would know what investment in a particular bond or a
stock implies, and that it implies the assumption of various forms of risk, financially
4.1 Geography and Asset Class Allocation 101

and otherwise, to invest in a particular asset, asset class, or jurisdiction. Even if one
might be surprised by how things play out, one would in asset selection generally
feel that one has a handle on the problem at the outset. For the factor approach, the
handle becomes less concrete. A complicating element is the variation over time in
how much a factor must be compensated in the respective markets. It is difficult to
see why factors should be expected to have a constant or predictable relationship
with incremental returns over time relative to the risk-free rate. Rather, the realized
spread is likely to result from various social and economic interactions. It would
be an empirical question to what extent the various factors will be compensated,
absolutely and relatively, in the future. After the fact, ex post, it is possible to divide
the realized return into a sum of the risk-free return and the returns of the various
factors presented. For a given basket of assets, which is typically relied upon in the
traditional approach, both the factor content and their economic compensation are
likely to vary over time. For a given basket of factor loads, the compensation will vary
over time. The same is likely to apply to its relationship with actual assets. At least
for decision-makers of moderate skills in finance, the factor approach may not result
in more clarity even if it should become the preferred approach in the construction
of performance benchmarks.
The most serious critique against a factor approach to investment is in this author’s
view that the factor concepts are somewhat elusive. The finding of factors may be
based on analysis of e.g. historical returns ex post, more than rooted in financial
theory. This critique applies also if the findings can be rationalized with regard to
theory ex post. There is thus a risk that the framework may be too ad hoc. It is
therefore important to track how easy it is to gain acceptance for new factors over
time, and how one would exclude ‘waned’ factors that worked in the past. It is not
possible to know how robust the returns attributed to several various factors will be
in the future. While some are likely to both be stable and remain important in the
future, others could become less valuable, including for reasons that might not be
well understood.
Regardless of how one judges the relationship between the traditional benchmark
constructed to mimic market returns and a constructed factor benchmark, an investor
must buy real assets. Real assets can again be understood as bundles of the various
factors—with several in each security. As the composition of factors and the return the
market provides for assuming their associated risk will vary over time, the attitude
towards various factors may be well-suited to guide asset selection within more
general guidelines, for short to intermediate time horizons.4 The framework may
be particularly useful in-house with the managers, for communicating changes over
time in the attitude towards various risks—for instance in investment committee
meetings.

4 One example of perfect correlation is inflation, as it is possible to buy government bonds with
inflation adjusted coupons and principal, for instance in the United States. This makes it possible
to buy or sell inflation risk. However, the factor inflation has a much wider application, also to a
range of other assets in relation to which also other factors may play a role.
102 4 Investment in Practice

The strategic benchmark for the GPF-G consists of 70 per cent equities and 30
per cent fixed-income securities. This benchmark is made up of investible securities.
One can as mentioned also invest up to 7 and 2 per cent in unlisted real estate and
infrastructure, since 2019. As mentioned, the investment strategy was much more
conservative at the outset in 1998, with allocations of 40 per cent to equities and 60
per cent to fixed-income securities. For many years to follow the allocation was kept
steady at 40 and 60 percent of equities and debt securities, respectively.
In 2007, the share of equities was increased to 60 per cent, with a reversal of
the weights for these two asset classes—to 60 per cent stocks and 40 per cent debt
securities. Further, a room for unlisted real estate of up to 5 per cent was introduced,
by allowing for a detraction of that share from the allocation to debt securities. In
2016, the equity share was increased once again to 70 per cent, within that framework.
This quite aggressive, yield-enhancing approach contrasted with the approach to risk
in the period to about 2004, when also the fixed-income allocation was under strict
restrictions with regard to credit risk—where government securities issued by OECD
countries and supranational institutions was allowed together with some short-dated
credit risk, with currency denomination confined to the OECD.5

4.1.1.1 Fixed-Income Securities—Also Known as Debt Securities

and Bonds

The simplest form of a fixed-income security is a zero-coupon bond for a fixed matu-
rity, issued by a highly credit-worthy government, for instance the U. S. Treasury
Department. In addition, there are supranational bonds, that is bonds fully guaran-
teed by several governments, each of which usually has a high credit quality—thus
potentially an even better credit than the United States—and so-called agencies, that
is specialized agencies of the U. S. government that have the right to issue their own
bonds for financing. Agencies have a marginally lesser credit quality compared to
that of the federal government of the United States, as it is possible, albeit not likely,
that the latter may choose not to pay up if an agency should fail. There has sometimes
been talk among market players of an implicit federal government credit guarantee for
bonds issued by agencies. This postulated implicitness implies that the credit quality
is lesser than that of the federal U. S. government. Due to the lesser credit quality
and, more importantly, smaller and less liquid bond issues, agency bonds trade at
yields above those of U. S. Treasury bonds, particularly compared to the most current
and liquid issues around maturities of 1, 2, 3, 5, 7, 10 and 30 years—referred to as
hot runs or on-the-runs. Formally, maturities up to ten years are called T-Notes, and

5 This more aggressive investment approach has been met with some criticism, inter alia from Knut

Anton Mork who dissented as chair in the report of a recent government commission that investigated
the strategic asset class allocation issue. His recommended equity share was 50 per cent. Earlier, the
first head of the management organization NBIM, Knut Kjær, expressed criticism explicitly linked
to the impact of the investment environment on the quantitative easing in the monetary policy by the
largest central banks after the financial crisis. When the strategic benchmark was revised in 2017,
Norges Bank recommended a 75 per cent strategic equity allocation to equities.
4.1 Geography and Asset Class Allocation 103

the 30 year maturity T-Bond. There is also short-dated debt—T-Bills—that trade on

a discount basis.
The bonds are issued with semiannual coupon payments and a principal to be
redeemed at maturity.6 These securities can be dissected into their respective cash
flows, so that an investor can hold zero-coupon bonds of the full range of maturities
if he so wishes. With yields from bond trading at various maturities and standard
techniques of interpolation and/or extrapolation, one can construct a continuous yield
curve, or zero coupon curve, for the U.S. Treasury market. This construct is widely
used in the non-exact science of pricing bonds in the U. S. bond market issued by
other issuers, for instance corporations—corporate bonds, or foreign governments—
foreign bonds. The yield curve unique to the issuance currency, in this example the
U.S. dollar.
For other issuance currencies, there is by parallel reasoning yield curves based
on a unique zero coupon curves constructed based on yield to maturity data for
traded securities and some assumptions. However, only in the largest currencies is
it possible to replicate to a high extent the exercise for the United States. In other
currencies, there are typically less traded securities, so that the assumptions needed
for instance for interpolation, may be cruder and more questionable. This could also
limit the practical use of the zero coupon curve construct in the pricing of securities
issued by other issuers than the central government. Nonetheless, in spite of fewer
data points the reasoning in relation to the pricing of most securities could be quite
similar. Based on assumptions on, for instance credit quality and liquidity of a non-
government bond issue, one can usually get something out of yields for just a few
points in time in the form of a hypothetical yield curve.
The task would be to arrive at a fair price for given cash payments at a future date,
and then also arrive at a fair price of the various bundles of such payments that specific
actual bond issues may represent. The individual components will correspond to the
zero coupon curve, which may in many currencies consist of only a few known
points. The more such points one knows, the easier would it be to approximate the
interest rate for a point in time where the yield cannot be based directly on trading
in a market for government guaranteed securities of the same maturity.
For zero coupons the potential investor must consider the net present value of
one single payment to be received from the issuer at redemption time. Since this
bond is issued by a highly credit-worthy entity, there is negligible credit risk (see
below). The value of this security depends on other investment opportunities in the
time to redemption. Ceteris paribus, the value will fluctuate more the more variable
are market interest rates for similar borrowers and the longer the time to maturity.
This variation in value, known as interest rate risk, also reflects the risk from interest
rate variation an investor who would contemplate to buy this security would face.
Related to interest rate risk are concept like inflation risk, real rate risk, and term
structure risk. Inflation reduces the purchasing power of money when prices, as is
usually the case, rise over time. Investors thus usually require a compensation in
terms of a higher nominal interest rate or yield. However, also other factors may lead

6 Semiannual coupons apply to the United States. Most other countries pay annual coupons on debt.
104 4 Investment in Practice

to an increase in nominal yields, such as for instance an increased demand in relation

to supply for borrowing at a specific maturity. This could bid up the real interest rate
for that maturity even if the inflation prospects stay unchanged. Higher interest rates
would in this situation reflect a higher real rate of return. Supply and/or demand for
funds may vary at different maturities, leading to changes in the shape of the yield
curve. Further, nuances in institutions and structure may also give rise to variations
in yields.
Most actual bonds are so-called coupon bonds—a security type that in addition
to the nominal amount to be redeemed at termination also pays interest annually, or
as in the United States semi-annually, over the life of the bond. Such bonds may, as
mentioned, be decomposed into their respective payments to create new zero coupon
securities.
One main difference between bond issues by similar issuers lies in how fast the
investment will be redeemed, technically termed duration. Two factors contribute to
duration—first the time to maturity, and second the size of any coupon payments.
On average the investor gets the invested money back faster if the time to maturity is
short, and/or the coupon payments are large. Long duration zero coupon bonds thus
have the highest duration and the lowest coupon interest rate. High nominal coupon
rates drive down the duration. The longer the duration, the more interest rate risk
is there for a given nominal amount invested. Risk refers to the expected variability
in returns. High variability could result in surprises—either negative or positive, a
situation which an investor would need to be compensated for in order to make an
investment. Compared to a situation of safety, rational investors and thus also the
aggregated market require a premium, that is a higher expected value or yield ex ante
to assume the risk represented by this variability.
Another important element of the risk an investor faces is credit risk—that is
the risk that a particular issuer will default on its obligation either to pay interest
(coupon payments) and/or to redeem a bond at par at the termination date.7 For
many governments of industrial countries, the credit risk during normal times is
small enough to be safely disregarded. This may be different in more uncertain times
as well as in developing countries and emerging market economies in normal times.
An approximation to the risk-free rate of borrowing for a maturity is thus the
interest rate that the U.S. government would have to pay. The mapping of this cost
across maturities is usually called the government yield curve. Normally, all rates
are small, positive figures. However, since about 2008 there has been both quan-
titative easing in monetary policy and a growing risk appetite among investors.
As a consequence, both governments and other issuers have experienced negative
nominal interest rates, which amounts to being paid to borrow money.8 This anomaly

7 This is an important risk that may overshadow other elements of risk in actual investment decisions.

It relates to the perhaps most fundamental question in investments—will the promises be kept?, and
in relation to this—who is one dealing with? It is introduced here as the second element, following
the less important interest rate risk, only or pedagogical reasons.
8 This is a new, but important development in the key government bond markets. There are currently

sizable negative returns also for long-dated bonds in low-inflation countries, like the Swiss 10-year
benchmark bond.
4.1 Geography and Asset Class Allocation 105

has lasted for a long while. It could end sooner or later. Meanwhile, it serves as a
powerful reminder that established patterns in relation to the investment markets that
may appear constant over long time spans may still be subject to change that typically
cannot easily be foreseen. This applies with particular force with regard to the exact
timing of changes.9

4.1.1.2 Equities—Also Known as Stocks and Shares

Equities, or stocks, are shares of joint stock companies. This usually implies no
other obligation than paying the purchase price of the stock, or subscription price
if it is acquired at issuance. The “upside” thus acquired, is a share of the surplus
if the company runs operational surpluses over time. Indeed, most companies are
established to make money and usually run operational surpluses. The size of the
payment required to buy this asset, vary both with broad market conditions and how
the respective industry and firm is viewed by market players.
There may be a significant risk of losing a stock investment in a bankruptcy.
Further, the mere expectation or fear of bankruptcy may lead to trading of the stock
at sharply reduced prices. Or it may lead to a stalemate between potential buyers
and sellers with no turnover, and considerable stock price uncertainty. Again, this
would depend on the characteristics of various specific firms and industries that one
might consider to invest in. The asset class of equities thus entails higher risks than
the risk faced by most investors in fixed-income securities: In times of financial
difficulty and distress the creditors of a firm are in a better protected position than
its shareholders. In the event of failure, a sequence of priorities must be respected—
with priority for variously secured debts, and also holders of unsecured bonds before
owner-shareholders. Only if all debt can be paid off will there be a dividend for
the shareholders. Dividends to be shared between the owners would correspond to a
situation where less than the full equity capital is lost, which is rare.
In a typical, old-fashioned bankruptcy, there will be a dividend for the creditors,
and nothing for the owners. Some creditors, i.e. holders of secured or collateralized
debt are typically paid in full. The reason for this, is that some creditors are very
conservative in extending credit. It is common to lend less than the pledged collat-
eral’s anticipated market value, a bit like in old-fashion pawn shops.10 There is thus

9A famous market adage that may have been wrongly attributed to Lord Keynes in the 1930’s,
is that ‘the market can stay irrational longer than you can stay solvent’. It is thought to apply
in particular to the timing of bearish bets. This phenomenon could bar the exploitation of even
widely acknowledged market anomalies. The extent to which there are anomalies, however, is often
disputed – which could render the above-cited adage more important.
10 Although every case may be different, it is probably a fair description that pawn shop owners to a

larger extent than bankers and other secured creditors, may be open to keeping the collateral instead
of having the loan repaid. For bankers and other institutional creditors, it may be more important to
receive the cash one has agreed on. One reason for this, is that there is a high degree of uncertainty
in large financial transactions. Whereas some players may specialize in absorbing various types of
associated risk, many lenders want to avoid most of these risks.
106 4 Investment in Practice

considerable firm-specific risk in equities. In modern-times finance, it may also be

typical to arrive at agreements between shareholders, i.e. owners, and various bond
holders, i.e. creditors. How important the difference between shareholders and cred-
itors will be, can vary over time. Typically, such agreements may imply the conver-
sion of debts into equity at conversion rates that may significantly dilute the initial
shareholders. By how much initial ownership is diluted, will depend on bargaining
strength which may inter alia reflect that the owner’s risk to lose all in the event
that an agreement is not reached (presupposing that there may be few others to turn
to, which may depend on several other factors, including the net value that one can
reach by saving such an entity from bankruptcy). Secured debt owners typically may
have little to lose, and unsecured debt holders typically fall between the categories of
owners and secured debt holders. What will usually be demanding, is to secure the
required support of members of these three main groups of stakeholders. Particularly
for large investors, however, this firm-specific risk element can easily be diversified
away by owning many different equities. This possibility has been referred to as the
only free lunch in finance.
For the typical large investor, the law of large numbers then stabilizes average
return, compared to the holdings of each individual equity: One obvious strategy that
provides shelter against firm-specific risk, is diversification into a very high number
of comparatively small investments. This may imply some modest costs and require
a certain minimum size of the operations due to transaction costs. Large investors
may obtain this effect more or less automatically, by making the market index their
strategic benchmark. A manager will then be evaluated in terms of deviations from
that benchmark and the associated payoffs. The GPF-G is a case in point: With very
few exceptions, one has chosen close-to exact replication of the strategic benchmark
which basically corresponds with the admitted investment universe. This has resulted
in actual holdings of many the equities that make up the indexes of various sub-
markets, in total more than 10,000 different firms. The holdings of equities have thus
consisted of a small percentage of each equity market one has invested in, with the
largest fraction in European equity markets. A potential problem with this way of
organizing the investments, is that a large order of words securities may be bough
mainly to avoid taking risk relative to the strategic benchmark index. This could
be meaningful to the extent that the very comprehensive benchmark contributes to
improved diversification and hence improved risk-adjusted returns. This is likely to
be the case most often. If many large players were to adopt this strategy blindly, there
might be too little control with how well the business firms that issue the stocks are run
and managed. The result could then be that equity funding would be easier to obtain
than it should be from a risk-reward perspective. The pricing should ideally reflect
the relative prospects of the listed firms.
4.1 Geography and Asset Class Allocation 107

4.1.1.3 Investments Tied to Specific Locations—Unlisted Real Estate

and Infrastructure

There are many possible investments, but stocks and bonds are the most important
ones in practice. Real estate and infrastructure projects may also be available as listed
stocks. Further, it may be possible to become exposed to these assets through the
purchase of debt securities.
These assets have some special characteristics compared to stocks and bonds in
general. Some aspects of these with relevance for risk are therefore discussed below,
in Chap. 6.

4.1.1.4 Performance Benchmarks of the GPF-G

The strategic benchmark of an investor can be thought of as an alternative cost of

capital. For a fund that aims to transfer income over time, to new generations, it may
make sense to use the returns of world capital markets as benchmark. Active invest-
ment strategies, that should aim at improved risk-adjusted returns, can be thought of
as deliberate deviations from the strategic benchmark to increase returns.
Table 4.1 shows the main guideline in investment of the GPF-G, as a strategic
performance benchmark. By 2017, real estate had been increased from zero up to
2.2 per cent. This share has since increased further, to 273 billion kroner or 2.7 per
cent at the end of 2019.
Room for real estate investments has been made by cutting down on the allocation
to fixed-income. Since real estate, on average, is likely to be a riskier investment than

Table 4.1 Strategic and

Asset class Strategic benchmark Strategic benchmark
actual performance
2014 (pct.) 2020 (pct.)
benchmarks of the GPF-G
Equities 60.0 70.0
Fixed-income 40.0 30.0
Property 5.0 7.0
Infrastructure – 2.0
The source for tables 6.1, 6.3 and 6.4 is Norwegian Ministry
of Finance (2015), Meld. St. 21 (2014–2015), pp. 18–19, and
Norwegian Ministry of Finance (2019), Meld. St. 32 (2019–2020).
There is one such proposition from the Ministry to Parliament each
year, which provides material for assessing the fund management.
The figures are from the end of 2014
Table 4.1 exhibits the perhaps most important decision in relation
to management of the GPF-G—the allocation to various asset
classes—often shorthanded by the equity allocation, an indicator
of the willingness to accept the risk of significant capital losses
in the pursuit of high returns on the investments. For practical
purposes, the actual asset class shares are kept close to the strategic
benchmark
108 4 Investment in Practice

fixed-income, with a higher expected return, the inclusion of this asset class in the
strategic benchmark should lead to yet an increase in the average risk and expected
return for the Fund. The variance of return is likely to increase. This is what is
meant by increased risk. However, that effect is offset by improved diversification
implied by the inclusion of a new asset class, with an empirically more modest return
correlation historically in relation to the other held asset classes than fixed-income.
Due to the rebalancing regime, which may also be understood as an integral part
of the strategic benchmark, rather than deliberate risk-taking (see below) the actual
holdings will deviate from the strategic benchmark. For the GPF-G there seems to
be a desire to rebalance portfolios less often than before. This implies that the actual
holdings will be more influenced by short-term price developments for stocks and
bonds, respectively.
The inclusion of real estate was decided by the Ministry of Finance in 2008.11 Up
to 5 per cent could be invested in the new asset class, property. For 2015 and 2016
there were plans to increase the unlisted property share by 1 percentage point per
year, to get nearer the 5-pct. limit (since 2019 this limit is at 7 pct.). This process,
however, slowed due to a large increase in the value of the fund. Prior to the allocation
to unlisted real estate, the split between equities and fixed-income was 60–40. From
the outset in 1996, the allocation to these two main asset classes had been fixed at
40–60, instead of 60–40, which implied a lesser risk tolerance. The increase to a 70
per cent allocation to equities was done in two steps, to 60 per in 2007, and to 70 per
cent in 2016.
The inclusion of real estate from 2008, which was allocated up to 5 percentage
points of the 40 points of the then fixed-income allocation, and 7 percentage points
of the 30 points from 2019, has implied some increased risk. Property represents
an intermediate risk level compared to the two other asset classes, with a low-risk
component represented by rent from tenants that resemble a cash flow from fixed-
income, and a component of higher risk linked to the valuation of the property object
that resembles equity risk. There is a tendency for the capital price to appreciate over
time, although a lesser one than for many stocks.12 However, real estate markets
vary much by location and type of real estate, the two most important of which are
commercial and residential uses. Compared to the outright increases in the equity
share, the increased risk from allowing real estate within the fixed-income allocation
was modest. Further, some of the real estate risk per se was offset by improved
diversification properties at the portfolio level with more asset classes.
If a fraction of a fixed-income allocation is used to buy real estate, the risk is set
to increase. Improved diversification, however, in isolation reduces the risk increase.
The returns on various assets classes are less than perfectly correlated. In some

11 See Norwegian Ministry of Finance (2008), St. meld. No. 16 (2007–2008).

12 For instance, in the United States the broad Case-Shiller home price index has underperformed
compared to the Standard & Poor 500 stock index. In the 30 years since 1990, this much more
volatile stock index has increased by a factor of about 8, whereas the more stable home price index
has risen to about the double of the 1990 level.
4.1 Geography and Asset Class Allocation 109

Table 4.2 The correlation of returns on REITs and other asset classes (illustration)
Stocks Stocks Stocks Stocks Bonds Bonds Bonds T-Bills Gold
Large Small International Emer. All U. High-yield Internatl (cash)
cap cap mkt S
0.48 0.68 0.39 0.43 0.22 0.69 0.24 0.11 0.06
The correlations are calculated for a U. S. dollar based investor under the assumption of reinvestment
of dividends, for instruments marketed by Vanguard. Instruments marketed by other firms should
exhibit similar results. The aim here is solely illustration of historical returns correlations. The full
correlations matrix is available in Appendix 2. Source: Themeasureofaplan.com (blog on personal
finance)
The table illustrates how inclusion of real estate (here REITs, where a high percentage of earnings
is paid out to investors due to regulation) can be used to diversify, both with regard to assets of high
historical returns correlation, like stocks, and misc. bonds – several of which exhibit low correlation.
Correlations of annual returns, 1986–2020

instances, the returns across asset classes have been very little correlated. This might,
but need not, indicate low correlation also in the future (Table 4.2).
Table 4.2 exhibits returns correlation for the real estate sub-class REITs, from
1986 to 2020. Its returns were little correlated with returns on bonds, both U. S. and
international bonds (0.22 and 0.24 respectively), and more correlated with returns
on U. S. small cap. and large cap. stocks (0.68 and 0.48 respectively). Returns on
REITs were less correlated with returns on emerging market stocks (0.43). For gold
the returns correlation was as low as 0.06. This may be of little help going forward,
however: Norway’s already then quite moderate gold reserves were sold in 2004.
As noted above, every piece of unlisted real estate or infrastructure is tied to a
fixed location. This makes every real estate object unique, and thus ‘stock picking’
relevant for this asset class. A large part of the risk in real estate is due to variations
in the capital value, which is sensitive inter alia to news relevant to the location
of objects. Since there may be many objects on the market at a point in time that
differ with respect to factors that impact on value, and since information, search and
transaction costs may be sizable and investors quite few, the pricing of unlisted real
estate is unlikely to be efficient. Although the same concerns may to some extent
apply to various exchange-traded, identical stocks, the tendencies will usually be less
marked. Stock-picking may therefore work in some listed markets, and be needed to
succeed in unlisted real estate.
The analogy referred to above, of fixed-income to rent incomes and equities to the
real estate value, does not give a complete picture. In part due to the overshadowing
role of location, unlisted real estate is an asset class of much unique undiversifiable
risk. Many thinkable real estate investments in marginal locations will therefore not be
carried out, which may also explain high returns. The GPF-G is not heavily invested
in real estate in marginal locations. However, the central role that location plays for
the asset class underlines challenges related to scalability and required managerial
effort. This means that the risks assumed are difficult to quantify and that personnel
resources can be tied up for a long time. Thus, a price has to be paid for higher yields
110 4 Investment in Practice

Table 4.3 The equities index

Region Pct Sector Pct
of the GPF-G by region and
industry (2014) USA 36 Telecommunication 4
UK 12 Finance 24
Japan 8 Health 11
Switzerland 5 Manufacturing 13
Other DMs 29 Consumption services 10
China 2 Power and water supply 4
Taiwan 2 Consumption goods 13
India 1 Materials 5
Other EMs 5 Oil and gas 7
Technology 9
Table 4.3 exhibits the composition of the GPF-G equities index
with respect to region and business sector at the end of 2014. DM
and EM denote developed and emerging markets, respectively

than in fixed-income investments. The asset class property seems best suited as a
small portfolio share for large, truly long-term investors.

4.1.1.5 The Strategic and Operational Benchmark

The operational or actual benchmark of the GPF-G is set by the fund’s management
(NBIM), not the Ministry of Finance. It may deviate from the strategic benchmark
for two reasons. First, a deviation may be indicative of a willingness to deviate to
actively absorb a risk to make money, i.e. an increased expected return. Second, a
deviation may merely reflect the rebalancing regime. This results in large positions
due to price movements for which the book-keeping is different than for intended
positions.
Overall, moderate risks have been accepted in terms of expected volatility with
a view to the so-called information ratio,13 whereas rebalancing may lead to large
balancing transactions that are triggered by automated decision criteria. The rebal-
ancing regime might thus generate gigantic trades subject to what would resemble
filter rules in trading.
Table 4.3 exhibits the regional and industry composition of the equity index at
the end of 2014. Although these data are not new, they are shown to illustrate the
applied approach. As the discussion above shows, region or country may be most
fundamental in relation to risk exposure, as it embodies risks linked inter alia to

13 The information ratio is a measure of how successful active management has been in a period,

that is the active return, which is the difference between the return on the benchmark and the return
on the investment divided by the tracking error – i.e. the standard deviation of the active return
which is the additional risk. The higher the information ratio, the higher is the active return of the
portfolio per unit of extra risk assumed. This measures performance.
4.1 Geography and Asset Class Allocation 111

politics, general business conditions, and what one might refer to as the relative ease
of doing business. Region or country also embodies varying prospects for economic
growth of various countries. About half the portfolio was placed in Anglo-Saxon
countries; 36 pct. in the United States, and 12 pct. the United Kingdom, together
with some smaller holdings in Australia and New Zealand. About 10 pct. was placed
in emerging markets, including China at 2 pct., Taiwan at 2 pct., and India at 1 pct.,
and the rest in the region other developed markets, in the main Europe at 34 pct.,
which included a 5-pct. allocation to Switzerland.
In addition to region or country, the composition by industries is important for a
stock portfolio. Profitability varies between various business sectors over time, for
instance due to business cycle changes. Economic growth is usually uneven with
respect to industries, as with respect to regions. New business opportunities may
apply to some industries and stability or stagnation to others. Over time, the industry
composition of an economy will change. To make money, or avoid losing money, it
is important to invest in sectors that are likely to grow, even though it will be difficult
to know ahead of time which ones and to what extent. One approach to this problem,
is a wide diversification between industries. This seems to be the approach followed.
At the end of 2014 more than half of the equity investments were concentrated
in technology-intensive sectors: Telecommunication at 4 pct., finance at 24 pct.,
health at 11 pct., oil and gas at 7 pct., and technology at 9 pct., altogether 55 per cent.
Consumer products constituted 23 per cent, about equally split on goods and services,
and manufacturing, materials, and utilities like power and water supply made up the
remaining 22 per cent. This may appear aggressive, with an emphasis on presumed
innovative growth stocks of high risk compared to more conservative value stocks
of lower risk. However, the composition by and large reflects market capitalization.
Thus, if ‘aggressive’ subsectors dominated this was because they performed well in
some earlier years. A string of good years in an industry may thus lead to higher
aggregate risk exposure through more investments in successful firms.
This is even more marked more recently, in particular for U. S. technology stocks
that have performed very well. An important change from 2014 till the end of 2019,
seems to be a higher allocation to large technology stocks, and a somewhat lower
one to finance.
Following the decision in 2017 to increase the strategic allocation to stocks to 70
per cent, to leave at 30 per cent the strategic allocation to fixed-income, there was
a need to simplify the currency allocation for fixed-income. In September 2017 the
manager suggested to reduce the number of currencies in the fixed-income index
from 23 to just three: The U. S. dollar, the euro, and the British pound. It was viewed
as important inter alia to reduce transaction costs in less liquid currencies, the number
of transactions, and the costs of rebalancing. Further, it was proposed to rebalance
the fixed-income portfolio less frequently—annually instead of monthly. The most
important function of the fixed-income portfolio is to provide liquidity. In particular,
the allocation to fixed-income securities denominated in U. S. dollars is important
in that respect. This is a substantial and indispensible contribution in addition to the
returns.
112 4 Investment in Practice

In this author’s view, an allocation to a particular currency of denomination will

be most meaningful for a priori specified sums of money payable in that currency.
The sums to be paid may be impacted by a rate of interest for the specific currency, or
related to this, a price index for that currency. When one holds equities, however, the
reference to the currency of denomination means less. Even if the sums to be received
in the future, as redistributed profits will be in the currency of denomination of the
stock, the size of the income may be impacted on by a number of other forces, linked
inter alia to international business conditions. It should matter less for a stock that
may rise or fall much in value what the specific denomination currency of the stock
is. It may be more important that it is a liquid currency, linked to liquid exchanges
of stocks. The same could also apply to real estate held over long time spans. It is
mainly the location and its usefulness for economic activity that determines how
the value of that piece of real estate will fare in the future. An investor is after the
value development of the acquired objects. In that context, particularly over long
time spans, the currency denomination should be less important. If one accepts this
view, it will follow that the most liquid currency or currencies are advantageous.
As of the end of 2019, only four categories of markets were indicated in the annual
reporting to Parliament—developed markets in Europe, at 33 pct., developed markets
in North America, at 42 pct., other developed markets, at 14 pct., and emerging
markets, at 11 pct. Thus, 89 per cent was allocated to developed markets, and 11 per
cent to emerging markets. There has thus been an increase in investments in emerging
markets, of two percentage points that have increased sharply in nominal value since
2014 due to the strong growth of the Fund. It has recently been decided to change
the regional weighting for stocks so that it reflects changes in market capitalization
for shares that are trading freely on the exchanges. This is referred to as a ‘floating
rate’ market capitalization framework. The regime in place was a variant of market
capitalization weights skewed a bit towards Europe and away from the United States.
There will now be some more weight on North America, and a small reduction in
the allocation to Europe. If that approach had been applied earlier, it would have
resulted in marginally better properties with regard to both risk and return in the
stock portfolio, and hence slightly better returns. Whether the same will be true in
the future, will remain an open question.
In the latest years, the returns on stock investments have been particularly high
in North America. This is due inter alia to high return on equity in listed firms. The
pricing of stocks is also more favorable towards the companies in this region than
elsewhere, in part due to high equity shares. North America’s share of the global stock
market value is therefore larger than the regional share of global business profits and
equity share could indicate. Thus, the asset markets are pricing the shares in future
payable dividends higher in North America than in other regions. In addition, the
large technological stocks have appreciated sharply for reasons that are difficult to
pin down. This trend could be due to, for instance, the high market power of some
large firms.
North American listed firms have benefited from good business conditions, that
have made global investors bid up shares prices so that this sector accounts for a
larger share of market weights of global stocks. Since comparatively more stocks are
4.1 Geography and Asset Class Allocation 113

Table 4.4 The GPF-G

Region Pct Sector Pct
fixed-income index
decomposed by region and U.S. dollar 41 Nominal government bonds 61
sector of issuers Euro 28 Real government bonds 6
Japanese yen 8 Supranational organizations 11
British pound 5 Corporate bonds 13
Other DMs 9 Preferential bonds 10
KRW 2
MXN 2
RUB 1
Other Ems 4
Table 4.4 exhibits the composition of the GPF-G fixed-income
index with respect to region and issuance sector at the end of 2014.
DM and EM denote developed and emerging markets, respectively

traded compared to in other regions, this applies in particular to free-floating market

weights. The figures for market value and free-float-adjusted market weights are 47
and 58 pct. respectively, with an equity value of barely 30 per cent. For emerging
markets there is an opposite tendency, with free-float-adjusted combined weights of
less than 15 per cent in spite of a high share in global business profits that reaches
almost 40 per cent. In sum, the pricing appears as favorable for North American listed
firms, which at present are able to capitalize more on the availability of investments
funds than the listed firms of the other regions: High prices in part reflect high investor
confidence and trust.14
Table 4.4 exhibits a corresponding breakdown for the fixed-income portfolio, on
currencies of denomination and bond market subsectors, at the end of 2014. The
most important denomination currencies were then the U. S. dollar, at 41 pct., and
the euro at 28 pct. Denomination in the four main currencies, which also included
the Japanese yen, at 8 pct., and the British pound, at 5 pct., thus made up 82 per
cent of the total. The remaining 18 per cent was allocated evenly to other developed
markets, at 9 pct., and emerging markets, also at 9 pct.
For bonds, the strategic benchmark is based on GDP in the issuing countries,
including in the euro zone. This is better than market capitalization because of the
credit risk for bonds. Many bond issues are denominated in the two largest currencies,
the U. S dollar and the euro. The reason for this is that there are well-developed and
liquid bond markets for these two currencies with actively traded benchmark issues
at various maturities that bonds with other issuers and different credit quality can
be priced in relation to. Thus, even foreign governments who can issue in their own
currency sometimes issue bond in these main markets.

14 This and the preceding paragraphs draw on Norwegian Ministry of Finance (2020a; 2020b; 2020c),

and Norwegian Ministry of Finance (2015) Meld St. 32 (2019–2020), Chap. 3, which refers to a
commissioned report by the Ministry from the index provision firm MSCI.
114 4 Investment in Practice

For some governments, particularly in developing countries, borrowing may be

more available with debt denomination in dollars or euro than in their own currencies.
Investors may also prefer to invest in the main currencies, rather than having to cope
with exchange rate risk in the currencies of smaller nations. A more important reason
for low interest for various bond issues, including some government bonds, may be
insufficient credit ratings, or a lack of confidence in that the borrowed money with
interest will be paid back as promised. In view of this problem, debt issuance may
sometimes not be possible irrespective of the currency of denomination.
The sectorial composition shows that the bulk was allocated to nominal govern-
ment bonds at 61 pct., with lesser allocations to real government bonds at 6 pct.,
supranational organizations at 11 pct., corporate bonds at 13 pct., and preferential
bonds at 10 per cent.
Due to the importance of credit risk in fixed-income investments, market capital-
ization plays a lesser role for allocations in the strategic benchmark for bonds than
for equities: One wants to avoid increasing allocations to any countries that get into
problems of increasing indebtedness, and then would have to issue more debt.

4.1.2 Political Risk Across Asset Classes and Space

The more vulnerable to distortions and non-tranquility the underlying economic

activities meant to generate economic returns on an investment, the more exposed
will the investment be to political risk. Note also that entrepreneurial activities that
involve trying out new procedures or ideas are more exposed to political risk than
most other activities (Knack 2003). Another name for this activity is innovation. This
may be even more risky than lending, particularly in politically unstable areas of non-
negligible default risk. One may think of economic activities intended to generate
a profit, as placed along a spectrum from the lending to a government or sovereign
(the less risky form), via investments in utilities, manufacturing, etc. under known
technologies (an intermediate form), to investments in new technology, or knowledge
and procedures (the riskiest form). This last category is indispensable for growth, due
to a need to innovate to become more efficient. Nonetheless, it is also highly risky as
most such attempts may fail even under very good conditions in industrial countries.
If one instead has to put up with prospects of plundering, pillage and thievery, the
chances of success may appear as very slim.
If we follow the influential reasoning of North (1990 and later),15 developing
countries are likely to be poor because they are subject to low-quality institutions
and internal unrest. If conflicts are plentiful and are solved by using brute force
instead of legal procedures, goods and services can be acquired at gunpoint—in

15 Weingast (1995) discusses the interaction between politics and economics in promoting growth
historically in the developed countries. That author emphasizes limited government, able to promote
growth but unable to abuse their powers to confiscate or expropriate wealth. The state level of
federations is suggested as particularly well fit in this respect: Britain and the United States are
examples from earlier times. China is a more recent one.
4.1 Geography and Asset Class Allocation 115

which case there would be no need to pay for them. Knowing this ahead of time,
potential producers could put little effort into production in markets they feared would
be too unstable: Products that could be taken away without payment are when this is
expected less likely to be produced.16 Non-production provides very good protection
against confiscation of valuable products: What doesn’t come about can usually not
be taken. Predation therefore remains a highly serious threat to productivity and
growth.
A SWF like the GPF-G will enjoy more protection than typical firms and citizens
of poor countries: It is backed by an industrial sovereign state. This will be important
even if Norway is of modest capabilities compared to some other states. Further,
this state controls large investment decisions whereby funds are allocated to various
regions, countries, and sectors. There could thus be a chance of discontinuation of
investments in domains that could be useful to recipients. The same logic could also
apply in other contexts: Consider credit risk, the risk that a counterparty reneges
on an agreement to perform. In the simplest form, a loan may not be paid back.
Failed promises to facilitate operations, development, or business more generally,
or not to expropriate property, may be interpreted similarly. This type of risk linked
to decisions may be understood as more fundamental to human behavior than other
types of economic risk, as it also includes willful deceit or a lack of willingness or
interest to act as promised. This could undermine trust, and thus also opportunities or
possibilities to conduct meaningful business operations in the future. The possibility
of willful deceit may thus play a more important role than ‘bad luck’ with respect to
value creation. However, it may be difficult to separate the phenomena empirically,
as one who deceives could want to explain any unfortunate events as due to bad luck:
Bad luck could be likely to change in future exchanges, whereas a bad character
could be quite stable.
The world is divided into regions where economic activities may be linked to
either production or predation (Pareto 1902; Knack 2003). If predation dominates in
an area, this area has little to offer an investor. Investors should thus be expected to
keep out, and capital to be comparatively scarce. The result may be a mirage of high
returns, which cannot be obtained because the capital would be unsafe and this is
widely recognized. It will then be difficult to attract capital. Judged ex post, promises
are likely to be void and the realized returns illusory.
Areas where production dominates will create value and have a comparatively
easier time in attracting the needed capital. Thus, returns will be lower. There will be
a crowding out of offered funds, as investors compete to invest in safe and productive
locations. Unsafe locations will be drained of capital, which ends up in safe locations
where expected returns are low, but quite safe.
From the perspective of an investor, the most developed investment markets are
comfortably safe, but offer low rates of return—due to a usually high number of
investors taking part in this comfort. To earn incremental returns, one must expose

16 This reason to be cautious applies with force to real estate, where the location of the investment

is pinned down to for instance a physical installation of long duration in economic terms, or to a
particular piece of land.
116 4 Investment in Practice

oneself to some sort of risks, possibly in less safe areas. The areas that offer the
highest prospective returns ex ante, however, may also be unsafe, and the investments
undertaken may be lost not only due to bad luck, but also because of expropriation,
or sometimes outright thievery. Above a certain level, high prospective returns that
appear too good to be true may be just that, and convey a signal of not to invest.
Frontier markets involve unique risks that cannot easily be inferred from avail-
able information. Although the same applies to some extent also in more developed
markets, investments in frontier markets are risky due to the lack of a framework that
can promote good-enough conditions for investors. Markets are less developed and
regulated, and investment vehicles may be less standardized. Simple operations may
then become complicated. The less one can take for granted, the more demanding
could information processing become. We abstract here from the possibility of relying
on trust, which could be available in more developed areas and which would short-
circuit calculations. Trust adds value by permitting risk-taking without information.
Tedious, complex calculations are not needed—which creates value.
Consider instead an investment in a block of non-developed real estate in a similar
location. This may be an ultimate commodity, embodying an array of development
opportunities, at least if it can be combined with resources controlled by others.
It may also appear as comparatively safe, since it’s a tangible object—compared to
abstract holdings in accounts with counterparties that can renege on agreements or go
bankrupt. It could also be registered in a land registry, and therefore not easily become
lost or stolen, one could think. However, depending on institutional quality, a project
like this could involve high risks.17 For instance, authorities may take decisions that
can hollow out the value of the investment by providing rights to others.
Apparent safety may thus be false. It may for instance be possible to steal the
stream of services from the asset without physically seizing the asset. On other
occasions, the asset or parts thereof may be stolen in a covert fashion. This could
include the possibility that a division lines in the terrain may be manipulated or
fiddled with, or that false maps or other documents may be produced, perhaps even
by responsible officials.18 Further, many of the institutionalized ‘rule of the game’
aspect of Western countries, that Westerners often take for granted, may not exist
or be enforced in some countries, or in some locations within countries. The risk

17 The hacking of computer systems has, however, turned out to be a problem for instance in

relation to bitcoins, a virtual currency which was presumed by many to be particularly safe as such.
However, large amounts have been stolen from accounts with various bitcoin exchanges (exchange
and payment facilities) by hackers of the exchanges computer systems. See for instance, CNBC
news 7 August 2016 on the theft, the day before, by cyber robbers of the world’s largest bitcoin
exchange, Hong Kong’s Bitfinex. Nearly 120.000 bitcoins were stolen, of a value of about U.S.
dollars 72 million. This exchange was able to stay in business. Theft cannot be avoided through
digitally stored wealth. Earlier, in 2014, a much larger theft was made at Mt. Gox, a Tokyo bitcoin
exchange: Half a billion U.S. dollars-worth of digital assets vanished. That exchange was also the
largest bitcoin exchange at the time, and then went bankrupt. There was suspicion that much of the
theft was due to an inside job, and the expression ‘getting Goxed’ was reportedly coined.
18 For instance, in relation to a natural resource pool, this may be tapped into in covert fashions—

either by drilling oil wells horizontally, or not only vertically, or by emptying a stack of resources
by truck in the night.
4.1 Geography and Asset Class Allocation 117

could decrease in income and development. Nonetheless, there may be differences

also within western countries in this respect.19 In view of this, assets that appear to
be of high quality need not really be safe.
The typical situation to guard oneself against may be one where public officials
in emerging or frontier markets practice a high degree of discretion in their decision-
making, and where they are unlikely to emphasize the interests of international
investors. For simplicity, abstract for the moment from the possibility of bribes and
other types of corruption. Such unethical actions are generally illegal, in Western
countries as elsewhere. Investors might, however, be tempted and become involved.
This latter, criminal, situation must be avoided all together. Perceived wrongdoing
could be an unusually good excuse for expropriation. It may therefore be difficult to
reap meaningful returns on investment in such environments: Once the investment
is made, local forces will have strong incentives to try to seize the asset and/or its
return, either directly with force, or indirectly by constituting a poisonous climate for
business operations by outsiders. This latter kind of development could also make it
impossible to sell the investment to others. This pattern of potential behavior may
amount to economic extortion, which in most locations constitute a serious crime.
However, the law may not be enforced with equal force in relation to all agents and
situations. This could apply in particular if the guardians were corrupt. A block of
unrefined, crude real estate may thus be either an ultimate investment opportunity,
with promising development options, or an investor’s nightmare, depending on the
institutions of a location. The location on that scale may be difficult to know ahead
of time.
The GPF-G is authorized to operate also in emerging markets that are not covered
by the strategic benchmark, referred to by manager NBIM as frontier markets. Simi-
larly, it can also choose not to invest in some areas that are included in the benchmark.
Such decisions will make use of some of the risk frame available for the management.
Decisions to invest in frontier markets, that are by definition not part of the strategic
benchmark portfolio, would require active decisions by the manager. This creates
an incentive structure that could lead to few investments in frontier markets: If one
does something unexpected or blunt that works out well, it might not be sufficiently
honored. If, however, it turned out to be a failure, many would easily remember
it. Sometimes very good results, in terms of profits, can be achieved by investing
in a new market. A manager’s behavior could depend on the extent to which such
successes will be rewarded.
Fund managers can assume active risk positions compared to their benchmark
portfolios in various ways. The discussion here shows why their frame for risk deci-
sions is not suited to act under poor institutional quality. Managers will typically have
skills and systems that are not well-suited to handle poor institutions. Indications of
the latter, should therefore probably often be interpreted as a strong signal to stay out

19 This author has sensed large differences within Norway in this respect, particularly between the

central part of the country in and near capital Oslo and the more peripheral parts in the inland and
coastal areas further to the North.
118 4 Investment in Practice

of an area. Hence, none of the asset classes that one would normally acquire should
be bought in that area.

4.2 The Management of Large Funds

The investment philosophy of the owners of the GPF-G, or the government as their
representative, stems from interaction of some widely held views of how the invest-
ment markets work, and some characteristics of the needs that have led to the estab-
lishment of the GPF-G.20 This is outlined in Sects. 7.1 and 7.2 below. It has important
implications for how one could best go about transforming income from the present
into the future, i.e. for the benefit of future generations.

4.2.1 How Investment Markets Work

A common assumption both in finance theory and among practitioners, is that the
markets are efficient, that is, essentially well-functioning in digesting any publicly
available information with relevance for asset prices. This means that it is not possible
to consistently beat the market over time, and is known as the Efficient Markets
Hypothesis, or Efficient Market Model. The most recent versions of this hypothesis
are open for small deviations from highly efficient outcomes, due to several possible
types of frictions. These frictions imply that the Law of One Price, also known as
the No Arbitrage Condition, does not hold exactly. Therefore, active management, in
particular to exploit specific comparative advantages investors might have in various
respects, may be worth undertaking. However, this endeavor will usually have very
limited implications with respect to enhanced returns: Costs accrue, whilst returns
could increase only marginally.
A major complication in economics and finance, is strategic interaction between
the players that impact on various outcomes, like income and its distribution.
According to Derman (2011: 140), “in finance you are playing against God’s crea-
tures, agents who value assets based on their ephemeral opinions”, that is, unlike in
physics where you are playing against God, who doesn’t change his laws very often.
As Burton Malkiel also emphasized in a 2011 review of Derman’s book: Humans do
change their mind.21
In any event, most relevant information will be reflected in the asset prices at
a point in time. In this situation, is it unlikely that one can ‘beat the market’ by
analyzing the available data, either as regards security selection or by attempts to
time market trends. Both tasks would require superior analytical skills, which are
rare. New information, however, may make market prices move, to the extent that

20 This section draws on Meld St. 21 (2014–2015), pp. 20–22.

21 The Wall Street Journal 14 December 2011.
4.2 The Management of Large Funds 119

the information is really new, that is unexpected. However, it will then most likely
be unexpected for fund managers, and therefore most often difficult to capitalize on.
Second, and consistent with the hypothesis of efficient markets, there may be
various types of risk premia. One can thus in certain situations reap higher expected
returns ex ante by assuming a risk of higher losses than the average risk for the
respective market. The risk adjusted return, however, will not increase due to the
acceptance of higher risk. Thus, both the risk level and the expected return will
increase. Nonetheless, investors are different with respect to their abilities to absorb
the various kinds of risk present in the market place. This is particularly relevant
if one really believes that ‘what goes up must come down’, as in physics, or that
there are deterministic trends over long time periods that determine the reward for
assuming various types of risks.
The problem with such views is that they, at best, produce high returns for a
limited time. An evaluation report on active management of the GPF-G, prepared by
Ang et al. (2009) for the Norwegian Ministry of Finance, gives an example linked to
the financial crisis from 2008, when the two risk factors credit and (il)liquidity led to
particularly bad outcomes with high negative returns in the fixed-income portfolio
of the GPF-G. Based on analysis of the situation, these authors first argue that it was
possible, at the time, to foresee the negative development following the bankruptcy
of the U. S. investment bank Lehman Brothers in September 2008. That is, the losses
could have been reduced. Second, they argued that actions were taken that reduced
the size of the negative returns compared to what would have been the situation
without corrective action. Third, they argued that the mentioned two, and several
other, risk factors embodied an inherent characteristic of normalizing over long time
spans. Thus, patient investors—typically funds with very limited liquidity needs—
would have a comparative advantage relative to other investors that they could use
to attain incremental returns. To actively absorb these two types of risk, in excess of
what would follow from ‘neutral holdings’ of various securities, could be understood
as selling insurance to other market players, or the active selling of insurance ‘to the
market’.
Clearly, this action can be advised only to the extent that it would be less problem-
atic for a fund manager than for another type of player to absorb the risks. In relation
to credit, this could seem plausible for a fund of ample resources—i.e. a very large
fund—and also for a fund with a long time horizon, as losses due to credit risk would
be dominated over time by off-setting gains. With regard to (il) liquidity, the time
horizon is key, as an investor with a long time horizon can just wait for times when
this factor again become less salient and emphasized—an event one might expect
based on prior experiences, but cannot really know will eventually surface. Strong
expectation that some managers may have in relation to long-term outcomes, may
in this way make up a rationale to sell ‘fire insurance’ to market players with more
pressing liquidity needs.
The argument is thus not that there is a free lunch, but rather that some investors
may have good reasons to accept a kind of lunch that is bit smaller, in order to
acquire protection against an important risk of dire circumstances that do occur from
time to time and that could else lead to significantly lesser returns: They pay an
120 4 Investment in Practice

insurance premium that compensates other players for holding assets rich in these
two risk factors they need protection from if a severe outcome of low probability
should occur. If or when the dire circumstances are triggered, one would enter into a
new state of the world, where many may lack the resilience required to be exposed to
credit and/or liquidity risk. Some more robust players may assume more of the risk,
both the downside risk and the upside risk. The latter means that they are paid off
nicely if or when the situation improves with time, as is often the case. An example
is the buildup of the Wallenberg family’s capital in Sweden in the crisis of the early
1930s. Once the new state of the world occurs, it may also lead risk averse players
to become willing to pay more for the relevant insurance. The players that want
protection may act like home owners who buy fire insurance. In each period, they
pay an insurance premium, by accepting lower expected returns. If their house burns,
they will get a new house. The insurer would in this instance incur a loss, but would
over the long haul still make money. A popular saying is ‘tough guys last, tough
times don’t’. Although no-one can know this for certain with regard to the future, it
has been used to rationalize risk-taking in the past. It may be seen as a restatement,
with money put on the table, of the conventional view that prophecies stating that
the world is about to end have tended to be proven wrong.
Third, there may be limits linked to the size of a fund.22 Size could, however,
work both ways, depending on what one would want to achieve. For the GPF-G,
disadvantages due to large size may be most important. These are further developed
and discussed below. Compared to smaller investors, however, large funds might
benefit from large size in the same ways other businesses tend to do: The large,
visible and dominant players may more often than others be approached, presented
for, and invited into new business opportunities, some of which may be of high value.
They also have better abilities to pay for various types of specialized expertise than
small players. Nonetheless, this may not be very relevant in comparing the GPF-G to
other similar funds, all of which are highly visible and able to pay for the expertise
they need.
Fourth, there are quite often challenges of the principal-agent type, i.e. agency
problems. Ang et al. op cit., see this as the most severe problem in the operations
of large investment funds. In general, much information related to operations is
asymmetric, implying that the managers have an information advantage in relation
to most others, including the owners. They may use this advantage, e.g., to further
slightly different goals, more to their own benefit than to the owners’, compared to
what one knows the owners would have wanted under equal information. Despite the
possibility of ‘mission drift’, the owner needs to delegate the investment activities to a
manager. The management works in a less than optimal fashion from the principal’s
perspective, but typically better than without delegation not least due to scaling.
There are probably unavoidable agency problems in relation to all large business

22 There are significant scale economies in investment. This is very important for small funds, for

instance with regard to the hiring of competent staff. For large funds, in particular the largest ones,
this is less pressing. This implies that large funds should be able to manage money more cheaply
than small funds. Costs are important, as the expense ratio outperforms, e.g., Morningstar’s funds
ratings as a predictor of future returns (Malkiel, 2013).
4.2 The Management of Large Funds 121

enterprises, also in the management of investment funds owned by others than the
managers. Indeed, this is an important perspective in most delegated activities.
Such issues, referred to as information asymmetry, arise in situations where one
party has an information advantage vis-à-vis one or more other parties. It is covered
by the literature in contract theory and economics, and has received a lot of attention.
Examples of such stylized situations, are adverse selection and moral hazard, or more
generally information concentration.23
Being dependent upon others that have their own interests, and thus cannot uncon-
ditionally be trusted, reduces the potential gain of an economic agent. The agency
problems that information asymmetry might give rise to are important because they
may reduce the overall return compared to what could else have been achieved.
These problems underscore the need for clear mandates and a clear management
model for investments of a SWF. The active participation by owners, in line with
established principles for good corporate governance, can contribute to reduce the
practical importance of agency problems. This could enhance the owners’ return on
investment.
Ang et al. ibid. points out that the GPF-G has an advantage over many other large
funds with respect to agency problems, since the manager NBIM as a wing of the
central bank has highly professional and public-spirited employees. This author sees
this as a rare combination and thus a valid and important point, that could ceteris
paribus lead us to have increased confidence in the management operations of the
GPF-G. When one wants to operate a large SWF, as in this case, this particular
arrangement may serve to reduce the potential impact of an important risk factor.
Fifth, there might be external effects, that is costs and or benefits in relation to
economic activities that do not accrue, or at least not in full, to the agent who gives
rise to them. This is a type of market failure, or an instance where the market if left to
its own devises can be expected to produce a socially undesirable result. Outcomes
could then not satisfy otherwise reasonable standards. For instance, pollution could
destroy environmental qualities and other values for affected parties. This perhaps
most used example of negative externalities, implies damage of environmental quali-
ties valued by others. Activities that produce negative externalities provide lesser net
values than the accounting of the agents responsible for the externalities suggests.
Without regulation, there may be too much pollution. A socially responsible investor
with a global perspective should be aware of this type problem, and invest less in
the associated activities. However, if the private return from socially undesirable
activities is high, there may still be too much undesired activity form society’s stand-
point. Operations that lead to that outcome should in that event preferably not be
funded through publicly owned investment funds, be it through equity purchases or
the extension of loans through money or bond markets.

23 See, e.g., The New Palgrave Dictionary of Economics, 2nd ed. 2008, particularly the contributions

by C. Wilson (2008), J. Ledyard (2008), and J. Hörne (2008). The 2001 Sveriges Riksbank’s Prize
in memory of Alfred Nobel (‘Nobel Prize’) was awarded to George A. Akerlof, A. Michael Spence,
and Joseph E. Stiglitz for their analyses of markets with asymmetric information. Another influential
contributor, is Arrow (1963), who had received the Nobel Prize with John Hicks in 1972—for their
contributions to general equilibrium theory.
122 4 Investment in Practice

Since undesirable side effects of production, like pollution, are often regulated
and receive considerable attention, and since socially unprofitable activities are often
also unprofitable for private owners, such problems could be less important than
stylized examples may suggest. It is also important to consider that use of a price
mechanism may be a superior regulatory approach compared to binary choices which
outlaw undesired activities. The optimum rate of pollution from society’s standpoint
is usually not nil, since many recipients have a capacity to absorb pollution. This
absorption capacity could be a resource for a society to exploit to create value. Other
examples than pollution, for instance child labor and human trafficking, may better
illustrate the situations where responsible investors would be well advised to just
stay out. This, however, rests on normative considerations, and some may disagree
on their foundations.

4.2.2 The Time Horizon of the GPF-G

The first and most obvious characteristic of SWFs may be large size. SWFs may
be of large size because they commit more funds than what may be needed for buffer
and/or stabilization purposes. A second possibility is that a SWF is set up for a
specific purpose, for instance to meet requirements for funds down the road in a
part of the public sector. Depending on its purpose, such a fund is usually not large
compared to many other funds. If the purpose is general, however, which includes
pensions, the fund may be very large. This section deals with funds created for the
even more general purposes of time transfer of wealth. As the discussion in previous
chapters should make clear, the size of funds often change over time. The GPF-G,
however, is very large and likely to remain very large for the foreseeable future.
Second, the GPF-G has a long investment horizon, even if it is difficult to know just
how long. It depends on the speed with which the government will draw on the Fund to
pay for government expenditures, typically purchases of goods and services through
the budget. In this context, revenue spending is an alternative financing source to
taxation. Without resource revenues, one would need higher taxes to maintain the
level of public spending. Particularly structural adjustment needs might make it more
palatable to draw on the Fund than to increase taxes if there is a shortfall in government
income. Tax increases are most often unpopular. Even when they are needed, the
citizens as voters may dislike to be reminded of this. This possible source of unrest
may be exploited politically. The low oil prices in some recent years, particularly
between 2014 and 2017, and again in much of 2020, also have important implications
for the future size of the GPF-G. As no-one knows how future oil prices will evolve,
it is uncertain whether, and if so to what extent and when, the experienced decline
in the real price of oil will be reversed.
If the downturn in oil prices is not reversed, the Fund could earlier than previously
anticipated decline significantly in size relative to GDP. Further, it is also possible
that the time horizon of the investments might be shortened due to a less favourable
combination of investments and use of funds. The creativity may be very high when
4.2 The Management of Large Funds 123

it comes to how the state could spend some more. A factor that works in the opposite
direction is, however, the already large size of the Fund and the compounding over
time of its capital.
Third, the GPF-G faces little need for liquidity in the short run. At least until now,
it has appeared as if the short-run liquidity need is indeed low. This is related to the
investment horizon. The liquidity needs will still increase over time as the cash flow
due to oil and gas production shrinks. When the Fund no longer grows due to this
income source, the annual transfer of the expected real return to the budget could
possibly imply occasional needs to raise large cash amounts through asset sales.
Although it would still be natural and desired to hold many assets for the long term,
the situation would be very different from one thus far, with a pile of fresh funds that
needs to be invested.
Fourth, the GPF-G has no clearly defined obligations or purposes to be met in
the future. The time horizon might therefore appear as very long. The Fund was
renamed, in 2006, from State Petroleum Fund to State Pension Fund—Global,
making ‘pension’ a part of its official name. However, there is no requirement to
use the capital or return of the investments for pension purposes.24 Thus, it’s not a
pension fund. It is also technically possible for the government, should it so wish, to
leave the Fund alone even in the event of large economic disturbances and associated
demands for funds that could be linked to state pension obligations. Another matter
is why it should want to do this. There are pressures from many sources towards
activism, as additional spending in many instances can be used to alleviate both
economic and political pressures.
Fifth, the GPF-G is owned by the people and handled by the government. It is not
clear that public ownership will be very important in practice. The return requirement
for a given risk profile should in principle be the same as for a privately-owned Fund.
The most immediate consequence may be on the time horizon for investments, which
is expected to be long. It would appear as unlikely that the owners should swiftly
change their attitude towards the investments of the Fund. It is also known that various
problems could arise that could shorten a long time horizon. Such events may strike
suddenly also in the public sector. In addition to this, public ownership highlights the
need to manage the Fund in accordance with some widely shared ethics principles.
This last point may be the most significant difference compared to a similar private
fund. All funds must respect ethical principles, but any reputation damage due to
the investments of a SWF may in addition stick not only to the fund but also to a
government, and possibly by extension to the state as owner and its population.
Together these five factors make the GPF-G different from most other funds,
although not too different from some other large funds, some of which are SWFs.
The Norwegian Ministry of Finance has emphasized that the Fund should be invested
broadly—i.e. to be spread out on various kinds of investments, with respect to,
e.g., geography and asset classes. Further, one aims at harvesting over time some
revenues due to risk premia, not least in relation to liquidity risk. This is due to
the perceived very limited short-term liquidity needs. Under this assumption, one

24 The official source for this is Innst. S. nr. 95 (2004–2005).

124 4 Investment in Practice

can successfully offer to absorb illiquidity risks from other players, subject to a
commensurable payment for this service. In isolation, this could enhance the returns.
Whether the properly risk-adjusted returns would rise may be less certain. This would
depend on the market price collected for the GPF-G’s abilities in absorbing illiquidity
risk. In principle, and given the very large size of the fund and its long time horizon,
it should be possible to earn a steady income by absorbing illiquidity risk. If this is
so, it would be possible to make money due to a competitive advantage for the Fund
in the offering such services. The market processes in which the relevant prices are
determined, may however not necessarily lead to that outcome. Often the side that
initiates a transaction, which in this example could be agents in need of protection,
may have to make it attractive, which in isolation should help. However, the Fund
as a prospective counterparty must know what prices are needed to turn a profit.
With large players and largely bilateral transactions, the market prices might not be
transparent. There may be agency problems in the pricing.
The Ministry of Finance has maintained a moderate frame for risk-taking relative
to the strategic benchmark in the operational management, and has emphasized, in
particular the importance of operating at low costs. Finally, it is stressed that the
management should be responsible, which implies inter alia that the structure of the
Fund must be clear-cut and easy to understand. While this would be desirable for
all funds, it is of a particularly high importance for a publicly owned fund. Else,
responsibilities in relation to the fund’s operations could become unclear, and/or the
operations could come to be seen by the public as less legitimate. The strategic aims
of a SWF may be difficult to obtain without these pieces in place.
This author assesses that the GPF-G may not stand out by much from the, admit-
tedly moderately sized, crowd of large investment funds: In particular, it’s not very
different from some other large SWFs. This implies that a growing specialized liter-
ature on large funds, including SWFs, seems to apply also to the operations of the
GPF-G and to a number of considerations in this respect.
In spite of many statements that highlight the long-term nature of funds like the
GPF-G, a long time horizon is by no means guaranteed. Such statements must be
understood and interpreted in the context where they are made. For instance, they
could be intended to fend off pressures for spending more of the Fund than the fiscal
rule would permit. It is hoped that investments have been made for the long term,
perhaps even the very long term as should be the case if the framework of a technically
speaking infinite horizon is interpreted literally. This may also be a desirable goal.
Still, it is not difficult to identify events that could lead to a shortening of the relevant
time horizon. Even if such events may be unlikely, they could occur under some
scenarios. Indeed, the very consciousness that there is a Fund that the government
has access to might by itself lead to an expected shortening of the time horizon. It is
possible that wide knowledge of existing funds that are set aside for the long term
can set in train processes that may result in a heavier use of the funds, at earlier points
in time than planned for.
The GPF-G is constructed in such a way that it could in theory be dramatically
altered by a single vote in Parliament. It is part of the general government, with
the Minister of Finance responsible for any important decisions that do not need
4.2 The Management of Large Funds 125

explicit parliamentary approval. In principle, large changes do need a parliamentary

approval. They can still be swiftly implemented. The reason why one might doubt
statements that the Fund is of a very long-term nature, is that a majority in Parliament
may at some point see it as in their interest to spend some of the Fund’s capital. There
is no guarantee against this, and any other solution would appear as unthinkable in
a parliamentary democracy.
Recent years have seen some dramatic financial crises with sharp declines and
volatility in asset values. In view of this, preservation of capital might be important
even for a fund manager that thinks he or she is investing for the truly long term.
The ability to collect risk premia based on a long time horizon is, when we disregard
the possibility of just being lucky, likely to depend critically on the ability to stick to
a long time horizon in stressful situations of genuine uncertainty, where there may
possibly also be an element of political unrest at play.
A strategy of selling insurance to the market, against e.g. illiquidity and credit
risk, could in light of the discussion above become dangerous if the demands on
the Fund changed, so as to reduce the time horizon and increase liquidity needs.
A long time horizon might then be transformed into a shorter one, due to formerly
unforeseen liquidity needs. A future time horizon of the GPF-G could therefore be
revealed that may be shorter than the Fund’s managers might believe today.
An important question is whether explicit statements by the fund managers that
refer to a very long time horizon by itself contribute to stabilization of expectations
and thus to assuring that the time horizon stays long. This may be a possibility. In
any event, as a strategy this is likely to work best when there are only moderately
sized shocks and distortions in the environment. Any dramatic changes in the critical
assumptions behind the postulated long-term horizon, might lead to large, unexpected
changes in the true time horizon. It is even possible that such potential changes could
become desirable in the greater context of fiscal and other macroeconomic policies.
For this, a severe and deep crisis could be required, and a willingness to pay up in
order to get out of it as soon as possible. In view of the large size of the fund, it should
be possible to stabilize even such situations without large changes in the expectations
of the long-term role of the Fund. However, more factors could at the time of a crisis
work in the same direction.
The argument here is therefore that assertions of a very long time horizon of a fund
like the GPF-G could become frustrated. The same could in that event apply to bets
resting on that assumption. A complex interplay of political and economic factors that
would be difficult to anticipate could lead to a shortening of the expected time horizon
of the Fund. The policy that presumes a long time horizon could be successful under
moderately-sized shocks, particularly demand shocks. In that context, intervention
intended to smooth the cycle by increased public spending could be successful.
However, if one is challenged by negative events and market developments of a large
order of magnitude, and/or from the supply side, the chances of success would appear
smaller.
The underlying argument here is similar in structure to that of a fixed exchange
rate regime, which was usual for industrial countries not so long ago. The rate needed
to be kept fixed, or at least stable, to stabilize expectations of a continued fixed rate. If
126 4 Investment in Practice

distortions tended to point in one direction over time, the question was for how long
the rate could remain fixed. If the fixed nominal exchange rate made the real exchange
rate appreciate, this was not sustainable. Sooner or later it could become in the author-
ities’ best interest to renege on their earlier commitment. Reasons linked to macroe-
conomic policy, including the ability to increase competitiveness in a recession,
could render devaluation, or depreciation under floating exchange rates, desirable.
One could perhaps think of both the time horizon of investment and a pegged nominal
exchange rate as situations of multiple equilibria, with a potential for instability that
depends in part on the policy itself.

4.2.3 Implications of Size for an Investment Fund

What is the implication of size, that is of operating a ‘large’ fund? The distinction
between small and large funds may not be obvious with reference to macroeconomics.
It may be reasonable to relate the size of a SWF to the GDP of the country that
owns and runs the fund, which is a commonly used yardstick. A large fund in that
context, could correspond to a sizable fraction of the respective country’s GDP. A
fund representing the value of a multiple of GDP, like the GPF-G, would be very
large. A fund that is large in that sense will also be large by other measures. Nominally
large SWFs may, however, not be big in relation to some large states as owners.
One may think that large size is positive in an economic sense, since financial
demands of a certain size may be easier satisfied the larger the SWF. As mentioned
earlier, and disregarding the possibility of creating debt financed funds, the establish-
ment of a SWF and accumulation of wealth in that entity requires fiscal surpluses and
current account surpluses. In most instances, this is politically painful. Resources that
could have been used to buy goods and services, are instead stacked away. Thus, at
least in democratic countries, large SWFs are not easily built up—and to the extent
that they exist, they are likely to be used to finance deficits incurred inter alia to
handle cyclical downturns. They can contribute meaningfully to stabilization under
the required economic adjustment, and may beyond that point also contribute to ease
political pressures. Savings for future generations would, however, usually not be
made without windfall gains. The costs of prioritizing the future, in terms of foregone
consumption also apply to autocracies.
A further aspect of size in relation to investment activities, could be to define
as large a fund that is larger than comparable funds that invest in the same kinds
of markets. In most types of business activities, it may be advantageous to be large
according to this definition, at least up to a threshold. One might through large size
become a force to recon with, in the eyes of other players. A large fund, would also
be in an industry that others want to be on good terms with, to cooperate or receive
invitations to joint ventures, and so on. However, the financially most interesting
effect of large size of SWFs, may be that large size could hamper the actions of large
funds. Small funds may trade on market prices without influencing them much, and
may thus more than large funds face an extensive menu of attractive transactions to
4.2 The Management of Large Funds 127

consider. Large size may therefore be a disadvantage. Another way of expressing the
same, is that activities that a large fund may contemplate to undertake, might not be
scalable. This makes it more demanding to come up with transaction-based ideas in
the management of the fund. In isolation, this should mean somewhat lower returns
than for otherwise comparable funds of smaller size.
Consider, for instance, the prospects for creating incremental returns through the
exploitation of some type of market inefficiency, for instance a reported tendency
by the market to underprice a complex asset due to neglect of one or more of its
specific characteristics. A manager of a small fund might be able to benefit from this
to a considerable extent, and so enhance his overall rate of return. His colleagues
in large firms, however, may not have that opportunity. Some such anomalies may
exist mainly because large players don’t exploit them. A characteristic of such inef-
ficiencies is indeed that they tend to disappear once someone of size notices their
existence and tries to capitalize on them. Many profitable arbitrage activities are thus
not very scalable. This implies, ceteris paribus, an advantage for small players in the
exploitation of known inefficiencies, where transactions are non-scalable.
A restatement of this, is that transactions in the large volumes that would be
meaningful for large players would often move market prices by creating a change in
the balance of supply and demand. This could reduce or erase any earlier exploitable
inefficiencies, particularly in the often ‘thin’ markets where economically meaningful
anomalies are most often spotted. Clearly, this problem would increase with the size
of a potential party to a contemplated transaction. There may sometimes also be
a tendency to see transactions by large players as moves by ‘smart money’ that
others could be well-advised to follow. Such tendencies could further strengthen
the operational disadvantage of units of large size in taking advantage of pricing
anomalies.
By the same token, it becomes more troubling and questionable to assume risk
in the form of departure from the strategic benchmark portfolio for a large than for
a small firm. Absolute economic size might thus matter for investment operations,
particularly if benchmarks are made to mirror possible investments in the market
and if alternatives to these investments may be few and far between. The occasions
where other large entities are happy to accept opposite bets or positioning may be
rare. Although the latter cannot be ruled out, that stance could be undertaken for a
reason that could make one think twice with regard to the value of one’s own strategy.
It is possible to choose to be small by design. Activities of large scale can always
be split up, and if needed new organizational entities may also be established. This
is at least possible. The splitting-off of units, however, is likely to entail higher
administrative costs. It may also lead to a weakened bargaining position in some
contexts. By contrast, it is not possible to choose to be larger than the available
funds permit, disregarding strategies of leveraged investment with borrowed funds.
Leveraged activities in the investment markets could, depending on the nature of the
investments and degree of leverage, be judged as too risky for SWFs.
An argument for splitting up a large operation, could be to spread the risks asso-
ciated with the managers of a fund. This risk may still be underemphasized and
under-researched. If all the capital is concentrated in one fund, the manager risk
128 4 Investment in Practice

applies to all capital. If, instead, two funds are established, the original manager
risk—with its likely ups and downs—will apply to only half the capital. Depending
on the degree of freedom in operations, the diversification of risk in this respect
could also be of some value. If a large fund was divided to create two smaller units,
one could, however, risk that the two units would try to copy each other in order to
manage risks. One could then need regulation to make each of the parts concentrate
on some specific tasks.
Through considerations along the lines suggested above, one could arrive at a
range of suitable sizes with respect to specific investment tasks, which should not
be too different from that of actual entities in the same market—in this context large
pension funds and the SWFs of other governments. It may be somewhat surprising
that the GPF-G of Norway is the world’s largest SWF. Unsurprisingly, governments
of some larger states, inter alia those of China and Saudi Arabia, have invested more
money in SWFs. These states, however, have chosen to establish several funds for
their long-term investments, all of which have thus far been smaller than the GPF-G.
More nearby there are several Swedish pension funds, not one large fund. Different
practices regarding the size of such funds could reflect particularly good conditions
for one large Fund in the Norwegian case. Or it could be that different factors and/or
weights have been applied in the different instances. If one wanted to argue that size
doesn’t matter, the different choices on size could also be coincidental. In any event,
the fact that others have avoided to run entities of sizes that could compare to the
GPF-G, could be a reason to further analyze this aspect of the management of large
funds. One large fund is no doubt good for oversight, but probably not so good from
the perspective of room of maneuver.
In a quite different domain, several Nordic countries have chosen a value added
tax (VAT) of 25 per cent, which is probably the world’s highest. It is known from
economic theory that the VAT has more beneficial efficiency implications than alter-
native forms of taxation. Further, it is usual to apply a number of different taxes
to minimize the impact from the various taxes on economic behavior, and thus effi-
ciency. A beneficial characteristic of the VAT is its ease of collection; about everyone
who runs a business has to collect this tax for the authorities. However, beyond a
given, high level of the VAT which is difficult to determine, the beneficial char-
acteristics probably decline. If one chooses to implement the highest VAT rate in
the industrialized world, as in the Nordic countries, one could suspect at least that
further increases in this tax could be ill-advised: One should consider why all the
peers preferred lower rates.
An analogous line of reasoning could perhap apply in assessment of the optimal
size of a SWF: The GPF-G is said to be the largest single fund in the world, with a
capital exceeding 1.000 billion, or one trillion U. S. dollars. The fund may therefore
be larger than the optimal size. Although one cannot conclude based on such a simple
argument, the burden of proof should perhaps be on those who want to deviate from
the usual behavior in the investment industry. One important implication of a smaller
size, could be a reduction of attention from the environment with respect to its
operations. Financial wealth is by itself very visible, and a large fund could be more
visible than several smaller ones of the same combined size. Further, size may have
4.2 The Management of Large Funds 129

a grip on the mind, in the sense that many may feel a requirement to stay current on
what the largest player might be up to. Some could also want to copy the decisions and
behavior of the largest players. In view of performance, less attention could probably
be beneficial, both operationally and financially. Attention could potentially impact
on the behavior of both political groups at home and other states and NGOs abroad,
and it could perhaps be particularly negative for a small, highly solvent state. Cash
and financial assets have, unlike undeveloped oil under the seabed, also attracted
a lot of attention that could instigate various forms of rent-seeking activities. One
could speculate that increased attention paid to a stock of wealth in a large fund,
in domestic politics as well as in foreign relations, could strengthen some types of
pressures that could translate into increased spending, and therefore also a shorter
time horizon of the investments.

4.2.4 Large Size Tends to Dampen Returns

As indicated above, large size is not of help in some of the strategies applied to earn
high risk-adjusted returns. An important reason is that the transaction sizes that are
done by large investors have the potential to move market prices in an unfavorable
direction for the party that initiates a trade. It may therefore become increasingly
difficult the larger the transaction size to execute any intended volume. For a large
investor, this underscores the importance of spreading investments out on available
markets and investment vehicles. This, however, could be of limited help if the
investor has such large investment needs that it will end up owning a considerable
fraction of the issued stocks and fixed-income securities that are available in the
respective markets. This can also be viewed as a reflection of the simple fact that
an investor who owned all securities of an asset class would by definition earn the
market return on his or her securities holdings. Further, it reflects that there could be
few counterparties to work with if or when one intends to make transactions of large
sizes relative to the respective markets. Small investors have more room of maneuver,
and do not need to consider these points to the same extent as large investors.
As mentioned, the GPF-G may own a considerable part in many markets, for
instance it owns around 2 per cent of the outstanding stocks in a number of stock
markets. For individual companies that do not represent listed real estate, there is an
upper bound on stock ownership at 10 per cent. The largest such holding was at 9.6
per cent at yearend 2019. The highest ownership ratio in a listed real estate firm stood
at 25.9 per cent.25 A net change in demand that is large in relation to the respective
markets, can always impact on the prices received or paid in securities’ transactions.
For instance, the stocks may not be for sale in the required volume at a current
market price. If one wants to increase the holdings above 2 per cent of the outstanding
volume in a share, it may be difficult to attract the required sellers without bidding up

25 According to Norwegian Ministry of Finance (2020a, b, c). There is no such cap for listed real

estate.
130 4 Investment in Practice

the price significantly—which would also amount to a lowering of the prospective

return. The same could also apply to sales of stocks: A significant lowering of the
price could be needed to attract enough buyers. These problems typically make it
difficult to execute trades at good prices, and could thus lower the return for a large
fund relative to the returns of an otherwise similar smaller fund. The point of interest
is not so much that one may already own 2 per cent of the outstanding volume, so that
additional purchases would have to be from the owners of the remaining 98 per cent,
but rather that a player that owns a large part of a market may also tend to effectuate
individual transactions of a large size—that could make it difficult for the respective
counterparties to the trades to quote good-enough prices.
One could make this situation less acute by splitting up a large fund. One would
then accept higher administrative costs to be able to organize in several units that may
operate with autonomy vis-à-vis each other. This could make one able to benefit from
strategies that would gradually be exhausted if they were pursued for large, combined
volumes, even if one could also end up competing with oneself. Subdivision into
smaller units could still be attractive from the standpoint of the market, at least
if the new units would create an overall more competitive environment. Markets
could also become more liquid to the extent that the different units would submit
offsetting transactions. Whether subdivision into several units would make sense
for the owner of a fund is, however, an open question. A large owner might enjoy
some market power which could be exploited by operating as one large unit, instead
of several smaller ones. One large unit could also be easier to administer. A large
size of a SWF would improve the respective fund manager’s negotiation position
in the relevant environment, also vis-à-vis the state as owner. The owner might
perhaps prefer a strong bargaining position, that cannot easily be achieved with
subdivision and independent decisions.

4.2.5 Stylized Facts of Active Fund Management

The short answer to the question of whether active management pays, is that real
investment managers who put real money on the table have slim chances to beat
the market consistently over time. This applies both to security selection or stock
picking, that is deciding which securities or other investment vehicles to apply, and in
terms of timing the market with respect to the performance of assets or asset classes
over time. In relation to a benchmark constructed to reflect investment opportunities,
excess expected returns ex ante is only possible through increased risk.
It is usually safe to disregard the additional theoretical possibility of supe-
rior analytical skills. This may apply in particular to large funds with many staff
members. The personnel are most often recruited from the same pool of financial
experts as in other firms or units in the industry. They are also to a large extent exposed
to the same environment. That most persons are quite ordinary people, suggests that
analytical capabilities will be normally distributed—with few exceptionally gifted
individuals. To the extent that some stand out as such, there could also be a tendency
4.2 The Management of Large Funds 131

for them to have higher wages. However, one could suspect that numerous other
attributes could lead to high wages in investments as in other industries. This last point
could, however, be less important in relation to a large investment fund. Although
hard working and successful people can sometimes beat a performance benchmark
by some basis points, depending on just how this yardstick is constructed, they are
unlikely to beat the market over time without absorbing risks. The other side of this
coin is that consistent high returns may suggest some sort of measurement error.
A benchmark may for instance be constructed in a way that provides some ‘slack’
that can in many circumstances be relied upon to beat it.
Ex post and in the short run, the return may also deviate from the market return
due to arbitrary deviations. Ang et al., op. cit., pointed out that the equity premium
had exhibited a standard deviation of 2 per cent over the last twenty years to 2009. By
a commonly applied rule of thumb, one should thus be prepared for equity premiums
of at least ±4 percentage points. If one also considers fat-tailed distributions the
standard deviation may double compared to the point estimate.26 The range is wide
enough to obscure the true equity premium for quite some time.
In any event, there is good reason to be skeptical towards accounts of consistently
earned, risk-adjusted excessive returns over time. This is, however, different from
claiming that it can never be achieved, it just means that it would be an unrealistic
goal ex ante. In each year, a fraction of the investment managers is likely to ‘get
lucky’ and beat their benchmark indexes big as judged ex post. This luck, however,
is likely to vanish over time, even if it can in principle occasionally last for numerous
years.27 Over time, one’s attitude towards risks will determine the possible realistic
return one could aim for, and the absolute return net of costs would depend on this
in combination with the cost level of a specific investor. If one believes in this, as
one perhaps should and many do, the management costs become a more important
concern for investors.
In spite of the above, there is evidence in empirical data that some fund managers
are better than others. It could thus be a strategy for a manager to hire someone
else to do the investments. Even if this may enhance the returns before costs, such
valuable services will come at a price. Further, as expected, there is no convincing
evidence that managers may consistently beat the market on a cost-adjusted basis. If

26 The approximation is that the distribution is assumed to be normal, implying that about 96 per

cent of the realized data points—the 96 per cent confidence interval—will be within the bounds
of ± two standard deviations. Realized returns will wary more, as the equity premium measures
excess return in relation to fixed-income returns with the highest credit quality, i.e. not an absolute
return level for equities.
27 Malkiel (2016) likens this with the tossing of a coin, where some genius might toss 8 heads in a

row. Thus, even if there were no true abilities, one might become mislead to think that there were.
Although this mechanism is too simple to cover the ability differences between fund managers, it
could shed some light on the likely explanations of differing track records. However, to the extent
that excess returns would not tend to decrease over long time spans, they are likely to imply skill
differences rather than luck. Another mechanism that may make investment management firms look
better than they are, is the tendency to discontinue funds that perform badly and merge them with
large, more successful units. There is thus a survival bias in the favor of successful investment
managers.
132 4 Investment in Practice

actual returns are high, this is likely to reflect exposure to a systematic risk factor. In
relation to that, the above example of fire insurance is relevant. In most years, houses
don’t burn down. However, a small probability still ‘guarantees’ that some houses
will burn over very large time spans. Thus, a fraction of the paid premiums will be
used to cover these events. A case in point is that many investors were able to cash
in on credit and liquidity premiums, by absorbing credit and illiquidity risk from
other market players up to the 2008 financial crisis. When the ‘fire’ struck, however,
these investments were penalized. From then on, fewer players including the GPF-G
benefited considerably more from assuming more of the risks associated with credit
quality and illiquidity. Many knew that it was expected to be profitable to assume
that risk at this time, but lacked the required means to take part. This explains in part
why it was profitable.
The GPF-G seems not to have had internal accounting suited for comparing
active investment strategies with passive indexing strategies further back in time
than 2013.28 If real resources are spent without creating excess risk-adjusted returns,
which is the most likely scenario, this will detract from the value of the fund and thus
allow less consumption over time by those meant to benefit from the investments later
on. The cheaper alternative should have been chosen in many such circumstances. The
ones who promise excess returns in highly competitive investment markets should
be met with skepticism. Further, their track records should be scrutinized. However,
even in the event of an impeccable record, it is important to remember that it could
be due to chance rather than superior skills. As Malkiel, op. cit., pointed out, it does
not take a genius, but rather good luck, to toss a coin and obtain eight heads in a row.
Ang et al., op. cit., emphasized in their 2009 report to the Norwegian Ministry of
Finance that while external mandates to undertake active management could benefit
a SWF, it was particularly important to be aware of the costs of active management.
These authors did not find evidence of any superior ability in the material analyzed
in this context. Rather, they found that there had been exposure to systematic factors
that could alternatively have been accomplished more cheaply. Their recommenda-
tion was to integrate these actual factor exposures into the benchmark. That would
increase the threshold external managers would have to overcome to be considered
to add value, and thereby also limit their ability to charge large commissions.
Ang (2010: 19) later summarized his concern about expenses as follows: “If a
factor can be obtained in an alternative low-cost way, then bringing that factor into
the benchmark raises the bar for portfolio evaluation. This is particularly true for
external management. Why should a SWF pay expensive fees to a fixed-income hedge
fund delivering credit and illiquidity risk, when the SWF could access that much
more cheaply in an internal strategy?” A reasonable interpretation might be that
there had been some overcompensation for the acquisition of a type of risk exposure
that could alternatively have been achieved cheaply in relation to systematic risk
factors. This is important even if the GPF-G appeared as an index fund where the
fraction of the Fund under active management was very small. The latter also made

28 According to a statement by Governor Olsen of Norges Bank to business daily Dagens Næringsliv

20 April 2016.
4.2 The Management of Large Funds 133

any unnecessary costs in the management very small in relation to the fund´s overall
returns as measured in basis points. Of course, unnecessary expenses, if they are that,
would not be justifiable.
According to Ang, op. cit., there is a need for a professional culture in a SWF, with
a relentless focus on minimizing the total expenses. In that author’s view, the NBIM
was an example of such a professional culture. Culture is important in particular
where it is not possible to foresee all possible situations in which decisions must be
made. This is perhaps never truer than in financial management. Culture can then be
a proxy, guaranteeing that decisions will be professionally made and public-spirited:
Decisions may remain less than optimal, but given a good culture things may not go
very wrong. The main implication of this, could be that the owner of a SWF should
contribute to establish the desired type of culture. This may have implications for the
organizational framework that the investments on behalf of a SWF are performed
within.
Interestingly, in relation to the GPF-G external management was hired for the
NBIM mainly in the early years. To a large extent this was needed, for instance
because the central bank did not have personnel with experience from management of
equities, as opposed to fixed-income. However, some of the new personnel distanced
themselves from the central bank culture of their internally hired colleagues, which
they saw as old-fashioned and not very dynamic. In view of the cited piece by Ang
et al., however, the internal culture appears as important for obtaining the public-
spirited mission of the GPF-G. In this author’s view, this may have been important
in the early years of the new investment organization, NBIM. Over time it has since
acquired and developed its own distinct culture. The Gjedrem commission (2017)
argued that it would be wise to separate the investment organization from the central
bank. A separation would presumably not change the culture for a while. In the long
run, this issue could be more open. The proposition of a separation, however, also
considered other arguments that are not covered here.

4.3 Asset Allocation, Management Style, and Returns

4.3.1 Liquidity Needs and Types of Funds

In principle, there are at least three ways to organize a central government’s holding
of capital. First, Foreign Exchange Reserves are held by most independent countries,
either as net assets or as a result of inflation of the balance sheet of the central
government, by borrowing to purchase a stock of foreign reserves.29 The intended use
of such holdings is usually foreign exchange intervention. The funds are available for
that purpose but usually still invested, in highly liquid short-term instruments, in order
to reap a return. Typical investments are government bonds and foreign exchange

29 Asmentioned above, IMF (2008) applies a slightly different typology, where the essence is the
same as here.
134 4 Investment in Practice

deposits at foreign banks, and to some extent commercial paper and other money
market instruments. The time horizon for the investments is very short, since one
cannot know when the funds will be needed—only that there is a high probability that
they may be needed relatively soon. The funds must therefore be available on short
notice, without any substantial penalty in the event of liquidation of the investments.
The key priority is liquidity, and the returns on the assets are thus less important.
They may be very low. This tendency has been particularly marked during the low
interest period that followed after the financial crisis of 2008.
A second type of international assets can be called an Exchange Stabilization
Fund. This could be understood as a second tier of foreign assets held by a central
government—to facilitate the smoothing of developments in the domestic financial
market in response to shocks in international markets. The time-horizon will be
longer than for the foreign exchange reserve holdings, but perhaps not by much:
Unforeseen events could still trigger needs to raise cash quickly. The urgency under
this arrangement would depend on the exact international shocks that one might
want to cushion and the degree of activism in economic policy. The investments
made would include the types for the Foreign Exchange Reserve holdings, and some
more—perhaps with a room for increased exposure with regard to credit risk, if not
illiquidity. Returns on the investment become somewhat more important, even if
liquidity would still be the main concern. This type of funds is sometimes referred
to as Rainy Day Funds, since some shocks are transitory and can be stabilized.
The third tier of foreign assets of a government could be labeled Sovereign Wealth
Fund, or SWF, which is the focus of this book. The name signals that these holdings
are intended to last for the long term. The key concern might be portrayed as one
of transferring wealth to future generations—which could be the case in relation to
financial wealth accumulation due to depletion of non-renewable natural resources.
Investments could in principle include the same types utilized for an Exchange Stabi-
lization fund type—but would be more open to additional risk exposure of various
forms. For this type of investments, returns play a much more important role than for
the two types of fund arrangements discussed above. The reason lies in the assump-
tion that the assets will be held for the long term. When funds are invested for the long
term, differences in realized returns become much more important for the absolute
level of gains than under short time horizons. A long term horizon should also make
it realistic to acquire more types of risk exposure and still maintain an acceptable
overall risk level.
The probability of realizing losses declines with the investment horizon. If the
investments are truly for the long term, there should thus be room for a considerable
additional risk exposure in relation to an Exchange Stabilization Fund. However, as
discussed above, the length of the time horizon of investments does not only depend
on the view of the owner(s) at the point in time when the relevant investment decisions
are made. As also discussed, the time horizon of a fund is unlikely to remain constant:
It might become severely shortened under certain, unforeseen circumstances. The
types of possible dramatic events that could trigger large changes in how the owners
view the time horizon, often receive little attention before they take place. Some of
the same forces that are set in motion by financial crises may also put pressure on
4.3 Asset Allocation, Management Style, and Returns 135

decision-makers to shorten the time horizon of financial investments. The reason for
a change, could for instance be that in a different situation it could be in the interest
of the owners to spend more and sooner.
Investment markets are impacted upon by investor behavior. Types of events
expected to be rare could become more frequent, and vice versa, if the type of behavior
that have given rise to expectations of relative frequencies or when someone tries
to exploit them. For instance, when interest rates were lowered in 2008 and later,
funding costs decreased. Some investors took advantage of this by borrowing in
the short end and investing in instruments with higher risk, either because of term
premia, credit risk, illiquidity or some other phenomenon. This new, riskier behavior
has been needed in order to earn meaningful returns. However, it is still risky to buy
the riskier assets in particular after their prices have been bid up. This also means that
the probabilities of certain types of events evolve over time: Those of the past may
no longer apply. A previous small risk of some unfortunate event might thus have
increased. Otherwise unlikely processes could be set in motion, e.g. if several players
were forced to reverse their positions at the same time. Effect like this could resemble
herd behavior known from other markets and magnify asset price fluctuations.
A SWF may be operated for multiple purposes. The pure accumulation and trans-
formation of capital into the future by itself implies a long time horizon. If there are
also other objectives, however, the investment horizon could be impacted upon by
other factors, including financial market developments, and be significantly short-
ened, in a more pressing way than in relation to a distant infinity. For instance, a
fraction of the fund could be understood as a rainy day fund, with an expected quite
short duration, say up to a few years. The expected time horizon of a multi-purpose
fund, could then depend on the relative sizes of the different parts.
The GPF-G is intended to benefit both future generations and the current one.
The aim is as mentioned to spend the expected real returns on the investment of
the Fund over time, which would produce a steady spending pattern. It would also
imply under-consumption compared to the permanent income criterion. If we assume
continued GDP growth of a 2–3 percent per year, however, under-consumption would
decline over time in relation to GDP. This plan, however, remains an intention. Over
the long haul it can be expected to change. As mentioned, it would requires no more
than a regular majority decision by Parliament to change the technically infinite time
horizon.
A further aspect in relation to size, is that for the GPF-G liquidity may be more
important than the organizational design that determines the size of its operational
units. Liquidity needs might arise under dire circumstances where demands for capital
at short notice could also lead to changes with respect to the fraction that will be
transferred into the future.
As discussed above, the investment horizon could be shortened by financial
distress. In the case of Norway, a sharp and persistent decline in the prices of oil and
gas could suffice. The hydrocarbon deposits that made the Fund a reality, still play
a prominent role in the composition of exports, even if an increasing share of the
income for the GPF-G is due to investment returns. An oil-related shortfall in govern-
ment income could thus still lead to pressures in public finances, as exhibited by the
136 4 Investment in Practice

significant price decline since 2014. There seems to be a strong willingness, and
associated political pressures, to spend significant additional funds through public
budgets to counteract the effects of negative oil price shocks. This resulted in a
net withdrawal of capital from the GPF-G in 2016, for the first time to date. This
effect may still not be dramatic. One could expect a lesser tendency for applying
increased public spending to stabilize income shortfalls that last long.
The inflow from resource sales is set to taper off over time, and thus to become
smaller over time than the expenses previously financed from the Fund. However,
the decline in the oil price by roughly one half from 2014 to 2016, by now seems
quite permanent and could warrant lower future oil price expectations. Although the
price of oil recovered throughout 2017 and recovered in the first quarter of 2018, to
70 dollars per barrel for the first time in some 3 ½ years, prices have since declined.
In the winter of 2020, the price again fell, first to a level in the low 30s, and by
early April 2020 to about 25 in U.S. dollar terms. Even if the circumstances were
very special, and were influenced both by the Covid-19 pandemic and cooperation
problems between OPEC and Russia, low prices and high volatility mark recent oil
price developments. Throughout 2020 the price climbed again to a level above 50
dollars per barrel at yearend. This trend continued into 2021. The overall picture is
therefore one of reduced oil prices since 2014, but also of high volatility of oil prices.
The most dramatic effect of the turmoil of the first half of 2020, was the collapse in
international stock markets early in the year. This made the value of the Fund decline
sharply. As mentioned, the FTSE Global All Cap stock market index declined by 34
per cent from 12 February to 13 March 2020.30 The reported value in Norwegian
kroner, at 960.000 billion as of 13 March 2020, should also be adjusted for a decline
in the krone of about 10 per cent to reflect reduced international purchasing power.
International stock markets rebounded in the second quarter and throughout the year.
The hard-hit stock portfolio recovered in the fall. Towards the end of 2020, stock
prices increased further in response to improved prospects for the future provided
by positive news on effective vaccines against Covid-19 from several large vaccine
producers. This changed the emphasis from the threats of the pandemic to hopes
of a much improved future.31 In the zero interest rate environment, in effect from
spring of 2020 and likely to continue into it not through 2023, the effects on stock
price development has been explosive. Zero interest rates mean that all who need to
produce positive yields will have to accept some risk, in the main either equity risk
or credit risk—which is also related to equity risk.
With respect to the GPF-G one should keep in mind that the resources that made
the investments possible were finite. This, in addition to the low returns in fixed-
income markets, could suggest that the Fund could have reached its peak real capital
level in 2020. What could make this unlikely, however, is the amount of risk assumed
by allocating 70 per cent to stocks, and allowing in addition for up to 7 per cent in real
estate. In expectation, the return of the fund could well be greater than the growth

30 Accordingto Norwegian Ministry of Finance (2020a, b, c).

31 For
2020 the Dow Jones Industrial Average, the Standard & Poor 500 and the technology-heavy
Nasdaq Composite indexes increased by 0.7, 16.3, and 24.3 per cent, respectively.
4.3 Asset Allocation, Management Style, and Returns 137

rate of GDP for mainland Norway.32 The limits on spending at 3 per cent per year is
due to a conservative estimate which could understate real returns. The transfers to
the budget could decline relative to the size of the economy, which may perhaps grow
at 2–3 per cent. If about all real returns are spent according to plan, the Fund could
decline relative to a growing economy: The GPF-G could grow slower than real,
mainland GDP in expectation. Further, in the long run spending could be adjusted to
consume returns, including high ones.
A perhaps stronger signal of the limited nature of even this large fund in rela-
tion to GDP, might lie in Norway’s strong, demonstrated appetite for imports. Most
consumer goods are imported, and the share of raw materials in Norwegian exports
remains substantial even if one adjusts for the large exports of hydrocarbons. There
is a strong need for imports to cover both public and private consumption. Further,
imports of large sizes are also needed in relation to oil and gas operations. This
implies a high demand for foreign currencies, and a correspondingly large offer of
kroner in the foreign exchange market. The market mechanism that can limit the
high import propensity is a weaker currency in real terms, either through nominal
depreciation, which we have seen quite a bit of in recent years—and which appears as
insufficient at tolerable exchange rate levels, or in terms of higher inflation. We have
not seen much inflation after the crisis of 2008, but inflation could rise in the near
future, reflecting inter alia mark-up pricing for many imports. Also internationally,
e.g. in the United States, inflation expectations have been on the rise lately.

4.3.2 Is Cash Still King?

The expression ‘cash is king’ refers to situations of strain in financial markets, which
tend to come and go over time. One extreme example is the situation that followed the
bankruptcy of the large investment bank Lehman Brothers, in September 2008. Since
it was not expected that this institution would be allowed to go bust, subject to the
too-big-to-fail argument, this failure had profound and widespread consequences.
Many investments instantly lost a large share of their value due to an increased
preference among investors for more liquid assets—in the limit cash. For anyone
wanting to withdraw funds from their investments, cash and cash-like investments
outperformed other asset types. This situation lasted for a while. If one fears that
something bad might happen to asset prices one can protect oneself by investing less,
that is by holding cash. Cash is king also reflects that for most investors investments
are made to support other, more important goals than the investments per se. The
other goals can often be satisfied by spending cash, even if there may be foregone

32 A simple back-of-the-envelope calculation, assuming returns from stocks, real estate, and bond

of 4, 2 ½ and 1 per cent, respectively, would suggest an outcome at about 3.2 per cent. The value of
this crude calculation is limited by our confidence in the input, as the true future returns are never
known ahead of time. In the latest years the GPF-G returns have been in the 5–6 pct. range for 2017
and 2018, nearly 18 per cent for 2019 and about 11 per cent for 2020. In view of this, one could
think that the best expectation of future returns may well be larger than 3 per cent p. a.
138 4 Investment in Practice

income from not absorbing market risk on one’s holdings, in particular if this is
maintained over time. If goals of higher priorities suggest that the capital should be
used for other purposes, the assets must first be converted into cash. Occasionally,
urges to sell may arise at the same time among several large players. There may
thus be a sleeping liquidity preference that might suddenly awaken, to cause assets
to be sold at large discounts during and shortly after crises, in what might resemble
fire sales. Many different changes can lead to the development of such a scenario.
For instance, developments in either politics, social life, economics, asset markets,
or other markets, could become triggers. A sell-off of illiquid assets could reflect a
reduced length of the investment horizon among the sellers on the aggregate.
Illiquidity means that an asset cannot be expected to be sold quickly at a fair
price. This is why asset prices may be sharply discounted in periods of market
turmoil. During such negative developments, the holding of illiquid investments
may cause stress. There are many examples of illiquid assets. Unlisted real estate and
many investments in emerging markets can be included. A quick sale of such assets
might require sharply discounted price, detrimental to returns on the investments
and capital preservation. Liquid long-term investors can accumulate new holdings.
Expectations that one or more large investor might become trapped due to such
circumstances, may cause stress and may in some instances be self-fulfilling. The
latter possibility is analogous to speculative attacks on fixed exchange rates, with an
unknown probability that a given transaction can set in train mechanisms that may
move the market.33 Investors don’t usually operate under full transparency, inter alia
to safeguard their operations. The private information they hold may, however, give
rise to speculation by other players for instance regarding unrealized capital losses,
financial vulnerabilities, or the likelihood of forced asset sales in the near future.
The GPF-G has so far been a large investor with ample liquidity, able to capitalize
on market turmoil by absorbing and accumulating holdings of illiquid assets and
assets with credit exposure. The latter type may perform in a fashion similar to that
of illiquid assets due to the increased default risk in a crisis. The stance adopted
after the financial crisis hit in 2008, of absorbing such exposure, was a large success
in this respect. If the Fund’s time horizon remains long in the future, and if one is
comfortable with the risk, it may be profitable to maintain that stance.
Unsurprisingly, activities aimed at the harvesting of liquidity premiums are not
risk-free. If one will need the money sooner than according to earlier expectations, one
could end up paying more than formerly collected premia to get out. Liquidity is rarely
guaranteed in such markets. This could apply with particular force if premia were
collected under tranquil market conditions for large volumes and later cash needs
developed under less tranquil conditions, as they may tend to do. To be successful
over time, it is of paramount importance to keep the probability of any fire sales low.
This is simply a restatement of there being no free lunch. Investors are willing to pay

33 Even if the price of liquidity in investment markets is not pegged under normal times, the large

movements in price of liquidity in relation to market turmoil, might overshadow the variations in
price prior to this development. Speculative attacks on fixed exchange rates have been analyzed, e.g.,
by Krugman (1979, and later) and Obstfeld (1994, and later). A source that tracks diverse financial
crisis across time and space, is Reinhart and Rogoff (2009).
4.3 Asset Allocation, Management Style, and Returns 139

for liquidity. As mentioned, unforeseen liquidity needs may surface simultaneously

for many. They may find themselves aiming for the same narrow doorway. If such
scenarios were not expected by investors, the ‘fire insurance sellers’ would not have
been able to collect liquidity premia in the first place.
As of yet, no other industries in Norway have been developed that can rival oil and
gas when it comes to export value. Developments in, e.g., seafood and fish farming in
recent years have not changed this picture. Although promising, these two industries
still have incomes of a different order of magnitude, and also appear as more exposed
than hydrocarbon extraction to political risks when it comes to access to the relevant
export markets. Fossil fuels are more needed by the importing countries, and can as
homogenous commodities be sold anywhere at world market prices.

4.3.3 ‘Best-Practice’ Factors in Financial Management

The principles of good fund management may be quite intricate, even if only the
financial aspects covered thus far are considered. As in some other fields of complex
management, ‘best practice’ guidelines have been suggested. These may be informa-
tive with regard to room for improvement in many instances, but are not encompassing
and must therefore be handled with some care.
As Rodrik (2008) made clear, in another context, best practice is a useful bench-
mark if the relevant country or setting faces a choice where the first best principle
can be applied. In the real world, by contrast, design choices are made in contexts
with deviation from optimal conditions in other important regards. This implies that
the second best principle should be applied.34 In the real world, best practice may
not be the best possible choice if one considers how the respective agents in a field
actually operate, for instance to neutralize other shortcomings. Rodrik applied as an
example a thriving economy in Vietnam, in spite of very serious shortcomings in
this country’s judiciary. Firms made up for this, e.g., by being careful with regard to
choice of contract parties and monitoring closely the fulfilment of contracts. Even if
challenges in the judiciary were more severe than in many African states, correcting
these shortcomings was according to that author hardly the best strategy to promote
growth. Indeed, such a strategy could backfire: If cheaters in business relationships
obtained an outside option, the costs of reneging on agreements could decline so as
to make not keeping agreements a more attractive choice.
Clark and Urwin (2008) developed an analytical framework for assessing what
they refer to as the governance architecture of SWFs they studied, in terms of
institutional coherence, people, and process. This work was written for interested

34 Related to this, Acemoglu and Robinson (2013) pointed out that in policy advice that aim to
reduce market failures and distortions, the political effects of contemplated reforms must also be
taken into account. One should be particularly careful when already strong interests in a society
would stand to gain from a proposed reform. If already strong groups gain further strength, the
effects of an otherwise wanted reform could be negative.
140 4 Investment in Practice

academics and the institutional investment industry. Further, Clark et al. (2013: 158–
162) referred to best-practice investment management, while referring to the work
of Clark and Urwin, op. cit. and later refinements of that work.
Even if one may be skeptical with regard to the utility of this kind of broad gener-
alizations, the framework may be suited to highlight some very important concerns
and considerations in the operation of SWFs. The most important caveat may, as
suggested, be that such guidelines may not be comprehensive enough in a complex
and changing environment, and thus could be misleading. Some comments on the
scheme is made below, with that qualification in mind, and briefly commented on
with reference to the GPF-G. The principles must be evaluated in their appropriate
context.

4.3.3.1 Institutional Coherence

The conditions underlying a SWF must satisfy a willingness to save the funds for
the future, rather than consuming them. This willingness to save, however, cannot be
taken for granted. As saving is typically conceived of as painful, there must usually
be a perceived need to save. The SWF could be an instrument suited for the fulfilment
of a savings plan that the government sees as good for the country, but that would be
difficult to fulfill without a SWF. However, it is not easy to see how the establishment
of a SWF by itself could establish the required savings motive, which is required for
the operation to be legitimate. States may in this respect—due to various processes—
resemble individuals who may have a hard time restraining themselves, and may thus
commit acts that in sum do not well take care of their interests.

4.3.3.2 Operations and Staff

The investment operation determines the needs in terms of organizational capabilities

and employees. The example of the GPF-G may illustrate how demanding it is to
establish a large operation. It could also illustrate that this task is unlikely to be
less demanding in the future. Much like in other government organizations, there
is a strong impetus for growth, given the resources allocated to management and
with respect to the range and complexity of tasks that one wants to undertake. It is
bound to be demanding for the government as owner to manage a large apparatus of
professional and specialized staff in a domain that usually receives little attention.
Even if the management costs appear small when measured in basis points, the
sums spent are very large compared to almost everything else in Norwegian public
administration. In 2019, the costs came in at 5 basis points, and during the latest few
years just above 5 basis points.35 Even if this is low compared to practically all other

35 While some funds undoubtedly have much larger costs measured in basis points, there are also

examples of index funds available for small retail investors that charge less than 5 basis points for
their service. Examples include the Fidelity and Vanguard mutual funds tracking the Standard &
4.3 Asset Allocation, Management Style, and Returns 141

large funds, it exceeds 5 billion kroner, or about U. S. dollars 600 million, at the
exchange rate at the close of 2020. For 2021, an allowance for management costs
has been given for the first time as a fixed krone amount.36
The manager NBIM has benefited from good operational knowhow and expertise,
but not least for a public-spirited culture among its staff from the outset—see Ang
et al., op. cit. This is atypical for the financial industry, and of large value in relation
to the mission that resulted in the creation of the GPF-G. Although the organization
today is more advanced and much larger than the central bank’s department for
investment of foreign currency reserves, which was its origin, it is difficult to think
that building the new unit could else have been equally successful.
In other words, the initially not fully appreciated central bank culture proved to
be both an advantage and, at least to some extent, scalable. This may have increased
the legitimacy of the Fund and its mission of transferring wealth into the future with
the population. It has most likely also limited the incurred cost increases over time.

4.3.3.3 Investment Process

The investment process may also be a challenge. It might be less easy than one could
think to excel, as evolution is needed over time. In order to deliver good results,
one needs to be in the forefront of the field and experience to be there. It is of
paramount importance for a long-term investment operation to deliver the highest
possible returns, adjusted for risk and after costs. If one should not be able keep up
this task sufficiently, public support for the savings operation could vane. Chances
would increase that many could find excuses and rationales to spend the funds faster
than one had planned for. Many stands ready with great creativity in proposing
projects to be funded by publicly owned resources, that some may hope to benefit
from also privately.
What matters in the fund management is future international purchasing power,
that is the Fund’s returns and future value in foreign currency—dollars or euros and
cents. The asset class allocation is made with a view to the likelihood of asset price
changes over time. It is judged as likely ex ante that stocks will increase in value
because they most often have and there are theoretical reasons to require a high
return, even if this is always unknown ahead of time. Thus, one also needs not to
be wrong regarding the large, strategic decisions on allocation of funds to various
asset classes. The single most important decision is the percentage of the fund to be
invested in stocks, or the allocation to equity.
One could have looked smart and lucky till February 2020, when the international
stock markets were severely hit by the development due to the Covid-19 virus disease.
From March, the disease was declared a pandemic by the WHO. In economic terms,
this was a kind of severe shock not experienced for a very long time, that the world

Poor 500 index, which cover about 80 per cent of the U. S. stock market by valuation. These funds’
expense ratio is only 1½ and 3 basis points, respectively.
36 Source: Norwegian Ministry of Finance (2020a, b, c).
142 4 Investment in Practice

was not prepared for. In the course of a few weeks stock values dwindled, with
purchasing power in the thousands of billon dollars evaporating. This hard facts
were partly obscured in Norway by the krone reporting currency, which depreciated
sharply in relation to most other currencies. This made a dramatic temporary shortfall
in international purchasing power appear less dramatic to non-experts. The Fund
appeared to maintain a quite high value measured in kroner through the crisis. For
experts, the high equity allocation at 70 per cent represented a bold bet. By some good
luck, the decline in stocks was reversed and a net gain secured from the second quarter
and through 2020. The krone was weak but off lows later in the year, again buffering
changes in the reported figures.
The motivation and operation for the GPF-G has been mainly economic. The main
point is to earn returns when the funds are transferred forward, into the future. This
implies that sound financial results are needed to keep the operation legitimate and
well-worth. The almost pure financial motive may differ from those of some other
SWFs operate. The simple aim is to buy into a fraction of the world’s productive
capacity, analogously to what economist or investment advisers could recommend
for individual investors. To the best of this author’s knowledge, there has not been
any thinking of exploiting strong finances for political purposes. Even if Norwegian
governments could have liked to experience a larger impact in world international
affairs than the country’s population or GDP could in isolation suggest, there does
not seem to be any reason to suspect that the GPF-G could be utilized to pursue
aspirations linked to foreign policy.
This may run counter to some views on how SWFs have operated, at least prior
to about 2007, in view of e.g. Truman (2008), Balding (2012) and Clark et al., op.
cit. A much referred-to article by Kimmit, op. cit., was titled Public Footprints in
Private Markets. It could appear to be expected that financial markets should mainly
be reserved for the private sector, and that SWFs were or could be used for polit-
ical purposes. At the time, not much research had been done on SWFs. This has
later changed markedly. According to Kotter and Ugur (2011), foreign government
ownership raised concerns in recipient countries in view of empirical evidence on
inefficiencies associated with government ownership, and concerns were raised about
some SWFs’ investment activities that were intensified by a lack of transparency
about these funds. These authors found that SWFs appeared as similar to institutional
investors in their preference for target characteristics and in their impact on target firm
performance, and further that SWF transparency influenced SWFs’ investment activ-
ities and their impact on target firm value. A positive effect of investments by SWFs
in private firms may be raised awareness of potential problems and communication
of the views of the managers of SWFs in that context. The GPF-G communicates
with private players e.g. through memoranda on behavioral expectations of firms.
The view that SWFs can be or are used for political purposes, were also expressed
by Cumming et al. (2017), in The Oxford Handbook of Sovereign Wealth Funds.37

37 The Handbook starts out as follows: “Sovereign Wealth Funds (SWFs) represent both an increas-

ingly important – and potentially dominant – category of alternative investor, and a novel form
for governments to protect their interests both at home and abroad. As such, they represent both
4.3 Asset Allocation, Management Style, and Returns 143

The issue of whether the GPF-G could be used as a foreign policy instrument has
to this author’s knowledge not been explicitly discussed in Norway. The official
view that the Fund’s objectives are financial seem to have been fully accepted by
the public. As in other locations, one could not rule out that some individual policy
maker could be willing to use the SWF politically, at least if no substantial costs were
expected. Such decisions would, however, need to be collective. Further, the public
could be skeptic, e.g., because the mixing of finance and politics could be costly.
For a small, peaceful state there may be little to gain from the flexing of financial
muscles. Norway’s overall power resources are limited, and must be applied with
care. Further, the investment strategy outlined above spreads the funds out on many
different investments. This would be counterproductive if obtaining political leverage
was an important aim. The Fund owns 1.4 per cent of all listed stocks globally.38 Large
holdings in stocks of individual companies are rare, and the GPF-G is not allowed
to own more than 10 per cent in any one company.39 Politics therefore appears
most important in relation to the possible exclusion of companies whose activities
are viewed as problematic in relation to ethical guidelines. These guidelines are
discussed in Chap. 5. They are mainly standards of conduct, that are agreed-upon
by most governments. Even in this limited context, it might be uncomfortable to
convey negative information to the parties it may concern. Any attempt to use the
Fund to exert political pressure, beyond reference to widely shared standards of
conduct, would be surprising. If that had been intended, the Fund would probably
have been assembled in a very different way. Therefore, while there may be room
for influencing private firms, there may not be room for power politics.

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Truman, E. 2008. “A Blueprint for Sovereign Wealth Fund Practices”. In Peterson’s Institute for
International Economics Policy Brief no. 3, Washington DC.
Weingast, B. 1995. “The Economic Role of Political Institutions”. Journal of Law, Economics, and
Organization 11 (1): 1–31.
Wilson, C. 2008. Adverse Selection, The New Palgrave Dictionary of Economics, 2nd ed. London:
Palgrave MacMillan.
Chapter 5
The Ethics of Investment

Ethics is a comprehensive and important field. It usually involves constraints on

human behavior—typically that one should restrain oneself in social relations
because one cares for others, too. Even if one should not care for others, one may
be concerned with one’s reputation in that respect. Opportunities may thus not be
exploited if others might have to bear associated costs and this could be visible and
perceived of as unfair. Over time, once hidden or secret facts may tend to be known.
Even deeds that once seemed to pass unnoticed, are likely to become known. For
related reasons, an accumulation of information may be in process regarding whom
not to trust. The good news may be that the worst thinkable outcomes and activities
can often be avoided.
The frame of reference in this part is ethical behavior within the state that operates
a SWF. This means that the ethical standards of the GPF-G are high if the Fund serves
the interests of Norwegians of the current and future generations well, in a broad
context that includes the fulfilment of strong, important norms of the international
community, such as avoiding corruption, crime and human rights abuses. I do not
address global justice stances, that may find it objectionable for a coastal state to
appropriate the hydrocarbon resources in its economic zone.1 The discussion accepts

1 An example of this, is Armstrong (2013), who thinks that Norwegians have extracted resources
that others, needier, could claim—morally if not legally: Should a tax be levied to the benefit of
all the world’s needy? One can understand that the accumulation of a large fund based on natural
resource sales to the benefit of nationals of one state might lead to feelings of injustice elsewhere.
Armstrong’s argument, however, seems to raise more questions than it answers. The World would
have been very different with alternative natural resources rights assignments. First, it could have
been much more demanding to develop the resources. Second, as Segal (2014) pointed out in the
following issue of Ethics & International Affairs, the most important constraint on global pro-poor
spending are national, not global. Segal cited Nigeria as an example: In 2011, 54 per cent of its
population lived below PPP $ 1.25 per day, which adds up to less than 60 per cent of that year’s per
capita oil rents of PPP $ 742. Føllesdal (2014) pointed out, also in the next issue of the journal, that
global justice had been discussed internally in Norway in relation to the SWF, which was rare for

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 145
O. B. Røste, Norway’s Sovereign Wealth Fund, Natural Resource
Management and Policy 54, https://doi.org/10.1007/978-3-030-74107-5_5
146 5 The Ethics of Investment

how the World’s states have divided rights to minerals and natural resources between
them.
It can be argued that investment is a very general type of activity, and that there
may thus not be a specific type of ethics that applies to investments. In any event, a
set of concerns and questions arises more typically for investors than for others. This
is due not least to capital being a scarce resource that many may compete to qualify
for the use of. This enhances the bargaining power of capital owners, who may be
approached by many prospective users and from different angels.
Within the group of SWF investors there may be specific related needs, in partic-
ular for funds based in democratic societies. The term ethical investment makes good
sense in general, and in particular in relation to self-restraint for the owners of SWFs.
Ethics was never unimportant for states. Its importance has grown over the recent
decades in several fields, including investments.
The norms referred to in ethics may differ between cultures. What is deemed
as ethically responsible in one country could therefore be seen as irresponsible in
another. Even if there may be common ground among many parties on some key
issues, there is no single ‘ethical truth’. However, common undertakings, e.g. in
relation to international conventions and humanitarian law made and respected by
various states, may unify and integrate the positions of many actors.
Often situations that raise ethical concerns may involve negative external effects
of one’s actions that affect other players. The ethical issues that arise for investors
may often be linked to quick profit opportunities, often with associated significant
costs or other burdens arising for others.
In most social settings, agents that depend on one another have both some common
and some opposing interests. The common interest may lie in creating a surplus
together, that would not or could not arise without the combined contribution of
several parties. Once created, however, the surplus could be divided between the
participants subject to certain criteria that might have been agreed-upon earlier,
perhaps after bargaining. One possible unethical investor behavior, is the financing
of specific kinds of entities or activities that may facilitate and/or proliferate activ-
ities that are perceived of as unethical. Activities can either be undertaken directly
or indirectly. There are many examples. One could be the production of goods or
services for sale. If a product leads to negative consequences when it is produced, or
has negative consequences in its normal or intended use, it’s provision may be judged
as unethical. This could result in discontent with all that take part in providing that
product the way this is done, including those who finance the relevant activities.
An indirect negative effect could stem, e.g., from the funding of a business entity
which performs business with parties known to be involved in unethical undertak-
ings—or which is known not to pay much attention to ethical concerns in its business
activities. This could lead to various types of critique. Although increased attention is
paid to ethics, including through indirect effects of actions, the most indirect effects

SWFs, and that Norway provided foreign aid of U. S. dollars 4.9 billion in 2013, i.e. of a magnitude
that could resemble a hypothetical tax on her receipts from hydrocarbon sales.
5 The Ethics of Investment 147

of most investors’ activities escape scrutiny. There are simply too many such possi-
bilities for one to consider. This would apply with particular force to large funds that
finance a broad range of activities across sectors and space.
In social life investors may have good reasons to care not only for returns, but
also successful outcomes in a broader sense. In any event, they are usually concerned
about their reputation. Unethical behavior may be sanctioned by others, also if a party
may seem to get away with unethical activities for a while. Investment is hardly
an exception to this general pattern, and the punishment of certain behaviors may
translate into losses, financially or otherwise. Since the stakes are typically high in
investment activities, it is important for investors to avoid negative surprises that are
avoidable. This is a good reason to be concerned with ethics, also for players caring
mainly for themselves. If investors could choose, they would probably prefer to play
games governed by laws of nature, or by God, rather against creatures of God with
their own laws-humans. This option is, however, not available. They need to perform
in the games they are in, which is likely to be reflected in their activities.
The same applies to the managers of SWFs, even if their official role and affilia-
tion may imply some resilience with respect to reputation. Managers of SWFs must
also occasionally pay more attention to their reputation than private investors. The
reason is that a bad reputation may have more serious consequences for a govern-
ment than a business firm. In a worst-case scenario, a business operation can be
relocated, discontinued, or restarted under a new name. The ‘new’ firm could then to
a lesser extent than its predecessor be impacted even by an earned negative image.
This defensive option is not available for the government of a country: A worsened
reputation due to investment activities could in the worst-case spill over into several
other fields, including international politics. A reduced perceived standing, between
states and other actors on the international scene could follow, and imply costs in
other issue areas governed by international politics. The main difference between a
private investor and a SWF could be that a perceived ethical good standing that could
be attractive for a firm, would be indispensable for a SWF.

5.1 The Ethics of Investment

From a philosophical standpoint, one might ask how ethical problems arise in the field
of investment. This chapter outlines the impact of normative constrains in investment
that apply with force to governments as owners of SWFs. It therefore also applies
to managers of SWFs. For any investor, prospects and propositions could surface
that one could not take part in without causing damage to some general, widely
held ethical principle. The ethical principle could be many things, like, e.g. to act in
good faith, in accordance with the law, or to pursue outcomes deemed equitable. The
principle could also be specific to a particular context, for instance due to perceived
needs to act responsibly with regard to someone that are affected by one’s activities.
With this in mind, there may for most investors exist a limit with respect to what
one could want to take part in. Further, one must be comfortable being observed
148 5 The Ethics of Investment

by market participants and the public during the process through which funds are
invested and the investments are managed. Another, wider limit, can be represented
by what one could justifiably be doing. Some could have few scruples with respect to
activities deemed unethical as long as they are seen as legal. Since laws vary across
space, there may also be variation on what kind of activities this could include.
Although both types of limits might be a bit elastic in practice, clear breaches could
imply steep costs. If breaches were to be repeated, and/or severe, the associated costs
could be very high. Even if all activities of an investor were legal, there could be high
costs attached to being perceived as one without concern for ethics. Both types of
limits are therefore relevant and often binding. The same follows from temptation:
More money can often be earned by players who want to take part in the most prof-
itable projects: Profits have been particularly high in some illicit activities: narcotics,
gambling, arms and alcohol smuggling, prostitution, and human trafficking. Such
activities usually breach both widely held social norms and applicable law. It is well
understood that this is so because they are likely to lead to severe negative conse-
quences for others. Since the activities are illegal, it is easy for investors not to take
part. Few have links to such activities, and those who do must expect negative conse-
quences if their participation is revealed. Most investors shy away, that is decline to
take part in financing such activities through debt or equity, or act in such ways that
they are unlikely to be approached with such propositions.
Because investors shy away, less funds are available for such activities than ordi-
nary business projects. This implies high returns. These high returns are out of reach
for most investors, due to strings attached in the form of unlawful and/or unethical
acts, or the expected consequences of the relevant activities. Stakeholders would
simply not tolerate large pension funds to start to aim at superior returns by investing
in illegal activities, like for instance illicit drugs. It is even less thinkable that a SWF
of a democratic government could consider this. However, there may as in many
other fields be different shades of grey at work: Some activities may be legal, but still
linked to the same type(s) of negative societal consequences as illegal activities. These
activities, too, may produce high returns for investors. Responsible managers must
still stay away. This should include many investors—SWFs, institutional investors,
and large funds are among them.
As indicated in this chapter, two government commissions have worked on ethical
regulation for the GPF-G. Both have indicated two main fields of particular interest;
first to save enough revenues and invest and manage this wealth responsibly to the
benefit of future generations, and second to avoid being involved in any serious
international norm breaches. The first main concern, touches on the raison d’être for
the GPF-G. This is discussed above in Chaps. 2 and 3.
The second main concern involves many difficult, and at times detailed ethical
considerations. This is discussed below. What is right and wrong varies across space,
both between and within countries. Exclusion from investment based on Norwegian
values may therefore not be well understood in the locations where the respective
business activities are carried out. Hence, there is a risk that exclusion of a firm will
be understood as a political act by the state of Norway. This author’s view is that the
acts are political, with an international motivation more than a domestic one: One acts
5.1 The Ethics of Investment 149

on the basis of a Norwegian interpretation of some important, shared international

norms. This activity is important, because it differs from what is done by most other
investors. It may be a part of the resource revenue institutional framework that is
difficult to recommend for poor countries who want to establish a SWF. Even if
all investors must have a policy on ethics, and this cannot be avoided, the GPF-G
framework might be seen by some as brutally honest.
In ethics one may be concerned with the consequences of one’s actions. According
to one view, consequentialism, this is all that matters. Normative properties depend
only on the consequences. The view embodies the basic intuition that what is best
or right is what makes the world best in the future, as one cannot change the past.2
One version of consequentialism is utilitarianism, where the aim is to maximize the
utility for all parties. However, there are also other views. Non-consequentialist views
include that morality may be about doing one’s duty, respecting rights, obeying God
and one’s own conscience, actualizing one’s potential, being reasonable, etc.3
Consequentialism may appeal to investors due to its clear focus on actions
and consequences. Nonetheless, there may even within this frame of reference be
disagreement on either the causality between various actions and outcomes and/or
on which outcomes are good and bad. In what follows, ethics is discussed from the
viewpoint of an investor based on on what one could do in view of opportunities, and
based on what one should do in view of moral obligations. The latter will be rooted
in a value system that is unlikely to be universal.

5.1.1 Ethics Based on What One Could Do

If an activity is known to cause damage to widely held principles or values, few could
want to take part in that activity. The other side of that same coin, however, is that
the activity, in isolation, is likely to be profitable. Some parties might therefore be
tempted to take part, in particular if there is limited transparency. For a government
who operates a SWF, it could be impossible to take part. The effective constraints
could be due to both national politics and international relations. That is, both the
relation between the respective government and its constituencies or electorate, and
the government’s relations with governments of other states may bar some acts.
Costs in the field of national politics are likely to be mainly of a political nature.
They might result inter alia in weakened political support for political parties and/or
political leaders, and thus potentially lost elections or failed reelection campaigns.
The operations of a SWF need not necessarily be affected by this. Still, for most
politicians it is highly important to be in a position where they may be able to have
their program(s) approved of and implemented. This has been stated by many to be
the main reason to take an active part in politics.

2 Source: Stanford Encyclopedia of Philosophy—plato.stanford.edu, accessed 4 January 2021.

3 Source: Internet Encyclopedia of Philosophy—iep.utm.edu, accessed 4 January 2021.
150 5 The Ethics of Investment

Costs in the field of international politics may also often be non-economic.

This may make them difficult to quantify, without rendering them unimportant. For
instance, a bad perceived standing on ethics could serve to justify otherwise unjust
treatment of a government or country, in other domains, perhaps with reference to
some sort of an overall fairness consideration. Potential measures to be taken in
such a context, may be biased to the advantage of players who would want to apply
them. An impeccable ethics record would in all likelihood be of value with respect to
avoiding such outcomes. To the extent that a pattern of behavior as described could
be expected, also among organizations and governments, one could easily imagine
that gains considered as unfair, including in the domain of investments, may come
at a price—both on impact and when assessed in relation to later developments.
In the approach to such issues, one could ask whether there is a relevant norm in
the domain of investments that addresses the relevant fairness concern. If no such
norm seems to be relevant, the related behavior could be relatively non-contentious.
However, if there is such a shared norm, one might get a feel for the kinds of behavior
that could be deemed more or less justifiable in response to breaches of that norm,
at least in response to breaches understood as deliberate.
Patterns of behavior in interpersonal relations may hint at the active mechanisms
involved: Between individuals, various sanctions, including discrimination in other
domains may often be motivated by reference to specific unethical behavior. Such a
mechanism might appear as an orchestrated tit for tat which may also involve others
than those affected by the original bad behavior. The one that breaches the norm
might be seen as deserving bad treatment, or punishment, much like in punitive legal
processes. Unethical behavior of one actor could then be used to justify unethical
acts by others, that could, e.g., be aimed at setting the record straight and/or to
ensure prevention in the future.
The rationale could be that such experiences could make the negatively affected
party aware of a link to his previous behavior, and perhaps lead to a change in later
such behavior. For this to hold true, it would be critical that the punished actor
understood the reason why, with reference to his own behavior. One example from
the literature, is Klitgaard (1990), who resided in the capacity of a foreign adviser
employed by the World Bank in Equatorial New-Guinea—a third world island state
off the coast of West Africa. In this country corruption is an important problem: In
2019, it was ranked no. 173 of 180 countries by Transparency International.4 Among
several stories shedding light on the effects of corruption, there is one about a sports
car that author owned. The car was envied by a man who reportedly started to spread
false, negative rumors about the car’s owner. That author interpreted this as a delib-
erate activity aimed to increase the chance of getting hold of the envied vehicle, either
directly or indirectly by putting pressure on its owner. The mechanisms involved in
this and similar stories may appear complex. However, they seem fundamental to

4 Othercountries with the rank 173 of 180 in the Corruption Perception Index for 2019 were
Venezuela, Sudan, and Afghanistan, implying that only four countries scored lower: Yemen, Syria,
South Sudan, and Somalia. Source: Transparency International, Corruption Perception Index for
2019.
5.1 The Ethics of Investment 151

human behavior, in various types of societies, also at higher income levels than in
the example. A setting of weak institutions and rampant corruption, may increase the
chance of succeeding in acts of predation, as many would denote them. Logically, in
such settings one can expect more such attempts—successful and unsucessful ones
alike.

5.1.2 Ethics Based on What One Should Do

In relation to investments, what one could be persuaded that one has an obligation
to do—or should do or refrain from doing—may depend on widely held norms as
well as an investor’s capabilities and other responsibilities. The latter could again
depend to a large extent on the investor’s identity, i.e. on his ID. However, the more
one is able to do, the more binding could the expectations of others also become.
Thus, attempts at doing well by doing good, for instance through climate-friendly
investments, may be seen as something of a duty of a rich state, even if what one is
expected to aim for may be difficult to square with financial theory in the example.
As mentioned above, SWFs are special in part because it is often in their owner’s
best interest to pay more attention to ethical questions than for many other investors.
Domestically, a government is often on the demand side in relation to the respect for
and conformation to ethical standards in the business community. On the international
scene, however, the governments may be investors that could benefit economically
from laxer attitudes towards ethics. However, higher standards may be expected
an from other investors of governments of democracies as investors, particularly
those seen as well off. Whereas a national government that transacts in international
markets may to a large extent fill the role of a business pursuing returns, it will often
also have to manage relations with other governments with respect to more general
principles, that may be linked not only to their own economic interests. In addition to
the risk of damage to widely held values, which one may or may not be able to repair
later, there is thus an important reputational risk involved. A worsened reputation
may make it more difficult to transact and negotiate with other governments, and
may thus imply significant costs in the future.
It might not be very tolerable that the government of a well-to-do democracy
that preaches behavior in accordance with high moral standards in international
fora, for instance at the United Nations, could also be associated with economic
activities that could widely be considered as unethical. Even powerful states that may
occasionally breach international norms and standards to serve their own interests,
may be intimidated by critique from other states. And even if there may not be an
immediate and material price to pay, they would often step out of their way to avoid
such criticism. One reason is that critique by other states might be interpreted by
some as an official recognition of discontent. Even powerful states could therefore
be advised to act with great care. If any breaches were interpreted as deliberate, one
could probably be well-advised to act even more carefully. This could apply with
particular force to small and/or less influential states of limited capabilities.
152 5 The Ethics of Investment

Views by others, in particular the peer group of states, on what one should be
doing may constrain behavior. The relevance of this could increase in the impor-
tance attached by a respective SWF owner to being seen as a responsible investor.
A desire to maintain a given normative position in relation to important commonly
shared norms, could by itself lead to considerable self-restraint with regard to oppor-
tunistic behavior, economically or otherwise. This may include behavior in relation
to investment markets, e.g., through a SWF.
In principle, it should be possible to analyze the holdings of an investor, for
instance of various stocks and bonds, to get a handle on what kind of activities
that may have become more or less easy to finance on the aggregate in view of the
investment activities of that particular investor. For SWFs, it could be reasonable to
demand contribution to improved prospects of ethical investments. Further, it could
probably be required not to exhibit any particularly bad names, judged by reputation,
in their holdings. The latter is easy to satisfy, but may not be sufficient.
A further dimension of ethics in relation to investment, is the ethical quality
of the actions linked to the management of capital. As mentioned, scarce capital
resources are wanted by many, which does imply power for capital owners. This
could lead to temptations and opportunities by owners that could lead to behavior
widely considered as unethical. Numerous different actions could result, ranging
from unethical market behavior in capital markets by the abuse of financial strength,
to steep demands on prospective users of the capital. This category may be important
for investments as such. However, in the context here of the SWF of a small state
with a broad approach to its investments, it may not be very important.

5.1.3 The Ethical Regulation of the GPF-G

The regulation on ethics still in force in 2020, was passed in Parliament in 2004 based
on the report of a government commission lead by Hans Petter Graver of the Law
faculty of the University of Oslo. The report was titled Management for the future (this
author’s translation).5 The main concerns in the report were the risks of contributing to
breaches of human rights or severe destruction of environmental values. These are still
the central concerns. The principles to be followed and the norms to be respected are
reflected in the OECD’s principles for corporate governance, the OECD’s guidelines
for multinational corporations, and the United Nations’ Global Compact. Even if
the ethics regulation was revised to become a bit stricter in 2019, more changes are
imminent that will make the regulation more restrictive.

5 See
The Ethics Commission I. 2003. Forvaltning for fremtiden (Management for the Future),
Norwegian Public Report. NOU 2003: 22. This author’s title translation.
5.1 The Ethics of Investment 153

A new government commission lead by Ola Mestad, also of the Law faculty of the
University of Oslo, filed a report on the subject in 2020, titled “Values and responsi-
bilities” (this author’s translation).6 The main conclusion was that the regulation and
guidelines had by and large worked well, and were flexibly enough formulated to be
of use in new, unforeseen situations. Even so, it was reasonable to expect changes in
the underlying norms over a period of fifteen years. Further, substantial insights had
been gained through the practicing of the original guidelines.
In particular, the Mestad commission proposed that ethical decisions in relation to
investments should also base its activities on the United Nations’ Guiding Principles
on Business and Human Rights, the UNGP, reportedly the world’s first comprehen-
sive guidance for companies to report on how they respect human rights.7 Another
interesting suggestion of this commission, is to adjust the responses to actions by
companies that operate in countries with deviating norms, in particular local compa-
nies with limited room for maneuver, while upholding the prevailing high ethical
standards and thorough evaluation. One will have to wait and see how this will turn
out.
Further, the newest commission report recommends prohibition of investment in
companies that produce deadly autonomous weapons. Under the weapon criterion a
stricter stance was recommended on nuclear weapons, by including in the prohibi-
tion criterion certain types of submarines and other platforms of delivery that can be
utilized solely in relation to nuclear weapons. Further, the commission emphasized
that particular care must be used in relation to indigenous peoples’ rights and human
rights breaches in relation to surveillance technology. Furthermore, it was recom-
mended to remove some examples in relation to the regulation on the human rights
criterion, in order to clarify that at all types gross or systematic violations of human
rights are included in this criterion and thus prohibited.
The commission also recommended an extension of the corruption criterion, to
include also other forms of gross economic crime. Finally, the commission recom-
mended to establish a new criterion to exclude companies that sell military supplies to
states that apply these in gross and systematic breaches of humanitarian law. Actions
in relation to the war in Yemen has been said to exemplify of the need for the latter
type of criterion for exclusion of some companies from the investment universe.
The proposals in the latest commission report were sent out to various stake holders
and interested parties by the government, as is common in Norway. Parliament will

6 See The Ethics Commission II. 2020. Verdier og ansvar (Values and responsibility), Norwegian
Public Report. NOU 2020: 7. This author’s title translation.
7 The UN Guiding Principles (UNGP), endorsed by the UN in June 2011, consist of 31 principles

that implement the UN’s “Protect, Respect, and Remedy” framework on human rights and business
enterprises, including transnational corporations. There are three pillars outlining how states and
businesses should implement the framework: (1) The state duty to protect human rights, (2) The
corporate responsibility to respect human rights, and (3) access to remedy for victims of business-
related abuses. The UNGP are also referred to as the ‘Ruggie principles’, due to authorship by
political scientist and legal scholar John Ruggie who conceived the principles and also led the
process for their consultation and implementation. Source: en.m.wikipedia.org “United Nations
Guiding Principles on Business and Human Rights”, accessed 21 November 2020.
154 5 The Ethics of Investment

decide on a new regulation in 2021, to replace the first regulation in force since 2004
which was amended in 2019.

5.1.4 Practical Aspects of Ethics Work in Relation

to the GPF-G

Since the regulation on ethics was introduced in 2004, there has been a permanent
Ethics Council in work with appointed members and the Ministry of Finance serving
as secretariat. This body have been working with perceived ethics breaches in the
companies the Fund are allowed to invest in. If one thinks there may be good reason
that a company should be removed from the investment universe, this would have to
be considered by the Ethics Council to become policy.
Prior to 2015, the Ethics Council channeled their recommendations through the
Ministry of Finance. All recommendations were made public. If a recommendation
should result in exclusion from the allowed investments, there would be a prohibition
with regard to new investments in the respective company’s stocks or debt instru-
ments. If one already possessed holdings in the respective company, which was often
the case with close to full replication of the broad strategic benchmark portfolios,
the holdings were liquidated before the decision was published. The alternative to
exclusion would in principle be either no action, or a decision to work as one owner
in cooperation with other owners to influence in order to make the company change
its behavior. This approach could easily consume much resources.
Since 2015, the central bank has been authorized to decide, on behalf of the
Ministry of Finance, on recommendations from the Ethics Council. Within the central
bank, the task is delegated from the Governing Board to the investment managing
arm, NBIM. One likely reason for the change was a need to reduce the flow of
cases through the Ministry of Finance, which has very extensive other obligations
in many fields. Another potential reason could be a want to de-politicize as much
as possible a class of decisions that are not made for political reasons but may
still have political consequences. The latter possibility is speculation: There has not
been public statements on this. In any event, one interesting question is whether the
administrative change could lead to different decisions, i. e. influence significantly on
the content of public policy. Strictly speaking this cannot be known, as the decisions
are made under one arrangements only—either the previous or the current one. So
far there have not been any strong indication of change. In 2020, however, a case
surfaced that could potentially work to illuminate the issue.
In early September 2020 it was made known that one had decided not to exclude
a Chinese oil producing company in spite of suspicions of corruption, formally
a considerable risk of becoming involved as owner in corruption, which led the
Ethics Council to recommend exclusion. The decision was instead to follow up this
company and their anti-corruption work through the means available to the GPF-G
as one among several shareholders. The Ethics Council had recommended exclusion
5.1 The Ethics of Investment 155

of the company already at the end of 2016, because several executive staff members
of that firm and its subsidiaries were accused of collecting bribes in relation to the
awarding of contracts to subcontractors. Further, the company had not in the Ethics
Council’s view substantiated its claims that it worked efficiently to avoid corruption.
The Council had made several attempts to contact the company, without getting
satisfactory answers or the required information. One decided to keep the firm under
observation, not to exclude it.
This soft reaction led to some public criticism. For instance, according to Tina
Søreide of The Norwegian School of Economics and Business Administration, this
company had been given many chances. Further, it was common practice for profes-
sional players to stay away from firms linked to severe law breaks on multiple occa-
sions.8 The situation in the field had changed much during the latest some 20 years,
and it was said to look odd that the GPF-G appeared to be extremely patient with
this particular company in spite of an overall development of lesser tolerance.
One could speculate that the case might have been treated differently due to
foreign policy considerations. China is a great power and the two countries differ
both with regard to size and power resources, and diplomatic style. It should be noted,
however, that this is only one among many considered cases. It may illustrate that to
practice ethical guidelines based on Norwegian values may be costly and involve an
additional workload. It is reasonable to assume that politics has been unimportant
in most of the considered cases. About 150 companies are formally excluded from
investment. The Fund has also sold its positions of stocks and/or bonds in about
250 companies. The decision commented on here attracted some attention, also as
the first in which the choice was not to follow the recommendation of the GPF-G’s
Ethics Council. The incident soon ended, however, when it was made known that the
respective stocks had been sold.
The Ethics Council has over time processed recommendations that has led to the
exclusion of numerous companies, and placed firms in the hundreds on an observation
list. The combined list as mentioned reflects the Council’s and the deciding authori-
ties’ practicing of the ethics regulation in force from 2004, with later amendments.
The criteria for potential exclusion include risks for gross corruption, a weapon
criterion, and an extensive human rights’ criterion, to mention but a few. Tobacco
producers have also been excluded due to negative health effects. There is also a
restrictive fossil fuel criterion covering coal. In relation to the human rights crite-
rion, one is also evaluating abusive labor relations, including of forced work and
work performed by children. Further, several companies have earlier been excluded
as producers of palm oil and tropical timber—as both these product categories were
seen as associated with illicit logging of rain forests.
In the 2000s numerous weapon producers were excluded under the weapon crite-
rion—under which one shall avoid investment in producers of weapons where the
intended or normal use leads to ethically unacceptable consequences. This includes
nuclear weapons, land mines, and cluster bombs that spread landmine-like muni-
tions. There are some examples of companies that have changed their practices and

8 According to Norwegian business daily E24.no, 5 September 2020, accessed 6 September 2020.
156 5 The Ethics of Investment

become allowed investments later on. The most notorious decision was probably to
exclude of the American firm Walmart, the world’s largest retailer, due to its practices
in relation to trade union membership among employees. In sum, all criteria that can
lead to exclusion imply significant risks for the SWF as investor of being associated
with severe norm breaches. The common denominator may thus be the aim to lower
the risk of becoming involved as investor in breaches of important norms required
to be satisfied by the owners of the GPF-G. Responses over time to the applied
measures from shareholders and other the stakeholders suggest that decisions rooted
in investment ethics are widely understood as official Norwegian policy. This effect
would be hard to avoid, with numerous visible; mainly restrictive decisions.
Interestingly, Frankel, op. cit. found the GPF-G to be a less suited model to emulate
for resource rich developing countries who wanted to establish commodity funds than
funds of some other countries, in particular Botswana’s Pula fund.9 The reason he
put forward was that the ethical considerations in the Norwegian case implied the
inclusion of politics—which was not wanted. To avoid political investment decisions
may be important for a developing country with pressing economic stabilization
needs. To avoid everything political, may nonetheless be close to impossible.
The politics of the Norwegian model should perhaps not be very controversial, at
least not in Western democracies. In the main, it is the most important international
norms one tries to satisfy through the Ethics Council. The decisions may still attract
unwanted attention, as ethics tends to vary across space. This author agrees that the
GPF-G may not be the best suited model to emulate for developing countries, but
for different reasons: One must accept that investment ethics is salient, requiring
policies for all investors of size. Norway’s framework and the attached institutions
may, however, be best suited for quite large investments which most non-developed
countries might not yet make. In view of this, it could be wise to choose a simpler
model. A further aspect is that saving for the future may not be attractive if one needs
the money soon. Nonetheless, the start of savings may be demanding: In view of this,
even poor countries could benefit from saving and investment.
The discussion above may illuminate that the ethics practiced by the Norwe-
gian SWF can become politically problematic, in particular when the fund is very
large. One reason is that large investors cannot hide behind a principle of owning a
tiny fraction of the stock market. In May 2021, the Fund owned 1.4 per cent of all
listed stocks globally—and considerably more in some markets. This makes it diffi-
cult also to avoid discussing ownership issues publicly, which may be demanding
politically and may possibly lead to increased operations costs.

9 Another fund worth emulating could be the commodity fund of São Tomé and Príncipe, which, in
Frankel’s words, has “extensive restrictions guiding how the oil revenues are to be saved, invested,
or spent.” (Monk, A. “And the Award for the Best Commodity Fund goes to … São Tomé and
Príncipe?” Oxford SWF Project, oxfordswf.wordpress.com/tag/Jeffrey-A-Frankel/, accessed on 29
October 2020.).
5.2 Implications for SWFs of Socially Responsible Investment (SRI) 157

5.2 Implications for SWFs of Socially Responsible

Investment (SRI)

The field of Socially Responsible Investments (SRI) has been developed in response
to concerns like those discussed in the previous paragraph. Another, similar and
frequently used term is ESG—Environment, Social Justice, and Governance, which
in our context here is mainly Corporate Governance. Governance has been important
for a long while. Recently, the environment and Climate Policy has also bcome
important. Social justice is important in its own right, but not easy to contribute to,
other than indirectly, for a large SWF. For brevity, the acronym SRI is used in the
continuation to also include ESG.
The existence of SRI as a separate field could by itself lead to a concentration
and an increase in attention paid to ethical responsibilities in relation to investments.
Although SRI may be traced back in history, it has been emphasized most in later
years by the investment industry. There is thus an increased attention paid to the
perceived consequences of investment. Compared to in earlier days, attention is
usually more permanent today, and linked to specialized professionals.
Although the considerations have been known for a long time, the SRI field as such
was established quite recently. Whereas one may avoid harm by ex-ante screening of
companies one contemplates to include in an investment portfolio, SRI also typically
includes active attempts to create a positive social impact through so-called impact
investment. Shareholder advocacy, and community investing, can also be included.
Community investment may, however, be of more interest to other parties than large
globally oriented SWFs like the GPF-G. The large SWFs, may prefer global invest-
ment alternatives. Specific, usually small and local projects may not be large enough
to justify investment and attention. The risks may also be too concentrated geograph-
ically to be palatable. Overall, information processing demands could become too
high to justify investment, also in view small volumes of outstanding securities and
planned issuances for later marketing and sale.
How the increased attention to SRI may change investment decisions and associ-
ated outcomes, is a complex issue. However, the expected value of negative attention
and sanctions in relation to any malfeasance and breaches of the ethical codes that may
be implicitly agreed upon among, e.g., institutional investors, may have increased.
One reason is that data collection and data analyses have become more automated
and thus also more affordable and available.
Potentially, this could nudge the investment industry to bridge gaps between
its overall ethical standards and those of other sectors of society. In addition, it
is possible, perhaps also likely, that individual investors may become more active
with regard to ethics if they can expect to receive some form of compensation. This
may for instance include mention in positive contexts, which can often be capitalized
on. Investors have overall become more concerned about how their contribution to
society are viewed. This seems to apply in particular with regard to investors that act
on behalf of the general public.
158 5 The Ethics of Investment

5.2.1 The UN Global Compact

The United Nations’ Global compact (UNGC) is a network made up of companies

concerned with socially responsible business practices. Three key areas for the social
responsibilities of businesses are named on their web site: The environment, social
sustainability, and governance. About 10,000 companies are voluntary members of
this network.10
Governance is defined as systems and processes that ensure the overall effective-
ness of an entity or institution, including business firms. Three sub-areas are identified
as anti-corruption, peace, and the rule of law. The promotion of good governance is
in view of this most often a multi-dimensional task.
Peace may be seen as the most fundamental of the sub-areas, as both an enabler
of sustainable development and a precondition for the rule of law and meaningful
efforts to reduce corruption. Logically, it therefore precedes the other two categories.
Although governments can usually do more to promote peace than businesses, the
contribution of several actors of various sorts, including businesses, may be important
for achieving lasting improvements also in this domain. Businesses are, however,
likely to play larger roles in relation to the other two sub-fields.
Anti-corruption is usually seen as essential both for the rule of law and for
peace-building. The reason is that corruption impacts negatively in fields like state
capacity, social inclusion, and the management of natural resources. Thus, also anti-
corruption has wide-ranging implications and is very important for overall achieve-
ments. Corruption is often seen as linked to abuse of power by rich elites in poor
countries, which may breed injustice and render investments by outsiders too risky.
Through this and several other channels, economic growth may be hampered. There
are many types of corruption, and the issue remains relevant for practically all coun-
tries, including rich ones. Independent of the income level of a society, low corruption
could be a necessary condition for economic freedom for citizens and residents alike,
and thus also for growth and development. This applies both economically and in
human terms. The latter is difficult to measure on the aggregate, but very real for the
affected individuals. A meaningful life would be difficult to achieve without wide
civil liberties. Further, it would not be realistic to expect unfree individuals to invest
much with a view to innovation. That would not make sense, as someone else would
own any successful innovations that imply economic progress. Economic develop-
ment is assessed through relative performance in GDP growth per capita. It may
often be difficult to know what GDP growth a corrupt country could have attained
without corruption. Corruption does not bar economic growth, at least not at low
levels of income and growth. It does, however, reduce investment and have strong
implications for inequality, and may thus hamper growth.
Further, the rule of law is required to effectively address the drivers of violent
conflict, illicit financial flows, and impunity. Furthermore, it is needed to provide a

10 On 7 January 2021 12.354 companies from 158 countries were members. Source: www.unglob
alcompact.org. This sub-section is in part based upon this site, which may provide more details on
the issued discussed.
5.2 Implications for SWFs of Socially Responsible Investment (SRI) 159

legal framework which ensures impartiality and predictability. It is usual to speak

of a strong rule of law, as the law on paper may not correspond well with how the
law is implemented and enforced in practice. It is quite common to have many laws
and regulations that are not enforced. Another possibility is that the enforcement
can differ depending on the identity of the involved parties. The latter may again
be related to impunity, which is common in many countries and areas. While there
may be impunity for some in a given location, others may be monitored closely
and sanctioned for minor breaches, or in the limit harassed without any breaches. In
this we may see the seeds of generally bad governance, with unbalanced decisions,
nepotism, and favoritism—all of which appear to uncertainty and be negative for
growth prospects.
A necessary but not sufficient condition for a strong rule of law, is that the judiciary
is independent from the legislative and executive state powers. If this is not satisfied,
the consolidated state may become too strong for the good of society. Judge and
political philosopher Montesquieu (1689–1755) wanted the three state powers at
the highest level to balance and keep each other in check. Other possibilities may
include politically motivated legislation and prosecution which may be tailor-made
to make life hard for opponents to a government. In that case, state power may be
abused to undermine democratic rule. A minimum of impartiality is needed for there
to be real competition for the authority to govern a state. For instance, members of
a political opposition must enjoy the tranquility needed to lead decent lives, be able
to make more than subsistence incomes, and free to organize political initiatives that
challenge those in power.
That some can act as they please without any sanctioning, i.e. enjoy impunity, and
that some may simultaneously find it difficult to lead a peaceful life while not breaking
any rules or regulations, lead to unbalanced social and economic situations, relations,
and outcomes. It could become impossible to achieve impartiality, predictability, and
justice, which could hamper economic growth strongly.
An illustrating case in this respect may be the difference between how the law
works in the United States and the Philippines, respectively. Formally these two
countries have very similar legal systems, since the Philippines have copied much
from the United States. However, there are large differences in how these two legal
systems function in practice. Weak institutions and corruption in the latter country
may explain much of this difference (see, e.g., Mishkin, 2006). The consolidated
power of the state in the Philippines may perhaps also play a role in the picture.
The discussion of governance linked to investment opportunities focuses on mech-
anisms. Issues in relation to the three mentioned sub-fields of the UNGC framework,
render it challenging to achieve good governance, but may also provide different
inroads in terms of ameliorating governance and contributions towards solving
governance-related problems. The sub-fields of the UNGC are described only super-
ficially here. However, the discussion complements the general discussion in relation
to risks and issues of various investments by Norway’s SWF in this book, that may
illuminate some of the same issues.
160 5 The Ethics of Investment

5.2.2 The OECD Guidelines on Corporate Governance

The OECD guidelines on corporate governance first published in 1999 focus on

the rights of shareholders in businesses. In the literature and in practice it had been
emphasized by many how particular mechanisms linked to the running of large busi-
nesses might lead to the promotion of other interests, sometimes even contradictory
ones, to those of the owners. The size of a business may attract interest and attention
from others than their owners. For instance, external parties may want to exploit the
effects and impacts of activities run by big business firms.
The OECD guidelines are important in relation to facilitating production in a capi-
talist economy. This organization’s strong reputation and prestige as an organization
of high-income countries make the guidelines more visible, and is likely to magnify
the guidelines’ social impact.
The background for the principles on corporate governance is to a large extent
work in relation to the long-term interests of shareholders in corporations. Business
firms may by and large be seen to further the interests of their owners. This is
understood as important in relation to the welfare of individuals as owners. However,
the corporations are also employers who create jobs and generate tax income for the
public sector. Further, they may produce goods and services at reasonable prices and
manage savings and secure retirement incomes. Successful operations over the long
term will therefore be important for various groups of stakeholders.
In relation to the social responsibilities of businesses, the drafters of the principles
acknowledged that “the best run corporations recognize that business ethics and
corporate awareness of the environment and societal interest of the communities in
which they operate can have an impact on the reputation and long-term performance
of corporations” (OECD 1999: 6; Demise 2006: 110). Thus, success in this respect
is important for many stakeholders. This observation, however, was not seen as an
indication of a reduced importance of the businesses’ shareholders.
The original 1999 guidelines covered the following sub-fields11 :
• The rights of shareholders
• The equitable treatment of shareholders
• The role of stakeholders in corporate governance
• The responsibilities of the board of businesses
Shareholder rights include participation and voting in general shareholder meet-
ings, including in the election of board members, and to share in the profits made by
a company. Ownership of shares also implies ownership of a fraction of the firm’s
capital. These rights are fundamental to the willingness to invest in shares. To SWFs
and some others that undertake large investments, the share in profits of the firms
they invest in may be particularly important.
The board of a company should ensure the strategic guidance of the company,
the effective monitoring of the company’s management, the boards accountability

11 SeeDemise (2006: 110). There was a revision of the principles in 2004, OECD (2004) see the
discussion below.
5.2 Implications for SWFs of Socially Responsible Investment (SRI) 161

to the company and shareholders, and more generally consider the interest of share-
holders. This is highly important, even if the board also has duties in relation to other
types of stakeholders—inter alia, governments at various levels of aggregation, local
communities and employees.
These principles are very general. Further, in the preamble to the corporate gover-
nance principles (OECD 1999: 9), it was made clear that there is no single model of
good corporate governance: There are for instance different legal systems and insti-
tutional frameworks, and also different traditions that may result in various more or
less distinct needs in order to achieve good results.
In relation to the OECD corporate governance principles, The Business Sector
Advisory Group on Corporate Governance emphasized four values—fairness, trans-
parency, accountability, and responsibility. The International Corporate Governance
Network, an investor-led body representing firms with combined assets in excess
of 10 trillion U. S. dollars, welcomed the principles as a declaration of minimum
acceptable standards for companies and investors in the global economy.
In 2004, the OECD revised the original version of its corporate governance
guidelines. The relevant sub-fields have since been stated as follows, ensuring.12
• the basis for an effective corporate governance framework,
• the rights of shareholders and key ownership function,
• the equitable treatment of shareholders,
• the role of stakeholders,
• disclosure and transparency, and
• the responsibilities of the board.
According to the first item above, the framework should promote transparent
and efficient markets, be consistent with the rule of law, and clearly articulate the
division of responsibilities among different supervisory, regulatory and enforcement
authorities—which should have the authority, integrity and resources to fulfill their
duties in a professional and objective manner.
To the fourth item on the list, two provisions were added, regarding whistle-
blowers and an insolvency framework and the right of creditors. There was also a
revised provision in item number six, according to which the board should ensure
high ethical standards. Further, high ethical standard should enhance credibility and
trustworthiness for other parties in relation to various long-term commitments that
could impact positively on the financial results of business firms.
Since this set of corporate governance guidelines have a strong status as norms,
and the standards have been interpreted also as minimum standards, there may be
costs associated with breaching them due to simple social mechanisms. Their most
important contribution to a more ethical and civilized business environment might
still lie in their status as recommendations of the OECD, and thus a policy benchmark.
The recommendations may be seen as quite clear guidelines with a normative
function that puts pressure on businesses and governments alike to contribute towards
a more ethical business environment. This is likely to be of high importance even if

12 This description is based on Demise, op.cit.: pp. 114–115.

162 5 The Ethics of Investment

there may be many examples of deviating practices also in OECD countries. Outside
the OECD area one can probably expect tougher challenges and more generally
lower standards with regard to business ethics. If this assessment is correct, it may in
part be because the corporate governance guidelines may constrain parties that might
without them not perform according to high and socially desirable ethical standards in
their conduct of business. The situation would probably have been worse without the
official corporate governance guidelines. However, there may still be more important
differences between OECD countries and the mainly poorer countries outside this
organization. Further, the enforcement of the high standard is informal. The main
mechanism at work is that businesses may find it advantageous and in their own best
interest to perform, and be perceived as performing, according to high standards.
Since there is wide agreement on the advisability of high standards, at least among
uninterested parties to specific transactions, high standards may increasingly turn
into binding legislation. To the extent this should take place, it is likely to emerge
first in the comparatively affluent OECD countries.

References

Armstrong, C. 2013. “Sovereign Wealth Funds and Global Justice”. Ethics and International Affairs
27 (4): 413–428.
Demise, N. 2006. “OECD Principles of Corporate Governance”. Corporate Governance in Japan
109–117.
Føllesdal, A. 2014. “Norway’s Sovereign Wealth Fund and Global Justice: An Exchange—‘A
Response by Andreas Føllesdal’”. Ethics and International Affairs 28 (1).
Klitgaard, R. 1990. Tropical Gansters. One Man’s Experience with Development and Decadence
in Deepest Africa. NY, NYC: Basic Books.
Mishkin, F. 2006. The Next Great Globalization: How Disadvantaged Nations Can Harness Their
Financial Systems to Get Rich. Princeton, NJ: Princeton University Press.
OECD. 1999. OECD Principles of Corporate Governance, Paris.
OECD. 2004. OECD Principles of Corporate Governance (revised), Paris.
Seagal, P. 2014. “Norway’s Sovereign Wealth Fund and Global Justice: An Exchange—‘A Response
by Paul Segal’”. Ethics and International Affairs 28 (1).
The Ethics Commission I. 2003. Forvaltning for Fremtiden (Management for the Future). Norwegian
Public Report. NOU 2003: 22, Oslo: Ministry of Finance.
The Ethics Commission II. 2020. Verdier og Ansvar (Values and Responsibility). Norwegian Public
Report. NOU 2020: 7, Oslo: Ministry of Finance.
The Gjedrem Commission (Sentralbanklovutvalget). 2017. “Ny Sentralbanklov. Organisering av
Norges Bank og Statens Pensjonsfond Utland.” Norges Offentlige Utredninger – NOU 2017: 13.
Oslo: Ministry of Finance.
Chapter 6
Risks and Uncertainty

Risk is associated with the variability of the returns made, that is ex post or after the
fact. As things tend to turn out a bit different than expected, returns may be higher
or lower than expected ex ante. This potential for negative and positive surprises in
relation to the return actually realized is usually called risk. There are several sources
of this risk in investment, such as fluctuating exchange rates and interest rates, war,
weather and natural disasters, to mention but a few. In many situations, there may be
most interest for the negative side of risk, that is for the downside risk.
Losses of capital are likely to be painful. However, there are wide differences as
investors differ in many respects, both psychologically and economically. Thus, they
may have different abilities to absorb negative surprises. For a given expected value
of a probabilistic outcome, a risk adverse investor will prefer the alternative which
exhibits the least variability ex ante. Many investors are risk adverse. Risk aversion
still may be most relevant for physical persons as investors, or organizations and
companies that are in need of foreseeability due to for instance indebtedness.
Alternatively, one can think of a risk neutral investor, that is someone who would
for instance be indifferent between receiving 1 dollar with certainty and 10 dollars
with a 10 per cent probability. This often unrealistic description of the attitude towards
risk may be preferred for simplicity. It may perhaps be realistic for institutional
investors or individuals who invest large sums. Investors will under this assumption
simply maximize the expected return of an investment. The reason is that risk doesn’t
matter, which again might be explained by a comfortable situation where a bad
outcome for the investments made is unlikely to imply hardship. A farmer may, for
instance, have enough crops stored to live comfortably through the winter.
Further, one can think of risk seeking investors, who would buy lottery tickets.1
For a risk seeking investor, the extreme variation in return that for instance lotteries

1A lottery ticket has a large, expected negative return expressed as a percentage of the purchase
price. For instance, in state lotteries in Norway the expected return is about – 50 pct. The tickets can
be sold precisely because the return exhibits a vast variability. Some may want to pay more than
the expected value for a very slim chance to win a big prize. This behavior can be sustainable only
if trivial amounts are spent, e.g. sums that could not else have made a difference. However, players
© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 163
O. B. Røste, Norway’s Sovereign Wealth Fund, Natural Resource
Management and Policy 54, https://doi.org/10.1007/978-3-030-74107-5_6
164 6 Risks and Uncertainty

may offer, may be attractive to take part in. At least if very small sums are spent. For
instance, individuals may buy lottery tickets for a very small amount, to take part
in the excitement of imagining a chance, however slim, of a very large prize. They
can in theory invest an arbitrarily small fraction of their wealth or income, which
will almost certainly be lost. The game would have to be fair, so that one could
occasionally win and collect. That is, the game should be against nature, following
rules by God, who in the view of Derman (2011) are rarely subject to change. Dubious
business practices are quite common in this field, implying a risk that the games need
not always be fair.
In real-world investment, risk aversion is a typical preference structure, at least
for individuals. Large investors, both individuals and institutions are likely to be
less risk averse, if not quite risk neutral. Risk aversion is also assumed in Modern
Portfolio Theory (MPT), also known as Mean –Variance analysis, following the work
of Markowitz (1952). This approach has been very influential in relation to how risk
has been viewed by institutional investors. A main problem with this approach is that
assessments are based on co-variation of returns in historical data that are not likely
to be repeated. For instance, there may due to emphasis on some lasting tendencies
be abrupt changes.
Another problem with the classification of attitudes to risk, is that in real-world
situations the probabilities are never known before decisions are made. Any attached
probabilities to outcomes are therefore subjective and as such prone to error and bias.
It is therefore not straightforward to distinguish at decision-time between the various
degrees of risk aversion or neutrality. The approach might therefore be better suited
for ex-post rationalization than for assistance in making decisions.
Uncertainty is associated with limits to our knowledge. It involves imperfect
and/or unknown information. Due to this, it may be impossible to exactly describe
an existing state of the world or future outcome, or even to know which outcomes
might be possible. For instance, in relation to natural resources, it may be uncertain
how much oil there is in each reservoir that can be economically exploited at a point
in time. Further, in finance future developments that can affect the prices of securities
are uncertain. It may be difficult to know which factors count. Due to the high values
involved, however, also imperfect information can have substantial value. There are
thus many attempts to get a handle on such problems, in spite of these difficulties.
Knightian uncertainty is due to a lack of quantifiable knowledge of some possible
occurrence. Economist Frank Knight (1885-1972) of the University of Chicago is
known for having distinguished risk and uncertainty in his seminal Knight (1921)
book Risk, Uncertainty, and Profit. To Knight, and many other economists of the
1920s and 1930s, risk was measurable, quantifiable uncertainty. This distinguishes
it from unquantifiable uncertainty. There is thus a distinction between known and
unknown unknowns, of which the latter is particularly hard to treat and analyze
formally. In spite of arriving at this important insight, Knights concept of uncertainty
is informal, and would need to be incorporated into a system of probability and belief

over time could have benefited from saving larger amounts to invest at higher returns, which would
require discipline.
6 Risks and Uncertainty 165

to be systematically applied in analyses. There is reportedly no obvious best way of

achieving this.
Knight’s book has been seen by many as one of the most influential economic
texts of the twentieth century. The methodology of distinguishing risk – randomness
with knowable probabilities – from uncertainty – randomness without knowable
probabilities – also served as the foundation of the Chicago School of Economics,
that advocates competition in a free market as the best method to achieve growth
and prosperity.2 A particularly important concern for Knight, was to avoid public
intervention in the markets. His thinking in this respect conforms with right wing
economic policy.
The future will be particularly vulnerable in relation to surprises from uncertainty.
Lindley (2006) holds that one is uncertain to a varying degree about everything in the
future, even though uncertainty is everywhere – also in the past and the present – and
cannot be avoided: Much of the past is hidden, and full information is lacking about a
lot of the present. With respect to the future, the standard tool box in finance, including
MPT, has depended on assumed correlations among returns on different assets based
on analysis of historical price data. This is known as the Gaussian approach to
finance.3 There is, however, no guarantee that historical data will contain enough
information with regard to events of the future. When also large parts of the past and
present may be unknown, or unrevealed, future events have yet to take place. This
happens in a fashion that in principle cannot be accounted for ahead of time. Thus,
any guesses are just that, even if the data generating mechanisms may have traits in
common over time.
Although it is an understandable inclination to want to study events yet to take
place to the extent possible in a framework that includes earlier realizations of e.g.
asset prices, it would be very surprising if that could generate any insights that could
be of consistent use in securities trading.
This approach to risk through historical data, that implicitly assumes that the
present is a lot like the past, has been criticized inter alia by Hubbard (2007). He
emphasized the implications of the use of pure probabilities, and lack of attempts at
explanations of an underlying structure to price changes. Engineers, by contrast, use
so-called probabilistic risk assessment, in economics known as structural models -
that account for the interaction of variables, for instance in relation to risk analysis
in nuclear power plants.4 The structural relations may be more stable in nuclear
engineering than finance. If they were, instead, to rely on a framework like MPT
or the Black-Scholes option pricing model, there would be no history of the most
dramatic system-level events. A meltdown in a nuclear power plant or a liquidity crisis
in finance could be examples of such extreme events. There is no way to calculate
the odds of this happening based on the available data. According to Hubbard, one

2 Thisis based on the preface to a 2012 Courier Corporation reprint published in Mineola, NY.
3 According to M. A. H. Dempster (2011), the pioneers of Gaussian Finance are Louis Bachelier,
Maurice George Kendall, Harry Markowitz, and Paul Samuelson.
4 Hubbard, ibid., exemplifies as follows for a nuclear power plant: “If valve X fails, it causes a loss

of back pressure on pump Y, causing a drop in [the] flow to vessel Z, and so on.”
166 6 Risks and Uncertainty

would be unable to calculate the odds of a meltdown at a plant until several similar
events occurred in the same reactor design. However, due to the low frequency of
such extreme events this kind of information may never be sufficiently available, at
least not in a meaningful relation to the limited length of human lives.
Fragility is another important characteristic in the context of risk and uncer-
tainty. If for instance the level of credit worthiness among investors is low at a time,
comparatively small unfortunate events or ‘accidents’ may lead to very bad realized
outcomes in terms of credit-related losses, the ability of investors to attain credit to
finance investments, and so on.
For an individual investor, risk tolerance is important for the approach towards
risk. In terms of the simple CAPM model, ‘the two-factor model’, market risk, also
called non-diversifiable risk, must be absorbed by investors. They do between them-
selves own all the issued securities, be it stocks, bonds, or other instruments. The
essence of the model is that a well-diversified market portfolio exists which minimizes
risk with regard to expected return. This is an efficient portfolio. All diversifiable risk
is thus avoided by investing in the market portfolio. In this simplistic framework,
investors can adjust their desired risk through degrees of leveraging, that is either
invest the bulk of the funds in a short-term interest-bearing instrument (‘cash’) to
avoid risk, or borrow additional money to leverage investment in the market portfolio.
Factor investing is an investment approach that involves targeting quantifiable
firm characteristics, called factors.5 Modern factor models are rich in content, and
contain several systematic factors in addition to market risk.6 The point of a factor-
based investment strategy, is to tilt equity portfolios towards or away from specific
factors in an attempt to generate investment returns in excess of benchmarks used
to evaluate performance. The simple CAPM framework suffices to illustrate the
main point in the investor’s approach to the market. A risk averse investor would
invest less of her investable funds in the market portfolio and keep some cash; a
risk seeking investor would invest all, and then borrow some more funds to invest
in the same market portfolio. In terms of the two-factor model with systematic and
non-systematic risk, all investments are composed of a fraction of the market risk. No-
one would assume diversifiable risk, which would in equilibrium not be compensated
by a higher return because it can easily be diversified away by investors. Investors
with varying tolerance for risk would according to the theory differ in the degree
of leveraging, not by security selection or investment type. In the real world this

5 This paragraph draws on the item “Factor investing”, at en.m.wikipedia.org, accessed 4 September

2020.
6 An intermediate example is the Fama and French (1993) three-factor model to describe stock

returns, which extends the Capital Asset Pricing Model (CAPM). In addition to market risk, it
includes as factors small cap stocks and stocks of high price to book value. The tendency of small
cap stocks to outperform the market was established by Banz (1981). The roots of value investing
go back to Graham et al. (1934). The three factors have reportedly been able to account for about 95
per cent of the return from investment portfolios. By including the factors in a benchmark portfolio,
it could thus be possible to absorb a few tricks managers could use to beat a benchmark not based
on the factors. The idea is based, however, on assumptions that small caps and high-quality stocks
will continue to produce superior returns in the future.
6 Risks and Uncertainty 167

is different, in particular because investors differ with regard to access to various

categories of securities. This is often a form of self-constraint introduced by the upper
echelons of institutional investor organizations, to limit risk-taking. For instance,
the investment universe may be limited to fixed-income instruments issued by the
governments of OECD countries. This was the regulation in force for Norway’s
foreign currency reserves prior to the establishment of the GPF-G in 1990.
The time horizon of an investor and his or her attitude towards risk are important in
determining the risk tolerance. The longer the true time horizon, the lesser would the
likelihood be that poor performance early in the investment period could lead to the
realization of losses. Rather, there would be an increasing chance over time that most
investments turned out to be profitable ones. The long-term investor might find it well
worth to stay put in relation to unfavorable market developments. Given the attitude
towards risk, one can approach the practical question of what investment vehicles, or
asset classes, that would be permissible as investments. This may be straightforward
for individual investors. But even in this simple context, other factors may impact
on the applied time horizon and thus also on the attitude towards risk. One example
of this, could be a bequest motive which might lengthen the time horizon, and other
things equal, allow for a higher overall level of risk. Other examples may be linked
to the long-term prospects for the investment vehicles, including stability in relation
to war and peace and/or civil unrest.
For collective entities, such as SWFs owned and operated by states, the situation
is more complex: The risk tolerance of the many individuals with stakes could in
principle, although hardly in practice, be considered and weighted. It is difficult to
meaningfully assess the risk tolerance of a collective. In practice, some sort of an
approximation is applied, as decided upon by policy makers who may in practice and
depending on the degree of democracy pay more or less attention to what is known
about the true preferences within a population. The difficulties as regard collective
units are also aggravated by the preferences of future generations. When we also
consider that the risk tolerance of an agent might vary over time, due to numerous
factors, this may boil down to a need for an approximation, or rule of thumb, that needs
to be simple and easy to be operational and suited for communication for operation
with stakeholders. With respect to meeting the most important objectives, a rule of
thumb would be unlikely to underperform by much compared to an “optimum rule”.
It’s other good characteristics, including practicability and ease of communication,
could most often make such an approximation rule the preferred choice in practice.
Now, consider the GPF-G’s construction: It is intended to last forever, because
only the real returns, as approximated by the government’s 3-pct fiscal rule, is allowed
to be consumed. However, in view of how spending decisions are made, it could be
naïve not to question the robustness of this construction. Parliament can decide, at
any time, to vote for a change that could entail consumption beyond the fiscal rule as
an estimated real return. Chances are that over time, numerous difficult situations in
this respect could arise. The consumption of at least some of the Fund’s capital could
therefore come to be considered as the preferred choice in difficult times. It would
appear as unrealistic a priori to rule out that one could face such difficult choices in
the future.
168 6 Risks and Uncertainty

With considerable oil reserves remaining, the dramatic decline in the price of oil
from the summer of 2014 to January 2016 – by 74 per cent, from about U. S. dollars
115 to 30, illustrates one mechanism through which this SWF could shrink.7 This
point is valid even if the price climbed again, to surpass 70 dollars per barrel in the
spring of 2018, before stabilizing just above 60 dollars through 2019. For a while
the Coronavirus pandemic crisis of 2020 brought the oil price back to the lower 30 s
in U. S. dollar terms. One should also keep in mind that the price of oil had not fully
recovered since the financial crisis of 2008. Further, the volatility has been massive,
which reflects not only the severe crises, but also a combination of lower demand due
to relatively weak economic growth, and fiercer competition between oil producers.
The good news in this respect, is that the Fund’s growth increasingly stems from its
own returns, i.e. the Fund’s earned dividends and interest.
A few years ago, model simulations by Statistics Norway suggested that the
current welfare policies would need to be accompanied by a sharply increased average
tax rate to be continued, estimated at 55 per cent if the oil price were to stay near
30 dollars per barrel.8 Such exercises are usually made with crude assumptions, and
in models deemed appropriate for illustration. The aim may be to get an appeal
for austerity across in the public debate, which has been difficult in Norway. The
dependence on oil income for the state was illustrated, even if the new estimated
average tax at 55 per cent should not be taken literally.
The exercise appeared more relevant, however, with crude oil prices much nearer
30 dollars per barrel than the about 100 dollars per barrel prior to 2014. During the
crisis in the spring of 2020 oil prices were as mentioned below 30 dollars per barrel
for a while. This level cannot be ruled out even over long time spans, as alternative
energy sources are developed at increasing speed and lower costs. Another thing that
cannot be ruled out is an end to off-shore oil production in a not too distant future, due
to e.g. environmental concerns. This may be unlikely, but if it happened the effective
oil incomes would be lowered also due to halts and required clean-up works. This
only restates that important unknown unknowns imply genuine uncertainty ahead.
The average tax rate for individuals has, depending on e.g. deductions, mostly
been below 30 per cent. Therefore, an average tax rate of 55 per cent could most
likely not be a realistic policy. In practice, a shortfall in available funds in response
to a reduced resource revenues would be met with a mixture of tax increases and
spending cuts. This, too, would of course be unpopular. Austerity measures are never
popular.
Among the largest risks in relation to SWF investments, one may count the poten-
tial illiquidity that might result if the view that the time horizon of investments is
very long was proven wrong. Events linked to various types of crises that are often
linked to financial markets might lead to a dramatic shortening of the time horizon
faced by decision makers. Some investment could then have to be liquidated before
they were sufficiently mature. In that event, there could capital losses. For the GPF-G

7 The U. S. dollar has appreciated vis-à-vis other key currencies over the same period, so the decline

in terms of other key currencies are a bit smaller, though of a similar order of magnitude.
8 Statement by staff member Erling Holmøy to Dagsnytt 18, NrK Radio, 25 January 2016.
6 Risks and Uncertainty 169

this seems particularly relevant in relation to actively absorbing liquidity risk, and to
some extent credit risk, during times of relative market tranquility.

6.1 Slumps, SWFs and the Elusiveness of Financial Risk

A prerequisite for the establishment for a meaningful SWF is joint fiscal and current
account surpluses. The fiscal surplus shows that the state is saving, and the current
account surplus shows that claims are built up vis-à-vis the foreign sector. An
economic decline could worsen the fiscal balance and make it difficult to save, which
could threaten the idea of a thriving SWF. Economic decline weakens public finances,
and leads to fiscal deficits, and often a need for fiscal stimulus. To the extent that a
decline becomes international – as is most typical – tougher conditions could also
affect exporters and the trade balance. It could become difficult to run current account
surpluses. Neither the public nor the private sector are likely to have a capacity to
save in severe economic downturns.
For the owners of SWFs, a slump or economic decline thus poses a double risk:
First, the decline is likely to reduce the funds that can be channeled into savings,
since a shortfall in demand may be met with increased public spending – that is
expansionary fiscal policy. Second, the market price of various holdings of assets are
likely to decline, as large investors may liquidate savings to finance public and private
spending. There could be an exception for government bonds, the safest investment
vehicle. The exposure to financial risks depends on the composition of holdings.
A third possible effect is that public opinion may change to reflect a lower degree
of optimism with regard to the future. This could lead to increased precaution in
spending by the public, and limit aggressive types of investments undertaken to
benefit from economic growth.
Stocks and corporate bonds with significant credit risk, particularly stocks, may
decline in value with lesser economic activity. This could hit most investors. There
may sometimes also be a risk of a liquidity crisis. Several types of negative effects
of weakened economic conditions may thus be interlinked. In a liquidity crisis, a
massive selloff of risky assets may take place, because investors may fear either that
some securities may become valueless or that other investors may have to liquidate
assets in large volumes. The latter could spill over to large classes of similar assets.
In addition, very negative market developments may also result in needs to sell off
more secure assets in order to raise cash to cover inter alia losses on the less secure
holdings of assets. More generally, the investment climate could turn more negative,
leading to reduced returns and lower expectations as regards the future. Furthermore,
in an economic downturn, the energy demand, and the price of oil, could also decline.
Due to these negative possibilities, a slump may imply considerable uncertainty
linked to the evolvement of the size of a SWF. In addition to the uncertainty linked
to the source of the wealth to be saved, e.g. the oil price and factors linked to the
extraction rate, financial markets could take a hit and thus limit the value of the
170 6 Risks and Uncertainty

known resource capital stock of the SWF owner. This could be problematic, as
several negative factors could strike together, and at times amplify each other.
The financial crisis that started around 2008 led to robustness tests of several
important assumptions that are typically applied in relation to investment through
world capital markets, including the ones behind the operations of large SWFs. Below
some of the learned lessons are summarized.

6.1.1 Demands on Liquidity in a Slump

An economic slump may have even more severe consequences for a SWF. A stylized
fact is that tax income will decline, whereas entitlements linked in particular to
unemployment will rise. There is thus a ‘double whammy’ with respect to the budget,
and the budget balance typically weakens. Owners of SWFs may therefore want
to withdraw funds, rather than invest more, which can create problems for fund
managers: The investment horizon may, through a combination of the mentioned
factors above, become quite a bit shorter than what was expected before the downturn.
In isolation, owners of a SWF are in a good position on such occasions, as they may
have the ability to pursue countercyclical fiscal policy at lower cost than if funds
were to be borrowed to be used for that purpose. Nonetheless, if a high fraction of
the investments undertaken by the SWF are illiquid, the advantage is reduced: If
countercyclical policies are used actively, the liquidity demands on the respective
SWF will increase. By the same token, the costs of pursuing investment strategies
based on cheap, ample liquidity will increase: One cannot both eat the cake and keep
it. Investments are not exceptions. It may be costly to liquidate long-term investments,
particularly if they were entered into due to an expectation of a very long investment
horizon – that may later turn out to be much shorter. It is therefore very important to
have realistic expectations as regards the investment horizon.
Pursuit of countercyclical macroeconomic policy is one of several mechanisms
that can dramatically increase demands on a SWFs liquidity in an economic slump.
Other possibilities may be linked to payments for large investment projects, and/or
refinancing if there is debt, and increased expenses through the budget.
The opportunities to raise cash through meaningful asset sales at reasonable prices
may diminish in an economic decline. The reason is that many tend to get similar
ideas at the same time. This could complicate a desired downsizing of a SWF, and
more so the more ‘exotic’ one’s holdings. High creativity in chasing incremental
returns may therefore imply costs. The growth of a SWF may slow or stop due
to worsened macroeconomic developments, as exemplified by an economic slump.
There may then be large net withdrawals earlier than one had anticipated. This gives
rise to a type of liquidity risk that is difficult to plan for, and that may in some
instances lead to fire sales of illiquid securities that one still could need to liquidate.
If many investors were to face such pressures simultaneously, as is not unusual, the
market changes could be dramatic.
6.1 Slumps, SWFs and the Elusiveness of Financial Risk 171

6.1.2 Finance Is not Physics

Derman (2011) emphasized the poor performance of some financial models in rela-
tion to the marked economic slump that started in 2007 and overshadowed 2008. A
model is a simplification of reality, and is usually constructed for a particular purpose.
Most models must be applied with caution even in relation to the purpose they
are built to help analyze. With some luck, models may still perform this task reason-
ably well over time. Physics is a field where modelling has been highly successful,
and compared to in economics also with regard to predictions for the future. The
reason is that one plays against nature, which remains passive, or in the words of
Derman, op. cit., one plays against Good who doesn’t change his rules often. Rules
of nature can often be thought of as permanent, at least to a first approximation. It
is mainly our ability to uncover them that may change over time. Since one aims at
uncovering rules that are changed rarely if at all, humans have been able to understand
progressively more of how nature works. Modelling in physics has therefore been
very successful also for prediction of the future. By contrast to nature, humans are
free to change their minds and may often have good reason to do so in view of, e.g.,
competition from other humans. This vastly complicates the prediction of future
outcomes. In particular, data on outcomes in the past may be of much less help.
In finance one tries to study the results of decisions and actions by humans –
in Derman’s usage Good’s creatures, interacting with other humans. There is thus
strategic interaction in the sense that an agent’s future action is likely to take into
account how he or she views the possible moves and associated reasoning of others.
Complexity thus increases, not least because humans may change their mind for
numerous reasons. In view of the marked differences between the subject matter
in finance and physics, it should not surprise that models estimated based on past
outcomes perform much better in physics than in finance.
Finance, by contrast, is very different. If one also considers the ‘tug of war’ for
any net gains that may be available from interactions via financial markets, this
conclusion is highlighted. Further, some activities performed via financial markets
are really zero-sum games, where gains made by some players are offset by losses to
others. Most trading activities, for instance, exhibit this pattern. The same goes for
trading activities in stocks and bonds, at least if one considers trading in very short
time spans. The stock market as such, however, can be envisaged as a growing pie
where gains accrue over time to those who hold stocks. There is a premium relative
to most other asset classes, the equity premium, which is usually thought of as a
compensation investors require for the risk of holding stocks.

6.1.3 The Elusiveness of Financial Risk

The factors relevant to risk assessments are more encompassing than one may be led
to believe from the risk concept in theoretical models. Genuine uncertainty, which
172 6 Risks and Uncertainty

plays an important role in practice, is often overlooked in approaches to financial

markets by practitioners. For instance, one might apply a belief in the mean reversion
of returns without a sound foundation. Another, more general, example is the belief
that scrutiny of historical information can result in profitable predictions for the
future. Although such approaches might, due to some inefficiency, work empirically
for a while, it is almost certain that they will break down over time. Despite this,
many get fingers or more burned when it becomes clear that an approach which used
to work well fails. High returns may for instance have been due to an overlooked risk
factor, linked to events that occur rarely. Alternatively, a once-successful strategy
may be utilized by many because it did work for a few, for a while. With many trying
to benefit, competition between them in the relevant transactions may lead to reduced
returns for the average such player.
Imagine that you know all the roulette results from a casino for the previous year.
Everyone knows that one is unlikely to benefit from this material in roulette play in
later periods. This metaphor is sometimes utilized to illustrate a basic insight that
should apply also to financial markets: The markets are believed to be efficient to a
high degree, i.e. they process information well, so that all relevant information that
is public is also to a large extent reflected in current asset prices. The market prices
have no memory, and the price formation process thus cannot be bounded by earlier
realizations of the same prices, other than weakly if they were influenced by the
behavior of investors who could have behaved as if asset prices had a memory of the
past. To the extent that past prize realization plays a role, as in technical analysis,
this is due to later human behavior. If many acts as if historic prices or their higher
moments impact on future prices, there may be a pale shadow of the past in the price
formation, at least for a while. What is more unlikely, however, is that this could
establish an enduring, consistent source of excess returns.
Financial markets are also less predictable than a roulette game in relation to
uncertainty. In the roulette example, we know before the wheel is set in motion all
the possible outcomes. If the wheel is fair, i.e. not manipulated or defective, we also
know the probabilities of the various outcomes – black or red, or specific numbers
including 0, and sometimes 00. This setting with only known unknowns is simplistic,
and a poor approximation to many real-life situations.
In financial markets and other real-world settings, there may be no equivalent to a
well-behaved roulette wheel. Even if this model may work to a first approximation,
occasionally outcomes could be realized that few or no-one had thought of. For
instance, something radically new might happen, that may change the economic value
of various known outcomes, or lead to outcomes not yet considered or understood.
Or what we may call the type of game might change. The additional uncertainty
of unknown unknowns is additional to the risk associated with more or less well-
known stochastic processes. It may be difficult to know what causes such exceptions
in relation to the expectations. There is uncertainty related to the type of processes
in social situations, particularly with regard to the future, especially when both the
future and humans with competing interests are involved. There may for instance be
strategic behavior, where the behavior of several independent decision-makers may
be coordinated to produce new, unexpected aggregate outcomes.
6.1 Slumps, SWFs and the Elusiveness of Financial Risk 173

The ‘new Coronavirus’ SARS-CoV-2

There may also be new developments in nature, both of the sort that we have reasons
to expect based on scientific knowledge and entirely unexpected events. Such things
can on rare occasions impact severely on social life, to challenges public policy and
impact on the working of markets. Examples include tsunamis, earth quakes and
volcano eruptions from geology but also life-science events – where for instance
some forms of life thrives or declines.
The former is easier to handle. For instance, we know much about the risks for
volcano eruptions in various locations, even if the exact timing and location may
be a bit surprising. Similarly, we know quite much about the risk of earthquakes
and tsunamis. Further, such episodes are mainly one-off events, even if there may
be after-quakes etc. In biology there is instead evolution and a kind of strategic
behavior on the aggregate, where ‘good moves’ may entail survival and progress for
a specie, without any role for acting subjects as in game theory with human players.
Insects may swarm and eat all the crops, to produce famine, or viruses may mutate
and be transmitted from animals to humans, perhaps most of the time without any
significant implications. However, every now and then a ‘pest’ develops that may
threaten human lives and livelihoods. There are many viruses that carry testimony of
this potential threat for human life and prosperity: Examples include SARS (Severe
acute respiratory syndrome), MERS (Middle East respiratory syndrome), and Ebola,
and as of late the new Coronavirus named SARS-CoV-2.
The latest problem soon caused thousands of deaths and led to complete lock-
down of many of the largest economies in the pandemic’s early phase in spring
2020. Everyone appeared to have been caught by surprise, even if there was a lot of
time to prepare in the Europe and the United States. In particular, it seemed that the
reproductive coefficient, that determines the growth rate in cases, had been severely
underestimated by public health services globally. This was serious because a large
number of people got infected that led to costly restrictive measures, and because a
fraction of the infected developed severe lung disease with high demands on intensive
care treatment and a quite high mortality rate. No country, including the richest ones,
seemed to have enough intensive care capacity to meet this problem as the pandemic
developed in the spring 2020. Italy was a frightening example early on, and a bit
later Spain and Brittain, and New York City.
For a while the Covid-19 pandemic led to the most severe labor market crisis
since the 1930s in both Europe and the United States. In March 2020 it also led to
a temporary melt-down in global stock end energy markets due to sharply reduced
expectations of growth and incomes. This happened first in Europe, and seemed to
spread with a lag of a few weeks to the United States. There are several reasons for the
sharp oil price decline – including what could look like reciprocal brinkmanship in
relations between oil producers Russia and Saudi Arabia. Russia did not agree to cut
back production to protect an oil price under downward pressure. The Saudis then
reportedly increased supply. Simultaneously global air traffic and other important
sources of consumption came close to a standstill. The later was due to draconic
measures implemented to stop the spread of the disease by many rich countries. No
174 6 Risks and Uncertainty

health system seemed prepared for a crisis like this, and the alternative with lesser
measures would have been to accept deaths in much larger numbers.
Norway is still oil-dependent, and took a double hit with both a sharp decline
in international demand for exports due to the virus disease, and an oil price cut
of roughly 2/3 from early in 2020. Nothing like it had happened before. It was
therefore not anticipated. Some have pointed to the pandemic Spanish flu of 1918 as
a comparison, with some 50 million disease-related deaths globally. That comparison
looked dramatic, as in spring 2020 the number of deaths was counted in thousands
in most countries. The situation was still very serious in terms of both health hazards
and economic impact. Throughout the year deaths increased dramatically in most
countries, reaching 346.000 in the United States, 149.000 in India, and 195.000 in
Brazil. Reported global deaths were above 1.8 million, and the number of cases in
excess of 83.5 million, i.e. a fatality rate of 2.16 per cent.9 Some ‘luck’ might lie in
the quite low fatality rate, which, however, varied across space with geography and
incomes.
Poor countries did not have the means to implement the draconic measures that
many rich countries introduced, and were therefore likely to suffer much taller death
rates. This also seems to have been the case in, for instance, Brazil, Argentina, South
Africa, and India. The number of deaths has been high. Probably they are also much
higher than reported, since poorer countries also tend to have less developed statistics
offices. Crises do, however, end at some point. This one is supposed to end with the
development of vaccines and improved drugs for treatment. In spite of this, no-one
quite knows what to expect, with regard to when it will be over in biologic terms, or
what the world will look like in social and financial terms ‘on the other side’.
A key problem with risk evaluation in finance, is specifically that historical data
are analyzed to make predictions about an unknown future. There may be an abun-
dant supply of cheap data that characterize the past. Careful scrutiny of this may
appear superior to admitting that the future is genuinely unknown. Events, however,
cannot have recollection by themselves, and some events may be as rare as they are
detrimental. The same applies to events as rated by standards developed by humans.
However, when historical data on various realization of financial risks are available,
it may feel intuitive in a first assessment to check how correlations have been between
some key variables in the past, perhaps even to estimate structural models based on
the price data. However, as hinted at, structural models in this domain are notorious
for breaking down.
Structural models sometimes perform well only on the data that have been used
to estimate model parameters, and not out of sample. Even for models that work for
some time, breakdown may be imminent for subsequent periods. Due to uncertainty,
historical data can only tell us what has been thus far, and not what will be later.
Many may have lost their life savings due to the Covid-19 outbreak. They will find
no consolation in statements that this severe disease and its devastating financial
consequences could not have been expected in view of historical financial price

9 These figures have been reported to the WHO, according to CNN Health. Source: edition.cnn.com,

accessed 1 January, 2021.

6.1 Slumps, SWFs and the Elusiveness of Financial Risk 175

data. However, those who left their investments alone were able to see them recover
through the year. To many, the quick recovery in asset prices was also surprising.
A pattern which has exhibited stability over some time might hint at regularities
that have survived from the past. Such patterns, however, may break down, typically
faster the more one tries to exploit them in transactions. The same insight must also
apply to higher moments of asset prices, such as volatility, the second moment. The
reason is that there is little in the past that can throw sufficient light on enough future
developments. If one confines oneself to the analysis of past asset prices or their
volatility, this cannot be expected to reflect well what the future will bring, not either
in terms of future realizations of the same asset prices and volatility. This must be so
both because the processes that generate the data may change over time, for instance
due to learning, and that some events of a very high importance are too rare to be
well reflected in the initial data. Thus, the relevant factors that influence asset prices
change continuously. Trying to make money from strategies that disregard this, may
be likened with picking up bills left on the side walk. If you find it you could as well
pick it up, as someone eventually will. Another similar metaphor, however, is that of
picking up nickels in front of a steamroller, which instead highlights the potentially
high risk involved in making the necessary bets to be able to collect.
Established patterns and relationships in historical data may still be useful in
trading operations of a short time horizon. Such positions can be entered into and
closed frequently to manage the risk. It is not by accident that trading desks try to
exploit this in the highly competitive financial industry; they tend to make money.
It is, however, also no coincidence that the involved decision-makers are careful to
limit the size of any risk positions even intraday, and much more so for any longer
time periods. The future is always somewhat open, and more so the deeper into the
future one might contemplate to move. To neglect this would be to be negligent of
risk.
Some have gone bankrupt because they have based large bets on insights from
the analysis of historical asset prices. Their main mistake has been to rely for too
long on something that did work for a short while, as suggested perhaps due to
some temporary market imperfection. This may be exploited by traders of financial
markets, more than by long-term investors. Over time, such opportunities that may
work well initially are likely to be exploited to an extent that makes it non-profitable to
continue to put on the same type of bets. This also follows from the market efficiency
hypothesis. To make money for a SWF it is probably better to act less aggressively,
to receive the appropriate long-term market returns for the various asset classes held.
One reason motivating those who try to exploit short-term inefficiencies in various
forms, often in technically sophisticated ways, is that there could potentially be big
gains if one were lucky and succeeded, and that success for a short time could some-
times be within an actor’s reach. In relation to this, it might also be possible to
convince some investors to be clients and increase the volume and value of trans-
actions in this business. The more actors that are willing to take part, the bigger
could the gains be in a period within which the concept might work well. However,
counterparties are needed in the transactions—who may as a group learn fast.
176 6 Risks and Uncertainty

Salesmen at work
Mature investment organizations may want to exploit marginal investment oppor-
tunities, i.e. an opportunity to pick up yield by entering new markets or abolishing
restrictions made earlier. One key insight of ‘new’ portfolio theory, is that less than
perfect correlation between the assets of a portfolio enhances the risk characteris-
tics: For a given expected return, this trait enhances diversification and reduces the
risk of losses. Thus, there has been a tendency to include various alternative assets,
in increased proportions of portfolios in recent years. Typically, these ‘new asset
classes’ are made up of assets not previously held by institutional investors, at least
not in large size. Real estate is one such example. Other important examples are
unlisted equities and infrastructure.
In a low interest rate environment, one may have to increase one’s risk toler-
ance to generate incremental returns. This is another rationalization for the new
approach by many investors to acquire alternative asset classes since the Great
Recession from 2008 on. This may entail danger. The alternative classes of assets
are typically less safe and less liquid than the conservative choices made earlier,
and thus potentially more vulnerable to market unrest. This is the reason why they
offer a yield premium, which is pressed down when additional players acquire
them. The yield could rise again (and prices fall) if there were forced sales in a
crisis. The ‘new’ assets could therefore incur capital losses and potentially under-
perform traditional ones if prospective returns in the investment markets worsened,
as they typically do from time to time. This resembles the so-called peso problem in
foreign exchange. For long time spans the nominal exchange could be fixed, despite
different interest rates, between, say, the U. S. dollar and Mexican peso. Inherent
instability may lead to occasional leaps in this exchange rate.
In the current low interest rate environment, there has been a tendency over time
for SWF owners and other investors alike to increase their risk-weighted returns
by expanding their investment universe. Norway’s investments through the GPF-
G is but one example. One has covered new ground both in terms of new asset
classes and new countries. This has increased the expected overall return, due to
larger holdings of alternative investments with higher yields, and contributed a bit
towards decreasing overall risk as conventionally measured due to broader combined
investments. In isolation there is better expected diversification. The latter means that
the significant net increase in risk is somewhat lesser than it would have been without
taking into account lesser correlation of returns across the holdings. The entering
into new countries has been motivated inter alia by a view that future growth will
increasingly come from today’s emerging market countries. One important caveat is
that one can rarely know from which country or countries. In terms of the level of risk,
some emerging market countries are much less secure than the western democracies
one has been used to investing in. The financial markets are unlikely to provide good
a priori estimates on how much less secure the ‘new’ countries are.
As mentioned, in the years before the formal establishment of a resource fund
(1996) and channeling of capital into this fund (1998), Norway’s external reserves
were invested in mainly fixed-income securities guaranteed by OECD governments.
6.1 Slumps, SWFs and the Elusiveness of Financial Risk 177

At that time the relevant risks were mainly linked to macroeconomics, via changing
yields and yield curve shapes over the business cycle, and changes in exchange rates.
As of late, by contrast, other forms of risk including political risks, have become
more relevant. This is due not only to the usual expansion by investors of their
activities in space and asset classes that are more sensitive to political risk, but also
to a deterioration recently in international relations between states. The latter includes
inter alia the more extensive turmoil in the Middle East following the ‘Arab Spring’,
the annexation of The Crimean Peninsula by Russia and the worsened relations
between Russia and Western states that followed, and unrest in the Middle East,
including in Turkey which saw a failed military coup in 2016. A further factor that
has caused tensions, is the rising role and size in the international economy of in
particular China, and trade-related tensions between China and the United states.
If one invests in financial assets that are listed with an exchange, one can hope
to have the opportunity of selling one’s investment if difficulties should arise. The
same may also apply to some unlisted investments, depending on the type, size, and
diversity of parties that make such investments. However, a specific exchange may
be closed when a fire sets in, or all investors in some type of assets may want to move
in and out of this investments’ narrow doorways like herds.
What may be even more important, is that it requires discipline to sell when prices
decline. No-one can expect to be able to sell strategically before a sizeable setback.
One reason is that it would require behavior that also in many instances would fail
to benefit from significant bull runs. After a decline has set in, it could be human to
focus on the losses that would be realized by selling, and delay sales in the hope that
the market would recover somewhat, so one could sell at a somewhat better price.
However, such opportunities are rarely available in large selloffs.
With location-specific fixed investments like real estate, there are some addi-
tional, perhaps more pressing problems. One is tied down to a specific location for
each single investment, and dependent on subsequent conditions in that spot. The
sometimes-available option elsewhere to take the money and run, will not be valid.
It is difficult to overstate the risks implied by this framework.
Although it would usually be in the interest of states to exhibit self-restraint to
guard their reputation, predation at the expense of foreign investors remains a risk.
International cooperation and the peer pressure from the international community of
states reduce the risk of seizure of assets, which still cannot be ruled out. In view
of the developments over the latest years, this risk has probably increased in many
locations. This could shrink the space of meaningful investments, particularly those
owned by SWFs, and perhaps in particular SWFs of small states.
The geopolitical situation has changed markedly over the latest decades, in partic-
ular with regard to the international role of the United States. This development, and
the other trends described above, have changed the international investment environ-
ment and are likely to impact negatively on this environment for years to come. In
particular, the United States appears as less interested than in earlier times in main-
taining tranquil international conditions. This may by itself have opened for more
unrest, including civil unrest, in many locations and countries. If this assessment is
correct, the risks may have increased, and could increase further compared to in the
178 6 Risks and Uncertainty

recent past. This is relevant for all international investments, and would apply with
particular force to location-specific investments like real estate and infrastructure. It
is too early to tell if this situation will be improved by the new administration from
2021 in Washington DC.
It may also be pertinent to warn against other types of risk that may be overlooked.
Psychologists have been interested in why we, in our daily lives, are often willing
to accept high probabilities or risks of some very negative outcomes, such as car
accidents, and less willing to accept extremely low probabilities for outcomes with
similar consequences, such as plane crashes. An important finding in this literature
is that one may establish an unfounded feeling of confidence when one for instance
drives a car, compared to in a situation when one may be a passenger on a plane.
When one is free to make decisions and navigate a car, one can change the speed and
direction, and falsely feel to be in control of the situation. In international investments,
there may sometimes be misplaced complacency due to a lack of publicly available
negative information. Further, one may feel that one is able to control a situation
where one is free to execute transactions through a counterparty or an exchange that
one may still not effectuate, perhaps due to psychological factors. The latter situation
can be avoided through precommitment and automation, but that solution could lead
to problems further down in the decisions’ chain.
A key risk in relation to investments, particularly in tangible assets in fixed
geographical locations, is that of seizure of assets by players that may exert brute
force. The logic of use of force, which may also be needed to defend an investment,
is very different from the logic of markets. Some investors could be well-advised to
simply stay away from fixed locations. However, the risks may materialize at a late
stage, when significant investments have been made or funds are committed.
One important implication of the expansion of the investment universe for a fund,
particularly a SWF, may be that security and geopolitics becomes more relevant in
relation to individual investments. Just as investments tend to become riskier in other
respects if one expands the mandates to chase incremental yield, geopolitical risk
could become more relevant if a fund were to expand in space into marginal locations.
As an increasing fraction of the total available investments space is covered, the
associated risks will also be assumed. This implies that a wide spectrum of problems
may become relevant, even if few were seen as likely to materialize in the short run.
Over longer time spans one should due to the law of large numbers be prepared to
meet with many problems, and hopefully to cope successfully with a subset of these.
A foreign SWF may appear as a new kid on the block in a new ‘exotic’ location,
likely to attract much attention from those already present. This may not be the best
setting for success in commercial terms.
6.2 Geopolitics and Risks of Expropriation and Confiscation 179

6.2 Geopolitics and Risks of Expropriation

and Confiscation

Above it was discussed how analysis of historic price data might be used to formulate
strategies in attempts to earn extra returns in listed markets with continuously updated
pricing, as well as why this approach – in view of expectations of market efficiency –
cannot be relied upon as more than a very rough guide as regards the future. Although
it is well known that empirical models rarely work well outside the data samples used
to estimate model parameters, it could be tempting to refer to data patterns of the
past to rationalize an assumed risk exposure. This is a potential pitfall in financial
risk-taking. Even if such strategies can be applied, it cannot be relied upon over
time. Some assumptions needed to underpin yield-enhancing investment strategies
do not appear as very approachable through historical price data. One example is the
relations with other governments, belonging to the domain of international relations.
The behavior of other social agents, particularly aggregate actors, is a highly complex
phenomenon that it is almost impossible to anticipate. A good approach in practice
can be to act cautiously and be aware of the limited predictability.

6.2.1 Geopolitical Risks Facing SWFs

Relations might improve or worsen and it may be difficult if not impossible to predict
ahead of time outcomes that rely on an interplay of actions among sizable players. The
future is always open to change. Further, there is likely to be a systemic component
in international relations, that could frame what it could be more or less reasonable
to expect or hope for. For instance, more tension between key powers or a higher
frequency of violence would usually be bad for investments. In practice, evaluations
of the risk of events like war or high tension requiring vigilant investor behavior,
might rule out numerous investments that one could otherwise want to make.
In this respect, too, it is important for investors that the risk of such developments
remain small after one’s funds have been committed. For instance, if it does not
appear certain that the rule of law would be maintained in relation to international
investors, one could usually be well advised to keep out. However, it is difficult to
know when the relevant information will become available. The players in financial
markets may not be good at pricing this uncertainty. At the same time, a strengthening
or cementing of the core conditions for pursuing business activities in an area would
be of paramount importance for investment decisions. There may thus often be a risk
of abrupt price action in instances when new, also favorable, insect information on
such issues becomes available.
The importance of this might not be well enough understood. It has a parallel
in societies in which there are larger expected gains to be made from taking rather
than making, see Pareto (1902), cited by Knack 2003: 1. In an equilibrium prior to
economic development only necessities may be produced. There would be little to
180 6 Risks and Uncertainty

steal, due to a high risk of that event. The other side of this coin is that there would
also be little if any meaningful development.
Innovation is by definition a high-risk activity. It consists of the practice of
making numerous propositions of new procedures and techniques that could poten-
tially outperform existing ones that have been shaped and formulated through exten-
sive practice over time. Unsurprisingly, most such attempts are doomed to fail. One
can safely assume that most attempts to arrive at better solutions than the already
known and applied ones are unsuccessful. Innovation activity is still indispensable
for making improvements every now and then, that may occasionally result in great
breakthroughs.
In order to invest in innovation, one would at least need to be convinced that
one could be able to reap the benefits from potential but unlikely successes. In a
Hobbesian state of nature, for instance, there is inter alia ‘no place for industry’
and very slim chances of successful innovation.10 If there are few or no deliberate
attempts at innovation, one can expect mainly coincidences of good luck to result in
progress over time. Some progress could be perhaps made with ongoing activities
and improvements that accumulate with time. The rate of innovation, however, would
be very low.
The state of nature could thus be a poverty trap – not so unlike poverty traps in
developing countries and regions of our world, as owners of capital would not want
to invest under such conditions. Institution building could be a viable strategy to
escape from this situation. However, the needed confidence among the members of
a society would take time to build and be fragile. Further, any confidence thus built
could vanish instantly in the event of setbacks, which would be likely. It is difficult to
invest if there is little reason to believe that one will receive the future fruits from the
investments. Ideally, investors should be confident that they would be allowed to keep
a sizable share of the extra income they could create and that some others, including
tax authorities, would also benefit. If this is not satisfied, funds are unlikely to be
committed for investment. A lack of suitable investments could remove the incen-
tives to save. What is not saved, is always consumed. Consumption may dominate
investment if the prospects of a future pay-off is deemed as low. This strong and
well-known mechanism leads to underdevelopment, and slows the rate of progress
in many parts of the world. To overcome this obstacle requires more than capital.
Just like for other types of risk, the realizations regarding geopolitical risk can
often differ from expectations. An essential point is that investors risk to burn their
fingers and more, and are likely to adjust their behavior accordingly – to the detri-
ment of the future prospects of a society. This is salient inter alia due to expectations
formation, even if it may happen after a particular event. Because it is difficult to

10 The English philosopher Thomas Hobbes (1588-1679), in his 1651 book Leviathan, depicts a

state of nature in which there is “no place for industry… no knowledge of the face of the earth; no
account of time; no arts; no letters; no society; and which is worst of all, continual fear of violent
death; and the life of man solitary, poor, nasty, brutish, and short”. Life is short and poor, and
immediate survival concerns overshadows long-term needs. Hobbes thought this could be avoided
only by a strong, undivided government. He propositioned a social contract, where ordinary men
would accept subordination in relation to a strong sovereign in exchange for protection.
6.2 Geopolitics and Risks of Expropriation and Confiscation 181

include this type of risk in systematic approaches that investors may use in plan-
ning, it could become neglected. It may be reduced to a binary choice – investable
or not, where most knowledge accumulates for the former case. An area of region
may change rapidly from investable to non-investable due to in particular geopolitical
tensions. This could indirectly be accounted for by careful and conservative investors.
However, the relevant consequences of opening a geographical space for invest-
ments are many and may be intevoven. They may therefore not be appropriately
considered before considerable investment and development takes place.

6.2.2 The Political Economy of ‘Envy’ – Confiscation

and Expropriation Risk

This section focuses on reasons to worry for the safety of investments. There are
many reasons for investors to act cautiously. Some problems are correlated with
geopolitical unrest or threats by some agents to further their interests through the use
of violence. An indicator or similar risks within a jurisdiction is rampant corruption.
In both instances, civilized means may not suffice to secure legal rights. In other
instances, informal norms held by someone influential may curb opportunities of
others for, e.g., investments.11
The focus is not on uncertainty linked to geopolitics but more generally on the
problem of confiscation. Geopolitical risk refers to an anarchic system of states,
where the use of force remains an option to be aware of. In instances where force
is thus applied, wealth and lives are at risk and assets may be confiscated. However,
most assets may be in locations that are not very vulnerable with regard to geopoli-
tics. Confiscation may often take place in locations where this was not anticipated to
be likely. This may be a severe problem, hampering business opportunities, growth,
and investment, in particular where the rule of law is weak. Thus, whereas confisca-
tion may be related to geopolitics, it mainly happens in contexts internal to jurisdic-
tions. Settings where law enforcement is weak or asymmetric vis-à-vis the respective
subjects may on the surface appear as worthy of receiving investments. Later, one may
find that the right to perform business is reserved for firms and persons with special
connections to those in control. Others might not be tolerated or may be required to
pay extra ‘taxes’, e.g., in the form of bribes. The rule of law may thus be either weak
or ineffective. As mentioned, law enforcement may also be particular with effects
varying with group membership. Skewed or biased law enforcement is informal, and
difficult to both detect and document. It is still common, also in ‘advanced countries’.
In such deficient settings, it can be difficult to stimulate growth and development.
Locations that experience severe problems of this type are often lagging in progress
and GDP growth per capita. The ruling elites may be well treated and able to cut

11 The section is also motivated by mechanisms of corrupt exchanges as outlined in the corruption
literature (e.g. La Porta and Vannucci, 1999, and to a very limited extent on experience by this
author with Nano-scale real estate.
182 6 Risks and Uncertainty

attractive deals for themselves. In particular for location-bound point-source invest-

ments, there may be a big information gap ex ante. Investors may learn how things
really work later, and could meanwhile incur losses. The easy way to protect against
this kind of problems, is to allocate investments conservatively across space. For
large investors, a simple and robust choice could be to just stay out of most dubious
locations. This is often defensible also because the dubious investments are usually
marginal in relation to the combined holdings of large investors.
A more general framework for considering confiscation, is the one of a small, less
powerful actor interacting with a large, more powerful one. For the smaller part to
be successful in such relations, some structure is needed: For instance, undisputed
and respected national borders may be helpful. Within one’s borders, one can escape
potentially detrimental effects due to the larger player’s superior power resources – at
least in relation to violence. An exception to this may lie in warfare, or aggressive
but rare acts that could involve both parties. In a world where an increasing number
of issues require contributions from several parties, and when actors and outcomes
are increasingly interdependent, as emphasized e.g. by the increased role of actions
in cyberspace, the shielding provided by one’s home turf is less encompassing than
before. Further, even in times of military tranquility in the traditional sense, there
may be a state of continued hostility between various powers in cyberspace. Power
relations also impact on incomes within sovereign territories by many other mecha-
nisms. Overall, the insulation effect provided by borders of sovereign states has been
reduced. As a consequence, the risk of harassment may have increased for small,
geographically distant states.
One implication could be that international investments should be undertaken
with more caution than under a scenario of guaranteed peace where some risks could
thus have been avoided. For SWFs, this might have implications inter alia for asset
class allocation and the time horizons of investments. It should also imply caution
in relation to absorbing some of the types of risk discussed above, particularly in
relation to illiquidity – since this characteristic might impact strongly on the fraction
of an investment that could be saved by a timely pullout from a given investment.
Under increasing uncertainty, there may be no truly safe haven for investments.
This may be an argument for investing less. Nonetheless, for most types of invest-
ments, the potential gains are likely to outweigh the risks, including that of seizure.
Ex ante returns can be expected to be quite high. In spite of this, one should be aware
of the kinds of investments that perform worse in a more volatile environment.
As indicated above, one type of investment that could be severely affected is
unlisted real assets, particularly real estate in locations it might be comparatively
difficult to exit from. An exit decision could then resemble a forced asset sale. Diffi-
culties to exit are usually linked to a long duration of the respective investment
objects, i.e. ‘fixed capital’ and a difficulty of convincing others to invest if or when
one wants to exit. If we disregard arbitrary liquidity problems, investors may want to
get out due to frustration with earlier performance of the investment. Usually, such
investments are made because they promise high returns. If one wants to get out,
there may be few interested buyers, who may wonder why someone wants to sell.
6.2 Geopolitics and Risks of Expropriation and Confiscation 183

An urge to sell may surface if an environment or a host government is less friendly

with regard to foreign owners than it appeared at the time the investments were made
and the respective funds committed. The performance of such assets are likely to be
information-sensitive, whereas honest and trustworthy information could be difficult
to come by.

6.2.3 Could Envy Trigger Confiscation of Assets by States?

Envy is known as a powerful social mechanism between individuals. It is charac-

terized by psychologists as an emotion, but also known as one of the seven sins of
death in Christianity, and a central theme in other religions, including Buddhism and
Islam. Psychologists have described is as a feeling of pain in relation to something
good that might happen to another individual. Responses could include to acquire
similar goods – if it is related to goods – oneself, or to inflict pain on the envied
individual, including by taking from that individual what is envied.
In Dante’s epic poem The Divine Comedy written in the early fourteenth century,
envy is covered in book two – Purgatorio, which is Italian for Purgatory. In Catholi-
cism, this is an intermediary state after physical death for expiatory purification.
The purgatorial fire is viewed as expiatory and purifying and is thus different from
punitive hell fire.12
Everyone has experiences with envy. For individuals, experiencing envy is part
of being human. Could the same or similar mechanisms also work as social mecha-
nisms among aggregate actors like states? That is, could the leadership of one state
to be envious of another state or its leadership based on material differences, like
differences in income or net financial worth? This author is not aware of any research
on this: It appears as an open question. One could suspect that the answer could be
affirmative, even if it is not straightforward to just substitute state leaders for indi-
viduals in basic psychological theory developed for individuals. There could also be
support for such a proposition in historical material, for instance for Europe from
the latest century or so. For individuals, envy is a social contexts’ phenomenon that
may require more information that what is envied by whom and why. For instance,
is the ‘lucky’ holder of something enviable seen as deserving? As such, it is directly
coupled with perceived fairness, where views could depend on one’s own position.
The answer to the posed question could be affirmative also from the standpoint
of principles. In many fields, success is difficult to measure with a reasonable degree
of accuracy. Politics may be one such field. For instance, it is always difficult for
the voters to know with any accuracy, even ex post, whether a good job has been
done on their behalf. To better live with this unsatisfactory situation, different kinds
of psychological shortcuts are available. Appearances may be important. In relation
to these, one may also find it natural to compare oneself with one’s peers – that
is some measure of relative status – in various dimensions that are perceived of as

12 See Le Goff (1986), cited by wikipedia.org, accessed 6 December 2019.

184 6 Risks and Uncertainty

both sufficiently important and easy-enough to observe and measure. It is difficult to

think that representatives of governments would differ systematically in this respect.
This initial approach seems to appeal to human nature with respect to either evalu-
ation of performance in relation to standards that may be difficult to grasp, or when
information of a more objective kind is not available.
Relative outcomes may be due to a number of different factors. It may be human
to abstract from these factors, and compare one’s own ‘end results’ with others in
terms of for instance income or net financial worth.
For the government of a state the relevant peers would be governments of other
states, or just other states. A myriad of economic statistics that are readily available
and of high frequency may be used to rank states. Material conditions of living, or
standards of living, is one central aspect in comparisons. Although wealth is but one
part of what one needs to lead a decent life, this aspect may be more available for
comparison than some other aspects. Further, economic accounting is objective in
the sense that the reported numbers refer to commonly accepted concepts or value
standards. They may thus play an important role also with respect to international
relations. More research is needed, but some ‘end results’ are known with certainty.
For individuals, other individuals that share similar characteristics may pose the
greatest threat to economic progress (Mishkin, op. cit.). Although rare in reality, there
are many tales in the United States on journeys ‘from rags to riches’. Mishkin utilizes
this as a proxy for opportunity: If you are homeless, other homeless people could ruin
your opportunities, or if you are a student the class mates could become dangerous
for prospects of future success. Further, if you work in a specific environment or fill
a particular position, others from that environment or of a similar position may pose
threats. One underlying factor could be limited to competition, which may be fiercest
from one’s peers. However, there may also be a psychological factor of envy at work
between peers. The latter is important in this author’s interpretation of Mishkin:
People in similar lines of work have similar capabilities, habits and lives. Many also
view their peers in a professional context as their most relevant reference group in
other contexts. For instance, the occupation and domicile of a person could constitute
objective conditions through which prospects for future developments could, or even
by someone’s judgment should, be filtered.
This mindset in relation to specific individuals nearby, could strengthen the role
of the social mechanism of envy. This could happen particularly in circumstances
when someone of an inferred ‘low status’, due to some criterion that may rightly
or wrongly be seen as measuring professional success, outperforms his professional
peers in some other domain. Net financial worth – boring as it is – may have a drag
on the mind in this context, as a standard few can escape and most can relate to.
Hence, ‘smart’ and ‘dumb’ people alike will grasp this. An actual relative situation
could perhaps be perceived of as unfair in relation to what ‘ought to be’ based
on some adapted criterion that could originate from a wide range of references. In
terms of intellectual content, it could for instance be due to animal spirits, as among
several other mammals, abilities to create wealth in a market context, or perceived
academic credentials. An important question is the extent to which it could be seen
to justify illegal acts aimed at ‘correcting’ some perceived wrongs inherent in the
6.2 Geopolitics and Risks of Expropriation and Confiscation 185

status quo. To justify such acts, that would typically be unlawful, various sorts of
blame or wrath could be directed against an ‘undeserving successful’. That behavior
can occasionally be observed when children play. If the context allows it, and is
sufficiently non-transparent, or if there is impunity due to the above or other reasons,
this author suspects that this type of behavior can spill over to become representative
for adults.
One extreme form of such behavior could resemble the Nazi’s treatment of Jews
before and during World War II. This example is, however, more complicated. The
highly visible associated uncivilized acts could happen due to large distortions in the
way politics functioned following World War I, and the Depression of the 1930s. For
instance, Jews became scapegoats in Nazi rhetoric. The accompanying mechanisms
may be sobering particularly in relation to how much injustice was tolerated by the
many not directly affected by the misdeeds. It may be reasonable to expect that
injustice can be particularly strong within confined groups, glued together by strong
internal norms. In such contexts fabricated disregard could become a rationale for
confiscation or expropriation from agents or individuals who have been seen as
belonging to a class of ‘undeserving’ rich or successful. One could in the limit be
judged as undeserving of anything good based on one’s identity. To become mentally
included in such groups, it could in the limit suffice to be more successful than
someone else, or deemed as ‘unacceptable’ for vague reasons.
The suggestion that emotions of envy, or similar ones, could come into play
between states in international relations cannot easily be ruled out and could be
investigated further. One could perhaps suspect that non-democratic states marked
by totalitarianism or absolutism could invoke reasoning based on envy to rationalize
confiscation from groups of individuals they may repress. An explanation based on
envy, or related emotions, could probably fit well in. A situation of uneven relative
‘deserved’ wealth, could for instance lead to a latent situation that could be triggered
by several types of events. Various ‘dues’ could be rationalized based on norms,
e.g. of perceived fairness, perhaps in combination with blame. In that context, envy
would become a force to reckon with even if it might be officially condemned on
moral grounds. For everyone who wants to take something from others, a justifying
explanation may not be too difficult to invent. Further, even if this was condemned
by most it could have appeal as potentially popular policy among populists. Under
undemocratic forms of rule, this could probably happen easier.
A powerful illustration might be the claim that the terror against the United States
on 11 September 2001 could be explained, at least partially, by an increasing and
ever more visible wealth gap between the typical citizen of the U. S. and other
Western countries and traditional groups in the Middle East taking part in religiously
based activism (Jihadism). This development was widely exposed by the interna-
tional media, which made the gap more visible. One cannot easily rule out that envy
may have played a role in triggering the following events of terror. In a world of
ever-expanding wealth gaps, frustration might have led to accusations or hatred,
directed against successful players, seen as ‘undeserving’ by those who pursued
terror. An obvious alternative strategy to reduce tensions by copying the material
186 6 Risks and Uncertainty

success of those who behaved differently may not have been available due to religious
constraints, at least de facto perhaps also de jure.
There may thus have been hatred directed against rich countries by agents of less
fortunate regions of the world, with less political freedom and lesser material stan-
dards. The deliberate destruction of, e.g., the twin towers at the World Trade Center
(WTC) in New York City could possibly be understood as a result of development
of hatred within confined groups. The WTC was a highly visible symbol of Western
capitalism, and thus, as such, vulnerable. This fact, however, was not new. The new
element was that an organized terror-group acted on this perceived situation and was
also able to outmaneuver the security systems.
Does this observation have implications for investing or acquisition of real or
financial assets? There may or may not be implications. One could for instance
question how wise it would be for a small state to be the registered owner of
prominent symbols of capitalism. It would probably not be as risky for this kind
of investor to own up to 2 per cent of the stocks on the main exchanges. This content
could appear as lighter, even if large values are involved. The reason is that the
values are dispersed around mainly developed economies, and therefore not highly
visible. It could perhaps be easier for humans to be provoked, for psychological
reasons, by the ownership of large, tangible assets than that of a lot of different stocks.
Larger holdings of shares in well-known companies could perhaps be an interme-
diary case with regard to owner visibility. Nonetheless, the potential envy of small
states would most likely imply lesser consequences than envy of a large power, or
of Western capitalism. One could perhaps still have to cope with risks of confiscation
or expropriation, in particular if funds were allocated to the ‘wrong’ destinations.
To the extent that there is regulation within a framework of rule of law, acts of
predation that one might otherwise fear would usually not be permitted. The problem
is that one can usually not be certain that the situation is as in law on paper, that is
as it appears to be. This could apply even within pockets of countries that overall
seem to be governed by a strong rule of law. As mentioned, the rule of law might
become defective, perhaps most obviously in ways that relate to more or less fair or
asymmetric law enforcement in relation to various distinct groups.
The sketched mechanisms above are negative for value creation but cannot quite
be ruled out. Excuses that rely on blame and scapegoats are used in several contexts,
including for leaders who struggle in governance and/or to be (re)elected. To further
one’s cause, it may fit to blame someone else for unfortunate events, mistakes, bad
results, bad luck, etc.
Within this line of reasoning, visible differences in income or wealth, might by
themselves cause less cordial international relations and thus contribute towards a
setting with increased risk for conflict and/or misunderstanding. This could in part be
attributed to the perception of others, outside a comparatively rich country. It could
not easily be avoided with highly visible income and wealth. Highly visible wealth,
perhaps particularly in relation to the investing of a surplus from oil sales in prime
real estate, could put one at risk by underscoring that a nation or its SWF is well off.
The citizens behind the GPF-G are well off, even though the SWF is owned by the
state.
6.2 Geopolitics and Risks of Expropriation and Confiscation 187

Transactions where comparable amounts of money are invested in other types of

assets might not be so easily noticed: ‘Out of sight, out of mind’, goes an old saying.
Within the asset class of unlisted real estate there would in this respect be a big
difference whether one acquired a highly visible object, say a sky scraper in New
York most of which have proper names linked to well-known firms or trade marks, or
a fraction of a large utility facility, either unlisted or registered in a security registry,
which might also be located quite nearby. The former example might be considered
as something like a ‘conspicuous investment’ - a parallel to Veblen’s, op. cit., notion
of conspicuous consumption. The latter investment is much more dull, boring and
prosaic, and therefore more robust in the context here.13
To view this in perspective, strings of good or bad luck may end for reasons
outside an investor’s control. Even if good fortunes were not to end, accumulated
results of good luck could present obstacles to success. Suppose that there were
large, and highly visible differences in outcomes in a peer group. The behavior of
highly visible players that is associated with success may be copied by others. This
could lead to increased competition. It may therefore help to escape the attention, if
one is good at something. At the individual level, some may be good at hiding their
successes, their wealth and their sources, thereby avoiding to upset others. This could
imply a lowered experienced economic status. A kid who just acquired a large bag
of candy could hide it or falsely claim to have eaten it all, when approached by other
children who are aware of the candy. In principle, wealth could be hidden by investors
in a similar way. That strategy would of course not be very available for a state,
particularly a democratic ones with highly transparent policies, and requirements of
accountability. However, highly visible wealth could in theory increase the risks for
asset owners linked to the behavior of others, particularly if the assets are perceived
of as physically difficult to defend.
In some less secure environments, violence may be a threat to cope with. Else-
where other, less aggressive, acts may be undertaken to confiscate an agent’s wealth.
This could be of particular importance in relation to tangible assets in a fixed loca-
tion that typically cannot economically be altered. One important reason is that
potential opponents linked to a fixed location have ample time for planning ahead.
Depending on the circumstances, the potential competitors could be well connected
in the respective community. Most states would restrain themselves with regard to
confiscating assets held by foreign investors. This would happen only rarely, if at all.
However, they could potentially look the other way if their private subjects did that.
If seizure was permitted without sufficient sanctioning by the government, the effect
would still be lost assets.

13 This concept conspicuous consumption is due to the American economist Thorstein Veblen (1857-

1929), and linked to his concept of a leisure class. The basic idea is that both available time and
products purchased may be visible and serve as signals of social class, including for the purpose of
attaining a higher social class. Veblen’s 1899 book The Theory of the Leisure Class: An Economic
Study of Institutions, is a critique of conspicuous consumption as a function of a class-divided
society and consumerism. Veblen’s concept may perhaps not be directly relevant for individuals in
modern industrial societies. However, it may still be of use in thinking of other, similar phenomena.
188 6 Risks and Uncertainty

If it is desirable that the world pays little attention to one’s investments, a fixed
geographic position as for highly visible real estate objects may not be a very good
idea. The same could apply for the assets of a fund. One could perhaps sleep best
at night owning objects that exist only in computer systems, like stocks and bonds,
particularly if they are government guaranteed.
If the sketched mechanism is correct, one should expect declining business condi-
tions internationally, and a less stable security situation, to make it more difficult
to hold on to wealth. The relative economic status of various countries is quite
visible. There might be tensions with respect to, in particular, visible wealth. A
worsened security situation could also pave the way for agents wanting to change
the status quo. Nationally, an economic slump could via similar mechanisms lead to
increased taxation for some. A motivation for tax increases could in principle also
include some envy or ‘hard feelings’. Not seldom, a crowd resembling last night’s
winners at a roulette game may have to give up new-found riches.
The potential impact of envy in investment should not be exaggerated.
However, even if many may see this type of motivation as uncivilized and crude it is
salient among persons. In social contexts, individuals have a propensity to compare
themselves with one another in a group. How one fares compared to group members
may be seen as very important. At the same time one could be uninterested in how
individuals that are not members of a relevant group fare. This may have important
functions from a biological viewpoint, linked to evolution of our specie over long
time spans, and may be important for our specie and identity.
To reduce the risk that envy could become relevant in relation to investments of
a SWF, it could probably help to keep a low profile. Further, it could be wise to
restrict investments to developed and/or industrialized countries, where one is used
to handling large sums of money and large transactions do not attract attention as
such.14 With regard to envy, there could be an important difference between being
seen as rich in an aggregated overall assessment, and being seen as such and pursuing
business for profit in poor regions of the world.
The latter situation could attract unwanted attention. To understand why, think of
the differences with regard to the reception that an aid agency and a SWF could expect
to receive in poor countries. Possibly, envy and the potential losses due to it as investor,
could be effectively avoided by keeping investments out of the most troubled areas.
SWFs do this indirectly by being conservative in relation to investments in emerging
and frontier markets. This helps, but may not be defensible in terms of returns: If one
is concerned particularly with the growth prospects, the most promising areas are
likely to be just emerging and frontier markets. In any event, one should probably be
careful not to chase high returns in such locations, where there may be severe risks in
addition to the financial and economic risks investors are used to handle. One reason

14 J.S. Mill (1848, quoted in Knack 2003) noted in relation to the industrialization of Europe in
the 1800 s that “the largest obstacle was there were few on this continent that could be entrusted
with large sums of money”, that is that personal integrity limited the possibilities for growth and
industrialization. Personal integrity, however, is likely to depend on the institutions of a given society
at a given point in time.
6.2 Geopolitics and Risks of Expropriation and Confiscation 189

for apparent promising prospects in poor areas, is that other investors tend to shun
away, for a reason. There may be a risk that the capital gets lost.
Behavior subjectively deemed as provocative in the respective locations could lead
to an increased risk level. Provocation could become an elastic concept, and in some
instances stretch to cover activities that are usually perceived of as either necessary
or innocent. Investors in such environments must be careful – not to be portrayed
as weak or vulnerable, perhaps also not to be seen as too affluent and successful.
SWFs that do invest in such locations are likely to receive much attention.15 It may
then be imperative not to insult anyone. What would count as an insult, however,
could remain unclear. There could in theory even be desires or needs by some to
consider themselves as insulted, as an excuse for later actions instigated to get even.

6.2.4 Point-Source Risk in Real Estate

In some instances, there could be a short step from perceived insults to actions
aimed at ‘setting the record straight’. On some occasions this could be inevitable.
With regard to foreign real estate investments, this could be particularly relevant in
relation to acquisition of expensive, high-profile pieces. An individual acquiring a
skyscraper in New York City is also acquiring attention. This could be useful for
private investors, for instance for improved name recognition. The public would
typically be more aware about such investors than anonymous ones who may invest
larger sums in less visible investments, like bonds and stocks, and even infrastructure.
For private individuals or corporations there may be good reasons for such ‘exhi-
bitionism’, that makes others aware that they are someone to reckon with. For a SWF,
this calculation will be different. While some small states could benefit from strength-
ening their image among states and foreign audiences, others lack the need for a
higher profile. Further, one could have to justify the acquisition of high-profile invest-
ment objects financially, due to increased attention: Why was the taxpayers’ money
used to buy real estate in New York City, or London, or Paris? The answer should
probably include the terms risk and return, which could both be low with high prop-
erty prices and central locations. Nonetheless, investment managers don’t want many
questions of this type. One possible response, could be to stay away from high-profile
investments, even if it may be difficult to identify alternative low-profile real estate
investments that could fit as substitutes in a portfolio. Infrastructure projects may,
however, be exceptions. Private investors in principle must answer similar questions
from their stake holders, including shareholders. All investors, public and private,
could depend on politics in specific, confined locations and contexts that one would

15 Tothis author’s experience it seems to remain a strong norm that mainly original inhabitants of
an area may be allowed to run profitable businesses in that area. Even if this attitude were to be
relaxed with increased exposure to ‘aliens’, as is increasingly likely, it may not fully vane any time
soon. At the very least, this could take a long time.
190 6 Risks and Uncertainty

typically know more about after making investments than before the decisions are
made and the funds committed to investment projects.
Although real estate investments are likely to be safe in the prime locations of
Western capitals, and in many ordinary locations, they would often be less safe in
frontier or emerging markets. It is a common situation in public finance, in most
countries, that there is a lack funds to undertake even the public projects seen as
most important. The reason for this, is linked inter alia to the tendency of deficit
financing in democracies, is not important for the purpose here. In any event, the
experienced needs and wants to address tend to stay ahead of the public’s willingness
to pay through taxation. Even if this was not so, the perception of a country so rich
that it stacks away wealth in buildings in large cities of other countries, could perhaps
further negative social emotions. The danger may lie in both the availability of funds
to stack away, and the visibility and high profile of some assets.
One consequence of this could be less attractive returns than anticipated from
some assets. This could happen in several ways: One possibility could be increased
taxation, either by new decisions or implicitly through interpretation of existing
rules and regulations. In addition, many less formal and direct possibilities could
lead to similar outcomes.16 Other, less likely, consequences could include pressures
to pay for larger shares of international cooperation projects. As indicated, for such
international projects the needs may be large compared to available means, perhaps
more so than for national projects. States perceived of as rich may face pressures to
pay more than their otherwise fair share. The situation may resemble that of a rich
person dining with family or friends at a restaurant. If all were equal, the norm could
be that they should pay about 1/n each, with n guests. A rich guest could, however, be
expected to pay for everyone. Appearances linked to inter alia investment activities
could leave inexact wealth impressions that could impact on such expectations.
In the following real estate is discussed in more detail. Readers not particularly
interested in that asset class could skip the rest of Sect. 6.2. The reason for including
this is the quite recent inclusion of real estate in the allowed investments of the GPF-G.
The allocation and size of investments in both unlisted real estate and infrastructure
are set to increase over time. The overall asset class real estate may, however, be less
well understood by the public than stocks and bonds. Further, the risks of real estate
investments are potentially high. Furthermore, these risks are linked to the respective
locations of the physical objects. For the GPF-G, however, the risks have so far been
capped by conservative location choices, i.e. by restricting investment to the largest
market economies and democracies, in particular the United States and the United
Kingdom, France, and Germany - all states deemed unlikely to become unsafe soon.
Some investments have still been made in less stable areas, a trend that will continue.

16 Due to the high importance of location for real estate investments, this type of uncertainty could be

more relevant for this asset class than some others – notably listed stocks and bond of large turnover
that are listed by an exchange. Particularly drains on returns that could arise in later interaction with
other agents, including local authorities, could be hard to foresee, and underestimated at the stage
when funds are allocated to a given real estate investment.
6.2 Geopolitics and Risks of Expropriation and Confiscation 191

6.2.5 Real Estate: Composition, Liquidity and Political Risk

Real estate may to a first approximation be described as a composite asset, made of

equity and fixed-income. It comes in the form of title to a physical property, whether
a piece of land, a building on a piece of land, or a fraction thereof. This entity may
generate an income stream. Title to property implies ownership of a real asset – much
like a stock. This analogy is quite powerful in relation to understanding the asset class
of real estate, even if it is incomplete: Whereas stocks and bonds are often traded in
liquid secondary markets, real estate is rarely traded, and even more rarely traded
actively – which requires listing with a regulated market place. Every piece of real
estate is unique. In principle, each real estate object is like an individual firm. In
addition, it is typically concentrated or pinned down to a specific location, hence the
term ‘point source’. This last point is important with respect to the risks assumed as
owner of real estate.
The specific location where an object is located is usually governed by authorities
at various levels who make and/or enforce legislation and regulations. The authorities
are linked to political constituencies and lobby groups. Due to economic development
and many international treaties on investment, the frequency of negative surprises
may be less than in earlier days. Nonetheless, varying investor-friendliness may still
apply to specific locations. This could be important even within countries widely
perceived of as operating unitary legal regimes of a strong rule of law. In the periphery,
this may work differently and the law may not always be enforced to the full extent
and equally in relation to all players. Someone may know influential players of
business and/or politics, which may in practice regulate disputes ahead of time. Even
if the law is in principle enforced, as it usually is, there might be asymmetries both in
the degree and the eagerness of enforcement. This could imply discrimination based
on the identities of various parties and investors, that is typically ruled out in the
wording of the law. Nonetheless, it may still be important. For instance, there may
be no-one of sufficient influence seeing to that the law is enforced on a particular
occasion.
This may obscure the content of an investment, and make valuation difficult. It
could suffice to render an otherwise valuable investment next to worthless, or at
detract a large fraction from its value. Further, there may be unlawful confiscation
or expropriation meant to benefit well-connected other players locally. Furthermore,
there may be lawful expropriation, possibly combined with extortion, that could
strongly reduce the value of an investment. There are many ‘tricks in the book’ in
this respect. Even if an investor can hold on to an investment for the long haul,
it may become impossible to develop its objective potential in economic or even
physical terms. Under a strong rule of law, there is no need to think about such
possibilities. Without such abilities, there would be a higher likelihood of a forced
fire sale. Even without this kind of incident, investments that were once promising
might for the foreseeable future turn into financial and/or administrative burdens,
that may consume instead of producing a cash flow.
192 6 Risks and Uncertainty

Since these kinds of risks are local, they need not be tied to particular states
and may be difficult to anticipate or protect oneself against. Due to limits of the
attention span of external parties to an agreement with limited or no interests in
many areas, there could be few restrictions imposed from the outside by investors on
what authorities could do or permit in their territories. In spite of the law on paper,
there could be illegal and/or covert practices. The possibility of ‘political’ losses on
exotic real estate investments could make this a risky investment vehicle compared
to bonds and equities in regulated markets. This risk is difficult to quantify, and could
have implications also in relation to what a SWF should invest or be permitted to
invest in, and linked to this what returns one should require in that type of investments.
The high importance of local conditions and private information highlights the need
for hands-on expert management, with its associated costs. Further, risks that are
external to finance and economics may sometimes be poorly understood, or not well
handled by finance professionals. One should therefore act cautiously.
Real estate investments are made by committing funds to a specific piece of ground
or location. For the GPF-G all objects of investment are located abroad. This means
that the Fund will be distant and other parties insiders in the respective locations,
at least in a comparative sense. This may increase the risk of being discriminated
against. Such activities and practices could be actively used, e.g., to favor local
businesses and owners. The relevant actions may be set in train by other agents.
Developed properties that are used by owners or rented generate a stream of
benefits or income, much like interest payments on fixed-income securities. A similar,
more moderate advantage can be attained through securities lending. The income
flow makes real estate investments easier to finance than other investments of a
comparable size. This may drive up the price of properties compared to other assets
that are harder to finance. One must compete with a quite broad spectrum of investors
because the assets can be acquired with a limited down payment. This is different for
undeveloped real estate – inter alia blocks of undeveloped land. This form of real
estate is less accessible and therefore possibly cheaper to buy, but also highly illiquid.
In addition, there may in particular be political risks linked to zooning regulation
of land for various purposes. Investment in such processes and contexts can be very
profitable. However, the competition is highly skilled and professional. The real
estate types of most potential interest to SWFs could be centrally located office
buildings and infrastructure in mature markets.

6.2.6 Gearing and Institutional Quality

Most real estate investors rely on gearing, where debt may be incurred often as a
sizable fraction of the price paid. This may apply even for those with ample available
funds, as financing increases the return on equity. The investments thus become
riskier in financial terms, but may still be very secure in mature real estate markets.
However, there are some important qualifications:
6.2 Geopolitics and Risks of Expropriation and Confiscation 193

First, macroeconomic developments may lead to increased interest rates and a

sell-off with an associated sharp decline in the prices of real estate and other assets.
What is important, is that other investors may be forced to sell their property, thereby
lowering the market prices. Gearing might for instance fuel forced sales and result
in breaches on debt covenants. This, again, could lead to more marked downturns
with increased volatility of asset prices. There may be more forced sales in real
estate than in markets where less of the investment values are borrowed with the
assets pledged as collateral. Thus, the coin related to ease of financing has two sides.
Second, the quality of social institutions in various localities are important: As Olson
(2003b: 126) observes, there is no private property without government (emphasis
added). Hence, it will be of utmost importance that the government does what it can
to promote the protection of property and that enforcing the protection is independent
of the identity of the respective property owners.
To approximate this, an independent judiciary with a fair justice system is called
for, separated from the executive branch of government or other undue influence.
However, this may be much rarer than one is lead to believe; it may indeed be close
to utopian in many real-world locations, especially in non-developed countries. It is
more typical that various actors who seek influence over outcomes and rulings they
have an interest in, invests in techniques and connections that implies bending or
breaching the applicable law. Property rights may become correspondingly weak,
regardless of the letter of the law. In practice, the true content of formal rights may
depend on behavior by a spectrum of various actors who perform in formal and
informal roles.
In a social context, the policy stance with respect to private property may evolve
over time and be linked with the identity of specific owners. Prospective investors
have to evaluate this ahead of investing, and may in many instances be locked in
subsequent to real estate investments. The illiquidity of some segments of this asset
class imply potentially high costs of reversing decisions. This poses important chal-
lenges with respect to risks. The risks are often difficult to quantify, or even to
get a reasonably good handle on. The location- and regime-specific risks consist
of several components, some of which investors may not be used to consider, inter
alia because they may be assumed away.17 Therefore, the overall risk may often be
underestimated. This problem could increase with the distance, both physically and
culturally, between real objects one invests in and an investor’s home office. In distant
locations, weak or hostile institutions could be indicative of large negative surprises
set to unfold. The main problem is that in order to recognize this state of affairs,
one would need knowledge on and usually an exposure to the relevant environment.
This, however, could be unrealistic to achieve prior to the commitment of funds.

17 One reason can be that the behavior for instance by local authorities, that give rise to the risk, could

be illegal or illegitimate. This usually also implies that the behavior cannot be easily observed: It is
typical to hide aggressive or dubious actions. In decision-making, risks linked to predatory behavior
can therefore wrongly be assumed away.
194 6 Risks and Uncertainty

6.2.7 The Real Estate Market

Real estate may as other investments be sold in a secondary market. Indeed, the
secondary market is dominant for this asset class. It is still not usually listed in
regulated market places. That would be difficult with many unique objects. Listed
real estate, by contrast, consists of identical shares of a portfolio of unique objects.
As an implication of this, the single real estate objects may be highly illiquid. This
implies that the value, in terms of what an item can be sold for within a reasonable
time frame, becomes uncertain. Due to a small number of parties, some of whom
may possess privileged information, transaction costs may be high. All his makes it
cumbersome and expensive to find sufficiently interested other investors if one wants
to pull out. If one wants to get in, however, there may be good opportunities.
An investor’s desire to pull out could also be interpreted as carrying information,
either of unrecognized risks that a future owner also could have to cope with, or that
the current owner needs to sell and thus could have to accept a low bid. A closer
scrutiny of the situation could be warranted. This, however, could reveal unfavorable
information or unexpected costs that could reduce the size of prospective bids. From
a prospective buyer’s perspective, the costs would also include usual search and
matching costs, taxes and other dues to authorities, and payments to various type of
advisors that are needed in a transaction.
By contrast, a high degree of liquidity could have implied reversibility at a low
cost. In practice, the high costs and the difficulty of finding a counterpart who wants
to invest, makes this kind of investments difficult to reverse. Many real estate invest-
ments undertaken for business purposes will be highly illiquid. Thus, a purchase of
real estate of a considerable size in a foreign location, or even a domestic location
with limited available information, could independent of the price be interpreted as
a vote of confidence with respect to the particular local investment environment.
Finally, there may be a severe, often underestimated, risk of crime related to real
estate. An important reason for this is that physical properties are pinned down to
exact locations and thus potentially also to location-specific crime. Location, that
is highly important in determining the value of property, is also very important
in relation to exposure to crime. Despite the involved private property rights that
to some extent protect property owners, the characteristics of real estate discussed
here facilitate long-term positioning among the local parties that may contemplate
predatory acts in relation to private property. This could make it difficult for an owner
to hold on to all the contents of an owned property over time. The content refers to the
functions it can perform and/or the space it covers. If the exact content of a property
is unclear or challenged, its value could become questionable. This could both lower
its value and make it less tempting to invest and become a legal owner. The risks one
needs to overcome imply that one may need to hold on to real estate for a long time.
Without significant safeguards to inhibit corruption and other crimes based on
superior abilities to exert influence in small communities, it may become too tempting
for strong players to secure their revenues through predation that may target the prop-
erties of investors from the outside. Investors from the outside are most vulnerable
6.2 Geopolitics and Risks of Expropriation and Confiscation 195

because they would need to use more resources than insiders to protect their rights
and interests. This could be exploited by others to generate income. The insiders
often have many options available to further their interests, at low or moderate costs,
which could include both formal and informal alternatives. Outsiders must often rely
on formal alternatives.
Particularly in mangund locations, predation may dominate production. Few
could have strong-enough incentives to promote equitable or even technically effi-
cient solutions. Dominance and nepotism may impact on local decisions. One can
assume that problems of this type are quite common. They could be most severe in
countries that lack strong central-level institutions. A strong central level of govern-
ment, could curb some local corruption. Still, this may be insufficient for real estate
to be an attractive investment. Lesser openness, and lesser unbiased media coverage
of local than national events is also important. This may render local affairs less
transparent than national ones.
This seems to apply also to Norway. There may be ‘two different Norways’: First,
consider the area around the capital, Oslo. This setting may often represent Norway
in studies and international comparisons. Events are visible and formal institutions
are strong compared to in the periphery. Second, one may consider the waste back-
country of smaller communities, that may be dominated by local business elites.
The two settings may differ particularly with regard to amenities they offer after
an investment has been made. At that time, investors may find that the strong rule
of law the country is known for may apply mainly in the most central location(s).
In less central areas, some may benefit from incomplete enforcement of laws and
regulations. It could therefore be difficult for others to compete.

6.3 Immigration: Wealth Dilution or Enhanced Economic

Growth?

The West, including Europe, is a desired location for many who originate from other
countries, as migrants or asylum seekers. It is not easy to know the extent to which
government wealth could impact on decisions to apply for domicile or political
asylum. For the affected individuals, there may be a need to make decisions fast,
with limited knowledge of the potential destinations, and increasingly few destina-
tions to choose from. Immigration, however, may impact on the composition and
relative size of the workforce, and is also likely to affect per capita net financial
assets.
Increased immigration tends to be highly controversial, especially if the central
government relatively easily allows new persons into the country, and many wants to
come. This has been experienced across Europe, especially since 2015. The pressures
declined somewhat in the subsequent years, however, mainly due to obstacles that bar
the way for migrants or asylum seekers headed for Europe. The underlying situation
in Africa and Asia that has led to a record number of refugees has not improved.
196 6 Risks and Uncertainty

Physical safety is of paramount importance for humans. So are the expectations of

having a chance to lead a life in accordance with basic human rights. The expected
material level in a new location could also carry weight. If one is to relocate, one
might as well try to get to a country as favorable as possible for newcomers.
The welfare system of Norway and other countries of North Europe are generous
compared to similar institutions and arrangements in most other countries and areas
one could consider to move to. This could in isolation increase the number of
attempted entries. Resource wealth may also enter into this picture, through an
improved wealth position for the state, that could make more generous welfare
arrangements possible, other things equal. Nonetheless, the increased difficulties
of getting into Europe from Asia and Africa may make such differences between
countries that are all relatively rich matter less today than before.
A large number of new persons in an area would dilute the share of resource
wealth associated with the average resident. Even if some public spending may in
practice be reserved for citizens or residents of long tenure, this tendency is likely to
remain. Further, it is typically the aim of new entrants to stay for the long term, which
may also be best for society if they qualify to stay. In addition, even if one could
think of regulations that would reserve the resource wealth for original inhabitants,
or perhaps more realistic, citizens, this could prove difficult in practice. Furthermore,
discrimination based on national origin could constitute a human rights breach.18

6.3.1 The Influx of Asylum Seekers of 2015

Early in 2015 there was a heated debate of whether Norway should accept 10.000
Syrian refugees, or a smaller number. The backdrop was a quickly deteriorating
situation for many Syrians due to developments in the protracted Syrian civil war. This
was early in the year, before the chaos at Storskog. A compromise was finally reached
at 8.000 refugees. The result for 2015 was an influx of about 30.000 persons, or
about three times the high number from the previous debate. The number of Syrians,
it turned out, was small compared to the total influx. In any event the Norwegian
number was dwarfed by Sweden’s reception on the same occasion of about 190.000,
and Germany’s of about one million. Since 2015, many have become more concerned
with the costs associated with immigration, and the uncertain estimates of costs,
not least linked to uncertain prospects for integration of the newly arrived into the
Norwegian society and labor market. There are also concerns that large groups of
immigrants from Islamic societies of Asia and Africa could give rise to ‘enclaves’ of
immigrants instead of integration of the newly arrived into society. Although people
are generally open-minded, and even though it is difficult to know if such enclaves

18 This follows from key treaties Norway has ratified both under the UN and the Council of Europe.

For instance, discrimination based on nationality is ruled out per the European Convention on
Human Rights, article 14.
6.3 Immigration: Wealth Dilution or Enhanced Economic Growth? 197

can be realistic in North Europe, the debate may have stimulated a more restrictive
stance on immigration.
It is important in this context that the fraction of refugees-migrants from Syria,
where the civil war led to massive refuge, was much smaller than many had expected.
This could indicate that the wave of sympathy in relation to Syrian refugees could
have been exploited by migrants from other countries, who had mainly economic
motives to seek relocation to a country in the Schengen Area. While this may not be
surprising, it illustrates well how difficult it will be to separate current and pressing
issues that may appear technical, from the underlying more general and also much
more difficult debate on an appropriate long-term immigration policy.
Towards the end of 2015 about 5.500 people from poor countries crossed the
Norwegian-Russian border at Storskog to apply for asylum.19 Although this was
less than 1/5 of the number of entrants that year, it caught a lot of attention as
something entirely new. Norway is shielded from immigration pressures due to her
remote location North of the European continent. At this point, however, someone
had found a hole in this shield for arrivals in the far North, through Russia. Per an
agreement between Russia and Norway, it is not allowed to cross this border on foot:
One is required to drive. Bicyclists are counted as drivers, so the asylum seekers
arrived on bicycles bought in the nearest Russian city, Nikkel. Prior to the late fall of
2015 there had never been any asylum seekers entering Norway at Storskog. The new
trend was reportedly due both to word of mouth and middle men usually professional
business men, who specialized in selling access to European countries so that asylum
applications can be filed.
Application for asylum from abroad is typically not allowed. Further, European
regulations require the asylum application to be filed in the country where the appli-
cant first entered the Schengen area.20 Thus, in addition to the importance of avoiding
a risky crossing of the Mediterranean by boat it is also important to avoid entering
Europe through the countries that have long been less friendly towards asylum
seekers, as some countries of South and East Europe, including Hungary and Italy.21
By contrast, some countries of North Europe, in particular Germany and Sweden,
were seen as more friendly at least temporarily. This resulted in a higher probability
of acceptance of asylum applications and therefore prospects for a better subsequent
life. However, due to the large number of migrants received in 2015, the attitude
towards newcomers soon worsened across Europe. Norway is no exception in this
respect.

19 About one third said they came from Syria, and about as many from Afghanistan. Of the remainder,

there were about 40 other nationalities and 350 who were considered stateless (daily Verdens Gang
27 January 2016 “10 ting du må vite om asylkaoset på Storskog” (“10 items you need to know
about the asylum chaos at Storskog”).
20 This is accordance with to the so-called Dublin Regulation, that requires applicants seeking

international protection under the Geneva Convention and the EU Qualification Directive. The
Dublin regulation and its enforcement has worked to shield Norway and other countries of North
Europe, since many applicants arrive in Europe by crossing the Mediterranean Ocean.
21 Per a statement by migration researcher Jørgen Carling to daily Verdens Gang 27 January 2016.
198 6 Risks and Uncertainty

The government in power since 2013 had on many occasions labeled its policy in
this field as ‘just and restrictive’. The support of this position rested mainly on the
premise that it was much cheaper to help refugees through financial contributions
near their home countries, and that one would then be able to provide more efficient
help to the benefit of a larger number of refugees. By contrast, it is expensive to
settle refugees in Norway, where it may also be difficult to become integrated into
society. Failed subsequent integration is expensive financially, and in addition gives
rise to significant other costs. Further, it would be unfair to admit those who have the
resources to come by themselves, before the refugees on the prioritized list of the UN
High Commissioner for Refugees (UNHCR). These points seem valid. The litmus
test could perhaps be the combined realization over time of the number of refugees
admitted through the UNHCR and financial aid granted, in relation to the number
admitted. If very few UNHCR refugees were admitted, and little aid given, the policy
could mainly be a restrictive measure. Nonetheless, many seems to support policy
along this restrictive line.
Within a timeframe of just about one week in 2015, the Norwegian Parliament
passed new legislation aimed at stopping the strong influx of refugees. Contrary to
the usual practice there was no advance hearing. This signaled a strong commitment
to act first. Hearings take time, but are generally thought to enhance the quality of
legislative procedures, particularly by allowing decision-makers to become aware
early-on of many side effects or complications that could be expected. Only two
small parties voted against the new legislation, referred to as the ‘Russia instruction’.
The Norwegian regulation has been such that one could refuse to consider asylum
applications from those who arrived from a country perceived to be safe, were they
also could have applied for asylum. The latter requirement – that they could also
have applied for asylum in that safe country was removed in the new legislation.
It was deemed as sufficient for not processing asylum applications that the respec-
tive person(s) came from somewhere considered safe; ‘a safe third country’. In the
particular context Russia was considered as safe. A willingness has been communi-
cated by the government to apply the same principles also to other safe countries.
The definition of safe in relation to the situation of applicants could, however, be
controversial.
Norway responded to the 2015 refugee crisis by being more restrictive on access
to the country, while simultaneously contributing funds to help in or near the troubled
areas the refugees originated from. Since 2015 one has contributed about 10 billion
kroner, or more than 1 billion U. S. dollars, to help Syrian refugees. This seems to
be in line with EU policy: The EU has paid Turkey to close its borders for migrants
headed for Europe. By contrast, Turkey and Lebanon have received close to 4 million
and 1½ million refugees each, mainly from Syria.
There had long been discontent with a lack of attention from the international
community in relation to the crisis in the Idlib province of Syria bordering Turkey.
This area had about 1.5 million inhabitants before the civil war, that had lasted for
eight years in 2020. Due to the military pressure against this province held by rebels
in opposition to the regime in Damascus, a large part of the population had become
refugees. From December 2019, the number of refugees increased further, with many
6.3 Immigration: Wealth Dilution or Enhanced Economic Growth? 199

living in tents near the Turkish border. Turkey had closed its borders due to the costs
of the already received refugees. This civil war near Europe stands out as particularly
brutal for civilians. The international community has been unable to help much since
the Syrian war started, but in particular since the U. S. troops were called home in the
fall of 2019. There are, however, many refugees also from other areas, in particular
Afghanistan, Iraq and various locations in Africa.
As for most other countries, it is not possible to file an application for asylum
from outside Norway. Her location to the very North has as mentioned shielded
her from migration pressures. However, some 30.000 asylum seekers were received
in 2015—a much smaller number than neighboring Sweden which is located equally
far North. The number was still large enough to generate a unified political response.
The Storskog incident, whereby a new Arctic route for refugees was created, appeared
to shock to the Norwegian political system. Then affairs seemed to normalize in terms
of new entries of asylum seekers. This reversed some of the political urgency, and
made it difficult towards the summer of 2016 for political parties to agree on what
measures, if any, one should implement to inhibit an increased influx of refugees.
The asylum policy nonetheless became more restrictive, which appeared to resonate
well with the electorate throughout 2020.
The asylum institute is anchored in international conventions that Norway and
most other European countries have ratified.22 It is an important individual right in
an uncertain and unstable world, where oppression remains the rule rather than the
exception in numerous countries. In spite of this, there seems to be a limit to what
many countries, perhaps particularly small ones, can and want to do in a time of
crisis. Some right-wing politicians have since 2015 argued against Norway’s human
rights commitments in relation to refugees and asylum seekers. This is a new stance
which should be understood in a context of a steady pressure against the borders of
Europe’s Schengen zone of countries. There is close to endless misery in the world,
and a very high number of migrants and potential migrants. Towards year-end 2020,
the eagerness to migrate to Europe appeared widespread across Asia and Africa.
Even in 2015 a small fraction of the arrivals were, as mentioned, linked to Syria.

6.3.2 The Costs of ‘New Countrymen’

As in many other rich countries, immigration has long been a contentious issue
in Norway. It is easy to understand why in an economic wealth perspective: First,
consider a static picture. New entrants mean that the wealth stock will be shared by
an increasing number of people. As one could expect, there is some resistance in
the population even due to this. In addition, the expected net burden is bound to be
unevenly distributed in the population. The less well-to-do Norwegians are mainly
individuals with a weak association with the labor market. They either receive grants

22 The 1951 Refugee convention a UN multilateral treaty, defines who is a refugee and sets out the

rights of individuals that are granted asylum and the responsibilities of nations that grant asylum.
200 6 Risks and Uncertainty

from the welfare system or sell largely unskilled labor and benefit from a higher
material standard than their peers in many other countries. This is one particular
characteristic of the welfare state that many in the old generation have been proud
of: One has been able to extend a generous material standard to all. This is so because
there is a generous floor for the benefits.
This arrangement is challenged by newcomers from poorer areas who are used to
lower standards. In particular, a generous welfare state would insure newcomers that
either did not succeed in getting integrated into work life or who failed to try hard
enough. New entrants to a rich country may therefore challenge welfare arrange-
ments. Among some groups there is fear that this will lead to reduced standards for
everyone – not only for entrants from foreign countries. This could also be a logical
consequence, as it would be difficult to discriminate citizens or residents based on
their country of origin. The relative strictness on immigration is an important issue
for all political parties. However, it seems particularly pressing for the ones who have
prioritized tax relief – in the main the progress party and the conservative party.
Since discrimination based on race, ethnicity or the like is forbidden, the welfare
arrangements must give the same to everyone who applies and meets the criteria
for support. There could thus be a risk of running up a large bill—possibly too tall
for the taste of the tax payers. A tendency in this direction cannot easily be barred:
Discrimination is not feasible. Individuals have to be valued as such, not based on
their geographical and cultural origin. This is due to equality concerns, international
regulations, and also significant national legislation. The welfare state could in view
of this have to be scaled back, or rearranged into less universal arrangements. An
increased demand for welfare could thus lead to reduced standard for all applicants.
Second, consider dynamic effects of immigration. Even if the ‘cake’ present
initially were eaten, there could still be gains from expanding the population with
new entrants – provided that they subsequently become productive. This, however,
would depend critically on their future employability, and thus on willingness and
ability to adjust, both of the new entrants and the receiving society. To the extent
that newcomers become less active in the labor market than the average population,
as has mainly been the case thus far, a burden might need to be passed on to the
original population. Such tendencies could trigger a stricter, more restrictive welfare
regime which could become a problem for the poorer Norwegians, who benefited
from welfare services administered by the state. This could possibly be a recipe for
social unrest.
Negative sentiments towards newcomers may to some extent be rationalized in
economic terms. Industries and business interests may be less likely to exhibit such
negative sentiments, as the supply of labor, particularly low-skilled labor would be
likely to rise, and the relative price (wage) for this type of labor, could decline.23 The

23 However, neither business interests widely defined nor industrialists are likely to approve of a
work force made up of a lower percentage of the population: This is likely to lead to increased taxes,
and thus less favorable business conditions. Further, the persons that represent business interests
often support conservative political parties.
6.3 Immigration: Wealth Dilution or Enhanced Economic Growth? 201

wage structure in Norway is still egalitarian. This is possible due to high produc-
tivity and high labor standards. The other side of this coin, is that not all can offer
the productivity that would make them employable. This constraint is likely, on
average, to be particularly pressing for people who may have little education and
were brought up in a different culture, with somewhat different values. Under the
Norwegian model, some concentrated benefits are available for firms and businesses,
including increased profits. The costs that may accrue in the event of a lesser overall
labor market participation would, however, affect others. First, the less affluent tradi-
tional Norwegians, who could experience cuts in support, and second for tax payers
including the employed fraction of the population, who would experience higher
taxes.
The less well-to-do thus face a high likelihood of a stricter, less generous welfare
system and of increased competition in the arenas with low skill requirements where
they could hope to be employed. Thus, this group has reason to dislike new entrants
from foreign countries even before considering the large cultural differences with
respect to some of the countries of entrants. The competition in the labor market will
remain strongest from the EEA countries of Europe. The cultural distance, however,
which may cause discomfort – will be largest with respect to migrants from outside
Europe. Due to the cultural differences, the original low-income residents are also
less likely to feel that they can benefit from the new residents, also in a wider context,
even if they are likely to benefit from reduced prices for some services, and a larger
diversity of goods to chose from.

6.3.3 Asylum Seeker or Migrant?

The above arguments apply to asylum seekers and labor migrants alike. The effect
of the presence of large groups of new people in Norway will be independent of
any difficulties of identifying protection needs of asylum seekers. Normatively there
is a difference between migrants who show up and the so-called quota refugees
channeled through the United Nations. The members of the latter group are certified
by the UNHCR as being in need of protection. This is politically important.
The welfare-centered discussion above may be deficient particularly in two
respects: First, it is possible for migrants to become integrated in society and take part
in production, in which case they would pay taxes and be net providers to society, also
economically. That not so much of this has been seen thus far, however, make many
skeptical. This could change if future integration policies become more successful.
Until now, labor has been in short supply in several industries, at least in the view
of employers and owners.24 There are thus some benefits, notably for businesses
and the government, that will increase with participation in the labor market by the

24 However, those who could have been employed in such jobs - without an influx of migrants - may

still have valid reasons to dislike immigration, as discussed above. Immigration is a social issue
associated with wide disagreement and conflict across Western societies. It has also been reported
to be important in the United Kingdom in relation to brexit. As elsewhere in Europe, there are signs
202 6 Risks and Uncertainty

newcomers. From the perspective of Norwegian workers, the associated workforce

increase would increase labor supply and stem wages increases, in particular for
low-skilled workers. Under this scenario, businesses could employ workers in large
numbers without bidding up the wages.
Second, as a rich country Norway can be seen as having a moral obligation to
help people in need of help, in spite of her modest size. Even so, the world’s refugee
problem has attained such large proportions that it cannot feasibly be solved by
anyone alone, not even large states.
Norway has a long history of extending help in various forms to remedy acute prob-
lems on other continents. Much of this work has traditionally been linked to religious
organizations. Missionaries who have been motivated by religious faith, and have
promoted Christianity, have been important in many projects. More recently, the bulk
of such projects have been undertaken on humanitarian grounds, either by the central
government through bilateral and multilateral aids projects and NGOs. The govern-
ment’s foreign aid directorate, NORAD, annually spends some 35 billion kroner, in
excess of three billion euro. Although the grants may be sizable in the contexts they
are applied, and even if Norway contributes a large share of her GDP to aids projects
in many countries, the grants are small in view of the needs. It is trivially true that
no-one cannot help everyone. The emphasis has therefore been on helping clearly
identified groups. The sense of a moral obligation to help, may have declined a bit
due to the increased visibility of very extensive problems globally.
The perception of an obligation to help may have been less pronounced recently,
as many fears a strong influx of migrants to Norway, with increased competition
for welfare and jobs that require moderate technical skills and moderate language
proficiency. If new entrants are to become active in the labor market, as the authorities
hope to lower the social costs, they will at least initially compete with marginal
domestic groups for the work they can expect to be hired for. The scarcity of such
jobs may have played a role in a more restrictive stance towards migration. The
emphasis has lately been on more on helping refugees in locations closer to their
countries of origin.
Even with such a new direction of policy, there could still be a steady influx of
asylum seekers. Physical barriers to stem migration have been established in the main
by other countries at the outer Schengen borders.

6.3.4 Some Societal Implications of Immigration

The international situation with respect to migration has changed dramatically in

recent years. A large number of people want to move from Asia and Africa to
Europe, including Norway. Particularly since the refugee crisis of 2015, but also
earlier, immigration in the traditional labor-related sense has been ruled out through

of higher tolerance for asylum seekers among young people and individuals of high social status,
and in the cities. The reason for this may, however, not be straightforward.
6.3 Immigration: Wealth Dilution or Enhanced Economic Growth? 203

legislation. Only refugees with a need for protection were allowed. Many needs
protection, but there could in addition be economic motives. Hence, more people
may claim to need protection than those who actually do. This sets the stage for
delicate bureaucratic decision-making. Those who succeed in relocating to Europe
receive both safety and improved living standards. Further, generous welfare state
arrangements, e.g. in many European countries, means that the economic well-being
of newcomers will not be as directly linked as before to success in the labor market.
This could imply competition for the ‘attractive’ migrants, in which case countries
that do not emphasize this economic aspect could lose out.
There are many reasons for the high flows of people across national borders in
recent years. Economic prospects abroad is, as mentioned, one of several factors
to consider. Still, a comparatively affluent public sector combined with high social
standards, may have made Norway more attractive as a destination to migrate into.
There has in any event been a steady influx of new persons into Norway since the
1990’s, which also accounts for most of the country’s population growth.25 Wealth,
measured as net assets per capita, is the most used measure to assess the average
wealth of a country. New entrants increase the denominator with full effect, without
increasing the nominator equally much, and will thus on impact drive this number
down. Many hope that the ‘earned’ nominator will increase for the newcomers, which
requires that many are successfully integrated into the society and labor market.
There are two main sources of immigration: First, the mostly young and educated
or skilled persons from the former East Europe who seek employment in the common
labor market of the EU which Norway is a part of, and, second, refugees from the
Middle East and Africa. There have been most people from the first category entering
Norway, which is not discussed here as the EEA entrants are closely integrated in
the labor market and productive. They typically come to work and earn money from
that source. On average, entrants from the Middle East and Africa are less qualified
for the labor market than EEA entrants, and able to contribute less to production and
as tax payers. This must be expected for a group admitted subject to a proven need
for protection. In a loose sense of the word, both of the very different groups could
be considered as immigrants.
The Perspective Commission of 1988 estimated the Norwegian population to reach
5 million in year 2025, of which 5-6 per cent would be immigrants and their chil-
dren.26 These figures were later shown to be large understatements of the importance
of immigration. The population size reached 5 million in 2010, and the percentage
of immigrants and their children, which also includes refugees, had reached around
10 per cent in 2016. There has been a rising long-term trend for this figure.
If immigrants were on average not much different from traditional Norwegians,
the associated effect of immigration would be small, and on balance positive as a
larger GDP could be produced with more productive labor market participants – at

25 Norwegians have fewer children than before on average, for mainly two reasons: First, more

emphasis on education by women leads to children later in life than before, and second, people who
get children tend to have one or two. Fewer parents than previously have three or more children.
26 Norges Offentlige Utredninger (NOU) 1988: 21, p. 13.
204 6 Risks and Uncertainty

least with some labor market participation-even if the effect of immigration would
be negative on impact due to a larger denominator in per capita wealth measure.
One should still expect a productive time lag, due to the need to pick up new, partly
location-specific skills. However, the entrants are not like other Norwegians. Thus,
they are less likely to contribute to production, and hence GDP. Immigration might
lead to a reduced GDP per capita and more so the more persons one would allow to
immigrate from poor countries. Under the current restrictive policies, the ones most
likely to be admitted are asylum seekers from poor countries. GDP per capita is
then likely to grow slower in the short to medium term. A cost may accrue, that can
be interpreted as a price to be paid in support of the asylum institute.
This assessment is simpler if it is confined to resource wealth alone. In particular,
the effects of the immigration for resource wealth per capita, will not depend on
the skills or motivation of new entrants to Norway. The net effect on total wealth
will, however, mainly depend on the extent to which they become active in the labor
market. Thus far entrants to Norway and their children have been less active in the
labor market than traditional Norwegians. Still, it cannot be ruled out that immigration
could become positive for growth, and thus over time for wealth accumulation. This
would require that the future entrants participate more in the job market than this
group have done till today. We will be unable to verify this for a long time.
Employability is likely to increase with education and technical skills, and partic-
ularly language proficiency. The latter may be a proxy for several characteristics that
promote exchanges across nations and ethnic groups. To the extent that entrants are
employable in a competitive job market they will contribute towards production
and pay taxes. However, if entrants do not become well integrated into the job
market and society, there could be an economic price of immigration in the form
of reduced wealth. This would appear as more likely the less the new entrants are
attracted by the prospects of working in Norway before entry, and the less successful
current and future policies aimed at strengthening integration into the labor maket
and society will be.
If the newly arrived remain less active than the traditional population in the labor
market, the latter would have to provide both for itself and the entrants. The extent
to which new entrants are likely to successfully participate in the labor market over
time is therefore a key issue. They are unlikely to participate to the same extent as
Norwegians based on the evidence to date. Job market participation by immigrants
could still increase over time. There has been a strong focus on this aspect in public
debate. This could influence on the employability of the admitted future entrants.
The large number of refugees that entered Europe from the South found it difficult to
traverse the continent to arrive in Norway. That many still achieved this, could reflect
a high level of human resources that could also reflect adaptability more generally,
and perhaps future employability. However, it is not possible to know this.
The main obstacles in relation to integration may not come from the entrants
themselves, on the supply side of the labor market. They may also be due to peculiar-
ities of institutions and procedures in Norway that could systematically work against
newcomers. There may thus be discrimination, even if this may rarely be intended.
As in other settings, there is a tendency for systems and institutions to work to the
6.3 Immigration: Wealth Dilution or Enhanced Economic Growth? 205

disadvantage of those who may deviate from established norms in appearance and/or
behavior. There could also be an informational disadvantage for entrants, associated
with ethnicity and culture. This kind of problems on the receiving end may be labeled
demand-side. Together with the challenge of quite high wages also for unskilled labor
that is typical for the Nordic countries, high prospective productivity is required to
be employed, which could slow the integration of newcomers.
In debate on immigration, some have feared that Norwegian resource wealth,
particularly the fraction that has become highly visible in the GPF-G, could work to
attract new residents. This is difficult to evaluate. However, the wealth could attract
both labor market-related immigration from the former East Europe – through labor
demand – and asylum seekers from the Middle East and Africa – to the extent that they
can chose their destinations. To the extent that there is an effect of the resource wealth,
it is likely to make Norway a more attractive destination for both types of migrants.
A restrictive political response in view of this possibility could, however, lead many
individuals to become alienated and frustrated in their meeting with Norway. For the
already-arrived the rhetoric could make it more difficult to become integrated into
society and become productive even if they were motivated for this, which could
represent a drain on public finances.
The topic of immigration must be seen in relation to the quite generous welfare
state of Norway, and the comparatively good financial standing of the Norwegian
public sector. It is likely that there is an attraction effect due to this, on some individ-
uals who would else have been more skeptics in relation to the idea of moving to a
country North of the European continent. At the same time it is evident that the dilu-
tion effect on impact from even very substantial immigration, that could be counted
in 100.000s instead of 10.000s, would be moderate. The value of the GPF-G in early
2020 was some U.S. dollars 200.000 per capita. This number would not be lowered
much even if the denominator was increased by 100.000.27 It therefore appears as if
the popular politics that makes it possible to benefit from restrictive views on immi-
gration, may be due to other considerations than the dilution effect with regard to
the Fund. This could change if there was a steady stream of immigrants, that is a
large number each year. If a number of 100.000 were to immigrate, say, each year
for ten consecutive years, population would grow by 1 million, or about 1/5 – with a
commensurate dilution of per capita wealth. Thus far actual immigration has been
much more moderate. Still, immigration has over time been high, and can better be
depicted as a flow than the sizable one-off effect experienced in 2015.
Another perspective that could change the conclusion, would be to divide the
population into fractions of Norwegian and non-Norwegian descent, since the rate
of population growth is stronger in the latter group. This group would be counted
as Norwegian nationals if they were born in Norway but they could still stand out
as ‘foreign’ to many. This implies that solidarity between the two mentioned groups
could be less than perfect, which could inter alia make it appear as less pressing for
some to spend for social purposes through the budget. The extent to which this topic
may be salient, depends on politics and is difficult to predict, both today and in the
future.

27 With 5.2 million inhabitants, and U.S. dollar 200.000 per capita, the per capita number at 5.3
million inhabitants would be about the same, U.S. dollars 196.300 – a 1.9 per cent reduction.
206 6 Risks and Uncertainty

6.3.5 Distributional Implications of How Resource Wealth Is

Spent

An issue of importance may be whether resource wealth is transferred to the popu-

lation through production in the government sector, of for instance services in
schooling, health etc., as in Norway, or transferred as cash to the population, as in the
U. S. state of Alaska. In Alaska, a fraction of the resource revenues is distributed in
a way that allows most persons that are present in the territory to receive transfers.28
They are therefore able to consume some of the returns from the resource wealth. The
Norwegian example shows that this is also possible without money transfers, through
mechanisms that inter alia involve public sector service production. A further mech-
anism is tax breaks. The distribution of the wealth differs from in Alaska: It is not
easy to share in the wealth for those ‘not present’, either as users of publicly supplied
goods and services they qualify for, or as tax payers. The services provided are also
by their very nature more suited for some, e.g. families with a number of children,
than for others. Hence, the utility from consumption varies considerably.
One needs to be particularly considerate if one also wants those ‘not present’ to
benefit. The future generations are indirectly taken care of by the fiscal rule that caps
spending. As long as this spending rule is respected, much of this problem is solved.
However, one may also need to care for members of the current generation that either
don’t consume much publicly provided subsidized services or pay much in taxes.
The adopted framework for spending is a good one, but some contentious issues
may be swept under the rug in relation to the fraction of the wealth spent on the
various groups that qualify as recipients. This problem may to some extent, but not
completely, be ironed out through the practiced spending patterns.

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Illusions with Reality Can Lead to Disaster, on Wall Street and in Life”. Quantitative Finance 12
(4): 509–511.
Fama, E., and K. French. 1993. “Common Risk Factors in the Return on Stocks and Bonds”. Journal
of Financial Economics 33 (1): 3–56.
Goff, L. 1986. The Birth of Purgatory. Goldhammer, Chicago, Il.: Translation by A University of
Chicago Press.
Graham, B., D. Dodd, and S. Cottle. 1934. Security Analysis. NYC, NY: McGraw-Hill.
Hubbard, D. 2007. The Failure of Risk Management. NYC, NY: Wiley.
Knack, S. (ed.) 2003. Democracy, Governance and Growth. Ann Arbor: University of Michigan
Press.

28 Citizens
and residents need to apply in advance to receive transfers that are set by the state of
Alaska, and restricted by guidelines that apply to all U. S. states. See, e.g., Alsweilem and Rietveld,
op. cit.
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Knight, F. 1921. Risk, Uncertainty and Profit. Boston, MA.: Houghton Mifflin Company, no. xxxi
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by the Courier Corporation, Dover Publications, Inc., Mineola, NY.)
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Growth, ed. S. Knack, 115–136. Ann Arbor, MI: The University of Michigan Press.
The Perspective Commission (Steigumutvalget). 1988. “Norsk Økonomi i Forandring. Perspektiver
for Nasjonalformue og Økonomisk Politikk i 1990-årene.” Norges Offentlige Utredninger – NOU
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Chapter 7
A Sketch of an Evaluation

An evaluation of the Norwegian SWF would be a large project, even if it was confined
to the most central aspects of this construction discussed here. That task is outside the
scope of this volume. Evaluation is an integral part of public policy, necessary inter
alia to assess how well one is doing in a policy field compared to what could have
been achieved under different policies.1 There is some kind of a counterfactual—in
relation to which the relevant choices can be evaluated. The counterfactual in relation
to the actual investments made by managers of a fund could for instance be a stock
market index, say the Standard & Poor’s 500, the Nasdaq Composite, or the Russell
2000. A much narrower stock index is the Dow Jones Industrial Average, or DJIA,
which consists of the 30 largest shares on the New York Stock Exchange. A much
broader index is the much-referred to FTSE Global All Cap, that covers global stocks.
The perhaps most well-known use of this concept in fund management, relates to
the selection of vehicles of investment, or asset classes, compared to the alternatives.
These are choices made after all the important decisions of the framework are made.
Although it should not be neglected, this is not the most interesting aspect of a SWF.
It is relatively easy to check what the value of the funds invested could have been with
other assets. Here, however, we are more interested in the decision to start saving
in a SWF, and the framework implemented for doing the investment. These are key
elements in producing wealth. A third one is the compounding of returns over time.
The purchases of various assets is a minor part of an investment operation, that
catches much attention due to extensive and visible practice: More important are the
establishment of a fund, capitalization of that fund, and the regulations that govern
the investments.
This exercise of evaluation can be understood as an important part of the contri-
bution to society through public policy. However, policy evaluation is never exact.
This follows already from the division of activities into certain fields or domains

1 Inaddition, it is customary to attach value to participation by citizens in public life and public
decision-making. This element, however, may have a less obvious value in circumstances where
large economic values are at stake.

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 209
O. B. Røste, Norway’s Sovereign Wealth Fund, Natural Resource
Management and Policy 54, https://doi.org/10.1007/978-3-030-74107-5_7
210 7 A Sketch of an Evaluation

of policy. Such distinctions are always somewhat arbitrary, and almost all policies
involve some sort of spillover between different fields and sub-fields, that should
be accounted for in an overall assessment of value of a respective type of policy.
However, some fields may be neglected for reasons of simplicity.
In this Chapter, some key elements in the Norwegian strategy will be discussed,
in relation to the extraction of large deposits of hydrocarbons underneath the seabed.
There has not been one continuously and coherently implemented strategy from the
outset in the late 1960s till today. Still, the chain of decisions and actions over time
can be evaluated much in the same way as if there had been such a strategy at work.
In any event, one can discuss the implications of several important decisions that
were taken, or not taken, in view of the decision’s alternatives.
Phillips (2008) has argued that Norwegian political culture may explain why
Norway was more successful at capturing economic rents from oil production than
industrial states like Alberta and Alaska.2 Norway has since the early 1970s captured
a high percentage of the economic rent from oil. In recent years this figure has been in
the upper 80s, which is high also compared to other developed countries. According
to estimates by Parkland Institute (1999), Norway between 1992 and 1997 was able to
capture about 2.7 and 1.7 times more rent per unit of oil and gas produced than Alberta
and Alaska, respectively. Taylor et al. (2004: 49; 51) reported that with the exception
of British Columbia, Alaska and Norway captured a greater portion of economic rent
from oil and gas developments than Western and Northern Canadian regions. In most
of the Canadian regions considered governments were not capturing as much rent as
they could. Some revenues thus accrued to companies as excess profits, instead of to
citizens.
Developed countries have a better bargaining position than non-developed or
underdeveloped countries, due inter alia to a higher predictability of state behavior
in relation to delivering on their promises. This also allows for a longer time-horizon,
and thus larger investments with lesser worries for private oil companies, which again
may lead to high sunk costs and committed oil companies in later periods.
There was an eagerness in Norway for the state to take part in the new industry early
on, in particular by establishing the state oil company Statoil, from 2018 Equinor,
and also to operate a petroleum tax system designed to capture the lion’s share of
economic rent from oil and gas. Further, there was a tradition of social democracy and
economic nationalism, and a mistrust of foreign capitalists. For Phillips, Alberta’s
political culture manifested, by contrast, “a state-capital relationship that stressed
a limited government role in economic activities, and favored an unimpeded private
sector as the key driver of economic development” (op. cit.: 14).
For resource revenues to reach ordinary citizens, it is required but not sufficient
that the state captures the rent from production.3 In Norway, this was secured through

2 Two other main contenders were ruled out by that author—the ‘resource differences’ explanation
based on the value of the resources being produced and the costs of extraction, following the approach
of The Alberta Royalty Review Panel (2007), and the ‘obsolescing bargaining model’ which predicts
that the host country’s bargaining position vis-à-vis private oil companies will strengthen over time
(e.g., Penrose 1959 and Jenkins 1986).
3 A main problem in many developing countries, is that funds are siphoned-off both by oil companies

and other corrupt agents of the private sector, as well as by public officials. Thus, the story might
7 A Sketch of an Evaluation 211

three sources: First, the state oil company Statoil established already in 1972, second,
direct ownership of revenue producing-assets in this sector, known as The States
Direct Financial Interest (SDFI), and third, taxation of the producing oil companies.
In combination, this has resulted in a comparatively large share of the resource rent
accruing to the citizens and residents of Norway. The incomes have been used through
public budgets, and in later years also saved and invested.
This fortunate state of affairs marks a contrast to institutionally weaker low-
income nations, but as mentioned also to Alberta and Alaska. Compared to the latter
states, it might also have played a role that Norway is a small unitary state with few
inhabitants, where a committed government has negotiated the relevant agreements,
which have been a top priority in national politics. This may, in isolation, have led
to firmer negotiation stances than the ones of state governments within federations.
Further, the oil finds in the North Sea may have been seen as opening up opportunities
that the large oil companies wanted to take part in. After a very short period on
generous terms, and with some sunk costs, they may have wanted to continue quite
profitable operations in spite of steeper oil taxes. According to Noreng (1980), cited
by Phillips, op. cit.: 17, “the key goals for Norwegian oil and gas policies after the
discovery of Ekofisk field in 1969, was national management and control, building a
Norwegian oil community and state participation.”
Necessary Conditions for a Successful SWF
Several events must take place for the utilization of a SWF to be successful in the
sense that economic benefits of natural resources benefit the general public. These
key events are serially dependent. I sketch here a rough illustration—which is by
intention simple compared to any real world situation. This must be approached one
step at the time. It can most easily be understood by solving the challenges backwards,
from the presupposition of sustainable revenues and investments over time.
However, it should never be implemented backwards. This could easily lead to
failure. The key insight is that for states, as for other entities including individuals,
one needs both to save and invest meaningfully in order to generate a sustainable
income stream from the resource capital. To be able to do this, one must put aside
large chunks of cash instead of spending them. This option may not be available for all
states, in particular for poor states. However, for many states it can be available if one
is willing to accept temporary sacrifices. The willingness to do this, may be difficult
to obtain under most circumstances in democracies. One reason is that saving may
be painful, a second that the future is uncertain both in international markets where
SWFs would invest, and domestically. A third reason, is that one can often hope to
spend money that could alternatively accrue to someone else. It may also feel better
to vote for spending one can hope to participate in than to postpone spending into a
distant future, and more so the less reason one could have to trust the government.

end here. If it should continue, one might hope that a meaningful portion of money can be put aside
and invested for the future. However, as Dixon and Monk (2011) makes clear in an African context,
“It is not enough to simply set money aside. The successful SWF is ultimately a function of good
governance and clear mandates (…)”.
212 7 A Sketch of an Evaluation

As mentioned, the required steps are serially dependent. This means that in order to
succeed, the earlier steps must be accomplished first. A brief version of these steps
is earn, save, and invest. Natural resources may result in earnings, which is required
but by no means sufficient. Most fundamentally, a good fraction of the earnings must
be saved, rather than spent, and the thus saved funds must also be invested.
Steps to follow in order to safeguard resource income from overspending:
1. Reason to expect resource deposits of, e.g., hydrocarbons. There may for
instance be seismic data.
2. Granting of exploration and/or extraction rights—often sales of rights on
generous terms.
3. Major resource discoveries.
4. A revision of the resource tax system for new licenses, to maximize rent capture.
5. Fiscal restraint: Channeling all resource incomes into a fund, and limiting
withdrawals, e.g., to reasonably expected real returns in view of the asset
composition. Credible escape clauses must be in place for the construction
to remain credible over time. The fund should stabilize the budget, and in
particular shield it off from volatility in the relevant resource price(s).
6. Profitable resource extraction, and the bringing of extracted resources to market.
7. A resource stabilization fund: This is an upgrade regarding the type of fund. It
should still be possible to stabilize the budget, but there should potentially also
be room for savings: The nation must live below its means to save.
8. SWF: A further upgrade to the ultimate type of fund. The savings must be
professionally invested and managed, to maximize returns at an acceptable risk
level.
9. The compounding of returns produces enough incomes over time to support
the state budget, while at least also keeping the real value of the fund constant.
Ideally, one should also a stabilize the real value per capita. After arriving at
this stage, it should be possible at least in theory to continue to fund a sizeable,
perhaps increasing, part of the state budget through returns.
Steps 1 and 3 usually require involvement from large private companies with which
a host government must have good working relations. To get going at step 1 and to
arrive at step 3 might require high expectations by private firms of the value of step 2.
This could expose public officials to a culture of corruption, which could be difficult
to avoid in processes where few parties with concentrated interests negotiate and
the winner may take all economically attractive ‘takeaways’. It may be too tempting
for some, e.g. to offer bribes. Corrupt exchanges are usually designed with a view
to siphon-off as much money as possible. Even if that amount may be small in the
context of oil extraction, it is not likely that any preferred arrangements under that
agenda would also be well-suited to maximize the revenue for a host government.
Another, related, possibility is that the public officials may not be sufficiently public-
spirited. Culture in the public sector is thus important. Step 6 is also usually taken
care of by mainly private sector entities. This step may be less critical with regard to
culture, since the most important conditions have been determined at earlier steps.
7 A Sketch of an Evaluation 213

During the remaining steps—2, 4, 5, 8 and 9—the host government is in the

driver’s seat. It must have good working relationships with private sector parties, but
not give away the resource rent. If the general public is to benefit from the resource
extraction, step 4 is of critical importance. It is important to tax heavily, but within
the range of the private parties’ expectations. It is usually of high importance that
the undertakings are sufficiently profitable for willingness to invest more later.
The accumulation of money for the state presupposes that one avoids corruption.
This requires transparency. The government must keep an arm-length’s distance to
all private resource-related interests. Further, the government must be able to restrain
both itself and its political constituencies with regard to temptations of saving less to
consume more contemporaneously. This requires that the public officials have faith
in the undertaking, and that they are able to advocate that position vis-à-vis the voters.
Whether or not it would be reasonable for the government and its electorate to have
faith in a brighter future due to the effect of compounded returns from investments
depends on many factors. The most critical one could be institutional quality within
the host country. For reciprocal trust to be established and maintained, transparency
is required both in fiscal affairs and for investments. In sum, one must at critical
junctures visibly ‘do the right thing’ to succeed. Even then there will be some, albeit
smaller, uncertainty in relation to the SWF’s investments.
The Case of Norway
Norway may today look bright in view of successful investment of gains from oil and
gas. Also, the establishment and operation of its fund, the GPF-G, in spite of some
criticism of results in the part of the management that has been ‘active’, is widely
regarded as a success. Active management in this context refers to bets on either the
timing of the market with regard to movements up or down, or the composition of a
given portfolio in relation to the benchmark.
There are, however, also less bright chapters in Norway’s recent economic history.
For instance, around 1990 Norway experienced the most serious banking crisis since
World War II. A crash in the real estate market following a persistent plunge in oil
prices from 1986 and various policy changes with less than perfect timing, eradicated
the equity of the largest banks. The government recapitalized all the major banks and
became owners for many years to follow.4 In retrospect, it has been stated that the
sharp cyclical downturn which caused much pain for many individuals was made
possible by an unfortunate coincidence of bad banking, bad policies and bad luck.
A main triggering factor on land, was a sharp decline of house prices, which had
been deregulated in the early 1980s. A run-up in house values led to a perception
of newly created wealth, which fueled consumption and further borrowing. More
borrowing to buy houses was allowed by the banks. In retrospect, but not at the time,
house price developments of the late 1980s have been called a bubble. One problem

4 Thelater extensive sales of bank shares have been successful from the government’s perspective.
The state still owns a stake in the largest commercial bank, Den Norske Bank, of 34 per cent, as of
December 2020.
214 7 A Sketch of an Evaluation

with bubbles, is that they become evident only when they burst. Without a burst, for
instance due to stabilizing public policy, they are not called bubbles.
By 2007 house prices had recovered and risen to new highs in terms of inflation-
adjusted prices. Judged by this metric, the 1987 level was attained anew in 1999, after
12 years.5 In the most recent international recession from 2008/2009 on, which left
Norway relatively unaffected, bank loans looked defensible in view of the value of
pledged collateral, also to a large extent real estate. To date, and apart from a decline
of some 14 percent. in Oslo and other large cities from 2014, that was recovered
in the first half of 2018, there has not been any sharp fall in domestic real estate
prices. However, when judged regionally, a decline since late 2014 in the South
West, including the oil capital Stavanger, stands out. This decline was due to a sharp
drop in the prices of crude oil by some 40 per cent between 2014 and 2016. The
recent regional downturn in the house market, however, was mild relative to the one
from 1987/88 on.
The main mechanisms at work can be sketched as follows: The dramatic fall in the
oil price led to a worsened job market, with substantial lay-offs. It became difficult
for unemployed workers to service their debt, which shifted the balance of the house
market towards more sellers than buyers. The liquidity of that market then drained.
However, after a while there were sales at lower prices. This appeared to trigger a
downward impulse which lasted for several years. In some instances, house prices
fell by as much as 50 per cent. The lending standards had become lax during the run-
up in house prices, like in many similar earlier instances. When many home owners
found themselves ‘under water’ on their house purchases, they had few options. In
particular people who had jumped on the band wagon late were forced to sell at a
loss. Also many others had to sell at a loss, or at sharply reduced profits. A hole
was created in the ‘balance sheet’ of many indebted individuals. Many saw their
net worth sharply reduced. The effect became low demand, including for housing,
as households sharply increased their savings. There was extensive and widespread
pessimism, and it took one decade and extensive public policy for the house market
to a new reach the nominal price level of the 1987 earlier peak.
In 2020 we experienced a new major downturn in production and stacks in the
spring, linked to the Covid-19 virus outbreak. The effect of the pandemic has been
described as a large, negative supply and demand shock. Optimism rebounded quite
soon, with a lowering of interest rates to zero, rising stock markets, and the rolling out
of vaccines later in the year. There have been severe consequences for both the global
economy and Norway. The crisis has already been long-lasting, and there are dire
consequences. One should expect large losses in banking, and bankruptcies linked
to in part draconic contagion-reducing measures. The housing market, together with
commercial real estate, seems to have fared better than some feared due to the interest
rate cuts. The housing market was also in a better shape than in earlier downturns,

5A stylized fact of property prices in Norway, is that the setbacks in price were more serious in
earlier years: It took 90 years for real prices to recover following a crash of the Christiania (Oslo)
property market in 1899. Both the dot.com crisis of 2001 and the 2008/2009 Great Recession led
to only moderate setbacks, with quick recoveries. Thus for the same seems to hold true for the
Covid-19 Pandamic.
7 A Sketch of an Evaluation 215

not least the one of 1987. However, valuations were high in Norway as elsewhere,
due to the extended period of low interest rates since 2009. The key to a healthy
turnaround seems to lie in future conditions that will allow a downscaling of Covid-
19 contagion measures. In the spring of 2020, unemployment rose over a few weeks
to levels not seen since World War II. Like many other countries, Norway had first
closed down in March. Since, there have been many smaller offensives linked to
contagion outbreaks. Temporary layoffs have been extended several times, and there
has been ample funds for relief packages. However, many of the firms that have been
forced to close may go out of business. The economy is vulnerable, and one is not
yet out of the woods.
In Norway, the big crises of the late 1980s and early 1990s were powerful
reminders of a very strong dependences between the domestic and the international
economy, in particular under increased uncertainty with regard to future oil prices,
but also due to dependence on significant exchanges of goods and services with
international trading partners. Since most goods and services are imported, a healthy
current account balance over time is extremely important. These shocks happened
early in Norway’s history as a major oil exporter, at a time where much of the resource
wealth was still held in the form of oil and gas deposits underneath the seabed.
The history since the inception of the GPF-G in 1996 is more pleasant. The
investments appear to have been very successful, perhaps surprisingly successful.
This could in principle be because of a fortunate combination of good investing,
discipline and good luck. In principle it could also be due to limited knowledge
on less successful aspects of the investments. International investment is a complex
undertaking which implies, among other things, that not all aspects of it are likely
to be well understood by the public. It is unlikely, however, that there could be
very significant negative ‘unknowns’ that has not become known to the public over
increasingly long time spans. Today the financial operations of the Norwegian SWF
are therefore understood as successful. One could perhaps be more critical with regard
to the activities that made this SWF possible: The extraction of huge quantities of
hydrocarbons underneath the seabed for export to others, even if the relevant actions
could count as standard behavior by agents of most countries at the time.
Good luck is unlikely to constitute a major factor behind any large success over
time. In relation to the Norwegian SWF, however, it cannot be disregarded as a
contributing factor. In particular, the recovery after big losses in 2008 were influenced
by some good luck. Even apart from this, however, there can be little doubt that
Norway has been forward-looking to an extent that is not very common among
owners of natural resources. This has been made comparatively easy by the tranquil
circumstances in Norway at the time of the major oil finds: Norway has long been
a stable democracy and an industrial country, with means and an institutional basis
that many other oil states did not have. The oil industry was thus developed with a
view to the other industries present in the country.
This probably also made it less demanding to cope with the temptations and
increased macroeconomic volatility that the oil economy introduced. As, e.g., Loayza
et al. (2007) makes clear, macroeconomic volatility is both a source and reflection
of underdevelopment. As such, it is a fundamental concern for developing countries,
216 7 A Sketch of an Evaluation

where major oil finds and windfall gains from resources more generally may create
larger distortions in the economy than in an industrialized country.
For Norway, is it also important to keep in mind that the environment has been
well-suited for accumulating financial wealth for most of the oil era. Times have
been good, and international trading conditions favorable. Norway has in particular
benefitted from a strong international demand for raw materials, including oil and
gas, not least linked to the emergence and growth of China as a major trading power.
High demand for raw materials from Asia has thus bid up and underpinned resource
prices, whereas new, cheap ways of production due, e.g., to cheap labor, provided
manufactured goods both for consumption and as substitutes for expensive inputs.
Norway’s terms of trade thus improved. This development has made financial savings
less demanding to achieve than it could otherwise have been. Fortunate developments
have therefore played a considerable role, not only in relation to the oil and gas
deposits underneath the seabed, but also to some extent in both fund management
and international business conditions.
Could the development thus be attributed to good management, fortunate inter-
national conditions and good luck? It is always possible to regard the discovery of
large oil deposits as good luck. This, no doubt, constituted a required component
also for the success in other domains, indicating that there was an element of luck.
Still, as inter alia the resource curse literature has documented, good luck is usually
not sufficient: Many resource rich countries have been unable to spend their windfall
gains wisely.6 Indeed, resource wealth even appears to be negatively associated with
economic growth. See, e.g., Sachs and Warner (1995; 1999; 2001).
In view of the challenges discussed above, it is necessary to look far beyond the
valuable natural resource deposits to account for the success in the Norwegian case
of management of resource income. To this author, it seems that Norwegian culture,
at least that of earlier times marked by modesty and cautiousness in the spending of
money, may be an important factor. Few resources were wasted in Norway prior to
the oil era. This has, in combination with the large incomes that were put aside, laid
the required foundation for savings and later investments.

6 An early piece in this tradition is Gelb (1988), who studied the effects of the sharp oil price increases

of 1974 and 1979 for six poor oil producing countries in Sub-Saharan Africa. His conclusion, after
studying institutional and political factors and how the oil revenues were used, was that these
countries were unable to capitalize on the new-found wealth. Much of the potential benefits had
disappeared, and resources alone seemed insufficient to spur economic development. In that author’s
view, the respective countries needed sound economic management, and to address political factors
that were seen to conflict with wise policy choices. Later, Karl (1997) explained why in the midst
of the two oil booms of the 1970s very different oil-exporting governments chose common policies
to follow common development paths, with disappointing outcomes. This book, The Paradox of
Plenty, illuminated economic, political and social factors that Karl saw as the nature of the oil state.
Very different oil countries, like Algeria, Indonesia, Iran, Nigeria and Venezuela, were characterized
by similar social classes and patterns of policy-making. Dependence on petroleum leads to fiscal
reliance on oil revenues and high spending. Oil booms are seen by that author as reinforcing the
oil-based interests, and weakening the state’ policy capacity. One can see this as a high risk if
institutions are unsuited for growth at the time of a major first discovery of oil. See also Mehlum
et al. (2006).
7 A Sketch of an Evaluation 217

Culture lags socio-economic developments, and the dominant culture and values
today were mainly developed in times of harder work and scarcer economic
outcomes. This may in combination with earlier experiences have made it easier
for voters to accept public policies with a high savings rate. Those who made the
key decisions had experienced World War II with its hardship even in a country with
more moderate losses than many others. However, the riches experienced today due
inter alia to the oil wealth and investments will also impact on culture, and could
make it more demanding to achieve similar positive effects in the future.
In a democracy, the willingness by the public to postpone consumption in order to
save for the future is indispensable for establishing and maintaining a large SWF. A
long collective time horizon seems to have been established in Norway. This would
have been difficult if the future appeared risky. Therefore, some of the success is
due to other factors than deliberate decisions. They include fortunate circumstances,
‘good luck’, and actions by others. This section aims at approaching an answer to
the admittedly quite tall question of what made the large success possible. Along the
way, some of the less fortunate aspects of the outcome are also discussed.
To sum up, the following questions appear as key in relation to the activities of
the GPF-G:
1. Should one undertake substantial savings to benefit future generations, and if so
in what volumes? The downwards revision in 2017 of the maximum spending
allowed under the fiscal rule reflects a preference in this regard, in an envi-
ronment of comparatively low yields since the 2008 financial crisis. More was
reserved, due to this decision, for future countrymen.
2. Should the time-transformation of funds take place domestically or internation-
ally? The build-up of claims on other states and their subjects require the latter,
which has been the sole approach followed by the GPF-G. Given the large size
of the operation, it is also difficult to imagine that all savings could have been
made at home. That would not have been possible without sharply pressing
down the return on capital, and asset prices up, in domestic markets.
3. What is the true time horizon of SWF investments, and in relation to this—how
should the funds set aside be invested, both with respect to geography and asset
classes?
4. How well have the investment activities been carried out, given the answers to
questions 1–3? A lot of attention has been paid to this last item on this list,
which as pointed out seems to be of comparatively lesser importance—but can
be addressed with relative ease. Since investment skills have large economic
implications, it is always important to evaluate the degree of success in opera-
tional management. Another reason for interest in this, is a link to attempts at
active management and the extent to which the market is efficient.
The evaluations of the investment activities presented to date have centered around
question 4, based on actual investments and largely on implicit answers to the funda-
mental questions (1–3) above. In view of the size of the time-transformation of funds,
one could have expected debate on inter alia the desire and/or need to save for the
future in large size. However, it may well be that this decision is not suited for public
218 7 A Sketch of an Evaluation

debate, since such a debates could emphasize instant needs. One could then have
ended up consuming more of the wealth sooner. Just before the Covid-19 virus crisis
hit, the GPF-G reached a level of U.S. dollars 200.000 per capita. In view of the
large adjustment needs due to the crisis and significant challenges and uncertainty
ahead, it must have been comfortable that the Fund had become so large, with more
freedom to spend large sums.
If one wants the time horizon to remain long for the SWF, which appears to be
a reasonable assumption, there may still be a need for a more robust and secure
anchoring of expectations and assumptions than we have seen thus far. This would
be democratic, and could both add legitimacy to the operation and dampen recurrent
spending.

7.1 What Could Possibly Go Wrong?

“After a year with major fluctuations in the financial markets, the fund has reached a new
milestone with the market value climbing above 11,000 billion kroner (…). Over 50 years
have passed since the historic day when Norway discovered oil in the North Sea. Today the
fund is twice as large as the governments estimated future petroleum revenues. The return
on the investments in global financial markets has been so high that it can be compared to
having discovered oil again.” NBIM at LinkedIn, November 2020 (emphasis added).

For many years, there was no fund. This has also been the situation for many other
countries that have found and extracted oil. The Tempo commission had made clear, in
1983, that one could manage without a fund, and further, that in the event that one was
established, there would be no need for a new organizational unit. The government
could simply maintain a krone account with the central bank which would reflect the
value of the international investments of the Fund.
However, since its inception in 1996, the GPF-G has gained in size and perceived
importance. Today, the GPF-G is recognized as very important by most citizens. The
new organizational unit established in 1998, NBIM, is today larger than the other
central bank departments combined.
Moving forward, the economic significance of the GPF-G could diminish. This
will happen if it grows less over time than GDP, as it will if the real returns are
spent. However, it could remain large in absolute numbers, and therefore also remain
important in the consciousness of citizens.
If we abstract from the possibility of a less secure world that could severely
shorten the time horizon of investments, the only development that could change the
situation where the Fund diminishes compared to the Norwegian economy seems to
be prolonged difficult times, i.e. a development with low or negative GDP growth.
This latter scenario could increase the importance of a fixed capital stock like the
GPF-G—at least if it were not spent at a high rate when developments started to turn
less prosperous. Even if persistent low growth may seem unlikely, the discussion
above shows that steady growth cannot be guaranteed. A stagnant economy in terms
of GDP growth was the situation in much of the 1800 years and earlier. The 1900s
7.1 What Could Possibly Go Wrong? 219

of consistently high-income growth over time due to industrialization, and in the

latter part of the twentieth century due to recovery from World War II, marked a
stark contrast. A return to the typical situation without significant growth before the
industrial revolution appears unlikely, but cannot be ruled out.
One inroad towards understanding this issue, may lie in waste and unsustainable
consumption of natural resources, both in the form of depletion and consumption
and emission of harmful substances. All this has been linked to the fast economic
growth since the Industrial revolution. Sustainability has in response to this become
a key term of our time in relation to all economic activity.
The concept of sustainability was coined in the report Our Common Future by
the Brundtland commission—Jarvie (1987).7 Sustainable development was defined
as “development that meets the needs of the present without compromising the
ability of future generations to meet their own needs,” and described how it could
be achieved, aiming at understanding the interconnections between social equity,
economic growth, and environmental problems. Today, there are contributions to
sustainability research in numerous interdisciplinary scientific journals. Further,
institutions like The World Watch Institute and many civil society organizations
actively promote the sustainability aspect in many different societal contexts. The
normative stances in the commission’s report had been developed over time. Similar
concerns are found in several publications linked to the fate of mankind within the
so-called alternative movement since the 1960s; such as the critique against use of
poisons in Silent Spring by Rachel Carson (1962), Paul Ehrlich (1968) The Population
Bomb, and Limits to Growth by Meadows et al. (1972).8 Although not mainstream yet,
concerns like these were much debated in the 1960s and 1970s. Since the late 1980s,
sustainability requirements did increasingly become mainstream policy. Today, this
is mainstream.
New economically significant innovations will be needed to keep GDP growing at
rates comparable to what we have seen since the industrialization. Under continued,
but perhaps lower income growth and if the GPF-G is managed according to the
current guidelines, the Fund could last infinitely long. However, as pointed out, it
could still decline in economic importance. Any giving in to temptations to spend
more could accelerate such developments. A further possibility is that future popu-
lation growth could reduce the Funds size per capita. This seems more likely today
than previously, in view of the increase in population size lately due mainly to immi-
gration. As discussed, there are many reasons for immigration from other parts of the
world, including wars, crises, and dire living conditions. To the extent that natural
resource riches has had an impact in this picture, it has probably been through making
Norway a more preferred destination than earlier due to good public finances. This
could have attracted some new residents among those who could choose where to

7 This publication was written by Michelle E. Jarvie, and released by the World Commission on

Environment and Development, sponsored by the United Nations and chaired by Norwegian Prime
Minister Gro Harlem Brundtland. Source: Britannica.com, accessed 31 March 2020.
8 Buckman (2004: 112–113) includes these ‘landmark publications’, together with some other

contributions in his discussion of the emergence of the opposition to globalization in the so-called
anti-globalization movement.
220 7 A Sketch of an Evaluation

move to. They may be quite few. Immigration increases the denominator in the GDP
per capita measure, given the moderate prospects for entrants of becoming inte-
grated into the Norwegian labor market. It could also imply increased spending,
due to costs of maintaining a statutory basic living standard for all. In any event,
improved prospects of future employment for the entrants could change this picture.
It is difficult to know what the welfare related spending could amount to. However,
the arguments made here suffice to illustrate mechanisms whereby the SWF could
decline in economic significance, linked to GDP growth and/or required spending in
view of welfare obligations.
As of late, here has been a marked widening in the activities of the GPF-G in
terms of increased absorption of various market-related risks, through changes in
the strategic benchmark set by the government. The single parameter most sensitive
to market risk, the share of equities in the holdings, has increased from zero in the
official foreign currency reserves before the Fund was established, via 40 per cent in
the newly established GPF-G from 1996, to 70 per cent currently. The 70 per cent
allocation was formalized in 2017, after a brief period at 60 per cent. Simultaneously,
one has allowed investment in unlisted real estate and infrastructure that also imply
increased market risk. In isolation, the increased willingness to absorb risk, mainly
by holding a larger proportion of stocks, should lead to higher expected returns from
the investments. However, the returns will not be much higher on a risk-adjusted
basis, even if improved diversification with the inclusion of new asset classes erases
a fraction of the increased risk. It is the high-risk operation.
To approach the challenges of fund management moving forward, it might be
instructive to start with a look in the rear-view mirror: As indicated, the story of
the GPF-G till today, is mainly a pleasant and successful one. Many decisions have
been taken and implemented professionally, that include both high savings and the
profitable investment of the saved funds. The less fortunate incidents seem to have
been quite few, far between, and unimportant in relation to the overall achievements.
Much effort and professionalism has been applied to arrive at the present situation.
Nonetheless, the Fund remains a quite fragile construction, in particular as regards
political consent. The most important stake holders have thus far agreed on a need for
prudent government spending. This may, however, change. Imprudent government
spending is one particularly worrisome possible way in which things may go wrong
for the GPF-G.
Due to the asset composition of the Fund, the realized returns exhibit large vari-
ations over time. Fortunately, the stock markets stayed strong for several years after
the latest increase of the equity share, to 70 per cent. In March/April 2020 the level
in international stock markets was reduced by about 30 per cent from the peak, due
to the economic knock-on effects of the Covid-19 crisis (as mentioned, 34 per cent
from 12 February to 13 March as measured by the FTSE Global All Cap stock market
index in U. S. dollars). By a rough back-of-the-envelope calculation, the value of
the Fund measured in U.S. dollars may have declined from about 200.000 to below
150.000 per capita. However, if we consider time periods of some length such varia-
tions would hopefully tend to even out also in the future. The achieved performance
7.1 What Could Possibly Go Wrong? 221

by fund managers given the adopted risk exposure is of less interest in this context.9
Their actions can be judged in relation to the evolvement of the strategic benchmark
portfolio, which moves with the market.
There will be a double effect of the Covid-19 crisis, as fiscal policy has been
adjusted to accommodate the downturn. Various packages of about 1/3 of the
expenses in a normal state budget were passed by March 2020. The spending
continued in the revised National budget of May, and the National budget for 2021
in October 2020. An estimated additional 400 billion kroner, at least, will be used in
2021 compared to the maximum ordinary allowance by the fiscal rule.10 In January
2021, new restrictive measures to reduce contagion were implemented due to a
‘third wave’ caused by an aggressive mutant of the new virus. Vaccines were rolled
out, but there were also new, negative surprises in the pipeline. In any event, tax
income will decline due to reduced economic activity and increased unemployment.
Furthermore, the oil price below 30 U. S. dollar in the spring of 2020, threatening to
erase anticipated state oil income to the Fund, estimated at 265 billion kroner in the
state budget presented in the fall of 2019.11 There could thus be needs to withdraw
invested funds at a time when the markets’ appetite for risk was sharply reduced. This
was, however, avoided under a more upbeat market sentiment through the summer,
due to prospects for prolonged low interest rates across the industrial countries. By
November 2020, the fall in value of investments had been reversed. Although several
factors linked to the Covid-19 crisis threatened to reduce the Fund by more than an
indicated 3 per cent of value of the Fund in early 2020, this was later reversed by the
markets.12
Summary statistics on returns for the Fund are envisaged in Table 7.1. The net
real return for the latest 20 years to 2019 was 3.6 per cent on average, i.e. about 40
basis points below the 4-pct. fiscal rule for the spending of resource income. The
underperformance in relation to the spending cap increased over time, however, even
if the strategic portfolio weights were adjusted to allow a higher equity share, and
thus a higher level of tolerance for capital losses. The rear-view mirror image thus
warns that sufficient returns to sustain a take-out rate of 4 per cent of the Fund’s value
while preserving its capital, was not satisfied. The lowering of the anticipated returns
to 3 pct. p.a. from 2017 appears well-advised based on results over this long period.
Table 7.1 shows that the overall returns are mainly determined by the strategic
benchmark index. Volatility is the risk metric. Relative volatility is the difference by

9 This measure may be most needed in the communication between Norges Bank as manager and the

Ministry of Finance as agent for the public as owners. The risk that really matters for performance
over time, is inherent in asset class composition of the strategic benchmark set by politicians on
behalf of the owners. The single most important number in this framework is the allocation to
equities, which since 2017 stands at 70 per cent.
10 This figure could still rise due to negotiations on stimulation packages in Parliament in late

November.
11 In January 2021, however, the price of Brent Blend oil held well above U. S. dollar 50 per barrel.

The utilise in oil prises has since continued.

12 A figure of 3 per cent was put forward in March/April by government sources to national news

media, including NrK Nyheter, the Norwegian state broadcaster.

222 7 A Sketch of an Evaluation

Table 7.1 Realized returns for the GPF-G 1999–2019, percent

2019 Latest 3 years Latest 5 years Latest 10 years Latest 20 years
Portfolio 19.95 8.57 7.05 7.83 5.63
Inflation 1.80 1.79 1.54 1.68 1.83
Management costs 0.05 0.05 0.05 0.06 0.08
Net real return 17.78 6.61 5.38 5.98 3.64
Benchmark index 19.72 8.40 6.82 7.59 5.42
Excess return 0.23 0.18 0.23 0.24 0.20
Absolute volatility 7.55 6.94 7.15 7.18 7.56
portfolio
Absolute volatility 7.38 6.87 7.06 7.04 7.18
index
Relative volatility 0.35 0.32 0.33 0.36 0.69
Sharpe ratio -0.02 0.01 0.02 0.01 0.00
difference
Information ratio 0.58 0.53 0.66 0.64 0.32
Beta estimate 1.02 1.01 1.01 1.02* 1.05*
Alpha estimate -0.16 0.10 0.15 0.10 0.03
Equities 26.02 10.86 8.99 9.84 4.95
Benchmark index 25.65 10.79 8.75 9.63 4.64
Excess return 0.37 0.06 0.24 0.21 0.31
Absolute volatility 11.48 10.21 10.97 11.55 14.09
portfolio
Absolute volatility 11.16 10.21 10.77 11.32 13.78
index
Relative volatility 0.37 0.36 0.41 0.43 0.72
Sharpe ratio -0.02 0.00 0.01 0.00 0.02
difference
Information ratio 1.22 0.34 0.67 0.55 0.49
Beta estimate 1.03* 1.02* 1.02* 1.02* 1.02*
Alpha estimate -0.17 -0.04 0.12 0.05 0.27
Fixed-income 7.56 3.77 3.18 4.05 4.76
Benchmark 7.35 3.56 3.07 3.86 4.61
Excess return 0.21 0.21 0.11 0.19 0.15
Absolute volatility 3.40 2.56 2.83 2.74 3.32
portfolio
Absolute volatility 3.53 2.66 2.99 2.90 3.19
index
Relative volatility 0.25 0.32 0.37 0.46 1.03
(continued)
7.1 What Could Possibly Go Wrong? 223

Table 7.1 (continued)

2019 Latest 3 years Latest 5 years Latest 10 years Latest 20 years
Sharpe ratio 0.09 0.09 0.07 0.13 0.01
difference
Information ratio 0.39 0.48 0.20 0.36 0.14
Beta estimate 0.96* 0.96* 0.94* 0.93* 0.99
Alpha estimate 0.30 0.25 0.20 0.38* 0.17
Unlisted property 6.84 7.30 6.49 6.32- -
Equity/fixed-income 13.02 5.73
sold
These annual geometric average return figures are from Norwegian Ministry of Finance (2020b),
Tables 2.1 and 2.5. For unlisted property, the history since the first purchase in Q1 2011 is listed
under latest 10 years. For the years 2014–2016 listed property is also included. The asterisk
shows statistical significance at the 5 pct. level. This report is made annually from the manager
to Parliament. Sources are the Norwegian Ministry of Finance and Norges Bank

this metric between the Fund and the benchmark index. The positive figures indicate
some moderate risk-taking. The information ratio measures the attained excess return
in relation to the assumed relative volatility. It will be positive if there is excess
return. The Sharpe ratio difference is the difference between the Sharpe ratio for the
portfolio and the benchmark index. In 2019 these two figures were 2.19 and 2.21,
respectively, so the difference is not much different from zero. The actual portfolio,
which realized a higher return than the index portfolio, was a bit less compensated
for its risk-taking. The calculations are based on few observations, and therefore
uncertain. Actual returns are published by NBIM in its quarterly reports.
Over the same period an excess return of 25 basis points was reported due to active
management in relation to the strategic benchmark, most of which was attributable
to equity investments. The good news was that the excess performance had been
relatively consistent over time, producing consistent incremental returns. The most
notable exception to this was fixed-income under the financial crisis from 2008.
In spite of this, Ang et al. op. cit., found that the excess return was mainly due to
systematic risk factors that should ideally have been included in the benchmark.
This would in their view have resulted in less excess returns in relation to a more
demanding benchmark. A restatement is that these authors think one did beat a less
demanding benchmark portfolio than one should have applied in view of the risk
factors. To the extent that this argument is accepted, one may also have overpaid
some ‘active’ external managers who had been quite passive in relation to so-called
non-systematic risk, which is what active managers can be expected to be paid for—
because they are thought of as good at either asset selection or market timing relative
to systematic risk, cf. so-called factor betas.13

13 These factors are constructed based on historic price data. Assessments with such a foundation

are bound to be at least somewhat naïve with regard to the future, which is genuinely unknown. The
factor approach still seems to work well enough over time to be maintained as a tool of investment
224 7 A Sketch of an Evaluation

In spite of this, even if there has been some active management for parts of
the holdings, the Fund is to a first approximation an index fund: There has been
limited risk-taking compared to overall returns, which implies that the success of
active management is of lesser importance for the GPF-G. Even if it is appropriate
to evaluate carefully the risks thus absorbed, it is important to be aware of the small
fraction of the fund that this critique seems to have applied to.
Overall, the GPF-G is an interesting case of time transformation of significant
savings. Sizable public resources have been set aside to generate a market-based
income on the capital stock to be consumed in later time periods by the generations
to succeed the one that set the funds aside. According to the statutes the capital shall
not be consumed, only the real returns. Even if the regulations may be changed in
the future, no changes appear imminent as of today.14 It should also be noted that
in 2017–2019, the achieved real returns have been at 5.4, 6.6 and 17.8 per cent,
respectively.15 The returns are volatile from year to year, illustrating the difficulty
in assessing the real rate of return that one can realistically hope for, cf. the 3-pct.
estimate in the fiscal rule. The returns in the latest years are well above 3 per cent.
The main driver for the high portfolio returns over the latest years have been
equity ownership. Still, also fixed-income investments have produced substantial
returns when one considers the environment since about 2008 of very low interest
rates. This, however, is mainly due to the effect of price appreciation on bonds
when the yields fall, and can therefore not easily be repeated moving forward under
close-to-zero interest rates and before too long rising interest rates.
The asset class unlisted real estate, introduced in 2011, had till 2019 in isolation
yielded around 6.3 pct. p.a. nominally, which is above the maximum 4 pct. spending
rule till 2017 also in real terms.16 A return of some size is needed in view of the
increased risk and overall more cumbersome management compared to the traditional
investment vehicles stocks and bonds. If we assume that one aims at reaching the
permitted maximum allocation to unlisted real estate of 7 per cent soon, the about 4½
real return till now would still not provide much revenue. In this author’s view a full
commitment to real estate investments could require expectations of increased real
returns from that asset class. It is therefore important how one interprets weakened
performance since about 2014—i.e. was this a negative event or a new normal? It
will also be of interest how real estate markets evolve after the Covid-19 crisis. An
important indirect cost linked to this asset class is lack of liquidity. It will probably
be unrealistic to liquidate unlisted real estate to put out moderately sized fires, like
those caused by the financial crisis from 2008 and the Covid-19 crisis. Thus, one

management. Systematic risk is risk with respect to the entire market, or a segment thereof, also
known as undiversifiable risk, volatility or market risk.
14 However, Parliament may as mentioned change this regulation. Needs could arise which could

justify changes. Thus, one may not want to take for granted a continuation of the current framework
for the long term.
15 Source: Meld. St. 32 (2019–2020). The return for 2020 was 10.9 per cent (Source: Norges Bank).
16 The inflation given in the table for the Fund’s currency basket, of 1.68 per cent for that period,

would indicate a real return of about 4.6 per cent. However, real estate investments are concentrated
to only a few markets.
7.1 What Could Possibly Go Wrong? 225

could need to hold more highly liquid assets than without a commitment to unlisted
property, in practice highly liquid government bonds. If this is a fair description,
there may be negative external effects from highly illiquid assets like real estate on
the average yield for the Fund. Real estate holdings may require larger holdings of
low-yielding bonds.
As for investments in other asset classes, it is difficult to know how the performance
of unlisted real estate will be in the coming years. One advantage of being exposed
to this asset class is that it is expected—albeit based on the past—to earn returns not
highly correlated with those of stocks, while yielding more than fixed-income in a
low-interest-rate environment. It may still be that real estate has become overpriced
due to a combination of low interest rates since 2008 and a quest for increased returns
from a variety of investor types, including both SWFs and other funds.
The move into real estate can potentially sustain higher returns in the long term.
However, if real estate becomes ‘re-priced’, which may signify lower prices due to
some unforeseen event(s),17 this asset class could lower overall returns for years to
come. This is a restatement of there being no free lunch, but also a consequence of
slow price adjustment in unlisted real estate. To buy unlisted real estate at high prices
could also imply risks in relation to a possible global economic downturn, which may
punish in particular holders of illiquid assets. Further, an increase in interest rates
could make it more expensive to finance any debt that apply to real estate investments,
to reduce net income for investors. It is difficult to know the correct price level, and
riskier to trust the market’s pricing than for other asset classes. A practical solution
to this problem could be to build the stock of unlisted real estate holdings gradually
over time and thus under varying market conditions.
The inclusion of a significant real estate fraction also implies some much more
personnel-intensive and cumbersome micro-level management. This could require
much attention from the managers. One may thus have to increase the number of
employees in fund management. Even if this may be expected, it could reduce over-
sight in an investment management organization. A main idea has always been lean
management. The Tempo commission, as mentioned, even claimed that one could
do without a new unit. Increases in the number of staff and/or units in the invest-
ment organization could lead to high costs, and potentially also loss of oversight.
The about 5 basis points the operations costs may be low compared to many funds,
but 5 billion kroner is still a lot of money in relation to Norway’s public budgets.
It is thought-provoking in this context that large American brokerages sell broad
index funds retail to the public at a fee of only 3 basis points p.a.18 High overhead
costs could be a second way in which things may go wrong for the GPF-G.
The period since the recovery from the financial crisis that struck in 2008 and lasted
till about 2012, known as the Great Recession, saw some spectacular movements in
asset prices. In retrospect, a success story can be identified from the holding on to

17 For instance, brexit, the exit of the UK from the EU, could have such consequences for real estate

in London.
18 The examples include (ETF), the VOO ETF of Vanguard, a Standard and Poor’s 500 index-linked

Exchange Traded Fund.

226 7 A Sketch of an Evaluation

and increasing positions in securities that in view of later developments appeared

significantly underpriced. In relation to the GPF-G, Ang et al., op. cit., pointed
out that the factors liquidity and credit risk led to sharp reductions of asset values,
particularly in fixed-income, and that prices later recovered. The Fund was successful
in holding on to such positions. This incident supports the view that the GPF-G, due
to its supposed although long time horizon, cf. the discussion in Chap. 6, had a
comparative advantage in relation to other investors in providing insurance to the
market in relation to factors that many would pay an insurance premium to avoid.
This arrangement would work such that the Fund would in normal times earn an
excess return compared to a “naïve” securities-based benchmark index over time,
but not in relation to a factor benchmark. When a crisis strikes sooner or later the
Fund will book a large loss, which one can think of as analogous to an insurer having
to pay for a burnt-down house. Another analogy that has been used is that of picking
up nickels in front of a steam roller. However, unlike a burnt-down house or rolled-
over nickel collector, the market value of assets high in the factors liquidity risk and
credit risk are likely to recover over time after a crisis. A long-term investor may
therefore become well compensated for the risk thus assumed, even with occasional
fires.
Looking forward under yields that remain near zero, it may be difficult to expect
significant investment income from fixed-income for a while. Stocks could be more
promising. However, rising unemployment due to lower demand may indicate that a
full recovery from the Covid-19 virus crisis will take time. GDP in the OECD area
declined significantly in 2020. Some, but not all lost production will be regained
in 2021. Some commentators have ruled out a so-called V-shaped recession for the
GDP of the industrialized countries. One could still hope for a U-shaped one, with
more time near the bottom. The fear is of a L-shaped recession, lasting long before
an unimpressive recovery. The still very low yields in long-term bond markets of
the major countries, may suggest that growth prospects were not good when the
Covid-19 crisis struck. This suggests that long-term yields could stay low for years
to come, limiting prospects for high real returns.
When yields start to rise in the future, assuming that economic growth picks up,
the situation could be ‘normalized’. However, this could take several years. This
reasoning applies to the established and proven markets of the industrialized coun-
tries. With respect to new types of investments, as these discussed above and partic-
ularly in yet unproven markets, there could be greater difficulties. These markets are
likely to be more severely hit than the main established and proven ones. This is
not to say that there will be no examples of impressing developments and returns in
less developed markets and countries. Growth has tended to be highest in a subset
of emerging market economies. While this is unlikely to change in view of recent
financial market headwinds, the risk-return tradeoff may appear as less favorable
than prior to the crisis, which could put some investments on hold.
This implies that the success story of the past in investment management, which
went along with a widening of the investment universe with respect to geography
and asset classes, cannot easily be repeated. This could be a good reason to remain
cautious. Further, it is comparatively easy to evaluate the small, frequent, and more
7.1 What Could Possibly Go Wrong? 227

mundane kind of decisions than more fundamental and rare decisions on asset class
allocation. In the context of the GPF-G, it is relatively easy to measure the perfor-
mance of the agent-manager, i.e. the NBIM, and less straightforward to evaluate the
strategic benchmark. The strategic benchmark has been constructed to reflect long-
term investment needs in the asset markets as they are known to date. It places the
main responsibility with regard to risk with the government. There may be no good
alternatives to this.
For returns over time, the strategic benchmark determines the lion’s share. In terms
of relative importance, the NBIM decisions may correspond to a first decimal, and the
strategic benchmark to the digit before this decimal. Although both are important in
their own right the implications at the two levels are of a different order of magnitude.
The evaluation of Ang et al., op. cit. which focused on active management, found
that the incentive structure had been motivating the manager to assume less risk
than the optimal risk level. Nonetheless, this was a minor issue, also due to the
small fraction that was put under active management. In view of this’ the Fund as
mentioned resembles an index fund. The active management applied has therefore
been unimportant for the overall performance of the Fund. The new Executive
Director of NBIM communicated in January 2021 that one would increase the extent
of active management.19 Large changes are, however, not expected. Unsuccessful
active management could be a third way in which things could go wrong for the
GPF-G, depending on the extent of external active investment mandates.
An important question is whether the establishment of the Fund and the associated
transformation of income over time to future generations was a good idea. However,
this is more difficult to evaluate than the asset composition of the Fund, and far more
difficult than the tasks the manager handle in adopting to the Fund’s strategic bench-
mark. In view of the cited evaluation report of Ang et al., the management has been
quite passive and excess returns relatively unimportant due to limited risk-taking.
In this picture, cost consciousness was emphasized as important by these authors,
together with the public-spirited personnel. In this author’s view this public-spirited
staff could constitute a valuable indirect safeguard against various thinkable orga-
nizational risks. In the language of Ang et al. this reduces agency costs. That it is
difficult to raise serious criticism against the fund management may be comforting
for the government, even though the more important larger questions of the estab-
lishment of the Fund and financial savings for the benefit of the future, possibly a
distant one, appears not to have been much researched. This can perhaps also be
understood in view of the commitment to the applied strategy. Those confident with
the decision may not have felt much need for that type of research.
Nonetheless, when one embarks on something fundamentally new and different,
one should logically be more concerned with the merit of the decision on new under-
taking per se than in the more technical aspects of implementing such a decision. One

19 Cf. Part I, section I.4 of this book. As far as this author understands the agenda is currently to

increase the fraction of external, active mandates to about 5 per cent, compared to a current about
3½ per cent, of the Fund.
228 7 A Sketch of an Evaluation

could perhaps have some reason to fear that a public debate on the merit of funda-
mentally new priorities could entail risks, and perhaps be analogous to the opening
of a Pandora’s box, for instance in relation to a goal to the Fund of keeping the
SWF large. There could in theory be an interest in limiting public debate. That could
be a risky strategy, however, given the indispensible requirement for legitimacy. In
practice, however, it is reasonable to expect conservatism in the approach.

7.1.1 Historical Price Data Cannot Be Forward-Looking

A pattern of historical data, however ‘well behaved’, can never be interpreted as a

guaranty for the same, or even of broadly similar patterns to be realized in the future.
Historical realizations of asset prices embody examples that underscore the impor-
tance of prudent behavior. What they cannot do, is to guide investment decisions for a
genuinely unknown future. This applies to all historical information on specific asset
prices or price correlations between various assets. To disregard this is to assume risk
which can increase, inter alia, in relation to herd behavior. The investment manager
who is wrong together with the herd can still hope to escape grave consequences
by emphasizing that ‘everyone was surprised and wrong on this.’ Patterns that have
worked well in the past can perhaps serve as a coordinating point in this respect. If
some follow them also in later time periods in which they can work for a while, those
who follow them will not be wrong alone.
One important reason for the relative uselessness of historical data is investor
behavior. What seemed innovative, smart and successful a few years back, and was
emulated by many, may no longer be successful. Emulation can be a strong force
in undoing the foundations of assumptions that once made one kind of investor
behavior successful. This ability to learn and adjust one’s actions, distinguishes
human behavior from acts of nature. In the usage of Derman (2011) one is playing
against creatures of God instead of against rules of nature. One can only catch the
same fish once. ‘Catch and release’ is not the way investment markets work. A larger
catch by other investors may reduce the return one can expect from the exploitation
of a given type of activity. By the same token, riskless harvesting of excess returns
would constitute a contradiction in terms.20
The onset of the financial crisis of 2007/2008 may illustrate further. In the run-up
to the crisis, perceived safe assets turned out to be toxic when it became profitable to
produce lots of them for investors constrained by guidelines but still either having to,
or choosing to, stretch or adjust mandates to harvest incremental returns in unusual
places. This was possible because investment guidelines that are often arrived at by a
rule of thumb approach, were defective in relation to the interests of the investors as

20 An illustrating example may be the behavior of international equity markets in February 2018.
After a long period of tranquility and low volatility in prices, there was a sharp increase in the VIX
index, an indicator of market fear, which in just one day wiped out formerly successful bets for low
volatility to continue.
7.1 What Could Possibly Go Wrong? 229

capital owners due to severe agency problems. In the same setting, many agents with
delegated authority faced incentives to generate sales to earn commissions. Effective
guidelines for investors were therefore loosened to increase returns. Formerly stable
empirical relationships between asset prices therefore broke down. When they did,
there were serious consequences.
Some investors lost a lot of money, often funds that were thought to have been
invested in safe assets of high credit quality, that it was highly unlikely to realize
severe losses on. This happened because credit quality assessment had been based
on historical price correlations that broke down. A particularly problematic field was
collateralized debt obligations, or CDOs, where for instance mortgages from specific
areas were bundled together and sold wholesale to investors. The idea was that credit
quality varied between home owners, so that it would be possible to bundle together,
for instance, the supposed best fractions of different geographically based pools of
mortgages, so as to create synthetic assets of very high credit quality. This could
have worked in other circumstances, with a less severe crisis. We know that it did
not work well in 2008. The crisis was too severe. One important reason for this, was
that an initially good idea became overexploited by too many.
In such situations it does not help much that more data on the past becomes
available over time, and that new techniques become available that can be used
to analyze and squeeze more information out of a given data set. There is a limit
to the type of inferences one can make, in this instance as in many other ones.
Fundamentally, it should be easy to grasp that historical data ‘know’ nothing about
the future.

7.1.2 Investment Opportunities in Emerging and Frontier

Markets

In the discussion above, one central element was a belief in the efficient market
hypothesis, i.e. that one cannot consistently beat the market. This also means that
past realized returns can never provide sufficient background to guide investment
decisions going forward, regardless of the location of the investments or the specific
instruments that are contemplated. This should be particularly clear when funds
are invested in foreign and remote locations. In that instance, not only a genuinely
unknown future, but also very different institutions than in known markets add to
uncertainty. In addition to the uncertainty implied by remoteness, the idea is often to
invest in markets that are not well developed—i.e. in emerging or frontier markets
which imply high risks and risk types that distant investment managers may not
always understand well.
Uncertainty in remote locations has made the world markedly less secure over the
latest few years, particularly due to developments in geopolitics. The changes have
been linked, e.g., to developments in the Middle East and in Russia’s stance towards
some of its neighbors. This uncertainty can also spill over to locations with which one
230 7 A Sketch of an Evaluation

is more familiar. For instance, the annexation of the Crimea by Russia from Ukraine
in February/March 2014 may have transformed the geopolitical risk environment.
This event is important because it was quite unexpected and has impacted on beliefs
of what might be expected ahead regarding, in particular, military intervention within
Europe. The associated chain of events has set a precedent that might de facto weaken
the influence of international law and set the stage for emulation by other states,
both nearby and further away. There is thus an impact on the environment both for
investments and international undertakings in general: The level of trust that others
will restrain themselves and respect international law has probably declined between
the relevant parties.
The annexation is likely to profoundly transform Crimea and East Ukraine. It has
probably also changed regional and global security policy in general. The changes
in the environment could trigger various responses, of a more or less defensive
type. Other states in that area may experience reduced safety. It is also possible
that countries in other parts of the world who could be suspected of having ideas of
performing similar acts, could feel less restrained by the international community
of states. The world could therefore become less safe. An implication of this is that
foreign investments could become riskier.
There may already be a new type of international environment in place where
actors pay more attention to what could go wrong politically. The continued increased
international risk-taking by investors in a quest for higher returns may be particularly
worrisome in an environment where increased risk is experienced from non-economic
sources. This applies also with respect to investment in new jurisdictions, particu-
larly emerging markets and pre-emerging markets, known as frontier markets.21 It
is dubious whether many such investments would have been made if the returns on
traditional investments were not as low as they have been since the Great Recession.
A too hefty appetite for investment in unsafe areas could potentially be a fourth
way in which thing could go wrong for the GPF-G.
As argued above, due to the current low yield environment, which may be
prolonged by several years due to the Covid-19 crisis, fixed-income can no longer
deliver returns without additional risks, most notably credit risk. The reason why
high risks have been accepted have been ambitious investments goals in terms of
returns. To avoid sharp declines in the cash flow compared to before 2007, the will-
ingness to accept risks may be too high. This may apply particularly to new asset
classes and jurisdictions. Investors must stretch themselves to counteract the cash
flow impact of close-to-zero interest rates. The alternative may not only be more risk
due to more capital allocated to stocks. In some new jurisdictions, there may be a
new security situation and increased risk, e.g., that laws and regulations may not be
properly enforced.

21 The web site Investopedia.com offers the following definition: “Frontier markets are less advanced

capital markets in the developing world. A frontier market country is a country that is more estab-
lished than the least developed countries (LDCs) but still less established than the emerging markets
because it is too small, carries too much inherent risk, or is too illiquid to be considered an emerging
market. Frontier markets are also known as pre-emerging markets.” Source: Investopedia.com,
accessed 15 April 2020.
7.1 What Could Possibly Go Wrong? 231

The key question is the extent to which this could lead to losses of capital. The
short answer to this question, particularly in view of the discussion in Chap. 6, could
be that there is reason to worry. Losses could be significant and pose problems also
for sovereign investors. Further, there may be severe problems particularly for small
investors and others that rely heavily on agreements and regulations. For Norway,
it could in view of limited power resources for securing her interests in foreign
jurisdictions, be timely to consider to simplify the investment operations, e.g. by
reducing some non-economic risk components.

7.1.3 Geopolitics Could Trump Financial Market Logic

As discussed in the previous section, the logic of financial markets can be expected to
work well only in ordered surroundings, in an environment of rule of law where the
law is respected and enforced equally with regard to all, irrespective of their identity.
These conditions may often not be sufficiently satisfied.
Similarly, for investors, there may be risks involved in the activities they undertake
even if the outcomes are in line with their expectations. The risks may only become
evident over time, if severe negative realizations are of a low probability ex ante.
In this way, one could ‘consistently’ realize returns above the expected long-term
returns. Risks associated with dishonest or opportunistic behavior by parties that one
needs to trust, could be detrimental to investment activities. The reason is that such
problems are avoided in many locations where high-quality institutions set behavioral
standards. Thus, even under lower expected returns, it could pay to invest mainly in
the latter locations of higher quality.
Authorities may, at least in democracies, be replaced by other types of authorities
that might view the need to maintain a stable environment for investments differently
from the regime in charge when investments were made. Further, the replacement
of governments may take take time or cause noise. Institutions within a jurisdiction
that might have made one want to invest, could in view of this become negatively
impacted upon and dwindle, which could pose threats to the respective investments.
To avoid such problems, one could simply invest in the largest and most devel-
oped markets. Many large investors, including institutional international investors
and sovereign ones, may have followed this logic. Investment mandates may still
have been expanded in terms of geography and/or asset classes to gain incremental
returns. This could have profound consequences.
232 7 A Sketch of an Evaluation

7.1.4 How Corruption and Malfeasance Limit Investment

Opportunities

Both historically and geographically, a required minimum standard to invest may

be less likely to be satisfied than some decision makers may imagine or assume.
Particularly in emerging and frontier markets where institutions may be weak, there
could be risks that force and connections might be used to systematically discrim-
inate against some investors. Good connections that some may have and cultivate
could substitute for impartial enforcement of laws and equal treatment. Thus, bad
equilibria might be established based on wrong incentives with regard to any plans
or hopes of creating an inclusive and prosperous society. Corruption is becoming
an increasing problem also in “advanced” countries. Thus, the type of tendencies
pointed out, to be avoided, are very general and not limited to the poorest countries.
Truly impartial enforcement of laws and regulations is hard to find in practice. The
institutional quality may also vary within countries, due inter alia to different roles of
local and/or regional politics. Enforcement may be political, selective, and/or asym-
metrical, and may benefit particular well-connected players. Many other contexts
are bound to be worse. Impartial enforcement can be hoped for, but hardly taken for
granted. To the extent that one cannot trust that laws will be applied and enforced
justly with respect to relevant parties, the risk of investing might simply be too high.
For most investors, investment in underdeveloped countries could in this perspective
be too risky. The non-economic risk may be too severe.
This is the reverse side of a main argument powerfully presented by North (1991),
and North et al. (2009), that poor property rights and more generally weak institutions
is the main reason for underdevelopment in much of the world. Owners of capital
know that investments would not be secure-enough, and avoid to commit funds in
such areas. When combined, these areas span large parts of world. If one goes back in
history some decades or a century, they would cover a very large share of the physical
space. It is the current situation in most of the North of the Western hemisphere that is
unique in this context. Therefore, capital will be extremely scarce in some locations,
compared with what purely technical considerations could make one believe should
be installed. The reason why capital may be abscent and not installed, in spite of
a high expected productivity physically, is a very high risk of confiscation and/or
expropriation.
A naïve use of the neo-classical growth model in economics focuses on the avail-
ability of factors of production, capital (K) and labor (L). Capital intensiveness, k
= K/L is a key variable. From the observation that capital is generally scarce in
non-developed countries so that k is low, one could be led to believe that the amount
of capital in isolation could solve the problem. Since capital is scarce it would earn
a high return for physical reasons which should induce capitalists to invest. This,
however, could only be true ceteris paribus. Due in particular to the significant
expropriation-confiscation risk, everything else is not equal in this example.
Capital owners do not want to invest in such settings because they know that
their capital will most likely, sooner or later, be lost, i.e. confiscated, expropriated
7.1 What Could Possibly Go Wrong? 233

or stolen. Thus, catch-up to the productivity and wealth of Western countries due to
positive capital flows is unlikely. Fundamental short-comings must be fixed first.
This important aspect is not present in the simple growth models, that have been
developed by implicitly assuming a Western democracy, as in the United States. The
models in their original form fit the stylized facts of that setting. The aspect of unsafe
capital is not present in the newer, endogenous growth model either, in which there
could in theory be catch-up to country specific levels of k, which could be lower
for non-developed countries than for Western states. Olson (2003a) emphasized that
none of these models of growth could account for the stylized fact that growth is
almost always highest for a sub-set of emerging market economies—i.e., the ones
that have undertaken successful institutional reforms that increase the confidence
among investors, and do not frustrate their expectations. The practical difficulties
would lie in knowing early on which countries that could successfully make this leap
to become ‘normal’. Today, it is widely believed that growth-friendly institutions
with increased predictability are key to making this leap.
Investment activities whose profitability depend on subsequent innovation and/or
trust, are particularly vulnerable with respect to weak institutions. If the play-ground
is not level in some areas, as is likely, some locations will be unable to attract capital. In
many locations, there could be little reason to risk losing money, as the investments or
fruits thereof might be unlawfully confiscated. International investors could also have
to collude with oppressing regimes, thereby illegitimately contributing to keeping
them in power, to protect investments. SWFs of democracies could probably not
participate. Players that would contemplate to take part, would risk to jeopardize
their credibility with other parties they would need to stay on good terms with. The
price could therefore be large, and the negative side effects long-lasting. Reforms
and confidence-building could be needed to attract foreign capital to promote growth
and prosperity. Mean while the risk would be high.

7.1.5 Financial Investments and Non-developed Countries

As growth is usually highest in some subset of underdeveloped countries (cf. Olson,

2003a), the factors that have barred capital accumulation, or some of them, may at
one time be overcome vis-à-vis some investors. From a low base, GDP would then
start to grow. The annualized rates of growth could in such situations easily reach
double digits. Although such high growth rates cannot be sustained for the long term,
an early entry could create substantial value for investors.
In a world with an infinite number of small investors, a necessary condition would
be sufficient improvement with respect to key national institutions. However, the
situation might be different with large funds, including SWFs. It could be tempting
for rulers who do not want reforms to collude with one or more large funds to secure
financing. In this way less than fully legitimate leaders could, at least in theory,
strengthen their hold of a country with the assistance of foreign investors. This may
be unusual. It still underscores the importance for SWFs of maintaining high ethical
234 7 A Sketch of an Evaluation

very standards. The financing that large funds could potentially offer can be hugely
important for some. On any such occasions, caution would be particularly precious.
The GPF-G operates with a high degree of transparency of investment activities
and decision-making that appears to rule out such instances. Nonetheless, even in
this type of setting one cannot rule out the possibility that capital could possibly be
exploited in illegitimate ways. There may be examples of this even when there is a
consciousness and framework in place to prevent abuses. One must thus be careful.
Being careful could imply limiting the the aggressiveness of investment operations
in terms of asset classes and credit exposure.

7.1.6 Operations-Size and Costs: Economies of Scale

or Dilution of Focus?

Finally, it may be important to discuss the financial implications of the building of

a large organization to manage a SWF like the GPF-G. From the outset in the early
1980s, the official reasoning was that a new organizational unit might not be needed.
This was as mentioned the view of the 1983 Tempo commission chaired by former
Central Bank Governor Skånland, who enjoyed a reputation for cost consciousness,
in particular. However, a fund that exceeded three times the size of GDP for mainland
Norway would at the time have appeared as pure fiction.22 Nonetheless, this is how the
events later played out, even with a much higher GDP. In the early 1980s, Norwegian
authorities were thinking of a much smaller fund than the one later created.
The large size of the Fund is due to political decisions to save and invest more
of the high resource revenues—that became larger than previously expected—due
to both high prices and high volumes—throughout the 2000s till around 2014. An
important political decision lies in ‘the fund mechanism’ whereby all resource income
first accrues to the Fund, before a part of it is, in an annual second step, used to cover
the non-oil deficit for the respective fiscal year.23
In view of the fundamental questions referred at the end of the introduction to
this book, the size of the staff of the manager of the Fund could appear as an issue
of lesser importance. However, it assumes dedication to the fundamental decision
of investing large chunks of funds in foreign countries, to be kept there for the long
term. With capital under management of more than 11.000 billion kroner, or some
1.3 trillion, U. S. dollars in May 2021, even substantial absolute costs would not
considerably reduce the return on investments after costs, compared to the return
before costs, when measured in basis points: Even very large costs could appear

22 As late as in 2002, no-one seemed to believe that the Fund could exceed GDP, at least not by

much. In a conversation with some fellow economists that year, there was disbelief expressed when
this author suggested that the Fund could perhaps become twice as large as twice the size of GDP.
23 The fiscal year follows the calendar year in Norway. The funds set aside to cover the non-oil

deficit can in principle exceed resource income from the same year. The first example of this, was
registered in 2016.
7.1 What Could Possibly Go Wrong? 235

small in this context. In absolute numbers, and in relation to all other activities or
magnitudes relevant for Norway, the amounts are large: These activities are large in
relation to most other things that taking place in or involves Norway.
A large staff could perhaps have been particularly appropriate for some years from
the 1996 inception of the Fund. The actual pattern, however, differs from this. There
has been most growth in the number of staff members in the most recent years, long
after the new structures had been established. In particular, some new, alternative
investment vehicles, specifically real estate, requires more hands-on management
than exchange-traded stocks and bonds, and thus imply more demand in terms of
personnel. Arguably, the growth in staff members attributable to this development has
been less needed than personnel needed to take care of the traditional investments,
in equities and fixed-income. Note also that in relation to new asset classes, the
purchasing of services, or foreign joint ventures, could reduce the need for hiring by
NBIM. Here we focus on the number of staff members of that organizational unit.
From the annual reports of NBIM, the size of staff at Oslo seems to have stabilized.
However, a reorganization in 2019, with establishment of support services to
serve both NBIM and the central bank functions may have led to a lesser staff count
without a lesser use than previously of staff resources. There are also people employed
by subsidiaries abroad linked to real estate investments. It would probably not be
possible, or desirable, to avoid a high use of staff resources in view of the investments
undertaken, particularly as regards real estate assets. In 2020, about 3 per cent of the
5 per cent allowance to this asset class had been exploited. It may therefore be too
early to conclude that the number of staff members has been stabilized. The staff
count is high compared to previously but may below in view of the activities.
When moving forward, it is important to keep an open mind in relation to
resources, structures and previous decisions. It is of high importance for the legit-
imacy of the operations that the costs are kept down, and that the undertakings
remain transparent and simple-enough for many citizens to understand. A struc-
ture composed of about thousand investment professionals has emerged. In Norway,
such developments are generally met with skepticism. Skånland, who as mentioned
chaired the 1983 Tempo commission, was particularly skeptical regarding growth
in the Bank’s investment activities abroad. His skepticism was rooted inter alia
in expected agency costs and a fear of ‘empire building’ by public officials who
could come to benefit from public funds. He thus might have sensed that publicly
employed personnel could recommend investment activities that would not neces-
sarily and/or sufficiently benefit the tax payers and citizens. The source for this is a
private conversation in 1991.
The evaluation of active investment mandates by Ang et al., op. cit. emphasized
that NBIM has an advantage in relation to the important agency costs that generally
may arise in the management of other people’s money. However, their assessment
was made in comparison with other, presumably less public-spirited managers of
other funds, not in relation to the scale and number of different investments or asset
classes in the GPF-G.
The current large-staff strategy, compared to the earlier situation of the GPF-G
if not of other similar investment organizations, could lead to an edge both in terms
236 7 A Sketch of an Evaluation

of risk management and financial expertise. However, in that process it could drain
human resources that could else have been available for other purposes, particularly
in the domestic private sector. It is difficult to know what the costs of this could be.
Could the operations of the GPF-G improve Norway’s competitiveness in financial
services in the future? This may not be unlikely. Today’s comparative advantages
are products of efforts in previous times. In view of this, Norway could perhaps
accrue a comparative advantage in investment management due to the operations of
the GPF-G to date. At least, similar effects have been noted in relation to maritime
activities, which Norwegians are comparatively good at because of Norway’s long
coast line and needs over long time periods to exploit what the sea had to offer.
Financial know-how, however, travels fast and with little friction. It will therefore
be made available where it is demanded. Generally, economic activity, i.e. trade
and investment, underpins financial markets. In view of this, it could be challenging
for Oslo to maintain any advantages gained from the GPF-G in competition with
financial centers closer to the centers of gravity of the world economy. Norway is
likely to remain a distant, small country in the periphery, but be good at finance.
The build-up to the current situation of almost one thousand staff members at
NBIM was probably necessary to get the job done with sufficient quality. Still,
the objective basis for this large size could diminish moving forward. In the main
asset classes, there are very significant economies of scale in the management. The
continuation of a large size in terms of staff could therefore hinge on commitments
to increased investment in personnel-intensive other assets, in particular real estate.
If the gains within this asset class are combined with a higher reluctance with respect
to diversifying into personnel-intensive fields, fewer staff may be needed.
The fact that a small state like Norway takes part in large acquisitions of real
estate abroad is bound to attract attention. In part, this is due to the openness of the
Fund with respect to its operations, which is mainly good and could also contribute
to build confidence. However, most other states, particularly small and distant ones,
don’t do this. This author thinks one should therefore act with care, at least as regards
highly visual and/or symbolic real estate. This notwithstanding, large resources have
already been committed to this asset class, which could make it difficult and/or
costly to downsize these activities, and more so to the extent that there may be
scale economies also in managing real estate investments which does appear as quite
reasonable.
The ‘new’ real estate assets therefore have complex implications for the overall
investment organization that may deserve attention. The context that surrounds a real
estate investment may be less formalized than for other asset classes. Presence and
information gathering is therefore important to generate a capacity to act swiftly if
such needs should arise. This could require dedicated personnel. Hence, if you say
‘a’ in relation to real estate, you may have also to say not only ‘b’, but perhaps also
‘c,’ ‘d,’ and ‘e’. One may in addition also have to take part in other activities.
7.1 What Could Possibly Go Wrong? 237

7.1.7 Considering the Future

As stated above, the GPF-G is in designed to last indefinitely: Only the returns from
this fund are meant to be spent via the state budget. Even though it is expected to
decline in value compared to GDP, at least if GDP hopefully continues to grow,
the Fund is likely to remain large in absolute size. In this context, it should also
be emphasized that there remains significant undeveloped hydrocarbon resources
under the seabed. The degree to which these resources will become exploited later,
may mainly dependent on future oil prices that are unknown today. Increased oil
prices could still imply significant growth of the Fund. Environmental concerns could
also in principle lead to decisions of not touching these oil reserves, although this
may be unlikely. Reasons why it may be unlikely, include the world’s dependence
on fossil fuels as an energy source, and the relative cleanliness of extraction in the
Norwegian sector compared to elsewhere. An important counterargument, is that
extraction is much cheaper on land in the Middle East. If there should be a future
global production cap with quotas, the cheap oil is likely to be extracted first.
Over time, Norway could again become a ‘normal’ country with net government
debt, due to the usual financing needs for the state. In the latest decade there has been
some debt issuance, but mainly to maintain a distinct sovereign krone yield curve. By
contrast, governments of most other industrial countries issue significant debt because
they need to finance the state. Norway will in all likelihood not remain an exception
for the foreseeable future. If or when this changes, it could make sense to smooth
the transition by selling financial assets to slow the speed of a debt build-up. Under
this remote scenario, there could be a need to scale down investment operations. It
could then make sense to simplify the central government’s balance sheet. Although
a period of a substantial volume of asset management without a significant net asset
position need not imply very large costs, it would imply operational risks that one
could typically want to avoid.
According to Clark et al. (op. cit.: 153), the legitimacy of the GPF-G is based
upon ‘national values and commitments’. First, the concept of national values and
commitments is quite vague. The interpretation may be linked in part to events that
have unfolded long after the creation of the Fund. It is important that values may
change with time. Second, to claim that the national values have resulted in the Fund
as it is today, could appear as an ex post rationalization. Third, governments, as the
responsible owners of SWFs, operate in a political environment where decisions are
shaped by evolving official policy views that are usually influenced by many factors.
One such important factor is the size, and thus also the economic importance, of the
SWF. The national values and commitments are therefore not set in stone.
One mechanism to be aware of, is populist policies that exploit a relative feeling
of poverty and lesser importance in Norway’s districts in relation to resource wealth
administered by the central government. To spend more money through the budget,
thereby reducing the size of the fund, could be understood by some as an act that
could diminish the impact on public policy of the elites who live and work in Oslo.
238 7 A Sketch of an Evaluation

Such activism could also be applied to secure funding for initiatives that could
otherwise risk not to receive public funding.
The Fund grew fast after a slow start, and increased size resulted in the building
of a large management organization. Willingness to utilize the SWF as an instru-
ment of politics has not been a factor. In spite of this, a perception that the Fund is
closely linked with national values and commitments constrains the activities that
the managers of the GPF-G can take part in. This appears as a political necessity.
However, if one were to become very preoccupied by such concerns, it could detract
from financial performance. The core aim, and raison d’ être for the Fund, remains
the conversion of income earned at early points in time through global financial
markets, into a capacity for public spending much later. Due to a different timing
of savings and spending, the funds spent will to a large extent benefit members of
future generations. Unspecified, delayed future spending can be achieved with the
money that has been put aside. In the meantime, it is important to earn good returns.
Hence, this is time transformation of money. Both the current generation and the later
generations care about the returns: With high returns, there will be a greater effect of
compounding, which would allow for less savings today, or more to be spent in the
future. There may be a combination of the two. The future generations must accept
the size of funds saved and put aside by the prior generations. Thereafter spending
abilities would increase in the returns. The later generations will therefore also benefit
from high returns on the investments.
Without this specific need, due to incomes in one period and unspecified spending
much later, there would in all likelihood not have been any GPF-G. National values
and commitments from earlier times may have resulted in a desired time profile for
spending of the resource revenues, which is in the short run limited by the expected
real return of 3 pct. p.a. Till now, this concern seems to have dominated other values
and commitments that may be relevant. This is not to say that there cannot be change
with respect to the values and commitments that will be relevant in the future, or
change with respect to the weighting of values and commitments.

7.1.8 Why the Wealth Was not Squandered

Norway today has something to show for its oil and natural gas endowment. The
financial task undertaken through the GPF-G also appears sustainable. In the period
prior to 1998 when the capitalization of the GPF-G started, some financially viable
investments, in real capital and mainly infrastructure, were undertaken by the govern-
ment. Proceeds from oil and gas extraction were thus invested also before the GPF-G.
Up to 1998, however, all resource revenues were channeled through the budget in
the year they accrued. However, it was not spent without regard for the future. After
1998, and up to at least 2014, large and increasing amounts were channeled into the
GPF-G, established in 1996. The mechanics after 1998 are such that all oil and gas
revenues first accrue to the Fund, which is then used to cover the non-oil fiscal deficit.
There may lie important elements of discipline both in ‘the Fund mechanism’ and the
7.1 What Could Possibly Go Wrong? 239

fiscal rule. Both devises seem to have contributed to disciplined policies where, for
quite some time, savings seems to have been favored over increased current spending.
The Norwegian experience marks a stark contrast to that of many other countries of
resource riches, where windfall gains from natural resources like oil and gas have been
succeeded by stories of how the newfound wealth was soon squandered. Still other
countries had no significant marketable natural resources. The less economically and
institutionally developed a country is, the more likely is seems that publicly owned
oil revenues, or revenues from other natural resources, are likely to disappear fast
without any substantial benefits for the common citizen or resident. In all locations,
it seems difficult to both save and invest for the funds to last. In many locations the
situation is also such that the resource incomes are not only spent fast, but also for
the benefits of very limited subsets of the population—quite often the ruling elites.
To understand why, it might be instructive, first, to consider the intricate transac-
tions between many parties that must be concluded to bring hydrocarbon resources
to international markets for sale. The starting point in a discussion of the ability and
also advisability of savings, presupposes that all the elements of a chain of serially
dependent steps have been sufficiently well handled. Chances are that some of the
same countries that would have problems with bringing the resources to market,
would also have problems related to savings and investment of revenues from sales
of the resources. Such countries may face a limited probability of success. Simi-
larly, the countries that manage this problem, may comparatively easily manage the
chain of required, sequenced events well enough. If so, they are also in an advanta-
geous position with regard to managing to put aside significant savings. For instance,
any significant corruption problems—a phenomenon that plagues large parts of the
world—the exception seems to be mainly the latest decades in the ‘North West’—
i.e. in the Northern part of the Western hemisphere, could be detrimental. This may
make it particularly demanding to conclude all needed transactions correctly. There
may thus be missing links in the required scheme for success, which may block that
road. The exact implications of this would typically be location-specific and case-
specific. However, it could perhaps be best in some locations and settings to leave
natural resources untouched. Then the resources would at least have a thin layer of
protection against grabbing hands.
Corruption is often rooted in weak, defect or lacking social institutions to guard the
common interest, and is often correlated with a low level of economic development, as
in most poor countries. Due to this, it is likely that severe obstacles hamper economic
activity. Economic development may be difficult to achieve due to some of the same
reasons that constitute the corruption problem. Some aspects of this are covered in
the resource curse literature, which documents that on average, resource abundance
is more likely to appear as a curse than a blessing with regard to growth in GDP
per capita.24 Thus, resource rich countries are likely to grow slower than their less
resource rich peers, making the net contribution of valuable resources less than zero

24 The true size of the negative impact of natural resources on GDP growth may be small. However,

even a zero or low positive effect on growth could be puzzling, since valuable resources should
ceteris paribus be a good thing.
240 7 A Sketch of an Evaluation

in a growth context. This is a paradox. The reason seems to be linked to activities

that aim at stealing or otherwise acquiring the valuable resources. This implies two
kinds of cost: First, the environment becomes hostile and threatening, and thus unfit
for investing for the future, and the most promising and skilled humans develop their
skills in the direction of being able to take something that is already provided—the
valuable resource—rather than creating new valuable items through either hard work
or innovation. Innovation, which could make a large difference over subsequent time
intervals, becomes particularly risky in a corrupt environment.
Weak institutions cannot provide a complete story of why societally meaningful
spending of natural resource revenues becomes so difficult in practice. Even highly
developed industrial states, like Britain and the Netherlands, have a record of seem-
ingly non-prudent and too fast, and thus not sustainable, spending of their former
natural resource wealth. In this latter instance, the problem was that too much resource
revenue was spent too fast, not that it was necessarily spent for wrong purposes. The
resource revenues in these two instances were from oil in Britain in the 1970s/1980s,
and gas in the Netherlands in the 1960s/1970s. One failed, in both instances, to deal
with the temptation to spend the incomes early. The situation is not too different
from the Norwegian one, which Norwegians seem to have handled wiser, albeit with
the benefit of lessons learnt earlier by other countries. Note also that in view of the
smaller size of the resources in the two cases of Britain and The Netherlands, even
perfect management could have been of moderate importance in relation to the rate
of consumption of the revenues. Interestingly, there were some instances in the early
2000s of unsustainable use of oil money in Norway. However, at that time increased
oil production and rising oil prices saved the day, and automatically and painlessly
corrected what this author sees as errors. Each year one was permitted a new start: It
was never needed to reverse too high spending, because the incomes from oil grew
even faster. Spending could both continue at higher absolute levels and comply with
the fiscal spending rule’s upper bound.
Sometimes it is emphasized as an ex post explanation, that wealth which became
squandered had also been newfound. Perhaps it is easier to let go of something
recently acquired than something that one has held on to for a while. This may,
however, not be obvious. It may seem more likely that controls may be weak at the
beginning, which may by itself work against attempts to curb the spending of wealth
that some can find ways to spend, whether it is newfound or not.
Although it seems wise and perhaps obvious to some in retrospect that Norwegian
authorities have rightly saved out of the petroleum earnings, this result could not be
taken for granted. The usual temptations and forces of political populism that may
promote financial myopia seem to be present and as strong in Norway as in other
countries, perhaps even stronger due to the resource revenues. Nonetheless, these
forces have been kept in check by the authorities so that it has not become necessary
to give in to temptations, at least not by much. Growth in the size of the Fund has
also, as mentioned, worked to mend fiscal rule breaches in instances when the rule
has not been respected.
To understand how comparatively very prudent spending became possible, cf. the
discussion in Sect. 3.1, it may also be of interest to consider the administrative culture
7.1 What Could Possibly Go Wrong? 241

of some key institutions responsible for economic policy, particularly the Ministry
of Finance and the Central Bank. In this author’s view, the fact that the population
of Norway owns a big chunk of capital abroad is due to the strong influence on
economic policy of these two institutions over time. The oil wealth was invested
abroad, mainly due to the potential ill consequences of domestic use of large sums
of oil money in a small to moderately sized, open economy. To invest all funds
domestically was never an option. If very large amounts of money were to be spent
in Norway, the prices of goods, services and real assets would have been bid up. This
could have been highly unpleasant, and inflationary beyond the asset price inflation
that would have followed. Further, the value of the currency would have increased in
real terms, through price inflation or appreciation of the nominal exchange rate, or
both. Either way, the competitive, or exposed, sector could have faced very difficult
times. A potential loss of competitiveness in international markets due to such factors
could have caused severe problems.
The competitive position of the exposed sector is important in a small, open
economy. In Norway, this has been a key concern in economic policy at least since
the 1960s. It is easy to understand that oil revenues will decline with time as a
fraction of export revenues, and that some other export incomes are needed for the
long haul. This priority has made it necessary to keep the real exchange rate at levels
consistent with a minimum certain size of the exposed sector, even if its size has
declined a bit over time. The continued holding on to this priority has also ruled
out more massive spending of oil revenues. The strong position in economic policy
circles of the Ministry of Finance and the Central Bank has made the applied policy
appear uncontroversial. Indeed, for a long time the binding concern in the spending
of resource wealth has not been the concern for future generations, but rather for
the economy’s absorption ability. This seems to have instigated creative suggestions
en masse on how more money could be spent, testifying to the presence of fiscal
populism also in Norway.

7.2 Did Norway Escape the Resource Curse Altogether?

The previous two chapters have dealt with a broad range of risks, some of which may
not be very well understood, or may have been under-communicated also in relation
to the GPF-G. These risks are still significant and worth considering. However, it
is possible to argue that the greatest risk to a continuation over time, according to
an adopted plan, is also of this SWF linked to the authorities whose role it is to act
as guardians and responsible owners of the Fund. There may be a temptation for
political leaders to buy increased popularity for the short term by drawing more on
a SWF than a doctrine of ‘only spending the return’ allows for.
Recently, this possibility has been emphasized by former Central Bank Governor
and Ministry of Finance Council Svein Gjedrem, since he retired from the Ministry
of Finance in 2014 to become a professor at the Norwegian School of Economics
and Business Administration. In a statement from September 2016 to business daily
242 7 A Sketch of an Evaluation

Dagens Næringsliv, he labeled the recent spending of oil money as ‘hyperactive’,

and expressed hope that politicians would want not to be remembered as those who
squandered the wealth accumulated in this Fund.25 As of 2016, the oil money spent
through the budget amounted to 7–8 per cent of GDP and about 16 per cent of central
government expenses. Spending has increased a bit further by these measures till
2020, and for 2021 oil money is intended to cover about 1/5 of the budget. For other
governments, this must be an enviable position to be in. To this author’s knowledge,
there is no historic parallel. It is more common to face financial constraints in rela-
tion to interest payments on government debts, for some even of a similar order
of magnitude. Comparatively speaking, the Norwegian government should thus be
exceptionally well positioned to please its citizens. However, under high expecta-
tions, this may not be very easy. Further, there are challenges linked to demographics
and public pensions, in Norway as in many other Western countries.26 This applies
even if Norway is less financially exposed to demographics than many other OECD
countries. According to Gjedrem, the political rhetoric in relation to the welfare state
must be tuned down as future governments will increasingly face the choice of either
reducing the entitlements or increasing taxes.
An important question is whether the fear of standing out in the future as
the Finance minister who squandered the oil money could be sufficient to deter
public overconsumption by spending more than the returns, which would amount to
consuming the Fund’s capital. Prospects of becoming infamous for this would prob-
ably not in or by itself suffice to deter overspending. One reason is that it is usually
possible for politicians to place at least some of the blame that could result from over-
spending on colleagues in former governments or other political parties: ‘The difficult
situation we face is due to the policies by the opposition, at the time when they were
in charge,’ is a well-known theme through time and across space. Although there
may always be some truth to this kind of statement, its main function is to lower the
political costs of failure for incumbent politicians. The blame for overspending could
thus be fragmented to hit several political figures and parties in small parcels, which
could significantly lower the cost of failure, and thus increase its likelihood. Gjedrem
commented that he was looking forward to a time when political rhetoric could start
to reflect reality. This wish may not be fulfilled soon. There are good reasons to
expect both imperfect accountability and gaps between rhetoric and reality, also in
the future. The truth may be unattractive compared to alternative stories that one

25 “Warns Against Crushing the Piggy Bank” (“Advarer mot å knuse sparegrisen”), Dagens

Næringsliv pp. 6–7, 16 September 2016.

26 Demographic developments are making the welfare state more expensive to operate over time,

with fixed qualification criteria for the various entitlements. The main component is pensions due to
old age, which increases both due to an increased number of old citizens and an increased number
of years that people who reach retirement age are supported by this arrangement. Other items, for
instance disability pensions, envisage similar implications on the cost side of the budget. Overall,
there is a strong tendency for welfare arrangements to require a steadily increased funding by the
state. However, these problems are to a large extent linked to the politically determined content of
entitlements. Compared to in other OECD countries, the increase over time in expected life length
at birth is moderate in Norway.
7.2 Did Norway Escape the Resource Curse Altogether? 243

may get away with, and the knowledge may be incomplete. Further, ‘real truth’ is
often contested. The Gjedrem commission’s proposal still embodied a message of
normative appeal that echoed former Central Bank Governor Skånland, who was not
afraid to criticize public spending. This practice, shared by a handful of prominent
bureaucrats and politicians, may have strengthened the general interest relative to
special interests. The messengers, however, could become unpopular.

7.2.1 Resource Curse?

The resource curse literature deals with the contra-intuitive finding that there is less
growth and development where there is natural resource abundance. For Norway,
however, things appear contrary to that prophecy: The extraction of oil and gas has
contributed to a quite sustainable development of the mainland economy. There thus
appears to be no resource curse in the usual sense, at least on the surface. The literature
has treated Norway as an exception to a general tendency of relative economic decline
associated with resource wealth. This finding has in part been attributed to favorable
institutions that allow prudent policies to be pursued. These institutions are strong
and well developed compared to the situation in many other countries. The behavior
of many actors in relation to, e.g., the oil and gas industry and the use of oil money
in Norway, may perhaps still be interpreted as a special case of resource curse.
For instance, institutions may have been significantly negatively affected by the
business methods and structures of the oil and gas industry. It is likely that the
agents and representatives of this highly profitable and influential extractive industry
have had a negative impact on important institutions, in Norway as in some other
countries. Notably, exposure to the business culture of this sector might have made
public agents in several countries more vulnerable and exposed with regard to various
kinds of corruption, in particular bribery. There is also some evidence from large,
partly state-owned companies in several sectors that may lend support to this view.
In these instances, corrupt practices may have been relied upon, e.g. to win contracts.
There can sometimes be a double whammy effect from oil and gas: First, the wind-
fall income may be used for illegitimate purposes, including acts aimed at holding
on to power by elites who may underperform in governance and/or repress their
people. Resource revenues might be misused to buy opponents or to reduce fric-
tions, e.g. through handouts to strategically chosen targets. Structures could then be
cemented, when there could otherwise have been changes in positions and structures
of power. This mechanism is often associated with autocratic rule, but is relevant
also with respect to political processes in democracies. Second, the industry that
extracts oil and gas has a reputation for comparatively low ethical standards, which
may reflect the often-large opportunities for personnel with few scruples in a domain
where the winner who gets a license may ‘take it all’: For instance, one big firm
may get all awarded contracts. Wielding influence via both these channels could
lead to increased corruption. Although there are few systematic studies for Norway,
244 7 A Sketch of an Evaluation

corruption is likely to have become more serious due to the oil and gas sector.27
Corrupt acts may have influenced politics both at the state level and lower levels
of government. As discussed above, this type of problems linked to the oil sector
are much more severe for emerging markets and non-developed states likely to have
more vulnerable institutions.
Corruption is known to slow down growth and development, in both economic
and human terms: Both incomes, operationalized within nations as GDP growth per
capita, and personal economic freedom may be reduced for corruption victims. This
may be the case even if average income should grow. However, the revenues from
oil and gas can be used not only to buy or rescue lost politicians or policies, but
also to mask problems related to underperformance relative to the potential. This is
a general problem that cannot easily be avoided, across space and jurisdictions.

7.2.2 Or Just the Contours of a Curse?

In the early stages of the oil era, one was concerned with a strong drain of resources
from the viewpoint of other industries. It followed from the decision to exploit oil and
gas that personnel had to be recruited from other activities, and persuaded to apply
for new jobs on platforms in the North Sea. Alternatively, one could perhaps have
recruited mainly newcomers to the labor market. In practice, a combination of the
two approaches was applied in the Norwegian case, with senior operative manage-
ment recruited from the large oil companies, together with many young Norwegians,
mainly peasants and workers from, e.g., manufacturing and other maritime industries.
From a theoretical perspective, one would need to change relative wages to instigate
job changes in a particular direction among the already employed. One could for
instance increase the wages in a new industry. Indeed, it became possible for some
to get both a 50 per cent wage rise and more time off, with cycles of one week on and
one week off. This total package was demanding, with intensive work and frequent
travel to and from offshore oil and gas installations, but still attractive for many.28
In the beginning the effect on national wages was moderate. Only 250 workers were
employed in oil and gas extraction in 1966. This number had increased 1000-fold,
however, by 2016, to about 250.000, or in excess of 10 per cent of the active mainland
workforce.29 Obviously, the large size of the offshore industry in combination with
its high capital intensity and high profitability, has over time worked to bid up wages

27 An exception is Andvig (1995), who studied corruption directed against middle-level management

in oil companies in the Norwegian and British oil industry in the North Sea.
28 The so-called off shore cycle of work has changed radically since the early days—in the direction

of more prolonged and intensive work, which has been compensated by even more time off than
on than the even split in this example. As a consequence, and made possible by better off-shore
housing, the travel time has been reduced very significantly.
29 Dagens Næringsliv 19 July 2016 “50 år siden startskuddet for norsk oljeboring” (“50 years since

the start of Norwegian oil drilling”).

7.2 Did Norway Escape the Resource Curse Altogether? 245

for large groups in Norway. For mainland industries the net result was that fewer
personnel were available, at higher costs.
Wages were bid up to absorb the increased demand for labor. For oil companies,
labor costs are a small fraction of the overall costs. The high wages needed to attract
personnel to operate capital-intensive installations thus became more burdensome
for other industries. The comparatively high income from this new employment
opportunity, could in theory have reduced creativity amongst a group of employees
who experienced easy money, and lowered their future ability to earn market-based
income. This latter possibility could entail high costs, but is difficult to document
or prove. Even if there might be a tendency for humans to relax once they have
achieved what they most wanted, most businesses that need qualified staff members
may also contribute towards stimulating training and investment in suitable skills
and abilities. The logic behind a proposition that success leads to less creativity,
may also be unconvincing in view of the possibilities of creativity having an impact
also in other domains. That is, success in one industry can open up opportunities,
also in other industries. In a growth-oriented economy, it could be appropriate to
turn the argument around, to suggest that increased income in one industry makes it
indispensable for other industries to fully utilize their employees.
It is noteworthy that the 1983 Tempo commission was well aware of the risks
implied by oil companies bidding up wages. Its approach to this scenario was that
the government could keep the wages down. This, however, has not been possible—
perhaps due to a combination of a much stronger wealth effect of the hydrocarbon
resources than one expected at the time, and also a more democratic society over
time with, not least, more democratic labor relations than in the 1970s and 1980s. In
relation to this, it may be of interest that Norway has at times been criticized by The
International Labor Organization of the United Nations, ILO, for not allowing strikes
aimed at higher wages and improved work conditions in her oil and gas industry. A
more liberal policy stance could perhaps have posed larger problems for the mainland
industries.
An important part of resource curse is often described as permanent deindustri-
alization. This could have become a more marked development if there had been
more room for wage increases in the offshore oil sector. In any event, there has
been some deindustrialization: It has been necessary to spend some of the windfall
revenues recurrently to benefit from it. As described above, this has happened through
government provision of goods and services financed through the state budget. This
expansion of government activities, and tax reliefs, have led to increased imports but
also to increased purchases in Norway since not all goods and, particularly, services
are tradeable. This again has bid up wages in the sheltered sector of the economy,
which manufacturing has needed to match to compete for personnel. Thus, the manu-
facturing sector has been scaled down, which is what is usually meant by deindus-
trialization. Although we cannot know that the decline of activity in the competitive
sector is permanent, it is reasonable to expect start-up costs if competitive industries
must be expanded later on to make up for the income shortfall when most of the oil
and gas is extracted.
246 7 A Sketch of an Evaluation

A further component of the resource curse which Norway has not been much
plagued by, is cyclical Dutch Disease. This implies procyclical public budgets and
becomes more severe the larger a fraction of the economy the resource sector accounts
for. Although the resource sector is large, it has been of a moderate size compared to
GDP. This has reduced the harm inflicted on the economy by volatile oil prices. The
budgetary framework, developed under broad political consensus and of which the
SWF is one important part, shields the economy from moderate shocks to the oil price.
In particular, the resource incomes are channeled through the SWF, and the spending
rule, i.e. the fiscal rule, is clear, easy to understand, and embodies escape clauses.
Adjustments are made via budget indicators both in view of the business cycle and
of oil prices. A coherent and transparent non-controversial policy framework does
in this way assist fiscal policy.
How about the institutional elements of resource curse? Frankel, op. cit., mentions
autocratic or oligarchic institutions and unsustainability and anarchy, none of
which have been very relevant in the Norwegian context. There were robust and well-
developed institutions in place, suited for growth and continued democracy, at the
time of the first major oil find, of Ekofisk in 1969. Compared to in many other
countries, there was thus a favorable home turf in Norway, from which one could
justify hope in relation to developing the common resources into positive welfare for
everyone.

7.2.3 Creativity and Ample Public Funding

The mentioned argument of a potentially reduced creativity among well-paid

employees may seem weaker in a context where extraction has been made possible
through overcoming large challenges posed by nature, in terms of exploration and
later drilling and extraction. The locations were far off shore in the North Sea, and
wells were drilled underneath the seabed, partly in deep waters. This resource extrac-
tion, no doubt, has been intensive in resources, technology and skills. Over time this
has led to improved skills that were also suited for other applications.30 There may
thus not have been reason to fear overpayment for simple work and underdevelop-
ment of more demanding skills. Indeed, it appears more reasonable that the offshore
industry may have led to improvements and improved quality in operations not only
needed in the extraction of hydrocarbons. This may also, over time, have improved the
foundation for sustainable future growth in other industries. Although these mech-
anisms might still be relevant, the main negative effect of oil in this context is the
one due to the increased spending through public budgets. It could be negative for
maintaining productive abilities that substantial wealth has been consumed that was
not created in a competitive environment. Although this is a possibility, it is due to a
windfall gain characteristic of incomes from oil exports. For a windfall gain from a

30 An important question, is the degree to which Norway will be able to capitalize on this after the

oil era. There is some positive evidence on this.

7.2 Did Norway Escape the Resource Curse Altogether? 247

large resource deposit, it may be difficult to suggest a better strategy than putting the
resource gradually to market, spending a limited part of it recurrently, and investing
the rest to produce long-lasting, perhaps even ever-lasting incomes.
The best political approach to this situation is perhaps to constrain spending, which
has been done systematically, cf. the fiscal rule. Second, in relation to public finances,
the resource revenues have made it possible to fund many projects which would have
been unrealistic without oil revenues. The availability of funds may also have made
needs to undertake adjustments in organizational structures of the public sector less
acute. A case in point is the large number of municipalities, at least until recently when
the number decreased due to more or less forced mergers first in 2017/2018, and then
in 2019. Many municipalities were small, often with less than 5.000 people.31 These
lowest-level political and administrative units may be small for several reasons, and
specifics of geography and topography are important among them. However, there
may also be political reasons, for instance linked to a lack of trust in agents from
the outside, which may characterize some small communities. In any event, small
municipalities receive transfers on an annual basis from other municipalities through
a state redistribution arrangement known as the income redistribution scheme, which
was made a bit less generous. There are economies of scale in many of the tasks that
local government performs, even though this point has its clear limits. Larger entities
are thus, on average, more economical than smaller ones, and consolidation should
lead to some savings. It is, however, easy to exaggerate the scale economies. Some
other values, e.g. active participation, can best be guarded with small units.
Suggestions of consolidation have been highly unpopular in the affected small
municipalities. In the recent reform, financial incentives played an important role,
both in terms of additional funds provided to new, merged units and reduced funding
for small units that were not willing to consider merging. Very few changes had been
implemented in the municipal structure since a large reform in the late 1960s. For
long, the most recent attempt to reduce the number of municipalities seemed unlikely
to achieve much, as it was met with intense opposition.
As hinted at above, there is reason to believe that easy access to funds may have
made it possible to postpone some important, politically uncomfortable, decisions.
One factor that has contributed to the reluctance to act is a 1/N effect with respect to
the costs of running small municipalities, with N representing the large number of
citizens. By contrast, the gross advantages created by operating small municipalities
has accrued to vocal and concentrated groups in each small municipality. This asym-
metry has been exploited politically to gather increased support for a structure with
on average small municipal units. Further, the municipalities are tied to identity.
With resource wealth there could be a general tendency towards leniency in public
finances, as decision-makers may experience funding as less scarce than in a hypo-
thetical situation without resource wealth. At one extreme, one could argue from this

31 There were 20 counties and 428 municipalities in 2017. As of January 2020, the number of
counties, or regions as they were now called, had through mergers been reduced to 11, and the
number of municipalities to 356—a 17 per cent reduction. The ambition of the government, however,
had been to reduce the number of municipalities to about 100—by 77 per cent.
248 7 A Sketch of an Evaluation

perspective that all windfall gain is bad, which is almost certainly wrong. Improved
financial resources can always be used for good purposes. Too easy access to funds,
to the extent that this is realistic, could still present a danger if the future standards
for using public funds could be lowered, which could lead to more negative side
effects from the use of public funds, in the limit resource squandering.
The potential problems in relation to the resource curse hypothesis is an addi-
tional uncomfortable thing we may get into the bargain when public funds are spent.
Although it is difficult to exactly identify the borderline between acceptable comfort
and easy access to funds that would spoil the citizens, Norwegian oil and gas income
has been so large compared to the economy that it would be surprising if it came
with none of the suggested negative side effects. However, one has been well aware
of this, and public policy seems to have worked to dampen these negative effects.
For most Norwegians, resource abundance has effects they have become used to,
even if they may not think of problems related to this. Perhaps the most pronounced
example is a high level of wages for most workers. Due to a compressed wage
structure, and till recently a strong currency in nominal terms, Norwegians have felt
wealthy when traveling abroad compared to peer groups in many other countries.
This effect has been stronger the lesser the education and skill level of a particular
individual. This may have bred different perceptions of other countries than one
could have experienced without the resource wealth. This situation probably cannot
be sustained over time. An associated needed ‘reality check’ might be an indication
of resource curse. A parallel in fiction may be found in the 1722 comedy Jeppe på
Bjerget by Ludvig Holberg, where the peasant Jeppe ended up, albeit once, in the
baron’s bed and is lead in a practical joke to believe that he is the baron. An interesting
question, if this description is fair, is whether it would cause much harm if someone
with skills and gifts that may have been quite ordinary felt superior for a while. At
least for a short while, the answer could remain ‘no’. A misperception caused by
a fixed-size windfall gain could, however, require normalization later. This could
imply some costs, at least in the form of uncomfortable adjustment.

7.2.4 A Brief Summary

If there is a natural resource curse in Norway, most possible associated excesses expe-
rienced by some other states, particularly developing countries, have been avoided.
This may have been due either to a more robust setting in Norway at the time of the
large resource discoveries, or to later policies aimed to address negative effects of the
resource abundance, or both. The argument presented here, is that both explanations
seem to have contributed to the relative success of Norway.
First, Norway was a stable democracy with strong institutions at the critical time
in the late 1960s. She was therefore less exposed to the curse than some other coun-
tries. It was early seen as important by state institutions and political parties that
all should take part in the oil wealth. The political culture, at the time marked by a
strong social democracy and economics profession, both professing frugality, made
7.2 Did Norway Escape the Resource Curse Altogether? 249

it possible to achieve political consensus on this goal. Special interests may still have
gotten something out of the Norwegian oil and gas sector, as elsewhere. However,
on balance, the pursued policies have served the interests of ordinary people well.
Second, the SWF, has played an important part in an overall policy framework that
has worked to counteract resource curse. The wealth has been invested abroad, which
has relieved the krone of appreciation pressures and Norwegian capital markets of
asset inflation. Further, large funds were put aside due to a design where all resource
income enters the SWF before some of it is used through the budget, subject to a
spending rule. Furthermore, one has invested in professional management, securing
high professional standards and high returns at the risk level one has accepted.
Political consensus has been important also in this respect.
As pointed out in the chapters above, the successful current use of a SWF, that
earns high returns inter alia due to its large size, depends on a sequence of serially
dependent steps. As in many games, to arrive at the ultimate successful step one
needs to manage all of the proceeding ones. There is a real possibility of failing at
every step, and thus only a moderate chance of succeeding throughout the sequence
of required steps. The odds of failure are particularly tall for countries with weak
institutions, where the interests of narrow groups may dominate over those of the
common man. In this sense Norway was fortunate to be endowed with institutions
from the start that made it possible to convert resource wealth into general welfare.

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Chapter 8
The Future of the GPF-G

If fiscal policy is constrained to allow only consumption of the estimated real returns
from the GPF-G, as in the current regulation for Norway, this SWF will last for the
long run. Nonetheless, even under this restrictive assumption of policy prudence,
the implications of the SWF for the average citizen-resident is set to decrease over
time. First, the resource income will decline in the future, as we have already seen
the first signs of when this is written. There will thus be less inflows to the Fund,
so that the take-out to finance the non-oil deficit will increasingly have to come
from the financial returns. Further, and more important, GDP will in all likelihood
continue to grow. If the average future growth rate becomes 2.0 per cent per annum—
a conservative estimate in view of the recent history—real GDP will double in about
35 years. An implication of this is that a SWF of about three times the size of GDP,
will decline in relative terms over that period to a more modest 1 1/2 times GDP.
With an average growth rate of 3.0 per cent per annum, GDP is set to double in
less than 23 years, with the same consequences in relation to the size of the Fund
relative to GDP.1 Since the population is also likely to increase, a decline in the size
of the fund per capita could drag these figures down some more, as regards value
for individuals.
In real life, such things tend to happen faster than thought experiments could
suggest, as the mechanisms that imply increased resource revenue consumption could
coincide with a decline in the value of the Fund for other or inter-linked reasons.
Two big negative shocks recently underscore this point; the Great Recession of 2008–
2009, and the Covid-19 crisis of 2020. As this is written in January 2021, a sizable
part of the GPF-G has been spent in response to the latter crisis. Some assets may need
to be sold, and revenues for the Fund could fall. Fortunately, the returns have been
particularly high since the sharp fall in value of the Fund in the spring of 2020. For

1 Atthe end of 2018, GDP for mainland Norway stood at 2.907 billion kroner. By comparison, the
Fund at that time stood at 8.256 billion kroner—representing about 2.8 times the value of GDP. At
yearend 2019, the value of the Fund had increased to well above 3 times a slightly larger GDP for
mainland Norway. If less than the real return is consumed recurrently, the size of the Fund relative
to GDP will decline by less.
© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 251
O. B. Røste, Norway’s Sovereign Wealth Fund, Natural Resource
Management and Policy 54, https://doi.org/10.1007/978-3-030-74107-5_8
252 8 The Future of the GPF-G

the crisis year 2020, there was a 10.9 per cent return. This became possible due to
rises in value of stocks, mainly U. S. technology stocks from April throughout the
year.
To assess the prospects for the future in some more detail, it could be useful to start
with the past. Norway was industrialized quite late and became an industrial country
in the main after year 1900. Growth was quite strong, however, in the second part of
the 1800s. At the end of World War II Norway benefited from the U. S.–sponsored
Marshall plan. In a global context, the country was well off just before 1970, when
the first major oil field, Ekofisk, was discovered. This means that home grown, robust
institutions attuned to democratic rule had developed. This holds true even if some
important political figures of the 1970s might not appear as very democratic judged by
today’s standards. One may also question the extent to which robust institutions were
established throughout Norway. In this author’s experience, particularly the Oslo-
based central government has secured growth-friendly institutional development. In
other parts of the country, modern, open-access type institutions in economic life
may be overshadowed by local peculiarities. Linked to this, and as actions on the
ground vary by district, even the institutional record may be weaker in the periphery.
In any event, a meaningful growth-oriented transformation was accomplished early
in the main by the central government.
A particularly important question is how the near future of the GPF-G will play
out. A successful development in demanding times, early on, is probably required
to maximize the chance of success at later stages. How significant the SWF will
be in terms of size, and how robust it will be to the new economic and political
developments, is difficult to assess. There are no known examples of stacked-away,
Western government-owned, financial wealth that has lasted for the long run to this
author’s knowledge. Democratic rule, to which there is no good alternative, could
make this exercise particularly demanding. It is easy in view of this to imagine
several types of events that may jeopardize the objective of saving and sharing the
wealth with future generations. Perhaps most trivially, a build-up of debts to fund
non-productive endeavors could erase or severely reduce the state’s net worth. An
increase in the net debt position would be economically equivalent to a decrease in
the net asset position. Numerous different events and developments could result in
needs for funds that could be used to justify deficit spending. Further, the priority to
save and protect investments could no doubt be changed by Parliament at any time,
with reference to other more pressing demands that might need to be met.
It is not too difficult to imagine circumstances under which a political majority
would prioritize to spend funds to better satisfy the needs of the electorate, rather
than those of future generations, who inter alia cannot vote in the elections to influ-
ence policy. Further, economic decline which appears to hit developed economies
at uneven intervals may lead to occasional hardship. At least in part, such situations
can be alleviated by drawing on the net financial worth of the state. In this context,
it is usually important to judge whether any large negative shocks are likely to be
permanent or transitory. This can usually not be known on impact. It is therefore
an inclination to try and alleviate not only transitory shocks that can be meaning-
fully evened out, but also shocks or disturbances that turn out to be long-lasting or
8 The Future of the GPF-G 253

permanent. In the latter case the negative impact of a shock remains, and hardship is
avoided for a limited time. It will then be of crucial importance for fiscal soundness
to switch to other activities sooner rather than later. The Covid-19 crisis may provide
a test of the ability to spend a limited amount within a limited time frame during a
long-lasting crisis. The jury is still out on that outcome.
Add to this the uncertainties embodied in economics and international relations
and, ultimately, geopolitics. Fixed assets in unsecure locations could in principle
be seized at gun point or by technically legal tools by some. Depending on the
specific conditions in each instance, guarantees to the contrary could be less than
perfectly credible, e.g. because it could become increasingly in the interest of local
elites to seize some assets. In view of this, even sovereign owners should act with
care. Sovereign ownership may, however, be more robust than private ownership
in such circumstances, due to intricacies and risk, and probably linked to this also
discomfort, involved in the challenging of states.
Assets may be seized also when it is not expected. Owners must therefore be
prepared for that outcome. The seizure of assets presents a higher risk in a world of
conflict. This possibility can be interpreted as an embedded, probabilistic tax that
can strike in part or fully with respect to some of one’s holdings and drive down
returns. Even if one should invest only in tranquil environments, the situation might
change after an investment has been made. Further, and more trivially, it is possible
that some agents may envy a small far-away state it’s wealth. A small, far-away
state may possess small to medium capabilities, and have few remedies to resort to
protect, in particularly physically, investments abroad. This suggests that it could
be wise to adopt a conservative approach with respect to non-economic risk for
this type of investor. This broad type of investment risk is more difficult to analyze
meaningfully than financial risk, and typically less properly analyzed by investment
management organizations. These organizations are typically experts at mainly the
financial aspects of risk, cf . the discussion above, particularly in Sect. 6.1. Limits to
the stretching or mending of investment mandates in recent years aimed at increasing
expected returns by increasing risk could probably be appropriate.
However, there appears to be few absolutes in investment management, and it is
possible for reasonable people to disagree on the extent to which one could benefit
from stretching mandates to achieve incremental return gains. An intermediate posi-
tion on this issue could outperform strategies of minimum risk. More aggressive
moves, however, could both increase risks and add to the complexity of management.
In view of the above arguments, one social mechanism might apply to a sovereign
investor that smaller investors may not need to consider2 : To the extent that riches are

2 An example may be the confiscation of 10 per cent of all bank account balances in excess of
100.000 euro in Cyprus in 2013 on the occasion of the administered closing of Cyprus’ second
largest bank, Laiki bank—see, e g., the news article by H. Dixon in The New York Times 24 March
2013, available at nytimes.com, accessed 26 September 2020. This ‘haircut’ was unprecedented and
unexpected, despite a funding gap estimated by some at a good e5 ½ billion and some confiscation
fear. The large deposits were often owned by non-EU foreigners, in particular Russian firms and
individuals. Similarly, the regional government of British Columbia (B.C.) in Canada proposed a
15 per cent transfer tax for real estate purchases by foreigners in the fall of 2016. This tax, also
254 8 The Future of the GPF-G

‘flashed’, either due to news of particularly high returns or perceptions of a high net
worth and deep pockets, social mechanisms may be triggered that can lead to lower
returns. This could perhaps also apply to SWFs of small countries, who could depend
on good relations with important other actors, for instance the governments of larger
countries. In particular, governments of large countries may have more remedies to
rely on in that context.
The typical situation in international cooperation is one of many good ideas,
combined with limited available funding. When several options are available it could
be considered fair that the bill for an undertaking of common interest is footed by any
actors perceived to have deep pockets. However, if claims were to become judged as
too steep, one could in addition to saying no terminate the respective project.
An alternative norm could be one that required the consumers of various goods
and services to settle their debts instantly. In the context of SWFs, including the
GPF-G, there could be a risk of spreading expectations of credit and/or generous
behavior to other domains, in which there might not be such expectations. It would
be important to avoid expectations that one specific party could pay by default if
others did not.
Despite the above-mentioned challenges, one may assume that the SWF is fit to
survive for the foreseeable future. It is of course also possible that the management
of the Fund can create its own serious hazards. That is, negative surprises could come
from within. A case in point seems to be the tendency to stretch one’s risk tolerance
in a low-interest-rate environment. There is thus an important feed-back-loop from
the ability and willingness to continue investing for the long run. Scandals, in terms
of ‘disastrous’ events that lead to very low or negative, returns, could create pressures
for a shortening of the investment horizon. This seems to be a stylized pattern of the
investment management business. On the other hand, the willingness to assume high
risks for those who can afford to invest seems to pick up in particular after crises. This
could explain some of the increased risk tolerance that followed the financial crisis
of 2008–2009. In view of the immense economic hit from the Covid-19 virus crisis,
interest rates could stay low for a long time.3 Yield pick-up by investor’s creative
adaption is therefore likely to remain fashionable. Unemployment has increased and
fiscal rescue programs are frequent in the developed economies. Inflation and higher
interest rates may still appear remote.
The low interest rates at low to moderate risks, and therefore also low real return
expectations, signal weak economic fundamentals and an uncertain investment envi-
ronment. This creates problems for investors. One example has been public sector
pensions in New York City. The NY Times reported on 26 July 2016 that the U. S.

referred to as a ‘speculation tax’, aimed at “pushing speculators out of the housing market, and to
help turn vacant and underutilized properties into homes for people who live and work in B. C.”
Source: bdo.co, the site of BDO Canada, accessed 15 April 2020. The new tax proposal led to an
unexpected situation where foreign investors and Canadians of other provinces could experience
less protection of their property rights in B. C. than this region’s residents.
3 Spokesmen for The Federal Reserve signaled linked to their 16 September 2020 Federal Open

Market Committee meeting that interest rates would remain low for about 3 more years through
2023. This was confirmed in a policy statement 17 December 2020.
8 The Future of the GPF-G 255

government would no longer guarantee the payment of public sector pensions in New
York, and that the situation would have been different under higher expected returns.
Skepticism could be warranted in relation to at least the timing when arguments for
increased risks in financial management surface at a time where they seem needed
to avoid spending cuts. If this was optimal purely on risk-return basis, there should
not be any strong correlation with bad times for yield-enhancing strategies. It may
have been too easy for players who wish to maintain spending patterns that no longer
seem sustainable to produce stories of how it might make sense to assume more risk.
This could, as by a surprise, potentially render the former unsustainable spending
sustainable under a new set of assumptions. This behavior could indeed resemble
that of picking up nicles and dimes front of a steamroller.
It should be expected that some parties would try to ‘save’ earlier permitted plans
and avoid spending cuts. This could be done in particular by absorbing more risk,
thereby raising the expected returns. However, one would then move forward with
increased risks, that could lead to larger problems ahead and even to jeopardize a
mechanism like a pension fund or a SWF. We are likely to see more such problems
to the extent that income shortfalls are remedied with increased risk.
Appendix 1
Cash Flow into the GPF-G, 2000–2020

Year Oil and gas income (1) Interest and dividends Inflow (1) + (2) Exchange rate (kroner
(2) per U. S. dollar)
2000 18.329 1.238 19.567 8.8058
2001 26.947 1.914 28.861 8.9879
2002 21.229 2.836 24.065 7.9702
2003 24.526 3.643 28.168 7.0824
2004 30.191 4.943 35.133 6.7372
2005 42.746 5.725 48.472 6.4450
2006 55.376 8.679 64.054 6.4180
2007 53.993 12.679 66.672 5.8600
2008 73.792 17.352 91.145 5.6361
2009 44.542 13.770 58.312 6.2817
2010 45.655 14.242 59.898 6.0453
2011 62.560 17.299 79.859 5.6074
2012 67.944 18.846 86.789 5.8210
2013 58.739 21.321 80.061 5.8768
2014 49.461 24.215 73.676 6.3019
2015 27.038 22.913 49.951 8.0739
2016 14.859 22.503 37.363 8.3987
2017 20.307 23.769 44.076 8.2630
2018 30.859 26.703 57.562 8.1338
2019 29.181 27.136 56.317 8.8037
2020 9.084 22.895 31.979 9.4781
Sum 807.359 314.621 1211.980 –

© The Editor(s) (if applicable) and The Author(s), under exclusive license 257
to Springer Nature Switzerland AG 2021
O. B. Røste, Norway’s Sovereign Wealth Fund, Natural Resource
Management and Policy 54, https://doi.org/10.1007/978-3-030-74107-5
258 Appendix 1: Cash Flow into the GPF-G, 2000–2020

The appendix exhibits income of the GPF-G from oil and gas, as well as from
interest and dividends, in billions of U. S. dollars. Sources: Norwegian Ministry of
Finance (2020), National Budget for 2021 and Norges Bank. The published figures
in the budget are in kroner. The U. S. dollar figures here are approximations based
on average annual krone-dollar exchange rates.
Appendix 2
Covariation of Asset Class Returns

Ranking asset classes by historical returns, 1986–2020 (monthly data reqularlly)

Ticker VFIAX VSMAX VTMGX VEMAX VBTLX VWEAX VTABX VGSLX VUSXX IAU
U.S. LC U.S. SC Intl. Dev. E. Mkt. U.S. U.S. HY Intl. REITs Cash (T Gold
Stocks Stocks Stocks Stocks Bonds Bonds Bonds bills)
2020 16.8 18.3 4.2 8.8 7.6 4.9 4.2 −7.2 0.5 23.9
2019 28.5 24.5 19.3 17.6 6.3 13.3 5.5 26.1 −0.1 15.9
2018 −6.2 −11.0 −16.1 −16.2 −1.9 −4.7 1.0 −7.7 −0.1 −3.2
2017 19.3 13.8 23.8 28.7 1.4 4.9 0.3 2.8 −1.3 9.3
2016 9.7 15.9 0.4 9.5 0.5 9.0 2.5 6.3 −1.8 6.6
2015 0.6 −4.3 −0.9 −16.0 −0.3 −2.0 0.3 1.6 −0.7 −12.3
2014 12.8 6.7 −6.4 −0.2 5.1 3.9 8.0 29.3 −0.7 −1.2
2013 30.4 35.8 20.3 −6.4 −3.6 3.1 −0.4 0.9 −1.5 −29.0
2012 14.0 16.2 16.5 16.8 2.4 12.5 4.5 15.7 −1.7 6.5
2011 −0.9 −5.5 −15.0 −21.0 4.6 4.2 0.8 5.5 −2.9 5.5
2010 13.4 26.0 6.8 17.2 5.0 10.9 1.7 26.6 −1.5 26.0
2009 23.3 32.7 24.9 71.5 3.2 35.6 1.6 26.3 −2.4 20.2
2008 −37.0 −36.1 −41.3 −52.8 5.1 −21.3 5.5 −37.0 2.0 5.4
2007 1.3 −2.7 6.8 33.6 2.8 −1.8 0.1 −19.7 0.7 25.8
2006 12.9 12.9 23.1 26.3 1.8 5.7 0.5 31.8 2.1 19.3
2005 1.4 3.9 9.8 27.7 −0.9 −0.5 1.8 8.3 0.5 13.0
2004 7.3 16.2 16.5 22.1 1.0 5.2 1.8 26.7 −2.0 1.4
2003 26.2 43.1 36.1 54.7 2.1 15.1 0.4 33.3 −0.9 19.2
2002 −23.9 −21.8 −17.6 −9.6 5.8 −0.6 4.2 1.3 −0.7 20.8
2001 −13.3 1.6 −23.1 −4.4 6.8 1.3 4.6 10.7 2.6 −0.4
2000 −12.0 −5.8 −17.1 −29.9 7.7 −4.1 5.4 22.2 2.5 −9.6
1999 17.9 19.9 23.6 57.3 −3.4 −0.2 −0.6 −6.5 2.0 −1.7
1998 26.6 −4.2 18.0 −19.4 6.9 3.9 10.2 −17.7 3.5 −2.4
1997 31.0 22.5 0.0 −18.2 7.6 10.0 8.9 16.8 3.5 −23.2
1996 18.9 14.3 2.6 12.1 0.3 6.0 8.3 31.4 1.9 −7.7
(continued)

© The Editor(s) (if applicable) and The Author(s), under exclusive license 259
to Springer Nature Switzerland AG 2021
O. B. Røste, Norway’s Sovereign Wealth Fund, Natural Resource
Management and Policy 54, https://doi.org/10.1007/978-3-030-74107-5
260 Appendix 2: Covariation of Asset Class Returns

(continued)
Ticker VFIAX VSMAX VTMGX VEMAX VBTLX VWEAX VTABX VGSLX VUSXX IAU
U.S. LC U.S. SC Intl. Dev. E. Mkt. U.S. U.S. HY Intl. REITs Cash (T Gold
Stocks Stocks Stocks Stocks Bonds Bonds Bonds bills)
1995 34.0 25.6 8.4 −1.9 15.3 16.2 14.3 10.0 3.1 −1.7
1994 −1.5 −3.1 4.9 −10.1 −5.2 −4.3 −7.3 0.4 1.3 −4.9
1993 7.0 15.5 28.9 69.4 6.7 15.1 10.7 16.3 0.2 13.9
1992 4.4 14.9 −14.7 7.8 4.1 11.0 3.3 11.2 0.6 −8.7
1991 26.3 40.9 8.7 54.5 11.8 25.2 7.5 31.5 2.5 −12.5
1990 −8.9 −22.8 −27.9 −16.1 2.4 −11.3 −2.7 −20.3 1.6 −8.3
1989 25.5 11.0 5.6 56.9 8.6 −2.6 −0.6 3.9 3.7 −6.8
1988 11.3 19.7 22.8 33.9 2.8 8.8 4.4 8.6 2.1 −19.6
1987 0.3 −12.7 19.3 9.3 −2.8 −1.7 4.5 −7.8 1.3 19.0
1986 16.8 4.5 67.5 10.4 13.9 15.6 10.1 17.7 5.0 17.9

Descriptive statistics of annual returns by asset class

Ticker VFIAX VSMAX VTMGX VEMAX VBTLX VWEAX VTABX VGSLX VUSXX IAU
U.S. LC U.S. SC Intl. Dev. E. Mkt. U.S. U.S. HY Intl. REITs Cash (T Gold
Stocks Stocks Stocks Stocks Bonds Bonds Bonds bills)
AVE 9.5 9.3 6.8 12.1 3.8 5.3 3.6 8.6 0.7 3.3
MED 11.3 12.9 6.8 9.5 2.8 4.2 2.5 8.6 0.7 −0.4
MAX 34.0 43.1 67.5 71.5 15.3 35.6 14.3 33.3 5.0 26.0
MIN −37.0 −36.1 −41.3 −52.8 −5.2 −21.3 −7.3 −37.0 −2.9 −29.0
SDEV 16.2 18.5 22.7 30.7 5.0 11.2 4.6 17.0 2.1 14.2

Correlations of annual returns (Pearson’s r)

VFIAX VSMAX VTMGX VEMAX VBTLX VWEAX VTABX VGSLX VUSXX IAU
U.S. LC U.S. SC Intl. E. Mkt. U.S. U.S. HY Intl. REITs Cash (T Gold
Stocks Stocks Dev. Stocks Bonds Bonds Bonds bills)
Stocks
VFIAX
U.S. LC x 0.84 0.67 0.50 0.25 0.69 0.25 0.48 0.11 −0.15
Stocks
VSMAX
U.S. SC 0.84 x 0.59 0.65 0.18 0.80 0.14 0.68 −0.10 −0.09
Stocks
VTMGX
Intl. 0.67 0.59 x 0.61 0.19 0.61 0.17 0.39 0.15 0.25
Dev.
Stocks
VEMAX
E. Mkt. 0.50 0.65 0.61 x 0.03 0.61 −0.07 0.43 −0.09 0.30
Stocks
(continued)
Appendix 2: Covariation of Asset Class Returns 261

(continued)
VFIAX VSMAX VTMGX VEMAX VBTLX VWEAX VTABX VGSLX VUSXX IAU
U.S. LC U.S. SC Intl. E. Mkt. U.S. U.S. HY Intl. REITs Cash (T Gold
Stocks Stocks Dev. Stocks Bonds Bonds Bonds bills)
Stocks
VBTLX
U.S. 0.25 0.18 0.19 0.03 x 0.40 0.68 0.22 0.51 0.05
Bonds
VWEAX
U.S. HY 0.69 0.80 0.61 0.61 0.40 x 0.37 0.69 −0.09 0.16
Bonds
VTABX
Intl. 0.25 0.14 0.17 −0.07 0.68 0.37 x 0.24 0.41 −0.03
Bonds
VGSLX
REITs 0.48 0.68 0.39 0.43 0.22 0.69 0.24 x 0.42 0.06
VUSXX
Cash (T 0.11 −0.10 0.15 −0.09 0.51 −0.09 0.41 0.11 x −0.29
bills)
IAU
Gold −0.15 −0.09 0.25 0.30 0.05 0.16 −0.03 0.06 −0.29 x

Source: Themeasureofaplan.com (blogpost), retrieved 15 March 2021.

Note: The calculations are probably accurate and calculated correctly, and have not been controlled by this author.
For our purpose here it matters little what he exact hisrtoric correlation were, as we use this to toughly indicate
expectations.
For the purpose at hand, it is sufficient to look at he first decimal of the historical asset class return correlations.