Forget Fiscal Discipline, Sovereign Wealth Funds Are The New Hot Thing That Every Country Needs

An Evaluation of Shane Parrish's Canadian Sovereign Wealth Fund Proposal

Preface

I acknowledge that the title of this article gives away my main conclusion. So let me at least state it upfront and then leave the rest of the article to be as objective as possible.

My conclusion is that a Canadian Sovereign Wealth Fund (SWF) doesn’t make sense and Canada would be better off implementing fiscal discipline.

Overall, I do like these types of proposals, even when I disagree with the conclusions or if I think it’s a bad idea. These types of proposals give us something to think about and ask “is the current way of doing things really the best it can be?” Ultimately, I believe in an idea meritocracy — the UFC of ideas, where we put ideas into the ring and let the best one survive or evolve into a practical, beneficial solution. The world is changing rapidly and the internet facilitates many more viewpoints to the discussion. This would normally have happened behind closed doors and among political and commercial elites, which the average citizen doesn’t get visibility into.

Before reading my evaluation, please go over to Shane’s article, podcast, and X feed to familiarize yourself with the contents of the discussion. Shane is a beacon of critical thinking, insight, and wisdom and I genuinely enjoy his content. Thanks Shane!

Proposal at a glance

Shane’s article proposes a SWF that is financed across provinces with a federal matching program. The program would be opt-in and allow provinces to get a pro-rata share of the contributions and corresponding federal matches. The proposal mentions several potential funding sources, such as government surpluses, taxes, levies, etc, which are commonly used “best practices” across successful SWF’s like Norway, Alaska, Singapore, and some of the gulf countries.

Potential benefits

Increase financial benefit per Canadian citizen

If the money is invested wisely, presumably in a diversified basket of assets to the idiosyncratic resource risk, then Canadians would benefit from those investment returns. Eventually, the fund would reach a large size and generate significant returns. In Shane’s estimation it could be around $150 per citizen annually by 2050. My calculations are a bit more generous, I got to around $250 per citizen by 2050. From here, the benefits would continue to accrue to citizens as the fund would be established as a permanent entity. Of course, it would not grow forever but it will have reached a critical mass in a few years that would ensure it’s long-term survival. Unlike a pension fund which has obligations, the fund would be evergreen (meaning it can live on in perpetuity, unless of course we get hit with an asteroid). There is risk that the fund winds down over time as provinces voluntarily contribute less into it and as the investment returns are paid out to citizens, but that’s not a huge problem either.

Increase investment into resource sector

Having the SWF could be a great way to invest into the natural resource sector and create jobs. The fund could allocate a percentage of it’s assets to infrastructure or actual resource development companies to generate more jobs and investment returns to the fund holders. This could be a powerful flywheel, since the resource sector is very capital intensive and has high returns on capital. It is not without risk, but if managed properly it could unlock a multi-generational commodities and boom and provide good investment returns to fund holders.

This would also attract more global investment into the Canadian resource sector, as investors would want to participate in deals with the SWF is a lead or backstop/guarantor.

If we were to create a SWF, we’d have a diversified base of resources to monetize

Canada is extremely rich in a broad range of natural resources. One common issue with SWF’s in general is that they rely entirely on one source of fund, most often it’s oil and gas. This can make managing the fund harder if oil prices are low and affect the dividends to citizens.

Since Canada has a broad range of oil, gas, mineral, and hydroelectric power resources, it can have a well-diversified source of income to fund the SWF. This gives the fund stability in it’s funding source and the ability to make long-term recurring investments into infrastructure projects.

Canada could dominate given it’s existing capital markets expertise

Canada already has well-established capital markets and fund management infrastructure. Unlike many of the other countries, we would not need to import global finance talent to manage the fund — we can source and hire all within Canada and do an excellent job at that. Some of the best minds in finance are in Canada.

Potential downsides

Doesn’t the market already do this?

One obvious critique is: why would we need to do this, doesn’t the market already allocate capital efficiently? Why wouldn’t I just invest accordingly?

There’s a few things to clear up here.

There are many ways to fund SWFs but they all in some way involve taxes. Normally, government surpluses are the main source of funds, which are essentially tax receipts related to this resource (from corporate taxes and land royalties). In Shane’s proposal, there is a wider range of taxes on the table. So it’s not quite the same thing to say “can’t I just invest it myself?”, since it’s paid from corporate taxes. The right way to think of it is: if the surplus from resource wealth translated to an individual tax payers lower tax rate, then where would they invest the savings and would they be better off?”

Now that we have that out of the way, let’s dig in.

At it’s core, SWF are an investment scheme where the government centralizes the fund management and creates incentives. This is an intervention and it has positives and negatives. Typically the positives are that surpluses are better invested into other non-correlated assets from the one you’re monetizing. In Norway’s case, they are being opportunistic and saying “let’s save some of the oil money and put it in tech stocks so that when the oil runs out, we still got the bag”. The negatives in this case are that we’re creating an economic scheme to generate investment returns. If we gave the same money back to Canadians in the form of lower taxes, how would they spend it? Or would it be best spend just paying down debt today? In my opinion, I am always for letting people decide what to do with their money. If they want to have dividends, they can invest it themselves and get the same returns the SWF would. It would only be worth it if the SWF has some strategic value unlock and was able to generate superior returns that would otherwise not be possible if the fund didn’t exist in the first place.

Crowding out of other economic sectors

Since the SWF would be financed by taxes in some way, it would be taking money out of the economy and into investments aren’t available to Canadians. This “crowds out” other investment in the economy and spending. To put it in simple terms, there (generally) a fixed amount of money in the economy and all businesses and people are competing for it. If the fund creates a vacuum and sucks up funds for investments abroad, then there’s less capital in the economy for Canadian businesses. This means lower wages for employees, higher interest rates for individual and business borrowers, and less capital investment to create new jobs.

Indirect taxation can actually hurt the resource sector

Whether we are considering provincial surpluses (from corporate taxes and royalties), levies, or taxes, we are increasing the tax burden on the economy. In the case where resource companies pay the tax to fund the SWF, this can actually hurt the competitiveness of these projects and stifle economic activity. This is not really an issue if the resource company’s cost of production is so low that it’s globally competitive even after the tax. Given how competitive the resource industry is, I don’t think this is a viable option. In the case where we make the tax small, then not enough money is being contributed and the fund never reaches critical mass, so why bother?

There’s also the question of where does the money come from? Since Canada has been running a budget deficit, we do not have “excess funds” to invest, unless we all want to pay more taxes to put the money in or borrow more money… In the case where we borrow the money, we should be asking 1) can we invest at a higher rate than we pay in borrowing costs, 2) does borrowing this money have any crowding out effect in the economy, and 3) is it really the government’s job to borrow money and invest it in this way? In the case where we pay for it with higher taxes, we should ask 1) does this crowd out spending or investment elsewhere, and 2) would we be better off just paying down debt?

A pathway to “financialized dutch disease”

Assuming everyone “bought in” and things were going well, then what would be the long-term impact on how the economy would reshape? I see this creating a large large voter block of financiers in Southern Ontario that just wants to grow AUM at the expense of taxpayers (because that’s what pays their bonuses) vs. resource companies that just want to export their products (hire people, etc). This could create a two-tiered economic society where the southern elites “extract” wealth from the northern resource companies. The net result would be a large wealth transfer from north/rural to south/urban.

Is it worth it?

By my calculations, we’d only get:

• $350 per citizen by 2055 (30 years from now)

• pay 12% of the current federal debt (holding 2024 levels constant)

My assumptions:

1. 9% return on investment

2. 30 year time horizon

3. Starting AUM of C$1Bn

4. AUM grows 50% per year up to a cap of C$20Bn annually

5. 20% of investment return paid as dividends to all Canadian citizen and

6. 20% of investment return paid as debt repayment on federal debt

This does not factor in inflation. If we assume 2.4% inflation per year, we’d only get around $175 per year in today’s dollars.

I’ve also assumed the debt to be constant at 2024’s levels, which seems very unlikely.

I don’t see this being worth it. $350 in 30 years seems like a lousy benefit. Canadians would also have a significant amount of money tied up into this fund that they can’t access for things they need like starting businesses, buying a home, or paying for their child’s education. By my calculations, the amount “tied up” in the fund would be around $21,058 per citizen in 2055 (30 years from now) or around $10,529 in today’s dollars.

Overriding provincial authority

There is also the issue of increasing inter-provincial and federal disputes. By creating the SWF, we inherently create a supra-provincial entity to manage the investments. Technically it is opt-in, but what happens when the provinces want to get out or want their money back? Do the other provinces suffer? I could see this adding rather than unifying provinces for the simple reason that natural resources are currently managed at the provincial level. It would also create a ton of extra rules and complexity that quite frankly we can do without.

Perspectives

My own bias

I want to lay out my own perspective and bias in writing this article so you can know where I’m coming from. I tend to agree with smaller government and Milton Friedman: no one knows how to better spend your money than yourself. I also come at this from a decentralization perspective: centralization erodes personal liberties and can more easily be compromised. The more we unlock personal economic freedoms the more the economy performs.

Seems Keynesian…

The article seems to window dress more government intervention (keysianism) as a solution to Canada’s problems. I think the problem is not that we aren’t investing enough or correctly, I think the problem is that there’s too much intervention. I think less taxes for resource companies and tax incentives for investors achieves the same thing and keeps the government out of having to “direct” things — it can simply write the rules of the game and let the players play.

Seems Finance-y…

Respectfully, I think Shane comes from an investment background and gets excited by the prospect of investment-related proposals. This might be a personal critique, but I do see this resonating with the investment crowd rather than the average canuck that doesn’t wear a suit to work.

Conclusion

Given that Canada already has a government deficit, then the SWF proposal is not a good idea because we would need to borrow the money or increase taxes to finance it. This has several drawbacks which I believe far outnumber the benefits. In my opinion, the better path forward is to get our fiscal house in order before considering this proposal. This would likely improve business and economic conditions enough that it no longer makes sense to have a SWF. So in that sense, we would be able to afford it but the juice is just not worth the squeeze.