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November 18, 2007
David Warsh, Proprietor


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Strong Medicine

With the price of oil flirting with $100 a barrel, there’s been a good deal of excitement recently about “sovereign wealth funds.” These government-controlled trust funds, billed as savings for the day the oil runs out, aren’t exactly new — they first gained recognition in the 1970s, when Kuwait and Abu Dhabi began investing some of their oil surplus in financial markets.  Nor is petroleum the only possible source of revenues; Singapore and China have accumulated substantial reserves through currency machinations: in effect, forced savings derived from their booming export trade. There is no US counterpart. George Bush’s proposal of a few years ago to invest part of the fleeting Social Security surplus in the stock market was dead on arrival.

Yet today’s sovereign funds are becoming fairly big players in financial markets — an aggregate 1.3 percent of global financial assets today, according to a recent report. They could grow to as much as 5 percent in a decade. (In contrast, all nations’ foreign currency reserves today are estimated to be about 2.5 percent, or $5.6 trillion) For a country like oil-rich Norway, the sums invested by money managers in world financial markets are huge — perhaps as much in the future as three or four times GDP. The joke in Oslo is about dealing with the swarms of new immigrants — Swedes.

The joke is funny only insofar as the Swedish economy traditionally has been a magnet to Norwegian labor. Nor has the situation changed much in any material respect, except for oil and finance. Real GDP per capita in Norway was $53,400 in 2006, as opposed to $33,900 in Sweden, thanks to oil. But the Norwegians have not become rich in manufacturing, and the Swedes have not become poor.

The Swedes do have a problem, however — to retain their traditional edge in emergent industries. The Finns and, for that matter, the Estonians, have stolen a march on them with respect to certain industries based on mastery of the Internet — the Finns, most visibly, with Nokia and the Linux operating system; the Estonians with Skype.

With that in mind, the Swedish Centre for Business and Policy Studies (SNS), a Brookings Institution-like think-tank sponsored by Swedish corporations and foundations, commissioned a four-person study of biomedical innovation, led by Hans Bergström and Håkan Gergils, that was published earlier this month as Medicin för Sverige! Ny lin i en framtidsbransch in Sweden (Medicine for Sweden! — Infuse New Life Into a Vital Industry) and translated into English as Titans and Tigers: Biomedicine and Innovation Systems in China, India, USA, Ireland, Denmark and Finland.

The authors say they hope the study will serve as a “rap on the knuckles” for Swedish policy makers who are often ignorant of what is happening even in neighboring countries, much less around the world. It makes for interesting reading for anyone interested in industrial policy. (A disclaimer is necessary here. SNS is my Swedish publisher, too, and I was in Stockholm earlier this month for the rollout of a translation of Knowledge and the Wealth of Nations: A Story of Economic Discovery.)

Gergils is a well-known manager and business consultant, a Swedish counterpart to Michael Porter; Bergström is a former editor-in-chief of Dagens Nyheter, the national daily newspaper. Their study is couched in terms of comparing the performance of various national innovation systems. Far too little has been said about this empirical effort to identify the sources of innovation and the mechanisms to which they could be turned to commercial advantage, which was developed by Richard Nelson, Nathan Rosenberg, Christopher Freeman, Giovanni Dosi, Luc Soete and other scholars in the 1970s and 1980s, and adopted in the 1990s by the Organization for Economic Cooperation and Development as a framework for policy analysis. 

The current study of biomedicine is built on an earlier survey by Gergils, Dynamic Innovation Systems in the Nordic Countries, in which he found that only the Finns had put the new idea into practice to any significant extent. Iceland, meanwhile, had adopted the Finnish model. Norway had been talking for thirty years about bringing its R&D spending up to the OECD target for 2010 of around 3 percent of GDP, but hasn’t hit it yet; Denmark might reach 1 percent by then, but only if it doubled current spending levels.

At 4 percent, Sweden was tops in the OECD, nearly double the present average, but realized far less than a satisfactory return on that investment.  According to one index developed by a high-level European Union study group, the productivity of US R&D spending in terms of commercial applications was more than three times that of the European average. Sweden did better than that in turning new ideas into new markets, but not much.

By zeroing in on biomedicine — pharmaceuticals, biotechnology and medical devices — Bergström and Gergils tipped what they think are the likeliest winners in Sweden’s high-tech portfolio and, not incidentally, the weakest suit in Finland’s hand.  (They might have added the somewhat related field of life cycle investings, meaning insurance and private money management, a business in which the Swedes, like the Dutch, excel.) The advantages in health care of China, India and the United States, are very great: broad markets and strong institutions, especially in the US — everything from long-range research funding by the National Institutes of Health to a highly competitive venture capital industry.

But secrets have become harder to keep in the global economy; advantage accrues to nations able to act quickly to make rapid and “sensible” changes in response to new knowledge developed at home and abroad. Nimble industrial policy requires more than wise and alert planning, the authors observe. It is not enough to say that research should be adequately financed; that schools should maintain high standards; that macroeconomic policies should be well-aligned. Strong political leadership by the prime minister is required as well.

The sky is definitely not falling on Sweden. Indeed, it has handled very well the transition from the complacent days of the 1970s, when it held itself out as “the Middle Way.” The old caricature is now wildly out of date:  taxes have been slashed, services privatized, financial markets deregulated, assets securitized, entitlements streamlined (but not abandoned), private accounts added to long-established government pensions to shift retirement decisions. Like Britain and Denmark, Sweden declined to join the European Monetary Union; most years since 1999 central bank flexibility has enabled it to grow faster and more than the EU. But the fact is that the country neglected its industrial policy during the decade that Göran Persson led the Social Democratic government as prime minister.  Job growth slowed and youth and immigrant unemployment rose as a result.  Persson was resoundingly defeated in 2006.

Sovereign wealth funds are in the news these days mainly because of the possibilities of strategic behavior that they offer their owners. As long as these vast sums of money are managed professionally and transparently, they will be no different from any other large pool of wealth — pension funds, insurance portfolios, mutual funds. They may, of course, be used for strategic purposes instead:  to buy controlling interests in companies that may be deemed inappropriate for one reason or another. China buying IBM’s laptop business is one thing; but what if China sought to buy Microsoft? Or Boeing? What happens when state-dominated enterprises like Russia’s natural gas giant, Gazprom, seek to enter new markets?  The possibilities for mischief here, not to mention losses, are very real.

The flip-side is the risk that these trust funds pose to countries like Norway or Kuwait is their potential to defer indefinitely productive new sorties into the international division of labor. After all, even an enormous fortune, such as Norway’s fund is projected to be, is no more than a cushion. So the entire country could afford to take a three year vacation.What would it find when it came back?  The rest of the world would have gotten three years ahead. This is Sweden’s blessing, of knowing that it must work for its living. Sovereign wealth may be a complement, a lagniappe, but it is no substitute for a thriving economy.

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