CHAPTER 6 The Economics of Sovereign Wealth Funds: Lessons from Norway

Amadou Sy, Rabah Arezki, and Thorvaldur Gylfason
Published Date:
January 2012
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Thomas Ekeli and Amadou N.R. Sy 


While most studies of sovereign wealth funds (SWFs) focus on their wealth management functions, particularly their investment strategies, it is essential to start with the basics. After all, an SWF is a tool that must support the development goals a country has set for itself.

Norway has one of the largest SWFs in the world, with total assets reaching approximately US$0.5 trillion. The Norwegian SWF is a petroleum fund, financed by the state’s share of oil and gas revenues—officially coined the Government Pension Fund Global—and it has one of the most sophisticated investment strategies and most transparent institutional set-ups among its peers.

Not surprisingly, most studies of sovereign wealth management discuss the Norwegian experience in harnessing volatile oil revenues to safeguard wealth for future generations. However, an important issue often overlooked by the burgeoning literature on SWFs is that the Norwegian oil fund and its accompanying institutional and fiscal frameworks resulted from a long process, one that started by asking the right economic questions. Perhaps the key lesson from Norway’s experience is that policymakers in natural-resource-rich countries need to start the process of setting up an SWF (or deciding not to) by going back to the key question: how to achieve sustainable growth.

Other chapters in this book study these economics principles in more detail, but Norway’s experience offers important and practical policy examples relevant to natural-resource-rich countries. First, implementing the Hartwick rule is one way to achieve sustainable growth and development, but it requires sound fiscal policy and public investment management.1 As stressed by Hamilton and Ley’s chapter in this volume, building wealth through fiscal policy involves (i) effective revenue instruments, (ii) fiscal rules to limit discretion, (iii) the operation of natural resource funds, and (iv) effective public investment management. As a result, the decision to set up (or not) an SWF, although an important one, is only one part of the much broader growth equation.


To borrow from the title of an influential World Bank volume, we start by asking, “Where is the Wealth of Norway?” Norway’s GDP per capita is the second highest among OECD countries, and it is tempting to seek a causal link between its oil wealth and its economic wealth.

Norway offers a useful benchmark for sub-Saharan Africa’s natural-resource- rich countries. Whereas in Norway oil wealth (discounted petroleum wealth and financial assets) accounts for 9 percent of wealth per capita, in sub-Saharan Africa natural wealth dominates at a whopping 50 percent of total wealth. And while the discounted value of labor accounts for 82 percent of Norwegian wealth, intangible wealth (both human and social capital) is small in sub-Saharan Africa, making up just 35 percent of total wealth. That is much lower than the 60 to 70 percent in a typical developing country (see Hamilton, 2010) and is indicative of a low return on total assets.

Norway’s management of its oil revenues has been successful in many respects, but it is clear from the evidence above that Norway’s affluence is due to many factors other than petroleum. The Norwegian experience highlights the importance of factors other than a sound management of natural resources revenues in establishing sustainable growth. Unlike the case in most developing countries rich in natural resources, productivity has been the key to welfare in Norway, not oil. It is also clear that the sources of growth in Norway and other OECD countries involve a number of policies, including stability-oriented macroeconomic policies, flexible and competitive product markets, a high degree of exposure to foreign trade, flexible labor markets, adequate education and training, a low level of taxation, and significant public spending on research and development.

It is therefore useful, especially for policymakers in countries where new discoveries of natural resources have been made recently, to take a step back and look at the bigger question, that is, the process that may lead to sustainable growth and which may or may not involve the establishment of an SWF. The first step is to ask how to achieve sustainable growth and development in resource-dependent economies.

One answer is the Hartwick rule, which depends on (i) effective revenue instruments, (ii) fiscal rules to limit discretion, and (iii) effective public investment management (see Hamilton and Ley’s chapter). Hamilton (2010) shows that had sub-Saharan African countries followed the Hartwick rule, their hypothetical produced capital would have been higher than their actual produced capital. He further shows that the resource-rich countries in sub-Saharan Africa would have much larger per capita capital had they followed the Hartwick rule. Specifically, he estimates that under that rule, countries such as Gabon would have had (hypo- thetically) a 2005 per capita capital of about US$68,000, compared to its actual produced per capita capital of about US$19,000. His figures for Nigeria are about US$5,350, compared with about the actual US$1,350, and for Congo US$16,000 instead of the actual US$3,700.


The Norwegian model is the result of a long and ongoing process, which shows that the decision to set up an SWF is part of a much broader issue. Harding and van der Ploeg (2009) offer a detailed account of Norwegian policy initiatives. The first oil field was discovered in Norway in 1969, and production started in 1971. During 1973-75, the Ministry of Finance and the Ministry of Industry initiated analytical work on a number of issues, including Dutch disease, the size of reserves, the likely lifecycles of oil fields, and environmental concerns. Interestingly enough, policymakers did not seem to pay much attention to long-run spending needs at that time.

In 1983, the Tempo Committee recommended that the government put its hydrocarbon revenues in a fund and spend only the real return on the assets accumulated in this fund (what Harding and van der Ploeg (2009) call the “bird-in-the-hand” approach). The Tempo Committee report also discussed how such a petroleum fund and spending rules should work in practice. It stressed the importance of converting oil and gas in the ground into financial assets in a fund and decoupling hydrocarbon income from spending. Owing to political pressures to spend, however, the Tempo Committee discounted the likelihood of such a stabilization fund being implemented and therefore recommended slow extraction of oil and gas as a way to distribute oil and gas wealth to future generations.

Five years later, in 1988, the Steigum Committee concluded that government spending should depend on the permanent income of total hydrocarbon wealth, consisting of the financial reserves plus the value of oil and gas reserves in the ground. It stressed that the calculation of total hydrocarbon wealth requires the prediction of an optimal depletion path, given expected oil and gas prices, technology, and interest rates. In contrast to the Tempo Committee, the Steigum Committee did argue for the establishment of a financial hydrocarbon fund. It stressed the importance of regarding this fund and the value of oil and gas reserves in the ground as part of the same portfolio.

The Norwegian Government Petroleum Fund was finally established in 1990, 19 years after production had started. The first net assets were accumulated in the fund in 1996, and in 2001 (30 years after production started), the 4 percent bird- in-the-hand rule was implemented. This means that four percent of the value of the petroleum fund at the end of the previous year was used as a reference for how much should be extracted from the fund and used to fund the government’s non- oil deficit. The Petroleum Fund changed its name to the Government Pension Fund Global in 2006 in connection with a broader pension reform.

However, it is important to note that the whole policy approach was very gradual from the period of discovery and extraction and that institutions were carefully calibrated and adapted to the lessons learned from initial mistakes and later experiences. It is also useful to note that Norway had already experienced a period of boom and bust in oil revenues before setting up the petroleum fund. Initially, Norway had used its oil revenues to expand its welfare system rapidly and to support the expansion of public services and employment. In the late 1970s, as noted by Qvigstad (2011), the government lowered the pension age, increased agricultural subsidies, widened industrial policies, and reduced taxes. Oil revenues were not used to boost infrastructure, since the country had already reached a level of industrialization.

The initial policy choice regarding oil revenues had serious consequences on both macroeconomic and financial stability as inflation increased, credit grew rapidly, the currency depreciated, and productivity stalled. As a result, after 1986 the Norwegian government undertook corrective policy actions by reducing the fiscal deficit and increasing interest rates to slow down lending. However, higher interest rates in the aftermath of German unification led to a severe banking crisis in 1990 in Norway, and unemployment reached record levels. To resolve the banking crisis, the Norwegian government fully nationalized three of the country’s four largest banks.2 Two of the problem banks were subsequently privatized, while the government retained 34 percent of the third one.

From a political economy perspective, the 1990 banking crisis provided Norwegian policymakers with an opportunity to push for structural reforms. As stressed by Qvigstad (2011), the Norwegian government leveraged the banking crisis to remove subsidies, close down government-owned enterprises, and deregulate the housing and electricity markets. It also implemented a tax reform that increased incentives to work and closed tax evasion loopholes, and reformed parliamentary budget procedures.3

It was only after a number of crises—the severe macroeconomic consequences of the initial choice for the use of oil revenues and of the banking crisis—that Norwegian policymakers implemented the key structural reforms crucial to the country’s longer-term economic prosperity (Figure 6.1).

Figure 6.1Norway—Timeline of crises and structural reforms

One can therefore conclude that adequate structural reforms helped the Norwegian economy take advantage of favorable terms-of-trade shocks to achieve robust economic growth and remain resilient to the global financial crisis. Over the past 20 years, Norway’s income has nearly tripled following positive terms-of-trade shocks. The price of oil has increased and so did the price of other Norwegian exports (such as fish and aluminum), while the price of the most important imports has decreased.

The policy process is ongoing, since issues need to be continually addressed. Harding and van der Ploeg (2009) question whether the current fiscal rule is sufficiently taking into account the aging of the Norwegian population. The recent global financial crisis has shown how important it is to have a transparent communication strategy, given the short-term volatility and tail shocks inherent in financial assets. More generally, research in finance is still working on the issue of deriving an asset allocation for SWFs that would take into account the liability side of the fund. For instance, Amenc and others (2010) study how the optimal asset allocation strategy takes into account the stochastic features of (i) where the money is coming from (the endowment process), (ii) what the money is going to be used for (expected liability value), and (iii) what types of assets are held in the fund’s portfolio.


A key insight of the Norwegian model is that petroleum revenues are different. They stem from the depletion of real wealth, they are volatile and uncertain due to price and volume changes, and they pose a number of governance challenges, including the appearance of “free money.” A key policy question is therefore how to transform these volatile revenues into a smooth consumption path.

Norway’s chosen solution—establishing a petroleum fund and using a fiscal rule—separates savings policy from the savings instrument. The choice of savings policy stems from the need to decouple spending from the petroleum cash flow, and the choice of savings instrument arises from the need to address the governance of savings. As a result, large and volatile oil revenues are split between domestic spending and oil fund savings.

The Norwegian petroleum fund is fully integrated with the state budget and builds on existing institutions to strengthen the budget process. The government collects taxes from all sectors of the economy, including the petroleum sector, and transfers the surplus to the petroleum fund, but only after all government expenditures are paid. This means that it is only through responsible fiscal policy that reserves will accumulate in the fund, and the fund will then be a reflection of accumulated budget surpluses (and financial returns). The fiscal guideline since 2001 mandates that the government should aim to use annually the estimated long-term real return on the Government Pension Fund Global, set at 4 percent. In the past 10 years, fiscal policy in Norway has therefore been geared toward a cyclically adjusted non-oil deficit, which corresponds to 4 percent of the fund every year. The fiscal framework allows the non-oil budget deficit to deviate from the 4 percent path, that is, to undertake countercyclical fiscal policy, while the 4 percent rule remains an important medium-term anchor for fiscal policy.

The chosen spending rule aims to use the real return of the assets in the petroleum fund, as prescribed by the bird-in-the-hand approach. It is therefore more conservative than a permanent-income rule linked to the sum of financial assets and petroleum assets, and partly reflects Norway’s demographics and attendant large future spending commitments. Following such a rule allows the real value of the petroleum fund to be kept stable while spending its estimated sustainable income, which is akin to perpetuity where equal amounts could be withdrawn forever. The oil fund is only invested abroad in financial assets in order to protect the domestic economy, diversify risks, and maximize returns. Together, the oil fund and the savings policy serve as a macroeconomic stabilization tool that protects the non-oil economy from overheating and deindustrialization by (i) investing fund assets abroad, and (ii) deciding on an appropriate amount of oil income to take into the domestic economy through the state budget.

The oil fund does not invest in domestic assets, either physical or financial. The Norwegian government has decided not to invest these revenues in such domestic assets as infrastructure and human capital, because it prefers to invest in them through the budget process and does not want the oil fund to be a second budget for less qualified projects. Moreover, there is no general lack of capital for private projects in Norway, and expanding domestic real investment would carry the risk of reducing the return on investment. Similarly, investing in financial domestic assets using oil revenues (which are not akin to national savings) could make the economy more cyclical. Such a process would also be at the mercy of poor governance practices.

Instead, the oil fund invests only in foreign assets, mostly financial ones. This is an efficient way of achieving capital outflows that reflect current account surpluses, and it shelters the domestic economy from overheating and deindustrialization. International financial assets, such as bonds and equities, are liquid and are traded in relatively efficient markets, which help spread risks. Foreign physical assets such as real estate, although less liquid and transparent than financial assets, can nonetheless offer marginal benefits from a portfolio perspective.

Of course, any investment strategy has to take into account the investor’s circumstances and preferences. In the case of Norway, a starting principle is that the general accumulation of assets belongs to the Norwegian people. The finance minister is responsible for the management and strategic asset allocation (the risk and return choice). The portfolio’s strong risk-bearing capacity reflects a very long investment horizon, no leverage, no claims for immediate withdrawal of funds, and no direct link to liabilities. The main risk is that political authorities might lose faith in the strategy for managing the petroleum wealth, so the investment strategy and governance arrangements need to bear this in mind.

Moreover, circumstances and preferences might change, leading to adjustments in the investment strategy. Starting with liquid and nominal assets such as investment-grade bonds, the oil fund’s investment strategy has evolved over time to gradually add liquid real assets such as listed equities and less liquid nominal instruments such as high-yield and emerging market bonds, and, finally, to include less liquid real assets such as emerging-market equities and unlisted real estate. Its strategic benchmark now allocates 60 percent of assets to equities and 35 to 40 percent to fixed-income instruments, with the remainder (0-5 percent) going to real estate investments. In addition, the oil fund does not take controlling stakes in companies, capping ownership at 10 percent, and it follows ethical guidelines. (See Figure 6.2.)

Figure 6.2Norway—Timeline of major changes in investment strategy

Source: Norwegian Ministry of Finance.

The oil fund’s governance structure leads to a clear mandate from political authorities. The governance of the oil fund is founded on an act passed by parliament and an investment mandate issued by the Ministry of Finance. As the fund owner, the Ministry of Finance has a separate asset management department with overall responsibility for managing the fund. It establishes its strategic asset allocation, both benchmarks and risk limits, and monitors and evaluates operation management. It is also responsible for investment practices and reports to Parliament. In contrast, the central bank, as the operational manager of the fund, has a separate entity within its organizational structure (Norges Bank Investment Management) charged with that responsibility. It implements the investment strategy and actively manages part of the fund to achieve excess returns. It is also responsible for risk control and reporting and exercises the fund’s ownership rights.

Reporting and transparency both help to build support for the management of the oil revenues. The Ministry of Finance reports to Parliament on all important matters relating to the fund and publishes all the advice it receives from external consultants in an annual white paper. Performance, risk, and costs are reported every quarter and published on a website by the central bank. The focus of these reports is on the contribution to value added in operational management. Press conferences are held on quarterly, shortly after an official meeting with the Ministry of Finance. Finally, an annual report listing all investments, both equities and fixed income, is made publicly available.

In 2010, the result of this process was a $525 billion fund with a transparent governance structure and a mechanism integrated with fiscal policy, which allows large and volatile oil revenues to be split between domestic spending and oil fund savings. This result has helped Norway in its objective of achieving sustainable financial and macroeconomic growth and stability.


Most studies of SWFs focus on sovereign wealth management considerations, including their asset allocation and governance. That focus is motivated by the rapid growth in number and size of SWFs and by the emergence of non-oil funds, since some countries have been able to accumulate very large international reserves through their exports of non-natural resource products.

However, a number of countries are now discovering that they are endowed in natural resources while others, having benefited from the acceleration of commodity prices, are considering setting up sovereign wealth funds. Our recommendation to policymakers in natural-resource-rich countries is to go back to the key question of how to achieve sustainable economic growth and development. In this regard, Norway’s experience in economic and wealth management is useful.

The decision to create an SWF and derive optimal asset allocations from it is only one part of a much bigger question. The first question is how to achieve sustainable growth and development in resource-dependent economies. One answer, given by the Hartwick rule, stresses the importance of effective revenue instruments, fiscal rules to limit discretion, and effective public investment management, which includes SWF management.

The key considerations for an optimal asset allocation in natural-resource-rich countries should include these:

  • A country’s starting point, including its stage of economic development and the strength of its public sector institutions and political culture;
  • The size of petroleum assets, their impact on the real economy, and the choice of savings policy (whether a buffer fund or long-term savings fund);
  • Economic and investment policy choices, which include transforming the revenues from petroleum to other assets such as human, physical, and financial assets; holding assets domestically or abroad; and diversifying assets and raising returns;
  • The risks and rewards of different allocation choices and how much to spend today and save for tomorrow (discount rate); and

A governance model will need to distribute responsibilities between various organizations while considering clear lines of responsibility and applying disciplinary pressures to perform. It will require acceptance and commitment by key stakeholders, aided by consultation and transparency, to ensure that the strategy is sustainable.

As a result, policymakers, especially in developing countries, will have to look out for a number of pitfalls. First, and not surprisingly, lack of fiscal discipline does not help transform a windfall into permanent income, and can instead lead to overheating and deindustrialization rather than sustained growth. Second, poorly chosen investments can lead to large-scale industry investments and public infrastructure projects with high political prestige but vague or low economic return, often to the detriment of investment in general education, health, and other social capital that is crucial to deliver sound and sustainable economic growth. Third, a loss of focus in structural policy can reorient policymakers so they are concentrating on how to capture resource revenues, leading to slower growth in non-oil activity, falling labor supply, and disappointing productivity. Finally, resource wealth is often associated with weak government institutions, rent-seeking activities, and increased corruption as governance weakens.

With increased awareness of the double-edged sword that resource revenues represent, countries are better placed to build more robust strategies for managing those resources in a manner that supports broad and durable economic development.


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Thomas Ekeli is economic counselor at the Norwegian Delegation to the OECD, and Amadou N.R. Sy is deputy division chief in the Monetary and Capital Markets Department of the IMF. This chapter is based on the authors’ presentation at “Natural Resources, Finance, and Development: Confronting Old and New Challenges,” a high-level seminar organized by the Central Bank of Algeria and the IMF Institute, which took place in Algiers, on November 4 and 5, 2010. The authors can be contacted at and
1J.M. Hartwick (1977) showed that a simple policy rule—invest all resource rents in other assets—will yield sustainable development in countries with exhaustible resources.
2See Drees and Pazarbaşioğlu (1998) who contrast the Norwegian crisis with that in two other Nordic countries, Sweden and Finland, which also experienced a banking crisis at the same time.
3Norges Bank Deputy Governor Qvistad (2011) notes that “...when bad news fills newspapers and television programs, the electorate is more likely to accept necessary measures. In the long run, reforms prove to be very profitable even though they are painful in the short run.”

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