By Jeffrey Garten

The growth of government-owned investment companies, often called sovereign wealth funds, has caused a lot of hand-wringing in the US and Europe – and rightly so.

Washington has asked the International Monetary Fund and World Bank to establish a code of good practice for SWFs. Berlin is eyeing new legislation to deal with these funds, modelled on US procedures for screening incoming foreign direct investment. Brussels is considering a European-wide set of guidelines. But so far no western government has had the courage to admit that dealing with SWFs may require departures from the conventional liberal orthodoxy concerning global trade and investment flows. Yet this is precisely what is needed.

When relatively few SWFs existed, such as Singapore’s Temasek Holdings or the Kuwait Investment Authority, the challenge they posed to the global financial system and to market-based cross-border investment was small. But now sovereign funds in countries such as Saudi Arabia and Russia are becoming active, Beijing is establishing the government-owned China Investment Corporation, and Japan and South Korea are contemplating similar SWFs. Moreover, the amounts under sovereign management could soar from about $2,500bn today to $12,000bn in 2015, according to Morgan Stanley.

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