Productive Capabilities, Economic Fitness and the Role of Sovereign Development Funds

February 21, 2023 | by Khalid Alsweilem, Masud Z. Cader, and Malan Rietveld

Abstract

This paper argues that a set of analytical tools from the emergent Economic Fitness literature can be productively applied to the challenge of establishing the strategic focus of a Sovereign Development Fund (SDF). Economic Fitness provides a systematic framework through which SDFs can distinguish between commercial and developmental dimensions of investment opportunities, as well as tools that aid the monitoring and reporting of SDFs’ contribution to economic development and diversification. The paper starts by situating SDFs in a broader context of recent trends in modern growth theory, industrial policy, and public investment. We argue that SDFs are institutional instruments for deploying State resources to address market failures and political constraints that impede the emergence of high-productivity areas of economic activity and diversification. Recent scholarship has emphasized the critical role of “economic capabilities” in this process. In the Economics Fitness literature, capabilities are modelled as being situated in (and cultivated through) a complex network structure characterized by non-linear dynamics.

In recent years, Economic Fitness indicators have been successfully integrated with the selection and execution of investment projects led by the International Finance Corporation, in a manner we argue holds valuable lessons for SDF. Our main contribution is to consider how this toolkit can help refine an SDF’s strategic direction (notably the identification of target sectors), as well as improve its portfolio- and investment-level analysis. We conclude that Economic Fitness provides robust and practical signals to SDFs and their government owners regarding sectors, industries and investments that are poised for growth. The framework provides tools for assessing the ways in which SDF investments are likely to contribute to a country’s Economic Fitness, which is the ultimate driver of sustainable, long- term growth and diversification prospects. We illustrate this by discussing the various elements of the Economic Fitness toolkit and their possible application by SDFs and their host governments to meet several policy design and execution challenges.

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