The first problem with the design of past stabilization funds is that they were implemented as saving rules and not spending rules. From the theoretical point of view, a saving rule is exactly the same as an expenditure rule. However, in practice they are not the same, because with saving rules politicians will have a greater temptation to spend the resources saved in stabilization funds (this is the appropriability problem). If a country has a large proportion of its GDP saved in an account for stabilization, the temptation to spend those funds is extremely large, and if the law prevents politicians from using the money accumulated in the fund, it can be offered as collateral for new borrowing. Alternatively, the law can be reinterpreted to allow withdrawal of the resources, or the executive can declare a state of emergency, allowing it to reassign the funds. In the end, if there is too much saved, some of it will be withdrawn.

Substituting expenditure rules for saving rules can address part of the appropriability problem. Consider the following example: assume that there is a target for fiscal revenue of $10 billion, and the actual income is $11 billion. The saving rule would require $1 billion to be placed in the stabilization fund. The government could follow the law and put $1 billion in the fund, then put it up as collateral to borrow an extra billion dollars and use that to increase expenditure to $11 billion. The letter of the law is respected (because the law does not say anything about the government’s ability to borrow), but its spirit is not respected, because there has been no net saving. On the other hand, an expenditure rule would have said that the government could spend only $10 billion. If congress then decides to increase expenditures, it will have to explain why it is violating a law. This is why it is much harder to appropriate under expenditure rules than under saving rules. Expenditure rules attack the source of misbehavior directly. Indeed, stabilization funds based on expenditure rules can be consistent with fiscal responsibility laws, while saving rules have to be changed yearly in order to achieve this. Of course, both saving and expenditure rules can be violated, but stabilization funds defined as saving rules are easier to breach.^a

The next problem that stabilization funds have to deal with is the issue of governability. Most of the time, if a country has several sources of fiscal risk, it tends to adopt one stabilization fund for each source of risk (the funds are created sequentially, and each new law does not change the existing ones). From a practical point of view, having several funds to achieve the same objective is inefficient, and the funds become unmanageable.

A third problem with the design of stabilization funds is the way in which fund resources are invested. The financial instrument that provides the best stabilization is one in which the returns to the asset are negatively correlated with the fiscal shocks faced by the country, but almost all stabilization funds invest their resources in short-term treasury bonds issued by the United States or other advanced economies. The objective of this investment strategy is to maximize the liquidity of the stabilization fund. The problem is that these financial instruments have a very limited correlation with the risk against which the country needs to be insured. Consider, for instance, an oil importer that wants to insure itself against a sudden increase in the price of oil. Wouldn’t a fund invested in stocks of oil-producing companies be better than a fund invested in U.S. treasuries? The latter have no correlation (or a limited correlation) with the price of oil; the former tend to do poorly when oil prices are low (i.e., when the country does not need the money) and do well when the price of oil is high (i.e., when the country needs the money). Consider instead an oil producer that wants to insure itself against a sudden drop in the price of oil. An ideal investment strategy would be to invest in securities traded on the Japanese stock market, which tends to move in the opposite direction with respect to the price of oil, delivering high returns when the price of oil is low (i.e., when the oil-producing country needs resources) and low returns when the price of oil is high (i.e., when the oil-producing country does not need extra resources). Clearly, these are just rough examples; the point is that countries can do better than holding their stabilization funds in short-term government paper issued by advanced economies.