Before the Great Recession, the need for rebalancing the global economy was on many minds – now that we no longer feel on the precipice of disaster, this fundamental question must be confronted again. The West will need to start saving more, and emerging economies will have to transition towards growth that is driven by domestic demand rather than exports. However, the picture has changed since the Great Recession in a profoundly important way, illustrated by how we are seeing the prices of asset classes moving much more in tandem than ever before.

This reflects the perception that there is no safe haven anywhere in today’s global economy, as we increasingly come to terms with the extent of interdependence among the world’s large economies. There is no longer any escaping from the fact that a crisis in one geographical area – as we saw with the bursting of the US real estate bubble – can have profound knock-on effects all over the globe. For example, China would have much to fear from the fallout if the eurozone were to disintegrate, given that Europe is its largest export market.

Although the feeling of immediate danger has passed, we do not yet see a quick path to growth. Interdependence means that one engine of growth can lift all boats; but somebody, somewhere is going to have to start taking risks. If nobody does, the danger is that the paradox of thrift kicks in – everyone in the global economy cautiously prioritizes saving, which creates a self-fulfilling vicious circle of low demand and depressed confidence.

On a more positive note, the realization of interdependence can spur determination to work together. While there is much political uncertainty, given the upcoming transition of power in China and elections in the US, there is nonetheless cause for cautious optimism that policy-makers are increasingly realizing the dangers of nationalism and protectionism. We must recognize that there is self-interest in offering support to other economies in making the structural transitions they need. And structural transitions – such as tackling the competitiveness gap between northern and southern eurozone countries – are greatly more difficult than cyclical ones.

In what kind of position will China be in the world in the future? This depends largely on how well China is able to handle its own structural transition, one which now seems to become urgent. The latest edition of the World Economic Forum’s Global Competitiveness Report sees a decline in the rankings for China, from 26th to 29th in the Global Competitiveness Index, the first time since 2005 that China has not improved its position year-on-year.

The last few years have seen China successfully keep its engine of growth running despite the Great Recession, by continuing to boost demand through investment. However, recently, fears have come to the fore that there has been too much investment, creating excess capacity in real estate and infrastructure. You can only grow an economy through investment for so long. Sooner or later, you need to shift the balance to a greater emphasis on consumption. The rest of world is looking closely at political changes, consumer sentiment and investment directions in China, hoping for signs of a smooth transition from investment mode to consumption mode.

The critical factor to enhanced competitiveness is to realize that natural resources and capital investment confer only a temporary advantage in competitiveness, and an unpredictable one. We can see this unpredictability with the shale oil revolution in the US, which has led to the US becoming surprisingly competitive again in the manufacturing sector – something which lower-cost, export-oriented countries did not expect to see.

We can assume that in the future world, capital and resources will flow even more easily across borders than before. Countries therefore need to look at sources of competitiveness which cannot flow so easily abroad, and top of the list is a culture of entrepreneurship. Real global competition in the future economy will be based on talent and innovation. You must equip workers with the skills they need to find employment, and give entrepreneurs the space they need to take risks which can create the jobs for people to fill.

What this means for China is a need to look at education, employment and entrepreneurship much more holistically. The Global Competitiveness Report findings specifically noted a relatively low score for the variable asking the business community about their perception of how well the educational system in the country meets the needs of a competitive economy. China ranks 57th out of 144 economies, with a score of 3.94 on 1 to 7 scale. If it can address this disconnect while simultaneously nurturing entrepreneurship, creating an ecosystem in which SMEs and the state play mutually supportive roles, it can create a self-reinforcing circle of competitiveness.

Lee Howell is Managing Director, and Head of the Risk Response Network at the World Economic Forum

This article has been published in the HBRC September issue. It is available here.

Photo: A mother prepares her daughter for her college graduation ceremony at Fudan University in Shanghai. REUTERS/Carlos Barria