What makes a country competitive? As economies become more interdependent and as resources become increasingly scarce, the economic, political and social policies initiated by the world's governments can make or break their ability to provide for their people. With the euro teetering on the edge of collapse, the possibility of sovereign debt default looming, the United States fighting off another recession and world trade coping with steadily rising commodity prices, understanding the macroeconomic at play provides investors and businesses with a better understanding of what markets signal growth and what funds to avoid.

TUTORIAL: Economic Basics

What It Means to be Competitive
The World Economic Forum, a non-profit organization whose members are sizeable global companies, recently released its annual "Global Competitiveness Report." The report reviews the "health" of 139 of the world's economies in the eyes of the world's business leaders, and serves as an important third-party indicator of how the policies of each country impact their ability to provide for long-term economic growth. It rates economies on twelve pillars: institutions, infrastructure, macroeconomic environment, health and primary education, higher education and training, market efficiency, labor market efficiency, financial market development, technological readiness, market size, business sophistication, and innovation. The ratings are derived from surveys given to businesses, and by comparing country-level statistics to statistics provided by international organizations, such as the IMF. (For more on the IMF, see An Introduction To The International Monetary Fund (IMF)).

The "Global Competitiveness Index" does point to some overall trends which investors may count as old news, but which are still telling. Emerging and developing economies are slowly but surely catching up with advanced economies. For those who have read newspaper headlines or watched the news recently, this should not come as a shock. Developing countries have steadily industrialized, creating domestic markets and forcing firms to become more productive. Latin America and China in particular have benefited from development, but future prospects only go so far. Short-run gains from increases in labor productivity will taper off for developing countries as more and more firms become efficient. In order to grow in the long-term, developing countries are forced to rely less on capital spending and migration to fuel growth. In order to continue developing, they must shift from unskilled to skilled labor, must modernize their financial systems and move away from exporting commodities to developed countries. This is an especially salient point, as many developing countries are factor-driven economies relying on commodities.

The Rankings
Being innovative today does not mean you will be at the top of the game tomorrow. The United States is a perennial member of the index's top 10 economies, but has edged lower in recent years. In 2005 it held the top rank, but fell to fourth in 2010 and now is ranked fifth. What has caused the decline? While it has maintained high levels of productivity, continues to be innovative and has the world's largest domestic market, the political climate has sapped confidence in the abilities of government institutions to maintain policies supporting growth. The index ranks the United States' macroeconomic environment at 90 and institutions at 39. For perspective, the ranking of the United States in basic requirements is lower than those of Germany (11), China (30), Japan (28) and France (23) – all of which are in the top five countries in terms of nominal GDP according to the International Monetary Fund (IMF).

The problems facing each of the five largest economies are different: Germany is export-driven at a time when demand is patchy, and faces euro pressures; France has several large banks teetering on the edge of collapse and also faces euro pressures; Japan has not fully recovered from recent earthquakes, and requires political reforms in order to bolster growth; Even China may struggle with the pains of modernizing a rapidly growing economy, as well as determining how to marry economic development involving over one billion souls with a political system afraid of loosening its grip.

The Trouble With the Rich World
Should investors panic? Not yet, at least. The U.S. still has an efficient labor market and is known for innovation, and is joined by other heavy-hitters who also find themselves in macroeconomic trouble. The rankings of Germany, Japan and France also declined, with China being the only top five economy to see a rankings increase. Larger countries – and larger economies – are likely to find the creation and application of policies to be more difficult than smaller countries. However, this cannot be an excuse. The health of a government's institutions and its macroeconomic outlook are closely tied, and decisions that politicians make heavily influence the economy. As has long been the case, in times of economic trouble many countries turn inward and focus on domestic issues. This myopic strategy ignores how interrelated the world's economies have become.

The Bottom Line
The report's silver lining may rest in one simple truth: businesses – precisely the groups weighing in on the Global Competitiveness Report – cannot abandon larger economies that are dysfunctional. This would be an untenable strategy. So even while the United States and other economic power houses make decisions that business leaders may scratch their heads at, the bottom line is that businesses will be forced to adapt. (For related reading, see A Practical Look At Microeconomics.)

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