Now that we have entered a new period of geopolitical conflict, protectionism and regionalism, one wonders whether the cosmopolitan, globalised world of Davos is gone forever. Returning after a two-year pandemic-induced hiatus, this year’s World Economic Forum meeting in the Swiss Alps was a shadow of its former self.

In previous decades, the event was brimming with optimism. New peace agreements were forged, emerging markets were propelling themselves towards prosperity and democracy was on the march. As New York Times columnist Thomas Friedman famously put it, the world seemed increasingly ‘flat’, with all the old hurdles to international interconnectivity disappearing.

It was all somewhat hyped, as was typical of that era. Few really believed that an earthly paradise was around the corner or that history had really ended. But there was no denying that things were looking up and that Davos was the place to go to pay homage to the spirit of the time.

This year, the weather was grey and drizzly, and the talk was of war, sanctions, inflation and supply shortages. The International Monetary Fund’s managing director, Kristalina Georgieva, sought to reassure everyone that she does not expect an economic recession. But depression was the dominant mood in most of the formal and informal discussions.

Pessimism certainly seems justified. With no end in sight to Russia’s war on Ukraine, any engagement with the Russian economy or the Kremlin will remain off limits for large parts of the world—and certainly the West—for the foreseeable future. China’s trajectory, meanwhile, has become increasingly uncertain. My guess is that the country’s leadership is feeling rather uneasy about President Xi Jinping’s recent commitment to a ‘no limits’ friendship with Russia, not to mention his zero-Covid strategy, which has locked down Shanghai—China’s centre of dynamism—and exacerbated the country’s mounting economic problems.

But it’s not all doom and gloom. The fight against Covid-19 has been a triumph for science and ultimately for the idea of an open global economy. Yes, the inequities in the distribution of vaccines, treatments and tests will leave a stain on the international community’s response; but the initial wave of trade restrictions and vaccine nationalism has given way to more cooperation. The past two years have underscored the value of global scientific cooperation, open markets and well-functioning supply chains.

The pandemic offers important lessons for managing future challenges, particularly climate change. While recent developments have injected some pessimism into the climate debate, there may yet be a silver lining. Rapidly rising oil and gas prices are creating powerful incentives to accelerate the transition to renewable and alternative energy sources. If science could deliver on vaccines, it should also be able to deliver on the climate challenge. Already, there is a growing awareness that the problem warrants urgent attention.

Digitalisation has also made significant strides during the pandemic. Sweeping lockdowns gave everyone a crash course in digital tools. The technologies and processes adopted during the pandemic will transform many economic sectors for years to come. At the global level, cross-border data flows are booming and continuing to grow annually by double-digit figures.

Even surveying the bleak political landscape, one can find the occasional bright spot. For example, Finland’s and Sweden’s applications for NATO membership have renewed the alliance’s credibility and relevance, and strengthened transatlantic relations. And the European Union, having exceeded its own expectations in marshalling support for Ukraine, is now emerging as a critical pillar in the European security order. While major challenges lie ahead, the EU now has a strong foundation on which to build.

More broadly, the democratic West has regained some of its lost vigour and moral clarity in its firm, united opposition to Russia. With Russia continuing to commit the international crime of aggression (as well as numerous atrocities), its support in the United Nations General Assembly has dwindled to just a handful of outlaw regimes.

Looking ahead, the critical international issue will be how to maintain global cooperation on global challenges. Russia will be out of the picture but China will remain a key player alongside increasingly relevant countries like India. It remains to be seen what, if anything, will emerge from the ruins of the G20 this year. The creation of a new grouping with a more relevant membership would not be the worst outcome.

The old Davos glory days are certainly gone. Far from becoming flat, the world has become scattered with new trenches and barriers. But it is not all bad. The current mood of depression may be as unwarranted as was the previous ebullience. We should focus on being realistic and clear-eyed about the mounting global challenges we face. If we can manage to do that, we may yet prevail over them.

Some months ago, Chinese authorities approached some of the biggest foreign companies in the country and asked them to tap a representative to participate in a small closed-door gathering on China’s new economic strategy. The meeting was to be with a senior official at an undisclosed time and location, and, according to two people with direct knowledge of the matter who insisted on anonymity to discuss it, companies were asked to send only ethnic Chinese representatives. In both content and form, the episode captured China’s eagerness to make its economy more recognisably Chinese, developing its own technologies and energy sources while relying on domestic consumption rather than on foreign demand.

Chinese President Xi Jinping’s new strategy centres on the concept of ‘dual circulation’. Behind the technical-sounding phrase lies an idea that could change the global economic order. Instead of operating as a single economy linked to the world through trade and investment, China is fashioning itself into a bifurcated economy. One realm (‘external circulation’) will remain in contact with the rest of the world, but it will gradually be overshadowed by another one (‘internal circulation’) that will cultivate domestic demand, capital and ideas.

The purpose of dual circulation is to make China more self-reliant. After previously basing China’s development on export-led growth, policymakers are trying to diversify the country’s supply chains so that it can access technology and know-how without being bullied by the United States. In doing so, China will also seek to make other countries more dependent on it, thereby converting its external economic links into global political power.

The shift to a dual-circulation strategy raises the spectre of a new ‘China shock’ that could dwarf the impact of the first one, which struck Western economies after China’s accession to the World Trade Organization in 2001. Although China’s inclusion in the WTO generated a huge amount of wealth and lifted millions of Chinese out of poverty, it also created losers in places like the American ‘rust belt’ and the United Kingdom’s ‘red wall’ districts, setting the stage for the UK’s Brexit referendum and former US President Donald Trump’s election in 2016.

The West’s political class took a long time to wake up to the China shock, because it had committed to a strategy of ‘reciprocal engagement’, whereby Western consumers would benefit from low-cost Chinese imports and Western companies would profit from China’s economic growth by tapping its massive market. These dynamics, it was assumed, would pressure China into opening up its market and society even more. But this assumption has not been borne out.

The new China shock’s impact on the West will differ fundamentally from the first one. For starters, the dual-circulation strategy will affect different parts of the economy and society. Rather than endangering legacy industries, the goal is to dominate cutting-edge sectors and compete with legal and financial firms in the City of London, carmakers in Baden-Württemberg and biotech firms in Sweden.

Specifically, Xi’s 2015 ‘Made in China 2025’ plan emphasises sectors such as artificial intelligence, semiconductors, batteries and electric vehicles, and aims to increase the domestic content of core technological components to 40% by 2020 and 70% by 2025. The goal is to use state subsidies, export controls and controls on data to allow Chinese firms to replace foreign ones—or to make the foreign firms more Chinese. If Xi’s plan succeeds, the new China shock could hollow out as many high-paid jobs in tech and services as the first one did in heavy industry and textiles.

The shock will not end there. Today’s main geopolitical contest is not just about enforcing global rules; it is about who makes them. Whereas the West previously struggled to secure Chinese compliance with the trade, investment and intellectual property frameworks it had crafted, China is now also seeking to make and enforce the rules. There are already or have been Chinese heads at the International Telecommunication Union, the International Organization for Standardization, and the International Electrotechnical Commission, and Chinese companies are increasingly trying to define the future of technology. Huawei alone holds more than 100,000 active patents, particularly in 5G technology, where it is competing with Western companies like Ericsson and Nokia to set global standards.

Moreover, today’s competitive tensions are no longer contained within the relationship between China and the West. With its Belt and Road Initiative, China has already established a network of economic ties with more than 100 countries, and it will not hesitate to use these channels to export Chinese standards along with its model of state capitalism and state subsidies. Soon (if not already), Western companies will face the same uneven playing field in third markets as they do in China itself.

One implication of the new China shock is that the new rules on data, research and development, and standards will force prominent Western companies to acquire Chinese characteristics, unless they withdraw from China altogether. As one well-placed private-sector observer put it to me, ‘China’s idea is that if companies like Daimler or Volkswagen want to work in China, they will have to move services, R&D, and new products there. Beijing hopes that dual circulation will transform them into Chinese companies.’

Needless to say, the new China shock demands a different set of responses than the old one did. Rather than trying to transform China or make inroads into the Chinese market, the West’s priority must be to transform itself, not least by developing industrial and investment policies to spur innovation and protect its intellectual property. And to ensure that their economic ‘champions’ have access to economies of scale, Western countries must establish shared standards for privacy, data protection, carbon pricing and other issues. Ideally, this cooperation would formalise new trade agreements, investment packages, financing and regulations to expand the share of the global economy that is open to non-Chinese technologies and frameworks.

Europeans, for their part, will need to enact domestic reforms to protect themselves from economic coercion in a world of gated globalisation and weaponised interdependence. While much of the attention now is on China’s crackdown in Hong Kong and repression of the Uyghur minority in Xinjiang, there is an even bigger shockwave approaching. Western leaders must not be caught off balance again.

Every society rests on a web of norms, institutions, policies, laws and commitments to those in need of support. In traditional societies, such obligations are borne mostly by families and kin groups. In advanced economies, a greater share of the burden is placed on the state and markets (through health insurance and pensions). Yet even in the latter case, much of the social contract is still upheld by families (through unpaid care work), civil society (voluntary and charitable organisations) and employers (through benefits they’re required to provide to their employees).

The social contract is not synonymous with the welfare state. Rather, the welfare state refers to the dimensions of a social contract that are mediated through the political process and subsequent state action, either directly through taxation and public services or indirectly through laws requiring the private sector to provide certain benefits. As such, the welfare state is best understood not as a redistribution mechanism, but as a source of productivity and protection over the course of a person’s life. As John Hills of the London School of Economics has shown, most people contribute as much to the state as they receive in return.

Nonetheless, much of the anger that has come to define politics in the developed world is rooted in people’s sense of having not received what they are owed. Those born into disadvantage feel as though they never had a chance. Those living in rural areas believe that policymakers have overwhelmingly favoured cities. Native-born populations fear that immigrants are receiving benefits before they have paid their dues. Men sense that their historic privileges are eroding. Older people regard the young as ungrateful for past sacrifices, and the young increasingly resent the elderly for straining social-security programs and leaving a legacy of environmental destruction. All of this distrust and animosity is fodder for populists.

So, too, are the effects of technological change and globalisation. The integration of global supply chains has delivered huge gains to the middle classes in emerging economies and to the top 1% globally, but it has hollowed out the middle and working classes in advanced economies.

The conventional wisdom is that workers in advanced economies have had to sacrifice wages or social protections to compete with emerging-market labour, and that these pressures have intensified as capital has become more mobile. Worse, the social mobility that once made inequality politically tolerable has stalled or declined.

In principle, the provision of adequate insurance against economic displacement should make the pressures from technological change and globalisation manageable. But many aspects of today’s welfare states are still designed for the old economy, where male breadwinners paid into reliable pensions over the course of a lifetime, while women stayed at home to raise children and care for the young and the old.

For the first time in history, there are now more women in higher education than men around the world. Educated women have fewer children, are more likely to be in paid work, and will increasingly feel tensions between their participation in the labour market and their traditional caring responsibilities. Yet recent research from the International Monetary Fund shows that closing the gender gap has significant benefits for growth. The challenge, then, is to redefine the social contract so that women can make full use of their talents without any loss of social cohesion.

In advanced economies, this tension is at the centre of debates about childcare and declining birthrates. Societal ageing means that a shrinking working-age population must cover rapidly rising healthcare and pension costs. Worse, today’s working-age population already has less security than previous generations, owing to the decline of defined-benefit pensions and a lack of access to many employment benefits or training opportunities.

Likewise, climate change represents a breakdown of the intergenerational social contract. Over the past year, young people staged massive protests against an economic model that doesn’t take adequate account of the environment. As the evidence of an impending climate disaster mounts, so too has support for alternative economic models that would enable more sustainable development.

Once we have acknowledged these global challenges, we can begin to envision what a new social contract might look like. For example, education will need to occur earlier in life, when the foundation for subsequent learning is established, as well as later, to meet the demand for reskilling. It also will need to focus on tasks that complement what robots can do. Serious investments in reskilling—on the order of 1–2% of GDP, as in Denmark—must be central to any modernised social contract.

A new social contract also may need to provide a minimum income for all, but structured in a way that preserves the incentive to work and retrain. Earned income tax credits, mandatory training and work placements, and employment guarantees should all be considered. And to tap into the world’s growing pool of female talent, large investments will be needed to expand childcare and eldercare, provide shared parental leave, and counter the effects of formal and informal biases that place women at a disadvantage. For example, if benefits were made portable and provided pro rata, more workers would be able to rely on part-time work to balance other commitments.

As for sustainability, we need to adopt an entirely different way of thinking about ageing and the environment. If a shrinking labour force is going to have any chance of supporting an ageing population, the investments needed to boost future productivity must be made now. In the meantime, ageing populations may have to commit to working longer—with retirement ages pegged to life expectancy—and demanding less medicalised health care at the end of life. Finally, current and future environmental costs will have to be incorporated into economic decisions. We need massive investments in green technologies to transform cities, transportation and energy systems. Considered together, such a new social contract has the potential to restore a sense of hope and optimism about the future.

Diplomatic relations may have been strained, but Australia’s trade relationship with China is growing ever closer. The latest trade report shows that China was the destination for a record 40% of Australia’s exports in June.

It was only a little over three years ago that China’s share of Australia’s monthly exports hit 30%. A decade ago it was just 20%.

The last time a single country took such a large share of Australia’s merchandise exports was in 1952 when it was the United Kingdom. Japan’s share of Australian exports peaked at a third in the mid-1970s and is now down to 14%.

Supported by soaring sales of LNG and high prices for iron ore and coal, Australia’s earnings from the Chinese market rose by 27% in the year to June. That’s almost double the growth rate of other markets.

While the China trade balance is massively in Australia’s favour, imports of Chinese goods are also growing rapidly. Over the past financial year, our imports from China rose by 15%, while imports from everywhere else fell by 2%. Businesses on both sides of the trade are making big profits.

The intensity of the trade relationship worries strategists. ASPI Executive Director Peter Jennings has argued that China’s ‘economic dominance’ is having an impact on the government’s strategic thinking. ‘[W]e urgently need a strategy to diversify economic relations’, he says. There are concerns that China could exercise economic coercion over Australia.

China has a track record of bullying on trade. Lowy Institute China analyst Richard McGregor notes that Norway suddenly lost its Chinese salmon market when the Nobel Prize was awarded to a Chinese dissident, Philippine mangoes were left to rot after its government won an international court case over the South China Sea, Chinese tourism to South Korea was restricted after it agreed to host US missiles, and, most recently, Canadian canola has been penalised following Canada’s arrest of Huawei’s finance director.

There were suggestions Australian thermal coal exports to China were being restricted earlier this year as punishment for the Turnbull government’s foreign interference legislation. However, the customs delays soon spread to all thermal coal exporters and it was hard to isolate a political intent.

China is trying to both lift self-sufficiency in thermal coal (it already supplies 95% of its own coal for power stations) and reduce coal’s share in the overall energy market.

One result of Beijing’s push for reduced carbon pollution has been absolutely stunning growth in Australia’s sales of LNG to China. Commonwealth Bank commodities analyst Vivek Dhar says Australia’s LNG exports to China rose by 37% last year, compared with growth of 10% in sales to Japan and 13% in sales to South Korea. In June, China is overtook Japan as Australia’s biggest LNG market, something Dhar says he didn’t expect to happen for years.

This points to an important strategic truth: China is heavily dependent on raw material and energy supplies from Australia. China’s steel industry wouldn’t function without Australian iron ore and metallurgical coal. LNG has become an essential source of energy for the Chinese economy and the quick sea route to Australia makes it the preferred supplier. China’s industry would soon face a crisis in the event of any lasting disruption to the Australian shipping route.

Education—Australia’s fourth-largest export to China—is more vulnerable. The dependence of major universities, including the University of Sydney and the University of Melbourne, on Chinese enrolments for up to a third of their revenue leaves them exposed.

China values its access to Western universities and its middle classes place a premium on English-language education, giving a resilience to Chinese demand.

Education highlights the implausibility of any strategy to diversify the economic relationship. Sydney University vice chancellor Michael Spence claims that government funding is a bigger risk than foreign enrolments. However, even in a hypothetical world where government boosted education funding, a university would still take an enrolment from the next foreign student if it could. No business will readily turn away a customer.

One of the most striking features of Australia’s trade with China has been the growth of non-traditional exports. While the big three—iron ore, coal and LNG—account for more than two-thirds of merchandise exports to China, the combined value of the next 20 largest Australian exports has risen by more than 70% over the last five years and is more than Australia gets in total from any other market except Japan.

Some of these gains—for example, barley and beef—have been helped by the China–Australia free trade agreement, while others—such as pharmaceuticals, crayfish, wine and baby formula—reflect middle-class Chinese demand.

For both sides, it is good business, and that’s the driving force behind the entire trade relationship.

While the mercantilist approach of the US administration regards exports as good and imports as bad, economists concerned with consumer welfare emphasise the value of imports: it is access to goods and services of the best value that lifts living standards. Australian consumers have benefited from low-cost Chinese technology and household goods, while business competitiveness has been enhanced by access to low-cost Chinese industrial supplies.

The strength of the economic relationship does shape the government’s strategic options. Australia hasn’t followed the US’s freedom-of-navigation operations close to the Chinese-constructed islands in the South China Sea, for example. However, prosperity is in the national interest and the relationship has delivered that over the past 15 years.

The most immediate risks are more economic than strategic. The Chinese government faces a supremely challenging task in achieving a controlled slowing of an unsustainable growth rate without imperilling the ability of its state-owned companies and local governments to service their massive debts. The trade conflict with the US makes that task all the more difficult. Attempting to sustain growth with resource-intensive infrastructure investment may be reaching its limit.

Through nearly all of the past 15 years, it has been a sellers’ market for most of the things Australia supplies China. Australia’s terms of trade (export prices compared with import prices) have been sustained at a higher level than at any time in the last century. Although both sides are dependent on each other, the balance would shift in a downturn. It would become a buyers’ market and Australia could become more vulnerable to pressure from its largest customer.

This month the European Union will celebrate the 60th anniversary of its founding treaty, the Treaty of Rome, which established the European Economic Community. There certainly is much to celebrate. After centuries of war, upheaval, and mass killings, Europe is peaceful and democratic. The EU has brought 11 former Soviet-bloc countries into its fold, successfully guiding their post-communist transitions. And, in an age of inequality, EU member countries exhibit the lowest income gaps anywhere in the world.

But these are past achievements. Today, the Union is mired in a deep existential crisis, and its future is very much in doubt. The symptoms are everywhere: Brexit, crushing levels of youth unemployment in Greece and Spain, debt and stagnation in Italy, the rise of populist movements, and a backlash against immigrants and the euro. They all point to the need for a major overhaul of Europe’s institutions.

So a new white paper on the future of Europe by European Commission President Jean-Claude Juncker comes none too soon. Juncker sets out five possible paths: carrying on with the current agenda, focusing just on the single market, allowing some countries to move faster than others toward integration, narrowing down the agenda, and pushing ambitiously for uniform and more complete integration.

It’s hard not to feel sympathy for Juncker. With Europe’s politicians preoccupied with their domestic battles and the EU institutions in Brussels a target for popular frustration, he could stick his neck out only so far. Still, his report is disappointing. It sidesteps the central challenge that the EU must confront and overcome.

If European democracies are to regain their health, economic and political integration cannot remain out of sync. Either political integration catches up with economic integration, or economic integration needs to be scaled back. As long as this decision is evaded, the EU will remain dysfunctional.

When confronted with this stark choice, member states are likely to end up in different positions along the continuum of economic-political integration. This implies that Europe must develop the flexibility and institutional arrangements to accommodate them.

From the very beginning, Europe was built on a ‘functionalist’ argument: political integration would follow economic integration. Juncker’s white paper opens appropriately with a 1950 quote from the European Economic Community founder (and French prime minister) Robert Schuman: ‘Europe will not be made all at once, or according to a single plan. It will be built through concrete achievements which first create a de facto solidarity.’ Build the mechanisms of economic cooperation first, and this will prepare the ground for common political institutions.

This approach worked fine at first. It enabled economic integration to remain one step ahead of political integration—but not too far ahead. Then, after the 1980s, the EU took a leap into the unknown. It adopted an ambitious single-market agenda that aimed to unify Europe’s economies, whittling away at national policies that hampered the free movement not just of goods, but also of services, people, and capital. The euro, which established a single currency among a subset of member states, was the logical extension of this agenda. This was hyper-globalization on a European scale.

The new agenda was driven by a confluence of factors. Many economists and technocrats thought Europe’s governments had become too interventionist and that deep economic integration and a single currency would discipline the state. From this perspective, the imbalance between the economic and political legs of the integration process was a feature, not a bug.

Many politicians, however, recognized that the imbalance was potentially problematic. But they assumed functionalism would eventually come to the rescue: the quasi-federal political institutions needed to underpin the single market would develop, given sufficient time.

The leading European powers played their part. The French thought that shifting economic authority to bureaucrats in Brussels would enhance French national power and global prestige. The Germans, eager to gain France’s agreement to German reunification, went along.

There was an alternative. Europe could have allowed a common social model to develop alongside economic integration. This would have required integrating not only markets but also social policies, labor-market institutions, and fiscal arrangements. The diversity of social models across Europe, and the difficulty of reaching agreement on common rules, would have acted as a natural brake on the pace and scope of integration.

Far from being a disadvantage, this would have provided a useful corrective regarding the most desirable speed and extent of integration. The result might have been a smaller EU, more deeply integrated across the board, or an EU with as many members as today, but much less ambitious in its economic scope.

Today it may be too late to attempt EU fiscal and political integration. Less than one in five Europeans favor shifting power away from the member nation-states.

Optimists might say that this is due less to aversion to Brussels or Strasbourg per se than to the public’s association of ‘more Europe’ with a technocratic focus on the single market and the absence of an appealing alternative model. Perhaps emerging new leaders and political formations will manage to sketch out such a model and generate excitement about a reformed European project.

Pessimists, on the other hand, will hope that in the corridors of power in Berlin and Paris, in some deep, dark corner, economists and lawyers are secretly readying a plan B to deploy for the day when loosening the economic union can no longer be postponed.