Hamish McRae: Good news for the US, but as for us...

Economic View

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The Independent Online

It is all going to feel different in a week's time. The US election will dominate the first half of the week and the noise from that will drown out everything else. But by the end I think our focus will have shifted from politics back to economics – and not just the economics of America, the economics of the world.

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The winner on Tuesday will inherit an improving US economy and a deteriorating global one. It may turn out that the very last bit of economic information before polling, the US employment figures on Friday, will tip the mood towards President Obama for they showed strong job growth. But it is equally possible that attention will focus on the small rise in unemployment, from 7.8 per cent to 7.9 per cent, and favour Mitt Romney. It would be unfair if it did, for the underlying trend in unemployment is down – but politics are not fair.

But come Wednesday, all should be clear. The improvement in the US economy is real. As well as those labour market figures, there is a strengthening housing market and a surge in car sales. You can see in the main graph new orders are stronger in the US than in China, the UK, Japan and the eurozone. The blue line is above the 50 point that signals expansion, whereas the others are below it, quite alarmingly so in the eurozone.

The US story gets better still. There has been a hiatus in investment, as companies put plans on hold until they know how policy will develop under the new president. The immediate issue is how Congress will deal with the fiscal cliff, the automatic tax increases and spending cuts that come in on 1 January. If nothing were done, these would be a fiscal tightening equivalent to some 4 per cent of GDP. The deficit is currently around 7 per cent of GDP, so cuts of that order will have to be made. But even those of us who believe the US has been dangerously lax in its fiscal management would not advocate too sudden action.

But, and this is the good bit, in another couple of months American business will have a better feeling for what will happen and will boost investment. Any fix, even a short-term one, is better than the uncertainty now. Assuming reasonable competence by the leadership, come the spring the US economy will have a spring in its step.

Elsewhere there deeper concerns, and the prime reason for that is Europe. The political economy – what is happening to the euro, to sovereign bond yields and so on – has improved. The perception is now that the risk of a Greek exit from the eurozone has been postponed, whereas in the summer it was that it was pretty imminent. But meanwhile the real economy has deteriorated. You can get another fix on that from the right-hand graph, which shows consumer confidence, while not plumbing the depths of early 2009, has slid steadily downwards since the middle of the year.

The practical impact of this is playing out not just across southern Europe, where the squeeze on the middle class has reached catastrophic proportions, but even in France, which will have to downsize its motor industry sharpish. The UK is the only major car market in Europe where sales are up this year on 2011. A brief visit to Lisbon a few days ago, talking to small business owners, has made me much more aware of the damage austerity is doing to social cohesion. If the middle class loses trust in government, then the glue that holds society together becomes dangerously weak.

This week the focus will shift back to Greece and whether it will get its next tranche of loans. You can patch and patch and patch, but suddenly something flips and you can patch no more.

The big question for the coming months will be whether the improving outlook for the US offsets the deteriorating one for Europe. We are more dependant on European markets, so we will have to rely on domestic demand to sustain growth, not exports. That will be the preoccupation here through the rest of this year. It matters politically because the coalition needs a bit of a following wind. But it also matters mathematically if the Treasury is to claw back sufficient lost ground on deficit reduction to have a hope of meeting its target for this financial year.

We are just over four weeks to the autumn statement, the forecasts for the economy, for public finances and all that from the Office for Budget Responsibility. Increased domestic demand will help revenues and underpin the rise in employment, the one area where the UK recovery has done much better than the US one. But hitting the target this year will be at best a scramble and next year the vice tightens further.

So it will be a week of two halves: political theatre will dominate the first half, economic reality the second. And from then on the grind resumes, on our side of the Atlantic as well as theirs.

After all these years it seems that manufacturing's coming home

One of the side stories of Lord Heseltine's review of the relationship between government and industry that struck me was the repatriation of bits of the textile industry from Asia. It has happened to some extent in Germany and it would mark a complete circle in the cycle of industrial development.

The story goes like this. The first mass industry, the one more than any other that started the Industrial Revolution, was textiles and it started in Britain. Then it left, as industry migrated to cheaper labour countries. It did not all go, for at the very top end the UK produces fine textiles and well as ground-breaking tailoring.

Two things have been happening recently that are reversing what was a 100-year global trend. One is that the disadvantage of higher production costs has been offset by the advantage of short delivery cycles. To get fashion goods into the shops fast, you have to make them up within a couple of days' container lorry's journey away. So you make them up in Portugal rather than Malaysia. You could airfreight but textiles are heavy relative to their value, unlike electronic kit.

The other is labour costs in Asia are rising so fast that the cost advantage has narrowed. The highest rates for labour in China, in the region round Shanghai, are now more or less the same as the lowest in the United States, at around $6 (£4) an hour. True, if you add on other social costs, or go to a lower-wage region of China, there is still a cost advantage. But it narrows every year.

So how far will this trend of bringing back manufacturing go? There are changes in other industries which will encourage repatriation of manufacturing. In printing, for example, the cost-effectiveness of digital as opposed to offset means short runs have become relatively cheaper. So you print what you need nearby.

The overriding economic issue here is: how do we in the West justify our standard of living when other people can do things cheaper? Maybe textiles are showing we are competitive again.