We're in rude economic health now, but America and China can't carry us forever

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If one-third of the world's growth this year is likely to come from the United States and another third from China, you only have to look at the two countries to figure out what will happen to the world economy in the months ahead.

If one-third of the world's growth this year is likely to come from the United States and another third from China, you only have to look at the two countries to figure out what will happen to the world economy in the months ahead.

It is simple mathematics. Europe will supply perhaps 10 per cent of the total growth, but if the eurozone has another disappointing year and growth is half the estimates, that could only knock 5 per cent off the global total. If, however, a similar miscalculation occurred in forecasting growth in the US and/or China, the world economy would take a huge hit.

Interestingly, the US and China have followed similar expansionary monetary policies. The world as a whole is awash with cheap money. Indeed, money, viewed globally, is, in effect, free (see first graph). But the gap between the cost of money and real economic growth has widened particularly sharply in the US and China (second graph). The result has been a surge in personal and national indebtedness in the US and fears of a "bubble economy" in China.

It takes quite a long time - no one really knows how long - for monetary growth to feed through into inflation, but just last week a couple of disturbing stories emerged. In the US, consumer prices rose by 0.5 per cent in March - faster than the market had expected. This followed strong retail sales figures and led to expectations that the US Federal Reserve might have to raise interest rates this summer. Long bond yields, which are set by the market rather than the Fed, rose sharply.

In China, it was the first-quarter growth figures that caused alarm. Growth was at an annual rate of 9.7 per cent, leading to concern in official circles that there was a bubble. The true figures may be even higher, with suggestions that the economy is really growing at about 12 per cent. Certainly, the building boom in the coastal cities continues apace, with China now consuming half the world's cement. I made a brief visit to Shanghai last week and found that tower blocks which were steel skeletons five months ago, on my previous visit, were now finished and occupied. But the demand for raw materials is putting a strain on commodity prices, which affects the whole world, not just China.

The problem, and it applies to both the US and China, is that it is hard to know quite how to slow the economy without tipping it too far. The general rule for a central bank is to try to get ahead of the markets - increasing rates before such increases are expected and certainly before inflation starts to show through. The Bank of England has had some success here, but it is really a bit late for the Fed and the People's Bank of China. Both have yet to act on interest rates and the People's Bank has made only modest moves to curb growth in bank lending - such as increasing the banks' reserve requirements.

So what will happen? Given the scale of the monetary boost in the world's two great growth engines, expect both to grow well this year. It takes a while for curbs on monetary expansion to feed through into the economy and there is not going to be much of a squeeze anyway. So the general perception that growth this year will be pretty strong will turn out to be right. The consensus forecast for the US is that it will grow by 4.7 per cent, while China is expected to push ahead by 8 to 9 per cent.

The more troubling question concerns the price that will eventually have to be paid for this immense monetary boost. Normally, you would expect it to be inflation and, as argued above, there is evidence of more inflation in the pipeline. But the symbiotic relationship between China and the US will keep the lid on inflation. America holds down the price of its manufactured goods by outsourcing more and more work to China. Meanwhile, not only does China help to finance the US budget deficit but its vast pool of cheap labour helps keep its own wage rates down and, through that, keep inflation under control.

So this is not a particularly serious concern this year. But markets have to look ahead, and as 2004 progresses, expect them to focus more and more on the need to re-establish a proper price for that normally scarce resource, money. The danger is not just the threat of inflation; a lot of evidence suggests that if money is too cheap, investors waste it. That is part of the problem in China: too much cash financing too many new luxury residential blocks that will be hard to fill at a profitable rent. As a result, many of the borrowers are unable to service their loans.

My guess is that next year, 2005, will be more of a problem than 2004. The two key things to watch out for will be: in the US, the threat of inflation; in China, signs of a crisis of confidence in the banking system. Both would be the result of an over-expansionary monetary policy. Whatever happens, growth in 2005 is likely to be a bit lower than this year. If either of those dogs bark, then growth could be quite a lot lower.

And because the US and China lead world growth, that will affect all of us. By rights, it should be the turn of Europe and Japan to take over the torch of growth. In reality, this is not going to happen. Japan's present economic bounce is shaky and may not be sustained. Nothing much is going to happen in the eurozone, and the UK economy is not big enough to help a great deal.

Moral? For all of us, expect good news through the summer, but then a rather chillier winter and late spring in 2005.

The state of British education: promising but could do better

"Education, education, education" is the mantra of our political masters - so how are we doing?

I have just caught up with the clutch of research on education from the Royal Economic Society's annual conference earlier this month, and it contains an intriguing mix of good and less-good news. For example, the "literacy hour" in primary schools has had a big impact on improving reading attainment, and some improvement runs through to GCSE level.

The research points out that this is hugely cost-effective, costing some £25 per pupil per year but increasing average lifetime earnings by between £2,000 and £5,500.

Our education system as a whole also seems to be outperforming that of the US. Labour productivity between 1994 and 2001 rose by nearly 1 per cent a year, whereas in the States it fell.

Good returns also come from vocational training, raising the chance that people who have left school without qualifications will get good jobs.

But there are problems too. Too few young people take any form of vocational education, and another study reveals the limited availability of workplace training. This is worrying, given that lower-skilled workers are losing ground, in terms of both jobs and pay, relative to higher-skilled people.

Wage inequality is rising not just in the UK but also in the US, and to a lesser extent in France and Germany. Reasons include the greater need for skills in the new-economy jobs and also the trend towards outsourcing lower-skilled functions abroad.

Immigration of skilled workers from the new EU countries, on the other hand, seems a benefit rather than a threat, at least among richer northern EU members including the UK. Skilled inward migration can increase exports and create jobs - though it may damage the position of southern EU countries such as Spain, Portugal and Greece.

Finally, on the subject of skills, there are a couple of studies on the Welsh job market. Wales is suffering from a "brain drain" as higher-skilled people move out. This, you might think, is bad news - except that another study shows job satisfaction is a lot higher in Wales than in London and the South-east. Trade union members, meanwhile, are less happy than non-members. And Welsh women are happier in their jobs than Welsh men. So there.

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