Hamish McRae: How to deal with a nation which makes 40 per cent of the world's socks

Ultimately the only defence against cheap imports is to use our brains to justify our wage levels

Whenever the world economy is struck by a new shock, there are winners and losers. That happened during the great inflation of the 1970s, the successive oil shocks, the currency devaluations, and naturally the advent of new disruptive technologies from the steam engine to the internet.

What we are seeing now is the impact of a new huge player in international trade. For China is not only the world's lowest-cost producer of manufactured goods, it also has the ability to expand production to such an extent that it can out-produce everywhere else. Thus the country makes about 40 per cent of the world's socks - all right, I know it also has 20 per cent of the world's feet, but that is not the point. The point is that it could, in two or three years, expand production so that it would produce all the world's socks if it decided to do so.

There are some historical parallels of dominance by a single producer. There was the scale of British cotton and shipbuilding in the 19th century, the opening up of the US prairies, which cut the world price of agricultural produce, and the domination of mass manufacturing by the US in the middle years of the 20th century. But what is happening is big by any standards. It is, for example, much more important than the advent of Japan on the world trade scene from the 1960s onwards. While Japan was initially a very low-cost (and high-quality) producer and could undercut most other developed countries, it did not have China's abundant supply of cheap labour. Its costs soon rose, eliminating that advantage.

We are still in the very early stages of this rise of China on the world economic stage, but we can already see its effects. There are many winners, apart from the 400m or so Chinese people who have over the past 20 years been lifted from subsistence levels to some sort of middle-class lifestyle. These winners obviously include US and European consumers who are able to buy cheaper goods and hence have more money to spend on other things. Less obviously, they include working people in other countries in Asia, for China has become an important market. It is Singapore's largest export market and a great one for Indian manufactured goods: India now has a trade surplus with China, a lot of that the result of component exports.

But there have been losers. These naturally include the textile producers in Britain and on the Continent, where employment has been shrinking for many years. They also include developing-world textile producers, including countries such as Bangladesh, which have comparable wage levels to China but don't have the investment or the infrastructure that China has developed.

The classic economic response to any such event is to develop other specialities - to go up-market - so that the cost disadvantage is not so serious. Britain has been particularly successful, at least from the point of view of the economy as a whole, in developing other industries and creating other forms of employment. Some other European countries, most obviously Italy, have been less successful.

Nevertheless - and this is absolutely fascinating - the speed of change of fashion in Europe has given lowish-cost producers in Eastern Europe, Spain and Morocco the edge over China. Thus in the case of the fashion chain Zara, it can get new designs to the shops faster than the designers can design them. If some line starts to walk out of the shops, it can get in new stock in a couple of days - not something you can do if you are making up in China.

The most extreme example of this need for physical proximity is in Paris, which still has a sizeable garment making-up capacity. If goods in a boutique start selling fast in the morning, one phone call and bundle of replacement stock can be on the racks that afternoon.

The big point here is that while China can out-produce the world in low-cost manufactured products, there are many opportunities for higher-cost producers to fight back. We certainly don't want to try and compete by squeezing our wages down, so we have to figure out ways of justifying being high-cost. These include using craft and design skills, witness the production of craft-skill cars, such as Bentley and Aston Martin, and top-range boats, such as Sunseeker. And even when our production costs are too high, much of the margin is in design and marketing, witness the success of Dyson vacuums.

There are, and will continue to be, two main problems and these are the legitimate concerns in trade negotiations. One is the suddenness of trade shifts, for adjustment to these takes time. The other is that some areas - or regions or even countries - will find it very difficult to adjust, however hard they try.

The time factor matters a lot because China does seem to have targeted particular industries with the aim - so it would seem - of wiping them out. So it is reasonable for General Mandelson's cohorts to try to resist the invaders. This is not just a matter of bras and knickers; there is also a case for slowing imports of bicycles and other bottom-end products. But ultimately, the only defence against cheap imports is to use our brains to justify our wage levels, so the aim should be to buy time, not to keep cheaper goods out forever.

The second set of problems is more intractable. We in Britain have the flexible markets and entrepreneurial skills that can find other ways of earning our living. But if you are a textile producer in Bangladesh, it is harder to know quite where your future comparative advantage will lie.

There are other examples of highish-cost producers displaced by a low-cost one - West Indian bananas by Central American ones, for example. But the scale and cost advantages of China present a challenge of a different order of magnitude from anything in recent global experience. There is no magic wand to solve this: trade restrictions may help for a bit, but they only buy time. In any case, it is hard to argue that the interests of a poor worker in one part of the world should be valued higher than the interests of an equally poor person in the other. The only way forward is to examine success in similar situations, to identify how that has been achieved and to nudge producers in promising directions. Meanwhile, back in Europe, it is pretty unhelpful to waste energy attacking a hapless EU commissioner.