Don't crow too soon

Beware crowing. This is going to be the year of the Anglo-Saxon economies. The US and UK, plus Canada and quite probably Australia, are going to grow more rapidly than the Continent of Europe or Japan. This period of relatively rapid growth could last up to three years, and will give a quite different tone both to financial markets and to the whole way in which international economic policy is discussed.

Of course the reason for this outperformance will be largely cyclical. The US and the UK went into the recession before the Continent or Japan and are emerging earlier. But just as, for the past two years, Continentals have been dismissive of UK or US economic performance, so we should expect the obverse reaction: the Continental economy in particular will look pretty sick, and attract the same pity and contempt.

This differential performance will raise a number of analytical questions. These cannot be answered at this stage, if only because no one knows just how bad the Continental and Japanese recessions will turn out to be. But they are worth asking now, before the Anglo-crowing drowns out the messages that the differential economic performances are trying to signal.

Three questions stand out. Do the rather larger manufacturing sectors of Germany and Japan make them more vulnerable to the economic cycle than the service-oriented Anglo- American economies? Is a financial system based on allocation of capital by securities markets more sensitive to the economic cycle than one based on allocation by banks? And will rising unemployment on the Continent lead to a radical rethink of employment legislation in the EC?

On the first, the fall in German and Japanese industrial output is already far greater than the trough of the US and UK output cycles. That fall took place from a higher base - both countries had enjoyed a longer boom before the downturn - but the severity of the decline does demonstrate the danger in having too large a manufacturing sector. Industrial production in Germany and Japan is running close to 8 per cent down year-on-year, and it is hard to see how this can be pulled up.

The Japanese government's economic package this week will help a bit, as might a further cut in German interest rates next Thursday. But economies with large manufacturing sectors tend to depend on exports to boost demand, and that is largely beyond the control of domestic policy.

There has been a lot of debate in Britain and North America about the extent to which manufacturing has been run down, and there is legitimate concern about this. But it is fair to point out that Japan and Germany now face the same sort of structural change that Britain and the US went through in the 1980s: they have to slim down their industries too, and may find it even harder to replace manufacturing jobs with service jobs than we have. Creating new service jobs is a rapid way of boosting employment, much more rapid than creating manufacturing ones.

That leads to the second question: might a different financial system have encouraged an earlier adjustment? Here one has to be very careful. One could certainly argue that had, say, Daimler-Benz been more attentive to the needs of its shareholders' interests, it would have started to slim down much earlier and would not face the quite radical surgery it is now having to carry out. But companies in stock market- driven economies make enormous strategic errors too. And it is very hard to support the argument that, had Daimler-Benz not had a large chunk of its stock held by a bank, it would have been more nimble.

In the coming months many people will argue that the allegedly short-termist bias of the UK and US system is actually a strength, in that it encourages companies to be sensitive to market shifts. But while there is some merit in that argument, we would need to see more evidence of the costs of excessive long-termism in Germany and Japan before we crow too loudly about the excellence of our system.

We should, however, become a little more critical of the overly cosy relationship between German industry and its bankers, as that relationship will come under increasing strain if German industry continues to underperform.

The hottest political debate, though, will be the extent to which the Continental European social welfare system - which is financed to a much greater extent than in the UK by levies on employers - actually increases unemployment. While UK unemployment remains at or a little above the EC average this sort of debate does not take place. But UK unemployment ought to turn down long before unemployment in the rest of the EC.

If it does, and UK unemployment dips below German some time early next year and is far below French levels, then this debate will come forward. It should certainly not become grounds for cheering, for UK unemployment will remain high by US standards. But it may look quite good in EC terms.

As we feel more self-confident, there will be a great temptation not just to crow, but also - and more seriously - to make mistakes. It is hard to believe that we will make another macro-economic error and allow a runaway boom to take place - we surely cannot be as stupid as that. But we might ease up on the painful process of structural change that has been carrying on, in different ways, since the middle 1970s. That is the real danger: not that we become conceited, but rather that we become complacent.