How can we compete with China?

So what can we do that other people on the far side of the world on one-fortieth of our wages cannot do as well?

Everybody wants China as their friend. And so our Chancellor is spending three days in the crucial run-up to his pre-election budget traipsing round Beijing, Shanghai and Guandong. There is the specific issue of whether Rover can do some sort of life-saving deal with China Brilliance, the Shanghai-based car manufacturer. But I don't think anyone nowadays believes such international commercial matters are much affected by political lobbying, so the reason for the visit must be something else. And no, I don't think our Gordon is seeing what it feels like to be a foreign minister, either...

Everybody wants China as their friend. And so our Chancellor is spending three days in the crucial run-up to his pre-election budget traipsing round Beijing, Shanghai and Guandong. There is the specific issue of whether Rover can do some sort of life-saving deal with China Brilliance, the Shanghai-based car manufacturer. But I don't think anyone nowadays believes such international commercial matters are much affected by political lobbying, so the reason for the visit must be something else. And no, I don't think our Gordon is seeing what it feels like to be a foreign minister, either...

It is much more basic than that. China's economic performance has become the largest single matter determining the shape of the world economy. So if you are invited to go, you turn up.

This year, in all probability, China will pass the UK as the world's fourth largest economy, measured in actual GDP. In another three years or so it will pass Germany to become number three, behind only the US and Japan. China is now the world's largest consumer of four out of five basic food, energy and industrial commodities: grain, meat, coal and steel. And it is second only to the US in the fifth: oil. The US consumes three times as much oil as China but China consumes roughly three times more steel than the US.

This is changing the world. Some of the effects are obvious. The China boom does much to explain the high price of oil. The present oil squeeze differs from previous oil shocks, in that they were triggered by restrictions on supply whereas this one is a function of a surge in demand.

Others are less obvious. One of the reasons why inflation is so low throughout the developed world is imports of Chinese manufactured goods. We don't see this here as obviously as they see it in the US, where most low-value consumer items are imported from China. Last week I was given a coffee mug with a picture of every president from Washington to George W. on it - underneath of course: Made in China. US firms have been under an intense squeeze to cut costs that forced them to outsource whenever and wherever they could. But in Britain the influence has been slower to develop. Yes, we import quite a lot of stuff from China and yes, our own branded companies are shifting production there, but the process is running five years behind the US.

In both the US and UK we are less aware of the imports from China because the brand names are our own. Only 10 per cent of the $500bn (£260bn) exports from China are locally branded products. Your mobile charger says Nokia on the front but underneath it says Made in China. The Ministry of Commerce is trying to boost domestic brands because, until and unless this happens, China is stuck as a producer of commodity-like manufactures. The added margin comes from branding, as the top Japanese companies have so successfully managed to achieve. But this is not easy. A brand, once established and carefully tended, is hard to displace. Indeed the main logic behind the Chinese interest in Rover is access to the brands that come with it.

If the time taken to build Chinese brands is a problem for the Chinese, we in the UK - or indeed in any high-income economy - have a starker one. What can we do that other people on the far side of the world on one-fortieth of our wages cannot do as well?

We have some technological lead but not much. For example, by 2009 about 15 per cent of the Chinese population will have access to broadband - where we were in about the middle of last year. In one of his speeches, the Chancellor referred to China's role as manufacturer to the world and stressed the strong UK position in services. That is fine as far as it goes. But we are now seeing more services - at least those that can be performed over the wires, such as the management of computer systems - being outsourced to India. So what can we do?

There are two ways of answering this, both of them valid. One is to say that we cannot ever know but something will turn up. This Micawberish approach recognises that we never can know what new jobs are around the corner. Take call centres. They hardly existed 15 years ago. So the jobs that are threatened are recent creations. I suppose web-page design may shift too. But wait a minute, there were no web-page designers 15 years ago either. The World Wide Web was only devised in 1989.

The "we cannot know what the new jobs will be" answer, though true as far as it goes, is unsatisfying. I think it is possible to do better and to identify areas where jobs (a) will never be internationally traded and (b) where UK skills will continue to command a considerable premium.

There are some jobs that will always have to be performed on site, so to speak. These include basic services such as the police, construction, most schools, health care and the big mass of personal services from haircutting to pubs and restaurants. But just as these services are hard to import, they are also hard to export. They affect our standard of living and our quality of life but, aside from the impact they have on tourism, we cannot pay for our imports with them.

The second set of jobs will be the ones that bring home the bacon. To do that, two things apply. You have to be good at something; and there has to be a demand for what you do. Mercifully there are several segments of the UK economy that seem to qualify.

Some are at the craft end of manufacturing: luxury boat-building, finishing the insides of Bentleys and so on. Individually these are quite small, but collectively they are big. And fortunately, there seems to be a rising global demand, not least from the new rich in China, for craft-manufactured products.

The other area of manufacturing is the high-tech end, where the manufacturing is attached to a huge amount of R&D. Examples include aircraft engines and pharmaceuticals. Labour cost - or rather the actual manufacturing labour cost - is quite a small element of the total cost of the product. And physical proximity of manufacturing to the boffins improves both aspects of the productive process.

But mostly our competitive advantage is in services. The financial service story is pretty well known, though perhaps not celebrated as it should be. Of course, London's lead could be chipped away but at the moment we seem to be gaining market share in international finance, not losing it.

I suspect that our success in higher education will increasingly come to be recognised and supported. Certainly we should hope so, for the universities have been undermined by insensitive and sometimes hostile policies from both parties. Education exports will be come an area that ought to carry on growing. The Chancellor should note that there are more Chinese students now in Britain than there are in the US. He should also note that his own ill-considered tax changes have almost halved the number of start-up companies a university such as Cambridge is spawning. Own goal there.

The big thought that the Chancellor ought to take away from his travels to China is that UK success stories - such as the universities, or indeed the best independent schools - need to be seen in economic terms. They don't need to be mollycoddled. But they don't need to be attacked - intentionally or otherwise. Provided we focus on what we are truly good at we need not worry so much about competition from China.