We don't manufacture anything any more. Most of the world won't buy our records or watch our films. Only our gift of the gab is keeping Britain's economy ticking over. But how long can the hot air last, ask Larry Elliott and Dan Atkinson

We all know what the Germans are good at. They do precision engineering: all those quietly humming washing machines and the cars with their sleek bodywork and gleaming chrome. We also know that Germany is a country in serious trouble, failing as it has to embrace the need for flexibility in the tough new global environment. We know this because Gordon Brown has told us many times over the past 10 years that the European model is washed up.

Germany was so abysmally competitive last year that it ran a record trade surplus and was the biggest exporter of any country in the world.

We know what the Japanese excel at also. In Tokyo and Nagoya there are world-beating companies in the field of electronics, designing the latest consumer gizmos. We know, too, that despite Sony, Panasonic and Mitsubishi, Japan, like Germany, is a country in serious trouble. It, too, has tried to stick its head in the sand and persist with an industrial model that may have worked in the 1960s and 70s but is an anachronism in 2007. Poor, washed-up Japan ran a trade surplus of around £50bn last year as it found a ready market in China for its exports.

Before he came into politics, Blair was a lawyer, as was his industry secretary Alistair Darling and the transport secretary Douglas Alexander. Brown's sole experience of the go-getting world of the private sector was as a journalist for Scottish Television. Not that the other parties are much different. David Cameron prepared for the task of repositioning the Conservative party by acting as PR for Carlton TV in the 1990s. He was described by one business editor, the Sun's Ian King, as a "poisonous, slippery individual" and a "smarmy bully who regularly threatened journalists who dared to write anything negative about Carlton". When you get down to it, this is a country that tries to make its living from talk, talk and more talk.

But how has Britain fared when it comes to paying our way in the world? Have the traders in the forex markets and the regulars at the Groucho Club earned enough to make the UK's age-old problems with the current account a thing of the past? Sadly not. Britain still has a world-class pharmaceutical industry, and still makes a tidy sum from selling arms abroad, often to some pretty unsavoury regimes. Yet the deficit in visible trade in goods - stuff we make - was more than £60bn in 2006. That's around 5% of GDP, far bigger than anything the UK has witnessed in the postwar period. Trade in services - accountancy, insurance, banking, architecture, advertising - brings the deficit down to around 4% of GDP. But for the past decade, the only thing that has made the deficit manageable is that Britain has been earning more money on its investments abroad than foreign investors have made here. One way of looking at Britain is as one big offshore hedge fund churning speculators' money while asset-strippers draw up plans for the few remaining factories to be turned into industrial theme parks.

That is not the way the government sees it, naturally. Labour believes Britain is at the cutting edge of the knowledge economy and that Britain's well-educated (sic), highly skilled (sic) and entrepreneurial (sic) workers are ready to kick German, American, Japanese and Chinese butt all round the global village.

The essence of successful 'bullshit' is that the really top-notch exponents not only manage to convince others but also manage to delude themselves. Some explanation has to be provided for Britain's increasingly lopsided economy, dominated as it is by those not-so-heavenly twins, the City of London and the housing market. And the explanation is that the UK's future lies not, as might seem apparent at first glance, in the drinking factories, the estate agencies and the clothing chains that make up Britain's monochrome Identikit high streets, but in the knowledge economy.

Well, we did warn you that the bullshit merchants are good at what they do.

We'll return to the creative industries, but you have to admit that Britain as the world's creative hub sounds a lot more impressive than saying that Britain is at the cutting edge of the call-centre economy, even though the number of people answering phones and inputting data into computers in white-collar industrial sheds now stands at just under one million. And it really would not do to say that Britain is a servant economy, even though there are at least four million people "in service" and the proportion of the population employed by the well-off to do their cooking, cleaning, childcare and gardening is as high as it was in the 1860s.

Well, we did warn you that the bullshit merchants are good at what they do.

We'll return to the creative industries, but you have to admit that Britain as the world's creative hub sounds a lot more impressive than saying that Britain is at the cutting edge of the call-centre economy, even though the number of people answering phones and inputting data into computers in white-collar industrial sheds now stands at just under one million. And it really would not do to say that Britain is a servant economy, even though there are at least four million people "in service" and the proportion of the population employed by the well-off to do their cooking, cleaning, childcare and gardening is as high as it was in the 1860s.

This, in the modern political jargon, is not the right sort of narrative. The idea that millions of people are toiling away in menial, low-paid, low-skill jobs jars with the impression Blair and Brown wish to convey: that Britain is an exemplar of how vigorous and committed western nations can ready themselves to meet the challenge from Asia. This, though, has proved only a minor difficulty. In Bullshit Britain you simply come up with a different kind of reality that provides you with the sort of narrative you prefer.

Robotic toy

The story as far as New Labour is concerned is that our failure in the second half of the 20th century to exploit the potential of higher consumer spending on cars, washing machines, hi-fis and personal stereos has actually left us better placed to exploit the sunrise industries of the 21st century - biotechnology, robotics, environmental protection, pharmaceuticals. Successful economies will require brains more than brawn, and Britain is full of smart people.

There is an element of smoke and mirrors in all this, however. It is true that as countries develop, the number of people employed in services tends to go up. The reason for this is that productivity growth in manufacturing is much faster than it is in services: it takes far fewer hours to make a car today than it did 100 years ago, but the same time to cut someone's hair. It is also true that each wave of capitalism since the industrial revolution has been based on a distinctive technology: coal and steam, then railways and electricity, then mass transportation and consumer goods. Although the vast numbers of poor people in India and China (let alone Africa and Latin America) suggest there will still be strong demand for consumer durables and machine tools for a good while yet, information technology and the human genome may be at the centre of the next long upswing.

But how do you square this with what's happening in Britain? It's simple: Britain has a long tradition of excellence in science, especially chemistry, and the government's commitment to the knowledge economy is evident from its target of ensuring that 50% of young people go to university. New Labour, therefore, has a neat syllogism. Britain is turning out more and more graduates. They are entering the workforce with the knowledge they have acquired through the education system. So, work is becoming more knowledge-based.

The problem, though, is that the syllogism is false. Many graduates are doing fairly menial jobs for which they do not need a degree (or anything like it). Research by Essex University's Institute for Social and Economic Research in 2002 found that a third of men and 41% of women were overqualified for the first posts they took up after graduating. As James Heartfield's study Great Expectations: The Creative Industries in the New Economy found, most employment growth has been, and will continue to be, at the low-skill end of the service sector - in shops, bars, hotels, domestic service and in nursing and care homes. The fastest-growing occupation in the UK between 1992 and 1999 was hairdressing.
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Extracted from Fantasy Island, by Larry Elliott and Dan Atkinson, published by Constable, £7.99. To order a copy for £7.99 with free UK p&p go to guardian.co.uk/bookshop or call 0870 836 0875.