Hamish McRae: A tale of two worlds: the 'new' one powers on, the 'old' one chugs along

The forecasts for the coming year, both for the world economy and for financial markets, are being brushed up. Will another year of reasonable, though slowing, world growth be enough to sustain the markets? Or will the evident slowdown in the US economy unsettle things? Or are we perhaps focusing too much on the developed world when we should be looking at the growth of China and India?

If the string of questions is long, the range of possible responses is huge. We are in a period of transition, when each year the balance of the world economy shifts just a little towards the so-called emerging economies and away from the developed ones. For the time being, what happens in the "old world" economies remains more important than what happens in the "new world" - but the "new" are growing far faster. So we have to balance what we can reasonably expect, from our experience of past economic cycles, of our own economies, with the greater uncertainties in the rest of the world.

The difference in performance is stark, as you can see in the left-hand graph. This comes from Lehman Brothers and gives a useful snapshot of growth this year and how it might evolve in 2007 and 2008. On the left you can see global growth, a touch under 3 per cent this year but falling to just over 2 per cent next year, before recovering a bit in 2008. Growth is projected to slow in all developed regions next year, with the US coming down to 2.5 per cent, the UK to 2.3 per cent (way below our Gordon's estimate) and the eurozone to 1.7 per cent. Japan slows a bit too. (These are central estimates rather than best- or worst-case scenarios, which Lehman also gives.)

The emerging economies are grouped into two: Eastern Europe, including Russia, plus South Africa; and Asia ex Japan, which is basically China, India and South-east Asia. These are expected to continue pretty much unaffected, with the European group remaining at or above 5 per cent and the Asian ones at or above 7 per cent.

So the proposition is that a marked slowdown in the "old world" will be contained, while the "new world" will continue pretty much unaffected. Lehman notes that much depends on the US housing market and it acknowledges a gloomier view holding that the slowdown next year could presage a fully fledged downturn. But it reckons the US will keep growing through 2007 and that by 2008 the Federal Reserve will be cutting interest rates again.

Lehman's projections for the main central bank rates are shown in the right-hand graph. As you can see, we get another quarter per cent on UK rates early next year, but by the end of 2007 the cost of borrowing will be back to 5 per cent. Euro rates will stay under 4 per cent, which seems about right given the lacklustre growth forecast for the zone.

All this seems pretty sensible. It is what ought to happen, given what we know about economic cycles in the developed world. But each cycle is different and this one will be the first when the emerging economies are almost as important as the developed ones.

So the question is how the emerging economies will react. Will they, as these forecasts suggest, continue to be an engine of growth or will they depend on Western demand to keep them growing?

We have no guide because this cycle is different in its balance from previous ones. However, we can see some basics. For example, if energy prices remain high, Russia and the Middle East will continue to do very well. But that will not necessarily pull the rest of the world along, for both regions are building up huge cash piles that they cannot currently spend.

The growth momentum in China is clearly self-sustaining, in that a huge amount of consumer demand remains unsatisfied. So in theory it should be possible to compensate for any shortfall in demand in the US by switching to the domestic market. For the moment, though, the problem is trying to keep a cap on growth. Given that the building boom, too, will continue at least until the Olympic Games in 2008, China does seem set to expand in at least the high single figures, and that will sustain demand for raw materials. On present trends, China will pass Germany to become the world's third-largest economy some time in 2008.

India? The business community there is currently tremendously self-confident and all the forecasts I have seen suggest growth continuing at the recent 6 to 7 per cent rate. It remains a much smaller economy than China's, so its impact on global issues such as the demand for commodities is less marked. Still, each year at that rate makes India a more important economic power.

So that is the most likely picture for 2007: slowing developed economies and booming emerging ones. There seem to me to be three main risks, the first two of which follow directly from the analysis above. One, widely appreciated, is that a stalled American housing market will slow the US more than currently expected. A second, less widely remarked on, is that were the "old world" to falter, it would have knock-on effects on the "new world" that aren't yet fully understood.

The third follows indirectly. It is that the present financial flows between the "old" and "new worlds" - with the US in particular borrowing so much from the latter to sustain demand - are putting strains on the global banking and investment mechanism which are also not fully understood. This has been a wonderfully profitable year for international finance, the best ever, for vast amounts of money have been hunting for homes. But as central bankers have repeatedly warned, these financial flows carry risks.

What does this mean for us in the UK? The most obvious point is that we need to be prepared for higher interest rates, though just how high remains to be seen. At some stage and at some level, the housing boom must come to an end. We may also need to be prepared for higher taxation, because slower growth than the Treasury expects would further unsettle public finances.

But while there are risks, no obvious disaster is looming. Next year should be another one of reasonable growth. It will just feel a bit tougher.

Another, obvious, change for the UK next year will be a change of chancellor. Reason says that this should not have any impact on our economy, just as the much-larger political change in 1997 had no discernible economic impact. The steady growth that had been established just continued.

But if reason says no change, what does emotion say? More caution? Time to rebuild savings? It shouldn't be a bad year in economic terms, but it may feel a rather different one.

Museums have more fans than football

The new killer fact I learnt last week is that more people in Britain go to museums than to football matches. The heaviest hitter in football is Manchester United, which in 2004-05 had just under 1.3 million attending its matches; the heaviest hitter in museums is the Tate, which had 6.3 million visitors.

In fact, Man Utd was the only football club above the million mark, with the British Museum, the National Gallery, the Science Museum and the Natural History Museum all in the three to five million range.

People have to pay to go to a football match, of course, while museums are free. Still, if you are trying to measure interest, 43 per cent of the UK population visited a museum in the previous year, whereas according to a Mori survey in 2005, only 41 per cent of the population confessed to being interested in football.

These statistics come from a report by Professor Tony Travers of the London School of Economics, which the museums are using to beef up their case for more state support. There has been a squeeze on funding: income has been flat in real terms whereas the number of visitors has been rising.

The report makes a further point on the long-term direction of the economy. This was summed up by James Purnell, when he was Minister for the Creative Industries. "In the last eight years," he said, "the creative industries have grown at twice the rate of the British economy, creating three times as many jobs and exporting four times as many goods and services. People ask politicians where the jobs for the future will come from in an increasingly globalised world. Part of the answer is the creative industries."

But we are now going into a squeeze on public spending, and the museums need a Plan B. This would be to follow rather more closely the US model, which relies on private sector help .

Meanwhile, though, they deserve a fair wind with the Government.