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Andrei Illarionov, Former Adviser for the President of Russian Federation
EUROPES ECONOMIC AGENDA: HOW TO STIMULATE ECONOMIC GROWTH IN NEW EUROPEAN DEMOCRACIES?

Good morning, Ladies and Gentlemen!

Its a real pleasure and high honor for me to be here and to have a chance to discuss the issues of common European Agenda. The topic for our second panel is Europes Economic Agenda. We have four questions and six people at the panel. So we dont have too much time for each of us to discuss all of these issues. As I am going first, Ive chosen to touch upon the first question that has been put here - How can the European Union stimulate economic development in Europes New Democracies?

Frankly to speak, I dont know precisely what is understood under the title Europes New Democracies? And what is Europes Old Democracies? Therefore, I would assume in my comments that New Democracies are ten new members of the European Union. Maybe it is not completely correct, but for making a point I hope it could be acceptable.

I have prepared a short presentation under the title Europes Economic Agenda. How Can We Stimulate Economic Growth in Europes Democracies?

First of all, we have to look into the relative position of the European Union, EU-25, relative to the United States of America. In 1950s, 1960s and even in 1970s the European Union was closing the gap between Europe and the United States in terms of GDP per capita. It was doing it pretty rapidly, having achieved remarkably high level in GDP per capita by beginning of 1980s. But since 1982 the trend went in opposite direction. Over the last 24 years GDP per capita in the EU-25 countries as a ratio to the United States has fallen from 72% to 66%.

We shall move from the EU-25 to the EU-15, to the so called Old European Democracies. We have very similar picture GDP per capita in the EU-15 as a ratio to the United States of America fell from 79% in 1982 to 73% in the year of 2006. We do see that Europe was lagging behind the USA. It is especially dramatic, since we know that the United States of America was not a world champion in terms of economic growth. Therefore, the growing economic backwardness of significant part of Europe is perhaps one of the most serious challenges for it.

But this conclusion is not correct for all Europe. There is a group of countries within the European Union that has a quite different trend. While EU-15 is gradually falling in terms of GDP per capita from 78% to 73% over last 15 years, New European Democracies, EU-10 (those ten countries that joined the European Union in 2004), do have their GDP per capita grown from 30% to 37% over same 15 years. It was a pretty remarkable achievement.

So, the very question that have been put here How Can the European Union Stimulate Economic Development? can be transformed into the question Whether It Is Necessary to Stimulate Economic Growth, if New European Democracies do already grow fast? Assuming the low starting point and still low current level of economic development in New European Democracies, we can conclude that there is some room for their improvement to close the gap with the advanced part of Europe.

Assuming that both trends we are observing over the last fifteen years will continue, one would take approximately thirty years for New European Democracies, NED-10, to reach EU-15 level.

But here would come time for the most interesting question. Since rate of economic growth in NED-10 is almost twice faster than in EU-15, the very intriguing question would be why? Why growth rates in two parts of Europe are so different?

As we know, many factors of economic growth do exist, there are different explanations of those factors, and there are thousands of economists that are quite busy developing different models, producing different advices to authorities what is to be done. Let me contribute to this debate and provide simple explanation of this difference and based on it suggest a modest advice.

The difference has simple explanation. It is a so-called size of government. Size of government is generally understood as the share of government expenditure in GDP. Size of government (as a share of GDP) in EU-15 over the last fifteen years was 48% on average, in New European Democracies 41%.

We can produce a chart, as you can see here, to plot government expenditures as a share of GDP vs. a real GDP per capita growth rate over the last twelve years since 1994. that is period when all countries of the current European Union did grow after the end of economic crises in Estonia, Latvia and Lithuania. You can see pretty clear negative correlation between the size of government and economic growth in European countries. The countries that in the European Union lagging behind most are those that are located in far right lower corner of the chart. They do have size of government larger than 50% of GDP and between 1 and 2,5% annual growth rate in terms of GDP per capita. The countries that are in a very far left upper corner, including Lithuania, Ireland, Latvia and Estonia, did enjoy the fastest economic growth in the European Union over the last twelve years between 5,5 and 6,5% per annum.

What is common in those four countries? Size of the nation? At the very first glance all of them look relatively small. But Malta and Luxembourg are even smaller in size of their economy, but their GDP per capita growth rate is lower around 3%. The main factor that put those four countries much ahead of other members of the European Union is the size of government. In all of those countries government expenditures as a share of GDP over the last twelve years was less than 38%. It is one of the most important factors of the impressive economic growth in those countries.

If we look into medium term perspective, we will see that since 2000 the size of government increases in both EU-15 and NED-10. Slowly, gradually, but it increases.

Here, let me conclude with three main conclusions.

The size of government and economic growth have inversed correlation for EU economies. This inversed correlation was known before. But it was confirmed once again for Europe.

Nowadays, New European Democracies are not too overburdened by the size of government. Due to that they do have faster economic growth compare to other members of the European Union.

But continuation of expansion in size of their governments presents the most serious threat to economic growth in all parts of Europe, both in Old Europe as well as in New Europe.

Thank you.





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