Slide Slide 11Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

Two Economic Challenges

1) Slow GDP Growth

2) Maintaining the Social Welfare System

Slide Slide 22Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

What is GDP?Or, how do we measure the size of an economy?

• Gross domestic product (or GDP) is the total value of all the goods and services produced by an economy

• Cars

• Cappuccinos

• iPods

• Insurance policies

• Haircuts

The US is the world’s largest economy. It has the highest GDP

If the euro area is counted as a single economy, it would be second largest

Slide Slide 33Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

How can we compare the standard of living?

• GDP per capita – total GDP divided by the population size, tells you the average standard of living (how “rich” or “poor”)

US GDP = $13 trillion. US Population = 300 million

Luxembourg GDP = $25 billion Luxembourg Population: 0.5 million

Slide Slide 44Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

Measuring GDP growth

Our GDP measure can increase because:

a) The economy produces more goods and services

b) The prices of goods and services increase

We are only interested in (a), the real increase!

-

Nominal GDP growth Inflation

=

Real GDP growth

Slide Slide 55Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

Explaining differences in living standardsExplaining differences in living standards

Euro Area (15) United States

(2008) (2008)

GDP (USD billions) 14 043.78 14 294.5

Population (million) 320.1 305.5

GDP per capita (USD) 43 873 46 790

Employment rate 54% 62%

Hours worked per employed person 1,600 1,781

Output per hour worked (USA = 100) 87 100

Slide Slide 66Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

Does GDP per capita measure “quality of life”?

Euro area GDP per capita is only 70% of US level, so the standard of living is lower in euro area on this measure

But Europe has:

• Much longer holidays!

• Slightly higher life expectancy

• Notably lower infant mortality

• Lower poverty and earnings inequality

• Lower levels of crime and violent crime

• Universal health care

Slide Slide 77Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

How do we raise the rate of economic growth?

If the economy is experiencing weak growth, sometimes the solution is to change macroeconomic policy and stimulate the economy.

Imagine you are driving a car.

If you want to go faster, you step on the gas:

• Monetary policy – reduce interest rates

• Fiscal policy – cut taxes, raise government spending

Slide Slide 88Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

Macroeconomic policy must avoid generating inflation

But if policy is too loose, this can lead to higher inflation. This is like driving too fast and going into a skid.

Avoid a skid (ease off the gas and gently apply the brakes):

• Monetary policy – raise interest rates

• Fiscal policy – raise taxes, cut government spending

Slide Slide 99Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

Driving at a safe speed: the potential growth rate

The rate at which an economy can safely grow without triggering higher inflation is called the potential growth rate. This rate will differ between economies.

€ area: 2% to 2.2%? US: 2.5% to 3%?

The potential growth rate depends on the growth of the labor force as well as productivity growth. Higher employment Higher employment ratesrates, longer hours worked and more productive workersmore productive workers all help to raise the potential growth rate.

Slide Slide 1010Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

Productivity is a key determinant of long-term growth

• Productivity – a measure of how much each worker produces

Marie-Claude Karl-Heinz• Marie-Claude designed 5 web sites

• Karl-Heinz designed 8 web sites

• Who is more productive?

• Marie-Claude worked 200 hours

• Karl-Heinz worked 400 hours

• Now who is more productive?

• Web sites designed per hour – Marie-Claude: 0.025, Karl Heinz: 0.020

• Marie-Claude has a higher hourly productivity than Karl-Heinz

Slide Slide 1111Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

Slow growth and high unemployment raise concerns

• In the recent past, Europe has suffered from slow growth, high unemployment and low productivity growth

• Labor and product markets less flexible than the US, harder to deal with economic shocks, globalization, etc

• Low productivity growth seems to stem from low investment in information and communications technology (ICT), less use of ICT relative to US, low R&D spending and relatively low workforce skills

Slide Slide 1212Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

*Also called Lisbon Agenda or

Strategy for Growth & Jobs

http://ec.europa.eu/growthandjobs

• The Lisbon Strategy* was adopted in 2000 to create a more dynamic and knowledge-based EU economy

• Initial results disappointing, Lisbon re-launched in 2005 with clearer focus

• Key objectives: raise R&D spending to 3% of GDP, raise employment rate to 70% by 2010

• Structural reformsStructural reforms now contributing to better economic performance in Europe (higher productivity and employment rates), but more reforms needed, e.g. to cope with ageing

The Lisbon Strategy: Europe gets a tune-up!

Slide Slide 1313Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

Challenge #2: Sustaining the “social welfare system”

- What is a social welfare system?

- Does Europe have one or many?

- What does it mean to have a system that’s “sustainable”?

Slide Slide 1414Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

What is a social welfare system?

• Pensions

• Health care

•

• Unemployment benefits

Slide Slide 1515Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

Europe has many types of social welfare system

There are (at least) four different European models

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Scandinavian: high employment, low inequality

English-speaking: high employment, high inequality

Rhineland: low employment, low inequality

Mediterranean: low employment, high inequality

Slide Slide 1616Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

Why is welfare system “sustainability” at risk?

16

• The “old-age dependency ratio” will rise due to fall in birth rate, fall in death rate and retirement of “baby boomers”

• 2000: Four people of working age for every one retired person

• 2050: Only two people of working age for every retired person

Europe is Ageing Rapidly!

Slide Slide 1717Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

Economic consequences of changing demographics

What happens to the economy when the working-age population shrinks?

• EU growth rate will more than halve by 2050 (fewer workers)

• Reduction in potential growth

• Social model under stress (fewer taxpayers, more social spending, e.g. on pensions, health care, long-term care)

Slide Slide 1818Nigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionNigel Nagarajan, Counselor, Head of Economic and Financial Affairs SectionDelegation of the European Commission to the United StatesDelegation of the European Commission to the United States

Sustaining the Social Welfare System

• Can Europe still afford its Welfare States?

• Does it need to adapt its social model?