A new arms race will erupt if Russia cannot agree with the west about a joint European missile defence programme, the Russian president warned today.

A Nato summit this month proposed an alliance missile shield and invited Russia to participate. Questions remain about possible joint command of such a system.

Dmitry Medvedev, in his annual address to Russia's houses of parliament, said: "In the next 10 years, the following alternatives await us - either we reach agreement on missile defence and create a full joint co-operation mechanism, or, if we don't go into a constructive agreement, a new phase of the arms race will begin. And we will have to make a decision on deploying new means of attack."

The Russian president also pledged his support for the Nato suggestion.

Experts from both sides will meet next month to consider linking Nato and Russia's systems to provide a shield against missiles from rogue nations. They will deliver a report to defence ministers in July.

Much of Medvedev's address focused on social and economic concerns, with comparatively brief and broad comments on political reforms and corruption.

He called on legislators to improve the lives of children and suggested giving land to families with three or more children. He said they should also be given a supplement of 3,000 rubles ($100) a month.

The focus on encouraging larger families reflected concern over the demographic crisis engulfing post-Soviet Russia. A high mortality rate and a declining birth rate have caused the population to shrink by 7 million from its 1991 high. However, the country reported a small population increase last year, to 141.8 million.

Medvedev told legislators in the Grand Kremlin Palace: "The 26 million children and adolescents living in our country should fully develop, grow up healthy and happy and become proper citizens - this is task number one for all of us."

Opening the address, he said Russia's budget deficit needed to be lowered for the country to develop effectively, adding that he aimed to reduce inflation from 7.4% to 4 or 5% in the next three years.

Russia is running a budget deficit for only the second time in a decade. It stands at 2.1% of GDP, though that figure is expected to rise to 4.6% because spending typically increases toward the end of the year.

The country is forging ahead with an ambitious five-year plan to sell stakes in prized state companies, such as the oil company Rosneft and the banks Sberbank and VTB, to raise some $40bn for state coffers. Medvedev said the proceeds would be used to fund a modernisation drive.

The president lamented that regional administrations often owned assets unconnected with their functions. "Authorities must not be the owners of factories, papers and steamships," he said, quoting a poem by the 20th-century poet Vladimir Mayakovsky, adding: "Everyone must stick to their own thing."

That remark hints at wealthy regions such as Moscow, which owns shares in several lucrative companies, including a major bank and a refinery.