Europe's Declining Working Age Population

Investing.com — A declining working age population, previously confined to East Asia where Japan and South Korea have battled economic challenges due to a diminishing labor pool, is now affecting Europe. This demographic shift raises significant concerns regarding its economic impact.

Overview of the Issue

According to Morgan Stanley's Future of Europe Bluepaper, published on Oct. 9, the working age population in the euro area is projected to decline by 6.4% by 2040. This reduction is expected to result in a 4% hit to euro area GDP in the same timeframe.

As working age populations decrease, fewer individuals contribute to economic output and productivity, adversely affecting GDP, particularly when coupled with an aging demographic.

Not all countries in the euro area will experience this decline equally. Italy, expecting a shrinkage of up to 10% in its working age population from 2025 to 2040, faces the steepest challenges. In contrast, France, with a more favorable demographic outlook, is likely to be the least affected.

Lessons from Asia: Japan and South Korea

The demographic challenges in Europe are not new; Japan and South Korea have dealt with these issues for decades. These Asian economies provide insights and examples of how to manage the dilemmas of aging populations and declining birth rates.

Japan has implemented various policies, including increasing female labor force participation, raising the retirement age, and welcoming more immigration. Yet, these measures have seen limited success due to cultural norms and economic pressures that discourage higher birth rates. Japan’s fertility rate has remained below 1.5 for three decades, with a record low of 1.26 in 2022, according to the Center for Strategic and International Studies.

Europe might consider a mix of these Asian policies to address its demographic challenges.

Proposed Policies to Mitigate Economic Impact

Three policy options suggested by Morgan Stanley to counteract this demographic crisis include:
1. Increasing net migration
2. Raising the effective retirement age
3. Closing the gender participation gap in the workforce

These strategies could contribute between 1.3% and 2.5% to baseline GDP for the euro area by 2040. However, the effectiveness of these policies varies by country, with Germany, the UK, and Spain potentially benefiting most from increased net migration. Italy could see the greatest improvement by addressing gender labor participation gaps, currently 8% below the euro area average.

Increasing net migration by one standard deviation relative to historical levels could boost euro area GDP by 1.8% by 2040. Closing the gender gap could yield a 2.5% increase, while raising the retirement age by one year might add 1.3% to GDP, especially benefiting France and Spain.

Corporate Impacts and Earnings Growth

This demographic challenge is already influencing European corporate outlooks. Without policy intervention, Morgan Stanley estimates can lower long-term corporate earnings growth from 5.1% to 4.2% by 2030. Conversations about the aging population are increasingly common among European executives, particularly when compared to US firms.

Role of AI and Automation

The estimated hit to corporate earnings assumes no increase in margins or productivity gains from AI and automation, which could mitigate some negative impacts. Morgan Stanley anticipates noticeable productivity boosts as companies continue investing in AI and automation, likely evident by 2024.

Germany's industrial robot density, for example, is significantly lower than South Korea's, suggesting considerable room for improvement through automation technologies.

Conclusion

As Europe navigates this demographic shift, it must urgently find solutions to mitigate economic repercussions and ensure sustainable growth. While Japan and South Korea's experiences provide valuable lessons, Europe needs to adapt these strategies to its unique social, political, and economic landscape. Key actions include implementing effective policies to increase migration, adjust retirement ages, and boost female workforce participation, while embracing technological advancements to address productivity gaps. The success of these initiatives hinges on their alignment with societal values and economic objectives.