How Significant is the Issue of Europe’s Declining Working Age Population?

Europe’s Declining Working Age Population: Challenges and Solutions

The issue of a declining working-age population, previously associated primarily with Asian economies like Japan and South Korea, is now becoming a pressing concern in Europe. This demographic shift raises significant questions about the economic implications for the region.

Recent projections indicate that the working-age population in the euro area could decline by 6.4% by 2040, which could lead to a 4% reduction in GDP for the region. As the working-age cohort diminishes, fewer individuals contribute to economic output and productivity, especially when combined with the fact that populations are aging.

Not every euro-area country will experience the same level of impact. Italy, in particular, is expected to face severe challenges, with its working-age population projected to shrink by as much as 10% between 2025 and 2040. In contrast, France’s demographic outlook appears somewhat more favorable, positioning it to be less affected among major economies.

Lessons from Asia: Insights from Japan and South Korea

Europe is not the first region to grapple with a demographic crisis; Japan and South Korea have faced similar challenges for years. These countries, having dealt extensively with aging populations and declining birth rates, provide critical insights into potential responses.

Japan has implemented a range of policies aimed at mitigating its demographic issues, including increasing female workforce participation, raising the retirement age, and cautiously permitting more immigration. However, these measures have achieved limited success due to deep-rooted cultural norms and economic pressures that hinder higher birth rates. Japan’s fertility rate has remained below 1.5 for the past 30 years, hitting a low of 1.26 in 2022.

Europe could draw from these experiences when formulating its own strategies to combat demographic decline.

Policy Solutions to Mitigate Economic Impact

To address the challenges posed by demographic decline, Europe may consider three key policy options: increasing net migration, raising the effective retirement age, and closing the gender gap in labor force participation.

According to analysis, these policies could potentially add between 1.3% and 2.5% to baseline GDP for the euro area by 2040. However, the effectiveness of these strategies will depend on the timely implementation and the specific circumstances of each country. For instance, Germany, the UK, and Spain are expected to reap the most benefits from increased net migration, while Italy could gain significantly by narrowing the gender participation gap in the workforce.

Enhancing net migration levels relative to historical averages might boost euro area GDP by about 1.8% by 2040. Similarly, closing the gender gap in labor force participation could contribute up to a 2.5% increase. In Italy, where female labor force participation currently lags behind the euro area average by 8%, reducing this gap could have substantial positive effects.

Raising the effective retirement age by one year is estimated to lift euro area GDP by 1.3% by 2040, particularly benefiting countries like France and Spain, where the retirement age is below the European average.

Corporate Earnings Outlook

The demographic shifts in Europe are already affecting corporate expectations. Without proactive policy measures, it is projected that long-term corporate earnings growth could drop from 5.1% to 4.2% by 2030. The topic of an "aging population" is becoming increasingly common in discussions among European executives, marking a contrast with trends observed among US companies.

The Role of AI and Automation

The anticipated downturn in corporate earnings does not account for potential boosts from productivity enhancements through AI and automation, which could help mitigate some of the negative impacts. Companies are likely to begin seeing the benefits of their investments in AI and automation in the near future. Both 2024 and 2025 are expected to be pivotal years for these advancements.

Automation plays a crucial role in addressing productivity deficits resulting from the decline in the working-age population. Notably, while South Korea has a much higher density of industrial robots compared to Germany, there remains significant untapped potential for automation technologies in Europe.

Urgency for Action

As Europe faces an impending demographic challenge, the time is ripe for strategies that can alleviate the economic consequences and promote sustainable growth. While Japan and South Korea provide valuable lessons, Europe must customize its approach to its specific social, political, and economic contexts.

The solution lies in implementing effective policies aimed at addressing the decline in the working-age population. Initiatives focused on increasing migration, adjusting retirement age policies, and enhancing female workforce participation must accompany a commitment to leveraging technological advancements, including AI and automation.

Successfully navigating this demographic transition will require a balanced approach that aligns with societal values and economic objectives while safeguarding Europe’s economic future.