How much of a problem is the decline in the working age population in Europe? Through Investing.com

Investing.com — The decline in the working-age population, once thought to be isolated to the East where Japan and South Korea have battled recessions with shrinking workforces for decades, has now washed ashore in Europe, causing serious concern. But how big of a problem is the shrinking working-age population in Europe?

“The number of working years in the euro area is expected to decline by 6.4% by 2040,” Morgan Stanley in its Future of Europe Bluepaper published on Oct. 9, which estimates a 4% hit to euro area GDP by 2040.

As the age of a country or region decreases, fewer people contribute to economic output and productivity, which marks a decline in GDP, or gross domestic product, especially when combined with an aging population.

But some eurozone countries are likely to feel the pain more than others: Italy, whose working-age population is expected to shrink by as much as 10% between 2025 and 2040, faces steeper challenges. While France, given its strong population, may have been the least affected among the major economies.

Lessons from Asia: Japan and South Korea

Europe's demographic crisis is nothing new. Japan and South Korea have faced these challenges for decades. These Asian economies, which have been on the sharp edge of dealing with aging populations and declining birth rates, can provide a window into the problem and valuable insight into how effective the solutions have proven to be, or not.

Japan has implemented a number of policies to address its demographic challenges, including efforts to increase female participation, raise the retirement age, and cautiously open up to more immigrants.

These measures, however, have had limited success, as cultural trends and economic pressures continue to reduce high birth rates.

For the past three decades, Japan's fertility rate has been below 1.5, and the most recent figures in 2022 recorded an even lower rate, 1.26, according to data from the Center for Strategic and International Studies.

However, Europe's prospects for dealing with this population explosion may include a mix of policies used in the East, says Morgan Stanley.

Turning to policy to cushion the economic shock from the demographic crisis

Three policy options that could face these storms in Europe: increasing net migration, increasing the active retirement age, and closing the gap between the participation rates of men and women.

These policies could add between 1.3% and 2.5% to the base GDP of the euro area in 2040, according to scenario modeling by Morgan Stanley. But the level of success of these policies in solving the population problem will vary from country to country as some may start following these policies earlier than others.

Germany, the UK, and Spain, “will see the biggest impact of increased mass migration, while Italy, could benefit the most from closing the gap in gender participation in the workforce,” Morgan Stanley said.

An increase in net migration by one standard deviation relative to each country's historical levels could increase euro area GDP by 1.8% in 2040.

Closing the gap between male and female participation rates could also have a major impact, potentially boosting euro area GDP by 2.5% by 2040, Morgan Stanley estimates. Italy, with a male-female labor force ratio of 8 percent below the euro average, could see a meaningful increase in its workforce if it were to narrow this gap.

Raising the effective retirement age by one year could increase euro area GDP by 1.3% in 2040. France and Spain, where the effective retirement age remains 2 to 3 years below the European average, stand out as the countries that will benefit the most from this. the policy.

Income growth in the crosshairs

This demographic challenge is already affecting the outlook of European companies. And if allowed to fester without policy action, Morgan Stanley estimates, it could reduce long-term corporate earnings growth from 5.1% to 4.2% by 2030.

This theme is already emerging as a hot topic of discussion in the analysis of the European C-suite, written in a quarter that shows a significant increase in expressions of “aging,” especially compared to US companies, it added.

AI, automation to the rescue?

The flat rate in corporate earnings in Europe, however, does not imply rising rates or productivity gains from AI or automation, “which may offset negative impacts,” Morgan Stanley said.

Productivity gains from the widespread use of AI and automation tools are likely to become more visible as companies begin to see the fruits of their AI investments and adoption efforts early next year.

“2024 is the year of AI investment and acquisition; by 2025, we think the benefits for companies should be more visible,” said Morgan Stanley.

Automation will also have an increasing role to play in bridging the productivity gap from declining working hours in Europe, which has been gradually absorbed by automation technology.

Industrial robot density in South Korea, for example, was just over 1,000 per 10,000 people employed in manufacturing by 2022, compared to less than half that figure in Germany.

A call for action to protect Europe's economic future

As Europe faces this demographic shift, the race will continue to find solutions that can slow down its economy and ensure sustainable growth for decades to come. Although the experiences of Japan and South Korea provide important lessons; Europe will need to adapt its approach to its unique social, political, and economic situation.

The challenge is clear: Europe must implement effective policies that address the decline in the working-age population. While policies aimed at increasing migration, raising the official retirement age, increasing female labor force participation will help reduce the impact, Europe must embrace technological advances including AI and automation to help close the productivity gap.

The key to effectively combating the impact on growth and securing the future of the European economy is to effectively implement these strategies while ensuring that they are compatible with social values ​​and economic objectives.