Europe’s difficult demographic dilemma

An ageing population and falling birth rate have serious social and financial consequences

19 July 2021 James Pomeroy, Global Economist, HSBC

Europe’s population could drop by 40 per cent by the end of this century. Even sooner, the workforce could fall by 20 million by 2030 because of falling birth rates. That may be good for the environment, but not for economic growth or fiscal sustainability.

The continent’s challenge differs from demographic changes elsewhere. Japan has already been through this transition but the US working-age population is still growing and emerging countries want to maximise the opportunities created by population growth.

Every European economy has a fertility rate of less than two children per woman – insufficient to maintain a population. Italy’s rate is just 1.4 and its populace will drop by a third every generation unless the fertility rate rises: by the end of the next century, its population could have fallen from 60 million to 10 million.

Later marriages, later first children, and economic pressures on the young mean fertility rates could fall further. But improved healthcare means people are living longer: since 1990, life expectancy at birth in many European countries has risen by around a decade, with eastern Europe, including Turkey, Estonia, Slovenia and Hungary, increasing most.

By 2030, Europe could have 4 per cent fewer workers, reducing its potential GDP growth by 0.3 per cent a year – possibly 1 per cent in Germany. But there will also be about 17 per cent more pensioners. The public-sector pension bill could increase by almost 1 per cent of GDP and higher health and long-term care expenditure will be only partly offset by falling spending on education.

The combined effect could increase public spending by almost 2 per cent across Europe – 3 per cent in Italy, whose debt-to-GDP ratio, like the UK’s, could reach 200 per cent by 2050. Future governments thus face spending cuts or potentially unpopular alternatives such as later retirement, lower pensions, or more immigration. Raising fertility rates has proved very difficult – and long-term.

This creates a major risk to Europe’s population pyramids. In 2000, the bulk of the populace was aged 15 to 45; by 2020, it was 30 to 60. And across southern Europe, including Italy and Greece, there will be twice as many people in their 60s than in their teens. Already, Italy has 40 per cent fewer school children than it had in 1980, and numbers are expected to fall by another quarter by 2040.

Better education and investment in new technology, including automation, can lift productivity, potentially maintaining per-capita growth while unemployment rates fall and people enjoy a high quality of life. But trying to honour pension promises made by past governments could mean higher taxation and higher inflation, possibly fuelling inter-generational conflict.

In countries with a high degree of pension wealth, capital, rather than earnings, will likely be the more important driver of consumption. And if savings demand drives down investment returns, people seeking a satisfactory retirement income will need to save even more, possibly in riskier assets to improve their yield.

But while investments in healthcare, wealth management or automation companies may benefit from these demographic trends, what if the lower birth rate reduces demand for housing, hitting property values?

First published 8th July 2021.

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