Europe’s population crisis could shave 4% off its GDP by 2040: Morgan Stanley

Morgan Stanley says Europe’s aging population could cut 4% from the euro zone’s GDP by 2040 as people live longer and birth rates fall.

The bank expects a significant loss in GDP based on projections that the working-age population in Europe will shrink by 6.5% by 2040, due to a decline in the number of working-age people who produce and pay taxes.

Italy is expected to be the biggest victim of this decline, as an aging population will cause the country’s GDP to decline by about 6% over the next fifteen years. France and Germany will also see sharp declines, albeit below the EU average.

In countries where hospitality is a bigger driver of the economy, the impacts on GDP are expected to be very large, as fewer people fill these roles while the number of older people increases the tax burden.

Morgan Stanley says the only country set to expand thanks to the demographic shift is the UK. The country is expected to add four percentage points to GDP by stabilizing the number of working-age population. However, low productivity is expected to remain an issue for the UK

How to solve the population crisis in Europe

Countries across the West are grappling with a steady decline in the working-age population, a trend that has already emerged in countries such as Japan and South Korea.

This has increasingly become a hot topic of discussion in boardrooms in Europe. Morgan Stanley looked at more than 300,000 comment texts to find that references to “population aging” have increased sharply in recent years, with nearly 5% of senior officials raising the topic.

However, the options available to policymakers to address the growing concern about this demographic time bomb do not look good.

Morgan Stanley says there are two main options to reverse the trend of population decline. The most desirable option, a new baby boom, is unlikely to occur.

“Even if there were an effective policy to raise birth rates that could be implemented immediately, it would take more than 15 years before that policy affected the labor force. It is hardly a short-term solution,” the authors wrote.

The bank hypothesized whether the surge in birth rates in the 2000s, driven by the advent of IVF treatment, could be repeated now. While the new growth resulting from artificial insemination was a one-off, implementing other policies may help.

“Recent steps to expand childcare could serve as a demographic measure, and high levels of net migration in recent years could provide some support for fertility rates. Hence, we believe there is scope for fertility rates to at least stop falling.”

Indeed, reforms aimed at increasing net migration are the most likely means of addressing the decline in the working-age population, and thus economic growth.

The issue of immigration has been heated in Europe in recent years, with far-right anti-immigration parties gaining significant ground this year, such as the National Rally in France and the AfD in Germany. This made it difficult for governments to promote the benefits of immigration to voters.

A third, less palatable option to save GDP is for the remaining working-age population to increase their working hours, Morgan Stanley says. Raising the retirement age is another option that is likely to be unpopular with voters.

The bank says the most effective, although still realistic, combination is increased immigration combined with an increase in the female labor force participation rate. This could address the current projected economic growth gap by increasing GDP by four percentage points.

While fewer working-age people may mean higher wages for remaining workers, Morgan Stanley notes that the negative impacts on GDP from a declining population are likely to have a negative impact on profits.

The bank’s report presents a grim set of obstacles facing Europe in overcoming one of its most existential challenges in the coming decades. Doing nothing can be disastrous.