Navigating demographic shifts and aging economies

By Christian Hyldahl, Head of Northern Europe & Senior Advisor on European Pensions at BlackRock

Demographic trends are silently reshaping our societies and economies in profound ways. Longer lifespans and declining birth rates, especially in developed markets and China, are leading to rapidly aging populations and a shrinking workforce. These developments pose significant long-term challenges that we can ill afford to ignore.

The impact of aging on economic growth depends on a country’s ability to counteract the decline in working-age individuals. Solutions include increasing labor market participation among women, older generational cohorts and other underrepresented groups as well as the politically sensitive option of attracting more foreign workers. However, these measures may not fully compensate for the anticipated workforce decline so economic growth across the G7 may slow down.

Aging populations could also trigger other macroeconomic ripple effects. As more people transition from actively contributing to economic output to enjoying their hard-earned retirement, their spending habits often remain quite consistent. It may result in a problematic scenario where there is a diminished supply of goods and services alongside sustained demand. Meanwhile, governments are likely to ramp up their pensions and healthcare expenses to support retirees. This combination could drive inflation, prompting central banks to keep interest rates above pre-pandemic levels.

Higher interest rates, in turn, lead to increased government debt servicing costs. To manage public debt, governments may face tough choices: cutting spending or raising taxes. Growing debt could also limit central banks’ ability to combat future inflation shocks by hiking rates, making higher inflation more likely in the future. These dynamics underline the importance of rethinking the journey from work to retirement.

In this context, it is crucial to identify and support effective solutions that can boost workplace productivity to offset the expected rise in spending across aging economies. The rapid advancement of technology presents unprecedented opportunities. For instance, artificial intelligence (AI) can automate tedious and laborious tasks, analyze huge datasets, and help generate innovative ideas, providing a competitive advantage to businesses and their employees.

These considerations are particularly relevant to the European Union (EU), as the bloc grapples with substantial demographic changes. The EU median age has risen from 39 in 2003 to 44.5 in 2023.¹ The euro area is expected to see a 10% drop in its working-age population over the next 20 years, with Italy facing a potential 25% decrease. Germany and France are also projecting workforce reductions of 12% and 5%, respectively.²

The ongoing demographic shifts will influence pension debates and government spending, as the old-age dependency ratio measuring the number of people aged 65 or more in relation to the working-age population is anticipated to rise from 36% in 2022 to 55% in 2050.³ Age-related expenses already account for a quarter of the EU’s GDP and are expected to increase.⁴

The longevity achieved through medical and technological progress is remarkable, but it also means that people will need more resources for their extended retirements. This highlights the need to incentivise individuals to utilise capital markets to complement state-sponsored retirement provision and so support Europeans in building long-term savings.

For many years, there has been an ambition to foster strong capital markets. However, the growth of capital markets starts with a regulatory environment that encourages retail investor participation – not the other way round. This approach can provide first-time investors with more accessible investment opportunities, enhancing their financial security as they approach their later years. It can also subsequently deliver additional funding for European companies as local capital markets become deeper.

As Europe’s populations age, the discussion around how to evolve retirement provision will intensify. Policymakers will need to address complex issues around intergenerational fairness and the significant gender gap in retirement savings. In doing so they must also prepare citizens for shifts from defined benefits to defined contributions with an appropriate balance of collective and individual provision.

Strengthening capital markets and reevaluating retirement strategies are crucial for Europe’s resilience and growth. While there’s no single solution for the challenges of aging economies, empowering and incentivising European savers to become investors is key to navigating these issues and ensuring a prosperous future for all generations.

Disclaimer

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of July 2024 and may change as subsequent conditions vary. There is no guarantee that any forecasts made will come to pass.