- Macro Strategist
Asia ex-Japan, Institutional
Change
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Europe’s population is ageing at an unprecedented speed. While discussed for years, I believe structural factors such as the energy transition, deglobalisation and changing European politics are accelerating this trend with major consequences for Europe’s economy and financial markets. Here I focus on Europe’s likely response to the resulting changes in labour supply and outline potential investment implications.
Accelerating decline in the number of working-age Europeans
Figures from the European Commission’s statistical department, Eurostat, show the sheer scale of the unfolding demographic change. Eurostat expects the proportion of people aged 65 years and more living in the European Union (EU) to increase from about 20% of the population at the end of 2019 to a peak of around 30% by 2050. In other words, the old-age dependency ratio will go up from approximately 34% in 2019 to circa 57% in 2050, so rather than having three adults of working age for every person aged 65 or more, the EU will have at best, two working-age people per person aged 65 or more.
The impact will be felt across many areas of the European economy, whether it’s health care, consumer behaviour or corporate investment, but perhaps nowhere more so than in the labour market, where we are already starting to see the first effects. While Europe experienced a meaningful economic slowdown in 2023, unemployment across most European economies hit multi-decade lows. We also observe signs of labour hoarding as companies are keeping employees that they don’t necessarily need because of worries that they won’t be able to hire once the economy recovers.
Structural changes will fuel this labour market squeeze
This tightening coincides with structural changes that necessitate a larger rather than a smaller workforce:
- The energy transition: While I believe the energy transition will ultimately be deflationary for Europe, building the required infrastructure will be labour-intensive.
- Redrawing of supply chains: For the last few decades, supply chains were all about improving efficiency and reducing costs. Now, with increased geopolitical tensions and a greater focus on supply chain resilience, European policymakers are trying to reshore production capabilities in a range of key areas, implying further demand for workers.
- Growing international competition for cheap labour: The demographic challenge is not just a European phenomenon. Japan has faced it for years, but companies have avoided paying higher wages domestically by outsourcing to China and other Asian countries. Now with China and other economies facing the same issue, that option is closing down. Over time Africa may offer new outsourcing opportunities, but these are likely to involve higher geopolitical, supply chain and climate change risks. Overall, I see more demand for cheap labour than supply.
Higher wages, higher inflation and lower margins
A shrinking workforce should allow labour to regain some bargaining power, meaning structurally higher wage growth. Everything else being equal, this change has two implications:
- Lower margins – Higher wage growth without corresponding gains in productivity will increase unit labour costs and reduce corporate margins, especially in labour-intensive industries. From a top-down perspective, the profit share of GDP tends to fall as the wage share of GDP rises.
- Higher inflation – Wage growth is a major driver of inflation especially within services. Absent productivity gains, it entails structurally higher inflation over the medium term.
Different responses are feasible, but greater investment in productivity is the likely path forward
Simply put, there are three ways to address the issue:
- grow the workforce through immigration;
- get the existing workforce to work more; or
- improve productivity.
While the path forward will likely turn out to be a combination of all three, I think the biggest opportunity is in improving productivity.
Immigration is unlikely to help in the near term
Oxford Economics expects the European workforce to shrink at a rate of approximately 700,000 people per year. Even in the most optimistic scenario, I think that would mean Europe will need around 1.2 million immigrants a year. This higher number reflects the reality that migrants will want to bring their families and often need to overcome language and skill hurdles. Attracting so many new immigrants in a year has not been achieved in more than a decade —except in 2022 when many Ukrainian refugees arrived in the EU. Moreover, immigrants tend to be under-employed, limiting their ability to replace higher skilled workers.
At the same time, Europe’s electorate’s increasingly critical attitude to immigration — evidenced by the recent political shift to the right — further reduces the likelihood of achieving the necessary immigration numbers.
Increasing hours worked likely to prompt significant pushback
A range of measures could encourage or force current workers to do more, but measures such as raising the pension age tend to be highly unpopular, as evidenced by recent events in France. If anything, we see growing demands for a shorter working week. Other avenues include facilitating part-time work in retirement or — as is currently being discussed in Germany — tax incentives for overtime. A more fruitful option would be to increase female participation in the workforce to the high levels seen in some Nordic countries, but that requires developing affordable and sustainable childcare models and tackling persistent pay differentials. However, political priorities appear currently focused on other areas, primarily the energy transition and defence.
Investments in productivity are the “easiest” path forward
I believe this is the most likely path forward. While European productivity gains were far from exciting over the last decade, I believe European policymakers can pull two levers to improve productivity:
- Less “red tape” — A range of business surveys suggest red tape is a major obstacle to doing business in the EU. Reducing red tape could significantly improve efficiency. Recent comments from EU politicians suggest the next EU parliament could make business-friendly reforms a major priority. The challenge will be to do so in a way that removes unnecessary bureaucracy while ensuring that the policy objectives that underpin these rules in areas such as public health and the environment are still met, as one of their main benefits would be to raise Europe’s longer-term productivity.
- Increased investment in training, automation and efficiency — Proposals by the European Commission to support the reskilling of workers (European Year of Skills 2023) or investments in digitalisation (a key pillar of the NextGenerationEU fiscal programme) are positive steps. They can complement the expected private sector investments in improving efficiency and productivity, with AI-related technology potentially acting as an accelerator across many sectors.
What are the investment implications?
Beyond pressure on corporate margins and higher inflation, I see two main investment implications:
Opportunities among the facilitators of productivity — During periods of tight labour markets, companies tend to redirect their capital towards R&D, software and industrial equipment to increase efficiency and automation. I consequently anticipate increased investments in these areas with several European stocks as likely beneficiaries. Companies that are the facilitators of this increased investment in efficiency through their solutions and services are particularly well-placed to benefit.
Differentiation between relative winners and losers — How effective countries are in their response to the demographic challenge is likely to become an important differentiator for European economies. Overall, I think Spain, the UK, Ireland and, to a lesser degree, Portugal have a clear advantage in that their languages are widely spoken. Even if they currently face a similar political backlash to immigration as other countries in Europe, having a common language generally makes it easier to attract and integrate immigrants.
Spain especially has been able to draw on a large pool of Latin American immigrants during previous periods of economic growth. With citizenship available after only two years of residence, Spain also attracts numerous skilled workers and wealthy individuals from Latin America. It is a key support for my structurally positive view on Spain.
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