Growth potential of EU human resources and policy implications for future economic growth. Working Paper 3/2013 Jörg Peschner & Constantinos Fotakis

Transcription

1 Growth potential of EU human resources and policy implications for future economic growth Working Paper 3/2013 Jörg Peschner & Constantinos Fotakis

2 Europe is confronted with important socio-economic challenges due to demographic ageing and the decline of the working-age population. Their impact on the size and structure of the European workforce represents one of the key challenges in this context. The paper focuses on what the demographic shift could mean for future employment growth over the period -20. The proposed methodology makes use of Eurostat's demographic projections (convergence scenario, Europop). It employs a set of assumptions related to future growth of the active population, building a high (maximum) and low (minimum) activity scenario. The paper then explores the potential of employment growth in the years ahead subject to these human resources constraints. Employment and social analysis portal: Contact: empl-analysis@ec.europa.eu Neither the European Commission nor any person acting on behalf of the Commission may be held responsible for the use that may be made of the information contained in this publication. The opinions expressed are those of the author(s) only and do not necessarily represent the European Commission s official position. Europe Direct is a service to help you find answers to your questions about the European Union Freephone number (*): (*) Certain mobile telephone operators do not allow access to 00 0 numbers or these calls may be billed. More information on the European Union is available on the Internet ( Cataloguing data as well as an abstract can be found at the end of this publication. Luxembourg: Publications Office of the European Union, 2013 ISBN ISSN doi: /793 European Union, 2013 Reproduction is authorised provided the source is acknowledged. September 2013 I 2

3 Table of Contents Summary Introduction A brief demographic profile of Europe s workforce A quantitative assessment of the impact of workforce contraction on the growth potential of the economy The analytical framework A stylised model What are the perspectives in terms of future potential employment growth at EU level? Can Europe sustain employment and GDP growth in the years ahead? A brief assessment of relevant policy measures Policies to increase overall employment Increasing working hours Increasing labour market participation of age groups beyond age Maximising the potential contribution of migration Mobility: a barely tapped source of growth Reducing qualification mismatches Policies to increase productivity Higher productivity through better education Higher productivity through training Conclusion and policy implications Bibliography Annex 1: Modelling educational progression Annex 2: Findings at EU Member State level September 2013 I 3

4 Summary Europe is confronted with important socio-economic challenges due to demographic ageing. Their impact on the size and structure of the European workforce represents one of the key challenges in this context. The paper focuses on what the demographic shift could mean for future employment growth over the period -20. The proposed methodology makes use of Eurostat's demographic projections (convergence scenario, Europop). It employs a set of assumptions related to future growth of the active population, building a high (maximum) and low (minimum) activity scenario. The paper then explores the potential of employment growth in the years ahead subject to these human resources constraints. The analysis shows that some of the economically strongest EU Member States will find themselves confronted with serious employment growth constraints due to labour supply bottlenecks already within the next 5 years, even under extremely high activity assumptions. Several other Member States will face labour constrains over the next decade. Given the strong inertia of demographics, even total EU employment will start shrinking in 10 to 20 years from now. Labour supply constrains will arise considerably earlier in the case of highly educated workers. The authors conclude that if European economies are to continue growing at a welfare-maintaining pace, the focus must be on productivity growth which will remain the only renewable source of economic growth in the long run. EU productivity growth will have to more than double within the next decade compared to the last two decades' relatively modest performance. How could these important productivity gains be generated in a socially sustainable manner? The paper makes use of model simulations to investigate this question focussing in particular on the potential impact of skills development and higher education. September 2013 I 4

5 1. Introduction The importance of the size and quality of human resources for competitiveness and economic growth has attracted particular attention both in economic literature 1 and in policy making. It is generally acknowledged that the path of economic growth of a country is critically affected by the size, quality, and utilisation of its human resources. In the most recent years, the link between human resources and economic growth has gained further attention in most industrialised countries due to the accelerated pace at which the workforce is ageing and declining. This is taking place in an increasingly competitive global economic environment which necessitates ever-faster structural adjustments across economic sectors and the labour force. At global level, Europe is at the forefront 2 of these demographic trends. Following a period of almost years of declining demographic dependency, often referred to as the period of demographic dividend 3,Europe is currently entering a period of workforce ageing and increasing demographic dependency as the baby-boom generation progressively exits the labour market and joins the ranks of dependent population. Although at first glance the economic downturn and its depressing impact on economic growth and labour demand in particular appear to defer the growing demographic pressure on labour supply, this is not confirmed by the analysis of demographic trends. More specifically, the quantitative analysis presented in this paper clearly shows that given how inert the ageing phenomenon is, this postponement effect is relatively small and does not substantially affect the demographic challenges ahead. Some of the best performing EU economies, namely Germany, the Netherlands, Finland and Austria, are already facing labour supply bottlenecks due to the speed at which their workforces are ageing and the lack of labour reserves. A number of important challenges arising from the on-going economic crisis are in direct interaction with the process of workforce ageing. In particular, during the last 5 years, there were substantial job losses in many of the traditional, labour-intensive sectors, in particular construction, manufacturing and trade. However, studies on Europe s future skills needs 4 indicate that demand for specific skills in the most dynamic sectors may continue to rise in the future, while demand for labour in a range of low-productivity sectors may keep declining. However, as age and education level appear to be critical factors for promoting skill and geographical mobility, it becomes increasingly difficult for policy makers to promote the employment of low skilled workers made redundant in declining sectors of the economy. This implies that even if there were to be a strong recovery in the years ahead, it would be practically impossible for many of the workers made redundant in these sectors to get an equivalent job since many of them show skills profiles which are different from those needed in the most dynamic sectors of the economy. This leads to the conclusion that a rapidly contracting and ageing workforce during a period of rapid structural change in the economy (and labour demand in particular) may imply a growing risk of labour mismatches which could worsen skill bottlenecks and hinder efforts to reduce unemployment. 1 For a literature overview on the link between Human Resources and Economic Growth see Platt et al (), Wilson/Briscoe (). 2 Japan is confronted with more advanced ageing of its workforce while South Korea, the Russian Federation, United States and China are among the major global economic powers that will also face increased demographic pressure over the years ahead. For more info see: UN World Population Prospects, the Revision Data/population.htm 3 Bloom et al (2003), Coomans (), p See for example CEDEFOP (). September 2013 I 5

6 Another growing concern relates to the chronically high youth unemployment observed in many member-states across the EU. It represents a serious risk for the future labour market performance of these generations both in terms of labour market participation and productivity. These considerations show the need for a more systematic study of workforce contraction and its policy implications on future employment and economic growth. Defining an effective policy approach requires a profound understanding of the evolving demographic trends and their interactions with the on-going structural changes in the economy. This paper aims to contribute to this important policy debate by exploring a wealth of reliable information on the future size and quality of the EU labour market. The projection methodology used purposely avoids the hurdles of forecasting future economic trends. Instead, it makes use of a maximum and a minimum activity scenario based on socio-demographic projections and assumptions about qualitative population characteristics. This allows to get a clear insight on Europe s potential to sustain employment growth during the period from to 20 under different hypotheses about future economic performance. The findings suggest that, even in the most optimistic activation scenarios, workforce decline is practically unavoidable and that this will induce a decline in total employment at EU level within a time horizon already between 10 and 20 years. How policy makers will respond to short term and longer term policy priorities within this challenging policy context will be of critical importance for Europe s future employment and economic growth. The quantitative analysis proposed in this paper provides policy implications clearing this context. Over the next decade, investment in human resources development, activation policies can and should help cushion the impact of both structural unemployment and labour force decline to the largest possible extent. It could help both to reduce unemployment and drive a faster economic recovery. However, the analysis shows that for the most dynamic EU countries like Germany, Austria, Finland and the Netherlands, this would not be enough, particularly if the economic outlook over the next decade becomes more favourable. 5 The shrinking workforce will hinder employment growth unless spectacular progress is made in a range of relevant policies including further to activation policies, substantially higher investment in human resources development incentives for higher intra-eu mobility and more effective economic migration and integration policies. With employment set to decline in the long term, the paper provides evidence that Europe s future welfare will increasingly rely on its potential to strongly accelerate productivity growth, at least until the effects of demographic transition on the EU workforce is expected to end, at some time beyond 20. In the multi-polar and highly competitive globalised economy of tomorrow, it will be of utmost importance for Europe to retain and further develop its competitive edge by investing in innovation, education and skills and the range of relevant policies necessary to sustain high productivity growth in the years ahead. Following an introduction of the key issues related to the demographic challenge and the future availability of human resources, section 2 provides a brief demographic profile of Europe s workforce. Section 3 focuses on the potential for future employment growth testing the sustainability of the available human resources at different levels of future employment growth. It assesses what productivity gains will 5 The analysis in chapter 3.4 shows that it will be difficult for these Member-States to sustain an annual employment rate of 1, equal to the EU average attained during the period -, even for 5 years. September 2013 I 6

7 be necessary to sustain a hypothetical 2 annual GDP growth path. Section 4 briefly assesses potential policy action to increase employment (4.1) before focusing on human resource policies aiming at higher productivity (4.2). It provides model-based evidence on the means by which a different educational mix and better skills formation can increase productivity growth. Section 5 concludes with policy-relevant implications. Country fiches in the annex illustrate the findings of the analysis at Member State level. 2. A brief demographic profile of Europe s workforce According to Eurostat s Europop demographic convergence scenario, 6 the EU working age population (aged years) attained its maximum of 4 million in. It is now starting to decline, setting off a long period of higher demographic dependency. Today, there are some 1.6 dependent people in total per person aged years in the EU-27; by 20 the ratio will have risen to almost 2. Graph 1: Long-term development of demographic dependency, EU-27 Annual changes in total demographic dependency rate (TDR), where TDR is the ratio of total population / working-age population (aged 20-64) p.a. >0: increasing demographic dependency Zero-migration-scenrio Convergence scenrio <0: demographic dividend Sources: Eurostat Europop population projection; before 19: UN population estimates per country; illustration follows Coomans (), p As people in the baby-boom generation get older, the demographic dividend which has been positive over the last years will turn negative for at least an equally long period, see Graph 1. By the EU working age population will already have shrunk by 13 million, or more than 4. 6 For details on Europop consult Eurostat on: September 2013 I 7

8 Graph 2: The impact of demographic ageing on the working age population, EU-27 Change of working age population since () change by age group since () 5, change from (), change from () Source: Eurostat Europop population projection, convergence scenario Besides the quantitative effects of ageing on the workforce, one should also take into account its structural effects; i.e. the changes it brings about in the workforce age structure. This is particularly important since different age groups have different characteristics in terms of activity rates and education levels. Although the decline in size of EU working age population is just starting, the effects due to changes in the age structure of workers are already visible. This is because the bulk of baby boomers are by now part of the + age group while the younger age cohorts are considerably smaller. This is important for at least two reasons. Firstly, the + age group is traditionally less active than the prime age group. Secondly, since younger age groups tend to have higher education, the falling numbers of new entrants to the labour market considerably reduce the capacity of labour supply to adjust to the rapidly changing skills needed, particularly in the high-skill segment. Analysis produced jointly by the European Commission s Directorate-General for Employment and Social Affairs (DG EMPL) and the OECD shows that the proportion of skilled workers among retirees will be significantly higher over the next decade compared to the previous one due to the progressive retirement of the baby boomers. New entrants to the labour force with tertiary education are projected to decrease from 3.5 entrants for each retiree to 1.4. As a consequence, despite progress made in terms of education levels, the study foresees a skills squeeze in the EU due to demographic ageing. 7 Hence, the size of the highly skilled labour force is expected to increase much more slowly than before. 8 The risk of a skills squeeze is a growing policy concern since signs of economic recovery and emerging new employment opportunities often go hand in hand with difficulties in satisfying the need for new skills in the fastest growing sectors of the economy. In turn, concerns over labour demand become predominantly qualitative rather than quantitative in nature. 9 Several recent studies converge to the conclusion that skilled employment will keep growing in the decade ahead OECD (2013, yet unpublished). 8 OECD (), 41, CEDEFOP (). 10 CEDEFOP (); World Economic Forum (). September 2013 I 8

9 3. A quantitative assessment of the impact of workforce contraction on the growth potential of the economy The analytical framework The proposed methodology aims to explore how Europe s future human resources will be able to sustain employment growth under different employment growth scenarios, in particular: How long could Europe as a whole - and each of its Member-States - sustain employment growth at annual levels ranging between before reaching maximum capacity? And then, what would that imply for Europe s economic growth in a situation where employment cannot grow any more or even declines? What levels of productivity growth will be required to keep the EU economy growing? To investigate these questions the proposed methodology avoids the uncertainties associated with the traditional econometric exercise of active population forecasting. Economic behaviour is treated as a parameter of the model rather than its outcome. Instead, the proposed model delimits the range of feasible future active population growth paths by defining a low (minimum) and a high (maximum) activity scenario. This approach does not contest the strong interaction between the demand and the supply side in the labour market. The choice of this methodology is justified by the fact that it is extremely risky to rely on modelling of long-term economic trends or to anticipate future policy-making and its outcome. Instead, the proposed model is based on the idea that it is possible to set up a space of possible future active population growth scenarios which is delimited by an upper and a lower frontier. 11 More specifically: The low activity rate scenario reflects a continuation of the current particularly unfavourable labour market situation. It describes a situation of persisting economic stagnation with no growth in activity and in which changes in activity rates relate only to (structural) demographic effects. In contrast, the high activity rate scenario assumes an exceptionally favourable economic outlook allowing for an extremely high mobilisation of human resources in the EU. This requires a number of very optimistic assumptions about future labour market participation behaviour. More specifically, the high activity scenario shows how many more people would participate in the labour market if the unused pools of human resources (namely women and older workers) could be better utilised and if the foreseen progress in education is fully reflected in terms of gains in participation (a well-educated and skilful workforce helps to improve both activity and employment rates). Obviously, the size of those benefits would also depend on a variety of factors, in particular: the global economic environment which affects the demand side of the economy, the effectiveness of policy making 12 and the overall competitiveness of the economy including the optimal functioning of the domestic labour market. Therefore, the high activity scenario should be seen as an extreme situation combining all favourable trends on both the demand and the supply side. 11 To be methodologically in line with the EU-target to achieve a 75 employment rate for people aged by, it is first assumed that employment and active population growth can only come from the population aged The assumption will be relaxed in section below. 12 The high activity scenario assumes maximum policy outcomes also including the possibility of new policies which nevertheless do not require a change in the Eurostat definition of working age population. However, the potential from a further increase in the retirement age is treated separately in chapter September 2013 I 9

10 3. 2 A stylised model The following technical assumptions are applied to the low and the high activity scenario: Low activity scenario The low activity scenario takes account only of the demographic effects as projected in the convergence scenario of Europop. That is, it includes the impact of workforce contraction and the effect of the changing age structure on activity, keeping all other factors unchanged. This implies that activity rates by age group, sex and educational attainment level are kept constant at 2011 levels. No further progress is assumed, so changing overall activity rates only reflect structural changes (in age, sex and educational structure). This appears realistic for the low activity scenario since the activity rates at the starting year 2011 reflect a labour market situation at the peak of the economic crisis. High activity scenario Alongside the purely demographic effects set out by Eurostat s Europop convergence scenario, the high activity scenario includes highly optimistic assumptions on future behavioural changes in terms of higher activity rates. More specifically: Educational progress is taken on board using Coomans method (see Annex 1 for details). Most Member-States have seen an increase in the number of highly educated young people at the expense of those holding basic degrees, while the share of medium educated people has stayed relatively stable. Based on the educational progression seen over the period for those aged between 25 and 34, we include a log-linear projection of the observed trend into the coming decades. Graph 3a shows that higher education has a measurable positive effect on labour market participation. Looking at the activity rates, there is a 10 percentage point difference between high and medium-skilled people and a 13 percentage point gap between medium and low-skilled people. Graph 3a: Activity rates by educational attainment level, age group, EU LOW educated MEDIUM educated HIGH educated Source: Eurostat EU Labour Force Survey (EU LFS) Therefore it appears safe to assume that the trend towards a higher proportion of highly educated people will continue to have a positive impact on activity September 2013 I 10

11 rates and hence on the size of the active population. However, following the log-linear trend prolongation, the pace at which the number of high-skilled (low-skilled) workers is projected to grow (decline) from now on will be much slower than it used to be in the recent past. Graph 3b: Projection of total workforce s educational attainment structure, based on computed educational progression of the age group, EU-27 Source: Own calculations based on Eurostat EU LFS and Eurostat Europop population projection, convergence scenario, method based on Coomans (), p. 202/203. Graph 3b shows the projected share of the total working age population holding high, medium and low educational degrees, following from the educational progression of the age group years. The impact of progress in education on activity is shown separately in Graph 7. Note that no further educational progression is assumed for the age cohorts aged 35 years and older. If one combines the age- and gender-specific activity rates by educational attainment level with the projected population shares, this results in an increase of the overall EU activity rate from 75.7 today to 77.7 by. This would be purely the effect of education, not combined with other effects (i.e., net of progress made in female and older workers participation). The female convergence effect is a purely behavioural assumption on activity. It is assumed that by female activity rates will converge to male levels for every age group and educational level. The chart shows the female convergence effect, (net of other effects such as higher activity of older workers, higher education). September 2013 I 11

12 Graph 4: Female activity rate assumed to attain male activity rates by for each age group and educational attainment level: activity rates in Males, age Females, age Source: Own calculations based on Eurostat EU LFS and Eurostat Europop population projection, convergence scenario A further behavioural assumption includes the older-workers-effect: Graph 5: Scenario of progression in the activity rate of older workers (age 55-64) to by, activity rate in Source: Own calculations based on Eurostat EU LFS and Eurostat Europop population projection, convergence scenario The high scenario assumes a 20 percentage-point increase of the activity rate among older workers by. If there is an overlap with the female convergence effect (i.e. for women aged 55-64) it is assumed that the two effects cumulate. The chart shows the isolated older workers effect, i.e., net of other effects (higher female participation, higher education). The resulting high and low scenarios for the EU labour force growth are illustrated in Graph 6 in terms of number of people and in percentage of working age population. Graph 6 shows that in the low scenario, where the only changes are due to demographics, the decline in the labour force already starts in According to this scenario (with no progress in activity rates), by, Europe will have lost 4 million active population compared to However, in the context of a more favourable economic environment and a more effective activation strategy reflected in the high activity scenario, Europe could mobilise some 14 million additional workers by September 2013 I 12

13 and another 9 million by, countering the effects of the shrinking and ageing workforce and maintaining positive growth of its active population until. In fact, the activity rate would shift to 81 by and around 87 by and after. Graph 6: EU-27, high and low activity scenarios of future activity growth EU-27 Potential development of employment at given growth scenarios Assumption: Further shift of activity rates, different scenarios Working age Active Population, Active Population, Past empopul. (age 20-64) Low activity scenario High activity scenario ployment 6 millions of Working Age Population (20-64 years) Source: Own calculations based on Eurostat EU LFS and Eurostat Europop population projection, convergence scenario The assumptions on activity rates among women and older workers are purely mechanical. Nevertheless, as the high activity scenario combines and accumulates a number of beneficial effects on activity resulting in activity rates close to, it could well be seen as the upper threshold of what is possible. The gap between high and low activity scenarios then provides a measure of the maximum gains in activity to be expected under a very favourable economic and policy environment. September 2013 I 13

14 3.3 What are the perspectives in terms of future potential employment growth at EU level? After setting out the higher and lower scenarios of potential growth in the EU labour force (active population), the next step is to examine the sustainability of employment growth on the basis of this set of labour force growth constraints. To answer this question, we looked at the sustainability of four different employment growth scenarios ranging from 0 p. a. to 1.5 at 0.5 -pt. intervals. Graph 7: EU-27, high and low scenarios of future growth of active population EU-27 Potential development of employment at given growth scenarios Assumption: Further shift of activity rates, different scenarios Working age Active population Active Population, Active Population, Past empopul. (age 20-64) Low activity scenario High activity scenario Education Effect ployment 6 millions of Working Age Population (20-64 years) Employment growth scemaro : p.a. 1 p.a. 0.5 p.a. none EU Source: Own calculations based on Eurostat EU LFS and Eurostat Europop population projection, convergence scenario 65.0 Taking the scenario of low activity growth (red continuous line), we can see that, even at 0 employment growth, the EU employment level will cross the low activity scenario level by. This implies that if the future activity outlook is best described by the low activity scenario then all unemployment could have been absorbed by due to workforce decline. However, this is quite improbable since this would require absence of labour market mismatches. In reality, one would expect to see growing labour mismatches as the economy approaches its activity limits. In such a case, employment in volume will start shrinking much earlier than in. At 0.5 employment growth, the lower scenario limit will be reached by. The remaining two scenarios of higher employment growth at 1 and 1.5 correspond to even shorter periods of sustainable employment growth (2019 and 2017, respectively). Nevertheless, in practice it would be rather improbable to have a situation where relatively high employment growth - at or higher than 1 - would be paired with such a pessimistic assumption on activity 13 since in practice labour shortages tend to encourage activity. 13 That would imply that strong demand for workers would attract many unemployed people, yet people that have been inactive to date would still stay away from the labour market. September 2013 I 14

15 Turning to the high activity scenario (blue line), it is projected that, with employment growth at 1, 14 the limit of active population will be reached around. However, attaining such a dramatic improvement in terms of activity rates as set out in the high activity scenario would be extremely difficult given the extremely generous nature of the assumptions made. As a result, it is a question of years rather than generations until the workforce decline will start inhibiting employment growth. The situation is likely to be even more restrictive than follows from the simplistic approach presented so far. More specifically: The high activity scenario cumulates various effects which overlap in reality 15 and is therefore to be seen as an upper, almost ideal, limit of what is possible in terms of active population growth. At aggregate EU-27 level, both scenarios implicitly assume perfect mobility of workers across the borders of the 27 Member States - a very generous assumption given the low levels of intra-eu mobility seen so far (section 4.1.4). As said earlier, the methodology employed here assumes that all unemployed people constitute a readily employable reserve of workers who could immediately respond to the arising labour market needs. This, however, is a highly optimistic assumption. The rapid structural changes in the economy imply that labour demand is changing quickly while labour reserves find it more and more difficult to respond due to their skill (and age) profiles. Skills mismatches are the result. They imply that an increase in labour demand will not automatically lead to an equivalent reduction in unemployment (section 4.1.5). Finally, the relatively high employment growth rates observed until (about 1 per year) were fuelled both by a strong global growth and an increasingly plentiful supply of labour (as children of the baby-boomers and migrants entered the job market); this in turn promoted economic activity expansion; In the future, in case of a strong recovery of labour demand, labour scarcity may represent a much stronger constraint for employment growth due to the advancement of workforce ageing and shrinking. Relaxing the above assumptions would lead employment growth constraints to materialise much earlier and much more profoundly than those depicted by both activity scenarios Can Europe sustain employment and GDP growth in the years ahead? A sustainable pattern of employment growth in the long run would theoretically require the active population and employment to grow at similar rates, a condition which, as we showed in the earlier section, will be practically impossible to fulfil in the future, even under very generous assumptions employment growth is equal to the annual average growth rate observed during the period -08 (before start of the crisis) and also to the rate needed to attain the EU employment objectives. 15 For example: the older worker effect and the gender effect are assumed to cumulate for older women. Also, although higher female labour market participation is partly due to better female education, both effects are taken separately and hence cumulative in the high scenario. 16 In that sense, even the low activity scenario could be seen as a rather favourable limit. 17 Sustaining the EU working age population growth could require a doubling of net annual migration inflows over the next decade and even higher net inflows thereafter. September 2013 I 15

16 Graph 8 illustrates the employment growth constraint and its implications for GDP growth. It depicts the situation shown in Graph 7, but in terms of (per-annum) growth rates rather than levels. The graph is divided into three parts. The first part on the left illustrates the pre-crisis situation in terms of employment (green line) and productivity (red line) growth rates. It shows that between and Europe achieved average annual employment growth of 1. Together with an average annual productivity gain of approximately 1, this led to annual average GDP growth (dark blue) of 2. The economic downturn has interrupted this relatively stable pattern of growth. Between and 2011 (middle part of the Graph 8) both employment and productivity growth collapsed 18 with employment growth turning negative and average productivity growth averaging at a mere 0.4 p.a. The third part of the graph refers to the future. Based on the scenarios of high and low activity rates presented in section 3.2, it aims to provide an answer to the question posed at the beginning of this section: Can Europe sustain employment and GDP growth in the years ahead? More specifically: will it be possible for the EU economy to sustain 2 annual GDP growth in the future as it did between and? The projection illustrated in Graph 8 (at right) assumes that, from onwards, a sustainable employment growth path (green line) of 1 will be achieved at first. 2 GDP growth, the level deemed necessary to maintain current welfare standards, would require annual productivity growth of 1 from onwards (red line). In other words, productivity growth is a residual variable equal to the difference between the GDP growth target (blue line) and employment growth (green line). The continuation of the 1+1=2 average annual growth path observed between and will be possible as long as employment growth is not constrained. However, as employment growth will start falling due to the declining working-age population, productivity growth will have to grow faster in order to compensate, i.e., to keep GDP growth at 2. This is projected to happen by in the low activity scenario and 2031 in the high activity scenario. Hence, the duration of the period during which Europe will still be able to maintain its 1+1=2 growth path depends on two labour sources: Firstly, it depends on the size of the active population. This will have to take account of both the accumulated stock of unemployed at the starting point and projected demographic developments that determine future balances between labour market entries and exits. The evolution of the low activity scenario illustrates the potential of labour resources in that respect. Secondly, it depends on how successful policies will be in further increasing employment and activity rates across all ages, genders and education levels. The high activity scenario outlines an upper limit of what could be obtained if policies of this kind were to be highly successful. The difference between the two scenarios represents this policy component. It offers the feasible outcomes depending on the extent to which the available human resources are mobilised. 18 It is worth noting that this fall in productivity is to some extent due to short-term job protection measures which diverted some of the pressure on employment towards cuts in hours worked to prevent an even steeper employment decline. September 2013 I 16

17 Graph 8: Future employment growth potential and levels of productivity growth required to sustain 2 GDP growth in EU Projected employment growth rate, low activity scenario Productivity growth required to have 2 GDP growth, low activity scenario GDP growth assumed Past productivity growth Projected employment growth rate, high activity scenario Productivity growth required to have 2 GDP growth, high activity scenario Past employment growth Past GDP growth avg - avg annual growth in 1.5 productivity growth needed to sustain 2 GDP growth (low sc.) future employment growth potential: +1 possible until 2019 (low sc.) High activity scenario Source: Own calculations based on Eurostat EU LFS and Eurostat Europop population projection, convergence scenario Under the low activity scenario (green line), Europe could sustain an employment growth path at 1 no longer than 2019 despite its current high levels of unused labour reserves. The declining working-age population would actually drag employment growth down to negative values as from In turn, Europe would find it difficult to sustain 2 GDP growth after since it would be impossible to sustain positive employment growth any longer. Compensating for this drop in employment would require a dramatic increase in productivity growth (red line) from 1 to as much as 2.5 already required by In the case of the high activity scenario, policies providing for a maximum utilisation of the available human resources (dashed green lines) would extend the possibility for growth at the 1+1=2 growth pattern for 12 more years, that is, from as set out in the low scenario to around in the high scenario. Hence, mobilising unused human resources could provide the European economy with an additional decade of employment growth needed to sustain GDP growth at 2. However, it will be practically impossible to sustain this growth path beyond. The predicted workforce decline will require ever higher rates of productivity growth (red dashed line) to sustain positive GDP growth. In fact, even assuming the high activity scenario, productivity growth rates would have to be at levels up to 2.5 annually in the long run, more than twice as high as in the pre-crisis period up to.those would still have to be combined with employment rates beyond 85, as seen in Graph 7 above (right). Although the situation varies considerably between EU Member States and even regions within Member States, 19 the pattern of future workforce shrinking is a common challenge affecting all Member States - with differences in terms of intensity and 19 Peschner (2011 and ) looks into Europe s NUTS-2 regions. He shows that even under very optimistic assumptions about employment performance in those regions which have lagged behind so far, the EU would still have to multiply precrisis-level productivity gains over the decades to be able to compensate for the inevitable overall employment losses. September 2013 I 17

18 timing. We have made use of the same methodology as above for each individual Member State in the country fiches set out in Annex 2. Graph 9a brings together the most salient information from the country analysis: it shows how long each EU Member State could sustain a rate of employment growth at 1. The length of the red bars indicate the number of years between the low and high activity scenario or, in other words, the extra period of time a country will gain if it employs effective activation policies to make the best use of its unused labour reserves. The chart shows a diverse situation in terms of future workforce constraints. A first grouping of countries, and in particular Germany, the Netherlands, Finland, Austria and Bulgaria 20, face more immediate risks of labour supply bottlenecks because of their very limited unused labour capacities and a rapid decline of working-age population as projected according to Europop. In this context, the labour market situation in Germany is the most interesting case, both due to its advanced ageing pattern and to its impact on the European economy as a whole. The decline of the working-age population in Germany has been underway for a number of years. In addition, German labour market figures show relatively low levels of unemployment. As a result, further activation policies show relatively limited potential to generate further active population growth so that the difference between the two scenarios is less pronounced. The results indicate that Germany could not sustain a 1 employment growth path beyond 2019 even with maximum activation of its unused reserves, see Graph 9b. Over the next decade Germany will find it difficult to sustain employment and its GDP growth path without recourse to much higher inflows of foreign workers and a substantial increase in its annual productivity growth (the Netherlands, Finland and Austria face similar challenges). As a result, for a 2 GDP growth, necessary productivity growth levels in Germany would peak at levels around 3 annually in both scenarios, three times the pre-crisis productivity growth levels. 20 Despite above-average unemployment, Bulgaria faces similar workforce shortages. It could sustain employment growth at 1 until at best. The working-age population is set to continue to shrink particularly quickly in that country. September 2013 I 18

19 Graph 9a: Critical year after which 1 employment growth will not be possible any more, EU countries 2035 Critical year, high activity scenario 2025 Critical year, low activity scenario 2015 Netherlands Germany Malta Austria Finland Bulgaria Czech Republic Romania Denmark Poland Slovenia EU-27 Belgium France Estonia Italy Latvia Hungary United Kingdom Lithuania Sweden Portugal Slovakia Greece Luxembourg Spain Cyprus Ireland, convergence scenario Another, more diversified, group of Member States have relatively larger reserves of unused labour capacity (longer bars in Graph 9a). These are countries with either a relatively favourable demographic profile in terms of workforce growth (Ireland, UK, Belgium, Cyprus, Luxembourg) and/or countries with substantial pools of unused labour capacity due, for instance, to low female participation or faster educational progress (as in the Mediterranean countries). These countries could extend their labour supply potential considerably through more effective activation policies. September 2013 I 19

20 Graph 9b: Future employment growth potential and levels of productivity growth required to sustain 2 GDP growth, example of Germany 4.0 Projected employment growth rate, low activity scenario Productivity growth required to have 2 GDP growth, low activity scenario GDP growth assumed Past productivity growth Projected employment growth rate, high activity scenario Productivity growth required to have 2 GDP growth, high activity scenario Past employment growth Past GDP growth 3.0 avg - avg annual growth in High activity scenario Source: Own calculations based on Eurostat EU-LFS and Eurostat Europop population projection, convergence scenario Labour market constraints appear more striking when focusing specifically on highskilled labour needs. This is of critical importance given that high-skilled employment is a decisive determinant of economic growth due to its direct link with productivity, investment and total employment. 21 How long could Europe sustain a 1 growth path of highly educated employment against the background of a rapid shrinkage of the highly educated workforce? Graph 9c is based on the low activity scenario. 22 The black squares indicate the year after which a total employment growth path of 1 stops being feasible. These points correspond to the lower end of the bars of Graph 9a. The bright circles indicate the same figure, but only for highly educated workers employment. The graph shows that employment growth at 1 for the highly educated will be inhibited well before the entire workforce becomes scarce although educational progress is projected to continue. This is because the demand for the highly educated is considerably stronger than average labour demand and the corresponding unused labour resources are therefore much more limited See section 4.2 below. 22 We limit the analysis here to the low activity scenario. This is because in the vast majority of Member States the bottlenecks in terms of highly skilled workers appear already within the current decade and therefore the results in the case of high activity scenario would not be substantially different.. 23 In 2011, average unemployment amongst the highly educated was 5.6 whereas total unemployment was 9.7 according to Eurostat EU Labour Force Survey. September 2013 I 20

21 Graph 9c: Critical year after which 1 employment growth will not be possible for total and for highly educated employment: EU countries in the low activity scenario 2045 critical year, total critical year, high-skilled Malta Czech Republic Germany Austria Finland Bulgaria Hungary Netherlands Italy Cyprus Romania EU-27 Belgium France Ireland Poland Slovenia Portugal Slovakia Estonia Denmark United Kingdom Spain Sweden Greece Latvia Lithuania Luxembourg Source: Own calculations based on Eurostat EU LFS and Eurostat Europop population projections, convergence scenario In most EU Member States the bottlenecks for the highly educated arise within the current decade, several years before total employment growth at 1 becomes unsustainable. It is particularly interesting to see that this kind of labour constraint also happens to countries with relatively larger overall labour reserves, such as Ireland, Cyprus and Spain. This is mainly because the economic crisis had less of an impact on the employment/activity of highly skilled people than the corresponding averages. In turn, due to the long economic crisis, the majority of Member States have accumulated a human resources buffer which is mainly composed of mediumand low-skilled workers. This buffer does not exist to that extent for high-skilled workers. 24 In most EU Member States employment rates among the highly educated are currently above the pre-crisis level. Hence, in the absence of adequate and proactive human resources policies, a lack of skilled labour could constitute an early brake on growth even for countries that have significant labour reserves. It should be underlined that this holds also true from the perspective of productivity growth: If the economy grows and absorbs the unused labour capacity, the average skill level in employment will decrease. Scarcity of labour, particularly of the highly skilled, has the potential to impede future economic growth. However, it is often argued that, although GDP may stagnate or even decline, demographic ageing could result in an increase in per capita income. There is no evidence to support this rather simplistic view. Quite the contrary: looking at the next four decades, the way in which the total population is expected to evolve relative to the working age population is likely to add to rather than solve the problem in most EU Member States. 24 The bottleneck at the high-skill end is actually a combination of two competing factors. On one hand, as mentioned above, education attainment keeps rising and the overall supply of skilled labour grows at the expense of low-skilled labour. However, this is more than offset by the fact that most unused labour capacity (the unemployed) are less-well educated. If and when the EU economy restarts its growth and demands more labour, it will be constrained by the available unused manpower as it is low-skilled. September 2013 I 21

22 This is because in most Member States the decline of the working age population will start much earlier than the decline of the total population. Graph 10a provides evidence of this phenomenon. The red dots indicate the year when the working age population will start to decline. The opposite end of the blue bar shows when the total population will start to decline. A red dot on top of a blue bar shows that the total population will start shrinking earlier than the population at working age. This is true only for Hungary, Lithuania and Romania. At EU level, the gap separating the two events is years. The EU total population will continue to increase and is set to decline only from 2043, while the working age population will start to decline in 2013 already. This time differential will mean that, for a relatively long period, a declining working-age population will have to generate income for an increasing total population, reflecting higher rather than lower economic dependency and thus more pressure on future productivity gains. Graph 10a: Starting years of decline of total population and working age population trend in total population starts shrinking trend in WAP starts shrinking 19 EU-27 Belgium Bulgaria Czech Republic Denmark Germany France Ireland Greece Spain Estonia Italy Cyprus Latvia Lithuania Luxembourg Hungary Malta Netherlands Austria Poland Portugal Romania Slovenia Slovakia Finland Sweden United Kingdom both total population and WAP were already shrinking shrinking in 1992 Source: Own calculations based on Eurostat Europop population projection, convergence scenario Graph 10b shows the current situation in the EU-27, whereby 2 average annual GDP growth is currently equivalent to a necessary 2.3 growth in GDP per capita as the total EU population is growing by some 0.3 per year. However, the difference will narrow in future decades (see thin blue line) and turn negative only after. As a result, the pressure on productivity will become even stronger as the total EU population continues to grow (see thin orange lines). Only after will the decline in total population give relief, and even then, it will not exceed 0.2 percentage points by 20. Hence, the result in per-capita terms stays the same as in nominal terms: productivity in the EU will have to grow twice as quickly as it grew before the crisis in order to counterbalance the impact of a declining workforce on economic growth Even for countries that are already facing small gaps between total and working age population decline, such as the Baltic States and Germany, this lower economic dependency will not provide real relief when the current high levels of public indebtedness are taken into account. During the crisis, average government gross debt in the EU-27 soared to 82 of GDP. Government debt will have to be repaid over the coming years. If the population shrinks, the per capita debt burden will be heavier when repayment is due. Hence, at given employment levels, higher productivity growth is needed to sustain welfare levels and pay down the accumulated debts. September 2013 I 22