Our Chief Europe Economist Jens Eisenschmidt and Europe Equity
Strategist Regiane Yamanari discuss the strain of an aging
population on the future of Europe’s economy and markets.
----- Transcript -----
Jens Eisenschmidt: Welcome to Thoughts on
the Market. I'm Jens Eisenschmidt, Morgan Stanley's Chief Europe
Economist.
Regiane Yamanari: And I’m Regiane Yamanari
from the European Equity Strategy Team.
Jens Eisenschmidt: Today we are discussing
one of the most urgent challenges Europe is facing right now, a
declining working age population – and its implication for
Europe's economy and potential solutions.
It’s Wednesday, October 23rd, at 3 pm in Frankfurt.
Regiane Yamanari: And 2 pm in London.
So Jens, people are getting older around the world, living
longer. Although the rate of change is different from country to
country, can you tell us what's the situation in Europe right
now?
Jens Eisenschmidt: Yes, Europe faces a
declining working age population, so much is sure. We have just
put out a big report, where we come up with numbers around this
issue. We think for the large four Euro area countries – Germany,
France, Italy, and Spain – we see a decline in Euro area working
population by 2040 by 6.4 per cent. People also get older, so
that doesn't necessarily mean the overall population is declining
by as much. It simply means that working age population, as a
sort of most direct, relevant measure for the economy, is
declining.
Regiane Yamanari: Why does an aging
population hamper economic growth?
Jens Eisenschmidt: So, think about the
economy producing, in a very stylized sense, with two factors.
One is capital and the other one is labor. And typically, these
two factors are connected. So, you can't really produce just with
one factor. Typically, you need at least some labor to produce
something or at least some machinery to produce something with
labor.
So we just; I mean, it's a very simple way of looking at the
economy, but typically very powerful in explaining what's going
on. So, if we take this approach and look at our economy through
the lens of these two factors and we have one factor declining
significantly, this will affect the amount the economy can
produce.
So, we are talking here about so-called potential growth or
potential output. And we think the declining working age
population will lead to a decline in potential output. For the
Euro area economies I was just mentioning, we think it could be
around 4 per cent over the period 2000, from now to
2040. And that amounts to on an annual basis around 25 basis
points lower growth potential.
Regiane Yamanari: Suppose policy makers
want to boost Europe's working age population, which they do.
What options do they have? Which European countries most benefit
from these policies or options?
Jens Eisenschmidt: Yeah, the oldest policy
measure, or if you want the most discussed one, typically has
been birth rates.
Now, many of the policies being implemented here – and they have
been implemented for decades already – have been found to be not
really changing [the] situation in a profound way. So, birth
rates have either stopped increasing again or actually continued
dropping. So, policy makers’ attention probably for this reason
has turned to other measures.
Other measures we think of here mostly in the current debate is
increasing net migration, so you're basically getting your
working age population replenished to some extent from the
outside. Changing participation pattern in your own domestic
labor market – typically, it's framed around the question,
how much or how high is the share of one cohort versus the other.
For instance, males versus females. We have countries where there
is a large gap between these two groups, just to name an example
here. And you know, closing that gap could help you increasing or
offset; some of the projected decline in working age
population.
Another measure that's often discussed is increasing, retirement
age. So essentially working age population is defined by those
age between 15 and 64. And of course, if you work for longer, so
you increase retirement age, that will also help, to stem against
some of the projected decline in working age population.
Now, if you look around for the countries that we are discussing
in the report, um, then there are different ways these
policies affect these countries.
So, for instance, in Italy, closing the gap between male and
female labor force participation would offset a large part of the
projected fall in its working age population because that gap is
so large. In France, in terms of our numbers, the most effective
measure would be increasing the retirement age. And again, in
Germany and Spain, it would probably be migration policies that
are most effective.
Okay now let's consider the alternative, Regiane. Suppose nothing
changes. There are fewer and fewer working age people in Europe.
How would this affect companies earning growth?
Regiane Yamanari: So, if there are no
policy action, and here assuming all else equal, I mean, no
change in productivity, for example. Due to a lower GDP growth,
we estimate the headwinds of European demographics could lower
companies long term earnings growth by 90 basis points. So, from
5.1 to 4.2 per cent by the end of the decade. And this compares
to an average growth of 6.4 per cent that we had in the past 10
years.
Jens Eisenschmidt: And how would this be
reflected in the stock market?
Regiane Yamanari: Yeah, so potential lower
earnings growth is negative for European equities, right? But
it's worth highlighting two points here. First, is that European
companies have been diversifying their activities and revenues
across the globe in the recent decades. And the revenue
exposure of European companies to develop
Europe, including the UK has reached a 30-year low. So, we
estimate that just 38 per cent of European companies’ revenues
are generated in develop Europe, on a free flow market cap
weighted basis.
And second, I think we see this impact being more idiosyncratic
at sector at stock level. Just to give an example, so we have
this factor analysis that we have done. We found that companies
reducing headcount in Europe have been outperforming companies
increasing. So in our view, this impact, it will be
idiosyncratic, and it will depend by sector and the the
stock.
Jens Eisenschmidt: What sectors and
industries then do you expect to be most affected by an aging
population and the declining labor force?
Regiane Yamanari: Yeah, so first of all, I
think one thing to mention is that it's very clear that the theme
of, aging population is gaining traction in European C-suite
commentary. So we found using AlphaSense Large Language
Model, when we analyze companies transcripts, a notable rise in
mentions of aging population – and in particular, if we compare
to the US, to the US companies, we know that labor intensive
industries like kept goods, construction and materials, business
services are among those at the top of
the list.
And those mentions have been increasing in most cases when we
compare to the average of the last
five years.
Jens Eisenschmidt: So how are companies
adjusting their business models to account for these challenging
demographic trends?
Regiane Yamanari: So we see, for example,
industrial automation, robotics, and software adoption
accelerating in the face of declining working age population
across Europe, which might surprise some people as some people is
relatively under-penetrated by technology.
Regiane Yamanari: For example, if we look
at industrial robot density in Germany, that is less than half of
South Korea. And there are some sectors, for example, like
hospitality that our analyst has flagged that the companies have
been changing and adopting initiatives related to recruitment,
technology adoption, portfolio rationalization – just a few
examples here – and adjusting their business models as well to
navigate a scenario of reduced labor availability and higher
costs. And well, not to mention AI, which we have seen a rapid
development and pace of adoption as well.
Jens Eisenschmidt: I'm glad you mentioned
AI. It was on my mind. I was about to ask you. So, what do you
think, uh, the role of AI could be in helping with the
demographic challenge?
Regiane Yamanari: Our view is mainly on
productivity gains. So, we them to start materializing, but they
are likely to be small and grow consistently over time. An
important portion of AI adopter companies cost base are related
to R&D, marketing, distribution costs – and these areas we
still are to see broad based application of AI, if this is really
to be meaningful at the corporate level or even a national level.
So the way we see is that the productivity gains being reflected
on margins, but still to be small at this level.
Jens Eisenschmidt: So, this one remains to
be seen. We will surely be watching closely whether AI can
deliver what it seems to be promising to generate productivity
gains to offset the demographic challenge.
Regiane, thanks a lot for taking the time to talk.
Regiane Yamanari: Great speaking with you,
Jens.
Jens Eisenschmidt: And thanks for
listening. If you enjoy Thoughts on the Market, please leave us a
review wherever you listen and share the podcast with a friend or
colleague today.
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