European governments in danger of underestimating risks from adverse demographics

Demographics are a crucial element among environmental, social and governance (ESG) factors increasingly relevant for credit analysis, as population trends affect multiple drivers of government debt sustainability long term – from productivity to welfare spending to capacity for long-run investment.

Given the importance of demographics, it is of more than only academic interest to see such large discrepancies in projections among official institutions and major question marks prevailing over their underlying assumptions.

Underestimating the impact of demographics on EU economic structures could be compounded by policy inertia, undermining abilities of governments to prepare their economies accordingly.

Our analysis raises questions surrounding EU ageing and migration forecasts

Our analysis of long-run population projections from the UN, the European Commission and the OECD on the EU-4 – Germany, France, Italy, Spain – raises questions surrounding forecasts relating to ageing dynamics and migration, albeit more relevant for some countries than others.

All institutions agree that EU economies face shrinking working-age populations and rapidly ageing dynamics over coming years. However, we find wide discrepancies in these forecasts, as well as rather optimistic assumptions surrounding fertility rates and migration trends, presenting, in our view, meaningful downside risks to projected baseline scenario results.

Without 1m people in net migration each year until 2060, which is the European Commission’s economic baseline, the EU’s working-age population would decrease 30% (80m people) and the old-age dependency ratio would rise to 70%. Including such migration, the working-age population instead falls (only) 16% and the old-age dependency ratio will be 60%.

Germany, Italy and Spain more exposed than the US, UK and France

Germany, Italy and Spain are more exposed to adverse demographic dynamics compared with the US, the UK and France. Our study also demonstrates that other large economies such as Japan and China are exposed to adverse demographics.

Most advanced economies face meaningful challenges associated with ageing populations in the years ahead, and the impact will be more pronounced contingent upon migration patterns.

Large differences in demographic forecasts of institutions

The case of Spain is most illustrative in comparing the forecasts of the European Commission, the OECD and the UN, while differences in projections across these institutions are less marked in cases of Germany and France while still sizeable for Italy.

For Spain, the working-age population will shrink by around 10-15pp from today by 2060 under baseline scenarios of the European Commission and the OECD, but by more than twice this figure according to the UN’s “medium-variant” scenario. This leads also to large discrepancies in old-age dependency ratio estimates. Specifically, while the Commission and OECD forecast an old-age dependency ratio of around 60% by 2060, the UN’s baseline is almost 80%.

These differences are exceptionally large with critical implications for countries’ long-run economic and fiscal sustainability.

Download Scope’s dual reports on 1) underrated long-term demographic risks for EU sovereigns; and 2) channels through which EU demographics impact sovereign risk long term.

For a look at all of today’s economic events, check out our economic calendar.

Alvise Lennkh is the Deputy Head of Sovereign and Public Sector ratings at Scope Ratings GmbH. Giulia Branz, Analyst at Scope Ratings and co-author of the reports, co-wrote this article.