Central and Eastern Europe still has time to improve its demographics

(©Envato)

In July the International Monetary Fund published a report titled “Demographic headwinds in Central and Eastern Europe” (hereinafter: the IMF report), in which it analyses the impact of demographic changes on the economic development of Central and Eastern European countries. The topic of demographic processes impacting the economy has been repeatedly addressed in the publications of various international institutions (e.g. OECD 2019, European Commission 2017). Deteriorating demographic prospects, that is, the shrinking and aging of societies, are becoming a potential barrier for growth, not only for the countries of the CEE region, but also for the majority of developed nations as well as some important developing countries, such as China (UN 2019).

The authors of the IMF report focus on the countries of Central and Eastern Europe, undertaking yet another interesting and comprehensive attempt at capturing the various aspects of the impact that demographic processes have on the economy. In principle, the report correctly identifies the negative phenomena that could potentially hamper future economic growth. However, the key findings are exceptionally pessimistic for the economic outlook of the region, despite the fact that similarly unfavourable demographic phenomena are, after all, also observed in other regions of Europe and the world. The conclusions seem surprising and excessively far-reaching also due to the fact that the methods used in order to arrive at them are largely discretionary, and the analysis itself is based on strong, arbitrary assumptions as well as frequently outdated assessments and sources of information. Let us briefly justify this opinion.

Firstly, the IMF report uses the 2017 UN population forecast as the basis for its simulation of the effects of demographic changes. However, this is not the United Nations’ most current forecast, as a new edition – released in the current year – is already available. It provides a more optimistic path for Poland’s population in the future. The current forecast indicates that in 2050 the Polish population will be larger by approximately 900,000 people than what was predicted in the 2017 edition. An even more positive scenario was outlined in the Eurostat forecast (published in June 2019), according to which in 2050 the Polish population will be larger by about 2.5 million people relative to the 2017 UN forecast. The difference between the estimates of the two institutions may be due to the fact that Eurostat assumes a positive balance of net international migration for Poland throughout the entire projection horizon. Therefore, it seems that the Eurostat forecast accounts for the fact that in recent years some countries in Central Europe have successfully attracted quite substantial numbers of immigrants, which alleviates the current demographic pressures and the supply-side shortages in the labour market. In particular, Poland has recorded an exceptionally high influx of people from Ukraine in recent years (currently estimated at 5-6 per cent of the national workforce).

“In recent years, some countries in Central Europe successfully attracted substantial numbers of immigrants, which alleviates the demographic pressures and the supply-side shortages in the labour market.”

Unfortunately, these changes have not been taken into account in the IMF report and the authors assume a continuation of sustained net emigration from the region. The adoption of a more realistic migration scenario, and an accordingly higher population in the forecast horizon, would have a significant impact on the results of the presented analysis. Given the fact that immigrants are mostly relatively young and well educated, their influx should have a beneficial effect on labour productivity. The potential positive effects of immigration – omitted in the IMF report – were heavily emphasized by Professor Christian Dustmann during discussions at the IMF conference co-organized with the National Bank of Croatia in Dubrovnik on 14-15 July 2019. The theme of the conference was related to the relationship between demography, labour markets, and economic growth in the region of Central, Eastern and Southern Europe. Professor Dustmann, who is a recognized authority in the field of migration research, argued that the demographic challenges faced by the countries of Southern Europe and Central and Eastern Europe are not significantly different from those faced by Western Europe. He also pointed to issues such as the possibility of return migration, as well as the faster rate of economic growth in this group of countries compared with Western countries. Professor Dustmann also expressed the general view that structural imbalances of supply and demand in the labour market are usually alleviated by migration, as long as there are no excessive barriers for immigrants and the economy of the host country is sufficiently developed and offers a relatively favourable level of wages and good living conditions.

Secondly, one of the key findings presented in the IMF report is the assessment that the growing share of older people in the population will adversely affect total factor productivity (TFP) in the economy. However, a review of the literature cited in the report does not allow for the formulation of such categorical conclusions. Some of the works included in the literature (Börsch-Supan and Weiss, 2016) even suggest that workers’ productivity could continue growing throughout the entire duration of their professional activity. This hypothesis could be supported by the trends observed in developed countries: along with progressing economic development, people tend to live longer, enjoy better health, and are more willing to continue working into their old age, and hence, are also more willing to acquire new skills and to improve their qualifications. These factors will work towards an increase in both labour supply and labour productivity.

It seems more intuitive, therefore, to expect increasing rates of professional activity among older people, as assumed in the report of the European Commission (“The 2018 Ageing Report”), instead of decreasing rates – as assumed in the IMF report. Additionally, it is worth noting that there are also other important factors significantly affecting labour productivity, which are frequently discussed in the literature. These include, among other things, technological progress, the growing percentage of the population with higher education, and the potential automation of work. These factors were only discussed to a limited extent or omitted entirely in the report.

Thirdly, the authors of the IMF report do not seem to sufficiently acknowledge the structural changes taking place in the economies of the region, which reflect ongoing adaptation to future challenges, including the demographic challenges. In particular, the authors assume that the  sectoral structure of employment will remain unchanged in the perspective of several decades, with a majority of sectors still being dominated by manual work. The assumption of lack of convergence with the Western economies in terms of sectoral structure may lead to a significant underestimation of labour productivity and TFP growth rates.

At the same time, this assumption seems hard to justify. Already during the current transition process, the countries of Central and Eastern Europe have managed to significantly transform their structure of production and employment in the direction of an increasing share of highly productive industries and services. Among other things, the sector of modern services based on human capital has been developing in the region. In Poland, the business services sector and the IT sector have been growing particularly strongly, which is reflected in fast growth in the exports of these services and increasing employment there. Sustained growth in labour productivity in the future seems even more likely if we consider the relatively high levels of education of new workers entering the labour market in the countries of the region.

“The assumption of lack of convergence with the Western economies in terms of sectoral structure may lead to a significant underestimation of labour productivity and TFP growth rates.”

In conclusion, it seems that the authors of the IMF report are presenting an excessively pessimistic vision of our region’s economic future. At the same time, they do not seem to sufficiently recognize the possibility of demographic problems being alleviated through appropriate economic policy adjustments, and they do not take into account the adjustment processes already taking place, including the large-scale inward migration. When reading the report, one gets the impression that the conclusions are formulated in a very categorical manner. This is surprising given the narrow scope of the analysis, the adoption of very arbitrary assumptions and the use of outdated demographic projections, which fail to account for migration predictions, leading to understated future population forecasts.

This doesn’t mean, of course, that our region isn’t facing demographic problems. Unfavourable demographic phenomena indisputably constitute a significant challenge to the region’s economic outlook. However, appropriate and pre-emptive economic policy measures can alleviate their future negative impact. Even though they are inevitable, demographic changes are also progressing very slowly and gradually. This leaves some time for appropriate adjustments in the areas of economic policy and labour market regulation. Poland’s position is relatively favourable in this regard, due to its very large labour reserves. The biggest untapped sources of labour reserves are found among people approaching retirement age (early exit from the labour market), young people (low propensity to combine education with employment) and among women of reproductive age (a growing group of women caring for their children as well as the elderly people in their family). Attempts to increase the professional activity rates in these groups, combined with rising levels of education, the growing role of immigration, and incentives for Poles living abroad to return home, could significantly alleviate the negative impact of the coming demographic changes.

Unfortunately, the reader of the IMF report will not find any specific recommendations concerning the possible remedial activities which should be taken in response to the identified challenges. The authors have only outlined general directions and objectives for changes, without pointing out any methods for their implementation. The report concludes with a statement that can be considered accurate: because the demographic situation differs significantly between the individual countries of our region, the priorities for economic policy should also be different. Unfortunately, apart from his vague statement, we will not learn anything more about the desired course of action from the IMF report. For these reasons, the document leaves the reader feeling unsatisfied. Moreover, for readers with limited knowledge concerning the economic realities of Central and Eastern Europe, it paints an overly pessimistic and somewhat inaccurate picture of the region’s development prospects.

The views expressed in this article are the private views of the author and are not an expression of the official position of NBP.

(©Envato)

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