Author: Vedran Obućina

Analyst, journalist specializing in the Western Balkans and Middle East domestic and foreign affairs

Demographics is not paramount

The main constraint for Croatia's long-term economic growth is the growth of productivity, and not demographic problems the country, together with Central and Southeast Europe (CSE), faces.
Demographics is not paramount

(geralt, Public domain)

Demographic constraints are important but are not crucial to the long-term success of the national economy. Long-term projections of economic activity are based on the application of the concept of potential output and production gap, the approaches most widely applied in various documents of the European Union (EU) institutions.

These documents use the Cobb-Douglas methodology which is based on access to production functions with factors of labor, capital and technological development. To measure the production potential of the economy in Cobb-Douglas’s production function, a constant share of output labor is assumed, which for some countries may be too restrictive. Among the new EU member states, Ganev (2015), on the example of the Bulgarian economy, presented a macroeconomic model designed to assess the production gap and the potential growth of the economy in the context of scarce data. The model presented followed the framework of the Cobb-Douglas model, which was adopted as a methodological basis at EU level.

Increasing labor activity of older people

The projection of active labor force or active population is based on assumptions about the movement of activity rates by individual age groups. The projections originate from the fact that Croatia currently has significantly lower rates of economic activity of the population than most EU countries, so it is assumed that the rates of activity by age groups and sex will converge with the rates recorded in the last years for the EU27 average. A similar assumption was also applied in European documents showing long-term projections. However, it should be emphasized that the activity rates in other EU countries are growing in order to avoid the negative economic effects of aging of the population and to align with the current rates of activity of the EU and further leaves a certain difference in activity rates in Croatia and the EU throughout the projected period up to 2050.

Population aged 15-64 as an indicator of potentially available labor force will decrease with the average annual growth rate of -1.0 per cent. The highest relative decline is expected for people in the so-called prime working age, or at the age of 25-49 years. Inadequate demographic trends will work intensively on the labor market regardless of which demographic projection is concerned. An essential prerequisite for achieving at least minimal development potential is the increase in the rate of participation of all age groups. Projection of the expected workforce starts from the activity rate by age group, i.e. the assumption of convergence by activity rates which are currently average recorded in the EU. The most prominent requirement to increase the activity rate refers to older people (50-64 years of age) whose rates of activity are comparatively low compared to other EU countries.

Productivity plays a key role

Due to the expected unfavorable demographic trends in Croatia. as well as in a large number of EU member states, potential GDP growth in the near future will almost entirely depend on labor productivity growth. European projections predict average annual labor productivity growth of 0.9 to 1.5 per cent for the EU28 through 2030, with significant differences in individual countries. Growth in productivity should be the main factor of convergence. In this period, the highest growth rates of labor productivity (more than 3 per cent a year) are expected for the least developed countries, such as Bulgaria and Romania. Other countries of the new Member States should also achieve a faster growth of labor productivity compared to the EU average by achieving an average double the growth rate. The only new member for which, according to European Projections (European Commission, 2017), does not expect productivity growth faster than the EU average, is Croatia, where production in the period 2021-2040. should average 1.4 per cent annually, which is at the same time the average growth rate of productivity in the EU. According to projections, about two thirds of labor productivity growth can be explained by the TFP movement. At the EU-wide level, growth in Total Factor Productivity (TFP) growth is projected to increase by about 0.6 percentage points annually (from 2016 to 2020) to 1 percentage point annually (from 2030 to the end of the projected period in 2050). The new member states will achieve average double the growth of TFP, while TFP growth in Croatia in the European Commission (2017) is estimated at below the EU average.

According to the baseline scenario of labor productivity trends, Croatia is poorly positioned compared to other EU countries, mainly due to the unfavorable growth rate of total factor productivity. Total GDP is not a result of increased capital productivity. This means that the country consumes a lot of capital with little incomes, that is, investments in low productivity sectors (tourism, trade and services) or very long recovery periods (infrastructure investments). According to the TFP convergence scenario, which is achieved with the efforts of all social groups, with the same capital equipment, labor productivity will rise faster than the average NMS-12 countries. In its projections, the European Commission expects that by 2050, three NMS-12 Latvia, Slovakia and Malta, according to GDP per capita, will be above the EU average. On the other hand, Italy, Portugal and Greece are an example of old members who, if current trends in productivity trends continue, can relatively fall back and fall into the group of less developed EU countries. Only in the case of the TFP convergence, Croatia will be more successful until 2050 than prestigious new EU members, such as Romania, Hungary or Estonia.

Productivity vs. demographics

Through economic scenarios up to 2050 show that economic growth in Croatia will range between 1.1 per cent to a maximum 1.9 per cent annually, depending on assumptions. Several research findings confirm the main hypothesis that the rate of growth of potential GDP is more dependent on the TFP rather than on demographic trends. Namely, the differences between different rates of GDP growth are more dependent on achieving convergence in productivity. Contribution to productivity growth in different scenarios contributes to GDP growth of 1.0 per cent in base up to 1.8 per cent growth per year in the convergence scenario. Therefore, the dynamics of productivity growth is mostly determined by the growth dynamics of Croatia’s total GDP by 2050.

On the other hand, demography is a limitation and certainly will have a negative contribution to growth in all scenarios depending on the population activity rate. The negative contribution of the labor factor (demographics) to GDP growth oscillates from -0.4 to -0.6 per cent per annum and has a smaller impact on GDP than (TFP. This is confirmed by the main hypothesis of the researches such as the Cooley and Henriksen’s (2018) research, which found in the US and Japan examples that in the long run, demographic trends can account for only one-sixth of the GDP per capita dynamics, while the rest explains productivity trends. Gonzalez Eiras and Niepelt (2012) also conclude on the example of the OECD countries that demographic transition and aging lead to lower GDP growth rates, but cannot explain the rest of the GDP dynamics.

Croatia’s GDP growth

The scenario of productivity convergence is the key to the long-term growth of GDP per capita of Croatia, but also the survival of the society as a whole. Namely, although currently in the focus of the public, different demographic scenarios can no longer change the outcome of total GDP growth in the period up to 2050, except for the growth of productivity in the case of Croatia, i.e. structural reforms. Similar conclusions come from Favero and Galasso (2015) on the example of fifteen old EU members, with the notion that they have the ability to maintain high rates of growth in accelerated structural reforms, which is increasingly difficult with the aging population. The growth of TFP in Croatia implies a significant improvement of the institutional environment that will be more stimulating for the growth of competitiveness of the Croatian economy, but a change in behavior or socioeconomic capital, conclude Croatian researchers. All demographic measures can at best only mitigate or slow down the lagging dynamics compared to other EU Member States. Only growth in productivity can ensure convergence and growth of standards in the period up to 2050. Otherwise, until the end of the decade, Croatia will reach the EU’s borders and stay there until the end of the projected period — 2050.

Vedran Obućina is an analyst and a journalist specializing in the Croatian and Middle East domestic and foreign affairs. He is the Secretary of the Society for Mediterranean Studies at the University of Rijeka and a Foreign Affairs Analyst at The Atlantic Post.

(geralt, Public domain)

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