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Overcoming Europe’s Twin Growth Challenges

MUNICH – As economic recovery finally begins to take hold in Europe, the imperative for policymakers is to ensure that growth can be sustained far into the future. Fiscal and monetary stimulus may have been appropriate at the peak of the crisis, but they will do little to address the biggest threat to the continent’s long-term prospects: a toxic twosome of weak demographics and low investment.

Even assuming a steady inflow of immigrants, the combined workforces of the 28 European Union countries are projected to shrink by 12-16 million people over the next 15 years, according to the OECD and the European Commission. A sharper rise in the number of newcomers could help ameliorate the situation; but higher immigration is not, on its own, an adequate solution to the EU economy’s long-term problems.

Europe’s only hope for sustained growth is to boost productivity, so that it can derive more value from its shrinking workforce. The trouble is that it has been many years since the continent last saw significant productivity gains. In Western Europe, growth in labor productivity (output per hour worked) has been decelerating for decades. In the 1960s, labor productivity grew at a robust 4% annual rate, before slowing to 2% in the 1980s and dropping below 1% around the turn of the century. Today it crawls forward at about 0.5% a year. Meanwhile, total factor productivity, which takes into account technological innovation, has been stagnant.

The EU desperately needs economic growth to enable its member states to sustain their social security and welfare systems as their societies get older – a challenge that other regions and countries are facing as well. But few confront Europe’s twin obstacles of anemic productivity growth and demographic decline. China, for example, is facing a similar demographic challenge, as its labor force shrinks and the number of retirees rises rapidly. But China’s labor productivity has been growing by 9% a year, on average, over the last decade.