Germany's aging population is dragging on its economy—all of Europe will soon be affected, and it's only going to get worse

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Germany’s economy has struggled lately, with weak demand and high energy costs blunting growth. But its greatest long-term challenge is likely from a demographic crisis that began decades ago. 

Like most developed societies, Germany’s population is getting older, which means relatively more retired people and fewer workers—a combination that threatens economic growth and public finances.

The impact is mild for now, but as the International Monetary Fund warned in a report Tuesday, population aging could cause significant pain a few years down the line.

What’s new? 

Nothing. Policymakers have known for decades that Germany’s demographics would increase its dependency ratio: the number of non-workers per worker. It’s just that now it’s starting to have an effect.

Though innocuous-sounding, the dependency ratio is a vitally important economic measure. All other things being equal, the fewer workers there are relative to the rest of the population, the higher the tax burden on each person who does work, and the lower the per capita output. 

The IMF predicts that Germany’s annual working-age population growth rate will fall by 0.7% over the medium term—it didn’t define that, but it typically means single-figure years in economics—more than any other G7 country, as baby boomers start retiring and the inflow of immigrants eases. 

“An aging population will… adversely affect public finances as tax revenue growth slows and spending on pensions and healthcare rises,” the organization said in its report. 

Germany’s pension system, which dates back to 1889, relies on contributions made by currently employed workers to support retired ones. However, the ratio of working to retired people has plummeted from 6:1 to just 2:1 since the 1960s.

Aging within the labor force is also a concern. While the effect varies by region and industry, there does seem to be a negative link between workers’ average age and productivity growth in the knowledge economy.

What does it mean? 

It’s going to get worse, and not just for Germany. Japan is the world’s great test case for an aging population, having had low birth rates and negligible immigration for decades. But much of Europe also faces a similar problem. 

Take Greece, for instance. It has the lowest fertility rates on the continent, registering the fewest births in 92 years in 2022. Italy and Finland also have birth rates well below the replacement level, meaning that each new generation is smaller than the ones that went before.

Germany is due to feel the decline more acutely in the coming years because on its ongoing difficulties with labor shortages. Its economy is already struggling with the effects of cutting itself off Russian energy while coping with high interest rates. That’s on top of other problems that could hurt its long-term competitiveness, including structural barriers like underinvestment and red tape. 

To be sure, some economic forces are working in Germany’s favor. Inflation has shown signs of cooling and the country’s unemployment rate is under control compared to some of its neighbors. But the drag from the aging population will only get stronger as time passes.

Can anything be done? 

The most obvious way to change this fate, or at least significantly delay it, is through large-scale immigration. The U.K. has taken this approach, for example, with record net immigration in recent years. 

“One key measure of long term success or less relative decline is your ability to attract migrants, and to incorporate them into the labor force,” Jens Eisenschmidt, Morgan Stanley’s chief Europe economist told Fortune earlier this month.

But that approach is creating political tensions, with far-right parties that typically oppose immigration growing in popularity in various European countries. 

An alternative is to tap into the parts of the German population that could join the workforce, such as encouraging more women to take on full-time jobs. That could mean incentivizing them if they’re caregivers by offering more childcare support.

Changes to the current pension system could also help the government account for higher spending obligations on its aging population.

Another strategy is to lean into technology. Germany already has a plan to supercharge the use of robots and AI in job functions that face a talent shortage or that can be supported by digitization.   

In reality, an aging workforce is too formidable a challenge to be fixed by a single measure, or even a handful of them. Instead, governments and businesses will likely need to adapt to it, which, appropriately enough for an issue like old age, will require some long-term thinking.

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