Europe needs structural skills-oriented labour market reforms

Employment & Income,Inclusive Economy24 Apr 2014Jörg Peschner

With a demographic shift ahead, Europe has to increase productivity and employment rates and structurally reform the labour market.

With unemployment still beyond 10%, the economic and financial crisis continues to impact on European labour markets. Given the extent to which human resources remain unused as countries recover slowly from the recession, attention is distracted from new challenges brought about by the demographic shift ahead. The EU working-age population between 20 to 64 years of age is currently peaking but in many member states the coming decades will bring workforce shrinkage, with an average annual decline of 0.4% for the EU until the year 2040. At the same time, thanks to longer life expectancy, the number of elderly people is increasing. The obvious result is pressure on Europe’s pension schemes.

However, the debate should go well beyond pensions. A prerequisite for more resources to be spent on the non-active part of society is stronger (potential) economic growth – which is the sum of productivity gains and potential employment growth. As the number of potentially employed declines, it is obvious that higher productivity gains must fill the gap. Since the 1970s Europe has been enjoying a ‘demographic dividend’ to economic growth: to some extent potential GDP was able to grow simply because the number of people potentially producing it was growing – relieving us to the same extent from making a stronger effort to increase productivity. As the dividend now turns into a demographic levy, the pressure on higher productivity gains will multiply. Indeed, over the decades to come EU productivity gains would have to more than double if the economy was to grow at the same pace as it did during the decade preceding the crisis.

As human resources will become scarce, it is obvious that existing employment potential must be more efficiently tapped. That is, activation policies must make up for higher employment rates across all working-age groups. Europe will no longer be in the position to waste human resources to the extent it does now, with an employment rate still below 70% amongst the 20 to 64 year-olds. By no means will the workforce decline ‘solve’ our problems on the labour market: the crisis has clearly shown that a high number of vacancies can well coincide with high and increasing structural unemployment due to labour market mismatches. The strategy to cope with demographic ageing must therefore begin now with structural skills-oriented labour market reforms in order to reduce mismatches and provide for a higher employment rate – creating the resources to sustain employment growth as long as possible. However, evidence shows that even if activation is a full success and in the theoretical absence of labour market mismatches, the EU workforce decline will result in negative employment growth from around 2030 at the latest. It is foreseeable that productivity growth will almost inevitably become the only source of economic growth in the long run.

Therefore, unless we do not give in to the pressure to generate necessary higher productivity gains only through deepening into capital (rationalization), there is only one socially sustainable policy response to the challenge: human capital formation through skills development and higher education. Today’s coexistence of structural unemployment with skills scarcities in many sectors will certainly be aggravated once the entire workforce shrinks – unless Europe generates the very skills supply that sources say will be increasingly demanded by businesses all over the globalized world.

Please read here the research that the European Commission, DG Employment, Social Affairs and Inclusion, has recently devoted to the impact of demographic ageing on potential economic growth.

The opinions expressed are those of the author only and do not necessarily represent the European Commission’s official position.