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Discussion Paper - Demography and its economic consequences in the Baltics: The case of Latvia

Discussion Paper - Demography and its economic consequences in the Baltics: The case of Latvia

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Published by Swedbank AB (publ)
Discussion Paper - Demography and its economic consequences in the Baltics: The case of Latvia
Discussion Paper - Demography and its economic consequences in the Baltics: The case of Latvia

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Published by: Swedbank AB (publ) on Oct 09, 2012
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11/01/2012

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Discussion Paper 
 
No. 25
October 8, 2012
Economic Research Department.Swedbank AB. SE-105 34 Stockholm. Phone +46-8-5859 1000.E-mail:ek.sekr@swedbank.comwww.swedbank.comLegally responsible publisher: Cecilia Hermansson, +46-8-5859 1588.
Mārtiņš Kazāks, +371 6744 5859. Lija Strašuna, +371 6744 5875. Kristilla Skrūzkalne, +371 6744 5844.
Demographyand its economic consequences inthe Baltics: The case of Latvia
The Baltic States are ageing and their populations are decreasing. The 2011population censuses find that, over the last decade, the populations of Lat-via, Lithuania, and Estonia have shrunk by 13%, 12%, and 6%, respectively.Their populations will continue ageing. With free labour mobility and wide in-come gaps vis-à-vis more affluent EU countries, emigration will continue totake its toll. Demographics is not the challenge of the future, it is the chal-lenge of today.Due to data availability, detailed analysis is limited to Latvia. Yet, most of thechallenges are also relevant to the other two Baltic States. Over the pastdecade, the population of Latvia has decreased by 309000 or 13%. Of thistotal, 119000 is due to a mortality rate being higher than the birth rate, and190000 is due to emigration. The decrease in population is across theboard. All major cities have seen their populations decrease. More remoteareas have emptied faster than centres of economic activity. Some adminis-trative territories have even seen their populations shrinkby nearly one-third.European Commission (2012) projects that life expectancy will continue in-creasing, fertility rates will rise but remain below the natural replacementrate, and emigration will continue over the next decade or so and then turninto immigration. If so, over the next 50 years the population of Latvia willshrink by a further 25% and the working-age population by a whopping 43%.This means moving from about four working-age persons for every personaged 65 and above to a ratio of four to three. Ofcourse, projections can bewrong, but they do point to the major underlying trends unless governmentpolicies are able to turn them around or soften them.Such demographic trends are likely to have both their own economic implica-tionsand/or reinforce other trends with a negative impact on the economy:
Economic growth is set to slow;also because the productivity gap vis-à-vis more affluent EU member statesnarrows. If reforms are imple-mented, per capita GDP growth over the next five-seven years mayspeed up to about6% per annum; if reforms stop, growth is likely tosink to below 3%. There is still a hefty productivity catch-up potential,but this can be effectively realised only ifreforms are implemented.
The strong centres will get stronger; rural and economically weak ar-eas will empty and age faster. Those of working age will tend to movetowards stronger centres of economic activity. The productive andspending capacity will be increasingly concentrated around a small
 
2Discussion Paper No.25
October 8, 2012
number of economically strong cities. Policy action will determine howfar and deep this process will run.
With the population shrinking and concentrating around themajor cen-tres of economic activity, public infrastructure and services will be-come increasingly unbalanced –too little where needed and too muchelsewhere. Business costs will rise if the infrastructure quality wors-ens. The rundown of public infrastructure and services depends onpolicy action –the longer the current status quo is maintained, theworse the situation.
To shield itself from the cost of ageing, the state has passed a largepart of the task of saving for retirement on to the population itself.People are likely to underestimate their need for savings, which, whenthey retire, creates risks of poverty and sharp falls in spending power.This situation hides the risks of transfers from taxpayers to tax evad-ers and tax increases.Governmental policy is unlikely to reverse the long-term demographic trends,but it can soften them and limit their negative economic impact. To start with,an important task is to address demographic trends per se. This means rais-ing fertility rates, reducing emigration, fostering re-emigration and work onimmigration. To do this, economic growth must speed up. This means mak-ing the population more employable and improving labour productivity.The general policy prescription is simple –to achieve Western Europeanlevels of productivity, a country must meet Western European benchmarksfor quality of the business environment, rule of law, education, investment inresearch and development, etc. Hence, the outcome will depend on the poli-cymakers’ ability to implement reforms. Reforms must be implemented now.Failure to do so will lead to permanent slippages in growth, and emigration isthen likely to kick off yet another vicious cycle of demographic contraction,putting at ever-higher risk Latvia’s economic and social sustainability.
Mārtiņš Kazāks
Contents:Page:1.INTRODUCTION.................................................................................................32.DEMOGRAPHY: what has been going on?..........................................................33.DEMOGRAPHY: where is it heading?..................................................................74.ECONOMIC IMPLICATIONS: what to expect?...................................................114.1. ECONOMIC GROWTH: slower going forward................................................114.2. REGIONS: strong ones survive, weak ones peter out.....................................154.3. PUBLIC INFRASTRUCTURE AND SERVICES: quality vs. coverage..............214.4. GOVERNMENT BUDGET: save for your retirement.......................................224.5. SAVINGS: need to rise, but will they?............................................................265.HOW TO SOFTEN ECONOMIC CONSEQUENCES OF NEGATIVEDEMOGRAPHIC TRENDS?....................................................................................286.CONCLUSIONS................................................................................................35 APPENDIX 1: Estonia and Lithuania face similar demographic challenges as Latvia.36 APPENDIX 2: GDP decomposition, data, and track record.......................................38
 
Discussion Paper No. 25
October 8, 20123
1.INTRODUCTION
Europe is ageing. Latvia and the two other Baltic States –Estonia andLithuania –are, too. Yet, the Baltic States are not only ageing, their popula-tions are shrinking. The shares of working-age population have peaked andwill decline going forward. Fertility is below its natural replacement rate, andthere will be fewer youngsters entering the labour market. Dependency ra-tios are increasing, putting a burden on economic growth and the socialsafety net. The 2011 population censuses, the data of which are being pub-lished only bit by bit, are producing new insights into demographics. Duenegative net migration flows (i.e., emigration), many of the risks that throughthelens of official statistics had previously been viewed as problems of thedistant future have been fast-forwarded into the very near future or even thepresent. Over the last decade, the Latvian and Lithuanian populations haveshrunk by 13% and 12%, respectively, and that of Estonia by 6%. This isnearly twice the official pre-census estimates, as the true size of emigrationhad been baldly underestimated. Many experts, including ourselves, havebeen warning about this for years, and the recent population censuses pro-vide hard supporting data. Demographics is not the challenge of the future, itis the challenge of today.The populations will continue ageing. Because of free labour mobility andwide income gaps with the more affluent EU countries, emigration will con-tinue to take its toll. Yet, by acting proactively it is possible to reduce the ex-tent of such demographic trends and limit their negative consequences onthe economic sustainability of a country and the businesses operating there.The aim of this report is, therefore, to analyse the implications for economicactivity and policy of such a demographic change.Data from the 2011 population censuses are still very scant,which puts con-siderable limitations on our analysis. This is the reason why we limit our analysis to Latvia (it simply has been faster to publish its census data); how-ever, most of the challenges discussed are relevant also to the other twoBaltic States.To put Latvian demographics and some of its economic impli-cations within the Baltic context, we have added Appendix 1, which brieflyoutlines the following issues for all three Baltic States: (i) demographic pro- jections until 2060; (ii) estimates of ageing and population decrease on per capita GDP growth; and (ii) estimates of the fiscal cost of ageing.
2.DEMOGRAPHY: what has been going on?
The 2011 population census data for Latvia are just rolling out of the statisti-cal bureau, and at the time of writing this paper there is a full data set avail-able only for the year 2011. The previous trustworthy data are for the year 2000, when the former population census was taken. In this chapter, weshall therefore discuss only the change between the years 2000 and2011and leave aside the volatility of the in-between years, as those data have yetto be revised to account for the dynamics of emigration.
The good, the bad,and the ugly…
 Ageing and the population decrease in Latvia have been driven by a mix of good, bad, and ugly trends. The good part of the story is that life expectancyhas been rising. From 2000 to 2011, life expectancy at birth has improvedfrom 76.0 to 78.7 years for women and from 64.9 to 68.8 years for men.Quite a spurt, but still far to go compared with the EU averages of, respec-tively, 82.5 and 76.7 years (or, respectively, 83.4 and 79.4 years in
The Baltic States areageing and their  populations areshrinking…… demographics is not the challenge of thefuture, it is the challengeof today Good news: lifeexpectancy has beenrising, people areenjoyinglonger lifetimes

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