Tuesday, July 14, 2009

Europe's Carbon Footprint will Shrink

Paul Ehrlich has emphasized the environmental impacts of population growth. Jared Diamond has emphasized the environmental impacts of per-capita income growth. New NBER research sketched below argues that Europe's low rate of fertility will lower its per-capita income growth and by definition its population growth. Perhaps Europe is pursuing this "low carbon strategy" because they anticipate that carbon permits will sell in 2050 for $100,000 a ton and relative to their baseline allotments they will be able to sell their excess permits and live off the interest? (I'm kidding).

While the authors discuss immigration, there is obvious political economy here. If a nation really really needs young people and if nobody is "producing" such kids in the domestic market then simple "make versus buy" logic says that you will import them from the Middle East or other nations with lots of kids. Now, this raises a host of globalization issues but this "insurance policy" must put a check on the extent of the problem that Europe faces. Europe is small relative to the rest of the world.

It is an interesting incidence question to think through, as the number of 100 year old people rises into the tens or 100s of millions, who is in charge of feeding this crew and nursing this crew? In english, who should pay the cost for these Abe Simpsons? Do you have the right to live to 100? What would Milton Friedman do here? He would have had these folks buy an annuity when they were working age to pay for their expenditure if they lived into their 90s. Now for the subset of people who had the audacity to live to 100 but didn't buy the annuity would the libertarians be firm and let them starve or rely solely on their own families for income?


The Cost of Low Fertility in Europe

In the long run, low rates of fertility are associated with diminished economic growth.

As in many parts of the world, Europe has seen a rapid decline in fertility. In 1960, Estonia was the only European nation whose total fertility rate was less than two. Today, only two European countries -- Albania and Iceland – have fertility rates above two. Several factors are thought to be driving that decline in Western Europe: socioeconomic incentives to delay childbearing; a decline in the desired number of children; and institutional factors, such as labor market rigidities, lack of child care, and changing gender roles. Also, the nations in Eastern Europe have gone through major economic, political, and social change.

In the long run, low rates of fertility are associated with diminished economic growth, according to a new study by NBER Research Associate David Bloom and his co-authors David Canning, G√ľnther Fink, and Jocelyn Finlay. In The Cost of Low Fertility in Europe (NBER Working Paper No. 14820), they observe that in the short term, low fertility rates raise per capita income by lowering families’ costs of child-rearing and boosting the share of working-age people. But as that working-age population moves into retirement, the number of workers who replace them will shrink. So, whatever short-term boon European nations may have gained from low youth dependency will be overwhelmed eventually by the economic burdens of old-age dependency.

If fertility rates stay at current levels and life expectancy averages 80 years, this study implies that Europe’s share of working-age people will fall from about 70 percent today to somewhere between 50 and 55 percent in the long run. That would suggest a 25 percent drop in the number of workers per capita, assuming that labor participation rates stay the same.

There are several ways to analyze the effects of fertility on economic growth -- these authors choose to concentrate on age structure. The idea is that fertility, mortality, and net migration together determine the size of a nation’s working-age population. The bigger is that group relative to the total population, the more workers there are, and thus the more income the nation is likely to generate. The smaller is that working-age group relative to total population, the smaller is output per capita in equilibrium.

Of course, small changes in any one of several variables can alter the picture dramatically. In France, for example, where life expectancy is 80, the fertility rate that would maximize the working-age share of France’s population would be 2.1 if young people started working at age 20 and retired at age 60. With retirement at age 55, the working-age share-maximizing fertility rate would have to rise to 3.1. With retirement delayed until 70, that rate would drop to two.

The same dynamic works at the other end of the working-age spectrum. If young people entered the workforce at age 15, the fertility rate necessary to keep everything in balance would rise to 2.6. If they entered at 25, then fertility only would need to be at 1.8 (below replacement level) to maximize the working-age share of the population.

Another factor is immigration, which typically helps to boost the size of a nation’s working-age population. But its impact is usually quite small. Austria, for example, has Europe’s third-highest net migration relative to its overall population, but over the past 45 years the absence of migration barely would have changed its share of working-age people, this study finds. Even if it did, political resistance to immigration is high.

“In short, migration is highly unlikely to have a major effect on falling working-age shares in Western European countries over the next decades,” the authors write. “The size of the economic repercussions of declining working-age shares on economic development, however, will critically depend on individual behavior.”

Previous research has shown that for every extra child that a woman has, her labor participation falls on average 1.9 years over her lifetime. So as fertility falls, women tend to spend more time working, which allows them to accumulate more savings, more experience, and possibly a better-paying job. This accumulation of physical and human capital may offset some of the overall long-term income decline that low fertility suggests.

-- Laurent Belsie