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3. Simulation results: impacts of demographic change

In this section, we extend previous work done at the Fraser of Allander Institute on the impact of demographic change on the Scottish economy. In recent work for the Scottish Executive, colleagues at the University of Strathclyde examined the economic impact of demographic change on the Scottish economy, through linking a demographic model with the AMOSCGE model for Scotland. Their findings and results are discussed in Lisenkova et al. (2008).

We extend this analysis by using the AMOSENVI model, rather than the AMOS model, for a set of anticipated changes to the Scottish total and working age population consistent to those modelled in this previous work. The AMOSENVI model has a more sophisticated treatment of energy inputs and a set of linked environmental accounts for Scotland. This provides considerably more detail on the relationship between economic activity in Scotland and energy and environmental impacts, and allows us to construct and report environmental and sustainability indicators. An earlier variant of the AMOSENVI model was used to examine the economic and environmental impacts of population change in the Jersey economy (see Learmonth et al, 2007).

The earlier work for Scotland (Lisenkova et al., 2008) found that forecasted changes to the level and age structure of the population of Scotland will produce significant impacts upon the Scottish labour market, and the competitiveness of Scottish industries, which will include energy industries. Changes in the size of total Scottish output, the composition of that output across industries and the structure of production within industries will have impacts on energy demand and environmental impacts, including on emissions. In this note, we explore these impacts of anticipated population change using the AMOSENVICGE model.

The AMOSENVI model is currently calibrated for a base year of 1999. Colleagues in the Fraser of Allander Institute have estimated a number of alternative projections for the Scottish population from 2000 to 2050. These use the same assumptions for key demographic parameters as are used by the Government Actuaries Department ( GAD) in their projections, but allow us to make annual projections, and create alternative projections, annually to 2050. For the simulations reported in this chapter, we therefore assume that our models base year of 1999 also represents the Scottish economy in the year 2000.

The demographic changes estimated by our colleagues are used as the exogenous disturbances in the model simulations which follow. The population scenarios used therefore differ slightly from those produced by the General Registers Office for Scotland ( GROS). We use a scenario of net migration to Scotland of 5000 per year as our "Central" projection. ⁴ This is similar, although not identical, to the assumed rate of net migration in the "Principal Projection" for the Scottish population used by GROS. Assumed changes in the total and working age population for Scotland from 2000 to 2050 under our "Central" scenario are shown in Figure 3.1.

Figure 3.1: Percentage changes from base year for working age and total population under "Central" projection

In 2050, under our "Central" scenario, total Scottish population is 1.7% lower than in 2000, however this is a significantly older population than in 2000, with the working age population down 14.9%.

We follow the method employed in Lisenkova et al. (2008) in estimating the impact on Scotland of population decline and ageing. The fall in working age population will cause the labour supply to contract at any given real wage rate. As the model is currently configured, we enter the changes in the labour force by means of a linear trend between 2000 and 2050, so that the change in the working age population over the 50 years is modelled as a linear reduction.

On the demand side, we assume that real per capita government expenditure remains constant, so that the level of government spending changes with the size of the Scottish total population. We would argue that this assumption is realistic since Government expenditure in Scotland is mainly financed through the Westminster Parliament and the experience of the Barnett formula over recent years is that per capita Government expenditure figures for Scotland have remained fixed relative to the level in England. Any changes in the composition of government and household consumption demand which occur because of demographic changes described above are not considered in this analysis. The results presented here will be driven by general demand side factors, such as movements between public and private consumption as population structure changes, as well as supply-side factors operating through the tightening of the Scottish labour market and the impact of this on the competitiveness of individual sectors.

Our central scenario takes the demographic data presented in Figure 3.1 and converts these to shocks introduced to the model in the form of disturbances to labour demand and supply. We assume regional wage bargaining in this scenario (as in the energy efficiency simulations in Section 2). As in all the other simulations reported here, we examine the impacts of the demographic and population changes (with constant per capita government spending) in isolation. That is, our results are changes relative to a base where nothing else changes (our simulations are not forecasts - i.e. the economy may be expected to grow due to other drivers, such as increased productivity, during our simulation period). The aggregate results are shown in Table 3.1

Table 3.1: Percentage change of aggregate economic and demographic variables under the central projection, bargaining labour market closure

The results in Table 3.1 should be interpreted as variations away from what would have occurred but for the changes in total and working age population. Our key results are as follows. We find that population decline and ageing has a significant impact on the Scottish labour market, and on economic activity, as well as on energy use and environmental damage. Our central case of a 1.7% decline in total population, and 15% decline in working age population, between 2000 and 2050 produces a decline in GDP of 9.30% and a fall in CO2 generation or 8.76%. The CO2 intensity of Scottish production thus increases. Energy (both electrical and non-electrical) demands fall.

Two important points can be noted from the results in Table 3.1 Firstly, the fall in employment (9.89%) is less than the fall in working age population (14.91%). This suggests that there is an increase in the labour market participation rate, and a fall in the unemployment rate. The tightening of the Scottish labour market is clear from the 7.89% rise in real wages by 2050. Secondly, the decline in GDP closely follows the observed reduction in employment. The reduction in GDP is driven by the reduction in the labour force, and increase in real wages, causing a reduction in Scottish exports generated by the reduced competitiveness of Scottish output.

In 2050 the consumer price index is 2.93% higher, but the increase in the export price index (Competitiveness Index) is higher at 4.00%. As a consequence the demand for exported goods falls in the central projection by 7.55%. The capital stock will adjust to changes in output demand but this will occur more slowly than the change in employment in particular sectors so that the change in GDP will slightly lag the change in employment. There will also be a tendency for production to be more capital intensive given the increase in the nominal wage rate, so that there is some substitution of capital for labour.

Public consumption, e.g. by Government in Scotland, is exogenously shocked in line with total population, but private consumption, e.g. by households, is endogenous within the AMOSENVI model, and can give a useful indication of the welfare of Scottish households. By 2050, the fall in private consumption is 6.08% - less than the fall in GDP and employment. This reflects the increase in the real wage for those in employment. As in Lisenkova et al (2008), private consumption falls by more than the reduction in total population, meaning a decline in per capita private consumption.

Figure 3.2: Impact on sectoral output and employment, % changes from base year values by 2050

Figure 3.2 shows the impacts on sectoral outputs and employment. By 2050 the output of, and employment in, all sectors in the Scottish economy are negative affected. There is, however, wide variation in the impacts across sectors, with the output of 'Education' and 'Public and Other Services' sectors falling by 5.9% and 4.9%, while 'Coal Extraction' and 'Construction' see a decline in output by 2050 of 14.2% and 12.9% respectively. The sectors in which government demand is concentrated in the base year IO - 'Education' and 'Public and Other Services' - are least affected since government expenditure per capita remains constant over the period simulated, and in total falls by 1.68% by 2050 (in line with the fall in total population). The other main sector of (in the Scottish Government Economic Strategy) that suffers a relatively large decline in output is the Communications, Finance and Business ( CFB) sector, which incorporates that the finance and business and 'creative industries' sectors. The CFB sector suffers a decline in output of just over 12% by 2050, and a slightly smaller drop in employment.

The extent of the negative impact upon other sectors is determined by two factors. Firstly, labour intensive sectors are worst affected because of the now increased cost of labour. Second, the sectors which are more exposed to international trade feel the negative effects on competitiveness more strongly. For example, sectors such as 'Sea Fishing', 'Fish Farming', 'Oil and Gas Extraction', 'Chemicals' and 'Transport and Other Machinery' suffer these negative export competitiveness effects, with each of these sectors having exports constituting more than 80 per cent of sectoral output in the base year data set. 'Sea Fishing', which is the most export intensive sector, sees the biggest decline in output of these sectors because is it also the most labour intensive.

Changes in the energy and environmental indicators can be seen in Figure 3.3. Looking firstly at GDP, we can see that under the central simulation for the change in total and working age population, GDP reduces by 9.30% per cent by 2050. As observed above, the output of each sector contracts by 2050 as competitiveness suffers, particularly for export- and labour-intensive sectors. The level of energy demands also fall as output declines. Electrical energy consumption (measured in GWh) and non-electrical energy consumption (measured in tonnes oil equivalent) fall by 11.09% and 8.63% respectively.

Figure 3.3: Energy indicators, % changes from base year under the central population projection, bargaining labour market closure

The other indicators of sustainability, in figure 3.3, show mixed results. These two measures relate the amount of energy consumption divided by GDP, and use electrical energy and non-electrical energy as the respective numerator. Note in these measures that GDP is the numerator, rather than the denominator as in the 'CO2 intensity of Scottish production' measure. A positive change in these indicators therefore indicates a positive movement in sustainability of economic activity, while a negative change indicates the opposite. As mentioned above the fall in electrical energy consumption is greater than the fall in GDP, and so the GDP/electrical energy consumption indicator moves in a positive direction, indicating greater sustainability. On the second measure, the fall in non-electrical energy consumption is less than the falls in GDP, and so on this indicator, there is a negative movement showing a fall in sustainability.

Figure 3.4: CO ₂ emissions and CO ₂ intensity of production indicator, % changes from base year under the central population projection, bargaining labour market closure

Figure 3.4 shows the changes in GDP and CO ₂ emissions as well as the CO2 intensity of Scottish production. Emissions of CO2 are 8.76% lower by 2050, a smaller fall than the decline in GDP. This means that the CO2 intensity of production - defined as CO2 emissions divided by GDP output (£million) - shows a small increase, i.e. consistent with decreasing sustainability of output. The carbon intensity of Scottish output is rising; however this is due to the greater relative decline in output than decline in CO2 emissions by 2050.

Detailed sensitivity analysis of these results to alternative population scenarios, labour market structure and key parameter values are reported in Technical Appendix 3. The key result arising from these sensitivity analyses is that if we assume higher values for net migration to Scotland the economic impact of ageing can become positive. While this will tend to increase CO2 emissions, a faster rate of GDP growth (as labour market conditions ease) means that the CO2 intensity of Scottish production falls. Figure 3.5 shows the impacts on the CO2 intensity of Scottish production under 3 alternative population scenarios: the "High" scenario revised the rate of net migration up from 5000 per year (central case) to 30000; "Medium-High" to 20000; and "Low" retains the assumption of 5000 in-migration per year but lowers the birth rate from 1.65 to 1.45 births per woman. Figure 3.5 shows that under the Medium-High and High scenarios (increased migration) the qualitative impact of population change on the CO2 intensity of Scottish production becomes positive ( i.e. the value of this indicator falls over the period modelled).

Figure 3.5: Trends in CO ₂ intensity of production indicator under "Central", "Medium-High", "High" and "Low" population scenarios

However, it is important to bear in mind that under these two scenarios both GDP and the level of total CO2 emissions generated in Scotland rise - see Figures 3.6 and 3.7 below.

Figure 3.6: Trends of Gross Domestic Product for "Central", "Medium-High", "High" and "Low" population scenarios

Figure 3.7: Trends in CO ₂ generation under "Central", "Medium-High", "High" and "Low" population scenarios

The only other case where we find a reversal of the impact of population change on the CO2 intensity of production is where we increase the substitutability between labour and capital. Increasing the value of this parameter means that we ease the pressure on the labour market, leading to smaller impacts on GDP. We find that as we raise the value of this parameter from 0.3 in the central case to 1 and over, the decline in CO2 generation overtakes the decline in GDP and, therefore, the CO2 intensity of Scottish production falls (see Technical Appendix 3 for more details).

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