Is aging in the regional labor market wiping out localized external economies? Evidence from European manufacturing firms

Abstract Aging is an increasingly relevant phenomenon for several European countries. While endogenous adaptations of technology downsize concerns about possibly shrinking productivity, we know little about the pressures that aging exerts on the effects of localized external economies—such as the economies of specialization and urbanization—on productivity. On the one hand, as the regional labor market ages, we expect that labor pooling and knowledge spillovers decline due to a reduction in job hopping, and entrepreneurship shrinks due to a limited time horizon for future income flows. On the other hand, technological adaptation should be faster due to selection and competition in thick labor markets. To study these mechanisms, we use data on manufacturing firms across NUTS-2 regions in eight European countries. We deal with endogeneity in the correlation between productivity and localized external economies such as industry size and entrepreneurial quality, and we design a regional varying instrumental variable to deal with endogeneity in aging. Our results indicate that while the impact of aging on productivity is positive, the effects of localized external economies are positive for younger regions and negative for older ones. We identify a threshold in the workforce’s age composition at which the positive effects of localized external economies on productivity vanish: 19.68% of workers in the older age group for specialization economies and 24.28% for urbanization economies.