Aug. 18 (Bloomberg) -- It doesn't matter what kind of stimulus it receives, the European economy remains as stagnant as a pond of tepid water.

When the euro plummeted against the dollar a few years ago? The economy shifted from first gear to, um, first gear.

When the European Central Bank finally started cutting interest rates? The economy showed about as much life as a slug on tranquilizers.

When governments in France and Germany threw aside the Stability and Growth Pact and said they'll start cutting taxes? The economy raised a weary eyebrow and wandered off for a siesta.

It doesn't seem to matter what kind of medicine Europe's economy receives, it doesn't respond.

Last week brought the news that the European economy didn't grow at all in the second quarter of this year. Germany, Italy and the Netherlands were all in recession.

The usual diagnosis, and the usual cures, come forth. Too much regulation, inflexible markets, interest rates are wrong, the euro is too high, and so on.

But perhaps everyone is whistling the wrong tune.

The questions that should be asked? Why are Europeans having so few babies and how can they be encouraged to have more?

Eurostat, the statistical arm of the European Union, has just published its latest survey of demographic trends. It reported that the region's population grew at a miserly 0.3 percent in 2002 to reach a total of 379 million people.

Almost three-quarters of that tiny increase came from net migration. Europeans, left to themselves, are struggling to reproduce. And soon they won't even be doing that. The United Nations predicts there will only be 44 million Italians in 2050 compared with 57 million now, and just 79 million Germans compared with 82 million at present.

Stagnation

Compare Europe to the U.S., whose population is still growing by almost 1 percent a year -- not great, but three times the European rate. One developed country with an almost static population is Japan -- and that economy has struggled to grow for more than a decade.

Once population levels slide -- and Europe is now on the cusp of that -- it is very hard for an economy to grow.

There are two reasons for that.

One is the cost of supporting an aging population. Deutsche Bank AG, citing UN figures, estimates that Europe's old-age dependency ratio -- which measures the number of retired people compared with the number of working-age people -- will rise from 0.35 now to 0.75 in 2050. In Spain, that ratio will hit 0.99. That means there will be almost one pensioner for every working person.

It will take incredible levels of productivity growth -- of which there is absolutely no sign -- to cope with that change.

Aging Europe

Second, aging countries are less entrepreneurial, and more conservative. They lose vigor and dynamism.

The big issue currently facing policy makers is how to create an economy that can adapt to shrinking, elderly populations.

For a period, it looked as if Europe could fix its demographics by importing workers from Eastern Europe. Forget it. They haven't got the babies either. The 10 acceding countries set to join the EU actually recorded a drop in population of 0.1 percent last year, according to Eurostat. Latvia led the way with a 6.1 percent population drop (some of them have left to work for Starbucks in London), followed by Hungary with a 2.2 percent decline.

EU enlargement is just going to make the demographics worse.

The answer? A better distribution of work across lifetimes would help. Retirement ages need to be raised, and companies need to be more flexible about making careers last longer. And productivity needs to be increased dramatically -- it is only by becoming a lot more productive that Europeans can maintain their living standards as populations fall. That means higher savings, more investment, and a lot more labor flexibility.

More Babies

But what Europe really needs is more babies.

Economic policy makers usually regard demographic trends as a given -- much like the weather. But fertility rates vary widely. In Europe, the Irish have the highest rates, with 2.01 children per woman, and the Spanish the lowest, with just 1.25 children per woman. The U.S. rate, at 2.06, is higher than any European country.

Cultural factors may not hold the key -- Spain and Ireland are both socially conservative, Catholic countries. Economic considerations provide more insight: France, with some of the best child-care provision in Europe and tax breaks for families, is one of the few countries where the UN expects the population to rise in the next four decades.

In some countries, few women work, so the cost of having children is low. In others where the female participation rate is higher, such as in the U.S., relatively low income taxes mean they can afford child care.

Child-Care Costs

In Europe, women work, but they also have to pay high taxes. So having a child either means they stop working, thereby roughly halving the income of a working couple. Or they have to pay for child care from taxed income -- which makes the cost prohibitive for everyone except investment bankers.

The solution? Make sure there is affordable child care across Europe. And make child care tax deductible, so that women aren't penalized for having babies.

If the lowest fertility rates in Europe could be moved closer to the highest, that would make a big difference.

Implausible? Not necessarily. European governments are capable of working together to address issues such as global warming. But demographic change is a much bigger threat than climate change.

If Europe cannot start to fix its demographics, it is condemning itself to a century of stagnation -- and tinkering with the money supply or interest rates won't change that.