Saturday, October 2, 2010

Projections of Australia in 2050

Projections of the future are of course fraught. There is always the possibility that black swan or game-changing events will make projections based on current knowledge irrelevant. Think the Internet. It has changed all our lives in recent times in a way unimaginable in the 1980s. While a few futurists might have imagined such a system, its impact on our social and work lives has been truly transformational. Think also about the impact on public finances of retired workers living longer as health outcomes improved over the post-war period. In earlier times many retirees died much sooner in their retirement thus placing much less of a burden on public provision?

Issues of population ageing and health expenses are major concerns for all developed countries with extensive public pension and health systems. In Australia the shift to compulsory super and the development of the future fund will help future fiscal burdens but many policy-makers and commentators continue to worry about the costs of ageing.
For those of you wanting a snapshot of Australian policy thinking on the subject then the various Intergenerational Reports (IGRs) are important reading.

Recently Treasury Secretary Ken Henry gave a speech discussing the latest IGR from January 2010.

As Henry puts it:
Some important stats are worth considering:
[T]he IGR is an analytical tool, based on assumptions and projections. It does not forecast where we think we will be, or should be, in 40 years time. Rather, it takes current economic and demographic trends, and current government policies and policy settings, and projects forward the implications of a continuation of those trends, policies and settings. While many people focus on the ‘point’ projections contained in the report, and how they compare with previous IGR ‘point’ projections, it would be safer to focus on the broad path of the pressures outlined in the report.

We currently have a population of around 22 million people with about 13½ per cent of those (less than 3 million) aged 65 and older.
By 2050, the population is projected to grow to nearly 36 million people with nearly 23 per cent of the population (more than 8 million) aged 65 plus.

[T]here will be only 2.7 people of working age to support each Australian aged 65 years or over by 2050, compared with 5 working age people per aged person today, and 7.5 in 1970.
But …

this is just one way to think about dependency. For example, unpublished projections indicate that for every adult without employment — excluding fully self-funded retirees — there will be only 1.8 people in employment in 2049-50, a fall from 2 currently.
This is a modest deterioration when compared against the ratios presented in the IGR. However, regardless of how dependency is measured, an ageing population is expected to lead to a deterioration in dependency ratios, with adverse implications for economic growth.
Over the long term what matters for economic growth is as the IGR makes clear, the Three Ps population, participation and productivity.
As Henry points out the proportion of working age people (those aged 15 or more), average hours worked by people of working age, and average output per hour worked determines real GDP growth per capita.  

Henry talks about the transitions in "prime working age", but this may change over time. It's likely that people will work til later than 65 in the future - some like me who will do so because they will want to and others who will have to to maintain their lifestyles.

Overall, however, the IGR and Henry argue that the main driver of growth will be productivity.

The proportion of the population of working age has risen steadily over the past 40 years — from 71 per cent to 81 per cent — and is projected to rise even further over the next 40 years — to 83 per cent. But among those of working age, the proportion in the age bracket with the highest rates of labour force participation — that is, aged 15 to 64 — is set to fall substantially — from 83 per cent today to about 73 per cent in 2050.
As this proportion falls, average rates of labour force participation will also fall. Ignoring productivity growth rates for the moment, that fall in labour force participation drives a projection of slowing rates of growth in GDP per capita.
Even with strong population growth, GDP growth will also slow. Thus, we project average annual GDP growth of 2.7 per cent over the next 40 years compared with 3.3 per cent over the previous 40 years.
Real GDP per capita is projected to average 1.5 per cent growth over the next 40 years compared with 1.9 per cent over the past 40 years.

In aggregate, the impacts of population and participation will be largely offsetting, leaving productivity as the major driver of future growth in real GDP per person over the next 40 years.
Henry then considers the implications for government spending:

We are projecting that nominal government spending per capita will grow at a faster rate than nominal GDP per capita, so that over the next 40 years government spending will exceed revenue by about 2¾ per cent of GDP — excluding interest payable on additional public debt.
In other words action needs to be taken now according to this framework:

Fiscal sustainability is a key theme of IGRs. Near-term, budget settings can have a substantial influence on the projected path of public finances over even a long period of time. Thus, the 2010 IGR demonstrates that by returning the budget to surplus in 2012-13 and committing to maintain a 2 per cent annual cap on real spending growth for some years, the medium-term fiscal strategy will make a significant contribution to addressing longer-term fiscal challenges.
This is not to say that, in light of the medium-term fiscal strategy, an ageing population no longer presents a threat to fiscal sustainability. Rather, what it demonstrates is that adjustments made now can reduce the need for larger adjustments later.
Spending on health is likely to increase substantially from 4 per cent to 7.1 per cent in 2050. Pensions and aged care will also increase.
The IGR projects total spending to increase to 27.1 per cent of GDP in 2049-50, around 4¾ percentage points higher than its projected low point in 2015-16. In today’s terms, that’s the equivalent of adding around $60 billion a year to government spending. Around two-thirds of the projected increase in spending over the next 40 years is related to health; reflecting pressures from ageing, increasing community expectations and the funding of new technologies. Growth in spending on age-related pensions (Chart 2) and aged care is also significant, both as a proportion of GDP and in real spending per person.
Just to show how fraught projections are note the differences between the 2007 IGR and the 2010 version.
Growing and ageing populations will have a big impact on Australia and it is likely that increases in immigration will be necessary as will increased infrastructure spending and city planning. But let's not kid ourselves that we really have any idea what the future will hold. Remaining a flexible, dynamic and equitable country that avoids historical vulnerabilities of resource and debt dependence will help Australia to deal with any black swan events in the future.

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