Productivity and population keys to future prosperity

On Monday we are releasing the fifth Intergenerational Report, a document that comes out every five years and that projects 40 years forward. It’s not a guarantee of what will be but an insight into what could be.

The report highlights economic and demographic trends: the age and size of our population, the long-term impact on the budget of our revenue and expenditure settings.

Coming in the wake of the Covid-19 recession, our first recession in nearly 30 years, it foreshadows the longer-term consequences the pandemic will have on our economy. In this sense the report provides a guide for future policy decisions.

There are three key insights from this year’s IGR:

● Our population is growing slower and ageing faster than expected. This affects economic growth and workforce participation. In the past, IGRs have underestimated population growth. In 2002 it was forecast Australia would reach 25 million people in 2040. We got there 20 years earlier. However, this is the first IGR in which population size is being re- vised downward, a result of Covid.

More people have left than have come to our shores during the past 12 months.

Population growth is 0.1 per cent, the lowest in 100 years.

Migration levels are forecast to get back to where they were by 2024-25 but do not recover ground lost during Covid.

As a result, Australia’s population is expected to reach 38.8 million in 2060-61. This is six years later than forecast in the previous IGR.

A lower-than-expected migration intake contributes to the ageing of the population as the average age of migrants is below that of the general population. Pre-pandemic, 82 per cent of new migrants were under 35, compared with 46 per cent of the general population.

Fertility rates also are declining. While Australia’s fertility rate has been below the replacement rate of 2.1 babies per woman since 1976-77, the fertility rate was assumed in the previous IGR to be higher than it is today.

In 2015, the assumption was 1.9, but today the fertility rate is 1.65, declining to 1.62 in 2060-61. As a consequence, future population growth will rely even more heavily on migration.

The other demographic challenge is the ageing of the population. Medical breakthroughs and healthier lifestyles mean people are living longer. Across the next four decades the number of people over 70 more than doubles, over-85s more than triple and over-100s increase more than sixfold to 40,900 in 2060-61.

The baby boomers now are reaching retirement, with the ratio of working-age people to those over 65 continuing to fall.

In 1981-82, the ratio was 6.6:1, today it’s 4:1, by 2060-61 it will be 2.7:1. The ageing of the population precipitates a fall in our workforce participation rate from more than 66 per cent today to 63.6 per cent during the next 40 years.

This is a structural change that can be partially offset only by higher participation rates of women and older Australians.

● The Australian economy will continue to grow, but slower than previously thought. Growth will continue to be highly dependent on productivity gains.

The economy is expected to be more than 2 1?2 times bigger in 2060-61 than it is today, with real GDP per person growing at an average annual rate of 1.5 per cent compared with 1.6 per cent during the past 40 years.

To generate this growth, it is assumed that productivity will maintain its 30-year average of 1.5 per cent. This, however, will require an improvement in Australia’s recent productivity performance of 1.2 per cent across the most recent cycle.

If we want to maintain our living standards, generate higher wages and create more jobs, Australia must pursue economic reform, much of which is hard and contested. It is a national imperative.

Further investments in skills, infrastructure and digital transformation are required together with reforms that reduce red tape and that lead to more flexible workplaces, increased business investment and a more efficient tax system.

With productivity responsible for more than 80 per cent of Australia’s national income growth during the past 30 years, the task is obvious.

Productivity, as US economist Paul Krugman said, “isn’t everything, but in the long run it’s almost everything”.

● While Australia’s debt is sustainable and low by international standards, the ageing of our population will put pressure on revenue and expenditure.

Deficits are expected to decline from 7.8 per cent of GDP today to 0.7 per cent in 2036-37, before widening to 2.3 per cent in 2060-61.

This is a trajectory similar to those in previous IGRs, reflecting the impact of an ageing population and existing policy settings.

The Howard government’s 2002 and 2007 IGRs forecast deficits at the end of the 40- year period of 7 per cent and 5 per cent respectively; the Rudd government’s 2010 IGR forecast a deficit of 4 per cent in 2050.

Only in 2015 was a surplus forecast of 0.5 per cent at the end of the period, but that was in the absence of Covid, the biggest economic shock since the Depression.

In this year’s IGR, health accounts for the biggest shift in government spending across the next 40 years, going from 4.6 per cent to 6.2 per cent of GDP, with aged care going from 1.2 per cent to 2.1 per cent of GDP and spending on the National Disability Insurance Scheme at 1.4 per cent of GDP, nearly 30 per cent higher than what was forecast in 2015.

Significantly, as expenditure rises, the tax take doesn’t go beyond 23.9 per cent of GDP, the self-imposed cap the Coalition put in place.

Growing the economy, not austerity measures or higher taxes, is Australia’s pathway to budget repair.

Only by growing can we continue to guarantee the essential services Australians rely on.

This year’s IGR underlines the fact the economic impact of Covid is not short-lived, and that boosting productivity will be key to our nation’s future prosperity. We are relatively well placed, but there remains much work to be done.

Josh Frydenberg is the federal Treasurer.