Intergenerational Reports: what are they on about?

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Sunday, 29 March 2015 18:30 by Ken Wolff

There have now been four Intergenerational Reports (IGR) from 2002  to 2015, issued by three treasurers: Costello (2),  Swan  and Hockey.  They were meant to come out at five-yearly intervals but Swan (and Rudd, although officially they are the Treasurer’s report) brought forward what should have been the 2012 report to 2010.

I will compare what each report has projected for the future, particularly the changes that have been made between each report, and how they relate to Hockey’s 2015 report.

The basics each report addresses are:

  • demographic changes (population, ageing, immigration)
  • GDP growth (population plus productivity and participation)
  • and what they mean for commonwealth government fiscal policy (revenue and spending)

 Population and ageing

There have been significant changes in the total population projections: from 25 million in 2042 in the 2002 report, to 28.5 million in 2047, 35.9 million in 2050 and 39.7 million in 2055 in the 2015 report. Australia’s population in 2014 was about 23.5 million.

The fertility rate has influenced the population projections as it was forecast to be only 1.6 in 2002 IGR but in the last two IGRs was forecast to be 1.9. The biggest change, however, comes from immigration projections. The original 2002 IGR forecast average nett immigration of 90,000 per year over the next 40 years but that increased to 110,000 in the 2007 report, 180,000 in the 2010 report and is now projected to be 215,000 per year, which suggests that immigration alone will add 8.6 million to the population by 2055 and leaves about 7.6 million in natural growth.

Those higher population figures have lowered the proportion of people aged 65 and over from a high of 25.3% forecast in 2007 (2002 was slightly lower) to 22.6% in the latest IGR (compared to 15% in 2014). The proportional fall is not quite as high as it could be in a larger population because it is forecast that people will live longer. 

Life Expectancy 2002 IGR for 2042 2007 IGR for 2047 2010 IGR for 2050 2015 IGR for 2055
Women 87.5 89.8 90.5 96.6
Men 82.5 86.0 87.7 95.1

 

What do you make of that? Quite a big jump in the latest IGR. One reason is that the methodology changed. The 2010 IGR used the ‘period’ method (as used by the ABS in its ‘Life Tables’) which applies age-related mortality rates in the year a person is born but Hockey’s IGR has used a ‘cohort’ method which makes assumptions about medical improvements over a person’s life time. Appendix C (Table C1) of the current report shows that, using the ‘period’ method for 2055, there is actually a marginal decline in the projected ages from those in the 2010 report: females 90.1 and males, 87.5.

I have my doubts of the headline figures in Hockey’s report. Unless we discover the ‘elixir of youth’ (which can’t be entirely ruled out!), I believe there is likely a biological limit to human lifespan. Some credence is given to my view by information contained in the reports that remaining life-span at age 80 has not significantly improved in a hundred years. I think Hockey has deliberately changed the approach to justify his cries of ageing and scare the population into supporting his draconian policies: the marginal drop in life-span using the ‘period’ method would not fit his argument.

Hockey has also emphasised the ‘dependency ratio’ of 2.7:1, which is the number of people aged 15-64 (the ‘working-age population’) for each person aged 65 and over, as though this is leading us towards disaster. The current figure, however, is slightly better than the 2.4 in 2007 and 2.5 in 2002 (and is the same as 2010). I find it interesting, however, that the ratio was 7.3:1 in 1974-75 and in 2014-15 is 4.5:1. We have already lost 2.8 workers for every ‘retired’ person and yet seem to have done so without major problems and will lose only another 1.8 over the next 40 years.

Despite all of the dire warnings about ageing, the international context, as reported in the IGR, makes it appear that Australia is still relatively well-placed.

Australia’s population, although ageing, is neither as aged nor ageing as fast as some other countries. Japan’s median age is almost 45 years and many European countries have a median age in the forties. By contrast Australia’s median age is 36.8. The proportion of the Australian population aged 65 years and over is smaller than many OECD countries, including Canada, France, Germany, Italy, Japan and the United Kingdom. On the other hand Australia has a much larger proportion of its population aged 65 years and above than China, India and Indonesia.

Economic projections

The main measures are real GDP growth, real GDP growth per person (which implies improvements in the standard of living), and they are influenced by productivity, participation (the proportion of people aged over 15 who are in the workforce) and hours worked. 

Annual average 2002 IGR for 2042 2007 IGR for 2047 2010 IGR for 2050 2015 IGR for 2055
Real GDP growth 1.9% 2.4% 2.7% 2.8%
Real GDP growth per person 1.5% 1.6% 1.5% 1.5%
Productivity 1.75% 1.75% 1.60% 1.50%
Participation 56.0% 57.1% 60.6% 62.4%
Hours worked per week 34.25 34.5 33.6 32.0*

 

* The 2015 IGR doesn’t give an actual figure, only a graph, and this is my best estimate from the graph, although it does seem a significant drop compared to the earlier figures.

The hours worked reduce as part-time work increases, catering for older people and more flexibility for working women. Productivity projections are simply based on the average of the previous 30 years, so as the reports now span 13 years, some earlier higher annual levels of productivity in the 1970s have dropped out. Productivity has been as low as 1.2% in recent years: if that picks up again in the next five years, before the next IGR, that would be reflected in a slightly higher figure then. The report does concede that lower productivity in the 2000s was partly a result of the massive investment in mining infrastructure: while such investment boosts GDP it adds nothing to productivity until the mines are actually in production.

The new, and higher, population figures in each IGR have led to a continuing rise in the participation rate. That change is partly due to the projected higher immigration as the majority of migrants are of prime working age. Hockey is also projecting that participation by those 65 and over will increase from 12% to 17%. The main working age group, aged 15-64, will increase from 15.8 million currently to 23.8 million in 2054-55 and while not everyone in that age group works (a number of the 15-24 age group are still in education), the workforce is projected to be over 20 million in 2054-55 compared to about 11.5 million at the start of 2015. We will have almost 9 million more people paying income tax and yet we have a major problem!

A significant change in the figures is in the ‘real’ GDP growth. It has improved in each successive IGR. If GDP had remained at 1.9% as forecast in 2002, then, I agree, that we may have been facing long-term problems but if we are now predicting real growth of 2.8%, then the problems should be proportionally less, not worse as Hockey is telling us — but perhaps he thinks no-one has bothered looking at the previous reports.

Some economic projections have remained consistent throughout the reports, notably inflation at 2.5% (the Reserve Bank’s target) and unemployment at 5%. The unemployment remains constant because this is the NAIRU (Non-accelerating Inflation Rate of Unemployment) level, below which inflation may increase. I have read criticisms of the whole NAIRU approach. To my layman’s eye, it seems no more than the neo-liberal position that lower unemployment may force employers to offer higher wages to attract workers, and that will lead to inflation. On the other hand, I would have thought that fewer unemployed would help boost GDP: it would certainly boost government revenue and also reduce government outlays for unemployment benefits (Newstart).

Government’s fiscal position

The four reports focus on commonwealth government expenditure that is influenced by demographic changes, such as spending on health, aged care, pensions, payments to families, and so on.

In the following table I compare only the first three IGRs because Hockey’s IGR approaches the issue differently and I will discuss that separately. 

Per cent of GDP 2002 for 2042 2007 for 2047 2010 for 2050
Health 8.1% 7.3% 7.1%
Aged care 1.8% 2.0% 1.8%
Aged & service pensions 4.6% 4.4% 3.9%
Payments to those of working age 1.9% 1.8% 1.9%
Payments to families 0.9% 1.0% 0.9%

 

As you can see, up until 2010 there was no major change to projections for aged care and payments to those of working age and to families. The projections for health spending and pensions were already trending down, indicating that previous governments had already taken measures to slow the rate of growth of commonwealth spending. That also suggests that a moderated approach with appropriate changes over time is already achieving reductions in future government spending. Instead of continuing that approach, Hockey was insisting we required drastic measures now.

Each of the previous reports has taken the line that the projections are based on current policy settings, although they also comment on possible future approaches to meet the fiscal challenges. As you know by now, Hockey included three projections based on previous (Labor) policy, current legislated policy (what he has managed to get through the Senate) and proposed policy. 

Per cent of GDP 2014-15 current spending 2054-55 current policy 2054-55 ‘proposed’ policy
Health 4.2% 5.7% 5.5%
Aged care 0.9% 1.7% 1.7%
Aged & service pensions 2.9% 3.6% 2.7%
Payments to those of working age 2.8% 2.6% 2.4%
Payments to families 1.8% 0.9% 0.8%

 

I have ignored Hockey’s so-called ‘previous policy’ because it is such a flagrant lie. He alleges it is based on former Labor policy but it is based on the problems created after Abbott and Hockey eliminated Labor’s revenue measures and increased the deficit in the 2013-14 MYEFO — and of course those changes carried into the 2014-15 budget. It is true that health spending was forecast to increase to 7.1% of GDP by 2050, and that was contained in Swan’s 2010 IGR, but it should be taken in the context that measures by various governments had already reduced that from 8.1%. And the same can be said of aged and service pensions.

Study the figures closely. Hockey is not only proposing slowing the rate of growth of spending, which may be justified, but wants to achieve a final result that is below what is being paid by government in 2014-15 for pensions and welfare for those of working age (payments for families were projected to fall anyway). If you need justification of statements that Hockey and Abbott are attacking those on welfare, then surely that is it.

The three earlier reports each summarised the commonwealth spending by giving a figure for the ‘fiscal gap’ (the difference between forecast government spending and revenue expressed as a percentage of GDP). In the 2002 report that fiscal gap was forecast to be 5% by 2042; by the 2007 report it was down to 3.5% in 2047; and in 2010 it was down to 2.75% in 2050. Hockey’s report does not clearly give a figure. Again this shows that since 2002 governments had already taken measures to close that gap — or that changes in the parameters were having an influence (such as the increase in population).

What the reports tend not to address in any detail are the issues arising from a growing population, not just an ageing population. If we have 15 million more people in 40 years that obviously means we require more housing, better transport systems, more energy and water, and so on and that also has implications for our environment, including carbon emissions. The 2010 IGR is the only one to make this more of an issue:

Population growth has implications for the environment, including: greenhouse gas emissions, biodiversity and water availability; urban amenity; and infrastructure and government service delivery requirements. The risks in these areas are manageable provided governments take early action to plan for future needs and introduce efficient market mechanisms to transition to a less emissions-intensive economy.

Swan’s IGR also introduced a chapter specifically on “A sustainable society’ which looked at well-being and sustainability, and human and social capital which included health, education and skills. It discussed health and education and training as means of adding to future economic growth not just as a potential drain on commonwealth finances. The three reports prepared by Coalition governments have notably ignored that, other than a brief mention that they may have an influence.

While the IGRs consistently suggest that commonwealth spending on education will decrease, partly a result of young people being a lesser proportion of the population, it has recently been suggested by the Australian Council for Education Research (ACER)  that we will in fact need additional education facilities because of population growth in recent years. ACER suggested that Victoria would require an additional 448 primary classes each year over the next decade, Queensland 443, NSW 385 and WA 351, and that will translate to additional secondary classes from about 2018. That is primarily a funding issue for state governments but it raises questions about what the IGRs are actually achieving by their singular focus on commonwealth fiscal policy.

The focus of the IGRs is justified to some extent in terms of the ‘fiscal gap’. What the gap implies is the need to raise taxes or cut spending to meet projected future costs; a warning that commonwealth government spending could result in very high taxation levels, even above 30% of GDP, whereas historically we have usually managed to keep tax below 25% of GDP. Despite that, the reports do not actually prove that gap exists, only that it might if the forecasts are accurate. The changes that have already taken place between reports show how inaccurate such long-range forecasting can be and the figures appear, to me, not to justify that ageing is the central problem to long term spending. Ageing was relevant to Treasury primarily in terms of the retirement of ‘baby boomers’ from the public service because the government had a huge unfunded superannuation liability — which is why the Future Fund was established.

The IGRs are very limited in what they set out to achieve. Inter-relationships between some spending, such as health and education, and their capacity to improve future participation rates, productivity and GDP may be mentioned but are not explored in any depth. The impact of environmental change on the economy again is mentioned without going into great detail and yet climate change has the capacity to throw all those forecasts out the window. They are not providing a grand vision for the future of Australia. They are doing little more than addressing fiscal policy and then only the commonwealth government’s fiscal policy. They would be of more value if they did discuss a future Australia and the role of the states and what sort of funding they will also require to meet the infrastructure demands of a growing and ageing population (and to meet shorter-term challenges like the demand for more school places).

I can understand that originally they were Treasury’s attempt to warn the commonwealth government that it could not keep spending the way it was or handing away revenue. Even retaining a fiscal focus, they could have become so much more and could have fostered a conversation at all levels of government about Australia’s future and the finances required for it. I think the sole Labor government IGR did attempt to give the concept a slightly broader relevance but that has disappeared in Hockey’s IGR.

I think that while the reports maintain a sole focus on commonwealth government fiscal policy, the name ‘Intergenerational Report’ is a misnomer and, when Treasury can’t get budget estimates right from year to year, I’m not sure how much credence we can place on their projections 40 years into the future. 

What do you think?

About Ken

What do you make of the Intergenerational Reports? Are they giving us important information or are they not worth much in their current form? Ken doesn't think too much of them and certainly doesn't believe Hockey's most recent report. Let us know what you think.

Next week 2353 will look at 'The "trickle down" effect' in economics and discuss a successful alternative approach taken by a US state governor.