In the face of demographic changes in the decades to come, can changing community attitudes and policy reforms maintain growth in living standards?
International evidence helps identify how attention to a range of reinforcing policy reforms, in a sound macroeconomic environment, could raise participation in the labour force, lower unemployment, and sustain high productivity growth, giving faster innovation and growth in GDP per person than projected on present trends.
If policies support such reforms, the Australian economy would offer a fairer access to wider employment options, and be better able to meet the challenges of an ageing population.
Australia has enjoyed exceptional growth in real incomes and rising living standards over the past decade. However, growth in living standards will slow in coming decades unless evolving policy reforms, designed to lift participation in the labour force and sustain productivity growth, can counteract the economic effects of demographic changes.
This potential slowdown is sharply at odds with the experience of the past decade, where growth in GDP per person averaged 2.4 per cent per year, driven by 2.5 per cent per year labour productivity growth. These growth rates were unusually high, both by Australia's historical standards and relative to other industrialised countries.
This exceptional productivity growth was a payoff from sustained macroeconomic and structural reforms. The OECD, in its 2003 Economic Survey of Australia, noted that:
'Dogged pursuit of structural reforms across a very broad front, and prudent macroeconomic policies firmly set in a medium-term framework, have combined to make Australia one of the best performers in the OECD, and also one notably resilient to shocks, both internal and external.' (OECD 2003c, p. 9)
This performance cannot be expected to continue indefinitely without further reform. In contrast to recent decades, demographic trends will result in an increasing proportion of the population moving into older age brackets. This means that a sharply declining proportion of the population will be in the traditional working age groups, particularly in the under 55 years age group where participation in the labour force historically has been highest. The inaugural Intergenerational Report 2002-03 (IGR) released with last year's Budget highlighted this issue.
Various scenarios presented in the IGR showed population ageing would slow growth in real GDP per person to about 1½ per cent per annum in the 2010s, 2020s and 2030s if recent trends of lower labour force participation in older age brackets continued and if productivity growth fell back to the average of the last 30 years. Not only would the economy grow more slowly than currently, growing age-related public expenditures would raise budget pressures. On current projections, taxes would need to increase by around 5 per cent of GDP to pay for the same government services in 2041-42 that we enjoy today.
An alternative to significantly cutting government services, or increasing taxation as a proportion of national income, is to increase GDP growth above the rate projected in the IGR. Australia can pursue policies to achieve this. Building on the policy reforms of recent years, this would require sustained efforts to remove obstacles or disincentives to participate in the labour force and to maximise productivity growth rates. Pursuing such reforms should lift GDP per capita and living standards, thereby reducing the pressures to raise taxes or cut expenditure. While pursuit of these reforms will present challenges, Australia's performance over the last decade and international evidence highlights the benefits that successful policy outcomes can bring.
Indeed, the OECD has stated that 'like the United States, Australia, Canada and Ireland also experienced much higher growth over the past few years than continental Europe or Japan' (OECD 2003d, pp. 4-5). This divergent growth performance among OECD economies is in part due to demographics, but also to 'considerable progress in improving the working of labour and product markets with very positive consequences for innovation, technical progress and job creation' (OECD 2003d, p. 5).
The next section outlines how population, participation and productivity trends have interacted in Australia and other OECD countries to generate divergent performance in growth of GDP per person.
The third section examines influences on participation in the labour force, and how reducing unintended obstacles or disincentives could increase the labour force participation rate and lower unemployment to benefit average incomes and widen access to employment opportunity.
The fourth section presents the latest evidence on what drives high productivity growth.
The fifth section notes a number of policy areas that, working in conjunction with a sound macroeconomic environment, can produce better participation and productivity outcomes, faster innovation, higher growth of GDP per capita and lower unemployment. The conclusions outline broad policy choices for Australians if we wish to enjoy the same relatively high growth in living standards in the 2030s that we enjoyed in the 1990s.