Australian Government, 2007–08 Budget

Policy priorities for maintaining full employment in the face of global change

The previous sections of this statement took a retrospective look over time and across countries at the characteristics of Australia's labour market and the policy and non-policy factors that have contributed to the labour market outcomes over the past decade and a half. In this section, a forward look is taken at the likely trend in labour utilisation.

Chart 20 extends Chart 1 presented at the beginning of this statement by adding Australia's projected labour utilisation and productivity over the next 40 years to 2046-47. As the historical segment (up to 2005-06) of the chart shows, there has been a general north easterly movement of the line, reflecting generally rising labour utilisation and productivity growth. The product of labour utilisation and productivity at each point on the line gives a measure of GDP per capita. The line represents Australia's path of economic growth in GDP per capita over time.

Increases in labour utilisation are projected to continue from 2005-06 to around the end of the decade, reflecting the continuation of the rise in the proportion of the working age population. By 2009-10, Australia will have reached its demographic 'sweet spot', where the dependency ratio is at its lowest level.

From the beginning of the 2010s the dependency ratio is projected to rise, reflecting mainly the retirement of the baby boomer generation. This will reduce the proportion of the traditional working age population and consequently reduce labour utilisation. By 2046-47, labour utilisation is projected to have declined to levels experienced in the mid-1990s.

Chart 20: Labour utilisation and productivity

Chart 20: Labour utilisation and productivity

Source: Australian Bureau of Statistics and Treasury calculations.

Implicit in this projection is the future impact of current policy settings — the bundle of macroeconomic and microeconomic reforms, including labour market reform, that have been introduced over the years. The projected decline in labour utilisation makes it more difficult for Australia to achieve strong economic growth and necessarily places greater reliance on productivity to drive economic growth.

Although labour utilisation is projected to decline, the impact on Australia is much less severe than for other advanced economies. As Chart 21 shows, the demographic 'sweet spot' is relatively deep for Australia (deeper than for France, UK, New Zealand and the US). Also, the rise in Australia's dependency ratio beyond this decade is lower than for Japan, France, and Canada and similar to New Zealand and the UK. The implication is that the economic adjustment and the consequent policy task is more severe for other advanced economies than it is for Australia.

Chart 21: International dependency ratios

Chart 21: International dependency ratios

Source: United Nations 2006 Revision Population Database, medium variant.

The Intergenerational Report 2007 identified that significant progress has been made since the first Intergenerational Report to arrest the backward trend in Australia's projected labour utilisation. The improvements are due mainly to higher projected participation rates of older workers and higher levels of skilled migration. These improvements have been large enough to more than offset negative impacts on labour utilisation arising from lower mortality rates and higher birth rates. They have shifted the path of economic growth in Chart 20 in an easterly direction relative to where it was in the previous Intergenerational Report, whilst maintaining the movement northward reflecting the contribution of productivity to economic growth. The challenge is to maintain these improving trends.

In broad terms, best practice labour market outcomes involve policy priorities for (i) ensuring that the labour market is flexible so that the existing labour force remains fully utilised and allocated to its most productive uses as the economy continues to respond to demographic and other change and (ii) expanding the supply of labour.

It is widely recognised (OECD 2006a) that Australia has a robust macroeconomic policy framework that has bolstered the economy's stability and reduced uncertainty. The priority is to continue to make timely adjustments within this framework in response to changing economic conditions. The broad thrust of existing labour market policy is to provide flexibility so that the economy is able to adjust quickly to internal and external shocks and shift resources to areas of new comparative advantage and, in so doing, provide opportunity for those who want employment to find employment and to reward effort. In terms of Chart 20, the path of economic growth is likely to be more stable relative to historical trends.

In an economy approaching full capacity utilisation, all activity, including of governments, that commands additional real resources without at the same time expanding supply capacity must impose a cost. Employment creation under such economic conditions essentially requires an increase in labour force utilisation. This may come about, for example, through raising the labour force attachment of older workers, providing assistance for people with disabilities to enter employment, or employment of Indigenous Australians who would otherwise face a life of passive welfare dependency. Another avenue is to increase the size of the labour market through immigration of suitably skilled workers. In terms of Chart 20, the path of economic growth would move in an easterly direction, raising GDP per capita for any given level of productivity.

Measures in the 2007-08 Budget continue the series of initiatives over recent years to promote participation and, thereby, higher labour utilisation. They will boost incentives to work in a number of ways.

Among the changes to the personal income tax system are increases to the 30 per cent, 40 per cent and 45 per cent thresholds and an increase in the Low Income Tax Offset. These changes will increase the returns from working. In particular, the increase in the 30 per cent threshold from $25,001 to $30,001 is likely to have a strong impact on participation, given the large number of people affected and the higher labour supply responsiveness of workers on lower incomes.

A high quality education system is crucial to enhancing the skills and productive capacity of Australia's young people and is an essential building block of economic growth prospects.

This budget includes a comprehensive package of measures to improve education outcomes across the university, vocational and school systems. A key component is the establishment of a new, perpetual Higher Education Endowment Fund (HEEF) with an initial investment of $5 billion funded from the 2006-07 surplus. This significant investment will broadly double the existing financial investments and endowments accumulated in the university sector. The earnings from this endowment will be distributed to institutions on a competitive basis annually to use for capital works and research facilities. The Budget also includes initiatives to promote the flexibility and diversity of the higher education sector, increase assistance for vocational education and training students, and enhance high quality teaching and learning in Australian schools (see Budget Statement 1 for further details).

As noted above, reductions in the cost of child care will encourage increased female labour force participation. The 10 per cent increase in the hourly rate of Child Care Benefit, included in the 2007-08 Budget, will provide a boost to participation. Furthermore, the new arrangements for payment of the Child Care Tax Rebate, by bringing the timing of the rebate closer to the time when child care is used, will sharpen the participation incentives provided by this component of child care assistance.