Our Economy in 40 Years: Insights from the 2021 Intergenerational Report

Since its first edition in 2002, the Intergenerational Report has served as the government’s economic crystal ball by providing a peek 40 years into the future of the nation.

Arguably Treasury’s biggest exercise in macroeconomic forecasting, the report examines current policies and historical trends to paint a picture of the budget and the economy over the next generation. Each report is grounded in the economic conditions of the day, effectively evaluating the long-term sustainability of current economic policies and warning of the looming challenges that will need to be addressed.

The 2021 Intergenerational Report was released in late June, amidst the country’s unexpectedly successful recovery from the COVID-19 pandemic. The extent of this recovery cannot be understated – in 2020, Australia outperformed every major advanced economy in economic growth (Commonwealth, 2021). It is likely why, perhaps surprisingly, this report predicts few lasting effects on the economy from the pandemic.

Instead, the report asserts that Australia’s economic performance over the next 40 years will be driven by three key factors: population, participation, and productivity. Each of these brings unique challenges that will only become more prominent with time.

↓ Population Growth = ↓ Economic Growth

The primary projection of the report is that economic growth will slow because of slower population growth over the next 40 years. The intuition behind this is that a smaller population means a smaller consumer-base to purchase goods and services as well as a smaller labour-base to produce them.

According to the report, this slower population growth will be the most enduring consequence of the COVID-19 pandemic. The closure of international borders since March 2020 has sharply stifled net overseas migration, which has been the largest component of population growth since 2005 (ABS, 2021). In fact, so central is migration to population growth that between July and September 2020, the country’s population actually shrunk for the first time since 1916 (Pupazzoni, 2021).

Albeit to a lesser extent, the natural population growth rate has also been stifled by the pandemic. The states’ various lockdown restrictions, from the intermittent closure of dining and entertainment venues to mere capacity limits, have made it difficult for people to meet and develop relationships. Although the ABS reported a fertility rate decrease of just under 5% for 2020, the report does not underestimate the snowballing effects of this lowered fertility in the coming years.

Taking this all into consideration, the report predicts a population of 38.8 million in 2060-61, almost 1 million fewer than the previous report predicted for 2054-55 (Murphy, 2021). The report further associates this reduced population growth over the next 40 years with a loss of almost 5% in real GDP by 2060-61.

However, even these population forecasts may be too optimistic. For instance, the report assumes that migration will return to pre-pandemic levels by 2025, which is contingent on factors such as the vaccine rollout and post-COVID immigration policy. If this is not the case, Australia’s economic growth will suffer even further.

↓ Participation Rate + ↑ Population Costs

Partially related to slower population growth, the report predicts a substantial change in the demographics of the labour market. Tied to this is also a fall in the economy’s overall participation rate.

Successive Intergenerational Reports have warned that Australians are living longer and healthier lives, which is affecting the composition of the workforce (Commonwealth, 2015). In 2060-61, 23% of the population is projected to be over 65 years of age, compared to 7% in 2020-21. This dramatic increase is not only the result of an ageing population, but a consequence of the much-reduced migration of younger workers as mentioned above.

Furthermore, the report predicts that the ratio of working-age people to those over 65 will fall from 4 to 2.7 over the next 40 years. Alongside a participation rate decreased by almost 3% by 2060-61, this portends a labour market that is shrinking relative to the size and needs of an ageing population (Chomik, 2021). Health and aged care will be the most expensive of these needs, with the former already 15% of total expenditure in 2020-21 (Hawkins, 2020) and the latter projected to more than double in costs per person (Machan, 2021).

Even in the face of these significantly increasing costs, the report makes clear that government remains committed to a self-imposed tax ‘cap’ of 23.9% of GDP. Yet given the slowdown in economic growth, this cap is expected to be reached by 2035-36 while costs will continue to rise.

What is more, the report expects that personal income tax will be the primary contributor to the cap on tax revenue. The report justifies this by branding corporate and other taxes as ‘volatile’, but it is a hard sell given the boost in corporate profits during the pandemic. Given the relative shrinking of younger taxpayers by 2060-61, and current ideological hang-ups about taxation, future governments may have to find creative solutions to fund an ageing society and its needs.

↓ Labour Productivity = ↓ Personal Income

As ominous as these predictions may be, the full extent of the challenges they pose are concealed by one central assumption about productivity in the report.

Labour productivity measures the efficiency of an economy’s production, and can be understood as the ratio between outputs and the total inputs of factors required to produce them (ABS, 2020). Improved by societal phenomena such as education, technology, and worker organisations, it is what has contributed to over 80% of the growth in real Gross National Income per person in the last 30 years (Commonwealth, 2021).

The report’s economic projections assume that the growth rate of labour productivity will converge to 1.5% per year over the next generation. However, it is a particularly optimistic assumption given that productivity growth in Australia has averaged 1.2% annually over the past 10 years and also has been slowing down in similar advanced economies (Chomik, 2021). If this growth does not converge to 1.5%, the economy and personal incomes may be up to 10% lower by 2060-61.

A major challenge for governments in the next 40 years is that this slowdown in productivity across developed economies does not have a clear solution. It is likely due to a combination of factors including population ageing, a slowdown in technological discovery, increased market power and concentration, among many more (Brennan, 2021).

As such, it is not something that traditional monetary or fiscal policy can easily fix, but rather will require ambitious changes to economic policy settings and ecosystems. Only time will tell how future governments will prepare us for these challenges ahead.

References

Australian Bureau of Statistics. (2020, May 26). Labour Productivity. https://www.abs.gov.au/ausstats/abs@.nsf/Lookup/by%20Subject/6102.0.55.001~Feb%202018~Main%20Features~Labour%20Productivity~13#backtotop.

Australian Bureau of Statistics. (2021, June 17). National, state and territory population. https://www.abs.gov.au/statistics/people/population/national-state-and-territory-population/latest-release.

Brennan, M. (2021). Productivity Priorities Post-Pandemic. CEDA Interactive Livestream. https://www.pc.gov.au/news-media/speeches/post-pandemic-priorities.

Commonwealth of Australia. (2015). 2015 Intergenerational Report. https://treasury.gov.au/sites/default/files/2019-03/2015_IGR.pdf.

Commonwealth of Australia. (2021). 2021 Intergenerational Report. https://treasury.gov.au/sites/default/files/2021-06/p2021_182464.pdf.

Chomik, R. (2021, June 29). The intergenerational report was sobering, but the reality may be worse. https://theconversation.com/the-intergenerational-report-was-sobering-but-the-reality-may-be-worse-163257.

Hawkins, P. (2020). Australian Government expenditure. https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/pubs/rp/BudgetReview202021/AustralianGovernmentExpenditure.

Machan, E. (2021, June 28). Intergenerational report: Five charts that show what Australia may look like in 2061. https://www.abc.net.au/news/2021-06-28/intergenerational-report-health-age-spending-charts/100249732.

Murphy, K. (2021, June 28). Three key predictions for Australia’s future: highlights from the intergenerational report. https://www.theguardian.com/business/2021/jun/28/three-key-predictions-for-australias-future-highlights-from-the-intergenerational-report.

Pupazzoni, R. (2021, March 25). Australia’s population shrinks for the first time since WWI as COVID turns off immigration tap. https://www.abc.net.au/news/2021-03-24/population-declines-as-covid-border-closures-bite/13256938/