ABUL RIZVI: Predictions for Josh Frydenberg's Intergenerational Report

With the forthcoming 2021 Budget in May, Treasurer Josh Frydenberg will also likely release the 2021 Intergenerational Report (IGR).

This will be Australia’s fifth IGR. These reports provide a 40-year insight into the Government’s thinking on Australia’s future population and economic direction.

Since the first IGR produced by Peter Costello, these reports have become progressively more optimistic even as the population of the developed world, including Australia, has aged and the performance of developed economies has correspondingly deteriorated. But treasurers are remarkably confident in their personal ability to save Australia’s economy through their far-sighted policies.

All treasurers since Costello have relied on the 3P framework for explaining Australia’s future economic directions. That is the combination of the change in population, participation (hours worked) and productivity giving the change in economic growth. After adjusting for inflation, this gives real economic growth.

Table 1 provides the changing assumptions for the 3Ps and the resulting real economic growth used in each of the past four IGRs.

Table 1: Change in population, participation and productivity equals change in economic growth

Costello’s 2002 IGR was by far the most pessimistic (but possibly most realistic) about the impact of population ageing on real GDP growth. Each subsequent IGR has been progressively more optimistic, even though actual GDP growth has continued to weaken since the developed world as a whole entered its demographic burden phase from around 2010.

From 2013 to 2019, Australia’s real GDP growth averaged only 2.4% per annum while productivity growth averaged just 0.8% per annum. Although the productivity growth rate assumption has been reduced in IGRs since 2002, in Joe Hockey’s IGR, it was still a comparatively high 1.5%.

Real economic growth in all developed nations, once they have substantially been in their demographic burden phase (working age to population ratio in decline), has been well below that in the phase when the working age to population ratio was rising. In the demographic burden phase, real economic growth has only very rarely been above 2% in any major developed economy.

Treasury knows: High levels of migration crucial to economic growth

Treasury's estimate of net overseas migration numbers lacks detail, meaning future economic growth remains uncertain, writes Dr Abul Rizvi.

Frydenberg said in his 2019 Budget that “unfavourable demographics will constrain potential growth rates in some of the world’s major economies. Slower productivity growth could also limit productive capacity in many countries”. During the 2020s, a large number of major economies will have shrinking populations. That will include China, Germany, South Korea, Russia, Spain and Italy. Japan’s population is already shrinking at 0.5 million per annum projected to rise to 1 million per annum by 2030.

Despite this statement, Frydenberg forecast real economic growth in Australia averaging 3% per annum in his ten-year plan — a plan that seems to now have been removed from the Treasury website or hidden somewhere. Is Treasury embarrassed to have signed off Frydenberg’s rubbish ten-year Budget plan?

Table 2: Demography in IGRs

Wayne Swan, Hockey and Frydenberg (2019) assumed fertility at 1.9 births per woman based on a brief increase in fertility between 2008 and 2011. That was due to the short-term impact of women in their 30s catching up after postponing having their first babies earlier in life. Long-term, it is likely Australia’s fertility rate will converge with the OECD average of around 1.6 births per woman (that rate is itself falling).

The 2021 IGR will likely use 1.6 births per woman as per Treasury’s December 2020 Population Statement. The gap between births and deaths will narrow significantly over the next 30 years.

The net migration assumption used in IGRs has continued to rise in each report. The 2021 IGR will likely pull back from the 268,000 per annum assumption in Frydenberg’s 2019 Budget but will still be an ambitious 235,000 per annum. Delivery of that will require a very strong labour market and major changes to immigration policy settings. There are significant downside risks to a net overseas migration target of 235,000 per annum unless immigration is well managed.

In his 2021 IGR, Frydenberg is likely to forecast population growth at a relatively optimistic 1.2% per annum (0.5% points per annum less than in his 2019 Budget). That will reduce the rate of growth in hours worked as will significant ageing during 2020s with around another 1 million additional retirees (rising to around 5 million by 2030).

Table 3: Labour force and prices in IGRs

Despite highly optimistic forecasts of wages growth in every IGR, between 2013 and 2019, wages grew at only 2.3% per annum. With employers (likely supported by the Government) opposing a proposed 3.5% increase in minimum wages, a 2% cap on growth in Federal public sector wages and rampant wage theft across the economy, wage growth of 4% per annum (as assumed in the recent Retirement Income Review) is quite implausible.

Inflation has consistently fallen below the RBA target of 2.5% per annum. While it may increase temporarily with the massive stimulus into world economies, population ageing will keep long-term inflation low. Population ageing is decidedly deflationary.

Average hours worked per adult aged 15+ will continue to trend down as the population ages.

Table 4: Federal Budget in IGRs

Impact of ageing on the Federal Budget has progressively become more optimistic with each IGR and was most optimistic in Frydenberg’s 2019 Budget who forecast rising Budget surpluses through the 2020s even with major income tax cuts.

Costello’s 2002 IGR forecast growing deficits from 2020 onwards to negative 5% of GDP by 2042.

Costello’s 2007 IGR was more optimistic, largely due to a faster real GDP growth assumption of 2.3% per annum.

Swan took this even further in 2010 by pushing up the real GDP growth assumption to 2.7% of GDP by 2019-20 and then gradually declining to 2.3% per annum by 2049-50. Due to Swan’s higher fertility rate assumption and a higher net migration assumption, he assumed the population would age much more slowly and thus was able to assume a higher rate of real economic growth. That then enabled a stronger budget position (relative to GDP) with the impact of ageing pushed back significantly.

Treasury’s latest population projections seem hard to believe

While the Treasury’s December 2020 population forecasts seem unrealistic, they're still more believable than those from the 2019 Budget.

Hockey in 2015 took this significantly further by assuming even faster population growth and thus slower ageing, an even faster rate of real economic growth being sustained for much longer and major cuts to government spending on health (such as the Medicare co-payment), aged care and the age pension (for example, pushing the eligibility age back further). Hockey was an adherent to the now-discredited theory of growth through budget austerity.

In the 2021 IGR, Frydenberg will need to accommodate higher aged care spending to implement recommendations of the Royal Commission on aged care as well as a much bigger starting net debt position than Swan or Hockey. Even if a net migration assumption of 235,000 per annum can be realised, the lower fertility rate will mean slower population growth and faster ageing. That will reduce real economic growth to levels much lower than Swan or Hockey assumed and hence higher expenditure as a portion of GDP.

While Frydenberg will want to forecast a rapid return to surplus, that would frankly be just fantasy as he is likely to rely on a real economic growth assumption that defies the reality of an ageing population in Australia and across the developed world.

Dr Abul Rizvi is an Independent Australia columnist and a former Deputy Secretary of the Department of Immigration. You can follow Abul on Twitter @RizviAbul.