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Australia's Economy and the Lasting Effects of Its Ageing Demographic

Susan Kelly

Dec 10, 2023

Australia's population will age significantly in 40 years. The post–World War II trend of living longer and having fewer children began to cause this aging more than four decades ago. Since we cannot change demographic shifts, we must adapt. The Treasurer often says, "Demography is destiny," emphasizing the certainty of these changes.

Demographic trends are predictable, but economic effects are not. Over 40 years, people have changed their financial behavior to improve their situation, introducing unpredictability. Discussing aging is about creating a realistic scenario to answer critical policy questions, not predicting the future.

The Demographics of the Australian Population

Population data shows that birth, aging, and death follow regular patterns. We can accurately predict future populations using current demographic data and realistic migration, life expectancy, and birth rate projections. According to IGR2, Australia's population will exceed 28 million by 2047, with significant age structure changes.

However, childbirth will also be relatively static, which is rather frustrating as it will imply that fewer young people will be available in the coming years. The working-age group aged 15-64 will increase in number, though not as fast as in the preceding forty years. This percentage will drop to 8% from 67.5%. 55-64-year-olds are the fastest-growing segment. A 50% increase in this segment is expected over the next 40 years. People aged 50–64 are less active in the labor market than those aged 20 to over 49.

Most growth is expected in the 65+ crowd. By 2047, this proportion will nearly double to 25% of the population. Over 85 will be the fastest-growing demographic, suggesting that older demographics grow faster.

Given these demographic shifts, the Australian economy demand and supply will change significantly. Geriatricians' and old people's care will be in high demand, but pediatrics may not. More schoolchildren won't increase educational demand. Moreover, Australian voters will age on average.

Births are rising in Australia during a mini-baby boom. Still, fertility is below replacement. The expected negative value of natural increase (births minus deaths) is not seen until the 2050s and is expected to decline. This means net immigration will drive more of Australia's GDP growth.

Australia is experiencing a rise in the number of births. However, fertility remains below replacement. Thus, natural increase (births minus deaths) will decline and become negative in the 2050s. Australian population growth will increasingly depend on net immigration.

Population Impact on the Australian Economy

When we look at the Australian economy, understanding how population changes affect it becomes crucial. The framework we use, called the "3Ps" - population, participation, and productivity - helps us project the economy for Australia from the supply side.

Workers typically slow down after 55. This decline in the work rate affects labor force participation. By 2046–47, the participation rate for 15-year-olds is expected to drop from 65% to 57%. The growing elderly population is driving this decline in workforce participation.

Labor productivity has grown above 1.8% annually for 40 years. The current pace should last 40 years. Over 40 years, population and participation changes will lower Australia's GDP per person growth from 2.1% to 1.6%. This half-percentage point difference suggests that this decline could reduce Australians' standard of living by 20% in 40 years.

Labor utilization is used to boost the Australian economy. However, labor utilization will likely fall in the 2040s, slowing economic growth. An increasing number of baby boomer retirees is contributing to this shift, which is crucial for the Australian economy.

The Effect of an Ageing Population on the Budget

In examining the fiscal consequences for Australia, the Intergenerational Report (IGR2) indicates that over the next 40 years, we'll see an increase in spending pressures amounting to 4.75% of the GDP. The significant areas of spending growth include health, age pensions, and aged care, with the aging population playing an important role, alongside factors such as new drug developments impacting health expenses.

IGR2 predicts a fiscal gap of about 3.5% of GDP by 2046-47, where spending exceeds revenue. This is an improvement from the 5% gap projected in the first Intergenerational Report (IGR1) for 2041-42. The better outlook is credited to slower growth in spending per person and a higher nominal GDP per person than previously forecasted. Notably, the reduction in spending is primarily seen in health, although there are offsets due to increases in education and aged care spending. The rise in nominal GDP per person is due mainly to a significant increase in trade terms. Enhancements in labor force participation and skilled migration have also contributed to this growth compared to IGR1.

The studies stress the need for strong economic growth policies. In the next four decades, government spending on GDP will reach 25.5 percent, the highest-ever level. The increase is 4.7 percent. Government spending per capita is projected to go up by 128% on real GDP per capita growth of 86%.

Discussing the ideal government size is complex, and while definitive conclusions are elusive, OECD research suggests that more enormous government expenditures and the taxes needed to support them can hamper efficiency and slow growth. Australia's economy has benefitted from having a relatively small and stable government sector compared to other OECD nations. In a fully employed economy, a larger government inevitably reduces the scope of the private sector.

Global Perspective

The number of older adults is on the rise at the global level. Old age dependency ratios that are higher compare the number of old people to the working age. For example, these ratios will double in Australia, Europe, India, and Japan while tripling in China by then. However, unlike most major nations, the US will rise just a little.

These demographic shifts are easier to manage in countries with open economies, innovative financial markets, and migration. Financial tools to manage retirement funds are needed as more people age. Examples include annuities, long-term bonds that track inflation, demographic-based derivatives, and home equity access.

The government should foster these financial products developments. This means ensuring regulations promote innovation. The G-20 has extensively discussed these issues.

These global ageing trends will affect the Australian economy, so we must consider them. With similar demographic shifts in the Australian economy, adapting is crucial. The economy for Australia must adapt to its aging population. This includes creating new financial products and considering economic policies to support an aging population.

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