Smaller, older and poorer? Projecting the pandemic's long-term economic impact is not an exact science, writes AICD chief economist Mark Thirlwell MAICD.
The publication of the latest intergenerational report (IGR 2021) provides an official take on the long-term economic implications of the pandemic. We know from economic history that some previous epidemics have had long-lasting consequences, making it reasonable to ask whether the same might be true for COVID-19, and if so, what that could mean for Australia’s economic future. The partial answer given by IGR 2021 is that while things could have turned much worse, it’s still not a particularly pretty picture. Moreover, if one big, optimistic assumption underpinning the report’s projections turns out to be wrong, then that picture could turn out quite a bit uglier.
However, before digging into the details, it’s important to be clear about what the IGR does and doesn’t do. First, IGR 2021 is not a serious attempt to forecast what the Australian economy might look like in 2060–61. Any attempt to forecast even four years ahead (sceptics might say four months) is fraught with difficulties: 40 years is impossible. And the report itself is clear about that. Rather, the objective is to “present what could happen over the next 40 years based on detailed analysis of historical trends and current policy settings. Long-term projections necessarily involve the exercise of judgement and simplifying technical assumptions. This underscores the importance of viewing the projections as one possible picture of the future. In other words, the report presents a world that could be, rather than will be.”
Keeping it simple
Second, the analytical framework for the IGR is restricted to a focus on the “three Ps” — population (the size of the working age population), participation (the share of those who work and their working hours) and productivity (output produced per hour worked). Together, these drive long-run trends in potential output (GDP). To keep things tractable, the focus is kept strictly on these “simplifying technical assumptions”.
Third, the projections in IGR 2021 combine the impact of the pandemic with the effects of pre-existing structural trends, especially some of the long-running concerns that motivated the original 2002 IGR (primarily the challenges of an ageing population) plus the interaction between both sets of factors. So, while the potential Australia conjured up for 2060–61 is partly a product of COVID-19 it’s also a result of ongoing demographic change, plus an assumed performance for productivity that is based on past performance.
What does IGR 2021 posit about 2060–61? Basically, it says that relative to the projections in its predecessor (IGR 2015) and relative to where we might have expected to end up without COVID-19, an extrapolation of current trends and policies points to a future Australia that could be somewhat smaller in terms of both GDP and population, somewhat older, and somewhat poorer — one that would be marked by larger budget deficits and more public debt. However, in absolute terms, the economy would still be significantly larger (more than two and half times bigger) and wealthier than it is now.
The key driver of this shift is the first of the three Ps — population — where the impact of pandemic- driven restrictions on net overseas migration (NOM) and a decline in the fertility rate imply a lower trajectory for population than assumed in IGR 2015.
After growing at an annual average rate of 1.4 per cent over the past 40 years, population growth is forecast to slump to just 0.1 per cent in 2020–21 due to the collapse in NOM. IGR 2021 then assumes that the rate of NOM will return to, and remain unchanged at, its pre-pandemic annual rate of 235,000 persons. Population growth then recovers to 1.3 per cent a year by 2023–24 before gradually slowing again, falling to 0.8 per cent a year by 2060–61 as a declining rate of natural increase due to lower fertility sees the share of population growth driven by NOM rise from 60 per cent over the past decade to 74 per cent by 2060–61.
Lower NOM, lower fertility and higher life expectancy also imply that Australia’s population ages more rapidly. Between 2019–20 and 2060–61, the number of people aged 65 and older is projected to double to 8.9 million and their population share to rise from 16 per cent to 23 per cent. The old age dependency ratio — the ratio of working age people to those over 65 — falls from four in 2019–20 to 2.7 in 2060–61.
An extrapolation of current trends and policies points to a future Australia that could be somewhat smaller in terms of both GDP and population.
Participation and productivity
These trends also weigh on the second P — participation — with an ageing population expected to see the participation rate slide from its March 2021 record high of 66.3 per cent to 63.6 per cent by 2060–61.
Post-pandemic projections for a smaller and older population plus a falling participation rate imply significant headwinds for economic growth and Australia’s fiscal position, but IGR 2021 partly offsets these adverse effects with an optimistic take on the third P — productivity. It assumes that labour productivity growth will converge — over a 10-year period — to its average growth rate over the past 30 years of 1.5 per cent. Not only is that faster than the average rate of productivity growth of 1.2 per cent recorded over the most recent complete productivity cycle (2011–12 to 2017–18), but it’s also considerably faster than productivity growth over the past five years, which has run at just 0.5 per cent. That sizeable gap suggests that risks to IGR 2021’s three Ps framework are skewed to the downside.
Earlier this year, the Productivity Commission reported that the most recent decade of Australian per capita economic growth was the weakest in at least 60 years, dragged down by slower productivity growth even before taking the impact of the pandemic into account. Unless we can reverse that recent productivity performance, then the IGR projections will be out of reach. But even if we achieve the “optimistic” IGR baseline with its forecast of post-pandemic 1.5 per cent per capita GDP growth, that would still see the economy underperform previous decades with the two uninspiring exceptions of the sluggish 1970s and the even more lacklustre 2010s.
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