An "age-old" problem we still haven't tackled
ACCORDING to the 2015 Intergenerational Report, by 2054 our public debt level will be somewhere around about Japanese or Italian levels (see Chart 2.5 of the Report if you want to be scared).
But then what do I care? I'll be in my 90s by then, and the good thing is that nothing much will have changed. I'll still be able to get a pension, as the nice little story in the Intergenerational Report about "Kathleen and Steve" assures me.
Kathleen and Steve are 68, own their home and have $1.1 million in superannuation, shares and bank accounts. They have no other income. They will receive a part-rate pension."
Phew. Only $1.1 million. How do they get by? Sure need that pension. Behind all of the projections and big debt and deficit numbers there is really just one big question in the IGR. The question is what kind of economy do we want in 2054? Do we want to look like Japan or Western Europe today - old, sclerotic and bankrupt?
Or do we want to rethink the policies that most OECD economies are continuing to persist with, despite their clear evidence of failure? Are we willing to promote self reliance and a culture of work, rather than reliance on government to support our ageing bodies?
We can afford the status quo. We can continue to fund Kathleen and Steve's pension, and their rising health care costs, and as the population ages the burden on a smaller and smaller share of the population who are working must continue to rise.
This is the European solution. Rising taxes, rising public sector deficits and debt, and dead economies. Pensions for Kathleen and Steve worked fine when pensions were introduced in Australia early last century.
That's because almost all Kathleen and Steves were long gone by the time they were 68. And if they did manage to last that long the odds were that they weren't going to last much longer. Small pension costs, small health care costs and a rising working age population to pay for a few oldies.
By 2054 there will be millions of Kathleen and Steves. Sure, Kathleen and Steve paid taxes while they worked, but the point of government is not to recycle their tax money back to them. The purpose of taxation is to pay for public goods, and to support those genuinely in need.
Some people should pay taxes over their lifetime, and the less fortunate should receive transfers. But we can't afford to churn tax receipts to the majority of citizens over the course of their lifetime because the IGR tells us what every demographer worth her salt knows - that not enough of us are dying.
Four reports, all saying the same thing
We have now had four IGRs and they've all said pretty much the same thing. We're getting older, and as a result our health and pension costs will continue to rise, but also our economic growth will slow down as the demographic dividend of rising labour force participation disappears.
Despite the warnings in the IGRs, we have not gotten close to controlling the two main costs associated with an ageing population. This is perhaps not surprising in a world where the aged vote, our voters are getting older, and our politicians pander relentlessly to the median voter, but this mix is a recipe for an impoverished Australia.
Economic projections over a long time horizon are fraught with difficulty, but some general trends are reasonably straightforward to predict. The 2002 report predicted that by 2012 Australia's population would be 21.5 million, with 14.6 million in the working age range.
The actual population was 22.7 million during 2012, with the fraction of the population of working age slightly above the IGR forecast. The 5% underestimate of the population was mostly due to immigration rates being higher than predicted, and with immigrants being younger on average than the non-migrant population the result was also a slightly higher fraction of the population of working age.
Immigration rates in the future are a little bit difficult to predict, but it is pretty certain that average life expectancy will continue to rise, and the total fertility rate will remain below the replacement rate, so that the share of the population of working age will continue to fall. The result will be rising health and other age related costs which were predicted in 2002 to rise from 6.9% of GDP to 12.7% of GDP by 2042.
While the demographic projections have been reasonably accurate to this point, the economic forecasts have been far too optimistic. Actual budget outcomes in the areas of health and aged spending have deteriorated more rapidly than projected, and with the global financial crisis and the recent falls in the terms of trade the actual budget outcomes in recent years have been well behind forecasts.
Status quo is not an option
What can be done about this problem? One option is the status quo. Assuming that GDP continues to grow, a rising welfare and health burden can be dealt with through increasing tax revenues and government expenditure. This option will see living standards decline dramatically in the coming decades relative to where they should be, so that the opportunities for our children will be far less extensive than they should be. Rising tax burdens stifle innovation and entrepreneurship, and our new competitors in the more dynamic emerging markets will increasingly occupy spaces that Australians should also enjoy.
What can be done to control these costs? In regard to both health and aged care spending, government spending must be provided only to those who are in need of assistance. Pension tests are still far too lenient, with many pensioners who receive some assistance such as Kathleen and Steve clearly capable of caring for themselves.
Relatedly, anyone who receives any pension also receives very substantial health benefits and other subsidies. Over the past decade the government's share of total health spending has risen. Private contributions to health need to be increased in future, notwithstanding the botched attempt to introduce co-payments in the last budget.
The IGR is a well intentioned attempt to get politicians to look beyond the next news cycle to the bigger economic issues facing Australia in coming decades. The IGR had identified the major challenges facing us. Unfortunately she'll not be right. There does need to be a major rethink about the shape or our economy in coming decades. On evidence of our policy efforts since the first IGR in 2002 I am not optimistic that our politicians are up to the challenge.
- Mark Crosby is Associate Professor of Economics at Melbourne Business School