The long term fiscal implications of raising Australian labour force participation or productivity growth

This paper examines the fiscal implications of a significant rise in Australian labour force participation or labour productivity growth over the next forty years, relative to the projections in the Australian Government’s 2002-03 Intergenerational Report (IGR). The alternative, higher, labour force participation projections assume that Australian participation rates by age and gender rise gradually over the next twenty years to just reach the top one fifth of the current experience of the OECD, and then remain at these higher levels over the subsequent twenty years. Results for higher productivity growth are presented for two alternative assumptions. Both assume average economy wide labour productivity growth at an annual rate of 2 ¼ per cent, which is ½ per cent faster than assumed in the IGR but close to its average rate since the early 1990s. They differ, however, in the assumed coverage across the economy of the higher productivity growth. The first alternative assumes higher productivity growth that is shared across all sectors of the economy, while the second assumes no rise, relative to the IGR, in productivity growth in government funded service sectors. The paper describes how the significant areas of Australian Government expenditure are modelled for the alternative projections, with a focus on Australian Government health expenditure, and in particular on the non-demographic component of that expenditure, because of its importance for the fiscal projections. The paper also presents estimates of the 'fiscal gap' for the IGR and the three alternative projections. The long term fiscal projections for all three alternative assumptions are more favourable than those in the IGR. The projection that assumes higher productivity that is not shared by government funded service sectors generates only a small fiscal improvement; the projection that assumes higher productivity that is shared across all sectors generates a significantly larger improvement, while the largest fiscal improvement occurs for the higher participation projection. The paper explores the reasons for this ordering, which arises primarily because of the economic relationship between labour productivity and real wages, and the link from real wages to the cost of providing both government services and government payments to individuals. The fiscal improvements for both the projection that assumes higher productivity that is shared across all sectors, and the higher participation projection are sufficiently large that, were either to be realised, that component of the IGR fiscal gap arising from the ageing of the population would be more than eliminated, although the rest of the IGR fiscal gap — arising from non-demographic growth in Australian Government health spending — would not be.