If a listed company announced that it was going to massively scale back its investment in people, and generally allow its workforce to age, the reaction of investors would presumably be very negative. After all, the principal driver of innovation, productivity and growth is ‘human capital’ (ie, you and me). Shareholders tend to be very sensitive to these things. Unsurprisingly, when you aggregate across all companies and think about an economy, or nations at large, you arrive at exactly the same conclusions. One of the critical enablers of productivity and thus economic growth is technological change (an Australian economist, Trevor Swan, was one of the originators of this idea). And innovation is in turn fuelled by human capital, which is broadly a function of our education, training and population base.
As I explain further below, the Federal Government’s Intergenerational Report (IGR) suggests that Australia will halve its population growth rate on average over the next 40 years (the actual decline from today through to 2050 is circa 60 per cent), which is influenced mainly by a major reduction in net overseas migration from current levels. Indeed, the IGR amazingly assumes that the absolute number of net overseas migrants coming to Australia each year does not increase at all between 2012 and 2050.
So what happens when you scale back your investments in people, as the IGR supposes? Well, we already have one sobering counter-factual: Japan. Over the years many explanations have been posited by the likes of Paul Krugman for Japan’s so-called ‘lost decade’ during which it experienced very low real economic growth. But this lost decade is actually looking like it will be a permanent phenomenon: real GDP per capita has remained low no matter how much Japanese authorities have driven down interest rates, or how much stimulus they have injected into the economy. Combined with an ageing population, Japan is running relentless fiscal deficits, which some are now arguing may presage a sovereign debt crisis in the future. It all looks awfully similar to what Australia’s Government claims will happen from 2030 onwards: based on some heroic assumptions regarding political fiscal restraint, the Commonwealth is still producing permanent deficits that rise to 2.75 per cent of GDP by 2050 with net government debt hitting 20 per cent of GDP. It is easy to conceive of far worse outcomes if we relax the assumptions about our politicians’ fiscal austerity.
To date, most economists have focussed on microeconomic explanations for Japan’s demise, such as the coincident stock market and commercial real estate bubbles in the late 1980s in conjunction with underlying institutional and corporate governance dysfunctions that undermined the integrity of the Japanese financial system, and contributed to the cataclysmic unwinding of the bubble economy in the 1990s.
I have personally favoured a far simpler explanation for Japan’s economic malaise, which my occasional co-author, Joshua Gans, has also tendered: simply put, its population base is shrinking. Japan has been subject to a declining rate of population growth since 1973, which finally turned negative in the noughties. The Japanese Government now estimates that its population will contract by nearly 30 per cent over the next four decades. The main problem Japan faces are cultural constraints whereby Japanese society has not historically been open to assimilating foreigners. This has in turn meant that Japan has been unable to defray its ageing population via net overseas migration. Joshua Gans has framed this in the context of a long-term effective demand challenge: that is, a secular stagnation in demand that manifests when population growth falls.
I think that Japan today is a case-study as to what Australia might look like in decades hence if we cease investing in human capital. Bizarrely, this is the Federal Government’s current position as evidenced via the IGR. Yet unlike Japan, Australia is actually an immigrant nation. One in every four Australians today were born overseas. Around 40 per cent of us have a parent that is not a native. In order to exploit our providential endowments of natural resources, Australia has had to rapidly expand its population base. Indeed, today we have the fastest rate of population growth in the developed world. But the Government’s IGR projections portend a very different world: one in which just like Japan the working share of the population sinks, real GDP per capita slumps, government expenditure on health and pensions exceed revenues, and the nation confronts the challenge of funding a tidal wave of deficits.
Before I turn to some solutions, let’s dive into the data in a little more detail. In 2004, the ABS estimated that Australia would have 28.2m residents by 2050. In 2008 they lifted their projection by an incredible 6m persons to 34.2m residents. Late last year the Treasurer was flagging a 35m estimate. And the IGR has increased that again to 36m people. Yet even these ostensibly high forecasts suppose a dramatic slowdown in population growth (refer to the three dotted lines that trend down in the first chart). To quote the IGR:
“While population will continue to grow, annual rates of population growth are projected to slow gradually, from 2.1% in 2008–09 to 0.9% in 2049–50. The projected average annual rate of population growth of 1.2% over the next 40 years is slightly lower than the average annual rate of 1.4% over the previous 40 years.”
Do you notice any pattern here? Do you think that perhaps our politicians might be just a little concerned about the electoral push-back associated with immigration and population growth? If the government’s net overseas migration numbers are out by just 100,000 persons per annum, which would put the annual flow at 280k rather than 180k (currently we are running at 244k), Australia is staring down the barrel of 40m people within four decades. For what it is worth, I think that the politicians’ anxiety is overcooked. We are an immigrant nation, after all. Xenophobia is really a fringe problem. But without a very thoughtful and positive plan as to how we are going to accommodate all these new people, and a compelling explanation of the economic benefits of doing so, politicians have little hope of bringing the community onboard.Scanning across all the IGR assumptions, there is one that sticks out like a proverbial bull’s balls: the IGR is forecasting a radically declining, as opposed to increasing, rate of immigration, which is counterintuitive given the economic constraints that arise from an ageing population. Indeed, the IGR amazingly proposes a decline in both the absolute number of net overseas migrants (ie, a falling growth rate), and zero annual growth in new migrants from 2012 onwards. That is to say, they hold the absolute number of net overseas migrants coming in each year constant. This runs against the grain of all economic logic, which the IGR subtly acknowledges: our demand for skilled labour is only going to rise, not fall, over time as the population ages:
“Net overseas migration is assumed to fall relatively sharply from an average of around 244,000 a year over the three years to June 2009 to 180,000 people a year from 2012…Net overseas migration contributes to population growth and tends to reduce the rate of population ageing since migrants are younger on average than the resident population. Currently, around 89% of migrants are aged less than 40 when they migrate to Australia. This compares with around 55% for the resident Australian population.”
As Australia’s population grows older, the number of workers as a share of that population falls. Real GDP per person and real GDP overall is, therefore, forecast by the IGR to similarly decline. This means that government will have a smaller revenue base to support rising pension and health liabilities associated with aged members of the community. That is, the so-called ‘dependency ratio’ increases. The IGR explains this as follows:
“In 1970, there were 7.5 people of working age to support every person aged 65 and over. By 2010 this has fallen to an estimated 5 people of working age for every person…By 2050 the number is projected to decline to 2.7 people of working age to support every person aged 65 and over.”
The IGR therefore predicts that the government will start running large fiscal deficits from 2030 onwards, with the net government debt to GDP ratio hitting 20% by 2050 (see next chart below). Or, in the IGR’s words, “A fiscal gap is projected to emerge in 2031–32 and grow to around 2.75% of GDP by 2049–50.” And this is in turn based on the rather implausible assumption that government can limit increases in real government spending to 2% per annum.
Setting aside incremental productivity improvements, which are likely to be marginal, there are only two realistic responses to Australia’s looming economic problems: we increase skilled migration and/or the natural birth rate. The alternative is Japan and systematic economic decline. We currently confront an international balance of payments problem: developed countries are short people—a deficit of human capital, so to speak. Developing countries, like China and India, on the other hand, are typically long people: that is, they have a human capital surplus. And so there is nothing wrong with importing new human resources to better support an ageing workforce. More broadly, it is disgrace that we don’t have a national population and infrastructure strategy. Policymakers should be looking forward over the next four decades and working out our optimal population growth rate in the absence of any constraints. They then need to evaluate the magnitude of the actual constraints. But they should do so with a forward-looking mentality. There is no point, for example, taking existing transportation technology and holding it constant. We have to back our ability to continue to innovate. By 2050 it is likely that all cars will be electric. This immediately removes the single biggest externality associated with traffic congestion: pollution. Over the past 50 years there have been enormous advancements in transportation, particularly with the advent of commoditised aircraft travel. We have on the immediate horizon many new technologies, such as scram-jet engines, that could facilitate further revolutions in the way in which we transport human capital and think about building our cities. So our national population plan has to look to the future and in a courageous manner address:
* Australia’s long-term human capital requirements;
* the ramifications of that population base for real GDP per capita and public finances;
* the infrastructure that will be required to support the resident population;
* how that infrastructure will be funded by both the public and private sectors;
* the consequences of the population projections for the nation’s housing needs;
* where we expect to locate this new housing, and hence our long-term urban plans; and
* the fundamental linkages between new housing supply and infrastructure investment, where the latter is an obvious condition precedent to ‘enabling’ accommodation.
Population planning, infrastructure spending, and housing supply are not state government problems. They are first-order national policy imperatives. The federal government needs to articulate the blueprint and then work with the states to implement it.
With all of this in mind, I would propose that the federal government immediately establishes a new Population and Infrastructure Planning Department to address the questions outlined above, amongst other things. Based on extensive due diligence and consultation with states, the Commonwealth should develop a national infrastructure architecture and ultimately provide funding for the key strategic projects that derive from this plan (alongside the private sector and states, as required). But instead of supplying ‘grants’, the Commonwealth should receive ‘equity’ in state infrastructure that they fund to provide a return on the capital they invest, and to ensure that they can continue to exercise control rights (this does not prevent the states from also securing ownership stakes).
Crucially, the infrastructure spend can then be used as a driver of housing supply. That is, the Commonwealth could demand zoning, building approval, and land release outcomes in exchange for funding new infrastructure development. The idea here is that you only elastify housing supply in areas where new infrastructure can support higher population densities.
All food for thought.
