© the treasury long-term fiscal projections under alternative labour force scenarios peter...

© The Treasury

LONG-TERM FISCAL PROJECTIONS UNDER ALTERNATIVE LABOUR FORCE SCENARIOS

PETER GARDINER, MATTHEW BELL & PAUL RODWAY

© The Treasury

The usual disclaimer...

The views, opinions, findings and conclusions or recommendations expressed in this paper are strictly those of the authors. They do not necessarily reflect the views of the NZ Treasury or the New Zealand Government. The New Zealand Treasury take no responsibility for any errors or omissions in, or for the correctness of, the information contained in this paper. The paper is presented not as policy, but with the view to inform and stimulate wider debate.

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© The Treasury

Overview

• Motivation– Long-term fiscal strategy– Growth assumptions

• Labour force participation

• Hours worked

• Labour productivity

• Fiscal and revenue projections

• Discussion - limitations and future work3

© The Treasury

Motivation – Treasury’s Long-Term Fiscal Strategy• Accompanying the yearly budget, Fiscal Strategy Report

provides a further 10 years of fiscal projections that provide key indicators like net debt and operating balance

• In 2006 and again in 2009 produced longer term projections (Long Term Fiscal Statement) to 40-50 years

• Highlight the implications of demographic change, namely population ageing

• The Treasury are in the early stages of planning the LTFS that is scheduled to be released in early 2013

• This work was undertaken to inform the LTFS

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Motivation – FTFS & LTFM

• Long-term fiscal projections aren’t forecasts (although they are follow from the Treasury forecasts)• They are based on a set of aggregate-level assumptions and do not incorporate any policy

responses. • However, they do portray potential paths for important fiscal indicators under current or planned policy

settings

5

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

%

Year ending 30 JuneLabour force participation hours worked labour productivity

Projections

Key assumptions that under underpin LTFMFuture participation rates based on Statistics NZ’s population projectionsHours worked and labour productivity (and inflation) projections are based on their respective historical averages

We are explicit about the impact that an ageing population will have in these key labour market assumptions – ie that it will cause a fall in labour force participation, but will not alter hours worked or labour productivity

This work looks at how to incorporate ageing effects more broadly...

© The Treasury

Labour force projections

59

60

61

62

63

64

65

66

67

68

69

70

Mar

-86

Mar

-87

Mar

-88

Mar

-89

Mar

-90

Mar

-91

Mar

-92

Mar

-93

Mar

-94

Mar

-95

Mar

-96

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11

Participation rate Trend (lamda=1600)

• Based on Statistics New Zealand’s Series 5 projection

• From which the Treasury derives a projected working age population (15+).

• Using the SNZ census-based labour force projections as a base the Treasury derive five-year age group labour force participation rate projections

• These are blended with aggregate level participation rate forecasts from Treasury’s macroeconomic forecasts to capture initial business cycle effects

• Age group participation measures to drive forward the projections for 40 years.

6

0

10

20

30

40

50

60

70

80

1880 1900 1920 1940 1960 1980 2000 2020 2040 2060

child Aged Prime age

© The Treasury


50.0

60.0

70.0

80.0

90.0

100.0

Jan-

86

Jan-

90

Jan-

94

Jan-

98

Jan-

02

Jan-

06

Jan-

10

Jan-

14

Jan-

18

Jan-

22

Jan-

26

Jan-

30

Jan-

34

Jan-

38

Jan-

42

Jan-

46

Jan-

50

Jan-

54

Jan-

58

15-24 yrs

Male Female

50.0

60.0

70.0

80.0

90.0

100.0

Jan-

86

Jan-

90

Jan-

94

Jan-

98

Jan-

02

Jan-

06

Jan-

10

Jan-

14

Jan-

18

Jan-

22

Jan-

26

Jan-

30

Jan-

34

Jan-

38

Jan-

42

Jan-

46

Jan-

50

Jan-

54

Jan-

58

25-34 yrs

Male Female

50.0

60.0

70.0

80.0

90.0

100.0

Jan-

86

Jan-

90

Jan-

94

Jan-

98

Jan-

02

Jan-

06

Jan-

10

Jan-

14

Jan-

18

Jan-

22

Jan-

26

Jan-

30

Jan-

34

Jan-

38

Jan-

42

Jan-

46

Jan-

50

Jan-

54

Jan-

58

35-44 yrs

Male Female

50.0

60.0

70.0

80.0

90.0

100.0

Jan-

86

Jan-

90

Jan-

94

Jan-

98

Jan-

02

Jan-

06

Jan-

10

Jan-

14

Jan-

18

Jan-

22

Jan-

26

Jan-

30

Jan-

34

Jan-

38

Jan-

42

Jan-

46

Jan-

50

Jan-

54

Jan-

58

45-54 yrs

Male Female

0.0

20.0

40.0

60.0

80.0

100.0

Jan-

86

Jan-

89

Jan-

92

Jan-

95

Jan-

98

Jan-

01

Jan-

04

Jan-

07

Jan-

10

Jan-

13

Jan-

16

Jan-

19

Jan-

22

Jan-

25

Jan-

28

Jan-

31

55-64 yrs

Male Female

0.0

20.0

40.0

60.0

80.0

100.0

Jan-

86

Jan-

90

Jan-

94

Jan-

98

Jan-

02

Jan-

06

Jan-

10

Jan-

14

Jan-

18

Jan-

22

Jan-

26

Jan-

30

Jan-

34

Jan-

38

Jan-

42

Jan-

46

Jan-

50

Jan-

54

Jan-

58

65+ yrs

Male Female

7

Labour force participation rates by age group, male and female...

© The Treasury


• The total labour force participation rate can be broke into a component due to the working age population structure and a component reflecting the participation performance within each age group as follows:

Structure component + Performance component

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© The Treasury

Average Hours Worked

9

20

25

30

35

40

45

15-24 25-34 35-44 45-54 55-64 65+

hour

s pe

r wee

k

1980s 1990s 2000s

20

25

30

35

40

45

15-24 25-34 35-44 45-54 55-64 65+

hour

s pe

r wee

k1980s 1990s 2000s

29.0

30.0

31.0

32.0

33.0

34.0

35.0

36.0

37.0

38.0

Mar

-86

Mar

-88

Mar

-90

Mar

-92

Mar

-94

Mar

-96

Mar

-98

Mar

-00

Mar

-02

Mar

-04

Mar

-06

Mar

-08

Mar

-10

Until recently, hours worked has been reasonably stable...

Age group profile highlights gender differences and lower hours worked among youth and older workers

© The Treasury

Projecting age-augmented hours worked (weighted average total that accounts for changes in population structure)

Where k is the age group, g is gender and WAP is the working age population.

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𝐴𝐻𝑊𝑡 = σ (𝑊𝐴𝑃𝑘,𝑔,𝑡𝑊𝐴𝑃𝑡 )𝐴𝐻𝑊𝑘,𝑔𝑘,𝑔

With no projected employment by age group, working age population projections are used as a proxy,

while average hours worked by age group and sex are based on historical averages.

provides an approximation of average hour worked that accounts for changes in the projected population structure.

31.50

32.00

32.50

33.00

33.50

34.00

34.50

weekly

Year ending 30 JuneBase Age adjusted

Projected Average hours worked: base and adjusted by age

© The Treasury

Labour productivity

• Little NZ based analysis that has looked at the impact of NZ’s ageing population on productivity...

• Internationally seems be a general acceptance that on some level ageing is correlated with declining productivity - largely based on health science studies that report a decline in non-cognitive skills with age among individuals.

• Although opponents argue that it is difficult to link to productivity and ageing because:

– there’s no strong evidence that demonstrates that cognitive skills decline with age and that worker productivity depends on many factors including the extent to which cognitive skills are relevant to specific jobs

– Furthermore others argue that population ageing causes shifts in both labour supply and demand for goods and services, for which the outcome, in terms of economy-wide productivity, is indeterminate.

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Labour productivity

• The question whether it’s reasonable to assume that ageing and productivity are linked is aptly summarised in “Economic Implications of an Ageing Australia” by the Australian Productivity Commission (2005). It suggests that differences in assumed projected growth rates arise from two sources:

– Different views about the effects of ageing on productivity– Different views about economy-wide productivity changes that are not directly

linked to ageing

• General approach is to use wage distributions to approximate productivity differences across age groups and to adjust for changes in population structure to capture ageing effects on labour productivity

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Projecting age-augmented labour productivity

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• Mincer wage equations is estimated to approximate relative differences in labour productivity across age groups and gender, controlling for education and year.

𝑅𝑒𝑎𝑙 𝑊𝑎𝑔𝑒𝑡 = 𝛼 + β1ሺ𝑘.𝑔ሻ+ β2(edu) + β3(t) + et

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

15-24 25-34 35-44 45-54 55-64 65+

Male Female

Depends on link between growth in real wages and labour productivity...

...Some NZ evidence supports this

© The Treasury

Projecting age-augmented labour productivity• Wage profiles are used to derive relative productivity differences by age and

gender weighted by working age population to average labour productivity growth of 1.5%.

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𝐿𝑃𝑡 = σ (𝑊𝐴𝑃𝑘,𝑔,𝑡𝑊𝐴𝑃 )𝑘,𝑔 𝐿𝑃𝑘,𝑔

1.0

1.1

1.2

1.3

1.4

1.5

1.6

Growth (%)

Year ending 30 JuneBase Alternative

Labour productivity projections don’t account for changes to age group productivity...

... rather they reflects changes in the structure of the population

© The Treasury

Fiscal and revenue projections

• Central to the Treasury’s projections are estimates of both real GDP and nominal GDP (inflation projections) – the key assumptions above drive much of the revenue and expenditure projections

• The Treasury restricts current policy effects to just the five-year forecast horizon and then require policy to be “neutral.”

• The net result of modelling projections is best summarized by four key fiscal indicators:

– Core Crown Revenue (%GDP):– Core Crown Expenses, excluding finance costs (%GDP):– Core Crown Debt (%GDP):– Total Crown OBEGAL (%GDP): Operating Balance excluding Gains and Losses

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© The Treasury


16

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

%

Year ending 30 June

Labour force participation hours worked labour productivity base hours worked base labour prod

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

%

Year ending 30 June

Base Alternative

Projection assumptions: PREFU 2011 base and two alternative age-augmented:•Labour productivity only•Labour productivity and hours worked

© The Treasury


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27%

28%

29%

30%

31%

32%

33%

34%

35%

% GDP

Year ending 30 June

Core Crown Revenue to GDP

PREFU 2011 LTFM Historic TrendsPREFU with age-adjusted labour productivity growthPREFU with age-adj l.p. growth & avg hrs wk

Actual & Forecast Projection

27%

28%

29%

30%

31%

32%

33%

34%

35%

% GDP

Year ending 30 June

Core Crown Expenses excl. debt-financing costs to GDP



-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

% GDP

Year ending 30 June

Total Crown OBEGAL to GDP



0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

% GDP

Year ending 30 June

Core Crown Net Debt (excl. NZS Fund and advances) to GDP



© The Treasury


• primary balance; (Core crown revenue - investment income) less (expenditure – debt-financing costs),

• shows a more modest decline compared to the OBEGAL projection

18

-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

% GDP

Year ending 30 JunePREFU 2011 LTFM Historic TrendsPREFU with age-adjusted labour productivity growthPREFU with age-adj l.p. growth & avg hrs wk


Primary balance (%GDP)

© The Treasury

Discussion, limitations and future work• This exercise has been useful in underlining a number of factors that

should be addressed if we are to incorporate wider population ageing effects when modeling the impact of population ageing on fiscal projections.

• It highlights that the main channel of future population ageing occurs through labour force participation

• And that while the impact on hours worked and labour productivity may be modest - they do have fiscal implications that could be important to incorporate more formally in the Treasury’s LTFM

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Discussion, limitations and future work• Several methodological and data issues need to be resolved, including:

– Labour force projections: Independent labour force projections are needed to generate more realistic participation rates beyond the initial 20 year projection horizon. Because of the way that age group labour force estimates are projected the decline in the aggregate projected labour force participation rate may be overstated.

– Employment: Labour force projections should disaggregated - employment– 65+ age group: Age groups could be extended to 65-69 and 70+ to better

and more accurately account for the changes in labour force participation that that are occurring among the older age groups.

– LTFM: While labor productivity is incorporated in the LTFM, this exercise has highlighted that more thought could needed to better accounting for hours worked in the model.

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© The Treasury

Discussion, limitations and future work• This work has also highlights some deficiencies in the adopted

approach. – The approach accounts for structural changes in New Zealand’s population

including in participation. – Supply-side methodology that doesn’t include likely feedback loops. For example,

doesn’t account for changes in demand for goods and services, or account for changes to age group hours worked or labour productivity that may be the consequence of population ageing

• On a positive note, Statistics NZ recently published experimental stochastic population projections for New Zealand (See Dunstan, 2011). This methodology could be a useful innovation that may resolve some of the issues identified above, if extended to age groups and labour force projections, and would also provide measures of uncertainty

• Given existing data limitations, this methodology is unlikely to be adopted in the main LTFM projections, although it could be presented as part of the alternative scenarios that accompany the central projections

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