Frameworks for the Future
Five years ago I launched Australia's first Intergenerational Report.
Today I release the first update to assess how far we have come in meeting the challenges that confront us over the next forty years.
The Intergenerational Report is required, by the Charter of Budget Honesty, every five years. It is to report honestly and openly on the effect this generation will have for the one that follows. It would be unfair if today we spent on ourselves and sent the bill to tomorrow's generation. It would be unfair if we indulged a standard of living today at the expense of the standards of living for our children and their children.
That is why we report intergenerationally:- to make sure that we account, and are held to be accountable, for fairness as between the generations.
The Charter of Budget Honesty – one of the most important reforms of this Government – requires open and objective budgeting, including mid-year and pre-election reports. It prevents any Government from ever again concealing large deficits as was the case under the previous Government. And it puts in place this mechanism to highlight and promote generational fairness.
The 2002 IGR
In 2002 I released the first IGR to widespread and bi-partisan acclaim.
It looked ahead forty years. It was the first long-term view on the Australian economy and the challenges we face.
Our framework is now being used and adopted by other countries around the world.
It was comprehensive and analytically rigorous, and I will take the opportunity here to thank the Treasury officials responsible for this work.
It was a road map to our future, and it gave us a clear understanding of our most pressing problems.
The first IGR put the ageing of the population on the map.
In releasing the report I said that "Demography is destiny" to make people realise the unstoppable changes that are coming towards us.
The IGR has been enormously influential in setting government policy.
We started talking about fertility rates and pushing back retirement ages, we began to understand the benefits and costs of rising life expectancy.
We introduced legislation across many areas to make progress on the three key determinants of economic progress – population, participation and productivity.
In practically every portfolio area – health, education, family benefits, welfare, superannuation, pensions – the IGR now provides the overall architecture within which we operate.
And now we are five years on.
The 2007 Intergenerational Report
The Report I release today shows that the ageing of the population and the changes it will bring remains the biggest economic challenge for Australia over the medium and long-term. But we are making progress. The challenges which seemed so daunting five years ago are a little less. And we are better able to handle them as a result of the progress we have made in the last five years.
Australia's long-term financial sustainability has improved since the first IGR.
But demographic changes are still working against us.
The fact is that the lower fertility rates of the seventies, eighties and nineties are still winding their way through the system. The large population bulge caused by the post-war baby boom is moving through the population and heading towards retirement.
The updated projections show that Australia's population continues to age, that is, that larger and larger proportions of our population will be in the older aged cohorts. And this will lead to slower economic growth.
Slide 1: Australian population projections for selected age ranges
Although the number of people overall will rise, the proportion of working age will decrease.
The proportion of people of traditional working age, 15-64 years, is projected to be below 60 per cent in 2047. That's 8 percentage points lower than 2007. Growing even faster than the proportion of people aged 65-84, is the proportion aged 85 and over.
In blunt terms that means fewer people of working age in proportion to those of retirement age. This is the result of lower birth rates in previous years and increasing life expectancies.
This also means that real GDP per person is projected to increase by 1.6 per cent per year on average over the next 40 years, compared with 2.1 per cent over the past 40 years.
Australia is pretty much at the best point – the sweet spot – in the demographic transition now.
After 2010, the dependency ratio – the ratio of children and older people to people of working age - is expected to increase more rapidly as baby boomers reach age pension age.
But over the last five years our fertility rate which has been declining for over forty years has bottomed and marginally turned up. However it is still below replacement rate.
Slide 2: Australia's historical and projected total fertility rate
Australian life expectancies has risen more rapidly than expected in IGR 1.
Slide 3: Life expectancies
And participation rates for mature men in the workforce have improved. This could in part be stronger jobs growth but also our message to remain active, longer, in the workforce appears to be having an effect.
Slide 4: Participation rates: Males
Slide 5: Participation rate: Females
In IGR 1 we projected that the fiscal gap – the demands of spending in excess of revenue – would be 5% of GDP in forty years time.
Slide 6: Projection of fiscal pressure
After taking into account the strong fiscal starting position of a surplus of just over 1 per cent of GDP, demographic trends mean that government spending is projected to exceed revenue by around 3½ per cent of GDP by 2046-47. This is a significant improvement.
Two financial measures have assisted our progress particularly. First, since IGR 1 we have cleared net debt. Second, we have now established the Australian Future Fund.
The Future Fund is designed to alleviate the massive pressures on the government in the future. The Government's liability for superannuation is now around $100 billion and is projected to increase to around $214 billion by 2046-47. In the absence of the Future Fund, these are costs that future generations would have to meet for liabilities being incurred now.
Slide 7: Australian Government projected defined benefit superannuation liabilities
By funding these liabilities now and covering future expense claims as they arise we are taking the debts of today's generations away from tomorrow's generation. Of course, the extent you raid that Fund today is the extent to which you send the bill to future generations.
Slide 8: Projections of Australian Government spending by category
When we come to the breakdown of spending pressures in the future, the main categories will continue to be in health and ageing – both aged care and the age pension.
These areas will be put under increasing pressure by demographic change. Other factors, such as new and improving technology, will increase costs particularly in health.
So we face a considerable task. My years as Treasurer have taught me that it is not easy to balance competing pressures, even on a short term basis.
Maintaining fiscal sustainability and economic growth over the long-term is much more difficult. Demographic change will make it even harder. And we do not assume the current improvement in the terms of trade will continue indefinitely.
But today I would like to share with you the reasons why I look forward to tackling these challenges.
The first reason is that the Australian economy is currently in a strong position.
Australia is not the only country to be considering the long-term sustainability of government policies. Many other nations have begun their own assessment systems in recent years. And nearly all OECD nations face demographic challenges.
Australia's key difference is that it faces these problems from a stronger foundation than most.
Slide 9: Australian real GDP per person relative to OECD average
In 2006, we eliminated net debt, becoming one of only a handful of OECD countries to achieve this. We have established the Future Fund.
So we are moving forward from a stronger starting position.
Second, we have already put in place frameworks that are making a difference now, and will continue to pay dividends for future generations.
We have also recognised the increasing pressure on the health system, in particular the Pharmaceutical Benefits Scheme – the PBS. Since 2002, the Government has put in place a range of measures, and recently announced reforms will reduce the cost to the government and consumers of many generic medicines. By doing this now, we can give ourselves vital 'space' to consider placing new medicines on the PBS as they are developed.
Australians can look forward to continued improvements in health care and technology. As we plan to enjoy the benefits, we should also prepare to ensure that our system remains sustainable.
We have also been establishing frameworks to maintain economic growth over time. It is due mainly to the influence of the first IGR that there is now a much broader general understanding of the components of economic growth.
Slide 10: Contributions to growth in real GDP per person
Population
As the population ages, the smaller proportion of people of working age is clearly a potential brake on future economic growth.
The 3 factors impacting on population are fertility, mortality and migration.
When we introduced the baby bonus I declared that parents should consider having "one for mum, one for dad, and one for the country".
Clearly some people were listening.
The Government has put in place measures to support families like the baby bonus. Increasing the maximum rate and the taper rate for the Family Tax Benefit has also been important. Uncapping childcare places has been introduced.
But in addition to the measures, I think it has been a willingness to talk about the importance of children to our collective future that has made a positive contribution to general attitudes.
The net migration intake has increased and has averaged around 110,000 over the last 10 years, with a shift in favour of skilled migration. This has had a positive effect on the number of people of traditional working age.
Participation
While increasing our fertility rates and migration has increased our number of possible workers, we need to ensure that people are able to work to their full potential.
We do this through improvements to participation and productivity. Participation is the average number of hours worked in the labour force by each working age person. Productivity refers to average output produced per hour of work. We have put in place policies that are delivering improvements now, and will continue to do so for many years to come.
With record low unemployment rates, the challenge is to reduce barriers to participation and help people rejoin the workforce where possible.
We have massively increased childcare availability, more than doubling federal funding, which allows parents more easily to participate in the workforce while raising children.
We have encouraged, and in some cases forced, people to work through welfare reform and tightening the Disability Support Pension. We have reduced income tax rates to increase incentive people to enter and re-enter the workforce. The mature age workers tax offset and recent superannuation reforms have also assisted.
In participation, Australia is already achieving great results – Australia's labour force participation rates are increasing with the trend towards increasing participation for women and older workers continuing.
Moreover, in the past five years, there has been a significant reversal in the long term decline in participation rates for men aged 55 to 64.
I think an excellent example of policy for the future is the recent Simplified Superannuation reforms. These reforms are the most significant reforms to the taxation of Australia's superannuation system in decades.
The reforms are a broad ranging package including changes to superannuation taxation, the age pension assets test, superannuation contribution rules and superannuation payment rules.
From 1 July 2007, superannuation benefits will be tax free if paid from a taxed fund to Australians aged 60 or over.
Another key reform is the greater flexibility individuals will have as to how and when they wish to draw down on their superannuation in retirement.
These reforms will make superannuation arrangements easier to understand, improve incentives to work and save, and strengthen incentives for older Australians to remain in the workforce.
This is obviously beneficial for the many Australians planning to retire soon, and also for Australians who will retire in the future. If more people plan and save for their own retirement, this will reduce spending pressures on governments in the future.
If people stay in the workforce longer, this is an enormous gain to the workforce over time. It is also a personal gain to people who have an enormous amount of energy and experience to continue to contribute to society.
This is policy design at its best – it is good for people now, and good for people and the country in the future. It promotes choice and flexibility and helps everyone to adapt to changing circumstances over time.
Productivity
In an economy that is close to full employment, productivity is a clear target for policy action.
The area cited by the outgoing Governor of the Reserve Bank as the area with the greatest scope for productivity improvement is industrial relations reform.
The Government introduced WorkChoices to assist in boosting productivity through creating a more flexible labour market.
Flexible, decentralised labour markets are an essential ingredient for a modern economy to prosper in an ultra-competitive world.
To re-regulate labour markets would harm productivity and make our challenges for the future even greater.
Significant productivity gains can also be made through federal-state reforms.
The National Reform Agenda – the NRA – announced by the Government in February 2006 is also providing an opportunity for Commonwealth and State Governments to work together to reduce unnecessary regulation across levels of Government, boost competition in areas of energy, transport and infrastructure and deliver improvements to human capital. This builds on gains already made by the National Competition Policy agenda.
Improving productivity will be a key focus in the next few years. It is important that implementation of the NRA continue to progress, and that we look for other opportunities.
Climate Change
One important issue that the IGR covers is climate change and the environment.
Our physical environment in Australia faces significant problems of global warming, water shortages, desertification and soil salination.
Australia is the hottest and driest continent on earth, and it is not in our interests to become hotter and drier.
A deterioration in our physical environment will lead to a deterioration in our economic conditions, not to mention our quality of life.
The IGR is primarily based on modelling from historical experience on demography, participation, tax and expenditure, and does not introduce the much more inexact variables involved in environmental change.
There is a consensus around the fact that significant levels of global warming imply losses in GDP over the longer term. While the exact estimation of the economic costs of environmental degradation are extraordinarily difficult to assess, they are costs that we as a government must avoid transferring on to future generations. We must steward our environment between generations just as we steward finances.
Water
I think one area where we can use current experience to try to change policies and attitudes to benefit current and future generations is water.
With many of our water sources either approaching or beyond sustainable extraction levels, and environmental impacts becoming increasingly apparent, this must change.
I think we all now understand that past practices are unsustainable, particularly if we wish to conserve both our environment and productive capacity for future generations.
Ensuring water is valued properly is key to encouraging more productive use, promoting efficient investment, and achieving an appropriate balance between the needs of the community, industry and the environment going forward.
The Australian Government's $10 billion water package, aims to place our critical river systems on a sustainable footing for the future. This should underpin progress in this area.
Future goals
The IGR provides a wonderful map with which to navigate our way forward.
The way forward for the future is to maintain discipline, and continue reforms which make progress towards our long-term goals.
I think that further lifting our fertility rate is an important goal. This means moral encouragement, but it also means developing policies which make it easier for families to have children, and to have more children.
This means workplace flexibility, it means support for families. It means, as I have said before, making Australia the most-female friendly country in the world.
We need Australians to be better skilled and better educated than ever before so that they can easily adapt to new circumstances and opportunities.
We must increase the engagement in the workforce of those who are marginalised, to increase participation and improve their self-esteem.
We need our governance arrangements to be world-class. Our current federal-state arrangements lead to too much buck passing and not enough accountability. In key areas such as transport, infrastructure, environment and energy, the State and Commonwealth Governments share responsibility. We need to work towards establishing national markets and reducing unnecessary regulation. In some areas, we may need to rethink roles and responsibilities within our federation to deliver better outcomes.
We must run a lean government that restricts spending only to where it is necessary.
We must be vigilant against those measures that chip away at the sources of our prosperity.
A lot of the greatest threats come not from things that are unpopular, but things that are popular.
Spending that gradually ratchets up tax levels.
Regulation that purports to protect consumers that gradually chokes our businesses.
Workplace rules that promise benefits but eat away at flexibility.
Protection for industries that push up costs for other businesses and consumers.
Raiding the savings set aside for future generations.
We must guard against these developments all the more vigilantly because of their populist appeal.
Conclusion
Sometimes people say that governments are too concerned with short-term interests and don't plan ahead for the long-term. The Australian Government was once guilty of this.
But we had the opportunity to do something about it, and did.
The IGR reflects what I really believe in – planning for the long-term, prudently and diligently.
Year by year over the last eleven years we have paid off the nation's debt, and we have endured massive political criticisms for introducing unpopular reforms. But we have strengthened our future.
Australia has emerged as a more powerful and prosperous country, a long way from the country once derided as the "poor white trash of Asia".
We will not rest on our laurels. We have a task to do if we want to be strong in forty years time. We owe it to future generations.
Thank you.
The Intergenerational Report 2007 is available on the Treasury website.