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Towards a better understanding of the effects of ageing on economic growth

An ageing population has significant implications for the structure and productivity of Australia’s labour force, the role of fiscal policy, efficacy of monetary policy, investment demand, asset values and the economy as a whole.

Understanding the impact that an ageing population will have on our growth prospects is critical for Treasury. Possible lines of inquiry include the implications for:

Fiscal policy: superannuation/public pensions, taxation, and expenditure

Public pension systems, particularly those that operate on a pay-as-you-go basis, are already under stress. Some countries are already partially funding pensions from general funds (which was typically not the intent), because current contributions to the country’s pay-as-you-go pension system are inadequate. The elderly also tend to put greater demands on public spending due to a higher propensity to consume health services. At the same time, the relatively smaller working age means that tax revenue will also be under pressure. Overall, aging is likely to cause deterioration in the government’s budget position.

Labour force participation

Fertility is falling in most countries, and the share of the population that is below age 14 (and even the share of people aged 15-29) is shrinking in many countries. A stagnant youth population share and rising elderly population share implies a declining share of the traditional working-age population (ages 15-64).The traditional working-age cohort is largely responsible for labour input underlying a country’s economic output. As a result, declining rates of labour force participation may limit future per capita economic growth.

Labour productivity

Based on their experience, older people may have skills and capacities that many younger workers lack, but in some instances they may be less productive than younger workers. The literature points to an inverted ‘u-shape’ labour productivity profile as a function of age; workers become more productive as they gain experience before hitting their peak, where after their productivity falls due to the their advanced ageing. As a result, by retaining older workers, some firms may be paying more for labour than would be economically efficient.

Saving, investment and the natural rate of interest

Working-age people are the prime savers in an economy. Older people typically draw on savings from their working life to support themselves in retirement. However, if large numbers of older people are liquidating their assets at the same time, asset values/returns will come under pressure, undermining stocks of wealth throughout the population and potentially discouraging investment. Lower rates of return will put added pressure on fiscal policy as more older people may need to access government payments such as the pension. A lower natural rate of interest may also affect the efficacy of monetary policy, with lower official rates associated with less accommodative policy.