Forecast and forget?

WHILE Joe Hockey has warned us we will be falling off our chairs when we read the fourth Intergenerational Report to be released tomorrow, I have decided to skip the knee and elbow pads and take my chances.

The reality is that the value and integrity of the IGR process have been significantly eroded over time, with Wayne Swan’s 2010 version being a complete shocker. We must wait until tomorrow to assess the value of the latest IGR.

The requirement to undertake IGRs is embedded in the Charter of Budget Honesty Act 1998. According to the first and best report, “an IGR assesses the long-term sustainability of commonwealth finances. It examines the impact of current policies and trends, including population ageing and slow population growth on the commonwealth’s budget 40 years from now”.

It was in the first IGR released in 2002 that we became familiar with the three Ps: population, participation and productivity. The message was clear that because of ageing, we could not expect to see much of a boost to living standards because of population growth or workforce participation. The only hope of the side was productivity.

In addition, ageing would place additional strain on the budget, with the size of the budget deficit — the so-called fiscal gap — forecast to be about 5 per cent by 2042.

By 2007 when the second IGR was released, the terms of trade had lifted significantly and the tone of the report was much more upbeat.

Based on some optimistic forecasts of commodity prices, the budget deficit would now be 4 ¾ per cent by 2047-48.

But in terms of gilding the lily, the 2010 IGR report — Wayne Swan brought its release forward by two years — really takes the cake. As a result of Labor’s outstanding fiscal policies, it was predicted that the fiscal gap in 2049-50 would be a mere 2 ¾ per cent, with us enjoying years of surpluses commencing in 2012-13 and continuing until the end of the third decade of the century. In the words of that IGR: “implementation of the government’s fiscal strategy will reduce ongoing spending by around one percentage point of GDP from 2015-16.”

Do you notice anything? As government spending got more out of control — it averaged over 3.5 per cent per annum in real terms under Labor but was rising at a similar clip in the last years of the Howard government — the long-term pressures on the budget were easing. If you think this makes no sense, you are right.

The third IGR also marked a low point by including all sorts of extraneous material that suited Labor agenda. There was a whole chapter about climate change, “building the low pollution economy” and supporting renewable technologies.

There was also much boasting about ­nation-building infrastructure, including the NBN and transport investments. Labor’s social inclusion agenda even got a mention. Compared with the first IGR, this report was unconvincing and off base.

When assessing tomorrow’s IGR, we should not forget the considerable scope for manipulating the underlying ­assumptions, set by the Treasurer.

Take population. Certain ­assumptions can be made in ­respect of fertility and mortality trends, but the big swing factor is net overseas migration, something the government controls to some extent. A high assumed NOM will lead to higher population growth and less ageing and vice-versa for a low NOM. We need to take a good look at the assumptions in this IGR and compare them with assumptions in the other IGRs.

We should also not forget that these exercises are pretty approximate, something the first IGR acknowledged. Essentially, trend figures are bunged in to estimate future movements in productivity and future age-specific workforce participation rates are basically straight lines from the latest figures.

It is now clear that previous IGRs overstated the future trajectory of workforce participation, which now seems to have peaked and is falling. And only half the­ ­explanation of this fall is demographic factors: the baby boomers beginning to retire.

So will we learn much from IGR Mark IV? In many ways, the National Commission of Audit — which was a lost opportunity for the government — has already undertaken the task by giving us forecasts of spending in key areas such as health, aged care, age pension and the like. We also now have the Parliamentary Budget Office undertaking longer-term projections of budget outcomes, filling a gap in our knowledge.

If the rumour is correct that Hockey has included a whole chapter in the IGR on the opposition’s policies and its blocking of government measures in the Senate, then the prestige and ­validity of the IGR process will be further eroded. It is probably fair enough that a government places a positive spin on its own initiatives, but in none of the previous IGRs did the opposition rate more than a passing mention.

I am also unconvinced that driving fear into the hearts of the electorate is the best way to explain and prosecute policies. The first IGR outlined the challenge, but was optimistic that we could rise to the task, including through private provision of health care and retirement incomes. Its message was simple: “Governments must live within their means to ensure stability and continuity in government services.” It’s a message worth repeating.