Predicting workforce participation is tricky, but more flexibility is vital

ONE of the good things about the Intergenerational Report process is that it has been going on for long enough to allow us to check some of the early predictions. Recall that the first report was published in 2002 as a requirement of the Charter of Budget Honesty Act 1998.

According to that first 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.”

We were introduced in that report to the three Ps: population, participation and productivity. We learnt that our future living standards would be shaped by movements in the three Ps.

And we also learnt that the impact of ageing could potentially have a shocking impact on the commonwealth’s budget. In that report, we were told that a fiscal gap — the difference between government spending and revenue — could be as high as 5 per cent of GDP by 2042.

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One of the trickiest variables to predict is labour force participation. We should first note that there are several ways of looking at participation, which is defined as those in work and those looking for work as a proportion of the population, variously defined.

We can think of the population aged over 15 years, the population aged between 15 and 64, the traditional definition of the working age population, or gender and age-specific participation rates; say, women aged 35 to 44.

What the IGRs tell us is that we can experience increases in age-specific participation rates while still experiencing a decline in the overall participation rate. This is because older workers traditionally have much lower rates of participation than younger ones and so as the population ages, the participation rate declines simply by virtue of this demographic shift.

To be sure, measures to lift age-specific participation rates can offset this impact, but it is here that the first IGR erred in being too optimistic in assuming that particular groups would increase their rate of workforce participation.

Take women aged 25 to 34. In the first IGR, it was assumed that their rate of female labour force participation would rise strongly between 2002 and 2022 before levelling off. But if we look at the actual figures, an early rise between 2003 and 2008 has not continued.

In 2008, the labour force participation of women aged 25 to 34 years was 74.1 per cent; five years later, it was 74.3 per cent. Indeed labour force participation of younger women aged between 15 and 19 and between 20 and 24 fell quite markedly over this five year period.

To be sure, there is some glimmer of hope with the jump in the participation of older workers, something that was not envisaged in the first IGR, at least for men. If we look at men aged between 60 and 64, their rate of workforce participation jumped from a tad under 50 per cent in 2003 to 62.5 per cent in 2013.

In other words, there was a jump of over 12 percentage points in the participation rate of men aged between 60 and 64 in the decade ending in 2013. Even for those over 65, there is clear evidence of an uptick in labour force attachment, with nearly 17 per cent still in the labour force in 2013 compared with 10 per cent a decade earlier. Similar trends are evident for older women, albeit from lower baseline figures.

Now why is all this important? The answer is that our ability to deal with the consequences of an ageing population is partly dependent on the ratio of workers (and taxpayers) to the total population.

If we look at the chart, we notice that labour force may already have peaked in terms of the overall participation rate. And the important ratio of employment to working age population (which washes out the impact of demography) is now much lower than the peak achieved in 2007.

Forget the scenario of 40 years out: there is now a possibility that participation has already peaked and is heading south, something which the first IGR did not envisage occurring until much later.

So what does this week’s IGR assume about labour force participation? The overall participation rate is expected to fall from the current figure of 64.6 per cent to 62.4 per cent in 2054-55. This is an acknowledgment of the impact of ageing on the overall participation rate.

But note that the figure of 62.4 per cent is considerably higher than the rate assumed in the 2010 IGR of 61 per cent. Now a difference of 1.4 percentage points may not sound much, but in terms of numbers of workers (and taxpayers) the difference is considerable. (In 40 years, the workforce will be well over 20 million persons.)

So how is it that Joe Hockey can afford to take such an optimistic view of the participation rate in 40 years?

One of the factors driving the projections is the rise of the age at which workers will become eligible for the age pension — the assumption is that this age will be lifted to 70. But another reason is that women’s participation is assumed to rise again, having flatlined for the past five years.

Now all this is well and good, although quoting international comparisons is less than convincing. But the one missing piece of the puzzle is the package of measures that would improve the incentives for employers to hire workers and enable workers, particularly low-skilled workers, to contract in the labour market.

On this, the latest IGR is completely silent. Predicting more jobs for older workers and women needs to be backed up by plausible scenarios in which these jobs will be offered and accepted.

My advice is for the government to step away from the numbers and to concentrate on creating an environment in which jobs can be created and participation is not boosted by spending taxpayers’ money. A more flexible labour market is crucial to achieving this.