Saturday, November 30, 2013

Rise in living standard set to slow

It's a funny thing about the awful truth: people are much more inclined to talk about it after elections than before. And it seems as though, of late, our top economists have done little but tell us our economic future is a lot more "challenging" than was contemplated during the election campaign.

The first sobering message is that getting the budget back to balance won't be as easy as it suited both sides to pretend in the three-year campaign. Indeed, it could be a struggle that goes on for at least a decade - depending on how long it takes us to face up to some tough decisions.

The next soberer is that our material standard of living is likely to improve at a much slower rate in the coming decade than it did in the last one. We got that warning in a speech last week by Dr David Gruen, the top macro-economy manager in Treasury. And we got it again in a speech this week by Dr Philip Lowe, deputy governor of the Reserve Bank.

The simple way to see what's happening to our standard of living is just to take real gross national income and divide it by the population, to give real income per person.

According to Treasury's calculations, this grew at an average rate of about 2 per cent a year during the 1970s, '80s and '90s. Over the 13 years to this year, it grew by 2.3 per cent a year. But over the coming decade to 2023, Treasury's best guess is the rate of real improvement will slow to a bit less than 1 per cent a year.

That's more than a halving in our rate of material advance. What is it that's expected to cause this marked slowdown? Well, that's a long story. Settle back.

The greatest single factor causing our standard of living to rise almost continuously over the years is improvement in the productivity of labour - that is, increased output of goods and services per hour worked. Labour productivity improves when workers are given more machines to work with, when workers' skills improve because of education and training, when improvements in public infrastructure allow firms to operate more efficiently and, particularly, because of technological advance: the invention of new and improved products and production processes.

The next most important contributor to our material standard of living is "labour utilisation": the proportion of the population that's of the right age to be in the labour force (often taken as everyone aged 15 to 64), the proportion of people of working age who actually are in the labour force, the proportion of these who are employed rather than unemployed, and the average hours worked by people employed (many of whom will be only part-time).

The standard story from economists is that the nation's income increases when we produce more goods and services. But it's not quite that simple. It's not just how much we produce, it's also what that is worth when we sell it to foreigners so we can buy what we want from them.

About 10 years ago the world started paying us a lot more for our minerals and energy - we called it the resources boom - and this increased the income we derived from the stuff we were producing. As Lowe puts it, "over time we have been able to buy more and more flat-screen televisions for each tonne of iron ore that we have sold overseas".

Economists call this an improvement in our "terms of trade" - prices we receive for exports relative to the prices we pay for imports. And the main reason our standard of living rose by a high 2.3 per cent over the past 13 years is the big improvement in our terms of trade.

It contributed about 0.8 percentage points of that 2.3 per cent growth, more than making up for a weaker rate of improvement in the productivity of labour.

But, as we all know, the fabulous prices we were getting for our coal and iron ore started falling back a year or two ago, and Treasury expects them to fall a fair bit further. Indeed, it expects the deterioration in our terms of trade to subtract about 0.5 percentage points from the annual growth in real national income per person.

And there's a second factor we'll have going against us. Until recently, we've been enjoying a "demographic dividend" as the population of working age grew faster than the overall population (mainly because of the falling rate of fertility).

Over the 30 years to 2010, the proportion of the population aged 15 to 64 rose from a bit more than 64 per cent to a peak of about 67 per cent. But now, with the continuing retirement of the baby-boomers, it's projected to fall to about 62 per cent over the coming 30 years.

So whereas until now the demographic dividend has contributed to the rate of improvement in our standard of living, over the coming decade demography will subtract from that rate (we'll have fewer producers relative to consumers).

Now, there's nothing we can do to stop world minerals prices falling back and not a lot we can do to delay the retirement of the baby-boomers. So, ready for the commercial message from your friendly econocrats?

Lowe says that "over the next decade or so, if we are to achieve anything like the type of growth in real per capita income that we have become used to, then a substantial increase in productivity growth will be required.

"If this lift in productivity growth does not take place, then we will have to adjust to some combination of slower growth in real wages, slower growth in profits, smaller gains in asset prices and slower growth in government revenues and services."