Saturday, November 1, 2014

The good news about ageing

Politicians and economists have been banging on about the ageing of the population for ages, but how much do we actually know about the likely economic consequences? Not much - until now.

We've been told incessantly that ageing spells bad news for the budget - greatly increased spending on pensions and healthcare - with ageing used to help justify the harsh spending cuts proposed in this year's budget.

In truth, it has suited the powers-that-be to exaggerate ageing's effect on the budget. And oldies are right to resent the way ageing has been presented as nothing but a terrible problem. If the fact that we're living longer, healthier lives is a "problem", it's the best kind of problem to have.

So let's ignore the budget and focus on ageing's other economic consequences, some of which are good. We'll do so with help from a speech given last week by Dr Christopher Kent, an assistant governor of the Reserve Bank.

Kent says population ageing is driven by three factors: the boom in babies in the early years after World War II (1945 to 1960), the subsequent sharp drop in fertility rates that created a baby-boomer bulge, plus rising longevity thanks to decades of prosperity and advances in medical science.

The authorities have been warning about the coming consequences of ageing for so long - and how bad it will be by 2040 - that I suspect many people have given up waiting for it to start.

Well, get this: although it's got a long way to go, it's already started. The baby boomers have been retiring since the turn of the century, thus reducing the share of the population that's of usual working age (15 to 64).

Kent says that, taken by itself, ageing is estimated to have subtracted from the labour force participation rate by between 0.1 and 0.2 percentage points a year over the past decade and a half. This effect has increased a little in recent years as baby boomers have begun reaching 65.

Point is, ageing's biggest and most obvious effect is not on the budget, it's on the labour market. Everyone alive contributes to the demand for labour, but only those of us willing and able to work contribute to its supply.

So ageing constitutes a reduction in the supply of labour relative to the demand. That suggests we can expect it to cause unemployment to be lower than otherwise (which is not to say it won't continue to go up and down with the business cycle).

Since Australians have worried that there aren't enough jobs to go around ever since the middle of Gough Whitlam's reign, that sounds like good news to me. We're in the process of switching from not enough jobs to not enough workers.

(What I wonder is how long it will take for our mentality to shift. The perception that there's never enough jobs is now so deeply ingrained that any shyster with a profit-making scheme he claims will "create jobs" is greeted as a hero and demands that he be showered with subsidies.)

And with demand for labour stronger than supply, this implies upward pressure on wages. Again, sounds like good news to me. Kent adds that the converse of higher wage rates is lower returns to capital.

Kent points out that the pressure on labour supply will be felt most by industries that rely more heavily on labour, mainly service industries. Prominent among those industries will be aged care and healthcare, of course.

But, Kent adds, there's likely to be scope for labour to be reallocated among service industries, with a lower proportion of young people meaning we'll require fewer workers to care for and educate children.

There'll also be relatively less demand for workers to produce goods. That's for several reasons. First, because older people tend to devote less of their spending to goods and more services.

Second, because all of us tend to spend an increasing share of our rising incomes on services. There are limits to our consumption of food, wearing of clothes and how many TVs, fridges and cars we can cram into our house.

Third, because of its greater reliance on machines, the production of goods is more amenable to continuous improvement in labour productivity than is the production of services. As one economist famously observed, you can't improve the productivity of a quartet by reducing the number of players.

All this implies the prices of services are likely to rise relative to those of goods.

But now, gentle reader, if I've trained you well enough you'll have noticed a weakness in my argument so far. I've described only the immediate effects of ageing - what economists call the "first-round effects".

That's where most people's analysis stops, but economic analysis keeps going. One of the most important questions economists ask is: "And then what happens?" It's the second-round and subsequent effects economics is supposed to illuminate.

Seen from an economist's mindset, what I've described is a change in relative prices: the price of (or return on) labour relative to the price of (or return on) capital. The prices of services relative to the prices of goods.

Kent says it's important that these relative price changes not be prevented from occurring. Why? So market forces can go to work on them, adapting to them, modifying them and, to some extent, reversing them.

The higher relative price of labour should encourage more middle-aged people to take jobs and more oldies to delay their full retirement, thus reducing the upward pressure on wages a bit. The higher relative prices of services should encourage more people to acquire the education and training needed to work in the services sector.

And greater longevity should encourage workers to save more for their longer time in retirement.

That's what happens in market economies: things adjust.