Dr. Christopher Ragan Addresses

1. Christopher Ragan
Department of Economics
McGill University
and
David Dodge Chair in Monetary Policy
C.D.Howe Institute
‘Big Thinking’, Parliament Hill, November 3, 2010
Productivity Growth
and Fiscal Adjustment
Two Policy Challenges Driven by Population Aging

2. The Basic Demographics
of Population Aging

3. A declining fertility rate has reduced the population
growth rate ...
Source: Statistics Canada and Office of the Chief Actuary’s 23rd Actuarial Report on the Canada Pension Plan.
Population Growth, 1950-2040
Current fertility rate
~ 1.6 children per
woman
3
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040
Historical Projected
(percent)

4. ... which inevitably leads to population aging.
Source: Office of the Chief Actuary’s 23rd Actuarial Report on the Canada Pension Plan and Statistics Canada.
1970, Population: 21.7 M
8 6 4 2 0 2 4 6 8
0-4
15-19
30-34
45-49
60-64
75-79
90-94
percent of population
Male Female
2008, Population: 33.3 M
8 6 4 2 0 2 4 6 8
0-4
15-19
30-34
45-49
60-64
75-79
90-94
percent of population
Male Female
2040, Population: 41.2 M
8 6 4 2 0 2 4 6 8
0-4
15-19
30-34
45-49
60-64
75-79
90-94
percent of population
Male Female
Distribution of the Population By Sex and Age Group
4

5. Aging will dramatically reduce the working-age share of
the population ...
Source: Office of the Chief Actuary’s 23rd Actuarial Report on the Canada Pension Plan.
Share of people aged 15-64 in Total Population
55
60
65
70
75
1966 1972 1978 1984 1990 1996 2002 2008 2014 2020 2026 2032 2038
Historical Projected
(percent)
Entry of the baby boom generation
into the labour market.
Baby boomers gradually reaching
retirement age.
5

6. 0
20
40
60
80
100
15 to 24 years 25 to 54 years 55 to 59 years 60 to 64 years 65 years and over
(percent)
... and will also cause a shift toward groups with lower LF
participation rates …
Source: Statistics Canada.
LF Participation Rate by Age Group, 2008
6

7. … resulting in a reduction in the aggregate labour-force
participation rate.
Source: Statistics Canada and Finance Canada calculations.
Aggregate LF Participation Rate
55
60
65
70
75
1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020 2024 2028 2032 2036 2040
Actual Trend
(percent)
Historical Projected
7

8. The Challenge
of Productivity Growth

9. 9
GDP/POP = (GDP/E) x (E/LF) x (LF/POP)
Past 40 years
Next 40 years

10. Decomposing past and future growth:
Source: Finance Canada calculations consistent with January 2009 average private sector forecast
Decomposition of per capita Real GDP Growth
10
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
1971-2008 2009-2040
GDP/POP of which: GDP/E E/LF LF/POP
(percent)
Historical Projected
Detail: Productivity is usually measured as GDP per hour
whereas here it is measured more simply as GDP per worker.

11. Policies to promote productivity growth?
1. A beneficial overall economic environment.
2. “Extra” policies are centered around:
- quality of labour
- quantity and quality of capital
- innovation and technical knowledge
- competition, role of FDI
1. The costs of productivity policies:
- direct fiscal costs
- winners and losers

12. Canada ranks highly in terms of the share of population
with post-secondary education:
0 20 40 60
Italy
Germany
France
U.K.
U.S.
Japan
Canada
Percentage of 25-64 population in 2007 with:
Source: OECD Education at a Glance (2009)
%
0 10 20 30 40
Italy
Germany
France
U.K.
Japan
Canada
U.S.
%
Post-secondary education University education

13. Canada is less intensive in the use of machinery and
equipment (which often embodies new technologies):
Source: Baldwin et al. (2008)
50
60
70
80
90
100
110
120
130
140
Total Structures Machinery and equipment
Capital-to-output ratio in Canada as a
percentage of U.S. level (2003)
%

14. Canada leads the funding of higher education R&D but
lags in terms of business expenditure on R&D.
0.0 0.5 1.0 1.5 2.0 2.5 3.0
Japan
U.S
Germany
France
U.K
Canada
Italy
Source: OECD Science, Technology and Industry Outlook (2008)
Note: * Data for 2006, or latest available year
% %
Higher education R&D as a
percentage of GDP (2006*)
0.0 0.2 0.4 0.6 0.8
Canada
U.K.
Japan
Germany
France
U.S.
Italy
Business sector R&D as a
percentage of GDP (2006*)

15. The Challenge
of Fiscal Adjustment

16. Part 1 of the demographic “fiscal squeeze”
Over the next 40 years there will be:
 reduced growth in real per capita GDP
(for any given rate of productivity growth)
 reduced growth in per capita tax base
(growth will be cut roughly in half from past 40 years!)
16

17. Part 2 of the demographic “fiscal squeeze”
1. Need for more public spending:
 Health-Care Spending
 Elderly Benefits
2. Offsetting effects expected to be small:
 Education, children’s benefits and some
social services
17

18. Not surprisingly, per capita health-care expenditures rise
rapidly in later years of life ...
Source: CIHI.
Per Capita Provincial-Territorial Public Health Spending by Age Group, 2007
18
0
5
10
15
20
25
0-14 15-24 25-34 35-44 45-54 55-64 65-74 75-84 85+
(thousands of dollars)
Age

19. ... but “other factors” (than aging) will also contribute
to rising health-care costs.
Source: OECD cost pressure scenario and author’s calculations.
Increase in Public Health Spending
0.0
0.5
1.0
1.5
2.0
2.5
3.0
2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040
Contribution from other factors
Contribution from aging
(percent of GDP)
FYI: Total public spending on health care increased from 5.4 to 7.5 percent
of GDP between 1975 and 2008.
19

20. Rising elderly benefits will also put upward pressure on
government spending as the population ages.
Source: Chief Actuary (scenario: benefits rates indexed at inflation plus 60% of the assumed real wage growth) and author’s calculations.
Increase in Elderly Benefits (~ OAS + GIS)
0.0
0.2
0.4
0.6
0.8
2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040
(percent of GDP)
Taken together, health and elderly benefits will add
roughly 3.5 percentage points of GDP to public
spending between 2020 and 2040!
20

21. Federal-Provincial Transfers
1. Most future growth will be in provincial spending
areas…
2. … but there will be no “automatic” re-allocation of
tax revenues toward the provinces.
33  increasing demands for fed-prov transfers.
21

22. Difficult Fiscal Choices
1. Restrain spending growth
- especially on non-age-related items?
1. Increase tax rates (or the “tax burden”)
2. Defer the problem
 increase borrowing (debt)
22

23. Source: OECD, CIHI, and author’s calculations.
Spending and Revenue Paths From 2020 to 2040
Can these costs be absorbed purely through debt?
-1
0
1
2
3
4
2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040
~ 35 p.p. Increase in FPT
Debt-to-GDP Ratio
(percentage points of GDP)
Spending
Revenue
Health
Spending
and
Elderly
Benefits
(3.5 p.p.)
23

24. 0
20
40
60
80
100
1995 2000 2005 2010 2015 2020 2025 2030 2035 2040
Historical Projected
(percent)
Debt Ratio Constant
at its 2009-10 level
For Canadian governments, this would mean a return to
the high-debt situation of the mid 1990s.
Source: Author’s calculations.
FPT Debt-to-GDP Ratio
High Debt!
24
Some genuine fiscal adjustment will be needed!

25. 1. The coming demographic forces will drive two policy
agendas in Canada:
1. The need for enhanced productivity growth
2. The need to make difficult fiscal adjustments
2. Productivity growth:  find cost-effective policies.
3. Fiscal adjustment:  identify our fiscal priorities.
25
That’s our job for the near future!
Final Remarks