Christopher Ragan
Department of Economics
McGill University
and
David Dodge Chair in Monetary Policy
C.D.Howe Institute
‘B...
The Basic Demographics
of Population Aging
A declining fertility rate has reduced the population
growth rate ...
Source: Statistics Canada and Office of the Chief Ac...
... which inevitably leads to population aging.
Source: Office of the Chief Actuary’s 23rd Actuarial Report on the Canada ...
Aging will dramatically reduce the working-age share of
the population ...
Source: Office of the Chief Actuary’s 23rd Actu...
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 als...
… resulting in a reduction in the aggregate labour-force
participation rate.
Source: Statistics Canada and Finance Canada ...
The Challenge
of Productivity Growth
9
GDP/POP = (GDP/E) x (E/LF) x (LF/POP)
Past 40 years
Next 40 years
Decomposing past and future growth:
Source: Finance Canada calculations consistent with January 2009 average private secto...
Policies to promote productivity growth?
1. A beneficial overall economic environment.
2. “Extra” policies are centered ar...
Canada ranks highly in terms of the share of population
with post-secondary education:
0 20 40 60
Italy
Germany
France
U.K...
Canada is less intensive in the use of machinery and
equipment (which often embodies new technologies):
Source: Baldwin et...
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...
The Challenge
of Fiscal Adjustment
Part 1 of the demographic “fiscal squeeze”
Over the next 40 years there will be:
 reduced growth in real per capita GDP
(...
Part 2 of the demographic “fiscal squeeze”
1. Need for more public spending:
 Health-Care Spending
 Elderly Benefits
2. ...
Not surprisingly, per capita health-care expenditures rise
rapidly in later years of life ...
Source: CIHI.
Per Capita Pro...
... but “other factors” (than aging) will also contribute
to rising health-care costs.
Source: OECD cost pressure scenario...
Rising elderly benefits will also put upward pressure on
government spending as the population ages.
Source: Chief Actuary...
Federal-Provincial Transfers
1. Most future growth will be in provincial spending
areas…
2. … but there will be no “automa...
Difficult Fiscal Choices
1. Restrain spending growth
- especially on non-age-related items?
1. Increase tax rates (or the ...
Source: OECD, CIHI, and author’s calculations.
Spending and Revenue Paths From 2020 to 2040
Can these costs be absorbed pu...
0
20
40
60
80
100
1995 2000 2005 2010 2015 2020 2025 2030 2035 2040
Historical Projected
(percent)
Debt Ratio Constant
at ...
1. The coming demographic forces will drive two policy
agendas in Canada:
1. The need for enhanced productivity growth
2. ...
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Productivity growth and fiscal adjustment

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  • Human capital is one of the key drivers of productivity growth. More human capital allows workers to bring new skills to bear and make better use of equipment. Workers with greater skills are also an important source of new ideas that can increase innovation.
    Canada does very well on the human capital front: Canadians are among the most highly educated in the world and perform well in international tests.
  • More capital allows workers to produce more output, thus directly increasing productivity. Physical capital also drives productivity growth higher because it embodies many of the new ideas that innovation produces.
    Physical capital consists of two types of investment: investment in structures (i.e., buildings and engineering assets) and investment in machinery and equipment (M&E). This chart shows that Canada compares well to the U.S. with regards to overall capital intensity. This is due to relatively higher intensity in structures, which is partly offset by lower intensity in M&E capital.
    Baldwin et al. (2008) suggests that Canada’s business sector is more capital intensive, primarily because of its industry structure and the focus on engineering assets. The industries where engineering assets are concentrated are transportation, communication and energy. These industries are more important in Canada—both because Canada has an inherent comparative advantage in some natural resource sectors that are associated with these industries, and because the Canadian economy is more diverse geographically and requires more of the services of these sectors per unit of GDP produced than does the U.S.
    It is concerning that Canadian businesses invest less than the U.S. in M&E. M&E investment, and in particular ICT. M&E, embodies the latest technologies. So investing in M&E is a way to get access to the latest technologies. Using new equipment is an important source of productivity growth.
  • Canada ranks well in terms of public expenditure in R&D and is a world leader in supporting higher education R&D (HERD). As this chart shows, Canada has the highest rate of HERD intensity of the G7 countries, and it has increased significantly in recent years.
    Higher education institutions (mainly universities) and government research institutes are key organisations for creating and diffusing scientific and technological knowledge
    In contrast to public expenditure on R&D and higher education R&D, business expenditure on R&D (BERD) is relatively low in Canada. This chart shows that Canada ranks 6th among the G7 countries in terms of BERD as a share of GDP.
  • Productivity growth and fiscal adjustment

    1. 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. 2. The Basic Demographics of Population Aging
    3. 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. 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. 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. 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. 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. 8. The Challenge of Productivity Growth
    9. 9. 9 GDP/POP = (GDP/E) x (E/LF) x (LF/POP) Past 40 years Next 40 years
    10. 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. 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. 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. 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. 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. 15. The Challenge of Fiscal Adjustment
    16. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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

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