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Special Topic 1: Recent trends in labour force participation

In the decade prior to the recent downturn, there appeared to be a strong inverse relationship between the labour force participation rate (the percentage of the working age population either employed or unemployed) and the unemployment rate (Figure 9). This is owing to the “discouraged worker” effect: when unemployment is higher, it is more difficult to find a job and so some people will drop out of the labour force; the reverse occurs when unemployment is low. Since the start of the recent downturn, however, this relationship appears to have broken down – unemployment has risen but the participation rate has not fallen markedly (Figure 9).

Figure 9 – Participation and unemployment
Figure 9 – Participation and unemployment.
Source: Statistics NZ

This special topic examines the reasons for this apparent change in the relationship, and examines potential outcomes for participation in the future. It is useful to examine participation by gender and age group to see what cyclical, behavioural and demographic factors are affecting aggregate participation.

Falling youth participation...

Younger people are traditionally more affected by recessions, and this is reflected by a fall in the participation rate for 15-24 year olds in the recent downturn (Figure 10). Youth participation is likely to be more sensitive to poor labour market conditions, as their lower skill base and lack of experience makes them particularly vulnerable.

Youth unemployment rates were already substantially elevated relative to the overall rate prior to the recession, and have increased quickly since its onset, recently reaching 18%. Policies such as the increase of the youth minimum wage to equal the adult minimum wage from 1 April 2008 may have exacerbated youth unemployment (as well as encouraging participation), although these effects are the subject of debate.

Figure 10 – Youth participation and unemployment
Figure 10 – Youth participation and unemployment.
Source: Statistics NZ

Interest-free student loans, accompanied by a wide range of courses available, may make education a more attractive prospect than trying to find a job. The number of people who are not seeking work and list “attending educational institution” as their main activity has more than doubled in the past three years from 8,500 to 18,700.

...offset by older people participating more...

Males aged 55 and over, and females aged 50 and over, have had steadily increasing rates of participation generally beginning in the early 1990s. In 1992 the superannuation eligibility age began progressively increasing from 60 to 65, which is likely to be responsible for triggering this trend (Figure 11).

Figure 11 – Participation rates for older groups
Figure 11 – Participation rates for older groups.
Source: Statistics NZ

However, these trends have continued at the same pace even after the completion of the increase in the age of superannuation entitlement. This may be reflecting continued adaptation to the new policy, younger cohorts who are more likely to participate, legislative changes removing compulsory retirement and age discrimination, and improving health and education amongst those entering these age groups. The large increase in participation amongst these groups, accompanied by their large share of New Zealand’s working age population, means that the increase in participation amongst these older groups more than offset the downward pressure from falling youth participation.

...but population ageing is negating increases

In the absence of population ageing (ie, only taking account of demographic changes and not allowing for behavioural changes), the aggregate participation rate would have risen over the recent downturn, but the effect of population ageing – the movement of more people from age brackets with higher participation to older brackets with lower participation – has subtracted around half a percentage point from the aggregate participation rate over the past three years. The downward pressure from population ageing will begin to accelerate as baby boomers continue to enter progressively older age groups, placing long-term downward pressure on the aggregate participation rate.

A similar pattern to previous downturns...

Examining previous downturns in New Zealand reveals a similar pattern. Large changes in the unemployment rate are associated with smaller changes in the participation rate (Figure 12).

Figure 12 – Participation and unemployment
Figure 12 – Participation and unemployment.
Source: Statistics NZ

Modelling suggests that participation may not be as sensitive to unemployment as expected (and particularly in downturns) with a one percentage point rise in unemployment associated with around a quarter of a percentage point fall in participation on average. A general downward trend in the unemployment rate and a general upward trend in the participation rate over the past few decades may make the relationship appear slightly stronger than it actually is.

… but for different reasons

In previous downturns in New Zealand, population ageing had not begun to have a negative effect on participation. The moderate falls in participation that can be observed were due to decisions by people to exit the labour force. In contrast, during the current downturn, the moderate fall in participation arose partly from demographic changes - an increasing proportion of the population becoming composed of groups with lower average participation. In the absence of such changes, participation would have increased, even taking into account the fall in participation of 15-24 year olds.

A positive short-term outlook...

Given the signs for an improving economy in the second half of 2011, the short term outlook for participation is positive. Even if labour market conditions recover relatively slowly, participation may increase in the short term as the fall in youth participation stabilises and eventually begins to reverse, and the participation of older age groups continues to trend upward. If the recovery becomes more robust, participation could even reach new highs over 69% by the end of 2012.

...but demographics dominate the long term

This optimistic outlook depends on current trends in the participation of older age groups continuing for the next few years. While this seems likely, looking over a longer time horizon raises some concerns. As some of the age groups with strong trends approach the levels of participation of their younger counterparts, these trends will begin to level off, and this point does not appear to be too far off – particularly amongst males. Coupled with ageing population effects increasing over time, the longer-term outlook for participation is almost certainly for a downward trend.

Cyclical, demographic, and underlying factors compete

The aggregate participation rate fell only moderately during the recent downturn despite downward pressure from the cyclical withdrawal from the labour force by youth, and the adverse effect on participation associated with an ageing population. The stabilisation of participation during the recession has been largely thanks to underlying upward trends in the participation of older age groups, reflecting policy, economic and social changes affecting older people in the workforce.

Special Topic 2: International fiscal consolidation and its implications

This piece considers the impact of international fiscal consolidation programmes on the global fiscal and economic outlook. The current fiscal consolidation plans announced overseas, if actually implemented as outlined, are likely to improve global public finances and would improve the economic outlook in the long run. However, risks to the global fiscal and economic outlook are substantially on the downside, if some countries are derailed from their planned fiscal consolidation programmes.

The pace of international fiscal consolidation accelerates in 2011 …

Most of the advanced countries with large budget deficits and high sovereign debts have announced fiscal consolidation plans for the medium term. However, there is considerable variation in the scale, timing and concreteness of fiscal consolidation plans.

In some countries, including Portugal, Ireland Greece and Spain, intense market pressure – expressed in sharp increases in their borrowing costs - has seen these countries front-load sizable deficit reduction policies in 2010 and 2011.

At the other extreme, Japan and the US – whose required fiscal adjustments are among the largest – have not yet detailed a medium-term strategy to achieve fiscal reduction targets. Their current approach has been to postpone the implementation of their plans until late 2012. In fact, the fiscal deficits in Japan and the US are expected to increase in 2011, as a result of the recently introduced stimulus packages.

...with uneven impact on economic growth

As tax revenues for Greece, Ireland and Portugal have already been negatively affected by lower economic growth, these countries have to implement substantial fiscal savings measures in order to lower their deficits. Discretionary fiscal savings policies, which include both revenue-enhancing and spending cut measures, will amount to 6.5% of GDP in Greece and over 3.0% for Ireland and Portugal (Table 1).

The abrupt and large-scale fiscal tightening in Greece, Ireland and Portugal will likely weigh on their economic growth in the short term. As there is currently no scope for these countries to manipulate their exchange rate to spur net exports, fiscal retrenchment can be relatively costly.

For other advanced economies, despite the large expected fall in their budget deficits in 2011 and 2012, the actual fiscal consolidation programmes are not so substantial as to put a significant brake on the economic recovery. In the US, the fiscal deficit is expected to reduce by almost 4% of GDP in 2012. However, economic recovery – which results in higher tax revenues – is the main factor behind the forecast reduction in the deficit as most of the fiscal savings policies announced in the 2012 Budget would not take effect until 2013.

Table 1 – Fiscal consolidation plans, 2011 - 2012
  Fiscal balance Annual change in
the fiscal balance
Discretionary fiscal
savings measures
  % of GDP % of GDP % of GDP
Fiscal year 2010 2011 2012 2011 2012
Greece -10.5 3.1 0.9 6.5 3.5
Ireland -11.6 2.5 2.1 3.9 2.3
Portugal -9.1 4.5 1.6 3.0 1.1
Spain -9.3 3.3 1.6 2.2 0.8
Italy -4.6 0.7 1.2 0.8 0.7
France -7.7 1.7 1.4 0.7 0.7
United Kingdom -11.1 1.2 2.0 0.6 2.0
Germany -3.3 0.8 1.0 0.4 0.7
Australia -4.3 0.7 2.1 0.2 0.1
Canada -3.4 1.1 0.7 0.0 0.0
United States -8.9 -2.0 3.9 -0.3 -0.1
Japan -9.5 -0.5 1.6 not yet specified

Source: individual country budget documents, except for Japan where the figures are obtained from the IMF. Ireland’s fiscal balance for 2010 excludes financial sector support.

Risks to the fiscal and economic outlook remain on the downside

If governments actually implement fiscal consolidation programmes as currently planned, it will be an important step to restore the health of public finances and economic growth (Figure 13).

Figure 13 – Fiscal balance outlook, 2010 - 2014
Figure 13 – Fiscal balance outlook, 2010 - 2014.
Source: IMF; New Zealand’s figures are the net lending forecast at Budget 2011 but presented on a Government-Financial Statistics and calendar year basis.

However, in the case that countries do not achieve their announced fiscal targets or governments fail to deliver their planned fiscal adjustment, the impact on the fiscal and economic outlook is likely to be significant. For the peripheral Euro-zone economies, lower-than-expected economic growth would feed back negatively on fiscal consolidation, while political uncertainty and weak institutional frameworks may prevent the implementation of the plans.

In other advanced countries, the back-loaded nature of fiscal consolidation plans increases concern whether some countries will actually implement their consolidation plans. The May 2011 OECD Economic Outlook identifies “the unsettled fiscal situation” in the US and Japan as one of the main risks to the global recovery.

In the US, most of the savings measures outlined in the 2012 Budget will only start to take effect at the end of 2012 – around election time - and there is increasing doubt whether the government will have the required political support to tighten its spending. In Japan, the absence of any specific policy to reduce the budget deficit, combined with the uncertainty about the scale, timing and financing of the earthquake reconstruction costs, increases the risks that the government will not enact fiscal adjustment programmes.

Market perceptions continue to be polarised

Sovereign debt concerns have intensified again for Greece, Ireland and Portugal, despite the EU/IMF financial assistance programme and the front-loaded fiscal consolidation efforts. Investors have become increasingly sceptical whether the EU/IMF programme will help these countries solve their financing needs. In the last week of May, 10-year government bond yields reached almost 17% for Greece, 11% for Ireland and 10% for Portugal (Figure 14). At the same time, banks in the three countries are not able to access market finance and are dependent on liquidity provided by the European Central Bank.

Figure 14 – 10-Year Government Bond Yields
Figure 14 – 10-Year Government Bond Yields.
Source: Bloomberg

On the other hand, the Credit Default Swap (CDS) spreads remain broadly flat for large advanced countries, suggesting that the market continues to view these countries as having low fiscal risks. As a result, these countries continue to enjoy cheap financing conditions, expressed in the relatively low yields on their bond rates.

The market optimism for some large advanced countries may suggest that the risk of losing market confidence is remote for now. However, markets typically react late and abruptly, as seen in the case of Greece where the 5-year CDS spreads were as low as 100 basis points in 2009, surged to 965 in May 2010 and reached 1480 in the early weeks of May 2011.

New Zealand’s fiscal position

New Zealand experienced a sharper reduction in its fiscal balance than some other countries and its improvement is occurring more slowly. This is in part due to the muted recovery arising from household and business consolidation and the short-term impact of the Canterbury earthquakes. Recognising this, the Government has outlined a fiscal savings plan in Budget 2011. New Zealand is expected to be one of the few advanced economies to have a fiscal surplus in the medium term. New Zealand’s low level of public debt also compares favourably with other advanced countries (Figure 15).

Figure 15 – Government gross debt
Source: IMF; New Zealand’s figures are the net lending forecast at Budget 2011 but presented on a Government Financial Statistics and calendar year basis.

The impact of the global fiscal consolidation on the world and the New Zealand economies has already been incorporated in the Budget 2011 economic forecasts. This set of forecasts allowed for some fiscal consolidation to take place in the US in the medium term.

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