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Productivity

Empirical estimates suggest that productivity rises with age up to middle age, before declining (Australian Productivity Commission, 2005). This could mean that ageing could produce a (small) decline in average productivity with the effects of a greater proportion of older workers being largely offset by relatively fewer younger ones. The present modelling, however, assumes that average labour productivity (real output per hour worked) grows by 1.5% annually for everyone over the projection period. This reflects the median growth in the output per hour worked between 1980 and 2003.

In section five, we will examine the effects of changing this productivity assumption on the fiscal position as measured by ratios to GDP. Labour productivity growth (which in the LTFM is assumed to equal the real wage growth) of 1.5% a year means that by mid-century real incomes will have doubled.

Labour productivity growth (which in the LTFM is assumed to equal the real wage growth) of 1.5% a year means that by mid-century real incomes will have doubled. 

Work done at the Australian Treasury after the release of the first Intergenerational Report in 2002 has considered the effect of having a lower productivity growth in the government-funded service sectors relative to the rest of the economy.[28] We may investigate such an approach for the final Statement.

Inflation and bond rates

The final major assumptions in the modelling are that annual inflation over the projection period is assumed at 2%, the middle of the present Reserve Bank target range, and that the real government 10-year bond rate is 4%.

Table 2: Summary of key economic assumptions, fixed from 2010 on
Variable Value Source of the assumption
Labour productivity growth 1.5% Historical average over 1980-2004
Inflation 2.0% Mid-point of Reserve Bank’s target band
10-year real gov’t bond rate 4.0% Historical average
LT unemployment rate 4.5% Based on an assessment of NZ’s LT rate
Average hours per week 38.4
hours
Based on an assessment of recent trends

Resulting GDP projections

In growth terms, nominal GDP in any one year (Yt) grows as follows from 2011 onwards:

where Yt-1 = GDP in the previous year, g = growth of labour force, p = labour productivity growth and i = the inflation rate.

In other words, growth of nominal GDP is roughly the sum of the labour force growth, labour productivity growth, and the inflation rate. This formula implicitly assumes that the employment rate and average weekly hours worked are constant after 2010 and so they drop out of the growth equation.

Combined with these assumptions, the demographic projections translate into weakening labour force growth and real GDP growth lowering from a 3.2% annual average over the past decade to a 1.6% average through the 2040s. Real GDP growth per capita is closer to labour productivity growth, but it falls below when population growth is larger than labour force growth from 2020 onwards.

Figure 15: Ageing reduces GDP growth, but not per capita GDP growth from 2030 onwards
Figure 15: Ageing reduces GDP growth, but not per capita GDP growth from 2030 onwards.
Source: Statistics New Zealand and Treasury projections

Notes

  • [28]Gruen and Garbutt (2004).
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