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Demographic insights: living longer with low growth

Australia is at a critical point on four fronts - economic growth, capital allocation, public finance and personal management of retirement income. To see how this position has developed we need to look beyond the 2008 GFC and commodities booms and examine longer term demographic changes and their effect on markets. I will examine each of these four aspects in turn and make some comments on what actions could be taken by Australian governments and individuals to moderate potential problems.

Economic growth

For too long public policy in Australia has focused on headline (real) GDP growth (rather than GDP per capita). This disregards important changes in demographic composition. For example over the past 10 years, headline GDP growth was 3% pa while GDP growth per capita was only 1.4% pa (from RBA data to September 2012). This difference is due to population growth adding to the population faster than total GDP is growing. Australia is one of the highest net migration countries compared to other developed economies as a percent of population. Our population has also maintained higher headcount than some others because of extended lifetimes.

If we look at a country like Japan that has negligible migration but now has the most aged population in the developed world, its latest (OECD 2011) 10 year GDP growth rate and per capita GPD growth rate are equal at about 0.7% pa. Due to low fertility and an extreme aged structure, Japan is now producing negative annual population change.

Before we get to the future implications for Australia, we need to factor in one more demographic element in the mix. When a country’s age structure becomes skewed towards older ages, the consumption mix in the economy changes. Income per capita is lower in older age groups and at lower income levels more spending occurs on food and essentials versus ‘other’ consumables. If there is a lesser demand for consumables, the size of the total market for domestic consumption (per capita) will reduce. The narrower range of consumables stimulates less demand.

At the present time Australia’s ageing structure is an amber light stage with 14% of total population aged 65 plus. Japan reached this level in 1995 and is now at 24%. My population projections using ABS mid-range assumptions show that Australians aged 65 plus will be 24% of the population in 2055. To allow comparison to Japan, and allow for zero migration, the 24% figure is reached 20 years earlier in 2035.

So ignoring the short term surface ripples of mining cycles and financial volatility, my view is that demographically-driven domestic demand in Australia over the next 10 years will generate significantly lower growth in GDP per capita. This has little to do with labour productivity – it is pure demographics.

I now look to external factors and the long-term global investment markets outlook. The best recent examination of this by Elroy Dimson and his team at London Business School which has just been published in the 2013 Credit Suisse Investment Returns Year Book. Their conclusion for future average returns in major investment markets over the next 20 to 30 years is for 3 to 3.5% pa real equity market returns and for about 0.5% pa real return from bonds. This compares to the period since 1980 to date which averaged just over 6% pa real return in both equities and bonds.

In summary, economic text books and investment models based on the last 30 years are likely to be of little worth in charting the life course over the next 30 years.

Capital allocation

Australia’s aggregate household balance sheet has two big capital items – superannuation assets and residential housing.

Superannuation assets were valued at $1,500 billion as at September 2012 – almost identical to both annual GDP and the value of the ASX-listed shares. The majority of superannuation assets (excluding a shrinking defined benefit component) can be allocated (and after age 60, spent) at the whim of households. These are assets which in the main were compulsorily acquired by superannuation guarantee contributions or involuntarily accumulated in conjunction with salaried employment.

I believe the job of administering and investing these assets with major funds is superior to putting them into federal government consolidated revenue. However, it seems to me we have reached a stage where some mandated investment allocation of part of these funds (say 30%) should be directed to balancing out the aforementioned adverse economic effects of ageing demographics. I support privately managed rather than using the Future Fund. Its investment mandate and governance has little relevance to the future.

How this directed investment is done needs more debate. It should not be too difficult to devise a scheme of targeted infrastructure development bonds and longevity reinsurance bonds backed by government guarantees (like we now have for bank deposits and flood and terrorist reinsurance).  Left as it is, super assets will force up prices for domestic listed investments which will then offer lower long term returns than currently priced in.

With regard to housing, the average Australian house price is currently about 8 times annual wages whereas 30 years ago it was 4.5 times. Whilst maybe you get more house in the ‘average’ these days, young couples just want a modest initial residence close to work and child care. This is becoming an impossible dream that is stalling young people from settling into productive occupations and starting families. For older age workers in outer city suburbs living in their 1980’s two storey McMansions, the position is also less than ideal. As they age and their children move out they are thinking single storey close to public transport. Apart from massive infrastructure spend, big migration increases and forced relocations, there appear to be few palatable solutions to facilitate redistribution of housing options between these two groups.

So in my view we have two major capital items not optimally allocated for the future: superannuation assets and residential housing.

Public finance

Income tax is collected by the federal government. It only really needs 75% of what it collects to cover its primary responsibilities in defence, social security, health and education and the rest should go to the states. States and local councils rely on the residual of federal collections as they have limited means of raising taxes to cover their responsibilities, although they do now get GST collections. In past high growth times, federal government has been able to gain a rising dividend from ‘bracket creep’. This will not be available in a low growth environment. Also the GST will suffer lower growth in an ageing economy because of the exclusion of food and health expenditure.

Politicians need to sit down with local electors and have an adult town hall chat about this situation. Instead, the head in the sand is clear to see on the website of the Australian Office of Financial Management. Federal borrowings are now at $260 billion (February 2013) compared to a standing start at $50 billion five years ago. A number of states now have substantial borrowings, part of which must be covering shortfalls on regular expenditure.

Personal management of retirement income

Most people arrive at the end of full-time work having had someone else worry about how their pay reaches their bank account. Few are well prepared to manage this task when retirement arrives.

Whilst the $1,500 billion in superannuation assets is a big item, it is very unevenly distributed.  About 60% of this ‘belongs’ to a well-endowed 20% of the population (SMSFs, public servants and military super). The majority of people retiring over the next 20 years will have modest balances. When we overlay this with the future low growth world and the variability of prospective life expectancy, retirement income planning is really ‘mission impossible’, despite the best efforts of financial planners.

One way to make this money go further is to ‘recycle’ part of what's left for the benefit of the surviving population when someone dies. There are two established ways of doing this. The best way is by compulsory annuitisation of part of superannuation at retirement. A less popular way of recycling is by applying a rate of death duties on super. There’s another useful if unpopular topic for that local town hall meeting.

I am fairly pessimistic of this retirement income issue being resolved by public policy. I expect that the 20% higher socio economic group will be able to deal with this acceptably. For the remainder of the population, it will require a more innovative and diversified life planning approach to cope with retirement living. This may involve some continuing employment, renting out rooms in houses, multi-generation households and formal paid arrangements for grandchild and aged care.  Public finances will not allow expansion of the age pension to cover this gap.

For further writings by Bruce Gregor on similar topics, see his website



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