Christopher Ragan Department of Economics McGill University and David Dodge Chair in Monetary Policy C.D. Howe Institute November 2011 Canada’s Looming “Fiscal Squeeze”

Great stuff that I won’t talk about:

Outline of Talk 1.The basic demographics of aging 2.The looming “fiscal squeeze” 3.Some non-fiscal solutions? 4.Difficult decisions 3

A declining fertility rate has reduced the population growth rate... Source: Statistics Canada, medium-growth projection. The 1971 observation is omitted due to a level change in the definition of the series. 4 Current fertility rate ~ 1.6 children per woman

... which inevitably leads to population aging. Source: Office of the Chief Actuary’s 23rd Actuarial Report on the Canada Pension Plan and Statistics Canada. Distribution of the Population By Sex and Age Group 5

Aging will markedly 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 in Total Population 6

... and will also cause a shift toward groups with lower LF participation rates … Source: Author’s calculations based on data from Statistics Canada, Labour Force Survey. 7

… resulting in a reduction in the aggregate labour-force participation rate. Source: Data from , Statistics Canada; projections from , Office of the Chief Actuary (2010), 25 th Actuarial Report on the Canada Pension Plan. 8

Two different directions for this talk: 9 GDP/POP = (GDP/E) x (E/LF) x (LF/POP) Future path of living standards Future fiscal implications Past 40 years Next 40 years Per capita income = (labour productivity) X (employment rate) X (LF participation rate)

10 Source: Author’s calculations based on data from Statistics Canada.

The looming “fiscal squeeze”: Part 1 Over the next ~30 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 rate will be cut roughly in half!) 11

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 12 The looming “fiscal squeeze”: Part 2

Not surprisingly, per capita health-care expenditures rise rapidly as we age... Source: Author’s calculations based on data from Statistics Canada and the Canadian Institute for Health Information. 13

... but “other factors” will also contribute to rising health-care costs. Source: OECD (2006), Table A2.3, and author’s calculations. FYI: Total public spending on HC increased from 5.4 to 7.5 percent of GDP between 1975 and

Rising elderly benefits will also put upward pressure on government spending as the population ages. Source: Office of the Chief Actuary (2008), 8th Actuarial Report on the OAS program, and author’s calculations. 15

Change in ppts of GDP “Fiscal Squeeze” T/GDP G/GDP 4.2 An illustration of the fiscal squeeze: 2020

Some popular non-fiscal solutions? 1.Increase immigration rate? 2.Increase fertility rate? 3.Increase labour-force participation rate? 4.Restrain the growth of health-care spending? 5.Increase the productivity growth rate? 17

What broad fiscal choices are available? 1.Restrain spending growth - especially on non-age-related items? 2.Increase tax rates (or the “tax burden”) 3.Defer the problem - increase borrowing (public debt) 18

Change in ppts of GDP “Fiscal Squeeze” T/GDP G/GDP 4.2 How much debt? 2020 Area = accumulated debt = 25×4.2×.5 = 52.5

For Canadian governments, this would mean a return to the “debt wall” of the mid 1990s. Source: Statistics Canada (National Balance Sheet Accounts) and author’s calculations. 20 Debt wall?

So, some fiscal adjustment will be needed.

Summary and Final Thoughts 1.A large, two-part “fiscal squeeze” is heading our way. 2.We must adjust in coming years – but we have many choices. 3.This is not about small versus big government – it is about avoiding high public debt. 4.There will be renewed tensions between federal and provincial governments. 5.We need to start talking soon about fiscal priorities! 22

Thank you. Questions? 24