Demographic Change and Projections for the Public Finances over the Medium Term Thomas Conefrey NERI Economics Seminar, 13 January 2016 1
IFAC: SOME BACKGROUND MANDATE OF THE COUNCIL: ASSESSMENT OF FORECASTS 9 th Fiscal Assessment Report FISCAL STANCE INDEPENDENT ECONOMIC ANALYSIS ENDORSEMENT OF MACROECONOMIC FORECASTS Five-member Council Six-member Secretariat COMPLIANCE WITH RULES 2
Outline Review of recent macroeconomic and fiscal performance (IFAC Fiscal Assessment Report, November 2015). Rationale for medium-term fiscal forecasts. Estimating medium-term demographic change and implications for public spending. Assessment of medium-term budgetary forecasts. 3
European/Domestic fiscal rules European Domestic Corrective Arm of SGP Preventive Arm of SGP Domestic Budgetary Rule Consistent with Preventive Arm of SGP 3% Deficit Rule 1/20 th Debt Rule MTO / Adjustment path to MTO Expenditure benchmark Domestic Expenditure Ceilings Domestic Expenditure Ceilings Consistent with Expenditure Benchmark Domestic Budgetary Rule 4
Complementary domestic and European elements Domestic ownership adds legitimacy to the European rules Effectiveness of Domestic Framework Effectiveness of European Framework Monitoring, peer pressure and possible sanctions of the European framework enhances the effectiveness of the domestic framework 5
STRONG RECOVERY AND CENTRAL GROWTH FORECASTS % Change Y-Y 12 10 8 6 4 2 0-2 -4-6 -8-10 Real GDP Real GNP Employment REAL GDP, REAL GNP AND EMPLOYMENT GROWTH (% CHANGE Y-Y) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Sources: Department of Finance (Budget 2016); CSO. 6
Increasing contribution of domestic demand to recovery CUMULATIVE CONTRIBUTION TO REAL GDP GROWTH SINCE TROUGH 20 18.2 % Growth Since Trough in Q2 2009 15 10 5 0-5 Residual Net Exports Domestic Demand Real GDP 8.8 9.4-10 2010 2011 2012 2013 2014 2015 Source: CSO. 7
Evidence of rebalancing 35% % OF NOMINAL GDP 30% 25% 20% 15% 10% 5% Investment Net Exports 0% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: CSO. 8
Current account near balance excluding re-domiciled PLCs 6 4 3.1 3.6 2 % GDP 0-0.4-0.6-1.0 0.5-0.1-0.8-1.2-1.5-0.2-2 -3.3-4 -6 Current Account Balance Adjusted for Re-domiciled PLCs -4.9-6.1-5.8-4.1-5.1-3.9-4.5-5.7-8 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 9
National Income and Consumption per Head 55 50 45 Macro indicators per head, real Consumption GDP GNP 40,000 35 30 25 20 15 10 Sources: CSO and Department of finance forecasts. 10
Sharper downturn + recovery than trading partners 110 REAL GDP PER CAPITA 105 100 Index: 2007 = 100 95 90 85 80 IE UK 75 US EA 70 65 60 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Sources: CSO; IMF and internal calculations. 11
Employment Rate 80 Employment rate, % of 15-64 population 75 %of 15-64 population 70 65 60 55 50 Ireland United Kingdom 45 40 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: CSO and Eurostat. 2015 (latest) 12
Growth Benefitting the Public Finances T AXES AND PRSI RELATIVE TO C UMULATIVE PROFILE Income Taxes VAT Excise Duties Corporation Tax Capital Taxes Stamp Duties "Other" PRSI 4000 3500 3000 2500 million 2000 1500 1000 500 0-500 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Note: These overruns are relative to Budget profile. SPU anticipated taxes and PRSI coming in 13
Exchequer Tax Revenue billion 50 45 40 35 30 25 20 15 10 5 - ANNUALISED EXCHEQUER TAX RECEIPTS 1995-2015 Jan-95 Nov-95 Sep-96 Jul-97 May-98 Mar-99 Jan-00 Nov-00 Sep-01 Jul-02 May-03 Mar-04 Jan-05 Nov-05 Sep-06 Jul-07 May-08 Mar-09 Jan-10 Nov-10 Sep-11 Jul-12 May-13 Mar-14 Jan-15 Nov-15 Source: Department of Finance. 14
EXCESSIVE DEFICIT CLOSED IN 2015 4 GENERAL GOVERNMENT BALANCE (% GDP) 2 % of GDP 0-2 -4-6 -8-10 -12-14 0.3-5.7-7.0-7.9-8.4-11.0-11.5-2.1-1.2-3.9 Primary Balance Interest General Government Balance EDP Ceiling 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: CSO; Budget 2016. 15
BUT SIGNIFICANT RISKS AROUND CENTRAL FORECASTS 8 6 REAL GDP FAN CHART BASED ON BUDGET 2016 PROJECTIONS (TO 2016) % Change Y-Y 4 2 0-2 -4-6 80% likelihood range 60% likelihood range 40% likelihood range 20% likelihood range Official Outturns / Central Forecasts 2008 2009 2010 2011 2012 2013 2014 2015 2016 Sources: CSO; Department of Finance; internal IFAC calculations. Note: Distributions or 'fans' around historical growth estimates are based on previous revisions to real GDP data. Both forecast errors and revisions are based on 1999-05 sample. 16
CRISIS LEGACY OF HIGH DEBT AND ASSOCIATED RISKS 160 GENERAL GOVERNMENT DEBT 140 120 100 80 60 40 20 Gross Debt (% GDP) Gross Debt (% Hybrid) Net Debt (% GDP) Net Debt (% Hybrid) 84.2 76.0 69.3 62.5 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Sources: Department of Finance; internal IFAC calculations. Note: Changes in EDP debt instrument assets for forecast years are assumed to be in line with Budget 2016 projected changes in cash balances. 17
Short Term Outlook Policy vigilance and economic growth have helped to improve the public finances But significant risks surround the forecasts. Importance of prudence to ensure sustainable growth. Medium Term Key weakness remains the absence of realistic medium-term projections for the public finances. Projections for expenditure, tax revenue, deficit and debt based largely on technical assumptions. With period of crisis management and repair coming to an end, opportunity to re-focus on medium term. 18
Why are Medium-Term Budgetary Plans Important? Budgetary process has focussed attention excessively on one-year ahead. This has contributed to pattern of procyclicality in Irish fiscal policy. Medium-term fiscal plans are required in order to: Provide a medium-term anchor for the public finances and avoid the risk that incoming cyclical revenues are spent. Increase the predictability of the budgetary planning process. Provide a link between resource allocation and Government policy and priorities. Key theme of recent Fiscal Assessment Reports 19
Deviations from Expenditure Plans 30% GROSS CURRENT EXPENDITURE, % DEVIATION FROM FORECAST 25% Yr1 % Deviation Yr2 % Deviation 20% % deviation 15% 10% 5% Yr3 %Deviation Real GDP growth 0% -5% -10% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2009* 2010 2011 2012 2013 2014 2015 Budget Year Source: Department of Finance Note: * denotes the Supplementary budget in 2009. Bars show the forecast error for 1 year ahead, 2 years ahead and 3 years ahead. Latest figures for 2016 to 2018 (used in calculation the latest deviation from Budget 2015 years 2 and 3) are adjusted by 1 billion to reflect the change in the treatment of the HSE from 2015. This adjustment is made for comparison purposes. 20
CONTINUOUS REVISIONS TO MULTI-YEAR EXPENDITURE CEILINGS 54 53 CHANGES TO CURRENT EXPENDITURE CEILINGS 52 Budget 2016 51 billion 50 49 48 Budget 2013 Budget 2015 Budget 2014 47 Budget 2012 46 45 44 2013 2014 2015 2016 2017 2018 Budget Year Source: Department of Finance. 21
Medium-Term Fiscal Plan in Budget 2016 Budget 2016 medium-term fiscal projections include: 0.4 billion per annum for demographic pressures Cost of Lansdowne Road Agreement until 2018 Tax forecasts allow for indexation but assume no change in policy, despite stated commitments to reduce taxes. Medium-term plans imply over-compliance with fiscal rules although stated policy is for minimum compliance. Develop an alternative medium-term expenditure scenario for 2015-2021 Scenario takes into account estimated demographic changes and assumptions on the cost of providing public services based on Budget 2016 macro projections. 22
Budget 2016 Projections imply Steep Fall in Primary Spending 45 Government Revenue and Primary Expenditure, % of GDP 40 35 % of GDP 30 25 Primary expenditure/gdp Revenue/GDP 20 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Note: Chart shows Exchequer revenue and primary expenditure as a share of GDP. Source: Budget 2016 and internal IFAC calculations. 23
Methodology: Steps 1. Produce baseline demographic projections using Cohort Component Method. 2. Demographic scenario with projections of population by age used as input into long-term fiscal model. 3. Volume of public expenditure linked to demographics, price indexed to relevant deflators. 4. Compare resulting scenario to Budget 2016 projections and estimates of fiscal space. 24
Medium-Term Demographic Projections First step in producing alternative expenditure scenario is to develop baseline population projections. Cohort Component Method used to build basic demographic model. Most frequently used methodology for projections. UK Office for National Statistics, AWG, CSO, Smith (2013). Provides projections not only of total population but also of demographic composition and individual components of growth by age and gender The cohort component equation describes population at time t+1 as today s population varied with changes in births, deaths, and net migration: 25
Overview of the Cohort Component Method Survival Rates (CSO 2015) Survival Rates for Under 1 year old (CSO, 2015) Survived Population Launch Year Population (CSO 2015) Child-bearing Population (Females, 15 54) Survived Births Projected Population Projected Migration Budget 2016, Dept. Finance. Fertility Rates (EUROPOP, 2013) 26
Steps 1. Calculate the number of people in the base population that survive to the next age interval. 2. Project migration flows for each year and add them to the survived population. 3. Project the number of births occurring during the projection interval. 4. Add the number of births to the rest of the population to get a projection of the total population by gender and age for each projection 1 year interval. 27
Assumptions Projections for the population structure involve assumptions about mortality, migration, and fertility. For our basic projections we assume : 1. Mortality: estimated by applying the survival rates from recently released CSO Irish Life Tables (CSO, 2015). 2. Fertility: ASFR used to calculate births. Fertility assumptions in line with EC AWG (2015) and imply slight decrease in fertility rate to 1.98 by 2065. Immigrants face same age-specific fertility rate (CSO, 2013). 3. Migration: most difficult component to estimate. Number of options for migration projections: Use CSO (2013) judgemental projections Model migration (ESRI) Use Department of Finance projections 28
Historical Patterns C ONTRIBUTIONS TO CHANGE IN N ET MIGRATION Immigrants Emigrants Net Migration 200 150 100 50 Title 0-50 -100-150 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: CSO Historical Data Note: Gross flows were not available earlier than 1987 29
Migration Questions Rates or flows? Components of migration (i.e., immigration vs emigration) or net migration? ESRI models specifically emigration and assumes a level for immigration In the spirit of Harris-Todaro migration model, having the UK as Ireland s main trading partner and wage and employment differentials as the drivers of the model Long Run Emigration Equation Where, em, is emigration in 000s, UR is the unemployment rates in Ireland and the UK, and RATW is an index of the real after-tax wage in Ireland and UK 30
Baseline Demographic Scenario -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% -60-40 -20 0 20 40 60 80 100 120 140 160 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 2043 2045 2047 2049 '000 Annual Population change growth in '000 % growth (rhs) 31
Dependency Ratios Dependency Ratios Very Old age dependency ratio (80+) Old age dependency ratio (65+) % of working age population 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% Youth dependency ratio (0-14) Total dependency ratio Share of People 65+ 0.0% Year Note: The dependency ratio is an age-population ratio of those typically not in the labor force (the dependent part) and those typically in the labor force (the productive part). It shows the pressure on the productive part of the population. For the estimation of the Total Dependency Ratio we took into account the share of the population over 65 and under 14 divided by the rest of the population. Source: CSO, EUROSTAT, Author s own Estimations 32
Population Pyramids 2014 2035 2065 Females 2065 Age 97 93 89 85 81 77 73 69 65 61 57 53 49 45 41 37 33 29 25 21 17 13 9 5 1-2.00% -1.00% 0.00% 1.00% 2.00% Share of Population Age 97 93 89 85 81 77 73 69 65 61 57 53 49 45 41 37 33 29 25 21 17 13 9 5 1-2.00% -1.50% -1.00% -0.50% 0.00% 0.50% 1.00% 1.50% 2.00% Share of Population Age 97 Males 2065 93 89 85 81 77 73 69 65 61 57 53 49 45 41 37 33 29 25 21 17 13 9 5 1-2.00% -1.50% -1.00% -0.50% 0.00% 0.50% 1.00% 1.50% 2.00% Share of Population 33
Medium-Term Expenditure Scenario Baseline demographic projections used to construct expenditure scenario. Macroeconomic assumptions from Budget 2016. Government expenditure split into five components: Health, Education, Social Payments, Capital Expenditure, National Debt Interest. Pay: LRA until 2018, thereafter public sector pay grows in line with non-ag wages and expected service demand. Non-pay: in health, education grow in line with expected demand linked to demographics. Social Protection: split into four broad components: old age, child related payments, unemployment and other. Capital expenditure: projections based on Infrastructure and Capital Investment Plan 2016-2021. Debt interest: average interest rate from Budget 2016 applied to difference between Exchequer balance projections. 34
Capital Expenditure 7.0% Departmental Capital Expenditure, % of GDP 6.0% growth in spending 5.0% 4.0% 3.0% 2.0% 1.0% Capital spending, % of GDP Average 1983-2015 0.0% 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016f 2017f 2018f 2019f 2020f 2021f Source: Budget 2016, Budget and Economic Statistics (Department of Finance). 35
Comparison of Expenditure Scenarios COMPARISON OF PRIMARY EXPENDITURE UNDER ALTERNATIVE SCENARIOS 32% 30% 28% % of GDP 26% 24% 22% 20% 2015 2016 2017 2018 2019 2020 2021 Primary expenditure, % of GDP - Budget 2016 Primary expenditure, % of GDP - IFAC Scenario 1 Primary expenditure, % of GDP - IFAC Scenario 2 Note: Scenario 1 allows for demographic change with no indexation. Scenario 2 allows for demographic change plus indexation. Source: Internal IFAC calculations. 36
Budget Projections imply Steep Fall in Primary Spending 45 Government Revenue and Primary Expenditure, % of GDP 40 35 % of GDP 30 25 Primary expenditure/gdp Revenue/GDP Primary expenditure/gdp, IFAC Scenario 20 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Note: Chart shows Exchequer revenue and primary expenditure as a share of GDP. Source: Budget 2016 and internal IFAC calculations. 37
Conclusion Significant progress made in resolving Ireland s fiscal crisis. Encouraging central scenario for projected growth. But significant risks around that scenario in environment of elevated uncertainty. Realistic medium-term fiscal plans needed to avoid repeat of past mistakes. Need for comprehensive bottom-up medium-term expenditure projections and comparison to likely fiscal space. Ongoing work: Impact of demographics on long-run growth. Link demographics and macro scenario with the fiscal model. Incorporate results of research on pensions, health projections from ESRI, IGEES. 38