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Population growth and the economy: A mixed blessing?

7 August 2023

From our ‘Thinking outside the box’ series

Christopher Day discusses population policy as one of the big three economic levers.

Immigration is an Australian success story. One of the great things about jumping on a train in Sydney or Melbourne is that you can immediately tell where you are in the world by the simple fact that the individuals beside you are from a bewildering range of cultures. This is seldom seen outside of Australia.

Following two years of border restrictions throughout the COVID-19 pandemic, the Australian Government has rapidly returned Australia’s immigration intake to above already high pre pandemic levels with the objective of “making up” for lost time. This has resulted in a goal to bring in close to 350,000 people this year (nearly 1.5 per cent growth)[1]. These moves have been heavily supported by business leaders who lament significant skill shortages caused by the pandemic hiatus on global mobility.

Although seldom discussed, population joins monetary and fiscal policy as one of the big three economic levers. Increasing population growth through immigration generates economic activity by bolstering aggregate demand and provides an effective avenue in which to plug strategic skills shortages. Australia is blessed in that its high standard of living makes it an attractive migration target, enabling the government to set population growth at any level it deems appropriate.

Economic growth, measured as a nation’s gross domestic product or GDP, is baked into the national psyche. It is engrained within us that high levels of economic growth are good, and declines are bad, the latter embodied in dreaded terms such as “recession”. One of Australia’s great boasts until the COVID-19 pandemic was its near three decades of uninterrupted economic growth. Our insatiable appetite for economic growth is grounded in the view that a larger economy will make us all wealthier. What is generally missed is that this relationship only holds when the economy grows on a per capita or per person basis. This creates an interesting dichotomy regarding the benefits of rapid population growth between businesses and government on the one hand and individuals and households on the other.

Population growth creates additional demand in an economy for goods and services from housing through to washing machines and haircuts. Business and asset owners benefit immensely from this as it creates more customers and enables them to grow sales and profitability without needing to snatch customers from another business. Government too is a beneficiary of population growth as more people increases spending which in turn makes the economy bigger. Given the public views economic growth positively, delivering as much increases the probability of electoral success. As such, population growth creates “easy” or “lazy” business and economic growth.

Making growth readily achievable for businesses reduces competitive pressure, thereby limiting the incentive for firms to invest in productivity enhancing measures such as research and development. Instead, retained earnings can be returned to business owners or shareholders in the form of dividends. Profit distributions may be positively received by business owners, yet they take away funds which could have been invested in a businesses’, and in extension the country’s, capital stock and capability. This is critical to maintaining global competitiveness. The absence of investment is reflected in Australia’s weak productivity growth which has plunged to a six-decade low. As the Productivity Commission has warned, it is the plateauing of productivity which has and will continue to undermine the living standards of all Australians.

Despite benefiting business and capital owners, rapid population growth is far from costless. Absorbing the equivalent of another City of Canberra in Australia every year places enormous pressure on existing infrastructure, services and resources used by the community. School places, hospital beds and housing stock each need to rise at a rapid pace to meet demand. Doing so requires absorption of green spaces around major centres, threatening biodiversity and amenity, whilst the net effect on economic activity generally fails to lift productivity. Housing construction and service delivery are labour intensive activities, making them ill suited to productivity growth whilst many goods purchased by a growing population are imported. Further, many of the migrants being brought in to fill labour shortages are simply creating more shortages in the absence of productivity growth as demand for housing, goods and services rises alongside the population.

A large share of uplift from rapid population growth channels into property prices. Evidence of this is observed in the “surprise” reversal of Sydney property prices in March 2023 (+1.4 per cent) despite the Reserve Bank of Australia’s rapid tightening of monetary policy since May 2022.[2] With supply failing to keep pace with demand, rents have surged upwards of 20 per cent in the last year with the national vacancy rate under one per cent. At the same time property listings have fallen, placing upward pressure on already high property values despite diminished borrowing power amongst buyers. Fundamentally, property prices will continue appreciating if demand outstrips supply.[3]

Whilst a classical view of economic functioning suggests that supply will rise to meet demand, the opposite is taking place. Higher interest rates and the tighter credit market have restricted capital available to developers, many builders have suffered financial difficulties due to high inflation and fixed price contracts and the availability of land, labour and materials is severely constrained.[4] Planning controls, which exist for many good reasons, restrict the type and volume of properties which can be constructed in an area. Ironically, controls tend to be strongest in more desirable regions close to employment opportunities. As such, we have a situation when we like to see our houses become more valuable and the aggregate benefits of population growth such as bigger dividends, but many communities are opposed to further development in their local area due to concerns over stretched services and infrastructure. This suggests that population growth creates a cost for Australian communities which they seek to externalise. Nevertheless, any solution to the pressures created from a rising population ignore better demand management and instead emphasise the challenging and prolonged task of lifting supply.[5]

Another potential and seldom acknowledged cost of rapid population growth is its contribution to inflationary pressure. Inflation is generally triggered by an imbalance between supply and demand which causes prices to rise. Rapid population growth works in a similar manner to low interest rates, in that it stimulates demand for goods and services. This creates a challenging policy dichotomy between the Reserve Bank’s desire to lower inflation by lifting the cash rate and the government’s introduction of a demand “shock” through high levels of immigration. If population growth continues unabated at a high level, it ceases to be a short-term shock, making it increasingly difficult for supply to catch up. This is especially true in a cycle of monetary tightening when investment is subdued. The end result will be inflationary pressure, particularly in the housing/rental market. Redirecting a greater share of the nation’s resources into housing stock is inherently inefficient and starves capital from productive investment opportunities which will actually lift living standards.

In summary, immigration has transformed Australia into the successful multicultural society it is today. Rapid population growth has made our houses more valuable and enabled our businesses to make larger profits by creating a bigger market. Yet population growth incurs costs and has masked falling productivity growth alongside heightened pressure on key services and rapid inflation of property prices. This has undermined living standards and fuelled the current rental and housing crisis. Supply cannot readily keep pace with Australia’s current population trajectory. Interestingly enough, it was the period of low immigration during COVID-19 that finally enabled wage growth to pick-up, rents to fall and unemployment to hit record lows![6]

We need to bring population policy to the forefront of policy debate and understand that it is not a limitless panacea for economic prosperity but a policy tool which must be carefully managed in the interests of the population at large.