Toward 2025: Assessing Ontario's Long-Term Outlook

Toward 2025: Assessing Ontario's Long-Term Outlook is the first-ever long-range assessment of Ontario's fiscal and economic environment produced by the provincial government. It is designed to inform Ontarians and those interested in Ontario's future about the challenges and opportunities that Ontario will face over the next 20 years.

The report arises out of the McGuinty government's commitment to transparency in decision-making and accountability to the people we serve. As part of that commitment, the Fiscal Transparency and Accountability Act, passed in 2004, includes a requirement for a long-range assessment of Ontario's fiscal environment within two years of each general election.

Toward 2025 is the first report of its kind in Canada and among the first in the world to be produced by a sub-national government. The United Kingdom, Australia and New Zealand have recently released similar long-term reports.

Predicting the future is a risky business. Inevitably, over the course of the next 20 years, there will be influences affecting Ontario that no one can foresee today. Speculation on those sorts of events is beyond the scope of this report. The intention here is much more focused: to identify and analyze the challenges and opportunities that this province may face over the next 20 years. The data in the report are the most reliable available today.

We hope the report will find its way to a broad audience of readers. It is designed both to inform, and to inspire informed discussion, on the issues that may influence policy making over the next several years. Clearly, it is not a statement of government policy nor a prescription for decision-making. Readers looking for in-depth analysis of current government policy and programs can turn to various other government publications, including the Ontario Budget, Economic Outlook and Fiscal Review, Ontario Public Accounts and Premier's Progress Report.

Democratic societies such as Ontario thrive when decisions on public policy issues are preceded by well-informed public discussion and debate. The goal of this report is to support those discussions and shape those debates with reliable information and relevant, articulate analysis. It is one important way in which we can work together toward a more vibrant economy and a stronger democracy.

Finally, I express our government's appreciation to the men and women both within and outside of our administration who have contributed to this report. The quality of their work stands as another concrete example of their commitment to Ontario's future.

In accordance with the Fiscal Transparency and Accountability Act, 2004, this report presents a long-range assessment of Ontario's economic and fiscal future. It includes a description of anticipated changes in the Ontario economy and in the demographic profile over the next 20 years; a description of the potential impact of these changes on the public sector and on Ontario's fiscal situation during that period; and an analysis of key fiscal issues that are likely to affect the long-term sustainability of the economy and the public sector.

This report represents an open invitation to governments, businesses, academics, labour, not-for-profit organizations and citizens, as well as to all of those interested in the future of Ontario for further debate and discussion.

In addition to the base case, alternative scenarios were produced to explore potential variations in the key underlying assumptions of the base case.

• past trends will continue;
  
  
• the current framework for government spending (programs and services) and revenues (tax structures) will remain the same; and
  
  
• some external factors will continue to affect Ontario: the health of the U.S. and global economies, oil and energy prices, federal policy decisions and interest rates.

The base case is not meant to suggest that policy will not change, but that the long-term projections cannot take into account what government policy may be.

The report has six chapters that together outline some of the major challenges and issues that Ontario may face over the next 20 years.

Chapter 1: Demographic Projections and Implications

This chapter presents the major demographic trends facing the province and provides some analysis of the implications of those trends. Demographics have a significant impact on the affairs of the province - including its labour force, revenues, health care costs and education needs.

1. Ontario is expected to have population growth of 3.1 million — for a total population of 15.7 million by 2025;
   
   
2. growth is projected to come primarily from immigration;
   
   
3. growth is expected to be concentrated in the Greater Toronto Area, which is projected to be home to almost 7.7 million people by 2025;
   
   
4. the population is expected to have an older age structure — the share of seniors in the population will rise rapidly from 12.9 per cent in 2005 to 19.4 per cent in 2025; and
   
   
5. growth of the core working-age population (ages 15-64) is projected to slow considerably from 1.6 per cent annually in 2005-06 to 0.2 per cent annually by 2024-25.

This chapter also analyzes five major implications of demographic trends including the slowing of labour-force growth; the changing composition of personal income and consumption patterns and their effect on government revenues; continuing pressure on health care expenditures; easing pressure on primary and secondary education expenditures; and increasing demands for urban infrastructure.

Chapter 2: A Long-Term Projection of Ontario's Economic Growth

This chapter describes the major assumptions in the report's economic base case in detail and discusses projections for the province's long-term economic growth. The chapter discusses the internal, external and structural factors that have, and are expected to continue to have, an effect on Ontario's growth.

Fundamental internal factors expected to affect Ontario's economic growth are total labour-force growth and growth in productivity. External factors discussed include the U.S. economy, oil prices, exchange rate, and inflation and interest rates.

Broader structural factors, beyond the scope of the base-case model, that are anticipated to shape the growth of the economy, include adapting to rapid technological change; changing trade patterns within Canada and with the world; and continuing globalization of financial markets. Chapter 2 also briefly identifies several key long-term infrastructure issues including public transit, energy supply and demand, and water supply.

This chapter also includes a discussion of structural forces that could affect Ontario's economy including the shift from goods to services employment and rapid change within sectors. The chapter indicates that annual GDP growth is projected to moderate slightly (to 2.3 per cent per year) as a result of slower labour-force growth. However, GDP per person is projected to rise from $38,000 in 2004 to $52,000 by 2025 (after adjusting for inflation), due to positive productivity growth. The unemployment rate, which is now 6.6 per cent, is projected to drop to 4.1 per cent by 2025.

Appendix 2A then focuses on three sectors that were specifically chosen for their significant employment growth potential. The appendix demonstrates that the Ontario economy has adapted to dramatic changes over the past two decades, and is well positioned to adapt to the challenges of the next 20 years.

Between Chapters 2 and 3, the report offers long-term views on Ontario of two external experts: Glen Hodgson, Chief Economist of the Conference Board of Canada, and Tom McCormack, Director of the Centre for Spatial Economics.

The Hodgson essay on global economic trends highlights the importance of key issues for Ontario including global demographic transformation; national economic policy; the pace and nature of globalization; the challenge of resource and environmental sustainability; and multi-faceted threats to security.

The McCormack essay provides an analysis of the factors that will shape the economic geography of the province. He describes the concentration of growth in the Golden Horseshoe and predicts the continuation of this trend over the next 20 years, stressing the need to provide infrastructure that will enable growth while sustaining a high quality of life.

The next three chapters describe the key issues that, at this time, are anticipated to have a significant effect on Ontario's economic environment. These issues — productivity, health care and intergovernmental finances — are not the only ones that will have an impact on Ontario, but they are most likely to have an important and even primary influence on the finances of the government and so were chosen for inclusion.

Chapter 3: Strengthening Productivity Growth

This chapter examines the importance of productivity to the Ontario economy and its impact on GDP. Increasing productivity is important; apart from labour-force growth, it is the only way for the economy to grow in real terms. It is the sole basis for improvements in per-capita incomes. The focus on productivity reflects its potential for wealth creation and improving the standard of living.

The focus of the chapter is on the levers that can improve productivity growth. They include an effective and responsive education system; a flexible labour market that supports new graduates and new immigrants; business investment that enables Ontario businesses to continue to compete effectively; research and development, including stronger ties between academia and business; a competitive tax structure; and good, functioning infrastructure. Government, business and academia all play a role in enhancing productivity.

Chapter 4: Drivers of Future Health Care Costs

This chapter depicts the potential future costs of health care. Health care represents a significant fiscal challenge for the Ontario Government. Given reasonable assumptions, health care's share of provincial program spending is projected to rise from 45 per cent (2004-05) to about 55 per cent (2024-25). Health care spending is projected to grow faster than GDP — averaging 6.0 per cent annually from 2009-10 to 2024-25.

The key assertion of this chapter is that both population growth and aging as well as utilization are the key drivers of costs. The estimated contribution of aging to projected average annual growth in government health spending is just over 1 per cent (of the 6.0 per cent growth). Towards the end of the next 20 years, the contribution of aging relative to population growth is expected to increase as the oldest cohort of the baby boom reaches their seventies. This is because, on average, health care costs are higher for older people. For example, in 2002, the average annual per-capita health care expenditure in Ontario was $2,238, while for those over age 85 the per-capita expenditure was $17,052.

Utilization plays a major role in increasing health care costs, but its future rate of growth is highly uncertain. While increases have the potential to improve people's lives and generally correlate with a healthier society, the government must be aware of the new costs associated with advances in medical technology.

Chapter 5: Intergovernmental Finances

This chapter describes the fiscal framework within which this provincial government operates. To comprehensively project Ontario's fiscal sustainability, it is crucial to include a discussion of the roles of funding partners. The chapter examines intergovernmental finance in areas such as taxes, transfers, revenues and expenditures.

Ontario's interaction with the federal government does and will continue to have a bearing on the province's fiscal position. Chapter 5 projects that the fiscal capacity of the federal government will continue to exceed that of the provincial government — particularly in light of the Province's responsibility for health care.

Ontario's 445 municipalities receive both federal and provincial financial support through various arrangements. They have an important and growing role in the economic future of the province. Municipalities deliver local economic initiatives, help support social programs and maintain a proportion of public infrastructure.

Chapter 6: Ontario's Long-Term Fiscal Prospects

The final chapter presents the key fiscal projections for the future. Some of the data are broken out into five-year segments to illustrate how the Province may, if there are no economic or policy changes, move in and out of surpluses and deficits over time.

As set out in the 2005 Ontario Budget, the government projects a budget balance in 2008-09 — or in 2007-08 if the reserve is not needed. The base-case projection then indicates that the Province is expected to be on course for a series of modest surpluses in the following decade if finances are managed prudently. After 2018, according to projections and absent of any policy change, there is a potential of returning to deficit, largely due to health care spending growing faster than revenues. Fiscal outcomes are sensitive to differences in the assumptions for economic growth.

Chapter 6 also provides a brief list of some factors that would profoundly alter all projections. These include, but are not limited to, a pandemic, environmental disaster or global recession. Positive events would also alter projections profoundly, such as a major economic boom or a significant new cost-saving, productivity-enhancing invention.

The chapter concludes with a presentation of alternative scenarios that describe potential outcomes for Ontario's finances (using assumptions of both high and low economic growth), health care costs and changes in federal transfer payments.

The high and low economic growth scenarios demonstrate how small positive or negative changes in costs or growth can have a profound long-term impact on Ontario. By the end of the 20-year period, for example, a small increase in productivity growth rates could compound to a significant increase in the annual real income of the average Ontario resident and could lead to budget surpluses. At the same time, a minor increase in the growth of health care costs, could, if no policy action was taken in the meantime, lead to budget deficits.

There is no doubt that in 20 years the Province will be operating in a different context than it is today. According to the data in this report, Ontario has the ability and resources to face the challenges of the next 20 years.

The report highlights, however, the importance of demographics and productivity growth. Ontario's population is growing, urbanizing and aging - placing pressure on health care, higher education and infrastructure. Economic growth will be rendered more challenging by a slower-growing workforce. Increasing productivity will require significant innovation from the public and private sectors alike. The Ontario economy is also sensitive to major external forces such as global economic performance and the price of oil.

All Ontarians play a role in responding to the challenges outlined in this report. Business and governments must be flexible enough to withstand and encourage change. Building and strengthening the foundation of a strong economy will involve upgrading productivity-enhancing infrastructure; supporting educational attainment; modernizing the regulatory framework; maintaining a competitive tax system; and managing government finances prudently.

The estimates and projections in this report underline the importance of enhancing productivity through innovation. Business, government and not-for-profit and academic sectors all need to encourage entrepreneurship and invention, enhance the skills the economy needs and champion Ontario to the rest of the world.

For its part, the Government of Ontario is on course to balanced budgets in the medium term. Staying the course and maintaining balanced budgets for the long term will require continued fiscal discipline. As this report emphasizes, managing health care costs while providing excellent care is key to the province's economic well-being.

Ultimately, Ontario has a strong economic future - its economic diversity, educated population, strong public sector and healthy private sector will help ensure success.

A federal transfer provided to each province and territory in support of health care.

The dollar value of all the buildings, machinery and equipment in a country. It is difficult to estimate the value of older capital, because capital depreciates and becomes obsolete over time.

A cash payment made from one level of government to another.

A notional dollar whose purchasing power remains the same every year, unaffected by price inflation. It is calculated by dividing the actual dollar price of something by a price index, which estimates the change in price from a base year.

A measure of the government's debt in relation to the capacity of the economy to carry and repay debt; government debt as a percentage of the gross domestic product (GDP) of the jurisdiction.

A measure of the number of people aged 0-14 and 65+ per 100 persons in the core working-age group (aged 15-64).

Federal cash transfer program that allows all provinces, regardless of their ability to raise revenue, to provide roughly comparable levels of services at roughly comparable levels of taxation.

The dollar value of all the goods and services produced in the economy in a year.

The annual number of births minus the number of deaths. An important component of population growth.

Involves outsourcing work to companies with the economic benefits of an offshore location, but a closer cultural, linguistic and geographic fit with the user organization; for example, business support service companies in Canada serving U.S. client companies and their customers.

An amount expressed in dollar terms without adjusting for changes in prices due to inflation or deflation. It is not a good basis for comparing values of GDP in different years, for which a "real" value expressed in constant dollars is needed.

Increase in output per unit of a factor of production in the economy. As used in this report, it means the increase in real GDP per hour worked. It is an important measure of increasing prosperity in the economy.

A technique used to study how results change if certain assumptions or input data in the model are modified.

A federal cash transfer to the territorial governments to assist them in providing public services; based on a formula that fills the gap between expenditure requirements and revenue-raising capacity.

A measure of the use of government services, for example, health care, not related to demographic or inflationary pressures. For example, increases in the number of drug prescriptions per senior. Utilization charges are often associated with advances in medical technology.

1 DEMOGRAPHIC PROJECTIONS AND IMPLICATION

Demographics influence fiscal prospects

The focus of this chapter is demographic trends as they have a significant influence on Ontario's long-term fiscal and economic prospects. This chapter discusses population trends in the past 20 years and projects demographic growth and change over the next two decades. Key implications of expected trends are outlined.

1. Slower but still significant population growth.
   
   
2. Population growth increasingly driven by immigration.
   
   
3. A concentration of population growth in urban regions.
   
   
4. Slower growth of the core working-age population.
   
   
5. A shift to an older age structure.
   

There are five key economic and fiscal implications of the demographic outlook:

1. The aging population and slower growth of the core working-age group will slow growth in Ontario's labour force, which may lead to a slower rate of real gross domestic product (GDP) growth.
   
   
2. The changing composition of personal income and anticipated shifts in consumption patterns as the population ages could moderate growth in government tax revenues.
   
   
3. Population growth and population aging will put continuing pressure on health care spending.
   
   
4. Slower growth in the number of children and youth may ease pressures on education spending.
   
   
5. The concentration of population growth in urban regions will result in increasing demand for urban infrastructure.

Demographic Trends Over the Past 20 Years

There have been significant changes over the past 20 years in how the Ontario population has grown and how it is distributed by age. The major trends in this period include:

Strong population growth

• Strong population growth of almost 3.3 million people between 1985 and 2005.
  
  
  • On average, the population rose 1.5 per cent annually in this period.
    
    
  • Ontario's share of Canada's population also increased, from 36 per cent in 1985 to 39 per cent in 2005.
  
  
• A rising contribution to population growth from immigration.
  
  
  • Natural increase (births minus deaths) now accounts for only 30 per cent of growth compared to 52 per cent in 1985 and net migration (net international plus net interprovincial migration) now accounts for 70 per cent, up from 48 per cent.
    
    
• Falling fertility rates.
  
  
  • The total fertility rate fell below the replacement level of 2.1 in 1972. By 1985, it stood at 1.6 and had reached an all-time low of 1.48 in 2002 (latest complete data available).

• A continuing shift to an older population.
  
  
  • Between 1985 and 2005, the median age of the Ontario population increased from 31.6 years to 38 years as a result of baby boomers aging, declining fertility rates and increasing life expectancies.
    
    
  • There were 974,000 people aged 65+ in Ontario in 1985 (10.5 per cent of the population). There are now 1.6 million seniors in the province (12.9 per cent of the population).
    
    
  • There were 1.9 million children aged 0 to 14 in Ontario in 1985 (20.5 per cent of the population). There are now just under 2.3 million children in the province (18.1 per cent of the population).
    
    
  • There were 6.4 million people in the traditional core working-age group (aged 15 to 64) in 1985 (69 per cent of the population). There are now almost 8.7 million people of core working age (69 per cent of the population).
    

• Concentration of population growth in urban centres, particularly in the Greater Toronto Area (GTA).
  
  
  • About 60 per cent of provincial population growth over the last two decades took place within the GTA, which encompasses the City of Toronto and the regional municipalities of Halton, Peel, York and Durham.
    
• Increasing diversity.
  
  
  • The 2001 census revealed that 2.2 million people in Ontario, or 19 per cent of the population, belonged to a visible minority group compared to less than 9 per cent in the 1986 census.
    
    
  • Nearly one-quarter of the population spoke one of more than 100 languages other than English or French.

Demographic Outlook Over the Next 20 Years

This section sets out the assumptions driving the demographic projections and highlights five key demographic trends. It is expected that the next 20 years will see an acceleration of the population aging trend of the past two decades and a continuation of immigration, fertility, mortality and regional growth trends.

Over the 2005-25 period, Ontario is projected to experience ongoing population growth. However, the rate of population growth is projected to decline from 1.3 per cent in the first year to 0.9 per cent in 2024-25 and to average 1.1 per cent annually over the period. This compares to average annual growth of 1.5 per cent over the past 20 years.

While the population growth rate is projected to slow, the resulting increase in population to 2025 is almost equivalent to that of the past 20 years. The population is projected to increase by nearly 25 per cent or 3.1 million. Ontario's population is expected to rise from 12.55 million in 2005 to 15.66 million in 2025.

The share of population growth coming from natural increase (defined as births minus deaths) is projected to fall from 29 per cent in 2005-06 to 27 per cent in 2024-25. This can be explained by the fact that while births are projected to rise as the population grows, these births will in part be offset by more deaths as the population ages.

Net migration (the difference between the number of people entering and the number of people leaving Ontario both from other countries and other provinces) is projected to remain the principal driver of population growth over the next two decades. Already accounting for 71 per cent of growth in 2005-06, net migration is projected to contribute 73 per cent by 2024-25.

3. Concentration of Population Growth in Urban Regions

Not all regions of Ontario are projected to experience the same rate of population growth. The GTA, which currently attracts about 40 per cent of all immigrants to Canada, is projected to be by far the fastest-growing region, accounting for about 60 per cent of Ontario's expected population growth over the period. It is projected
to grow by 33 per cent, from 5.8 million in 2005 to almost 7.7 million in 2025.
The GTA's share of provincial population is projected to rise from 46 per cent today to 49 per cent by 2025.

Central Ontario is projected to grow by 24 per cent, from 2.7 million in 2005 to 3.4 million in 2025. Eastern Ontario is projected to grow by 20 per cent, from 1.7 million to almost 2 million over the same period. Southwestern Ontario is projected to experience growth of 16 per cent, reaching over 1.8 million in 2025.

Northern Ontario communities currently have a relatively older age range and a trend of low levels of in-migration. Because of these trends, Northern Ontario communities and districts are projected to grow slowly or experience population decline over the next two decades. The aboriginal population in the North, with its high birth rate, may help keep the age structure slightly younger than would otherwise be the case. The overall population of the northeastern region is projected to decline by seven per cent, or by approximately 38,000 people. The overall population decline in the northwestern region is projected to be six per cent, or about 14,000 people.

Over the next 20 years, the age structure of Ontario's population will change significantly. One key demographic trend, which will likely affect labour-force growth and hence economic growth, is the projected slower growth of the core working-age population (ages 15-64).

The core working-age population is projected to grow at a slower rate than in the past, increasing just 17 per cent compared to 35.1 per cent between 1985 and 2005. It is projected to grow from 8.7 million in 2005 to 10.1 million in 2025. Its share of population is projected to begin to fall in 2011, from 69.6 per cent in that year to 64.8 per cent by 2025.

The annual growth rate of the core working-age population is projected to decline over the whole projection period, from 1.6 per cent in 2005-06 to 0.2 per cent by 2024-25. The seniors and children's age groups are both projected to grow faster than the core working-age population during the second half of the projection period.

5. Shift to an Older Age Structure

The aging of Ontario's population will accelerate over the next 20 years as baby boomers begin to enter their senior years starting in 2011. By 2031, all baby boomers will be seniors (see also Appendix 1A).

Over the next 20 years, slower projected growth in the number of children and people of core working age, along with rapid growth in the number of seniors, will result in a shift to an older age structure. The median age is projected to rise from 38 years in 2005 to 42.1 years by 2025.

The number of children aged 0 to 14 is projected to increase by only 9 per cent over the projection period compared to total population growth of 24.7 per cent. Their share of the total population is projected to decline from 18.1 per cent in 2005 to 15.8 per cent in 2025.

The seniors age group is projected to grow fastest and increase by 88.4 per cent, from 1.61 million to 3.04 million in 2025. The share of seniors in the population is projected to increase from 12.9 per cent in 2005 to 19.4 per cent in 2025. The number of people in the oldest age groups (75+) is also projected to grow rapidly (see Appendix 1B).

During the first decade of the projections, the annual growth rate of the seniors population is projected to rise from 2.2 per cent in 2005-06 to a peak of 4.1 per cent in 2011-12. It is projected to remain above three per cent annually for the rest of the projection period, a rate of growth about three times that of the total population.

Aging Population Will Cause Dependency to Rise

The total dependency ratio is projected to rise from 45 people in dependent age groups for every 100 individuals of core working age in 2005 to 54 by 2025.

The total dependency ratio is a conventional measure of age-dependency, showing how many people aged 0-14 and 65+ (the dependent population) there are for every person in the core working-age group of ages 15-64. It is generally interpreted as a rough indicator of the ability of a population to support itself.

In the early 1960s, the dependency ratio reached a peak of 68 people in dependent age groups for every 100 individuals of core working age. Today, the ratio is much lower at 45, similar to that of the early 1980s.

In the 1960s, the high share of children in the population was the reason behind the high dependency ratio. Over the next 20 years, however, the rising dependency ratio will be driven by the increasing share of seniors. Since per-capita government spending (including health care and pensions) on the elderly for Canada is estimated to be two to three times that spent on children, the higher dependency ratio in the future is likely to generate growing fiscal pressure on governments.

However, the total dependency ratio cannot be treated as an exact predictor of the fiscal pressures resulting from population aging, since not all core working-age people are active in the labour force, not all seniors are retired, and not all income is earned from employment sources.

Can Population Aging Be Avoided?

It would take much higher immigration and fertility rates to significantly change the underlying age structure and offset the shift to an older age structure.

If the total fertility rate jumped from the rate of 1.5 children per woman used in the base-case scenario to the population-replacement level of 2.1, the immediate result would be a jump in the annual number of births from current levels of about 130,000 to almost 185,000, rising to more than 215,000 births annually by 2025. All of these extra births would have barely begun to affect the working-age population by 2025. However, the core working-age group of ages 15-64 would have about 306,000 more people than in the base-case scenario. With more children, the share of seniors, at 18.1 per cent, would be lower than in the base case.

Raising the annual immigration assumption from 125,000 to 300,000 for the next two decades provides an indication of the extreme levels of immigration required to significantly slow the aging of the population. Seniors' share of population in 2025 would still rise significantly over 2005: 16.4 per cent of the population compared to 12.9 per cent in 2005, but below the 19.5 per cent share in the base-case scenario.
In this high immigration scenario, the population would be 4.3 million higher than in the base-case scenario. All age groups would grow much more rapidly; in particular, the core working-age group.

SECTION II: IMPLICATIONS OF THE DEMOGRAPHIC OUTLOOK

Labour-force growth will slow with population aging and slower growth in the core working-age population. As discussed in Chapter 2, slower growth in the labour force may slow the overall rate of Ontario's real GDP growth over the projection period.

Population aging contributes to slower labour-force growth because participation rates for older age groups are significantly lower than for younger age groups. While the recent trend of increasing participation rates for seniors is expected to continue, the impact of such increases is unlikely to fully counter the downward impact of population aging on labour supply.

As baby boomers age, the annual number of people turning age 65 is projected to become higher than the number of entrants into the core working-age group (people turning age 15) by 2017-18. Thereafter, the core working-age group is still projected to grow, due to net migration gains, but at a much slower pace.

As immigration is a key component of net migration, its importance as a source of growth in the working-age population will grow. As the population ages and fertility rates remain low, new Canadians may be the only source of net labour-force growth within the next decade.

Improving the integration of new Canadians, as well as encouraging the broadest labour-force participation of the working-age population, including older workers, will be increasingly important.

3. Continuing Pressure on Health Spending

Demographics will continue to be one of the key drivers of growth in health care spending. The impact of demographics on the growth of provincial health care spending includes both population growth of 3.1 million and the increasing share of seniors in the population over the projection period.

4. Easing Pressure on Education Spending

The number of children in Ontario is projected to continue to grow very slowly over the next 20 years. The elementary school-age group (4-13) is projected to experience a small decline of five per cent to 2012 as the large cohorts of the baby boom echo move out of this age group. From 2012 to 2025, the number of elementary school-age children is projected to rise by about 0.9 per cent annually on average, compared to average annual increases of 1.1 per cent over the last 20 years. This age group is projected to grow from 1.58 million in 2005 to 1.67 million in 2025.

The secondary school-age group (14-17) is projected to grow to 2010 and then to decline by about nine per cent over the next nine years before resuming slow growth to reach 668,000 by 2025, slightly lower than today's level of 671,000.

The 18-24 age group, the main-source population for postsecondary education, is projected to grow until 2014 and peak at a level nine per cent higher than today. Subsequently, a gradual decline is projected up to 2025 to levels slightly higher than today. Growth in this age group will resume again after 2025.

The number of children aged 4 to 17 is the major driver of elementary- and secondary-school enrolments. However, the number of young people aged 18 to 24 is only one determinant of enrolments in postsecondary education since not all people in this age group attend postsecondary institutions. Future postsecondary enrolment levels should also continue to be influenced by the upward trend in postsecondary education participation rates, reflecting the growing importance of postsecondary education attainment and lifelong learning.

Overall, the slower growth in the number of children and youth may ease the pressure on education spending.

With the aging of the workforce and constantly changing requirements of the economy, lifelong learning for adults will become a key element of Ontario's effort to ensure that individuals have the skills they need. While governments will provide financial and institutional support to individuals acquiring initial skills and qualifications, increasing demands for lifelong learning may not necessarily translate into rising costs for the public sector. Lifelong learning costs will be shared by employers and not-for-profits active in the training and retraining of their employees and by individual learners themselves.

In the base case of this long-term report, provincial government spending on elementary, secondary and postsecondary education is projected to rise 3.4 per cent on average annually over the 2009-10 to 2024-25 period, with a 0.2 per cent contribution from demographics, 1.0 per cent from increased utilization and 2.2 per cent from inflation.

Population growth of more than 3.1 million people in Ontario over the next two decades will by itself increase the demand for infrastructure. The regional distribution of growth is projected to occur overwhelmingly in the already more densely populated GTA and other large urban centres of the province.

The GTA is part of a larger geographic area, the Greater Golden Horseshoe (GGH), which encompasses the GTA and a large part of Central Ontario including Peterborough, Waterloo, Niagara and Simcoe. The GGH is among the fastest-growing regions in Canada and North America.

In addition to regional patterns of population growth, the rapidly growing number of seniors will influence the demand for certain types of public infrastructure such as residential care facilities.

CONCLUSION

APPENDIX 1A: THE BABY BOOM GENERATION

APPENDIX 1B: THE OLDEST SENIORS

This chapter provides a base-case projection of Ontario's macroeconomic growth as well as high and low growth scenarios based on different assumptions about productivity growth. It is not a forecast but rather an exercise in taking a plausible set of assumptions about Ontario's potential and adding up their consequences for Ontario's economic growth¹. These assumptions form the basis for projecting government revenue, which in turn underlies the long-term fiscal outlook in Chapter 6.

This chapter's macroeconomic projection does not attempt to predict cyclical fluctuations in demand or the impact of individual extreme positive or negative events. Booms and downturns will inevitably occur in the future. The projection shows what the economy would be like when growth is averaged over the long term.

The base-case projection assumes, most importantly, no changes in current public policy. This assumption is not meant to suggest that policy will not change, but that the long-term projections cannot take into account what government policy may be.

Section I sets out the key elements of the base-case projection and what it means for growth in incomes. Section II presents alternative scenarios with higher and lower growth assumptions.

Section III examines the two fundamental determinants of long-term growth: labour supply and productivity. Section IV examines the four key factors external to Ontario that affect the economic projection, including the performance of the U.S. economy, oil prices, the exchange rate, as well as inflation and interest rates. Over the long run, these factors are expected to influence the composition of the economy rather than its total size.

Section V discusses three key structural factors that, while not explicitly modelled, are expected to shape the industrial makeup of Ontario's economy: technological change, changing trade patterns and globalization of financial markets. Section VI examines the role of infrastructure as a requirement for economic growth. Appendix 2A considers the composition of Ontario's economy in 2025.

This section sets out the base-case projection of Ontario's macroeconomic growth. The following table shows the main highlights of the projections. The details are presented in Appendix 2B.

Ontario's labour force and total employment are projected to grow at a slowing pace over the next two decades. By the final five years of the projection period, both the labour force and employment are projected to grow at an annual rate of 0.9 per cent, compared to annual growth of over two per cent in the most recent five-year period. This is primarily the result of the slower rate of population growth projected in the first chapter.

The unemployment rate is projected to decline to 4.1 per cent by 2025. Well below current levels, this is expected to result primarily from the older age structure and rising education level of the labour force. This means that the economy can maintain a lower unemployment rate without putting upward pressure on inflation. The lower unemployment rate partly offsets the projected slower rate of labour-force growth.

Inflation in the projection is tied to the existing Bank of Canada two per cent target. The Bank has maintained this target with considerable success for over a decade, which has contributed to macroeconomic growth and stability in Canada.

Ontario's real gross domestic product (GDP) growth is expected to remain positive, though slowing, as a result of much slower growth in the labour force. However, as a result of productivity growth, the rate of increase in real GDP per person is expected to remain relatively steady.

The chart on the next page shows decade-long averages in total Ontario real GDP growth over the last 50 years and the 20 years projected in this report. Average growth trended down from five per cent over 1955-65 to just over two per cent over 1985-95. Following the downturn of the early 1990s, growth rebounded and the average for 1995-2005 was similar to that of the 1975-85 period.

Ultimately, the focus on future economic growth is relevant due to its effect on the future prosperity of Ontario's citizens. The implication of productivity growth is that real GDP per capita can maintain a steady rate of increase in spite of slowing labour-force growth. It is also projected that there will be some modest increases in the employment rate. Taken together, this implies a steady rate of increase in the real income received by individuals. The chart below shows that real GDP per person is projected to rise to about $52,000 (constant 1997 dollars) by 2025 compared to $38,000 in 2004.

Personal income is defined as the income that goes directly into the hands of individuals. It consists of wages, salaries, pensions, social benefit payments, interest and dividend income, plus profits earned in unincorporated businesses. Personal income has grown considerably more slowly than overall GDP since the early 1990s for a number of reasons, but especially because of the large decline in interest rates, which has cut into the interest income received by individuals. Interest rates are likely to increase moderately in the next few years, and then stabilize. This is expected to reduce the gap between personal income growth and GDP growth.

The personal savings rates, which is the ratio of savings to disposable income, is assumed to rise back from a recent annual low point of 2.7 per cent in 2004, settling into a range of three to four per cent. This assumption would mean that household finances would be on a stable basis. However, the amount of investment undertaken in an open economy like that of Ontario does not depend significantly on the savings of households. This is because international financial markets are highly open and capital flows to profitable opportunities without regard to where the savings are from.

This section describes alternative scenarios for economic growth, based on alternative paths for productivity. It provides an explanation of why productivity growth might be higher or lower than has been assumed in the base-case economic projection. Details of the high and low economic growth scenarios are provided in Appendix 2B.

High Growth Scenario

In the high growth scenario, a path of higher investment and greater payoffs from technological progress leads to productivity growth that is, on average, 0.3 per cent per year higher than in the base case over the 2010-25 projection period.

As was noted, the base case assumes that productivity growth is only slightly higher than it was over the previous 20 years, relatively low by historical standards.

Stronger economic growth would also make Ontario a more attractive location for people from other countries and other provinces. This would raise both the productive capacity of the economy and the requirement for health, education and other public services.

Moreover, the trend of the past two decades has seen employment in advanced countries shift from labour-intensive to knowledge-based industries. Ontario is well positioned to capitalize on this trend, as it has a higher proportion of postsecondary graduates in its workforce than any country. Ontario also has a very well developed electronic communications infrastructure, making this a very convenient location for many types of high value-added service activities geared to a global market.

Stronger economic growth would lead to higher government revenue growth, making possible even greater government investment in training and education, thereby reinforcing Ontario's strengths in that area.

Low Growth Scenario

If Ontario's economy is less successful in making the changes needed to face growing international competition, more aggressive external competition could leave Ontario without good replacements for the industries that decline. Average wages would be lower, resulting in weaker growth in real income.

Weaker economic growth would make Ontario less attractive to people from other countries and other parts of Canada. This would also curb growth of the economy's productive capacity while lowering demand for privately produced goods and services, notably housing, and for some of the services provided by government, such as health care and education. Weaker economic growth would also put pressure on social services.

The alternative scenarios depicted in this report form a fairly narrow band around the base case. Average productivity growth is about 0.3 per cent lower or higher than in the base case, but this is enough to result in a substantial difference in the level of per-capita real income by the end of the projection period. As will be seen in the fiscal analysis in Chapter 6, it would also make a very substantial difference to the fiscal position of the Ontario economy.

The fundamental determinants of long-run economic growth are the supply of workers and the growth in their productivity. Both of these factors are discussed in more detail in Chapters 1 and 3, but this chapter will link them together to provide the result in overall growth in real GDP. (GDP is the total volume of goods and services produced in the economy.)

In this report, productivity is measured as real GDP per hour worked. Therefore, real GDP growth will be the sum of the growth in productivity, the growth in the number of people employed and the growth in the average number of hours worked per year by those who are employed. It is assumed that, over the long run, cyclical fluctuations in employment will average out so that the growth in employment is about equal to the growth in the labour force.

The labour-force participation rate is defined as the percentage of people who are ready and willing to work out of the available population. This includes both those looking for work as well as those already employed. This varies by age and sex and is highest for people in the 25-44 age group. In recent years in Ontario, about 87 per cent of the people in this age group have been in the labour force.

It is assumed that in the future the percentage of older people, particularly those over age 65, who continue to work will be higher than in the 1990s. More older people have had careers as knowledge workers rather than manual workers, giving them greater potential for a longer attachment to the labour force due to less physically demanding jobs. As more of the population approaches age 65, employers are likely to adopt flexible work practices, such as greater opportunities for part-time employment, to entice some of their staff to remain in the labour force. As well, the Ontario Government has introduced legislation to abolish mandatory retirement.

However, as discussed in Chapter 1, the dominant trend is likely to be a declining rate of growth of the core working-age population. This reflects the relatively low birth rates in Ontario in the 1980s and 1990s, and the passage of the baby boom generation into the senior age group. The overall result is likely to be labour-force growth considerably lower than in the past.

Older people tend to have lower unemployment rates than young people, who are exploring their alternatives and change jobs more frequently. For example, in the last few years (2000-04), the average unemployment rate among youth in Ontario has been about 17 per cent, while for individuals over age 45, it has averaged about 4.5 per cent. As older workers are expected to represent a larger share of the labour force, the potential sustainable rate of unemployment that is compatible with steady inflation is expected to decline². In addition, the lower overall labour-force growth and stable macroeconomic environment is expected to lead to lower unemployment. The unemployment rate is projected to decline from 6.8 per cent in 2004, to 5.9 per cent in 2010 and 4.1 per cent in 2025.

2. Productivity and Investment

Overall economic growth depends on both labour-force and productivity growth. This section will briefly examine the factors affecting productivity growth and the productivity assumptions that were used to develop the base-case macroeconomic growth projection as well as the high and low growth scenarios.

The chart above shows average annual growth rates in real GDP per worker, averaged over periods of 10 years. Following growth of 2.5 per cent annually in the 10 years ending in 1965, average annual productivity growth in following periods ranged in a narrow band of 1.1 to 1.2 per cent. There were a number of major disturbances, some global and some unique to Ontario, which may have contributed to lower growth in more recent periods³. Within the decade-long averages, there was a great deal of year-to-year volatility depending on events in the business cycle and utilization of the workforce and capital stock.

In the five-year period ending in 2005, average productivity growth is estimated to have been considerably lower than the historical average, at only 0.4 per cent per year. This was the result of a series of shocks to the economy, and it would be excessively pessimistic to extrapolate it forward as the likely future rate of growth.

Productivity growth results from a combination of factors: technological change, investment in capital equipment, and growth in skills and knowledge. A more in-depth discussion of the factors underlying productivity growth is contained in Chapter 3. An important factor favouring stronger productivity growth is an expected faster rate of increase in the capital/labour ratio in the economy. Projected investment is expected to result in the stock of capital growing more rapidly than the labour force.

Real investment in machinery and equipment over the next two decades is projected to grow by about 4.0 per cent annually compared to a projected average annual growth of the labour force of 1.2 per cent. This contributes, along with real investment in commercial and industrial structures, to a projected increase of 40 per cent in the amount of capital that each worker has to work with.

For the base case, a cautiously optimistic viewpoint has been adopted. This assumes that average productivity growth over the next 20 years will be just over 1.3 per cent, slightly higher than the average of the past few decades. Ontario is highly integrated with the global economy and will share in the technological advances that are expected to increase productivity worldwide.

1. The U.S. Economy

The health and growth of the Ontario economy depend to a large extent on economic activity in the United States. The United States is Ontario's largest trading partner. The United States purchases about two-thirds of Ontario's total exports,⁴ equivalent to about 40 per cent of Ontario's GDP. The economic projection assumes that the U.S. economy will continue to be a steady source of demand for Ontario's exports. The United States is expected to remain Ontario's primary trading partner over the next 20 years, in spite of continued rapid growth of demand from China and India.

There are some major short-term challenges facing the U.S. economy, including very large deficits in the federal budget and in the international balance of payments. However, the United States is the world's leading economic power, and it is reasonable to believe that it will continue to have good access to international credit, so that the deficit problems can be resolved gradually without a major disturbance to economic growth.

2. Oil Prices

Oil prices can have a significant impact on Ontario's economic growth. A high oil price is a negative factor for Ontario's economy, a net importer of oil and natural gas, but it is a positive for other provinces that are exporters of energy. Higher world oil prices also have a negative impact on the U.S. economy, dampening demand for Ontario's exports.

The negative impact is somewhat mitigated because Ontario exports services and manufactured goods to oil-producing provinces, and the demand for these exports rises as a result of their stronger growth.

There are strongly opposing views about the future trend of oil prices by experts in this field. Some argue that the world is running out of oil, and that demand from newly industrializing countries such as China will push the price to $100 per barrel. Others argue that demand does not fall greatly in the short run, but that high prices eventually elicit substitution and conservation, as well as new sources of supply (such as the synthetic crude oil from the tar sands in western Canada). Past experience has shown that when there have been oil price spikes to very high levels, which have lasted a few years, this has been followed by much lower oil prices.

3. The Exchange Rate

4. Inflation and Interest Rates

Inflation and interest rates are considered together because there are strong linkages between them. First, nominal interest rates, the rates actually charged for loans or the current yield of bonds, equal real interest rates plus the expected rate of inflation. Second, it is largely real interest rates that are important for encouraging or discouraging real investment. Third, nominal interest rates are a key tool that central banks such as the Bank of Canada employ to encourage or discourage demand growth in the economy.

Low and stable inflation allows interest rates to remain low and supports economic growth. Projections of inflation affect the long-term path of both government revenues and expenses. Projections of interest rates determine the cost of financing the public debt.

A stable financial environment is vital for economic growth and it is reasonable to assume that this can be achieved in Canada ov