Archived — The Labour Market and Skill Implications of Population Aging in Canada: A Synthesis of Key Findings and Policy Implications

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Prepared by Economic Research and Policy Analysis Branch (then Micro-Economic Policy Analysis Branch), Industry Canada and Policy Research Directorate, Human Resources and Social Development Canada

April 2008

This document presents Skills Research Initiative (SRI) research and summarizes its findings and implications as discussed at SRI workshops. The report represents the views of the researchers and workshop participants and as such does not necessarily reflect the policies and opinions of Industry Canada, Human Resources and Social Development Canada or the Government of Canada.


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Table of Contents

Executive Summary
1. Introduction
2. Population Aging in Context
3. Population Aging, Productivity and Growth in Living Standards
4. Labour Force Participation of Older Workers: Challenges and Opportunities
5. Population Aging, Skills Development and Human Capital
6. Policy Implications and Conclusion
References


Executive Summary

The Canadian population is aging. Population aging will affect Canada's ability to provide the talent and skills needed to build an increasingly innovative and productive knowledge-based economy; and population aging will have a wide range of labour market impacts beyond its effects on skills.

Policy responses to the skills and labour market effects of population aging require knowledge of these effects, but there are important knowledge gaps. To address these gaps, the Skills Research Initiative (SRI) identified "Skills and Labour Market Implications of Population Aging in Canada" as one of its four research themes.

The SRI research projects on this theme are now completed. This synthesis report discusses the knowledge they have generated and its implications for policy.

Questions addressed by SRI research include:

  • What is the likely impact of population and workforce aging on levels of human capital investment by youth?
  • What role can policy play in ensuring continued high levels of human capital investment by youth?
  • Does workforce aging have important implications for productivity growth and for Canada's ability to become an increasingly knowledge-based, innovative economy?
  • What barriers are there to continued labour force participation by older workers that could be removed by policy actions?
  • What is the likely impact of workforce aging on firms and on their labour market practices? How can policy address unfavourable impacts?
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Principal Findings

The principal research findings include:

Scenarios
  • In a "base case" scenario, most of the economic impact of population aging occurs after 2021. Between 2021 and 2051, growth in living standards (Gross Domestic Product (GDP) per capita) would be 1% a year, about half the growth rate between 2001 and 2021.
  • Doubling productivity growth would lead to growth in living standards of 1.9% a year between 2021 and 2051. Raising men's labour force participation rates to the 1976 levels would yield an annual 1.3% growth of GDP per capita between 2021 and 2051. An increase in the annual flow of immigrants would have very little effect on standards of living.
  • Another study finds that increasing the flow of highly skilled immigrants could have a significant impact in raising standards of living, but only if these immigrants have skills that can be easily substituted for those of highly skilled Canadians. However, an increased flow of highly skilled immigrants might result in decreased incentives for the Canadian-born to invest in skills.
  • A third study shows that population and workforce aging is likely to increase regional disparities. Tighter labour market supply due to more rapid aging in Eastern Canada and Quebec would lead to slower growth in these regions than elsewhere in Canada. Growing regional disparities due to aging will be amplified by immigration if current location patterns of immigrants persist.
Aging, skills, productivity and innovation
  • A review of psychology and economics literature suggests that performance in many physical and mental tasks declines with age, but that verbal abilities and "soft skills" such as leadership are less tied to age. Older workers have a large stock of accumulated knowledge and high job match quality, both of which contribute to high productivity.
  • Another study finds that workforce aging may have some impact on firm productivity due to the decreased productivity of older workers with a university degree.
  • Two studies indicate that by leading to increased wages, workforce aging will tend to increase skills investment by youth. Over the long term, this will increase productivity and lessen the effects of population aging on living standards.
  • This increase in skills investment by youth will only occur if post-secondary education is readily available, according to one of these studies. This study found that the availability of places is a critical determinant of how many youth enrol in university programs.
  • A literature review on the effects of an aging workforce on innovative capacity notes that there is a very broad range of skills involved in innovation. Experience is a key element in the commercialization aspects of innovation, so that an older workforce may increase this dimension of innovative capacity. Much remains to be learned about what skills are required for innovation and the relation of these skills to age.
Barriers to participation and effects in the workplace
  • A study of the effects of Canada's public retirement income system shows that features of this system may result in significant work disincentives for older workers. The greatest impact is on low-income Guaranteed Income Supplement (GIS) recipients.
  • Work disincentives in public retirement systems are much smaller in Canada than in many European countries. Canada's public retirement income systems have some incentives to stop working at age 60 and strong disincentives to working past age 65.
  • The provisions of private registered pension plans (RPPs) also contain significant work disincentives to continued work by older workers, and these disincentives often begin at age 60. Another study points out that employers can adjust the provisions of pension plans in order to retain older workers, for example, by providing actuarial adjustments to pension levels for workers who continue to work beyond the usual retirement age. An aging workforce is likely to have a significant impact on workplace practices. Older workers require less supervision and may prefer flexible work arrangements, according to one study. Public programs may discourage flexible work arrangements, however. For example, payroll tax ceilings make it costly for employers to offer short work hours or fewer weeks of work.
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Policy Implications and Issues

The principal policy implications and issues raised by these research findings are:

  • The results of this research underline the need to maintain or increase productivity growth if living standards are to continue to rise despite population and workforce aging. Further increases in skill levels of Canadian workers can make an important contribution to productivity growth and to increased standards of living.
  • The effects of population aging will not be the same in all labour markets. The modelling results indicate that population aging will tend to increase regional disparities within Canada, with the most rapid population aging occurring in the poorer regions. This is likely to lead to increased pressure for interregional transfer payments.
  • Population aging is likely to lead to increased scarcity of labour, relative to capital, thus resulting in an increase in wage rates relative to the return on capital. The sectoral and occupational labour markets where wages are likely to increase most rapidly are in the health sector, due to rising demand for health services. Moreover, the demand for health services will increase more rapidly in the poorer regions. These regions may find it increasingly difficult to compete for skilled workers, especially in health.
  • Immigration as a possible offset to population aging critically depends on two conditions. First, the immigrants must be highly qualified. Second, highly qualified immigrants must have the skills needed in Canadian labour markets. If immigrants lack language skills or if their skills are not well suited to the requirements of Canadian employers, even highly qualified immigrants may not contribute much to raising Canadian standards of living.
  • Increases in skilled immigration may tend to lower the return to skills investment by the Canadian-born, and consequently to decrease the supply of skills available from this group. Also, if current patterns of immigrants' choice of location persist, reliance on skilled immigration may increase regional disparities.
  • If individual Canadians — in particular, highly skilled Canadians — worked until later in life, it would have an important effect on standards of living as the population ages. Trends in labour force participation of older men have been toward earlier retirement in recent decades, although there has been a reversal in this trend in recent years.
  • The strongest work disincentives in the public retirement system are for persons who receive or will receive the GIS. There is not likely to be many skilled workers in this group. Indeed, skilled workers are likely to have significant income from sources other than the public retirement system. Under these circumstances, the disincentives to continued labour force participation due to the public retirement income system are small.
  • Increased flexibility, allowing for part-time or part-year work, might be a useful approach to keeping older skilled workers attached to the labour force. As the cost of labour increases with population aging, employers are likely to adjust their employment practices to retain older workers.
  • There are barriers to increased flexibility that could be addressed by policy initiatives, including mandatory retirement, limitations on receiving pension income and employment income simultaneously from the same employer, and contributory plans that make it more expensive to hire part-time or part-year workers.
  • The composition of the skills available may change due to workforce aging. Research shows that certain physical and cognitive abilities decline with age. Older workers are less likely to acquire new skills, but over their work life they have already accumulated a large stock of skills. Older workers may have relatively more soft skills and relatively less technical skills than younger workers, but both of these types of skills are important for innovation and for productivity growth.
  • With smaller cohorts of youth entering the labour market, relative to the size of the existing workforce, training of the cohorts already in the workforce is likely to become an increasingly important source of skills for the Canadian economy. An important role for governments is to support the development of the most relevant and efficient skills development strategies and training methods for an older workforce. Similarly, there is a role in promoting the adoption of such strategies and methods by institutions and employers.
  • Relatively smaller cohorts of youth entrants will also mean that the level of skill investment by these youth will be an important determinant of the skills available to the Canadian economy. Increases in the levels of real wages due to aging will favour increased skill investment by these youth.
  • The skill levels of new entrants, however, will depend critically on the capacity of the post-secondary educational system. Thus, post-secondary educational policy will play a crucial role in determining to what extent the increased skill levels of new-entry cohorts will compensate for their smaller relative size.
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1. Introduction

Population and workforce aging pose significant challenges to Canada's ability to provide the skills needed to build an increasingly innovative and productive economy.

Canada is committed to building a more innovative, more productive, knowledge-based economy. A key part of this commitment is to ensure that the talent and skills required are available. The Skills Research Initiative (SRI, see box) is a medium-term policy research program undertaken in response to concerns that the development of Canada's knowledge-based economy and innovative capacity may be hampered by persistent shortages of skilled labour.

This synthesis report is on the subject of "The Labour Market and Skills Implications of Population Aging in Canada," one of four SRI research themes. This document summarizes SRI and other research findings related to this theme and draws out their policy implications. A draft of this report was presented and discussed at a policy workshop held in January 2006.

Considerable recent work has been done on the implications of population aging for Canadian living standards and retirement income systems (e.g. Organisation for Economic Co-operation and Development (OECD), 2005; Policy Research Initiative, 2005; Standing Senate Committee on Banking, Trade and Commerce, 2005). Many of the labour market and skills implications of population aging have not been examined, so that the challenges posed for skills and labour market policy have not been fully identified. This paper seeks to make a significant contribution to a better understanding of these issues.

Skills Research Initiative (SRI)

The Skills Research Initiative was established in 2003 by a Memorandum of Understanding between Industry Canada, Human Resources Development Canada and the Social Sciences and Humanities Research Council. The SRI sought to:

  • Foster policy-relevant research on skills, organized around four themes:
    • Labour market and skills implications of population aging in Canada;
    • International mobility of highly skilled workers;
    • Employer-supported training in Canada;
    • Adjustments in markets for skilled workers in Canada.
  • Encourage dialogue between researchers, policy makers, and practitioners through conferences and publications;
  • Support the dissemination and application to policy of research on skills, particularly within government, in the academic community and among other stakeholders.

Three policy workshops were held in the National Capital Region in 2006: Labour Market and Skills Implications of Population Aging, International Mobility of Highly Skilled Workers, and Adjustments in Markets for Skilled Workers (which included the theme of Employer-supported Training). Following the workshops, final versions of the synthesis report for each workshop and an SRI overview report were prepared. The synthesis reports present the research results of the theme, and discuss their policy implications. The overview synthesizes the findings of all the themes and presents the broad policy implications including an overall diagnostic.

The paper is divided as follows. Section 2 provides a brief overview of population and workforce aging in Canada. Section 3 discusses research related to various scenarios on the impact of population aging. How will labour force, productivity and living standards be affected by population aging? Will the effects be the same across regions, industries or occupations? How effective could different policy options be in offsetting the impact of population aging?

Section 4 considers policy-related barriers to older workers' participation and firm-level impacts of an aging workforce. What barriers are there to continued labour force participation by older workers that could be removed by policy action? What is the likely impact of workforce aging on firms and on their human resources management practices? How can policy facilitate adjustments and address unfavourable impacts?

Section 5 considers relations between aging, skills and productivity; it also examines the impact of an aging workforce on levels of skills investment. Do younger and older workers have different skills? Does workforce aging have important implications for productivity growth? How will population aging affect the capacity to innovate or to adapt? What will be the impact of population aging on human capital investment by youth?

The sixth and final section indicates possible policy directions based on the research findings, and indicates areas for further research to support policy development.

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2. Population Aging in Context

Population and workforce aging will have wide-ranging and important effects on the Canadian economy and labour market.

All of the developed economies are experiencing population and workforce aging as the result of decreased fertility and longer lifespans. Like the United States, Canada experienced high fertility during the post-war baby boom, followed by a low-fertility "baby bust." As a result, a large part of the working-age population in Canada will reach age 65 years between 2010 and 2030. While Canada's population is younger than that of many other OECD countries, aging between now and 2030 will be more rapid in Canada than in most of these countries. The proportion of retirees in the population will grow rapidly, relative to the working-age population. This aspect of aging has implications for the fairness of Canada's public pension system and the sustainability of income security. These issues have been widely debated, in Canada and abroad.

In past decades, rising educational levels among new labour force entrants have been an important source of growth in skills. As a consequence of the baby bust, Canadian-born labour force entry cohorts will be smaller, relative to the size of the workforce. Immigration will become a relatively more important source of entrants to the labour market, although Canadian-born school-leavers will continue to be the largest source of entrants. Labour is likely to become scarcer, relative to capital, leading to rising wages and increased employer perceptions of skill shortages. There also tends to be more skill acquisition among the younger workforce than the older workforce. This implies that the aging of the workforce may reduce growth in skills over the next several decades.

Taken together, these trends will pose a challenge to Canada's ability to provide the increasingly skilled labour force required if Canada is to become a leading innovative economy and to improve its productivity performance. A reduction in the labour force growth may affect living standards, unless employment of older workers increases or productivity growth rises.

An older labour force also implies an increased level of retirement. Firms or industries with a higher concentration of older workers may face substantial replacement costs. It also means that a greater share of turnover will involve older workers (Kuhn, SRI-2003), who tend to be less mobile than younger workers (Abe, Higushi, Kuhn, Nakamura and Sweetman, 2002). This suggests that population aging may impede the ability of the Canadian economy to adjust to structural changes or may increase the costs of such adjustments.

Because older people consume different goods and services (e.g. housing and health care) than younger individuals, a rise in the proportion of the older people in the population may also lead to final demand changes (Börsch-Supan, 2001). Such a change in the consumption mix may significantly impact the sectoral composition of production and may consequently necessitate a shift of workers between industries. However, as these changes are likely to be gradual and predictable, they may not be too serious and costly (Kuhn, SRI-2003).

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3. Population Aging, Productivity and Growth in Living Standards

Predicting how population and workforce aging will affect labour markets and the availability of skills requires modelling the intertwined dynamics of the economy, the labour market and individuals' skill investment decisions. Results from models show that population aging may lead to a slowdown in growth of living standards and may have significant regional, sectoral and occupational impacts.

Economic models have become increasingly sophisticated, allowing policy analysts to explore the various consequences of changes in the characteristics of the population on the economy and the labour market. One such model is the latest version of Models of the Economic Demographic System (MEDS) developed by Denton, Feaver and Spencer (SRI-2006) for the SRI. Assuming different scenarios, the authors present a series of demographic projections where trends in labour force participation are estimated along with the impact of population aging on productive capacity until 2051.

In the "base case scenario", the total fertility rate, immigration, emigration and intensity of work remain at their current levels, while life expectancy, participation rates, educational attainment in the population and productivity are allowed to change following recent trends. The annual total factor productivity growth is assumed to be 0.5%.

  • Between 2001 and 2021, according to this scenario, the population would grow by 17% and the labour force by 18%. The proportion of individuals under 15 years of age would decrease from 19% to 14%, while the proportion of individuals 65 and older would increase from 13% to 27%. Real Gross Domestic Product (GDP) and real GDP per capita are projected to increase by 70% (2.7% average annual growth) and 44% (1.9% average annual growth), respectively.
  • Over the longer term, the model predicts that population aging significantly reduces growth in productive capacity. Between 2021 and 2051, real GDP and real GDP per capita are projected to grow respectively by 45% and 35% (i.e. 1.2% and 1% per year on average). In 2051, the size of the population will be only 7% larger than in 2021 while the labour force will be 2% smaller.

The authors also present several alternative scenarios where fertility, immigration, labour force participation, education and productivity are assumed to be either lower or higher than in the base case. These assumptions are examined separately as well as simultaneously. Although these projections were performed for illustrative purposes, they provide some interesting findings for policy.

  • Increasing the participation rate of individuals 65 and older by 10% (which could simulate the elimination of mandatory retirement) would have a negligible impact, raising projected real GDP in 2051 by less than 0.5% compared with the base scenario (annual growth rate would remain virtually the same).
  • Higher fertility (assuming the birth rate reaches the replacement rate by 2012 and remains constant thereafter) would have little impact on the labour force and GDP by 2021. By 2051, the labour force would be 17% larger and the GDP 10% higher, but GDP per capita would be 8% lower.
  • Increasing the number of immigrants by 50 000 per year in 2005 and after would result in a GDP that is about 7% higher in 2051, but GDP per capita would rise by less than 1%.
  • Gradually raising labour force participation rates for men between ages 20 and 64 (restoring the 1976 levels by 2016) and raising rates for women so that the gender gap is unchanged would result in a GDP higher by 7% in 2051 (with an average annual growth of 1.3% over 2021 to 2051). The projected increase in GDP per capita is of the same magnitude. Similar results would be achieved in 2051 by accelerating the rate of change in the educational attainment of 15- to 34-year-olds.1
  • Productivity is an important driver of GDP. Doubling the annual total factor productivity growth rate to 1% (from the 0.5% assumed in the base case) would result in a GDP that is about 33% higher in 2051 than in the base case scenario, with an average annual growth rate of 1.9% instead of 1.2% over 2021 to 2051.

Computable general equilibrium (CGE) models take into account the economy-wide effects of changes like population aging and the interactions of these effects. Using a CGE model, Fougère, Harvey, Mercenier and Mérette. (SRI-2005a) estimate that:

  • Population aging will lead to a drop in real GDP per capita of more than 11% by 2050, relative to the level if population aging had not occurred.
  • Over the next 10 years or so (until 2014), however, the impact on real GDP could be positive due to the effect of a more experienced and skilled labour force.

The intensity and speed of the upcoming demographic change will differ markedly across the Canadian regions. Fougère et al. (SRI-2005b) find that regional differences in fertility rates, international/interregional migration, participation rates and retirement decisions will lead to a substantial increase in regional income disparity across Canada.

  • Eastern Canada and Quebec are likely to face much tighter labour supply constraints, leading to slower growth in productive capacity than the rest of Canada. Some provinces like Ontario will be little affected by population aging.
  • Since immigrants tend to settle in some regions more than in others, regional disparities could amplify if recent trends in immigrants' location continue.

Besides slower labour force growth, population aging will likely trigger changes in the demand of goods and services because of the specific needs and preferences of older consumers. The impacts of population aging could thus be different across industrial sectors and occupations. Mercenier, Mérette and Fougère (SRI-2005) investigate these differential impacts with a sectoral CGE model.

  • Compared to 2000, the share of the health sector in total GDP would be nearly 50% higher in 2050.
  • Sectors like finance and insurance would also increase their share, but not as much as the health sector. Other sectors like manufacturing, construction, education and retailing would experience a reduction of their share.

The results of Mercenier et al. (SRI-2005) also suggest that, despite changes in the relative importance of industrial sectors, wage pressures due to slower labour force growth will keep relative wage increases very similar across sectors.

  • Real wages will increase across all occupations and skill levels, but some differences will appear over the long run.
  • Wages in health occupations are projected to be 17% higher by 2040 and 2050, an increase nearly twice that projected for occupations in manufacturing, trades and transport.

Fougère et al. (SRI-2005a) examine the potential impacts of alternative scenarios regarding immigration policy:

  • Immigration could lead to only small economic gains if immigrants are not well targeted. Attracting a large proportion of immigrants with a weak attachment to the labour market and low productivity may reduce growth and lead to a deterioration in the fiscal balance.
  • Raising the proportion of highly skilled immigrants by 0.25% of the population could offset the expected negative impact of aging on growth in productive capacity by almost half.
  • These positive impacts of highly skilled immigration assume that immigrants with a given credential can easily replace a worker with the same credential who was trained in Canada.

Recent experience suggests that it is not always the case that immigrants with a given level of educational credential can be readily substituted for Canadian-born persons with the same credential. Recently published results from the International Adult Literacy and Skills Survey show that immigrant workers with a university degree are far more likely to have low levels of English or French literacy skills than Canadian-born workers with a university degree. (See Coulombe and Tremblay, SRI2006). Immigrants' training abroad may not correspond exactly to Canadian training, requiring costly mechanisms of retraining or of credentials recognition.

One potential downside of targeting highly skilled immigrants is that raising the supply of skilled workers in the economy could reduce the skill premium and the return to investment in education, potentially leading to lower levels of skill investment by Canadian youth.2

These research findings raise policy issues:
  • Maintaining current rates of growth of standards of living after 2021 will be extremely difficult. It would require increases in the rate of productivity growth, in labour force participation rates of older workers, or both. For example, an increase in trend productivity growth in Canada from 1.7% to 2.1% a year would completely offset the effects of population aging on GDP per capita. Can these increases be attained and how? Can it be by policies to reduce the effective cost of capital in Canada? How much can increased skills investment by Canadians contribute? To what extent will decreased availability of labour due to population aging lead firms to make productivity-enhancing investments?
  • Effects of population aging will vary by region, with Quebec and eastern Canada experiencing greater difficulties in maintaining growth in standards of living, due to more rapid population aging. To what extent will these regional differences increase pressures for interregional transfers?
  • The principal sectoral and occupational effects of population aging will occur in the health sector, where increased demand for health services will lead to increased employment and increased relative earnings in health sector occupations. If governments attempt to restrict income and employment growth in health care occupations for budgetary reasons, what will be the results for the availability of skilled health care workers? Since health is a critical factor in retirement decisions, how will health care policy affect the labour force participation of older workers?
  • The results above show that immigration is not a magic cure to the issues posed by population aging. Skilled immigration has the greatest positive impact, but only if the immigrants' skills are equivalent to those of workers trained in Canada and are recognized to be equivalent by employers. Recent experience suggests that skilled immigrants may need costly skills upgrading and credentials assessment to be able to work in their fields of training in Canada. Also, the research suggests that increases in skilled immigration might decrease incentives for skill investment by Canadians. What should be the balance between increased educational and skills investment for Canadian youth and workers and investment in recruiting and integrating skilled immigrants? Will it be increasingly difficult to recruit skilled immigrants, as demand from other advanced economies increases and economic conditions for skilled labour improve in source countries?
  • The results also suggest that, if current patterns of immigrant location persist, increased skilled immigration could worsen regional disparities. To what extent should policy seek to influence immigrants' choice of where to locate, if the result is a decrease in the contribution of skilled immigrants to increasing Canadian productivity?
  • Substantial changes can be expected in the global economy that could have an impact on how individual countries experience population aging. What conditions could mitigate projected wage pressures in the Canadian labour market and how would different groups of workers be affected?
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