Labour market pressures have become acute over the past year in New Zealand, as the economy rebounded from the onset of COVID-19, and businesses adapted to operating without the previously plentiful supply of migrant workers. However, this pressure is not a fleeting challenge. New Zealand’s population is ageing, and although the transition to an older population and comparatively smaller workforce is a continuous process, New Zealand is entering a period of chronic labour market pressures as the large baby boomer cohort starts to exit the workforce.

The level of tightness in the labour market is neatly encapsulated by the unemployment rate, plunging to 3.2% in the December 2021 quarter, the lowest rate since the current household labour force survey began in 1986 (see Chart 1).

Such a low unemployment rate presents a significant challenge for businesses trying to retain and attract staff, with responses to NZIER’s Quarterly Survey of Business Opinion showing that businesses found it harder than ever to find both skilled and unskilled labour in the December 2021 quarter.

Despite an incredibly tight labour market, migration has offered little help in the past year, plunging to a net outflow of 7,800 in the year ending December 2021 (Chart 2), with a collapse in foreign migrant arrivals driving the current net outflow. The ongoing reduction in quarantine requirements for inbound migrants removes one barrier for bringing in migrant workers, but net migration is expected to extremely subdued over the next two years. The ability to freely move across the international border will facilitate more Kiwi citizens to head overseas for their OE or in search of better living (and living costs!).

Our immigration settings have also tightened considerably over the past year, so the ability for migrants to gain work visas is limited to a narrower range of higher-skilled occupations.

Overall population growth in New Zealand is set to slow in the coming decades. Although we expect net migration to be sustained at the moderate level of 30,000pa over the long term, natural increase (births minus deaths) continues to weaken over time (Chart 3). A falling fertility rate means that the number of births is projected to stay broadly flat despite a growing population. This sustained births track is outweighed by a steadily growing number of deaths, as the number of people in older age groups outpaces the effect of growing life expectancy.

The net effect of these changes is a slowing in population growth, from an average of 1.5% per annum in the 2010s, to 1.1% in the 2020s and 0.8% in the 2030s.

The effect of an ageing population is neatly encapsulated in the labour market entry-exit ratio. This ratio expresses the number of people aged 15-24 years (labour market entrants) to those aged 55-64 (labour market exits). Ideally, the number of 15-24-year-olds would exceed the number of 55-64-year-olds – a ratio well above one. This ratio of above one means that there are enough young people entering the workforce to fully replace all retiring workers and allow for a little growth. Net migration can then provide a further top-up for stronger growth.

The entry-exit ratio has been creeping closer towards one for at least the past 25 years, accelerating in the past five years as the baby boomer cohort moved in the 55-64-year-old age group (Chart 4). The ratio reached 1.04 in 2021, is projected to trough at 1.03 in 2022, and won't get above 1.10 until 2030.

This declining ratio means that over the next decade, and especially the next five years, there will barely be enough young people entering the labour market to replace retiring workers. In aggregate terms, any growth in employment will be almost entirely reliant on net migration – or older people working longer.

The entry-exit ratio is a basic summary of the complexity of the population and labour market relationship. In practice, the relationship between population and the labour market can shift in response to market conditions – we regularly see the labour force participation rate rise when employment is growing strongly, as more people are drawn into a prosperous labour market. We also expect that labour market participation of over 65-year-olds will continue to grow as the health status and life expectancy of our over-65s improves. The labour force participation rate of over-65s has risen from 19% in 2011 to 25% in 2021 and is likely to continue rising.

There are a range of options to encourage retention of older workers in the labour market, such as offering part time employment or additional annual leave, to give older workers a taste of retirement while they remain working. But there is a natural limit to these options, as sooner or later people decide that it’s time to retire, or in many cases their health decides for them.

We need to make better use of our all age groups too – for example, through more flexible employment arrangements to enable more parents to enter the workforce. Improving productivity more generally will become increasingly important as growing the workforce becomes increasingly challenging.

The reopening of New Zealand’s borders represents a welcome boost to labour supply, but labour market tightness is here to stay, and we’ll need to get creative.