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November 20 2012, 1:15PM

Productivity improvements are crucial for Australia to cope with an ageing population and declining terms of trade if living standards are to be raised, a senior Treasury official says.

David Gruen, executive director of Treasury's macroeconomics group, told a conference on Tuesday that productivity growth was historically the predominant source of income growth in the economy.

However, the 2000s was unusual because labour productivity growth contributed to only half the growth in average incomes, compared with 90 per cent on average over the previous four decades.

"In the 2000s, the Australian community experienced strong growth incomes only because of the unprecedented contribution of rising terms of trade," Dr Gruen told a Productivity Commission-Australian Bureau of Statistics conference in Canberra.

But in the future, Australia's terms of trade would detract from income growth, rather than add to growth as they had in the past.

"While commodity prices are expected to remain elevated compared to history, we expect they will trend lower over time as global supply expands rapidly," Dr Gruen said.

As well, Australia's ageing population was also likely to detract from labour force participation as the baby boomer generation moved into retirement.

"So the terms of trade and the ageing of the population are both likely to work against us, rather than for us, in the future," Dr Gruen said.

"If this is the case, we will rely on productivity improvement to again become the dominant contributor to growth in Australian incomes."

For the government, declining workforce participation and terms of trade imply slower growth in national income and tax revenue, reducing the capacity to fund essential services relative to demand.

He said the economy continued to adjust and transform, there would be a need for more productivity research at the industry level, as well as comparisons with international benchmarks.