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REBUILDING THE CANADIAN ECONOMY POST-COVID
Rebuilding the Canadian economy in the post-COVID era | The next age of uncertainty
STEPHEN POLOZ | SPECIAL ADVISOR AT OSLER, HOSKINS & HARCOURT
With over 80 per cent of the population vaccinated in Ontario, pandemic restrictions lifting, and employees returning to the office, it can seem like the worst of the pandemic is behind us. But many of the businesses we’re returning to have faced significant challenges since the country’s first lockdowns two years ago, and have questions about the future of their industries in a post-COVID economy. On January 26, ORBA’s 2022 Summit opened with a keynote address by Stephen Poloz, special advisor at Osler, Hoskins & Harcourt, former Governor of the Bank of Canada, and author of The Next Age of Uncertainty: How the World Can Adapt to a Riskier Future. Here he shares his insights into inflation and the economy, what it means for companies and investors, and what to expect for 2022 and beyond.
On inflation
Inflation has emerged as a topic of conversation both at the boardroom table and at the kitchen table for the first time in at least 30 years. Recent inflation figures have been disconcerting, but it is important to distinguish between “price increases” and “home-grown” inflation. Most of the rise in inflation we have seen so far has come from rising prices — either prices that declined during the pandemic (deflation) and now are moving back up — or from shocks external to the normal inflation process (higher oil, gas and food prices related to the war in Ukraine or to last year’s floods and drought). Excluding food and energy, the average trend rate of inflation over the two years since the pandemic began is only about three per cent. What this means is that a lot of what we are seeing should dissipate over the next 12 months or so.
What is most concerning is that Canada’s labour market is also very tight — unemployment is at a 40-year low and there are nearly one million job vacancies. We therefore have the potential for a wage price spiral — home-grown inflation — that could shake people’s longstanding faith in two per cent inflation. Rising interest rates and quantitative tightening, more immigration, and the deployment of the government’s childcare program should help relieve the pressure on domestic inflation in the coming months.
So the trend in inflation is simply not as bad as it looks, and to a large extent this bulge in inflation will be temporary. We also know that there are supply chain issues which are boosting prices of many goods in the economy. There are longer times for delivery, more expensive delivery, and higher fuel costs. This too is something that will go away. Problems would have to get much worse on the supply chain front in order for them to be inflationary, so it’s very unlikely that this will become a trend. There’s too much money at stake for people who run supply chains not to fix them.
What about growth and wages? If we did an experiment and assumed that everyone stayed in the same job and recalculated how much wages would have gone up, the average is about three per cent. That suggests that there’s no fundamental inflation there. We’re getting mostly measurements that are going to subside as we go through this year.
I expect that makes me part of Team Transitory. Everyone expects transitory to last only a few minutes or perhaps one month of inflation data, but to an economist transitory is just something that goes away by itself. It may take 12 to 18 months to do that, which is to say sometime later this year.
This is not to say that inflation is not a concern because it is. The economy is still being stimulated even though it’s running at capacity. That means there’s a risk that inflation will end up higher than hoped, but there are also some important forces acting on inflation in the opposite direction.
On the forces acting against inflation
The first is that economic capacity is expanding as we speak. Immigration is picking up again and the supply chain issues are gradually being resolved. Investment in new capacity is on the rise, so supply can outpace demand for a couple of months or even years and that puts a lid on the inflation process.
Secondly, and perhaps more importantly, the fourth industrial revolution is underway. Digitalization, the deployment of AI, and biotech are all certain to increase our productivity. Higher productivity will manifest itself in lower prices. Why? When one company innovates, its competing company has to innovate, and the customer gets many of the benefits of those innovations. That’s what happened in the first three industrial revolutions from the steam engine to electricity to the computer chip — and now we’re in the fourth one.
I expect that in a couple of years we’ll be puzzling about why inflation is lower than most people were expecting. It will be because of that new technology spreading through the economy. Nevertheless, there are some big, competing, offsetting forces and figuring those out and what’s bigger than the other is very difficult. It’s not a simple matter and it’s an environment in which mistakes can easily be made. So we need to take the risk of higher inflation seriously.
On trends and forces acting on the economy
At this stage, the economy is operating more or less at its full capacity. Looking beyond the immediate future, there are some important forces acting on the economy we all should be thinking about.
1. Lower global economic growth
The first trend is that global economic growth will be lower than most people expect because the entire global population demographic is aging. The baby boom bulge is now entering the retirement phase of their lives. Literally the past 50 years have been unusual historically. It’s difficult to get used to the idea that the last 50 years have been an aberration, but it’s a very long aberration and now we’re going into a much longer period of normalcy. Normalcy means an older population and slower growth in workforces.
This means that economic growth globally will be lower than the base lines we’ve become used to. In countries like Canada, we can resist this trend to a certain degree through higher immigration. We have an immigration plan in place that should put a floor in Canada’s growth rate of at least one per cent. The rest of our growth needs to come from higher productivity. It’s crucial that we continue to boost productivity if we are going to grow our way out of the debt load that we’ve created during this pandemic. Canada has a comparatively poor productivity performance, so we need to be looking at our productivity inhibitors very carefully.
By far the most effective way to offset inflation pressures is to boost productivity in the economy. There are many aspects to this, but infrastructure investment clearly plays a central role. The government has set out an ambitious infrastructure financing plan, but its deployment has been slow, lumpy, and unpredictable. ››
We must acknowledge that having an infrastructure financing plan is only the first step in the path to higher productivity for the firms that use it, and there are many ways to streamline the process, ranging from permitting to intergovernmental coordination. These uncertainties affect the suppliers of infrastructure projects as well. Without certainty as to when projects will go ahead, construction companies cannot plan their resourcing, so the capacity of the industry is often stretched. Construction companies also must post performance bonds to bid for projects for which there is limited private sector capacity. The Canadian Infrastructure Bank may be well-placed to address this particular impediment, and to help bring more predictability to the flow of project work at the same time.
2. Globalization has peaked
The second trend we need to be mindful of is that globalization has peaked. There are geopolitical reasons for this, but there’s also volatility in the global system. Some of it we’re experiencing now because of the pandemic, but there was volatility before supply chain disruptions. This volatility is leading companies to diversify their supply chains and add resiliency. These shifts will add costs, perhaps adding to inflation. Globalization was a source of disinflation for us over the past 20 years, so taking that away might mean there’s a higher base line for us over the next couple of years.
3. Net zero carbon emissions
The third trend is the transition to net zero carbon emissions which adds another level of complexity to the outlook for all of us. We know that this transition is already limiting investment in Canada’s own energy sector, and global leaders are struggling with reaching agreements on how the world will adapt. The recent COP 26 (UN Climate Change Conference of the Parties) is the 26th attempt to reach those kinds of agreements. Then there’s the federal-provincial dynamics we have to go through to reach agreement on how Canada will manage its net zero transition. In contrast to that, investors clearly embrace the concept of net zero by 2050. There’s every reason to believe that Canada can remain a major producer and exporter of energy and other derived products for the foreseeable future. Over 80 per cent of world energy today is fossil based. Three billion people in the world have no electricity or gas available to them for cooking or heating. For them it’s not just switching to electric — it’s just not something that can happen. In addition, global demand for energy will grow by at least 50 or 60 per cent over the next 30 years by 2050.
Meeting that rise in energy demand with pure green sources will be a major challenge for all of us, but it can be done. However, even if major economies can go pure green, others may not be able to during that transition. In 2050, it’s quite possible that at least 50 per cent of global energy will still come from fossil fuels. That’s not to mention all the other things we use every day that have as their source fossil fuels, oil or natural gas. Therefore, to me the only way to reconcile the world’s green ambitions with its carbon backbone is through extensive deployment of carbon capture utilization storage technology (CCUS). Canada clearly has the capacity to be a leader in this space. Because we have this incredible endowment of energy, we have a huge incentive to be a leader and remain in the energy game for the foreseeable future, not just until 2050. That means taking the word “net” seriously as opposed to “zero by 2050” — it’s net zero by 2050.
4. A shift in market power from employers to employees
One of the central conclusions of my book, The Next Age of Uncertainty, is that we can expect a trend shift in market power from employers to employees in the next few years. This is because of the interaction of three tectonic forces: population aging, the rapid deployment of digital technology, and rising income inequality. Up to 15 per cent of global jobs will be disrupted, workers will become increasingly scarce, and the stresses of income inequality will fuel divisive politics. This confluence of forces will create volatility that will strain government policies, and create a lot of stress for companies and their employees. I would expect companies to work much harder in future to attract and retain workers which could mean offering better compensation and more flexible work arrangements, and even herald the return of defined-benefit pension plans. Shareholders will reward companies that do a good job of this — those who do not may face a resurgence of unionization.
In conclusion
In a couple of years I think the pandemic will be seen as having been an important pivot point in the world economy. The narrative will shift to disappointing economic growth, growing disruption due to technological progress, lower than expected inflation, rising income inequality, and rising political polarization. On top of all this, somehow we need to transition to net zero. I think policy makers will find themselves quite limited in their ability to manage all of this given persistent low interest rates and high levels of indebtedness.
This combination is going to deliver a complex cocktail of interacting forces likely to give rise to major economic and financial volatility — a rising tide of risk which I like to call the next age of uncertainty. Employees and employers will work hard to adapt to this new world, and successful companies will be those who can manage that volatility and create value for their multiple stakeholders out of those higher risks.
Lara Henry is a communication specialist and editor of ROADBuilder.
