David Aston
Dec. 7, 2020
With recent news of successful vaccine tests, we are starting to glimpse light at the end of the COVID-19 tunnel. So now is a good time to start to look ahead at how the economic “new normal” is shaping up after the economy recovers from the pandemic.
Here are three long-term economic questions to consider: Will key consumer and workplace trends from the pandemic continue or revert to pre-pandemic patterns? What will the trend be for economic growth? Will interest rates and inflation stay low?
To help envision what the “new normal” might look like, I talked to three leading economists: David Rosenberg, chief economist at Rosenberg Research; Craig Alexander, chief economist at Deloitte Canada; and William Robson, chief executive officer of the C.D. Howe Institute.
Of course, it will take a few years for this “new normal” to fully take shape. We’re now in the midst of COVID-19 second wave. A gradual and lengthy economic recovery is anticipated. Even after vaccines are widely disseminated as is expected some time next year, many economists expect it will take until some time in 2023 to get employment back to pre-pandemic levels.
Some pandemic-driven trends are more likely to persist than others
Alexander draws a useful distinction between trends that originated during the pandemic versus prior trends accelerated by the pandemic. Accelerated trends are more likely to have staying power because they build on change that was already underway, he says.
Accelerated trends include shifts to the digital economy, remote work, and e-commerce. The pandemic gave companies, consumers, and employees compelling reasons to speed up new ways of doing business in these areas. “There is a strong rationale those trends could be sticky,” Alexander says.
Alexander gives the example of a business client which had a five-year plan to develop digital sales. Then the pandemic struck and the company was compelled to essentially implement the plan in two weeks. Since the digital transformation was already deemed necessary and planned, the company is unlikely to backtrack after the pandemic is over.
In contrast, shifts to do-it-yourself services, eating at home, and increased savings are new trends that sprang out of the pandemic. Their persistence seems to be more of an open question.
Rosenberg makes a case that many of those new trends are also here to stay. The pandemic, he argues, provided a sharp lesson in the benefits of frugality and savings. Rosenberg says one “startling statistic” was that over half of households didn’t have enough cash or savings at the start of the pandemic to get them through three months of inactivity.
Meanwhile, people learned or upgraded DIY skills ranging from cooking to auto repair in order to cope with shutdowns. They invested in home renovations, kitchenware and more. In many cases they saved money doing so. Once skills are learned, money is invested, savings are proven and practices are ingrained in day-to-day routines, then one can argue the trends are likely to stay.
“We’ve become a nation that is more self-reliant,” says Rosenberg. “I think we’re going into a prolonged period of consumer frugality. We’re going to have more of savings culture. People will be going out and eating again at restaurants, but they will be doing it less than they did before.”
With little evidence of these particular trends before the pandemic, however, Alexander argues otherwise: “I think Canadians will go back to eating in restaurants just like they were before.”
Be prepared for slow growth
Many economists expect that once we get through some pent-up demand in the recovery, then we’re headed for a “new normal” of slow growth.
In the decade before the pandemic, the annual increase in real gross domestic product trended in the vicinity of two per cent, although it had fallen off a bit to 1.7 per cent in 2019.
While we might be hard pressed to reach two per cent growth again, even that isn’t any great shakes. “The simple fact was that pre-COVID Canada wasn’t on the path to prosperity,” says Alexander. “It felt like it because we had very low unemployment. But the simple reality was the pace of economic growth was not supporting strong gains in living standards.” In contrast, real annual growth was about 2.8 per cent during the 1990s, he says.
Alexander says the annual real growth trend going forward would have been about 1.7 per cent without the pandemic (as it was in 2019) and thinks that provides a reasonable base case after the recovery. Rosenberg and Robson expect the “new normal” growth rate will be more like 1.5 per cent.
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Several factors contribute to the low-growth prognosis. Compared to earlier times, we’ve been seeing trends of low levels of investment and weak productivity growth. An aging population results in a lower proportion of working Canadians. Corporate and household debt levels are high, which crimps other spending.
A big new factor is the dramatic growth in government deficits and debt at both the federal and provincial levels. It’s uncertain how governments will carry the costs of this debt — whether they will raise taxes, or need to undertake austerity programs threatens to diminish growth in different ways.
A lot is at stake with the growth rate. As Robson explains it, his 1.5 per cent real-growth trend estimate has several components. About 0.5 per cent is attributable to growth in the working-age population, so it doesn’t affect growth rates per person. So the remaining components comprised of productivity growth (contributing about 0.3 per cent), and additional physical capital invested per worker (“capital deepening,” contributing about 0.7 per cent) have to do all the heavy lifting of raising per-capita growth.
Meanwhile, growth per capita has to cover the redistributive impact of an aging population that requires working Canadians to pay for more seniors’ benefits, health care, and public-sector pensions, Robson says.
When growth rates per capita are low and significant wealth is redistributed away from the working population, then many working Canadians will see stagnant or falling living standards, Robson explains. “Those redistributive stresses are a troubling thing,” he says.
Governments might hope to squeeze out a bit more growth with the right policies. Alexander sees potential to increase the growth rate trend from 1.7 per cent to as much as 2.7 per cent with what he calls a “pro-growth” agenda. He advocates a collection of policies ranging from further skills training, to removing barriers to labour-force participation by immigrants and the disabled, to investments in early childhood education (which helps parents return to the workforce).
Alexander acknowledges the full 2.7 per cent growth potential is a big stretch, but “if we managed to get the trend from 1.7 per cent to 2.0 per cent that would still be a significant improvement.”
Don’t count out rising interest rates and inflation
Most economists expect reasonably low interest rates and inflation for the foreseeable future, which is consistent with a slow-growth outlook. (Some modest and gradual upward movement in long-term interest rates from current ultra-low levels is likely, which is expected to return those rates back to a position where they are still low by historical standards.) But you should never completely discard the possibility of interest rates and inflation kicking up more sharply a few years out after the current economic slack gets used up.
While Robson isn’t specifically forecasting a rise in inflation, he acknowledges a plausible scenario where it could happen. Fiscal and monetary policies are both pretty focused on stimulating growth and employment these days. With a loss of significant productive capacity due to the pandemic, policy-makers may reach the point in a few years where they need to apply a relatively heavy dose of stimulus to try for the ongoing growth and employment gains they are hoping for. “I think you could see the economy running hot for a while to the extent that you could see inflation start to rise a bit,” says Robson.
If inflation starts to rise, then central banks may need to raise their benchmark short-term interest rates to help contain it. In addition, massive global government borrowing could tip the balance of supply and demand in bond markets a little in favour of investors getting a bit more yield. Moreover, if inflation stays a bit high for a while, then bond buyers might also expect a modest inflation premium incorporated into yields.
