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Innovation acceleration could be pandemic’s economic silver lining

The middle of a hurricane is not an ideal time to attempt to measure the full extent of the damage done by the storm.

The middle of a hurricane is not an ideal time to attempt to measure the full extent of the damage done by the storm.

But as Canada’s experience with COVID-19 approaches the half-year mark, we find ourselves ruminating about the lasting economic consequences of this extraordinary shock. 

In the spring, the spread of the virus stopped much of the global economy in its tracks as governments instituted unprecedented lockdowns and international trade was disrupted. Most national economies are now healing, albeit on different trajectories. Today, the question on the minds of many analysts is what the “new normal” will look like once the worst of the pandemic is behind us.

For economists, a common way to approach this topic is to consider what the pandemic means for long-run or potential growth in output and incomes. This is the economy’s “speed limit” – how quickly it can grow without overheating. The COVID-19 crisis will influence potential growth through several channels. Unfortunately, most have negative implications for future economic performance.

Begin with the eye-watering escalation of public sector debt as tax revenues have plunged and governments have rolled out massive economic support packages. These fiscal injections were necessary, but they come with a cost. In Canada, the federal government is on track to run a $350 billion deficit in 2020-21, equivalent to 17% of GDP. Even under favourable economic conditions, it will take years to get Ottawa’s deficit below $75 billion. We estimate that by 2023, the federal debt/GDP ratio could reach 65%, more than double the level in 2019. The provinces are also looking at a dramatic deterioration in their finances.

Fortunately, today’s exceptionally low interest rate environment should mitigate the near-term burden of servicing ballooning government debts. But in time, both interest rates and public-sector borrowing costs will rise, and governments in Canada will find it necessary to stem the tide of red ink.  This will require some mix of expenditure reductions and – in all likelihood – higher (or new) taxes. One risk is that the looming return of fiscal restraint will see spending cut on things that make the economy more productive: education, infrastructure, and scientific research. Another concern is that tax hikes, if poorly designed, could dampen incentives to work, save, invest and undertake entrepreneurial activity, further reducing the economy’s growth potential.

Another consequence of the pandemic is higher long-term unemployment. As of August, employment in Canada was still 7% lower than in February. Academic research confirms that deep recessions and sputtering economic recoveries leave lasting scars on unemployed workers who are unable to return to their former positions or transition to new jobs quickly. This, too, harms the economy’s growth potential. 

Finally, we also worry about the pandemic’s impact on schooling and the formation of human capital generally. Not being in school early in life slows cognitive development, and it’s hard to make up for this by spending more time in class later on. That helps to explain why governments are keen to reopen schools.

The long-term effects of COVID-19 may not be all bad. Historically, pandemics and other economic shocks have sometimes accelerated innovation and, with a lag, led to stronger productivity growth. Indeed, productivity growth in the U.S. during the Depression-era 1930s was the fastest of any decade in the 20th century. This fits with the theory of “creative destruction” proposed by economist Joseph Schumpeter in the late 1930s. Schumpeter showed that new and better ways of doing things and the emergence of more productive businesses often result from episodes of economic dislocation. Looking specifically at the Depression, he argued that the disappearance of old firms and the restructuring of various industries paved the way for successful new businesses and stimulated waves of innovation that, over time, spread throughout business and industry.

COVID-19 does seem to be speeding the demise of longstanding business models in some sectors. It is also giving a huge boost to the adoption of digital tools, technologies and platforms across the economy. The explosive growth of e-commerce, the surging popularity of remote work and the shift to telemedicine are three examples of how pre-pandemic trends have been given new impetus since February. This offers some hope that the legacy of the terrible COVID-19 crisis won’t be entirely negative. •

Jock Finlayson is the Business Council of British Columbia’s executive vice-president and chief policy officer; Ken Peacock is the council’s chief economist.