One of my key concerns about the post-lockdown economic recovery is the potential slowdown (or outright decline) in labour productivity growth. There is evidence that, on average, workers tend to be less productive when working remotely than when physically in the office. Since remote work is likely to remain a significant part of doing business until a vaccine is fully deployed, aggregate productivity is likely to suffer. This could be further exacerbated by physical distancing rules in retail, finance, transport, and other service-producing sectors. The new restrictions will likely increase costs and require investment in potentially non-productive capital (barriers, scanners, etc.) when maintaining an office, operating a store, or producing in a factory. In the absence of productivity gains, the rising operating costs will put downward pressure on wages or upward pressure on prices, and make a slow recovery scenario much more likely.
However, this somber short-to-medium term view masks the possibility of some very large long-term productivity gains, if the opportunities are realized. To illustrate this, let us consider the main macroeconomic and geopolitical trends from three distinct perspectives.
First, the Canadian economy prior to COVID was undergoing structural changes that are still affecting Canadian businesses. This includes issues like the aging of the labour force, the rising importance of immigration to economic growth and policies aimed at addressing climate change.
Second, some of the existing trends have been accelerated by COVID. The pandemic has accelerated the shift towards digital adoption, and consumptions likely to rapidly speed-up the deployment of AI and use of Big Data. The future of work is also being transformed by accelerated automation and the shift to remote work, which is likely to linger even after the economy, is reopened.
Third, the pandemic has also created new trends that did not exist before, like changes in consumer behavior around health and trust.
These transformative forces are likely to lead to many business failures during the current recession and its aftermath. Closures related solely to the new disruption from the pandemic are a particular economic loss. However, many firms that fail will be those that were already being disrupted by the first two factors. For example, we are seeing firms that invested in digital prior to COVID thriving and businesses that underinvested in the shift to digital falter.
With this perspective, one could argue that the process we are seeing is an acceleration of the creative destruction that is an inherent part of economic evolution - a cornerstone of economic theory since the 1950s.
We can lament the loss of businesses, but we should also be mindful that the closures would enable the opportunity to create new firms during the recovery and subsequent expansion. Indeed, I believe policymakers should establish incentives and create an environment to encourage start-ups—something that would greatly help the job recovery. These new firms will be positioned to thrive in the new post-COVID environment that will be more digital, more automated, more informed by AI and employ more flexible workers. This would make the Canadian economy more flexible, productive and competitive.
There is also the possibility that many of the small businesses that are lost are lifestyle businesses. These are businesses where the owner’s ambition is to provide a good quality of life for their family instead of looking to grow and scale significantly. In the post-COVID world, we could have stronger more competitive businesses if new start-ups are more oriented to growth and scaling.
Turning to today’s economic data, U.S. consumer confidence nudged up in May. The US Conference Board consumer confidence index edged up to a reading of 86.6 this month from a downwardly revised 85.7 in April. The present situation index fell to 71.1 from 73.0 in April, no surprise given the depth of the downturn. The expectations index climbed to 96.9 from a reading of 94.3 in April. This makes sense given the plans for reopening the economy, but there is still enormous uncertainty and consumer sentiment is likely to remain fragile.
Closer to home, we are at the start of the quarterly earnings announcements by the major Canadian banks. Given the economic contraction, there is considerable attention on loan loss provisions. The Bank of Nova Scotia was the first to report, and its profit in the second quarter plunged by 41 percent. The dividend held steady at 90 cents per share the bank signaled that it expects to maintain dividend payments. Bank analysts anticipated larger loan loss provisions. Therefore, there will be some debate in markets over whether the provisions are adequate or will need to be expanded.
