Trevor Tombe: The pandemic’s lasting scars on Canada’s economy

The COVID-19 pandemic, and the economic disruptions it caused, appear to have left deep and long-lasting scars on Canada’s economy. 

The latest data from Statistics Canada measuring the size of Canada’s economy through to the end of 2022 shows we have shifted down to a lower growth path—and one that might be felt for years to come or potentially even be permanent.

Specifically, new quarterly data on Canada’s economy shows a clear and sizable gap between where we are now and where we were previously headed. I plot this below. In the fourth quarter of 2022, the economy is roughly 6.5 percent smaller than its pre-COVID trend.

This is a very large gap. It is equivalent to $180 billion per year in lost output. That’s $4,500 per person in Canada per year. It’s larger than Canada’s entire energy sector. 

While this outcome was foreseeable, it wasn’t a foregone conclusion.

More than a year ago, writing for Maclean’s Charts to Watch in 2022, I raised a concern that “future growth may, unfortunately, be lower for longer.” Whether COVID permanently damages Canada’s economy or whether workplace innovations (like remote work) and policy responses (like childcare) could boost productivity above pre-COVID trends would be revealed by this data.

“Where our economy goes in 2022 will give early indications about which of these two possibilities may be likely,” I wrote. More than a year later, with the data now in, it appears the worse of the two occurred.

Understanding what factors led to this outcome is critical.

This is neither a novel development, to be clear, nor one unique to Canada.

Recent research suggests recessions in general can permanently shift an economy to a lower growth path. The United States experienced this following the financial crisis, for example. Canada was not spared then either. A broad investigation of nearly two dozen OECD economies found countries suffered a permanent ratchet down with only a few examples.

Even normal run-of-the-mill recessions—as opposed to large-scale ones or those following financial crises—may exhibit this pattern.

There are many potential causes. Losing a job may lead some, especially older workers, to permanently withdraw from the labour market. Lasting negative health effects of the pandemic may also be a factor. Investment could also fall, lowering the pace of capital accumulation like machinery and equipment. And productivity growth may slow.

To measure how important each of these factors might be for understanding Canada’s current situation, I use a technique known as “growth accounting”. The intuition is simple.

Labour and capital are critical inputs into the production of nearly all goods and services throughout the economy. Technology, skills, and knowledge each determine how much output we get for any given number of workers and machines—that’s our productivity. Each of these is (imperfectly) measurable, so we can estimate how much increases in employment tend to increase GDP, or how much decreases in capital investment affect GDP, and so on.

I do just that and find lagging productivity growth is the key.

Of the overall drop below pre-COVID trends, productivity accounts for roughly 4 percentage points of the total. That’s about 60 percent of the overall gap between where we are now and where we were previously headed. Productivity growth has been so poor recently it has actually been negative. I estimate it is roughly back to the same level it was at in early 2019.

Lagging investment levels and the country’s overall capital stock, interestingly, account for only a small fraction. Some have pointed to lagging business investment as a central challenge for Canada. And while this is certainly important, it doesn’t appear to account for much of why we remain so far below trend.

It’s therefore labour that accounts for the rest of the decline. I estimate total hours worked in Canada is about 4.4 percent below its pre-COVID trend and accounts for a third of the gap between Canada’s GDP and its prior trend. 

It’s not that we’re working fewer hours individually (though we are a little bit). It’s mainly that there are fewer workers overall due to Canada’s ageing population. 

By the end of 2022, 62 percent of the population was aged 18 to 64 years—that’s down from 64 percent five years earlier, and also below its pre-COVID trend. These small changes can have large effects, given how important labour is to produce almost everything.

Can we boost our longer-term growth rates?

There are options: we can increase our inputs or we can increase our productivity. Demographic challenges are hard to overcome, however. Immigration can partly compensate but comes with considerable challenges of its own. 

That leaves increasing business investment and productivity growth. The list of areas where we can turn to improve this is long. Increasing technology adoption, growing our internal and international trade flows, boosting the level of competition within several protected sectors, enhancing skills training, exploring and enacting tax reforms, easing regulatory burdens, improving transport infrastructure, and so much more, could all yield dividends. 

Each deserves a deeper dive than I can provide here. But one thing is clear: if we cannot reverse recent trends, Canada’s economy risks falling even further behind.