Stephen Poloz, Special Advisor with Osler, Hoskin, and Harcourt, and Author of “The Next Age of Uncertainty”

The Canadian economy was in excellent shape when the pandemic struck in early 2020. Inflation was right on target at 2%, and unemployment was at a 40-year low. There is no healthier starting point for an economy that is about to be struck by a major shock – just as a healthy individual can usually shake off COVID, so can a robust economy.

Nevertheless, economists were uniformly pessimistic about the Canadian economic outlook when COVID landed. I remember well in April of 2020, when I was Governor of the Bank of Canada, we chose for the first time not to provide an updated economic forecast in our policy report. Instead, we offered two planning scenarios to help people understand what the economy was going through. The best-case scenario assumed a relatively short business shutdown, and an orderly transition to virtual business; the worst-case scenario assumed that there would be a much longer shutdown and considerable long-lasting damage to the economy.

As it turned out, the Canadian economy tracked the best-case scenario quite closely, outperforming everyone’s expectations. That healthy starting point was clearly very helpful, as other countries fared less well, but actions taken during the crisis were important, too. First, the nascent financial crisis was nipped in the bud through the deployment of a wide array of financial tools, including zero interest rates and quantitative easing. Second, the government launched targeted programs to support people and companies that would expand or contract elastically, depending on the condition of the economy.

The worst-case scenario for the economy would probably have seen the federal government’s debt/GDP ratio roughly double, from a respectable 30% to as much as 60%. Even if the possibility of incurring that much additional government debt seemed daunting, it was not unprecedented – a government debt ratio as high as 60% would still compare favorably with the situation in 1994, when the Canadian debt ratio rose to about 67%.

In the event, the federal government debt ratio peaked at less than 48%. It is now projected to fall back below 40% in the next 4 years. Along the way, the government has introduced some new programs as well. Of course, the merits of the government’s fiscal plan are worth debating, but we can agree that the “worst recession since the Great Depression” was successfully averted, without major damage to the government’s finances.

But not all is well. As in many other countries, inflation has risen to levels not seen in over 30 years. Most of this rise in inflation – some 4-5 percentage points – was the product either of the effects of the invasion of Ukraine on commodity prices or of various international supply chain issues. These external sources of inflation have all reversed or stabilized, so this part of headline inflation should continue to decline in the coming months.

The rest of the inflation we are seeing is domestically driven. It arose because, like other central banks, the Bank of Canada sought to minimize deflation risk by allowing inflation to return to 2% before beginning to normalize interest rates. This strategy was consistent with a modest inflation overshoot, to perhaps 3-4%, but actions taken over the past year should reverse this, while preventing any of the external inflation from becoming embedded domestically. The economy is almost certainly more interest rate sensitive today than in the past, and the effects of higher rates will be augmented by quantitative tightening as the central bank shrinks its balance sheet. All things considered, I expect that inflation will fall more quickly than most economic models would predict.

In other words, we can expect before long to be back quite close to where we were prior to the pandemic. It is natural to expect, or at least hope for, a return to economic and financial tranquility by then. However, there are other forces acting on the economy that are likely to come to the fore in that timeframe, and their inevitable collisions point to more trouble ahead.

First, the global workforce is aging rapidly as the post-war baby boomers who entered the workforce between 1965-1985 are now retiring. This will keep labour markets tight for years, and will result in slower economic growth. Promoting more immigration into Canada can help mitigate this, but our infrastructure, our housing market, our medical care system – not to mention our immigration system – are not well prepared for this, so strains are likely.

Second, the world has just entered the Fourth Industrial Revolution – the digitization of our economy. This is clearly a force for good, but the three past industrial revolutions (the steam engine, electricity, the computer chip) have also been hugely disruptive for companies and individuals. Estimates are that some 15% of the global workforce will be disrupted by this technological wave.

Third, to arrest global warming, the world aspires to reach net zero carbon emissions by 2050. This is a very complex structural change for the world economy, not least because the path to 2050 is not well defined. Although the direction of travel is clear, uncertainty about the route the Canadian economy will take is likely to continue to distort investment decisions.

Fourth, global geopolitics have entered a new and dangerous era. The Russian invasion of Ukraine and rising tensions between China and other major powers have threatened security of at least three existential elements – food, fertilizer and fuel. Canada happens to be a major producer of all three of these, but some perceive a contradiction in helping address these problems while still meeting our carbon emissions goals. Further, efforts to de-risk global supply chains will be costly, and trade-dependent economies like Canada stand to be affected more than most.

With such tectonic forces acting on our economic outlook, it is no wonder that forecasters are struggling to provide concrete insights into the future. The situation is too complex for any of the economic models in existence today, which suggests that it may be futile to try. Instead of building a business plan around an economic forecast, companies should focus their energy on preparation for a wide range of possible scenarios.

In short, we should prepare for even more volatility in all things economic and financial. More economic booms and busts, a higher probability of job loss, a greater risk of inflation variability than we have seen for more than 30 years, and very high financial volatility. More companies will flounder in this volatile environment than in the past, and yet more companies are likely to be created, too. Today, Canada loses some 40,000 companies every month, while a few more than 40,000 new companies are created, leading to steady growth in the population of companies in good times. This churn is Schumpeter’s creative destruction in action, and an increasingly volatile world is likely to see a rising trend in company churn.

Rising company churn will probably boost Canada’s productivity performance, which has been lagging most other OECD countries for many years. Some would ascribe at least part of this poor performance to the survival of low-performing companies as government policies moderate economic shocks. This effect is sure to have been magnified by the pandemic, when many weak companies were able to take advantage of the government’s loan guarantees, regardless of their situation. We will almost certainly observe above-normal rates of business failures during 2023, but a rising tide of volatility could turn that surge into a trend.

Since every company bankruptcy and every company creation requires legal services, our legal frameworks will come under considerable strain in the volatile environment I am describing. Our legal system is ill-equipped to manage things today – just as our health infrastructure is ill-equipped to manage a pandemic, let alone seasonal surges in respiratory illnesses or a surge in immigration – and the environment we will face can only put the legal system under more strain.

The bottom line? After nearly three years of economic and financial turmoil, households and companies alike are hoping for a return to relatively tranquil times. These hopes are likely to be dashed by a rising tide of volatility, driven by tectonic forces beyond our control. Adapting to the shifting economic landscape will become a major preoccupation for all of us.