How to fix this error inside VScode?
Go to your Mac terminal and run the following commands
~ % which code ~ % code . // don't forget the dot after "code"
New window open with VSCode prompting if vscode can access all the folder. Select "YES". You are done. Relaunch VSCode again, now try Ctrl + ~ to launch a new zsh terminal.
Note: This is the fix I found after upgrading to MacOS BigSur. VSCode was working before the OS upgrade for me.