The Goldman Sachs Group, Inc.

Goldman Sachs Research

Discussion of Crafts (2014) Irelands Medium-

Term Growth Prospects: a Phoenix Rising?
Kevin Daly
Managing Director and Senior Economist
kevin.daly@gs.com
+44(20)7774-5908
Goldman Sachs International
January 2014
Investors should consider this research as only a single factor in making investment decisions. For Reg AC certification and other important disclosures, see the Disclosure
Appendix, or go to www.gs.com/research/hedge.html.
Goldman Sachs Global Economics, Commodities and Strategy Research 1
 Key points

Crafts (2014) provides a comprehensive and robust treatment of Irelands medium-

term growth potential. His findings represent an improvement on the OECDs (2013)
medium-term projections and, as a central case, we find his estimates to be entirely
plausible.

However, two caveats:

1. Small regional economies can experience permanent shocks: Growth projections

of this type assume that population growth is reasonably stable and that, given
the right policies, productivity will converge on the US average. But the US
experience suggests that, even given similar institutions, tax structures, etc.,
small regional economies can systematically grow faster or slower than the US
average. Ireland could converge to the US average but it is also plausible that it
converges towards the Silicon Valley or towards Detroit.

2. Irelands output gap is large: While estimates of the output gap are uncertain, it is
clear that Ireland has a significant degree of spare capacity. Given such a large
output gap, potential growth as estimated by Crafts (2014) and the OECD (2013)
is unlikely to be a binding constraint on Irelands growth prospects for some
time.

Goldman Sachs Global Investment Research 2

 Caveat #1: Small regional economies can
experience permanent shocks

1. In Crafts (2014), OECD (2013) and other simulations of this type, the assumed rate
of labour productivity growth in the productivity frontier which, in turn, is
assumed to be the level of productivity in the US as a whole is the key
determinant of productivity growth in close-to-frontier economies, such as
Ireland.

2. The labour force/population projections underlying projections of this type

typically assume reasonably steady growth.

3. But the experience of the US suggests that small regional economies can remain
stuck at productivity levels that are significantly different from the US average
(even given similar institutions, tax structures, etc.)...

4. ...and migration flows result in significant changes in relative population and

labour force size over time.

5. Ireland could converge to the US average and this seems reasonable as a central
case. But it is also plausible that it converges towards the Silicon Valley or
towards Detroit.

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 Wheres the productivity frontier? Significant
divergence in productivity across US states

Productivity level (2012) relative to the US

50

40

30

20

10

-10

-20

-30
MO

MN

MD
ME
MS

MA
MT

MI

LA
NM

CO
NH

NC

ND
NE

NV

US

CA

NY

DE
ID

UT
IN

CT
IA

NJ
IL
RI

HI
TN

TX
FL

OH

OR
OK

GA
WV

WA

WY
WI
AR
SC

SD
KY

KS

PA

VA

AK
VT

AZ
AL

Source: BEA, Goldman Sachs Global Investment Research

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 GDP growth differences across US states
tend to be persistent

Average annual GDP growth across US states

6.0
1995-2012
5.0

4.0

R = 0.145
3.0

2.0

1.0
1978-1995
0.0
0.0 1.0 2.0 3.0 4.0 5.0 6.0

Source: BEA, Goldman Sachs Global Investment Research

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 Employment growth differences across US
states are particularly persistent

Average annual employment growth across US states

3.0
1995-2012
2.5
R = 0.6914
2.0

1.5

1.0

0.5

0.0

-0.5
1978-1995
-1.0
0.0 1.0 2.0 3.0 4.0 5.0 6.0

Source: BEA, Goldman Sachs Global Investment Research

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 Productivity growth differences across US states
are not persistent (but convergence is limited)

Average annual productivity growth across US states

4.5

4.0
1995-2012

3.5

3.0

2.5

2.0 R = 0.0053
1.5

1.0

0.5

0.0 1978-1995
-0.5
-1.0 0.0 1.0 2.0 3.0

Source: BEA, Goldman Sachs Global Investment Research

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 State-specific GDP shocks in the US are
typically not reversed

Impulse response of 1pp state-specific GDP shock

2.0

1.8

1.6

1.4

1.2

1.0

0.8

0.6

0.4 GS (76-12)

0.2
years
0.0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Source: BEA, Goldman Sachs Global Investment Research

Goldman Sachs Global Investment Research 8
 State-specific employment shocks in the US
are typically not reversed

Impulse response of 1pp state-specific employment shock

2.0

1.8

1.6

1.4

1.2

1.0

0.8

0.6 GS (76 -12)

0.4
B&K (5 2-90)
0.2
y ears
0.0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Source: BEA, Blanchard & Katz (1992), Goldman Sachs Global Investment Research
Goldman Sachs Global Investment Research 9
 Caveat #2: Irelands output gap appears
large

1. Crafts (2014) and the OECD (2013) provide estimates of potential or trend output
growth.

2. However, it is clear that aggregate demand in the Irish economy is significantly

below potential.

3. While estimates of the output gap vary, the most plausible estimates ones which
are based on production function estimates rather than on statistical trending
techniques suggest that the output gap is currently equal to between 5 and 10%
of GDP.

4. Given such a large output gap, potential growth is unlikely to be a binding

constraint on Irelands growth prospects for some time.

Goldman Sachs Global Investment Research 10

 Ireland economys is operating 5-10% below
potential output

Output gap (% of potential GDP)

10 GS
OECD
IMF
5

-5

-10
90 92 94 96 98 00 02 04 06 08 10 12 14

Source: OECD, IMF, Goldman Sachs Global Investment Research

Goldman Sachs Global Investment Research 11
 Recap: Key points

Crafts (2014) provides a comprehensive and robust treatment of Irelands medium-

term growth potential. His findings represent an improvement on the OECDs (2013)
medium-term projections and, as a central case, we find his estimates to be entirely
plausible.

However, two caveats:

1. Small regional economies can experience permanent shocks: Growth projections

of this type assume that population growth is reasonably stable and that, given
the right policies, productivity will converge on the US average. But the US
experience suggests that, even given similar institutions, tax structures, etc.,
small regional economies can systematically grow faster or slower than the US
average. Ireland could converge to the US average but it is also plausible that it
converges towards the Silicon Valley or towards Detroit.

2. Irelands output gap is large: While estimates of the output gap are uncertain, it is
clear that Ireland has a significant degree of spare capacity. Given such a large
output gap, potential growth as estimated by Crafts (2014) and the OECD (2013)
is unlikely to be a binding constraint on Irelands growth prospects for some
time.

Goldman Sachs Global Investment Research 12

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I, Kevin Daly, hereby certify that all of the views expressed in this report accurately reflect my personal views, which have not been influenced by considerations of the firms
business or client relationships.
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Goldman Sachs Global Investment Research 13