Global Markets Analyst

20 July 2023 | 1:52AM EDT
Global Markets Analyst
The Impact of Artificial Intelligence on Macro Markets

(Wilson/Chang)
n Our economists estimate that widespread AI adoption could fuel a 10-year Dominic Wilson
+1(212)902-5924 |
period where annual productivity growth is as much as 1.5ppt higher than dominic.wilson@gs.com
Goldman Sachs & Co. LLC
otherwise, an impact comparable to the productivity booms around the adoption
Vickie Chang
of electricity and the PC/internet. Beyond its micro impacts, this kind of +1(212)902-6915 | vickie.chang@gs.com
Goldman Sachs & Co. LLC
productivity increase should have consequences for macro markets. We provide
a framework to think about what they might be.
n The impact is clearest in equities, which should rise on a higher forward outlook
For the exclusive use of NATHALY.ASTUDILLO@GS.COM
for GDP and profits. Major DM currencies, especially the USD, may benefit at the
margin versus other economies. The impact on rate markets is more ambiguous,
but the more the market anticipates the increase, the more likely that rates are
higher than otherwise. Commodity prices should also track higher over time.
These patterns match some key experiences of the 1990s (and to a degree the
1920s).
n Although equities are the most obvious winner, aggregation constraints place
limits on the plausible boost from even a large productivity boost. GDP and
earnings will end up on a meaningfully higher track, but it is hard to see more
than 10-15% US equity upside from this source. In both the 1920s and the
1990s, those valuation limits were violated for a while and large bubbles ensued.
Sustained productivity booms may be more prone to those bubble dynamics, so
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an AI-driven boost could raise this risk.
n Economics has less to say about the specific market winners and losers. But it
suggests that firms that supply the investment for transition to the new
technology (enablers), those where the share of spending increases or cost
savings can be retained (beneficiaries), or providers of new products enabled by
the new technology (innovators) may capture a higher portion of market
earnings. Barriers to entry or market power may be needed to turn these into
sustained advantages.
The Impact of Artificial Intelligence on Macro Markets
Our economists have illustrated the potential for generative AI adoption to raise
productivity growth, perhaps substantially, over the period following widespread
adoption. On their estimates, widespread AI adoption could fuel a 10-year period
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Goldman Sachs Global Markets Analyst
where annual productivity growth is as much as 1.5ppt higher than otherwise. If so, that
would be comparable to the two large innovation-driven productivity booms since 1900,
around the widespread adoption of electricity and the PC/internet.
The most interesting opportunities from these shifts will likely take place at the
company level. But this kind of sustained productivity increase would almost certainly
have consequences for the macro markets too. Although there is a lot of uncertainty
over those impacts, and their timing, we think it is helpful to provide a framework to
think about what they might be.
Our starting point is to consider the impact this kind of productivity boost should have
on major financial markets. The impact is clearest in equities, which should rise as the
forward outlook for GDP and profits rises. Currencies of the major DM economies, and
possibly the US most of all, may benefit at the margin versus other economies. The
impact on rate markets is more ambiguous. The more the market anticipates the
increase, the more likely it is that rates are, at least for a period, higher than they would
otherwise be. Counterintuitively, the relative prices of products that do not benefit from
AI-related productivity, including commodity prices, should rise over time. These
patterns match some key experiences of the 1990s productivity boom (and to a degree
the 1920s).
Although equities are the most obvious winner, aggregation constraints place limits on
the boost to economy-wide earnings that even a large productivity boost can plausibly
deliver. Most reliably, GDP and earnings will end up on a meaningfully higher track. The
earnings share (margins) may rise too, but the historical support for a large shift is
weaker. In both the 1920s and the 1990s productivity booms, however, those limits
were violated for a while and large bubbles ensued. Beyond the usual risks from
momentum, periods of sustained improvement in productivity may be more prone to
those bubble dynamics, so an AI-driven productivity boom could raise this risk.
Economics has less to say about the specific market winners and losers. But, combined
with history, it suggests that areas that supply the investment for the transition to the
new technology, areas where the share of spending increases, or areas that generate
new products enabled by the new technology may all capture a higher portion of market
earnings. Barriers to entry or sustained sources of market power are generally
necessary, however, to turn these into sustained sources of advantage.
Macro implications of a productivity boost

We begin by thinking about how a prolonged productivity boost of the kind our
economic analysis describes could affect the main macro markets. The main potential
macro implication of our economists’ analysis is a 10-year productivity increase of
around 1.5ppt per year in the US and other major economies, but smaller (a bit less than
1ppt) and possibly later in the EM economies. The theoretical macro consequences of a
shift like this will always depend on the assumptions,1 and one of the key assumptions
1
The impacts we map out here follow the broad logic of “cost-of-adjustment” investment models like those
set out by Blanchard and Fischer, Lectures on Macroeconomics; Obstfeld and Rogoff, Foundations of
International Macroeconomics; and the more complicated G-cubed model by McKibbin and Wilcoxen.
20 July 2023 2
is whether the productivity boost is anticipated or is a surprise.
If the expected gains to productivity are fully anticipated, equities will reprice ahead of
the productivity boost. With higher expected returns on capital and a transition to the
new technology, investment should rise, especially in those areas expected to benefit
most.2 With increased wealth and increased future income prospects, consumers
should also want to spend more. Because the boost to desired demand comes
immediately, while supply improvements come only gradually, inflationary pressures
may increase in the short term. Monetary policy is likely to need to be tighter—at least
initially—than it would otherwise have been. The Fed should understand over time that
the economy can grow more rapidly than before the innovation but will still need to
restrain demand given the boost to up-front spending and will need to squeeze
rate-sensitive areas to make room for investment demand. The capital stock in the
economy should increase more rapidly over this period, specifically in areas that benefit
from the new technology or the transition to using it. In the areas that benefit most from
improving productivity, price inflation will tend to fall over time. But for areas that do not
benefit from those productivity improvements while still benefiting from rising demand,
prices will tend to rise more.3
Exhibit 1: An earlier boost to equities if productivity boost is Exhibit 2: More upfront pressure on demand if productivity boost is
anticipated anticipated
Source: Goldman Sachs Global Investment Research Source: Goldman Sachs Global Investment Research
From an international angle, what matters most is whether the productivity boosts from
AI are uniform across countries. In general, countries or groups of countries that see a
larger, earlier, or faster boost to productivity are likely to experience capital inflows,
currency appreciation and current account deterioration in the early part of the boom.
Essentially, part of the desire for increased investment and consumer spending can be
“borrowed” from the rest of the world, mitigating some pressure on the local economy.
In the scenario where the boost to productivity is unanticipated, the path will be
different. In this case, equities should rise over time by a comparable amount, in
response to improving earnings, but will accrue those gains more gradually. The boost to
2
In the language of these macro models, Tobin’s “q” should rise, raising the value of capital in the
beneficiary sectors relative to its replacement cost.
3
Essentially, those sectors will see higher demand, but more constrained supply given capital flows to the
newly productive sectors and no improvement in their productivity.
20 July 2023 3
domestic spending, investment included, will likely be more muted and gradual than
when the productivity boost is anticipated. In this situation, higher productivity growth
will continually surprise investors, companies, consumers, and policymakers. This raises
the risk that monetary policy will remain tighter than needed; that inflation will
undershoot over time and unit labor costs come under downward pressure; and that
there will be short-term upside to profits as productivity surprises accrue to companies.
4
Although the pace of investment will vary depending on how far in advance productivity
gains are anticipated, the transition to the new technology should boost investment
rates along that path. In considering the AI investment cycle, our economists outlined a
scenario where AI-related investment peaks around 2-2½% of GDP in the US within the
next 10 years, with smaller and more delayed effects in other countries. The US
investment impact is likely to be larger not just because US companies may be early
adopters, but also because the US is positioned as a market leader in AI technology.
In either case, there is also a risk that the transition towards AI leads to significant job
losses in the short term that are not reabsorbed quickly. That dynamic would also tend
to put downward pressure on inflation and the monetary policy path. Relative to the
shifts in manufacturing seen over recent decades, the jobs exposed to AI are probably
less geographically concentrated and more urban. This may mitigate the risks of costly
job displacement but might not be enough to avoid it. More rapid or less anticipated
change would also raise the risk of this kind of displacement.
Macro market implications of an AI-driven productivity boost

Putting it together, we can summarize our expectations of the major macro markets.
For equities, prices should rise because of higher earnings from the productivity boom.
The more the productivity boost is anticipated, the more those gains should come up
front and boost equity multiples initially. But comparable gains should eventually accrue
simply through higher earnings growth rather than multiple expansion, even if the
market does not anticipate the productivity boom. Higher interest rates, to the extent
that they materialize, may offset some of the potential gains in equities. We will discuss
plausible magnitudes to these shifts shortly.
In FX, currencies of those who gain more or earlier from the productivity boosts should
tend to appreciate. This should favor the currencies of DM economies over EM
economies broadly, all else equal. The more these productivity gains are anticipated, the
more that tendency for FX appreciation may come up front. The impact on equilibrium
exchange rates may not be very large. In our GSDEER framework that estimates FX fair
values, the 10-year differential of DM over EM productivity growth in our economists’
estimates of 0.5ppt per year translates to an appreciation in DM equilibrium real
4
A simple way to think of the central difference in these two scenarios is to think about the balance of
supply and demand. With an extended productivity boost along the lines of what our economists lay out, the
supply profile is predicted to improve slowly over time, relative to a non-AI baseline. If the productivity boom is
anticipated, equities will respond strongly in advance and domestic demand pressures are likely to rise ahead
of the change in supply that is coming. If it is not anticipated, then supply is more likely to surprise on the
upside and demand is likely to fall short, creating the risk of a persistent output gap and disinflationary
pressure.
20 July 2023 4
exchange rates of around 2.7% versus EM, though if productivity gains came later or
more slowly in parts of the EM world, that effect could be larger. But cyclical pressures
in the leading group of countries could reinforce the structural tailwinds to exchange
rates. Domestic demand boosts from higher expected productivity growth could push
monetary policy tighter, as we have described, providing cyclical support for the leading
group of countries. Capital outflows from countries that are not experiencing the
productivity booms towards those that are experiencing them and towards markets with
companies dominating the provision or benefits of AI-related services could also
reinforce appreciation pressures. Both because it is likely to be an early adopter and
because the rise in AI investment rates may favor US companies and equity markets,
the US Dollar may well be the “first among equals” in terms of these effects.
For interest rates, the situation is likely to depend more than elsewhere on how much
the improving productivity outlook is anticipated. As with FX, the cyclical picture may
well dominate. If optimism gathers early, the boost to demand is likely to outweigh the
boost to supply early on and rates are likely to be higher than otherwise at least for a
period. To the extent that the associated productivity gains from AI fuel an investment
boom, this is also likely to pressure the monetary policy path tighter. If the impact is
underestimated, then supply may continually outperform expectations and the impact
may be to put downward pressure on inflation and ultimately the policy path over time.
Significant labor displacement would also push towards lowering the rate structure.
Beyond the cyclical impact, these shifts may also affect perceptions of the “neutral”
rate. Some approaches, like the well-known Laubach-Williams model, rely on tight links
between the so-called neutral interest rate and trend growth.5 Although the 1.5ppt boost
to productivity growth that we envisage is not permanent, this kind of approach would
still imply a meaningful rise in estimates of the neutral rate. We have generally argued
that the empirical basis for a large or reliable link between trend growth and neutral
rates is weak. But it is plausible that a rise in desired investment relative to desired
savings could push perceptions of the neutral interest rate higher, at least for a while.
For commodity markets, counterintuitively, the lack of benefit from productivity
improvements alongside a stronger global demand picture introduces upside risk to the
path for real commodity prices over time relative to what it would otherwise have been.
With capital likely also flowing away from these sectors towards those experiencing
productivity gains, supply constraints may also increase, though historically that
backdrop has ultimately set the stage for a new investment cycle in these areas.
5
The LW model essentially implies a one-for-one mapping between trend real GDP growth and the real
neutral Fed funds rate.
20 July 2023 5
Exhibit 3: Our expectations for the impact of the AI productivity boost on macro markets depend on whether the boost is anticipated or not
Asset Class: Equities FX Interest rates Commodities
Appreciation pressure for DM

from structural rerating and Interest rates likely higher as Commodity prices higher than
Equities rise up front, valuations
Anticipated cyclical boost. USD may benefit domestic spending rises. Neutral baseline as cyclical pressures
increase.
as early adopter and beneficiary rate may shift higher. build.
of "investment phase".
Greater chance of disinflation.

Gradual upward pressure on DM
Equities rise more gradually in Policy could remain tighter than Commodities rise more gradually
Unanticipated equilibrium FX rates. Less scope
line with earnings. needed. Less pressure on neutral vs baseline as incomes rise.
for cyclical outperformance.
rate.
Source: Goldman Sachs Global Investment Research
Lessons from the PC/Internet and electricity eras

How do these predictions compare with history? In practice, we have few comparable
episodes to guides us. We focus on two major innovation-driven productivity booms:
around the widespread adoption of electricity after World War I and around the broad
adoption of PCs and the internet in the late 1990s and early 2000s. We look at the
periods of the clearest productivity gains: 1919-1929 for the electricity boom and
1996-2005 for PCs/internet. One challenge of looking at these episodes is that other
factors beyond the productivity boom were major drivers. The EM crises of 1997-1998
had major impacts on the global economy and asset prices; and after 2003, China’s
accession to the WTO prompted big shifts in manufacturing. Similarly, the start of the
1920s productivity boom overlapped with the transition from a wartime to a peacetime
economy. Because of data availability, and the development of financial markets, only
the later of these two provides the basis for a full comparison across the major markets.
Exhibit 4: We focus on two major innovation-driven productivity booms around the invention of electricity
and the personal computer
Percent change, US Labor Productivity Percent change,
5-year annual rate 5-year annual rate
6 6
Productivity boom: 1919-1929

Personal computer
5 Development of electric invented: 1981 5
motor: Productivity boom: 1996-2005
~1890
4 4
3 3
2 2
1 1
0 0
-1 -1
1885 1905 1925 1945 1965 1985 2005
Source: US Bureau of Labor Statistics, Woolf (1987), Goldman Sachs Global Investment Research
Exhibit 5 and Exhibit 6 show how the equity market behaved during the electricity- and
20 July 2023 6
PC-driven productivity booms, while Exhibit 7 shows how major asset markets behaved
over the same time period. Over that entire period, US equities showed healthy if
unspectacular gains. Profits,earnings, and the S&P 500 outpaced nominal GDP by a
modest amount. The USD appreciation over this longer period was more modest and
excluding the EM economies, there was little net FX change. Similarly, both the funds
rate and 10-year yields were clearly lower in 2005 relative to 1996 and, for obvious
reasons, tracked the pattern of the cycle in domestic demand. Oil prices fell sharply
during the EM crises in 1997-98 but had moved higher by 2005.
Exhibit 5: S&P 500 initially outgained GDP during the 1919-1929 Exhibit 6: Profits, earnings, and the S&P 500 modestly outpaced
productivity boom, while earnings broadly tracked nominal GDP nominal GDP over the 1996-2005 period
Index, 1919 = 100 Index, 1919 = 100 Index, 1996 = 100 Index, 1996 = 100
350 350 250 S&P 500 250
Corporate Profits
230 S&P 500 Total Diluted EPS 230
S&P 500
300 300 Nominal GDP
S&P 500 Total Diluted EPS 210 210
250 GDP 250 190 190
170 170
200 200
150 150
150 150
130 130
100 100 110 110
90 90
50 50
70 70
0 0 50 50
1919 1921 1923 1925 1927 1929 1931 1933 1996 1998 2000 2002 2004 2006
Source: Robert Shiller, Haver Analytics, Goldman Sachs Global Investment Research Source: Haver Analytics, Goldman Sachs Global Investment Research
But this view over the entire period obviously masks a much larger boom and bust in
asset markets and the economy. Exhibit 7 shows the changes in asset markets to the
peaks in 2000 and then from there to 2005. During the initial boom, the pattern of
market shifts, though not the magnitudes, match what you would broadly expect to see
from an (over-)anticipated productivity boom. Equities rose sharply and valuations
climbed to extreme levels.
Exhibit 7: Asset market performance during 1996-2005 shows a Exhibit 8: Valuations rose sharply before seeing large declines in
boom and bust previous innovation-driven productivity booms
Change from: Ratio Ratio
1996 to 2000 2000 peak to 50 50
1996 to 2005
peak 2005 45 Shiller Cyclically-Adjusted P/E 45
40 Electricity: 40
Effective Fed Funds Rate -140bp 98bp -238bp 1919-1929
35 35
10-year Treasury Yield -118bp 101bp -219bp 30 30
25 25
Real Broad Dollar 9% 21% -10%
20 20
Nasdaq 100 199% 687% -62% 15 15
10 Personal Computing: 10
S&P 500 105% 142% -15% 1996-2005
5 5
Oil (WTI) 218% 83% 74% 0 0

1900 1914 1929 1944 1959 1974 1989 2004 2019
Source: Haver Analytics, Goldman Sachs Global Investment Research Source: Robert Shiller, Goldman Sachs Global Investment Research
A significant domestic economic boom accompanied these moves. The investment

share climbed, savings rates fell, and the current account deteriorated.6 Both the Fed
6
The current account reversals from the EM crises played an important role in that deterioration, though the
20 July 2023 7
funds rate and longer-dated yields fell during the 1997-1998 period as the Asian financial
crisis and Russia default hit, but with domestic demand booming, the funds rate rose to
a fresh cycle peak in 2000. Longer-dated yields rose too but remained below their 1996
levels, as the term premium was held down by low and stable inflation. The backdrop of
low and stable inflation was helped in part by goods price deflation not just from the
new innovations but also from the Asian crisis, and in fact wages and unit labor cost
growth picked up during the boom despite rising productivity growth. The USD
appreciated significantly in the late 1990s, ultimately peaking in early 2002. A significant
part of that appreciation was attributable to the EM devaluations of 1997 and 1998, but
the USD—as the preferred recipient of capital flows—also rose against other advanced
economies. But as boom turned to bust, equities saw large declines, interest rates fell,
and the bulk of the USD strength reversed.
Exhibit 9: The PC productivity boom was accompanied by a domestic investment boom
Percent of GDP Percent of GDP

5.0 16
Tech Investment (Software and Information Processing
Equipment)
Total Nonresidential Investment (right axis)

15
4.5
14
4.0
13
3.5
12
3.0 PC Productivity Boom: 1996-2005

11
2.5 10
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Source: Haver Analytics, Goldman Sachs Global Investment Research
The evidence around the productivity boosts in the 1920s, as electricity adoption
spread, is sparser but provides some parallel lessons. Equities again saw sustained
gains, alongside the productivity boom. Once again, the equity market rally ended in
outsized gains in equities and a very sharp climb in equity valuations, followed by the
crash of 1929. The story for rates and FX is harder to map to the current context given
the differences in monetary policy and exchange rate management. Inflation was
extremely low over the period (the price level was essentially stable). But the Fed’s
discount rate again followed the economic and equity cycle, falling in 1924 as the
economy weakened before rising steadily and hitting new peaks as the equity bubble
accelerated and then burst.
US again experienced more significant current account deterioration than other major economies. Easy US
monetary policy in the face of those EM crises also reinforced the drop in savings and the boom in
investment.
20 July 2023 8
Overall, these two prior experiences suggest that the biggest impact on asset markets
was felt in equities and equity valuations (ending both times in bubbles). The behavior of
rates and FX appears to have flowed more from the impact on the domestic cycle than
from persistent structural shifts from the change in trend productivity, though the 1990s
provide some support for the idea of FX appreciation for economies that are seeing
outsized productivity gains.
The macro upside in equities

Consistent with history, US equities have already been the focus of the potential gains
from AI so far, so the question of how much of an increase can be fundamentally
justified is most pressing here. Our equity strategists have provided benchmarks for
those impacts, with their central case arguing that AI-related productivity gains could
justify upside of a bit less than 10% in the S&P 500. We think understanding the core
logic of how to value this productivity boost from a macro perspective is helpful.
For the aggregate equity market, the basic arithmetic is reasonably simple. The impact
of a 10-year period where annual productivity growth is 1.5ppt higher is to raise the level
of GDP permanently. If workers are not permanently displaced and investment
increases to match the productivity improvements, then the mapping from productivity
into GDP would be roughly one-to-one and the GDP level would move around 15%
higher relative to where it would otherwise be, as Exhibit 10 illustrates.7 If the share of
profits in the economy (the profit share) is stable, the path of profits will look similar,
with the level of profits permanently around 15% higher beyond that transitional period.
The value of the equity market should ultimately increase by the discounted value of
those additional profits. Because of the transitional period where profits are closer to
their baseline, the impact on the value of the market will be less than the 15% increase
in the long-run level of GDP and profits. The difference between an anticipated and an
unanticipated boost to earnings may change how much these gains accrue up front (and
so how much multiples rise rather than the market simply following the path of earnings
through time). But the long-term value that accrues should be roughly the same either
way.
7
If workers are permanently displaced, so that employment grows more slowly than it would otherwise
have done, or investment does not increase alongside the boost to productivity, then the shift in the GDP level
would be smaller. Those more conservative assumptions are closer to what underpinned our economic
analysis. The same basic logic to valuing the increases still applies, though the implied increase in market
value would be correspondingly smaller.
20 July 2023 9
Exhibit 10: A productivity boost should move the level of earnings permanently higher, though more if the
profit share increases
Equities could only rise more than this on a fundamental basis if either the discount rate
were to fall or if earnings growth outpaces GDP growth. As we saw, the outlook for
interest rates is likely to be determined by the cyclical outlook. But there is no very
strong basis for expecting lower interest rates, and the scenarios in which equities rise
strongly are more likely to be the ones in which interest rates should be higher rather
than lower. There are two ways that index-level aggregate earnings can grow faster than
GDP, increasing the potential upside (as in Exhibit 10). The first is that the share of profits
in the economy can rise. The second is that the share of listed company earnings
relative to economy-wide profits can rise.
We have seen examples of both phenomena in recent history, but in practice the bar is
high for productivity growth to translate into large increases in profitability over the
long-term. On a year-by-year basis, annual productivity growth is clearly correlated with
annual changes in the profit share (Exhibit 11). But that is largely because cyclical
surprises in productivity often impact profits. The links between productivity growth and
changes in the profit share over longer time periods (like the 10-year period in our central
scenario) is a lot smaller and weaker (Exhibit 12). This pattern suggests that accelerating
productivity growth can accrue to profits initially but that those gains tend to dissipate
over time.8 Despite significant technological advances, S&P earnings have also not
systematically outgrown national account profits either over the long-term and the
relationship between their outperformance and productivity growth is, if anything,
negative.
8
Using the estimates from the 10-year productivity/profit relationship, for instance, would say that margins
might rise by around 0.6ppt, equivalent to an additional boost of 5.5% to earnings over that period. This would
bring the total potential earnings boost in Exhibit 9 close to 20%, only modestly higher than the simple
assumption based on a constant profit share.
20 July 2023 10
Exhibit 11: Annual productivity growth is highly correlated with Exhibit 12: ...but this relationship is much weaker over longer time
annual changes in the profit share of the economy... periods
2.5 1-year productivity growth vs 1-year change in profit share 2.5 0.6 10-year average productivity growth vs 10-year average change in 0.6
profit share
2.0 2.0
R² = 0.2055
Productivity Growth (%, yoy, 10y avg)

0.4 R² = 0.025 0.4
1.5 1.5
Productivity Growth (%, yoy)
1.0 1.0
0.2 0.2
0.5 0.5
0.0 0.0 0.0 0.0

-0.5 -0.5
-1.0 -1.0 -0.2 -0.2
-1.5 -1.5
-0.4 -0.4
-2.0 -2.0
-2.5 -2.5 -0.6 -0.6

-2 -1 0 1 2 3 4 5 0.5 1.0 1.5 2.0 2.5 3.0 3.5
Change in Profit Share (pp) Change in Profit Share (pp)
Source: Haver Analytics, Goldman Sachs Global Investment Research Source: Haver Analytics, Goldman Sachs Global Investment Research
History also supports the notion that the linkage between productivity growth and
earnings outperformance versus GDP is quite weak. The available evidence suggests
that earnings growth accelerated in the 1920s productivity boom but did not outpace
GDP growth meaningfully. In the late 1990s, the profit share increased initially before
falling in the later years of the boom (1998-2000). Over the longer 1996-2005
productivity boom, the profit share rose only modestly while S&P earnings grew roughly
in line with national account-based profits. More than a decade later, and during a period
of relatively low productivity growth, there has been a much clearer increase in both the
profit share and S&P earnings growth has outpaced economy-wide profit growth, but it
is hard to attribute that easily to the productivity boom. While enhanced productivity
growth is not an obvious candidate for the increase in the share of profits in the
economy in the last 10-15 years, the increased profitability and rising share of the large
technology companies in the S&P 500 is a big reason for the rise in the profit share and
in S&P 500 margins. Shifts in spending patterns towards companies with high margins
and high market power may also have played a role in driving the profit share higher,
though a persistently weak labor market was arguably part of the story too.
Our overall conclusion is that while there are reasons to believe that accelerating
productivity growth might quite plausibly lead to a short-term boost to the profit share
(and so faster profit growth than economy-wide growth), and while it is possible that
more of the economy’s activity shifts to “high margin” sectors, the historical record
does not provide a lot of confidence in that dynamic. The main story at the aggregate
level is simply that a faster-growing economy provides a larger stream of profits over
time: this is a real gain, but one that is more limited in scope.9
9
The link between returns and productivity growth is also weak, as our strategists have shown. Controlling
for shifts in other macro variables we also find that over 5-year periods, knowing the trajectory of productivity
growth would not help to predict 5-year S&P 500 returns. We do find, however, that our measures of equity
valuation relate more consistently to productivity growth, with the market tending to pay higher valuations
during periods of higher productivity growth. Specifically, an increase in 5-year productivity growth of 1ppt is
associated with a roughly 60bp lower “cyclically-adjusted earnings yield” (or equivalently a couple of points on
the multiple). We think this is consistent with the broad notion that the market tends to pay ahead for
improving productivity growth and the magnitudes are broadly consistent with the kind of 10-20% increases
we arrive at using the simple methods above.
20 July 2023 11
The risks of overpaying

One way for the equity market to move more than this is for it to overpay for future
profit and overshoot the kinds of valuations that are justified by the shifts in the
fundamental outlook. As we saw, both the productivity boom of the 20s and the
productivity boom of the 90s ended in bubbles and busts. Could it happen again?
Bubbles are complicated phenomena: momentum and self-fulfilling price dynamics

often end up driving. But several reasons explain why productivity booms can lead
markets to overpay.
First, investors may fall prey to a fallacy of extrapolation. With genuine innovation,
productivity gains will be real. In the short-term, accelerating productivity growth can
lead to an increase in profit shares even at the economy-wide level. But, on average,
competition or investment often erodes those initial gains over subsequent years. This
implies that a faster phase of profit growth at the start of periods of innovation tends to
be “paid back” over time. To the extent that markets price initial increases in profit
growth as persistent, the long-term potential shift in the earnings trajectory may be
overestimated.
Second, investors can fall prey to a fallacy of aggregation. During periods of innovation,
some individual companies may be capable of stretches of stunning earnings growth
driven by a new technology. But it is a mistake to assume that what can be true for an
individual company can be true on aggregate. Even at the individual level, competition
and market entry can ultimately limit the potential for sustained high profits. With
potential “winners” sometimes more obvious than losers, investors may price a chance
of increased profitability across a broad range of potential winners. If that process is too
broad, the aggregate result may imply a rate of economy-wide profit growth that is
unlikely to be feasible, as we saw in the late 1990s.
20 July 2023 12
Exhibit 13: Long-term growth expectations implied by equity values increased in the tech bubble to
implausible levels
Long-term growth expectations as proxied by ERP + 10-year yield – Dividend yield
% %
8 8
S&P 500 long-term implied real growth
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
-1 -1
1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009 2014 2019
Source: Robert Shiller, Goldman Sachs Global Investment Research
Third, activity fueled by the bubble itself can appear to justify the optimism. As asset
prices rise, they may encourage a boom in investment and consumer spending. This
increased demand may itself provide a boost to the profitability of companies supplying
those areas. But if increased revenues and profits are ultimately based on unsustainable
demand that is generating major economic imbalances, then those gains too will
eventually unwind. In that sense, a domestic boom created by overvalued asset prices
can fuel the perception that higher profit growth can be maintained. For example, in the
late 1990s, the domestic boom generated a major savings-investment imbalance that
ultimately unwound in the bust but that generated more rapid demand growth for a
period.
Fourth, to the extent that an acceleration in productivity growth leads to monetary policy
that is easier than it “should” be, it can help fuel asset price overvaluation. This could
happen for several reasons: because the acceleration in productivity growth leads
inflation to undershoot; central banks could be slow to appreciate that the neutral rate
has risen; or unsustainable current account deterioration could postpone the inflationary
consequences of a boom. This is particularly a risk when a boom overlaps with other
disinflationary forces, as it did for the US in the late 1990s.
Fifth, the market may be too optimistic about the timing of adoption and improvement.
Many of the innovations from the 1990s PC and internet boom—and the companies that
benefited most persistently from them—appeared after the initial bubble itself had
burst. It may take time for the initial excitement around an innovation to translate into
sustained commercial uses. Our baseline assumption, for instance, is that the broad
impact of AI in many sectors may still be a few years away.
20 July 2023 13
Bubbles can form without these conditions, and not all high-productivity periods lead to
bubbles. But the challenge with periods of sustained productivity improvement is that
the underlying economic shifts are both powerful and real. They provide fundamental
support for higher asset prices—and create the basis for dramatic gains for some
companies—even if that fundamental improvement is then too widely or too
dramatically priced. The potential AI productivity boom we are describing does share
some of the key features that have led to these issues in the past: a breakthrough
innovation that might lead to sizable increases in productivity and profitability; creates
the basis for substantial new investments; and fuels belief in a broader cycle of
innovation.
If the market does overpay for the AI productivity boom, that has the capacity to impact
the broad set of asset price shifts. The 1990s history suggests that this dynamic could
be associated not just with a period of unsustainably high equity prices, but also larger
demand booms, greater FX appreciation, and higher interest rates in the leading
countries than would otherwise have been the case.
Winners and losers

Although the impact on aggregate equity market values, excluding a bubble, should be
limited by the economy-wide constraints that we have discussed, individual sectors and
companies in the market are not constrained to the same degree. Identification of the
winners and losers within the equity market is likely to be the central challenge for many
investors. Economics has less to say about those issues but does offer some
perspective supported by the historical record.
For innovations like AI, there are different reasons why certain areas of the market might
potentially benefit.10 First, they may be “enablers”—suppliers of the innovation itself or
of the infrastructure needed to increase adoption, or they may provide support or inputs
to those who do. Second, they may be “beneficiaries” who are empowered by the cost
savings resulting from the innovation, either if demand (or their share of existing
demand) is very responsive to lowering the cost of their product or if they have enough
pricing power to hold onto part of those cost savings. Third, they may be “innovators”
who develop new products that the innovation makes possible (or affordable) as costs of
some previously expensive tasks fall sharply. Exhibit 14provides examples of sectors in
each category in previous episodes, and lays out sectors that might potentially fall into
each category in the current episode.
10
A complementary way to think of the potential winners is to think about equity prices as an (imperfect)
signal of where capital is needed. Unusually high equity prices are not simply a signal of profitability but also a
signal of where capacity expansion is needed. This is the micro counterpart to the macro story that we told
earlier – rising equity prices are a signal to increase investment both for the economy overall, but also for the
sectors and companies where that investment is most needed because of the innovation.
20 July 2023 14
Exhibit 14: As in previous innovation-driven productivity booms, different parts of the market may benefit for
different reasons and at different stages of the productivity wave
History also suggests that there is a natural progression in terms of the kind of impacts
from these innovation-driven productivity waves. Exhibit 15 shows the adoption rates in
those two prior innovation booms and illustrates that the phase of productivity benefits
generally did not occur until adoption rates were relatively advanced. As a result, the
main impact in the early years of the innovation was largely focused on the adoption of
the technology itself and the suppliers of that process, with the most rapid growth in
adoption rates coming ahead of the productivity boom itself. It took some time for
adoption to be broad enough and for other businesses to work out how to reap the
benefits of the new innovations. And it took even longer for entirely new products to be
developed and/or for a sharp enough fall in costs of producing the innovation to enable
those new applications (Exhibit 16).
Exhibit 15: Previous productivity booms did not begin until Exhibit 16: Some innovations from new technology came long after
technology adoption was well underway widespread adoption
Percent Adoption of Previous Technologies Over Time Percent Percent Percent

1981 1986 1991 1996 2001 2006 2011 2016 100 100
100 100
90 90
^Personal computer invented Productivity boom
80 80
80 80
70 Electricity: Household 70
60 Refrigerator Adoption 60
60 60
50 Personal Computing: 50
50% Adoption Threshold Household
40 40 40 Smartphone adoption 40
Productivity boom
30 30
Electricity: Manufacturing
20 Electricity: Household 20
20 20
Personal Computing: Workplace
⌄Development of electric motor Personal Computing: Household 10 10
0 0
1899 1908 1917 1926 1935 1944 1953 0 0
1889 1899 1909 1919 1929 1939 1949 1959 1969 1979 1989 1999 2009 2019
Source: US Bureau of Labor Statistics, Census Bureau, Our World in Data, Woolf (1987), Haver Source: US Bureau of Labor Statistics, Census Bureau, Our World in Data, Woolf (1987), Haver
Analytics, Goldman Sachs Global Investment Research Analytics, Goldman Sachs Global Investment Research
In keeping with that, most of the current focus so far is on the first group—those who
are likely to provide AI services, those who provide the inputs to those providers and
those needed to support the transition/adoption phase. As AI-related hardware and
20 July 2023 15
software investment ramps up through the transition, those areas may remain in the
spotlight. Over time, the focus is likely to shift both to those who benefit from the
productivity gains from generative AI and, beyond that, to the potential for entirely new
goods and services that become possible as the costs of certain kinds of tasks
(software production and debugging, information search, production of written
materials, certain kinds of teaching and training) fall substantially.
That progression is a reminder of the difficulties of maintaining sustained high profit

growth. Building physical infrastructure has arguably been the riskiest proposition
(railroads, utilities, telecom networks) because they require long-term commitments,
have historically often been debt-financed, and are vulnerable to overproduction. Growth
for companies that support the adoption phase eventually peaks, and so the most
sustained winners may be those who produce the goods and services that the
innovations make possible. Shifts in the landscape may also bring unforeseen shifts in
policy, regulation, and taxation: those issues may end up being significant for AI, given
potential defense uses and associated national security concerns.
Economics also reminds us that even at the individual company level, higher productivity
growth is not generally sufficient to lead to sustained improvements in profitability. Over
time, competition works to push productivity gains into lower prices and/or higher
wages, and capacity expansion and the arrival of new entrants to highly profitable areas
tend to lower the return on capital. As a result, the ability to sustain unusually high
returns on capital is often a function of market power or barriers to entry. Simply put, in
competitive markets, cost improvements are in general ultimately passed on to
consumers instead of retained by the company, while in monopoly settings that need
not be the case, as Exhibit 17 shows. A company may have an advantage now in
producing a certain kind of product, but a reason to believe that that advantage can
plausibly be maintained is needed to justify a large valuation premium. Possible reasons
are when economies of scale or networks are significant benefits, where there are very
high fixed costs of entry, or where brand value is important. But most of the channels
for profit growth mentioned above are ultimately based in shifts in the share of the
economy’s spending that specific sectors or companies can capture, not in sustained
margin increases.11 And because AI should drive productivity increases across a broader
range of less concentrated industries, it may be harder to generate the same rise in
mark-ups as tech companies managed to do in the last cycle.
11
History also provides mixed lessons as to whether those shifts will be captured by existing companies or
by new ones. GE and Westinghouse successfully transitioned from providing infrastructure for electrification
to broadcasting, appliance manufacturing and other subsequent beneficiaries of the electric era. Microsoft and
Apple also evolved to transition from basic software and PC provision to capture shifts to new product areas.
Today’s large technology companies may have some advantages that mirror those earlier stories, in terms of
scale, large R&D capacity and the ability to purchase smaller innovators and bring them in-house. But the
1990s experience also illustrates that investing only in the initial winners from the PC/internet boom would
have meant missing out on many of the ultimate long-term winners from that development, given that several
of today’s largest companies were newcomers.
20 July 2023 16
Exhibit 17: Market power allows producers to retain more of a cost saving
The macro impacts we described may also vary along that timeline. The productivity
gains from AI are likely to be widely dispersed, as our economic analysis shows. But the
list of companies that are investing most heavily in AI capacity is currently still highly
skewed towards the US. The longer the focus remains on the investments in building
and refining AI capacity, rather than in the use of that AI capacity by other firms, the
more likely it is that the market impacts are felt more in US assets.
AI-related repricing is already underway

The impacts we describe here are already underway. Consistent with the timeline in
past episodes, the focus has largely been on those that are investing in the generative
AI process itself and the suppliers to them. As a result, the impact has been heavily
concentrated in the semiconductor and US technology sectors so far and some of their
competitors and suppliers in North Asia. Valuations have already risen here, and a
premium for AI looks to have built in US tech since the start of the year. The
out-performance of “AI-related” and megacap tech companies in the US in 2023 has
been a key market dynamic this year and this group of companies has contributed as
much as ~70 percent of year-to-date US index-level performance, though drivers beyond
AI have contributed to the out-performance of many of the large tech companies. This
pattern is reminiscent of the 1990s experience, where a premium was quickly priced
into many areas that were closest to the technology spending itself.
Over time, the benefits from AI and its productivity gains should be more broadly
dispersed across sectors and geographies. But the peak period of adoption and so for
meaningful investment from non-tech firms—and the productivity benefits that flow
from that—could still be a few years away. The obvious question is whether the market
will end up overpricing or mispricing these impacts in the meantime, as it has done at
times in the past.
20 July 2023 17
20 July 2023
Goldman Sachs
Vickie Chang
Dominic Wilson
18
Global Markets Analyst
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Global Markets Analyst - The Impact of Artificial Intelligence On Macro Markets (Wilson - Chang)

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The Impact of Artiﬁcial Intelligence on Macro Markets

The Impact of Artiﬁcial Intelligence on Macro Markets

Macro implications of a productivity boost

is whether the productivity boost is anticipated or is a surprise.

Macro market implications of an AI-driven productivity boost

Appreciation pressure for DM

Greater chance of disinflation.

Source: Goldman Sachs Global Investment Research

Lessons from the PC/Internet and electricity eras

Percent change, US Labor Productivity Percent change,

Productivity boom: 1919-1929

100 100 110 110

Oil (WTI) 218% 83% 74% 0 0

A signiﬁcant domestic economic boom accompanied these moves. The investment

Exhibit 9: The PC productivity boom was accompanied by a domestic investment boom

Percent of GDP Percent of GDP

Total Nonresidential Investment (right axis)

3.0 PC Productivity Boom: 1996-2005

Source: Haver Analytics, Goldman Sachs Global Investment Research

The macro upside in equities

Source: Goldman Sachs Global Investment Research

Productivity Growth (%, yoy, 10y avg)

0.0 0.0 0.0 0.0

-1.0 -1.0 -0.2 -0.2

-2.5 -2.5 -0.6 -0.6

The risks of overpaying

Bubbles are complicated phenomena: momentum and self-fulﬁlling price dynamics

Source: Robert Shiller, Goldman Sachs Global Investment Research

Winners and losers

Source: Goldman Sachs Global Investment Research

Percent Adoption of Previous Technologies Over Time Percent Percent Percent

That progression is a reminder of the difﬁculties of maintaining sustained high proﬁt

Source: Goldman Sachs Global Investment Research

AI-related repricing is already underway

Global product; distributing entities

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