Galor-Zeira model

The Galor-Zeira model describes the inequality-education-growth relationship, explained by the mechanism of unequal access to education due to imperfect capital markets. It claims that this mechanism might lead to a negative effect of inequality on growth. The initial distribution of income determines whether an economy will converge to a low- or high-income regime,[1] as there are multiple steady states in the model.

The model was developed by Oded Galor and Joseph Zeira in 1988, and it was published in the paper “Income Distribution and Macroeconomics”, 1993.[2]

The Neoclassical viewpoint has been challenged in the past two decades, as both theories and subsequent empirical evidence have demonstrated that income distribution has a significant impact on the growth process. In contrast to the representative agent approach which dominated the field of macroeconomics for several decades, the modern perspective, originated by Galor and Zeira (1988, 1993), has underlined the role of heterogeneity in the determination of macroeconomic activity. It has advanced a novel viewpoint that heterogeneity, and thus income distribution, plays an important role in the determination of aggregate economic activity and economic growth in the short-run as well as in the long-run.

Galor and Zeira have demonstrated that in the presence of credit market imperfections, income distribution has a long-lasting effect on investment in human capital, aggregate income, and economic development. Moreover, in contrast to the classical hypothesis, which underscored the virtues of inequality for economic growth, their research advanced the hypothesis that inequality may be detrimental for human capital formation and economic development.

Dynamics of the model

The model consists of four assumptions:[2]

There are three possible individual scenarios in the model:

Long-run implications

The economic situation of each dynasty depends on its initial wealth, due to credit markets’ imperfections and an indivisibility in investment in human capital. In rich dynasties, all generations invest in human capital, work as skilled and leave a large inheritance to their children. In poor dynasties people inherit less, work as unskilled, and leave less to the next generation. They can get stuck in a poverty trap.[3] Thus, the initial distribution of wealth determines the size of these two groups: the rich and the poor dynasties. As a result, it also determines GDP, as skilled are more productive. Therefore, inequality may negatively affect macroeconomic activity and economic development due to “intergenerational transfers and their effect on the persistence of inequality”.[4]

Policy implications

A government policy can change the long-run equilibrium. The government can subsidize education, which reduces the individual cost of education and finance it by taxing those who study and become skilled. This increases human capital investment in the short- and long-run, increases GDP and is a Pareto improving policy. The model gives an explanation to the rise of public education.

Realistic application

According to the Galor-Zeira model, the wealth-equality relationship works two ways:

Acknowledgments

The Oxford University Press named the Galor-Zeira paper("Income Distribution and Macroeconomics") among the 11 most path-breaking papers published in The Review of Economic Studies in the past 60 years.[5]

See also

References

  1. Razak, Nor Azam Abdul (December 2006). "Income Inequality and Economic Growth" (PDF). Louisiana State University.
  2. 1 2 Galor, Oded; Zeira, Joseph (1993). "Income Distribution and Macroeconomics". The Review of Economic Studies. Oxford: Oxford University Press. 60: 35–52. doi:10.2307/2297811.
  3. Ferreira, Francisco H.G. (June 1999). "Inequality and Economic Performance". World Bank.
  4. Galor, Oded (October 2009). Inequality and Economic Development: The Modern Perspective. International Library of Critical Writings in Economics. Edward Elgar Pub. ISBN 184720676X.
  5. Journals, Oxford. "Virtual Issue: The History of RESTUD". Retrieved 15 June 2014.
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