Galor–Zeira model

The Galor-Zeira model is t he first macroeconomic model t o explore t he role of het erogeneit y
in t he det erminat ion of macroeconomic behavior. In cont rast t o t he represent at ive agent
approach t hat dominat ed t he field of macroeconomics t ill t he early 1990s and argued t hat
het erogeneit y has no impact on macroeconomic act ivit y, t he model demonst rat es t hat in t he
presence of capit al market s imperfect ions and local non-convexit ies in t he product ion of human
capit al, income dist ribut ion affect s t he long run level of income per-capit a as well as t he growt h
process.  

The model was developed by Oded Galor and Joseph Zeira in 1988, and it was published in t he
paper “Income Dist ribut ion and Macroeconomics”, 1993.[1]

Thesis

In cont rast t o t he Neoclassical paradigm and t he represent at ive agent approach t hat denied t he
role of inequalit y in t he growt h process, novel t heories t hat emerged in t he lat e 1980s and
empirical st udies of t hese t heories have est ablished t hat income dist ribut ion has a significant
impact on t he process of development .

The modern perspect ive, originat ed by Galor and Zeira (1988, 1993),[1] has underscored t he role
of het erogeneit y in t he det erminat ion of macroeconomic act ivit y, and has demonst rat ed t hat
income dist ribut ion is an import ant det erminant s of t he growt h process and t he evolut ion of
income per capit a.[2] In part icular, Galor and Zeira have argued t hat since credit market s are
imperfect , inequalit y has an enduring impact on human capit al format ion, t he level of income per
capit a, and t he growt h process.

In cont rast t o t he classical paradigm, which underlined t he posit ive implicat ions of inequalit y for
capit al format ion and economic growt h, Galor and Zeira’s hypot hesis suggest s t hat inequalit y has
an adverse effect on human capit al format ion and economic development , in all but t he very
poor economies.

The Galor-Zeira model suggest s t hat t he impact of inequalit y on t he growt h process, is governed
by t he effect of unequal access t o educat ion, due t o imperfect capit al market s, on human
capit al format ion and economic growt h. The init ial dist ribut ion of income det ermines whet her an
economy converges t o a low-educat ion, low-income st eady-st at e equilibrium, or high-income,
high educat ion st eady-st at e equilibrium. In part icular, t he model predict s t hat inequalit y have an
adverse effect on human capit al format ion and economic growt h in all but t he very poor
economies.

Testable Predictions

The Galor and Zeira’s model predict s t hat t he effect of rising inequalit y on GDP per capit a is
negat ive in relat ively rich count ries but posit ive in poor count ries. These t est able predict ions
have been examined and confirmed empirically in recent st udies.[3][4][5] In part icular, Brückner and
Lederman t est t he predict ion of t he model by in t he panel of count ries during t he period 1970-
2010, by considering t he impact of t he int eract ion bet ween t he level of income inequalit y and
t he init ial level of GDP per capit a. In line wit h t he predict ions of t he model, t hey find t hat at t he
25t h percent ile of init ial income in t he world sample, a 1 percent age point increase in t he Gini
coefficient increases income per capit a by 2.3%, whereas at t he 75t h percent ile of init ial income
a 1 percent age point increase in t he Gini coefficient decreases income per capit a by -5.3%.
Moreover, t he proposed human capit al mechanism t hat mediat e t he effect of inequalit y on
growt h in t he Galor-Zeira model is also confirmed. Increases in income inequalit y increase human
capit al in poor count ries but reduce it in high and middle-income count ries.

This recent support for t he predict ions of t he Galor-Zeira model is in line wit h earlier and recent
findings. Robert o Perot t i showed t hat in accordance wit h t he credit market imperfect ion
approach, developed by Galor and Zeira, inequalit y is associat ed wit h lower level of human capit al
format ion (educat ion, experience, apprent iceship) and higher level of fert ilit y, while lower level of
human capit al is associat ed wit h lower levels of economic growt h.[6] Roland Benabou's finds t hat
t he growt h process of Korea and t he Philippines "are broadly consist ent wit h t he credit -
const rained human-capit al accumulat ion hypot hesis."[7] In addit ion, a recent st udy by Andrew
Berg and Jonat han Ost ry[8] suggest s t hat  inequalit y seems t o affect growt h t hrough human
capit al accumulat ion and fert ilit y channels.  

Model & Implications

The Structure of the Model[1]

Aggregat e out put is produced in t wo sect ors:
1. Skilled-int ensive and unskilled-int ensive product ion processes.

2. Skilled (educat ed) workers are more product ive t han unskilled (uneducat ed) workers.
Individuals:
1. Live t wo periods.

2. Ident ical in abilit ies and preferences.

3. Differ in parent al wealt h.

Individuals’ occupat ional choices:
1. First period of life: invest in human capit al or work as an unskilled worker.

2. Second period of life: work as skilled or unskilled worker (based on decision in t he first
period).
Imperfect capit al market s: Int erest for borrowers is higher t han t hat for lenders (due t o
monit oring cost ).

Fixed cost associat ed wit h invest ment in educat ion, reflect ing:
1. Indivisibilit y of academic degrees.

2. Different ial ret urn t o college graduat e vs college dropout .

Short-run Implications

Decision t o invest in educat ion depends on parent wealt h due t o credit market imperfect ions.

High parent al t ransfer relat ive t o t he cost of educat ion reduces t he cost of borrowing for
educat ion and induces individuals t o invest in human capit al.

Low parent al t ransfer relat ive t o t he cost of educat ion increases t he cost of borrowing for
educat ion and dissuades individuals from invest ing in human capit al.

Long-run Implications
The societ y is segment ed int o t wo dynast ies (due t o t he fixed cost of educat ion):

Skilled (educat ed) dynast y in which individuals t ransfer sufficient resources from generat ion t o
generat ion so as t o just ify invest ment in human capit al.

Unskilled (uneducat ed) dynast y in which individuals do not t ransfer sufficient resources from
generat ion t o generat ion so as t o just ify invest ment in human capit al.

Inequalit y affect s development :

In non-poor economies, inequalit y t raps a larger fract ion of societ y in under-invest ment in
human capit al and t herefore reduces income per capit a and economic growt h.

In poor economies, inequalit y permit s at least some individuals t o invest in human capit al (since
t he average level of income is low relat ive t o t he cost of educat ion) and is t herefore
conducive for growt h.

Policy implications

Government policy can improve t he long-run equilibrium (in non-poor economy) by:

Subsidizing t uit ion cost .

Subsidizing st udent loans.

Improving financial market s (reducing t he gap bet ween t he int erest rat e for borrowers and
lenders).

Significance

The Review of Economic St udies named t he Galor-Zeira paper ("Income Dist ribut ion and
Macroeconomics") among t he 11 most pat h-breaking papers published in The Review of
Economic St udies in t he past 60 years.[9]

See also

Income dist ribut ion

Capit al market imperfect ions

Economic growt h

Economic inequalit y
References

1. Galor, Oded; Zeira, Joseph (1993). "Income Distribution and Macroeconomics" (https://mpra.ub.uni-m
uenchen.de/51644/1/MPRA_paper_51644.pdf) (PDF) . The Review of Economic Studies. Oxford:
Oxford University Press. 60 (1): 35–52. doi:10.2307/2297811 (https://doi.org/10.2307%2F229781
1) . JSTOR 2297811 (https://www.jstor.org/stable/2297811) .

2. The World Bank Group (1999). "The Effect of Distribution on Growth" (https://www.brown.edu/Depart
ments/Economics/Faculty/Oded_Galor/pdf/WB.pdf) (PDF) .

3. Brückner, Markus; Lederman, Daniel (2015). "Effects of income inequality on economic growth" (http
s://voxeu.org/article/effects-income-inequality-economic-growth) . VOX CEPR Policy Portal.

4. Brückner, Markus; Lederman, Daniel (2018). "Inequality and economic growth: the role of initial
income". Journal of Economic Growth. 23 (3): 341–366. doi:10.1007/s10887-018-9156-4 (https://doi.
org/10.1007%2Fs10887-018-9156-4) . hdl:10986/29896 (https://hdl.handle.net/10986%2F29896) .
S2CID 55619830 (https://api.semanticscholar.org/CorpusID:55619830) .

5. Battisti, Michele; Fioroni, Tamara; Lavezzi, Andrea Mario (2019). "World Interest Rates and Inequality:
Insight from the Galor-Zeira Model". Macroeconomic Dynamics. (forthcoming).

6. Perotti, Roberto (1996). "Growth, Income Distribution, and Democracy: What the Data Say". Journal of
Economic Growth. 1 (2): 149–187. doi:10.1007/bf00138861 (https://doi.org/10.1007%2Fbf001388
61) . S2CID 54670343 (https://api.semanticscholar.org/CorpusID:54670343) .

7. Bénabou, Roland (1996). "Inequality and Growth" (https://doi.org/10.2307%2F3585187) . NBER

Macroeconomics Annual. 11: 11–92. doi:10.2307/3585187 (https://doi.org/10.2307%2F3585187) .
JSTOR 3585187 (https://www.jstor.org/stable/3585187) .

8. Berg, Andrew; Ostry, Jonathan D.; Tsangarides, Charalambos G.; Yakhshilikov, Yorbol (2018).
"Redistribution, inequality, and growth: new evidence". Journal of Economic Growth. 23 (3): 259–305.
doi:10.1007/s10887-017-9150-2 (https://doi.org/10.1007%2Fs10887-017-9150-2) .
S2CID 158898163 (https://api.semanticscholar.org/CorpusID:158898163) .

9. Journals, Oxford. "Virtual Issue: The History of RESTUD" (https://web.archive.org/web/201307010402

09/http://www.oxfordjournals.com/our_journals/restud/resource/history_of_restud.html) . Archived
from the original (http://www.oxfordjournals.com/our_journals/restud/resource/history_of_restud.h
tml) on 1 July 2013. Retrieved 15 June 2014.
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