Measuring Income Inequality

What is inequality? From Merriam-Webster: in·equal·i·ty Function: noun 1 : the quality of being unequal or uneven: as a : lack of evenness b : social disparity c : disparity of distribution or opportunity d : the condition of being variable : changeableness 2 : an instance of being unequal

Our primary interest is in economic inequality. In this context, inequality measures the disparity between a percentage of population and the percentage of resources (such as income) received by that population. Inequality increases as the disparity increases.

If a single person holds all of a given resource, inequality is at a maximum. If all persons hold the same percentage of a resource, inequality is at a minimum.

Economic Inequalities can occur for several reasons: Personal Preferences – Relative valuation of leisure and work effort differs Social Process – Pressure/Opportunity to work or varies across particular regions or areas Public Policy – tax, labor, education, and other policies affect the distribution of resources

Why measure Inequality? Measuring changes in inequality helps determine the effectiveness of policies aimed at affecting inequality and generates the data necessary to use inequality as an explanatory variable in policy analysis.

The Gini Coefficient The Gini Coefficient has an intuitive, but possibly unfamiliar construction. To understand the Gini Coefficient, one must first understand the Lorenz Curve… Don’t worry, we will only look at theory (not math – this is not econ...)

Cumulative Population The Gini Coefficient An equality diagonal represents perfect equality: at every point, cumulative population equals cumulative income. The Lorenz curve measures the actual distribution of income. A – Equality Diagonal Population = Income B – Lorenz Curve C – Difference Between Equality and Reality Cumulative Income A C B Cumulative Population

The Gini Coefficient When there is perfect equality, the Lorenz curve is the equality diagonal, and the value of the Gini Coefficient is zero. When one member of the population holds all of the resource, the value of the Gini Coefficient is one.

The Gini Coefficient Pros Generally regarded as gold standard in economic work Incorporates all data Allows direct comparison between units with different size populations Cons Requires comprehensive individual level data Requires more sophisticated computations Measures only economic inequality

Gini Coefficients:

Data from www.oecd.org

There are less poor people in the world today than there were 26 years ago, but the world is more unequal… Between 1970 and 2005 appr. 2/3 of all OECD countries experienced an increase in income inequality...

According to 2007 calculations, CEOs of the top 15 companies in the USA each earned 520 times more than average worker, up from 360 times in 2003… Similar patterns have been registered in Australia, Germany, H.K., Netherlands, Canada, Mexico, Latin America, Sub-Saharan Africa

Richest 10% to Poorest 10% 10 to 1 in Italy, Japan, Korea 14 to 1 in France, Japan, Spain are only OECD countries where income inequality has not increased significantly since the 1970s 10 to 1 in Italy, Japan, Korea 14 to 1 in Israel, Turkey and USA 27 to 1 Mexico & Chile

Increased Income Inequality Higher crime rates Lower life expectancy Slowdown of economic growth Malnutrition Increased likelihood of children taken out of school to work