Understanding international indices of inequality
In her second guest post on understanding development definitions and statistics, Aderonke Gbadamosi reviews the internationally recognised measures of inequality.
Developing countries have experienced significant levels of economic growth over the past decade. According to the latest UNDP Human Development Report released in March 2013, global progress on the Millennium Development Goals has been impressive. It has been noted, however, that the goals are measured at a global and national level and do not take account of the inequality gap between the wealthy and the poor. Various attempts have been made to provide comparative data on inequality. The most common, the Inequality-adjusted Human Development Index (IHDI), Gini Index and Palma Ratio are briefly explained below. Other widely used measures of economic inequality are the percentage of people living with under US$2 a day (at 2005 international prices) and the share of national income held by the wealthiest 10% of the population.
The GINI Index
The Gini index is the most frequently used inequality index. The Gini coefficient was first defined in a 1912 paper by the Italian economist Corrado Gini (1884-1965). It is used by the World Bank, United Nations (UN), the US Central Intelligence Agency (CIA), and the Organisation for Economic Co-operation and Development (OECD) as a standard gauge of family-income inequality in a country.
The Gini coefficient measures the extent to which the distribution of income among individuals or households within an economy deviates from a perfectly equal distribution. Gini-coefficient is based on the calculation of Gross national income per inhabitant and factors in the number of inhabitants of each country concerned. The coefficient gives each of the world’s countries a score between 0 and 1, with 0 representing perfect equality and 1 implying perfect inequality. The coefficient is then put into a complex formula to provide the Gini index, which determines how much money would have to be redistributed for everyone to have the same income. The higher the figure, which ranges between 0 and 100, the more unequal the country.
The Organisation for Economic Development and Cooperation (OECD) maintains its own GINI index and related statistics for member countries. The U.S. stands out as a developed economy with a large divide between rich and poor with a Gini Index of 43.2. Nordic countries like Sweden, Hungary and Slovenia top the global list, reflecting the fact that they have the most equal economies while other countries particularly in Latin America and South and Central Africa have the most income inequality. The Gini Index gives a useful empirical snapshot, it does not however capture where in the distribution the inequality occurs.
The Palma Ratio
The ‘Palma’ is an alternative measure of inequality based on the work of Chilean economist Gabriel Palma that addresses the Gini index’s insensitivity to changes in the top and the bottom and the oversensitivity to the changes in the middle of the distribution. It is based on the observation that the middle class income of every country almost always represents half of the gross national income. The measure of inequality that differs from country to country is the remaining 50% of GDP, which is to be split between the richest 10% and the poorest 40% of the population. Palma has suggested that since inequality is simply the struggle between the rich and the poor, the ratio more accurately reflects income inequality in society. A Palma ratio value of 5.0 can be directly translated into the statement that the richest 10 per cent earn five times the income of the poorest 40 per cent of the nation.
Inequality-adjusted Human Development Index (IHDI)
Averages like the HDI conceal disparities in human development across the population within the same country. The IHDI attempts to take this into account to provide a more rounded view of a country, by not only calculating the achievements of a country on health, education and income, but also on the distribution of this achievements among its citizens. It does this by discounting each dimension’s average value according to is level of inequality.
The Human Development Report (HDR) shows that countries with less human development tend to have larger losses in human development due to multidimensional inequality. The HDR uses the Inequality-adjusted HDI (IHDI), which accounts for inequality in the measurement of the level of human development of people in a society. The IHDI can therefore be viewed as the actual level of human development. For perfect equality, the IHDI is equal to the HDI, but falls below the HDI when equality rises.
The 2013 Human Development Report shows that The East Asia and the Pacific Region perform well on the IHDI, and former socialist countries in Europe and Central Asia have relatively egalitarian distributions.
OECD – An Overview of Growing Income Inequalities in OECD Countries, 2011 report