5
Income Inequality
To begin to understand what life is like with the help of Figure 5.1, which shows
in a country—to know, for example, the percentages of national income How does income
how many of its inhabitants are poor—it received by equal percentiles of individuals inequality affect
is not enough to know that country’s per or households ranked by their income lev-
capita income. The number of poor peo- els. In Hungary the richest 20 percent
poverty and
ple in a country and the average quality (quintile) of the population receives about quality of life in a
of life also depend on how equally—or 4 times more than the poorest quintile, country?
unequally—income is distributed. while in Brazil the richest quintile receives
more than 30 times more than the poorest
quintile.
Cross-country Comparisons of
Income Inequality Compare these ratios to an average of
about 6:1 in high-income countries. In
In Brazil and Hungary, for example, GNP the developing world income inequality,
per capita levels are quite comparable, but measured the same way, varies by region:
the incidence of poverty in Brazil is much it is 4:1 in South Asia, 6:1 in East Asia
higher. This observation can be explained and the Middle East and North Africa,
Figure 5.1 Income distributed by population quintile
in Brazil and Hungary
Brazil, 1989 Hungary, 1993
Richest 20%
of population 67.5 36.6
Second 20% 16.8 22.3
Third 20% 8.9 17.6
Fourth 20% 4.9 14.0
Poorest 20% 2.1 9.5
0 20 40 60 80 0 20 40 60 80
Percentage of total income Percentage of total income
27
BEYOND ECONOMIC GROWTH
10:1 in Sub-Saharan Africa, and 12:1 in percent in each) or 10 groups (10 percent
Latin America. in each) and the income of each group is
calculated and expressed as a percentage of
GDP (see Figure 5.1). Next economists
Lorenz Curves and Gini Indexes plot the shares of GDP received by these
groups cumulatively—that is, plotting the
To measure income inequality in a coun- income share of the poorest quintile
try and compare this phenomenon among against 20 percent of population, the
countries more accurately, economists use income share of the poorest quintile and
Lorenz curves and Gini indexes. A Lorenz the next (fourth) quintile against 40 per-
curve plots the cumulative percentages of cent of population, and so on, until they
total income received against the cumula- plot the aggregate share of all five quintiles
tive percentages of recipients, starting with (which equals 100 percent) against 100
the poorest individual or household percent of the population. After connect-
(Figure 5.2). How is it constructed? ing all the points on the chart—starting
with the 0 percent share of income
First, economists rank all the individuals received by 0 percent of the population—
or households in a country by their they get the Lorenz curve for this country.
income level, from the poorest to the rich-
est. Then all of these individuals or house- The deeper a country's Lor enz curve, the
holds are divided into 5 groups (20 less equal its income distribution. For
Figure 5.2 Lorenz curves and Gini indexes for Brazil and Hungary
Percentage of total income
100 Hungary
(Gini index = 27.0%)
Brazil
80 (Gini index = 63.4%)
Line of absolute
y
lit
ua
60 inequality
eq
e
ut
s ol
ab
of
40
e
Lin
20
0
0 20 40 60 80 100
Percentage of total population
Poorest Richest
28
5 INCOME INEQUALITY
comparison, see on Figure 5.2 the “curve” greater than 0 percent but less than 100
of absolutely equal income distribution. percent (see Figure 5.3 and Data Table 1).
Under such a distribution pattern, the
first 20 percent of the population would
receive exactly 20 percent of the income, Costs and Benefits of Income
40 percent of the population would Inequality
receive 40 percent of the income, and so Is a more equal
on. The corresponding Lorenz curve Is a less equal distribution of income good distribution of
would therefore be a straight line going or bad for a country’s development? There
from the lower left corner of the figure (x are different opinions about the best pat-
income good or
= 0 percent, y = 0 percent) to the upper terns of distribution—about whether, for bad for a country’s
right corner (x = 100 percent, y = 100 example, the Gini index should be closer development?
percent). Figure 5.2 shows that Brazil’s to 25 percent (as in Sweden) or to 40 per-
Lorenz curve deviates from the hypotheti- cent (as in the United States). Consider
cal line of absolute equality much further the following arguments.
than that of Hungary. This means that of
these two countries, Brazil has the highest An excessively equal income distribution
income inequality. can be bad for economic efficiency.
Take, for example, the experience of
A Gini index is even more convenient socialist countries, where deliberately
than a Lorenz curve when the task is to low inequality (with no private profits
compare income inequality among many and minimal differences in wages and
countries. The index is calculated as the salaries) deprived people of the incen-
area between a Lorenz curve and the line tives needed for their active participation
of absolute equality, expressed as a per- in economic activities—for diligent
centage of the triangle under the line (see work and vigorous entrepreneurship.
the two shaded areas on Figure 5.2). Thus Among the consequences of socialist
a Gini index of 0 percent represents per- equalization of incomes were poor disci-
fect equality—the Lorenz curve coincides pline and low initiative among workers,
with the straight line of absolute equality. poor quality and limited selection of
A Gini index of 100 implies perfect goods and services, slow technical
inequality—the Lorenz curve coincides progress, and eventually, slower eco-
with the x axis and goes straight upward nomic growth leading to more poverty.
against the last entry (that is, the richest
individual or household; see the thick dot- On the other hand, excessive inequality
ted line on Figure 5.2). In reality, neither adversely affects people’s quality of life,
perfect equality, nor perfect inequality is leading to a higher incidence of poverty
possible. Thus Gini indexes are always and so impeding progress in health and
29
BEYOND ECONOMIC GROWTH
Figure 5.3 Income inequality in selected countries, various years
Gini index (percent)
70
63%
60 56% 58%
48% 50% 50%
50
Average for middle-income countries, 1989
40% 41%
40 Average for OECD countries, 1989 33%
27% 28%
30 25% 26%
20% 22%
20
10
0
92 .
19 en
19 any
19 rus
19 ine
19 nd
ni 19 nce
19 tes
19 sia
19 ssia
ne 992 o
19 sau
19 ep
19 ina
19 nya
89 l
19 azi
1 ic
ed
U 2
89
Sw93
92
G 92
d 9
94
89
91
la
ay
R
93
M 95
92
a
ex
la
a
Ch
s
m
a
9
Br
Ru
Ke
te 8
St
Bi
kr
Po
ak
Fr
Be
al
M
er
a-
ov
Sl
ui
U
G
Note: An index value of 0 percent represents absolute equality in income distribution; 100 percent represents absolute inequality.
education and contributing to crime. energy efficiency (see Chapter 15),
Think also about the following effects of but in the face of serious inequality,
high income inequality on some major governments introducing even
factors of economic growth: slightly higher rates risk causing
extreme deprivation among the
• High inequality threatens a country’s poorest citizens.
political stability because more peo- • High inequality may discourage
ple are dissatisfied with their eco- certain basic norms of behavior
nomic status, which makes it harder among economic agents (individu-
to reach political consensus among als or enterprises) such as trust and
population groups with higher and commitment. Higher business risks
lower incomes. Political instability and higher costs of contract
increases the risks of investing in a enforcement impede economic
country and so significantly under- growth by slowing down all eco-
mines its development potential (see nomic transactions.
Chapter 6).
• High inequality limits the use of These are among the reasons some inter-
important market instruments such national experts recommend decreasing
as changes in prices and fines. For income inequality in developing coun-
example, higher rates for electricity tries to help accelerate economic and
and hot water might promote human development.
30