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Why we need to rethink how we measure inequality – please welcome the Absolute Palma index

March 11, 2016
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nick galassoOxfam’s Nick Galasso (left) and ODI’s Chris Hoy (right), author of a new paper on the topic, argueChris Hoy Presenting for a rethink on inequality metrics

The world is abuzz about inequality

  • Pope Francis famously tweeted that inequality is the root of evil.
  • As we witnessed in Davos in January, the media can’t get enough of Oxfam’s statistic that the richest 85, 80, 62 people have the same wealth as the poorest half of the planet.
  • In 2014, a 700-page book on inequality by a French academic was a worldwide best seller.

But what exactly is this inequality everyone is talking about? It turns out that we might be measuring it all wrong. The Gini coefficient and (increasingly) the Palma Index are the most popular tools for measuring inequality within a country. These indicators calculate the ratio of the incomes of the rich over the poor. For instance, the Palma is a score calculated by dividing the share of income of the richest 10% by that of the poorest 40%.

The problem with these approaches is that they only measure relative inequality. If the incomes of the poor grow asChina inequality fast as those of the rich, these measures will stay the same over time, but the difference in income from a one percent growth for the poor versus a one percent growth for someone already rich can be significant. As the Italian demographer, Livi Bacci, said ‘it is not much of a relief for somebody living on $1 day to see that his income, up by three cents, is growing as much as the income of the richest quintile’.

Unfortunately, relative inequality measures don’t tell us about the absolute gap in incomes between the rich and the poor.  

Exploring the difference between relative versus absolute inequality

To explore the differences between absolute and relative inequality consider the example of the Philippines (see figure).

Over the last 25 years, relative inequality remained fairly stable in the country. This can be seen by the fact that the red line is quite flat across the income distribution as on average all people have experienced a growth rate in their incomes of around 2% a year. However, the green line shows that the additional income generated from this growth is massively weighted towards the rich end of the income distribution – they got the lion’s share of the dollars, a fact obscured if we stick to measures of relative inequality.

In other words, absolute inequality increased dramatically.

Chart 1

[Note: The slower average income growth for the top percentiles is largely due to the very richest people in the Philippines suffering considerable loss in incomes during the 2008 financial crisis.]

Why does this matter?

Politicians, pundits, and other voices often herald the impressive economic growth of developing countries in recent decades as a sign that the end of poverty and extreme inequality is near. And, in many countries relative inequality indicators are suggesting the poor are catching up with the rich.

For instance, using a relative inequality measure the World Bank boldly concluded that an era of shared prosperity is already upon us. According to its Global Monitoring Report, the poorest 40 percent fared better than the average in 58 of 86 countries. Yet, a recent paper shows that while the income of the poor may have grown faster, in a number of these countries they captured a smaller share of new income from growth compared to the richest 10 percent.

Even more shocking, a recent ODI paper shows that in the past 30 years absolute inequality always increased when countries experienced long periods of growth across income groups.

The insights gleaned from comparing relative versus absolute inequality tell us that growth needs to be even more intensively pro-poor than often suggested. In fact, closing the gap between the rich and poor requires the bottom 40 percent to grow around twice the country average.

A new measure of the gap between the rich and poor

Measuring how the gap between the rich and poor changes over time is an essential first step in addressing

Credit: Paul Smith, Panos

Credit: Paul Smith, Panos

inequality. The ODI paper proposes a new measure called the ‘Absolute’ Palma, which is the average income of the top 10 percent minus the average of the bottom 40 percent.

This is a modification of the Palma ratio that was first proposed on this blog. As mentioned above, the Palma is a relative measure, calculating the ratio of the share of income of the top 10% to that of the bottom 40%. In contrast, the ‘Absolute Palma’ captures what this means in terms of the actual income gap between the top 10% and bottom 40%.

People scoffed at the initial proposal for the Palma ratio, (which was a big improvement on the Gini), but it has caught on rapidly. We think an Absolute Palma would be an even better measure of inequality – let’s hope it catches on just as quickly.

 

4 comments

  1. Curious to know why you OXFAM guys only show photographs of poor people in India or other Asian/African countries (please note that I’m NOT finding excuses for the inequities there) but never in Western countries like Australia/Canada/US etc. where the inequities are even less excusable. Is it because it is harder to reach them or simply because like many Brits and Europeans you are yet to reconcile to the loss of Empire?

    Also do you take the permission of the slum dwellers before you take photographs of them? Most middle-class white people would not tolerate this kind of voyeuristic intrusion that poor people around the world have to put up with.

  2. I thought the photo of poor people in front of the high rise blocks demonstrated absolute inequality very effectively. In the UK you just don’t see absolute poverty like this. True, there are homeless people here, but only about 1 in 20,000 sleep rough (and I’m not excusing that) – you can easily find photos of them on Google.

    Most people here in the UK are not struggling with the loss of Empire! We are just not old enough to remember stuff from more than 50 years ago. It’s slightly odd that you mention Australia/Canada/US – because they were British colonies too.

    As for permission – in the UK there is no right of privacy from photos taken in public places and they are frequently used in the press, so if I wasn’t so dull then yes I would have to tolerate this kind of voyeuristic intrusion.

    (By the way, I can’t comment on Oxfam and their use of photos, I think I read that they do get permission.)

  3. Please give the formula for the enhanced index. The charme of the Palma Index is its simplicity – which makes it an ideal tool for lobbying.
    I looked into your ODI-Paper too but found no comprehensive formula.
    If I get it right, that equation would sum up in a US-Dollar? Purchasing Power Parity? figure. That might not be very helpful if one does not know too much about the economic situation of a given respective country.

    Best regards and keep up the good work,
    Uwe

  4. Having come from a poor background, I can say inequality matters here in the UK also. It often brings early deaths and bad health. My father died at 45 years-old – about the age my health deteriorated.

    The Palma ratio is supposedly better for showing inequality (comparing 40% poorest to 10% richest) – but to me it is obviously as flawed (useless) as the Gini coefficient.

    Perhaps you can show me how I am mistaken – that this isn’t another statistical confidence trick.

    To explain: If you can think for a moment about just the richest 10% part.

    In any one year the bottom of that range will rise relatively little, whilst the richest at the top income can rise by millions.

    So even in that range alone, inequality has worsened.

    Now think about the bottom 40% range – similar will happen there.

    The bottom raises little or not at all (with poorest staying in poverty) whilst the top of 40% range rises much more.

    Inequality has worsened in this range also.

    The outcome being that both ranges may have increased – but undeniably so has inequality.

    So at the end of this you could see ‘inequality’ using the Palma has improved, purely because of the bottom range total rising more – a statistical con.

    That is how the deception in similar comparison inequality measures work e.g. S80/S20.

    I made a video to show how the Gini con works – though I think you will know already.

    https://www.youtube.com/watch?v=x1Y_fUlYs-Q

    Very intelligent people have been been told how to do something simple and have not understood – which is unbelievable to me. Unless you can show how I made an idiot mistake.

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