The concept of inequality is distinct from that of poverty and
fairnessDistributive justice concerns what some consider to be socially just allocation of goods in a society. A society in which incidental inequalities in outcome do not arise would be considered a society guided by the principles of distributive justice...
.
Income inequality metrics or
income distribution metrics are used by social scientists to measure the distribution of
incomeIncome is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...
, and
economic inequalityEconomic inequality comprises all disparities in the distribution of economic assets and income. The term typically refers to inequality among individuals and groups within a society, but can also refer to inequality among countries. The issue of economic inequality is related to the ideas of...
among the participants in a particular economy, such as that of a specific country or of the world in general. While different theories may try to explain how income inequality comes about, income inequality
metricsIn mathematics, a metric or distance function is a function which defines a distance between elements of a set. A set with a metric is called a metric space. A metric induces a topology on a set but not all topologies can be generated by a metric...
simply provide a
system of measurementA system of measurement is a set of units which can be used to specify anything which can be measured and were historically important, regulated and defined because of trade and internal commerce...
used to determine the dispersion of incomes.
Income distribution has always been a central concern of economic theory and
economic policyEconomic policy refers to the actions that governments take in the economic field. It covers the systems for setting interest rates and government budget as well as the labor market, national ownership, and many other areas of government interventions into the economy.Such policies are often...
. Classical economists such as
Adam SmithAdam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...
,
Thomas MalthusThe Reverend Thomas Robert Malthus FRS was an English scholar, influential in political economy and demography. Malthus popularized the economic theory of rent....
and
David RicardoDavid Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...
were mainly concerned with factor income distribution, that is, the
distributionDistribution in economics refers to the way total output, income, or wealth is distributed among individuals or among the factors of production .. In general theory and the national income and product accounts, each unit of output corresponds to a unit of income...
of income between the main
factors of productionIn economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...
, land, labour and capital. It is often related to wealth distribution although separate factors influence wealth inequality.
Modern economists have also addressed this issue, but have been more concerned with the distribution of income across individuals and households. Important theoretical and policy concerns include the relationship between income inequality and
economic growthIn economics, economic growth is defined as the increasing capacity of the economy to satisfy the wants of goods and services of the members of society. Economic growth is enabled by increases in productivity, which lowers the inputs for a given amount of output. Lowered costs increase demand...
. The article
Economic inequalityEconomic inequality comprises all disparities in the distribution of economic assets and income. The term typically refers to inequality among individuals and groups within a society, but can also refer to inequality among countries. The issue of economic inequality is related to the ideas of...
discusses the social and policy aspects of income distribution questions.
Defining income
All of the metrics described below are applicable to evaluating the distributional inequality of various kinds of resources. Here the focus is on income as a resource. As there are various forms of "income", the investigated kind of income has to be clearly described.
One form of income is the total amount of goods and services that a person receives, and thus there is not necessarily money or cash involved. If a subsistence farmer in Uganda grows his own grain it will count as income. Services like public health and education are also counted in. Often expenditure or consumption (which is the same in an economic sense) is used to measure income. The
World BankThe World Bank is an international financial institution that provides loans to developing countries for capital programmes.The World Bank's official goal is the reduction of poverty...
uses the so-called "living standard measurement surveys" to measure income. These consist of questionnaires with more than 200 questions. Surveys have been completed in most developing countries.
Applied to the analysis of income inequality within countries, "income" often stands for the taxed income per individual or per household. Here income inequality measures also can be used to compare the income distributions before and after taxation in order to measure the effects of progressive tax rates.
Properties of inequality metrics
In the economic literature on inequality four properties are generally postulated that any measure of inequality should satisfy:
Anonymity
This assumption states that an inequality metric does not depend on the "labeling" of individuals in an economy and all that matters is the distribution of income. For example, in an economy composed of two people, Mr. Smith and Mrs. Jones, where one of them has 60% of the income and the other 40%, the inequality metric should be the same whether it is Mr. Smith or Mrs. Jones who has the 40% share. This property distinguishes the concept of inequality from that of
fairnessDistributive justice concerns what some consider to be socially just allocation of goods in a society. A society in which incidental inequalities in outcome do not arise would be considered a society guided by the principles of distributive justice...
where who owns a particular level of income and how it has been acquired is of central importance. An inequality metric is a statement simply about how income is distributed, not about who the particular people in the economy are or what kind of income they "deserve".
Scale independence
This property says that richer economies should not be automatically considered more unequal by construction. In other words, if every person's income in an economy is doubled (or multiplied by any positive constant) then the overall metric of inequality should not change. Of course the same thing applies to poorer economies. The inequality income metric should be independent of the aggregate level of income.
Population independence
Similarly, the income inequality metric should not depend on whether an economy has a large or small population. An economy with only a few people should not be automatically judged by the metric as being more equal than a large economy with lots of people. This means that the metric should be independent of the level of population.
Transfer principle
The Pigou–Dalton, or transfer, principle is the assumption that makes an inequality metric actually a measure of inequality. In its weak form it says that if some income is transferred from a rich person to a poor person, while still preserving the order of income ranks, then the measured inequality should not increase. In its strong form, the measured level of inequality should decrease.
Common income inequality metrics
Among the most common metrics used to measure inequality are the Gini index (also known as
Gini coefficientThe Gini coefficient is a measure of statistical dispersion developed by the Italian statistician and sociologist Corrado Gini and published in his 1912 paper "Variability and Mutability" ....
), the
Theil indexThe Theil index is a statistic used to measure economic inequality. It has also been used to measure the lack of racial diversity. The basic Theil index TT is the same as redundancy in information theory which is the maximum possible entropy of the data minus the observed entropy. It is a special...
, and the Hoover index. They have all four properties described above.
An additional property of an inequality metric that may be desirable from an empirical point of view is that of 'decomposability'. This means that if a particular economy is broken down into sub-regions, and an inequality metric is computed for each sub region separately, then the measure of inequality for the economy as a whole should be a weighted average of the regional inequalities (in a weaker form, it means that it should be an explicit function of sub-regional inequalities, though not necessarily linear). Of the above indexes, only the
Theil indexThe Theil index is a statistic used to measure economic inequality. It has also been used to measure the lack of racial diversity. The basic Theil index TT is the same as redundancy in information theory which is the maximum possible entropy of the data minus the observed entropy. It is a special...
has this property.
Because these income inequality metrics are summary statistics that seek to aggregate an entire distribution of incomes into a single index, the information on the measured inequality is reduced. This information reduction of course is the goal of computing inequality measures, as it reduces complexity.
A weaker reduction of complexity is achieved if income distributions are described by shares of total income. Rather than to indicate a single measure, the society under investigation is split into segments, e.g. into quintiles (or any other percentage of population). Usually each segment contains the same share of income earners. In case of an unequal income distribution, the shares of income available in each segment are different. In many cases the inequality indices mentioned above are computed from such segment data without evaluating the inequalities within the segments. The higher the amount of segments (e.g. deciles instead of quintiles), the closer the measured inequality of distribution gets to the real inequality. (If the inequality within the segments is known, the total inequality can be determined by those inequality metrics which have the property of being "decomposable".)
Quintile measures of inequality satisfy the transfer principle only in its weak form because any changes in income distribution outside the relevant quintiles are not picked up by this measures; only the distribution of income between the very rich and the very poor matters while inequality in the middle plays no role.
Details of the three inequality measures are described in the respective Wikipedia articles. The following subsections cover them only briefly.
Gini index
The range of the Gini index is between 0 and 1 (0% and 100%), where 0 indicates perfect equality and 1 (100%) indicates maximum inequality.
The Gini index is the most frequently used inequality index. The reason for its popularity is that it is easy to understand how to compute the Gini index as a ratio of two areas in
Lorenz curveIn economics, the Lorenz curve is a graphical representation of the cumulative distribution function of the empirical probability distribution of wealth; it is a graph showing the proportion of the distribution assumed by the bottom y% of the values...
diagrams. As a disadvantage, the Gini index only maps a number to the properties of a diagram, but the diagram itself is not based on any model of a distribution process. The "meaning" of the Gini index only can be understood empirically. Additionally the Gini does not capture where in the distribution the inequality occurs. As a result two very different distributions of income can have the same Gini index.
Hoover index
The Hoover index is the simplest of all inequality measures to calculate: It is the proportion of all income which would have to be redistributed to achieve a state of perfect equality.
In a perfectly equal world, no resources would need to be redistributed to achieve equal distribution: a Hoover index of 0. In a world in which all income was received by just one family, almost 100% of that income would need to be redistributed (i.e., taken and given to other families) in order to achieve equality. The Hoover index then ranges between 0 and 1 (0% and 100%), where 0 indicates perfect equality and 1 (100%) indicates maximum inequality.
Theil index
A Theil index of 0 indicates perfect equality. A Theil index of 1 indicates that the distributional entropy of the system under investigation is almost similar to a system with an 82:18 distribution. This is slightly more inequal than the inequality in a system to which the "80:20
Pareto principleThe Pareto principle states that, for many events, roughly 80% of the effects come from 20% of the causes.Business-management consultant Joseph M...
" applies. The Theil index can be transformed into an
Atkinson indexThe Atkinson index is a measure of income inequality developed by British economist Anthony Barnes Atkinson...
, which has a range between 0 and 1 (0% and 100%), where 0 indicates perfect equality and 1 (100%) indicates maximum inequality.
The Theil index is an entropy measure. As for any resource distribution and with reference to information theory, "maximum entropy" occurs once income earners cannot be distinguished by their resources, i.e. when there is perfect equality. In real societies people can be distinguished by their different resources, with the resources being incomes. The more "distinguishable" they are, the lower is the "actual entropy" of a system consisting of income and income earners. Also based on information theory, the gap between these two entropies can be called "
redundancyRedundancy in information theory is the number of bits used to transmit a message minus the number of bits of actual information in the message. Informally, it is the amount of wasted "space" used to transmit certain data...
". It behaves like a
negative entropyThe negentropy, also negative entropy or syntropy, of a living system is the entropy that it exports to keep its own entropy low; it lies at the intersection of entropy and life...
.
For the Theil index also the term "Theil entropy" had been used. This caused confusion. As an example,
Amartya SenAmartya Sen, CH is an Indian economist who was awarded the 1998 Nobel Prize in Economic Sciences for his contributions to welfare economics and social choice theory, and for his interest in the problems of society's poorest members...
commented on the Theil index, "given the association of doom with entropy in the context of thermodynamics, it may take a little time to get used to entropy as a good thing." It is important to understand that an increasing Theil index
does not indicate an increasing entropy, instead it indicates an increasing redundancy (decreasing entropy).
High inequality yields high Theil redundancies. High redundancy means low entropy. But this does not necessarily imply that a very high inequality is "good", because very low entropies also can lead to explosive compensation processes. Neither does using the Theil index necessarily imply that a very low inequality (low redundancy, high entropy) is "good", because high entropy is associated with slow, weak and inefficient resource allocation processes.
There are three variants of the Theil index. When applied to income distributions, the first Theil index relates to systems within which incomes are stochastically distributed to income earners, whereas the second Theil index relates to systems within which income earners are stochastically distributed to incomes.
A third "symmetrized" Theil index is the arithmetic average of the two previous indices. Interestingly, the formula of the third Theil index has some similarity with the Hoover index (as explained in the related articles). As in case of the Hoover index, the symmetrized Theil index does not change when swapping the incomes with the income earners. How to generate that third Theil index by means of a spreadsheet computation directly from distribution data is shown below.
An important property of the Theil index which makes its application popular is its decomposability into the between-group and within-group component. For example, the Theil index of overall income inequality can be decomposed in the between-region and within region components of inequality, while the relative share attributable to the between-region component suggests the relative importance of spatial dimension of income inequality.
Comparison of the Theil index and the Hoover index
The Theil index indicates the distributional redundancy of a system, within which incomes are assigned to income earners in a stochastic process. In comparison, the Hoover index indicates the minimum size of the income share of a society, which would have to be redistributed in order to reach maximum entropy. Not to exceed that minimum size would require a perfectly planned redistribution. Therefore the Hoover index is the "non-stochastic" counterpart to the "stochastic" Theil index.
Applying the Theil index to allocation processes in the real world does
not imply that these processes are stochastic: the Theil yields the
distance between an ordered resource distribution in an observed system to the final stage of stochastic resource distribution in a closed system. Similarly, applying the Hoover index does
not imply that allocation processes occur in a perfectly planned economy: the Hoover index yields the
distance between the resource distribution in an observed system to the final stage of a planned "equalization" of resource distribution. For both indices, such an equalization only serves as a reference, not as a goal.
For a given distribution the Theil index can be larger than the Hoover index or smaller than the Hoover index:
- For high inequalities the Theil index is larger than the Hoover index.
This means for achieving equilibrium (maximum entropy) in a closed system, more resources would have to be reallocated than in case of a planned and optimized reallocation process, where only the necessary minimum share of resources would have to be reallocated. For an open system the export of entropy (import of redundancy) would allow to maintain the distribution dynamics driven by high inequality.
- For low inequalities the Theil index is smaller than the Hoover index.
Here, on the path to reaching equilibrium, a planned and optimized reallocation of resources would contribute more to the dynamics of redistribution than stochastic redistribution. This also is intuitively understandable, as low inequalities also weaken the urge to redistribute resources. People in such a system may tolerate or even foster an increase the inequality. As this is would be an increase of redundancy (an decrease of entropy), redundancy would have to be imported into (entropy would have to be exported from) the society. In that case the society needs to be an open system.
In order to increase the redundancy in the distribution category of a society as a closed system, entropy needs to be exported from the subsystem operating in the that economic category to other subsystems with other entropy categories in the society. For example, social entropy may increase. However, in the real world, societies are open systems, but the openness is restricted by the entropy exchange capabilities of the interfaces between the society and the environment of that society. For societies with a resource distribution which entropywise is similar to the resource distribution of a reference society with a 73:27 split (73% of the resources belong to 27% of the population and vice versa), the point where the Hoover index and the Theil index are equal, is at a value of around 46% (0.46) for the Hoover index and the Theil index.
Ratios
Another common class of metrics is to take the ratio of the income of two different groups, generally "higher over lower". This compares two
parts of the income distribution, rather than the distribution as a whole; equality between these parts corresponds to 1:1, while the more unequal the parts, the greater the ratio. These statistics are easy to interpret and communicate, because they are relative (this population earns twice as much as this population), but, since they do not fall on an absolute scale, do not provide an absolute measure of inequality.
Ratio of percentiles
Particularly common to compare a given percentile to the median, as in the chart at right; compare
seven-number summaryIn descriptive statistics, the seven-number summary is a collection of seven summary statistics, and is a modification or extension of the five-number summary...
, which summarizes a distribution by certain percentiles. While such ratios do not represent the
overall level of inequality in the population as a whole, they provide measures of the
shape of income distribution. For example, the attached graph shows that in the period 1967–2003, US income ratio between median and 10th and 20th percentile did not change significantly, while the ratio between the median and 80th, 90th, and 95th percentile increased. This reflects that the increase in the Gini coefficient of the US in this time period is due to gains by upper income earners (relative to the median), rather than by losses by lower income earners (relative to the median).
Share of income
A related class of ratios is "income share" – what percentage of national income a subpopulation accounts for. Taking the ration of income share to subpopulation size corresponds to a ratio of
mean subpopulation income relative to
mean income. Because income distribution is generally positively skewed, mean is higher than median, so ratios to mean are lower than ratios to median. This is particularly used to measure that fraction of income accruing to top earners – top 10%, 1%, .1%, .01% (1 in 10, in 100, in 1,000, in 10,000), and also "top 100" earners or the like; in the US top 400 earners is .0002% of earners (2 in 1,000,0000) – to study concentration of income – wealth condensation, or rather income condensation. For example, in the chart at right, US income share of top earners was approximately constant from the mid 1950s to the mid 1980s, then increased from the mid-1980s through 2000s; this increased inequality was reflected in the Gini coefficient.
For example, in 2007 the top decile (10%) of US earners accounted for 49.7% of total wages (
times fraction under equality), and the top 0.01% of US earners accounted for 6% of total wages (600 times fraction under equality).
Spreadsheet computations
The Gini coefficient, the Hoover index and the Theil index as well as the related welfare functions can be computed together in a spreadsheet. The welfare functions serve as alternatives to the
medianIn probability theory and statistics, a median is described as the numerical value separating the higher half of a sample, a population, or a probability distribution, from the lower half. The median of a finite list of numbers can be found by arranging all the observations from lowest value to...
income.per
Group
!style="background:#D8E0E0;"|Income
per
Group
!style="background:#D8E0E0;"|Income
per
Individual
!style="background:#D8E0E0;"|Relative
Deviation
!style="background:#D8E0E0;"|Accumulated
Income
!style="background:#D8E0E0;"|Gini
!style="background:#D8E0E0;"|Hoover
!style="background:#D8E0E0;"|Theil
|-
!style="background:#E8F0F0;"|1
|style="background:#FFFFC0;"|A
1
|style="background:#FFFFC0;"|E
1
|Ē
1 = E
1/A
1
|D
1 = E
1/ΣE - A
1/ΣA
|K
1 = E
1
|G
1 = (2
* K
1 - E
1)
* A
1
|H
1 = abs(D
1)
|T
1 = ln(Ē
1)
* D
1
|-
!style="background:#E8F0F0;"|2
|style="background:#FFFFC0;"|A
2
|style="background:#FFFFC0;"|E
2
|Ē
2 = E
2/A
2
|D
2 = E
2/ΣE - A
2/ΣA
|K
2 = E
2 + K
1
|G
2 = (2
* K
2 - E
2)
* A
2
|H
2 = abs(D
2)
|T
2 = ln(Ē
2)
* D
2
|-
!style="background:#E8F0F0;"|3
|style="background:#FFFFC0;"|A
3
|style="background:#FFFFC0;"|E
3
|Ē
3 = E
3/A
3
|D
3 = E
3/ΣE - A
3/ΣA
|K
3 = E
3 + K
2
|G
3 = (2
* K
3 - E
3)
* A
3
|H
3 = abs(D
3)
|T
3 = ln(Ē
3)
* D
3
|-
!style="background:#E8F0F0;"|4
|style="background:#FFFFC0;"|A
4
|style="background:#FFFFC0;"|E
4
|Ē
4 = E
4/A
4
|D
4 = E
4/ΣE - A
4/ΣA
|K
4 = E
4 + K
3
|G
4 = (2
* K
4 - E
4)
* A
4
|H
4 = abs(D
4)
|T
4 = ln(Ē
4)
* D
4
|- style="background:#D8E0E0;"
|style="background:#D8E0E0;"|
|style="background:#D8E0E0;"|
|style="background:#D8E0E0;"|
|style="background:#D8E0E0;"|
|style="background:#D8E0E0;"|
|style="background:#D8E0E0;"|
|style="background:#D8E0E0;"|
|style="background:#D8E0E0;"|
|style="background:#D8E0E0;"|
|-
!style="background:#E8F0F0;"|Totals
|ΣA
|ΣE
|Ē = ΣE/ΣA
|style="background:#F0F0F0;"|
|style="background:#F0F0F0;"|
|ΣG
|ΣH
|ΣT
|-
!style="background:#E8F0F0;"|Inequality
Measures
|style="background:#F0F0F0;"|
|style="background:#F0F0F0;"|
|style="background:#F0F0F0;"|
|style="background:#F0F0F0;"|
|style="background:#F0F0F0;"|
|style="background:#D0FFD0;"|Gini = 1 - ΣG/ΣA/ΣE
|style="background:#D0FFD0;"|Hoover = ΣH / 2
|style="background:#D0FFD0;"|Theil = ΣT / 2
|-
!style="background:#E8F0F0;"|Welfare
Function
|style="background:#F0F0F0;"|
|style="background:#F0F0F0;"|
|style="background:#F0F0F0;"|
|style="background:#F0F0F0;"|
|style="background:#F0F0F0;"|
|style="background:#D0FFD0;"|W
G = Ē
* (1 - Gini)
|style="background:#D0FFD0;"|W
H = Ē
* (1 - Hoover)
|style="background:#D0FFD0;"|W
T = Ē
* (1 - Theil)
|}
In the table, fields with a yellow background are used for data input. From these data inequality measures as well as the related welfare functions are computed and displayed in fields with green background.
In the example given here, "Theil index" stands for the arithmetic mean of a Theil index computed for the distribution of income within a society to the individuals (or households) in that society and a Theil index computed for the distribution of the individuals (or households) in the society to the income of that society. The difference between the Theil index and the Hoover index is the weighting of the relative deviation D. For the Hoover index the relative deviation D per group is weighted with its own sign. For the Theil index the relative deviation D per group is weighted with the information size provided by the income per individual in that group.
For the computation the society usually is divided into income groups. Often there are four or five groups consisting of a similar amount of individuals in each group. In other cases the groups are created based on income ranges which leads to having different amounts of individuals in the different groups. The table above shows a computation of inequality indices for four groups. For each group the amount of individuals (or households) per group A and the total income in that group E is specified.
The parameter pairs A and E need to be sorted for the computation of the Gini coefficient. (For the Theil index and the Hoover index no sorting is required.) A and E has the be sorted so that the values in the column "Income per individual" are lined up in ascending order.
Keeping these points in mind helps to understand the problems caused by the improper use of inequality measures. However, they do not render inequality coefficients invalid. If inequality measures are computed in a well explained and
way, they can provide a good tool for quantitative comparisons of inequalities.
There is evidence from a broad panel of recent academic studies shows that there is a nonlinear relation between income inequality and the rate of growth and investment. Very high inequality slows growth; moderate inequality encourages growth. Studies differ on the effect of very low inequality.
Robert J. Barro,
found in his study "Inequality and Growth in a Panel of Countries" that higher inequality tends to retard growth in poor countries and encourage growth in well-developed regions.
and Julius Court (2001) reach slightly different conclusions. The authors therefore recommend to pursue moderation also as to the distribution of wealth and particularly to avoid the extremes. Both very high egalitarianism and very high inequality cause slow growth. Considering the inequalities in economically well developed countries, public policy should target an ‘efficient inequality range’. The authors claim that such efficiency range roughly lies between the values of the
s of 25 (the inequality value of a typical Northern European country) and 40 (that of countries such as the USA, France, Germany and the UK).
The precise shape of the inequality-growth curve obviously varies across countries depending upon their resource endowment, history, remaining levels of absolute poverty and available stock of social programs, as well as on the distribution of physical and human capital.