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The Difference Is in the Details
According new research by a top economist at the World Bank, how we measure inequality is all wrong.
Many politicians and economists consider it an unfortunate truth: Economic growth leads to greater economic inequality. But what if this long-held notion is the result of a flawed measurement? According to Branko Milanovic, a lead economist at the World Bank, timeworn calculations of economic inequality, such as the Gini coefficient, miss key indicators, such as how much wealth a country has to divide. That means that countries deemed to have a large gap between rich and poor may be far more equal than many believe.
A new method of measuring inequality, the inequality extraction ratio, developed by Milanovic, Harvard University’s Jeffrey Williamson, and Peter Lindert of the University of California, Davis, incorporates a critical statistic: the size of a country’s economy. Why is that important? "When you have a growing economy, the maximum possible inequality goes up," says Milanovic, because there’s more wealth to go around. That surplus is what makes true inequality possible.
"Say that 99.9 percent of the people [in a country] live at a subsistence level, and one guy takes the entire surplus," he says. "Although that guy is very rich compared to everyone else, the [traditionally measured] level of inequality is not going to be very high."
Using their new measurement, Milanovic and his partners find some countries to be far more unequal than economists traditionally believe. Using the Gini coefficient, for example, an impoverished country such as Ethiopia appears to have only slightly more inequality than the United States. Using the new measurement, however, which takes into account that the two economies differ greatly in size, Ethiopia has more than double the level of U.S. inequality. They also find that developing economies such as China and Russia, for example, have actually become more equal — not less — as they have transitioned to free market capitalism during the past two decades. When it comes to inequality, size apparently does matter.