To begin to understand what life is like in a country- to
know, for example, how many of its inhabitants are poor-
it is not enough to know that country's per capita income.
The number of poor people in a country and the average quality
of life also depend on how equallyor unequally-income
In Brazil and Hungary, for example, GNP per capita levels
are quite comparable, but the incidence of poverty in Brazil
is much higher. This observation can be explained with the
help of Figure 5.1, which shows the
percentages of national income received by equal percentiles
of individuals or households ranked by their income levels.
In Hungary the richest 20 percent (quintile) of the population
receives about 4 times more than the poorest quintile, while
in Brazil the richest quintile receives more than 30 times
more than the poorest quintile.
Compare these ratios to an average of about 6:1 in high-income
countries. In the developing world income inequality, measured
the same way, varies by region: it is 4:1 in South Asia,
6:1 in East Asia and the Middle East and North Africa, 10:1
in Sub-Saharan Africa, and 12:1 in Latin America.
To measure income inequality in a country and compare this
phenomenon among countries more accurately, economists use
Lorenz curves and Gini indexes. A Lorenz curve plots the
cumulative percentages of total income received against
the cumulative percentages of recipients, starting with
the poorest individual or household (Figure
5.2). How is it constructed?
First, economists rank all the individuals or households
in a country by their income level, from the poorest to
the richest. Then all of these individuals or households
are divided into 5 groups (20 percent in each) or 10 groups
(10 percent in each) and the income of each group is calculated
and expressed as a percentage of GDP (see Figure
5.1). Next economists plot the shares of GDP received
by these groups cumulatively- that is, plotting the income
share of the poorest quintile against 20 percent of population,
the income share of the poorest quintile and the next (fourth)
quintile against 40 percent of population, and so on, until
they plot the aggregate share of all five quintiles (which
equals 100 percent) against 100 percent of the population.
After connecting all the points on the chart- starting with
the 0 percent share of income received by 0 percent of the
population- they get the Lorenz curve for this country.
The deeper a country's Lorenz curve, the less equal its
income distribution. For comparison, see on Figure 5.2 the
"curve" of absolutely equal income distribution. Under such
a distribution pattern, the first 20 percent of the population
would receive exactly 20 percent of the income, 40 percent
of the population would receive 40 percent of the income,
and so on. The corresponding Lorenz curve would therefore
be a straight line going from the lower left corner of the
figure (x = 0 percent, y = 0 percent) to the upper right
corner (x = 100 percent, y = 100 percent). Figure 5.2 shows
that Brazil's Lorenz curve deviates from the hypothetical
line of absolute equality much further than that of Hungary.
This means that of these two countries, Brazil has the highest
A Gini index is even more convenient than a Lorenz curve
when the task is to compare income inequality among many
countries. The index is calculated as the area between a
Lorenz curve and the line of absolute equality, expressed
as a percentage of the triangle under the line (see the
two shaded areas on Figure 5.2). Thus
a Gini index of 0 percent represents perfect equality- the
Lorenz curve coincides with the straight line of absolute
equality. A Gini index of 100 implies perfect inequality-
the Lorenz curve coincides with the x axis and goes straight
upward against the last entry (that is, the richest individual
or household; see the thick dotted line on Figure
5.2). In reality, neither perfect equality, nor perfect
inequality is possible. Thus Gini indexes are always greater
than 0 percent but less than 100 percent (see Figure
5.3 and Data Table 1).
Is a less equal distribution of income good or bad for a
country's development? There are different opinions about
the best patterns of distribution- about whether, for example,
the Gini index should be closer to 25 percent (as in Sweden)
or to 40 percent (as in the United States). Consider the
An excessively equal income distribution can be bad for
economic efficiency. Take, for example, the experience of
socialist countries, where deliberately low inequality (with
no private profits and minimal differences in wages and
salaries) deprived people of the incentives needed for their
active participation in economic activities- for diligent
work and vigorous entrepreneurship. Among the consequences
of socialist equalization of incomes were poor discipline
and low initiative among workers, poor quality and limited
selection of goods and services, slow technical progress,
and eventually, slower economic growth leading to more poverty.
On the other hand, excessive inequality adversely affects
people's quality of life, leading to a higher incidence
of poverty and so impeding progress in health and education
and contributing to crime. Think also about the following
effects of high income inequality on some major factors
- High inequality threatens a country's political stability
because more people are dissatisfied with their economic
status, which makes it harder to reach political consensus
among population groups with higher and lower incomes.
Political instability increases the risks of investing
in a country and so significantly undermines its development
potential (see Chapter 6).
- High inequality limits the use of important market instruments
such as changes in prices and fines. For example, higher
rates for electricity and hot water might promote energy
efficiency (see Chapter 15),
but in the face of serious inequality, governments introducing
even slightly higher rates risk causing extreme deprivation
among the poorest citizens.
- High inequality may discourage certain basic norms of
behavior among economic agents (individuals or enterprises)
such as trust and commitment. Higher business risks and
higher costs of contract enforcement impede economic growth
by slowing down all economic transactions.
These are among the reasons some international experts
recommend decreasing income inequality in developing countries
to help accelerate economic and human development.