Inequality: Measurement and Trends

Inequality is one of the central themes of political economy. How is inequality measured? How has it changed historically? Why has inequality grown in many countries over recent decades? The answers to these questions are key for understanding contemporary politics and economics.

How to Measure Inequality

There are numerous ways to measure inequality:

Gini coefficient. The most popular indicator. Ranges from 0 (complete equality) to 1 (everything in the hands of one person). Calculated on the basis of the Lorenz curve—a graph showing the share of income received by a share of the population.
Decile and quintile ratios. The ratio of the incomes of the top 10% (20%) to the bottom 10% (20%). A straightforward, easy-to-understand measure.
Shares of top groups. The share of national income going to the top 1%, 0.1%, 0.01%. Especially important for analysis of wealth concentration at the very top.
Theil index. An indicator that allows decomposition—it is possible to divide total inequality into "within-group" and "between-group" components.

What to Measure?

Income vs. wealth. Wealth is distributed even more unevenly than income.
Market vs. disposable income. Before and after taxes and transfers.
Individual vs. household. Should family size be taken into account?
Consumption. Consumption inequality is lower than income inequality (smoothing).

Historical Trends

Thomas Piketty and other economists have reconstructed the long-term dynamics of inequality:

Early 20th century: extreme inequality. The top 1% received 15–25% of national income in developed countries. Enormous concentration of wealth among elites.
1914–1980: "the great compression." World wars, the Great Depression, progressive taxation, and the welfare state sharply reduced inequality. The share of the top 1% fell to 5–10%.
1980–present: "the great divergence." Inequality is rising again, especially in Anglo-Saxon countries. The share of top groups has returned to levels seen at the beginning of the century.
Global inequality: inequality between countries is decreasing (China, India are catching up), but inequality within countries is growing.
"Milanovic's elephant": the winners are the middle class of developing countries and the global elite; the losers are the middle class of developed countries.

Reasons for Rising Inequality

Why has inequality increased since the 1980s?

Technologies. Skill-biased technological change: new technologies increase demand for skilled labor, reducing demand for unskilled labor. The education premium rises.
Globalization. Competition with cheap labor from developing countries depresses wages in labor-intensive sectors of developed countries. Capital benefits from global markets.
Weakening of institutions. Decline in union coverage, deregulation of the labor market, and decline in (real) minimum wages have weakened workers’ positions.
Tax policy. Declining progressivity of taxes, reduced rates on capital income, inheritance. The rich pay a smaller share than before.
Financialization. Growth of the financial sector with high salaries and bonuses. A significant part of the income growth of the top 1% is financial earnings.
Superstars and winner-take-all. In certain professions (sports, entertainment, management), technology and globalization amplify gaps—the stars take all.

Piketty’s Theory

Thomas Piketty, in his book "Capital in the Twenty-First Century", proposed an influential theory of inequality:

r > g. When the return on capital ($r$) exceeds the growth rate of the economy ($g$), wealth becomes concentrated. Owners of capital get richer faster than the economy as a whole.
Historical data. Piketty showed that $r > g$ is the historical norm, and the low-inequality twentieth century was an exception. Wars and inflation destroyed capital; high growth rates narrowed the gap.
Forecast. With slowing growth (demographics, technological frontier), inequality will increase. Without interventions, there will be a return to "patrimonial capitalism".
Criticism:
- $r$ is a gross return, net return is much lower
- Wealth is spent, divided among heirs, given to charity
- Entrepreneurs create new wealth, not only inherit it
- Institutions and policy matter—it is not an automatic process

Consequences of Inequality

Why does inequality matter?

Economic arguments:

Inequality can reduce aggregate demand (the poor spend more)
Credit constraints prevent the poor from investing in human capital
High inequality is associated with financial crises

Political arguments:

Wealth is converted into political influence
Elites capture institutions
Growth of populism as a reaction to inequality

Social arguments:

Inequality correlates with social problems—crime, health, trust (book "The Spirit Level")
Restricts social mobility
Undermines social cohesion

Counterarguments:

Inequality is an incentive to diligence and innovation
Absolute standard of living is more important than the relative
Inequality is the result of free choice
Redistribution has costs (distorts incentives)