Although Gini, Lorenz and Palma sound like names of pretty women, they are tools for measuring inequality. Inequality in a country is often measured using the Gini coefficient, which shows the share of total wealth or income by population segment. A higher Gini coefficient indicates greater inequality, with high-income individuals receiving much larger percentages of the total income of the population. Critics of the Gini argue that it is an imperfect measure as it ignores the informal economy and flattens distortions in the income distribution, leading to non-intuitive interpretations. The Palma ratio is another way to measure inequality, better weights observed income distributions using a simple and easy-to-understand ratio.
For years, the number used to measure inequality has been the Gini coefficient. 0 denotes perfect equality, in which everyone's income—or occasionally, wealth—is the same; 1 denotes perfect inequality, in which a single individual makes all the income (figures above 1 could theoretically result if some people make negative incomes).
If you plot population percentiles by income on the horizontal axis against cumulative income on the vertical axis, you get something called the Lorenz curve. In the graph below, we can see that the 54th percentile corresponded to 13.98% of total income in Haiti and 22.53% in Bolivia. In other words, the bottom 54% of the population took in around 14% of Haiti's income and around 23% of Bolivia's. The straight-line states the obvious: in a perfectly equal society, the bottom 54% would take in 54% of the total income.
In a hypothetical society in which the top 10% of the population earns 25% of the total income, and so does the bottom 40%. You get a Gini coefficient of 0.225.
Now, if you cut the bottom 40%'s income by two-thirds—to 8.3% of the nation's total income—and give the difference to the top 10%, who now earn 41.7% (the amount earned by the 40%-90% chunk stays steady). The Gini coefficient nearly doubles to 0.475. But if the bottom 40%'s income falls by another 45%, to just 4.6% of the total, and all of that lost income again goes to the top 10%, the Gini coefficient doesn't rise much—it's now just 0.532.
Roughly speaking, a Gini ratio of about 0.5 and above is deemed as a highly unequal society while those with Gini ratio of below 0.30 as a more equal society. We (Malaysia) have been stuck at 0.4 for years.
Two economists Alex Cobham (now chief executive of the U.K's Tax Justice Network) and Andy Sumner (now professor of international development at King’s College London and director of the Economic and Social Research Council (ESRC) Global Challenges Strategic Research Network on Global Poverty and Inequality Dynamics), viewed the Gini just didn’t make much sense.
In 2013, Cobham and Sumner proposed an alternative to the Gini coefficient: the Palma ratio. They named it after José Gabriel Palma, a Chilean economist. Palma noticed that in most countries, the middle class—defined as those in the fifth to ninth income deciles, or the 40%-90%—take in around half of the total income.
The Palma ratio is calculated by dividing the richest 10% of the population's share of gross national income (GNI) by the poorest 40%'s share.
The rich getting richer and the poor getting poorer is the main driver of inequality. The Gini, however, is more sensitive to changes in the middle group, which is where shifts in income less frequently occur. The Palma was developed to remedy this issue by focusing on the differences between those in the top and bottom income brackets. The higher the Palma ratio, the greater the inequality.
In a sense, inequality is not just about income and wealth but of opportunities. Where people lack opportunities to better themselves, they will end up with lower incomes and wealth. And how do we measure inequality of opportunities? That’s for another day!
References:
Measuring inequality: Forget Gini, Go with Palma Ration instead, David Floyd, Feb 28, 2022 (https://www.investopedia.com)
What is a Lorenz Curve? Eric Estevez, (https://www.investopedia.com)
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