Keeping an eye on the have-mores

Inclusive Economy,Poverty & Inequality03 Apr 2013Ricardo Fuentes-Nieva

On why the post-2015 agenda should include a goal to limit the negative characteristics of inequality and how indicators of income concentration are better suited for this. One proposal that could be used is the Palma index.

The world of development wonks is abuzz with discussion about what to include in the post-2015 MDG framework – a follow up to the eight Millennium Development Goals designed to track progress in different development areas between 1990 and 2015. One of the areas that has gotten plenty of attention is the issue of inequality (although it didn’t feature prominently in the summary report of a recent meeting in Bali, but that’s another story).

This lively debate on inequality is already a welcome change. Not long ago, the topic was taboo in many development circles who dismissed such non-sense as the “politics of envy”. In 2003, for instance, the then Managing Director of the IMF, Anne Kruger said in a speech : “One has to wonder about this preoccupation with inequality. Poor people are desperate to improve their material conditions in absolute terms rather than to march up the income distribution. Hence it seems far better to focus on impoverishment than on inequality.” But recent research at the Fund has provided an alternative view on the ills of inequality: “Do societies inevitably face an invidious choice between efficient production and equitable wealth and income distribution? Are social justice and social product at war with one another? In a word, no.”. Times have indeed a-changed.

The post-2015 process provides an opportunity to maintain the interest in inequality in the medium term. The discussion has now moved (prematurely, it seems to me, but more on that later) on what kind of indicators could be used to monitor changes in the distribution of income. One of the most recent additions to this conversation comes from Alex Cobham and Andy Sumner from the Center for Global Development and King’s College London. Cobham and Sumner (C&S) propose the “Palma index”, which is a ratio of the income shares of poor and the rich populations in a given country (more precisely, the ratio between the top 10 percent and the bottom 40 percent). One of the main arguments in favour of this index, C&S say, is the empirical regularity where the share of income going to the middle class is broadly the same across countries and time. The Palma index has many interesting qualities: it is simple to understand; there is enough data to calculate the index for close to 80 countries (including, very importantly, rich countries) and it’s closely correlated to other inequality indicators.

It has several problems too. Branko Milanovic has voiced some: first, he says, it “too simplistic” but I don’t think this is necessarily a problem. Other simple indicators have been very successful at making a point – think of the Human Development Index. Second, he says (in a tweet, no less) “[s]uppose that you have (for simplicity) no overall growth, but you have an increase in the bottom share, and an even greater increase in the top share, Palma goes up. The middle class share declines. So inequality increased although the poor are now better off”

On this, Milanovic has a strong point. We do not know the axiomatic properties of the Palma which might then lead to some changes in the indicator that reflect the opposite to what it’s supposed to measure. For example: imagine a change in the income distribution where the shares of the bottom 40 percent and the top 10 percent remain the same but the distribution in the middle 50 percent becomes more compressed; the Palma index would remain unchanged when the income of half the population is more evenly distributed. But then we should ask, what is this index supposed to measure? Since it focuses in the extremes of the distribution, it is not an index of general inequality, it is more easily interpreted as a normalized index of income concentration.

Now, why would it be important to focus on concentration of income instead of total inequality? First, in the context of the post-2015 discussion, it’s not an either or. There are eight Millennium Development Goals with 40-something indicators to track progress. The first goal “Eradicating extreme poverty and hunger”, for instance, had five indicators. Including an inequality goal in the post-2015 process does not mean that we have to choose between the Palma index (which measures concentration of income) and, say, the Gini Index (which uses information for the whole distribution). If the post-2015 agenda includes a goal on equity/inequality, it doesn’t need to choose only one indicator to track progress. Second, concentration of income is important because it is closely associated with elite-capture, a distortion of the political process and regulatory weakness. This is one of the core arguments of J. Stiglitz’s new book The Price of Inequality where he shows that the uber-rich have used their power to influence the political debate and macroeconomic policy (tax cuts and monetary policy, mostly) in their favour.

Stephan Klasen and Martin Ravallion have argued against the inclusion of an MDG on inequality. One of Klasen’s and Ravallion’s main points is that it’s hard to know what is the right level of inequality, and thus how much we should reduce it. This is true. In a way, there is “good” inequality (the result of entrepreneurship and merit) and some “bad” inequality (the result of rent-seeking and state capture). The awfully hard exercise is how to disentangle between the two of them.

The Palma Index also provides a starting point for this. One of its weaknesses (it can’t tell what happens in the middle of the distribution) can be one of its strengths as the “bad” inequality happens mostly, one would think, between the two extremes of the distribution.

The post-2015 should have equity at the center of its agenda but we need to think harder about what we want to measure and about the difference between inequality and just concentration of income. We need to think about the overall goal before moving to indicators. We care about rising inequality because it’s , at least partially, unfair but also because it’s consequences and any goal in the post 2015 should reflect that. There is more and more evidence that higher inequality is closely associated with low social mobility and lower equality of opportunities. This all sounds abstract, but just ask yourself if you think that the sons and daughters of the lower and middle-classes should always and in every turn have a much lower chance to succeed in life, be healthy, educated and more confident regardless of their abilities or their effort. Just ask yourself if it’s acceptable to tell a child in the slums of any city that she can never live the life of his wealthier peers because there is, as Chrystia Freeland calls it, a permanent class divide. And this is not only unfair but inefficient, as the IMF paper referred above suggests.

There are problems in the selection of the indicators and the reduction targets regarding inequality, if any. But dodging the issue in the post-2015 agenda because it’s difficult to know the desirable level of any indicator is akin to eating your way through obesity just because you don’t know your perfect weight. In one thing everyone seems to agree: there is too much inequality. The top 10 percent get too big a share of the spoils. Time to revert that trend.