A few days ago, I had no idea what the Gini Coefficient was. You probably don’t have a clue either other than what is in the headline.

Imagine a country where the median income is something like $40,000 a year and the top 1% of the population earned 10 times that. This is known as income inequality (or disparity). By itself this doesn’t seem like a really big deal. What I described to you is basically the United States. But what if the top 1% started earning 15 times what the median was making? The disparity has grown!

The Gini Coefficient measures the income inequality among the entire population of the country. The higher the number, the more income is being taken in by a small group. Likewise if most of the money is being made by the majority of the population, the lower the Gini Coefficient will be.

Pop Quiz: Order these four countries in terms of lowest to highest Gini Coefficients, remember that low Gini scores coincide with low income inequality:

Brazil 56.7
Thailand 42.0
Egypt 34.4
USA 45.0

The correct order is: Egypt, Thailand, USA, and Brazil. That’s right, the US has the 3rd worst income inequality behind Egypt and Thailand. Not that these numbers mean much to us, but their Gini Coeffecients are 34.4, 42, 45, and 56.7 respectively. You can see a full list of Gini Coeffecients by Googling it or checking out this list here.

Measuring income inequality allows us to learn more about the economic conditions in our country. Say you used to make $18/hour at a factory. But your company laid you off and hired people in Sri Lanka to do the same job at $4/hour. The CEO got a big raise for improving profitability and you now can only find work at $10/hour. This transaction has just increased the income inequality in this country.

Seeing a pattern of increased disparity could mean trouble for a country. If it gets high enough, you may see calls for taxes on the wealthy or curbing of executive pay (sound familiar?). On the flip side if just about everyone makes the same amount of money, then there is little incentive to pursue riches through innovation. Imagine if you were told you would never get a raise because everyone makes the same amount of money. You have no incentive to try to go above and beyond.

It’s important to note that the Gini Coefficient does not measure poverty or wealth. It’s also not a great idea to compare the coefficients of various countries for anything other than income inequality. Egypt may have less inequality than the US, but the quality of living in the US is substantially better than in Egypt.

The United States Gini Coefficient has been steadily increasing for the last few decades. What do you think this means and at what point will it become a problem?

categories: economics