Global Inequality when Unequal Countries Create Unequal People

The prevailing approach to measuring global inequality pools all household incomes—as  measured in sample surveys—across the world. One then measures inequality in this global distribution the same way one measures inequality within one country. A good example of this approach is found in Lakner and Milanovic (2016).

These measures of global inequality attribute no economic advantage to living in a richer country beyond what is already reflected in the household incomes measured from  household surveys. This restriction is hard to defend on either theoretical or empirical grounds.

One way that national income may matter stems from the longstanding idea of relative deprivation. This postulates negative economic gains to co-residents. Then we can rationalize a nationalistic view that “global inequality” is just the average national inequality across countries. This emerges as the limiting case in which it is relative income within the country of residence that matters.

However, that is hardly plausible. One can point to reasonable arguments for positive external effects of living in a richer country at given own income. Examples of how this can happen include the likely positive correlation between national income and factors conducive to a higher long-run personal income, better public services, and greater security. None of these gains are likely to be properly reflected in current incomes as measured in surveys.

The implication is clear: the (large) differences in average incomes found between rich and poor countries create an extra (horizontal) inequality between their residents, not reflected in their current incomes, as observed from surveys. This is a source of downward bias in prevailing measures of global inequality. Yet the likelihood that living in a richer country delivers gains to economic welfare that are not reflected in survey-based incomes has been entirely ignored by past measures.

I explore this issue in a new paper, “Global inequality when national income matters,” which proposes a new way of measuring global inequality that allows national income to matter at given “own-income” as measured in surveys (Ravallion, 2018).

I find that this issue is highly salient to the quantitative measures obtained for global inequality. If one defines economic welfare in terms of relative income alone then one sees far less inequality in the world than if one puts a sizable value on the external benefits of living in a richer country. Using what can be considered the ideal inequality measure for this purpose, namely the Mean Log Deviation (MLD), the paper finds that relative deprivation theory implies that global interpersonal inequality is far lower than prevailing measures suggest since it is then entirely within countries.

This changes dramatically when one allows a positive value of national income (at given own-income), such as when living in a richer country brings benefits in terms of access to non-market goods and services, and better opportunities for private support in times of need. From what we know based on past global studies using micro data, the national income effect could well be 50% or more of the own-income effect on subjective wellbeing. Then global inequality is far higher than prevailing measures suggest, and far higher than found in even the most unequal country.

Indeed, the differences in levels of inequality due to even rather modest differences in how one values national mean income tend to swamp the differences seen over time in standard measures, or the differences we see between countries, and are also large relative to the impact of even a substantial underestimation of the incomes of the rich.

For example, suppose that incomes of all the richest 1% in the world are actually double the numbers in Lakner and Milanovic (2016) for 2008. This would add about 0.1 to the global MLD. I find that this is about the same as adding a modest 10% of log national-mean income to log own income to allow for the gains from living in an economically-better off country.

So the level of global inequality could well be very much higher than current measures suggest, once one allows for the likely external gains from living in a richer country. Nonetheless, I still find that the stylized fact that global inequality has been falling since around 1990 is robust to all except a seemingly high negative weight on national income, such as due to relative deprivation. The finding of falling between-country inequality is robust whatever value one attaches to national income in assessing individual economic welfare.

There is almost certainly more inequality in the world than we think, but it is likely to be falling.

References

Lakner, Christoph, and Branko Milanovic, 2016, “Global Income Distribution: From the Fall of the Berlin Wall to the Great Recession,” World Bank Economic Review 30(2): 203-232.

Ravallion, Martin, 2018, “Global Inequality when Unequal Countries Create Unequal People,” European Economic Review, forthcoming.