Palma ratio

What Is the Palma Ratio?

The Palma ratio is a measure of economic inequality that compares the income share of the richest 10% of a population to that of the poorest 40%. It falls under the broader field of Income Inequality Measurement, offering a distinct perspective on how income is distributed within a society. Unlike other measures that consider the entire population, the Palma ratio focuses on the tails of the income distribution spectrum, specifically recognizing that the middle-income groups often hold a relatively stable share of national income across different countries. This specific focus helps highlight the disparities that exist at the extremes of wealth accumulation and poverty.

History and Origin

The Palma ratio was developed by Chilean economist José Gabriel Palma, an emeritus professor at the University of Cambridge. Palma introduced this measure in his 2011 paper, "Homogeneous middles vs. heterogeneous tails, and the end of the 'inverted-U': It's all about the share of the rich." His research observed that the middle 50% of the population (specifically, the 5th through 9th income deciles) consistently receives approximately half of the national gross national income (GNI) across a wide range of countries and time periods. This finding suggested that variations in overall inequality are predominantly driven by the differing shares of income held by the wealthiest 10% and the poorest 40% of the population.⁴ This insight led to the creation of the Palma ratio as a more intuitive and policy-relevant indicator of income disparity, moving beyond the traditional focus on the entire income spectrum.

Key Takeaways

• The Palma ratio measures income inequality by comparing the income share of the richest 10% to the poorest 40% of a population.
• It is based on the observation that the middle 50% of a population's income share remains relatively consistent across different countries.
• A higher Palma ratio indicates greater income disparity, meaning the rich hold a significantly larger share of income compared to the poor.
• The ratio offers a clear, policy-focused perspective on income concentration at the extremes.
• It is used by international organizations and policymakers to assess and address economic growth and inequality challenges.

Formula and Calculation

The Palma ratio is calculated by dividing the income share of the richest 10% of the population by the income share of the poorest 40% of the population.

The formula can be expressed as:

Where:

• Income Share of Richest 10% represents the percentage of total national income or household income held by the wealthiest decile of the population.
• Income Share of Poorest 40% represents the percentage of total national income or household income held by the lowest four deciles of the population.

For instance, if the richest 10% earn 30% of total income and the poorest 40% earn 10% of total income, the Palma ratio would be 3.0. This indicates that the richest 10% earn three times as much as the poorest 40%. The income shares are typically derived from surveys or national accounts data, providing a snapshot of wealth distribution.

Interpreting the Palma Ratio

Interpreting the Palma ratio is straightforward: a higher ratio indicates greater income inequality. For example, a Palma ratio of 1.0 means that the richest 10% and the poorest 40% receive equal shares of the national income. A ratio of 4.0 implies that the richest 10% receive four times the income of the poorest 40%. This direct comparison helps policymakers and economists focus on the most unequal parts of the economic analysis.

The Palma ratio is particularly useful because it bypasses the middle-income groups, whose share of income has been observed to be remarkably stable across various economies. This stability allows the Palma ratio to more effectively highlight changes at the extremes of income distribution, which are often the primary drivers of overall inequality and are typically the target of public policy aimed at redistribution or poverty alleviation.

Hypothetical Example

Consider a hypothetical country, "Prosperia," with a total national income of $1 trillion.

• The richest 10% of Prosperia's population earns $400 billion (40% of total income).
• The poorest 40% of Prosperia's population earns $80 billion (8% of total income).
• The remaining middle 50% earns $520 billion (52% of total income).

To calculate the Palma ratio for Prosperia:

A Palma ratio of 5.0 indicates that the richest 10% in Prosperia earn five times as much as the poorest 40%. This ratio immediately highlights a significant level of economic inequality at the tails of the income distribution. It provides a clear, actionable economic indicator for policymakers to assess the severity of income disparities and consider potential interventions such as fiscal policy adjustments.

Practical Applications

The Palma ratio is increasingly used by international organizations, governments, and non-governmental organizations to assess and monitor income inequality. Organizations like the Organisation for Economic Co-operation and Development (OECD) have adopted it as a supplementary measure to understand income disparities, often alongside other economic indicators.³ It serves as a valuable tool for:

• Policy Design: Governments use the Palma ratio to inform the design of social welfare programs, tax reforms, and other redistributive policies aimed at narrowing the gap between the rich and the poor. A high Palma ratio might prompt discussions about progressive taxation or increased investment in education and healthcare for lower-income groups.
• Cross-Country Comparisons: The ratio allows for straightforward comparisons of inequality levels between different nations, regardless of their stage of economic development. This helps in identifying global trends and best practices in addressing income disparities.
• Advocacy and Awareness: Non-profits and advocacy groups frequently cite the Palma ratio to raise awareness about extreme income inequality and pressure governments and international bodies for more equitable policies.

Limitations and Criticisms

While the Palma ratio offers a compelling and focused perspective on income inequality, it is not without limitations. A primary criticism is that by focusing exclusively on the top 10% and bottom 40%, it disregards the income dynamics of the middle class (the 50% in between). While Palma's research suggests the middle's share is stable, neglecting this large segment might obscure important shifts in their economic well-being, such as declining real wages or increased household debt, which contribute to overall economic stress but are not reflected in the ratio.²

Furthermore, like other income-based measures, the Palma ratio relies on the accuracy and availability of income data, which can vary in quality across countries. It may not capture wealth inequality, which often presents a much starker picture of disparity than income alone, as wealth includes assets like property, stocks, and savings. Despite these criticisms, its intuitive nature and focus on the most unequal parts of the income distribution make it a valuable addition to the toolkit for analyzing and addressing economic inequality.

Palma Ratio vs. Gini Coefficient

The Palma ratio and the Gini coefficient are both widely used measures of income inequality, but they approach the concept from different angles.

The Gini coefficient measures the overall inequality across the entire income distribution, ranging from 0 (perfect equality, where everyone has the same income) to 1 (perfect inequality, where one person has all the income). It is a comprehensive single number that reflects the distribution across all income levels. However, because it averages out disparities across the entire population, it can be less sensitive to changes at the extreme ends of the income spectrum, and different income distributions can result in the same Gini coefficient.

In contrast, the Palma ratio specifically highlights the disparity between the richest 10% and the poorest 40%, deliberately excluding the middle 50%. Its strength lies in its focus on the income shares where most of the inequality dynamics are observed. Proponents argue that the Palma ratio is a more "policy-relevant" measure because it directly points to the areas of the income distribution where policy interventions aimed at redistribution are most likely to have an impact.¹ While the Gini coefficient provides a broad overview, the Palma ratio offers a sharper, more focused lens on the most significant income gaps.

FAQs

Why is the Palma ratio important?

The Palma ratio is important because it highlights the concentration of income at the extremes of the income distribution, specifically comparing the wealthiest 10% to the poorest 40%. This focus makes it a particularly relevant economic indicator for understanding and addressing the most significant disparities in a society, informing public policy decisions related to redistribution and social welfare.

How is the Palma ratio different from other inequality measures?

The Palma ratio differs from other common inequality measures, such as the Gini coefficient, by concentrating solely on the income shares of the richest 10% and the poorest 40%. It is based on the empirical observation that the middle 50% of the population's income share tends to be remarkably stable across diverse countries, meaning that changes in overall inequality are largely driven by what happens at the top and bottom.

What does a high Palma ratio indicate?

A high Palma ratio indicates a high degree of economic inequality, specifically that the richest 10% of the population commands a significantly larger share of national income compared to the poorest 40%. For example, a ratio of 4.0 means the richest 10% earns four times as much as the poorest 40%.

Is the Palma ratio used by governments?

Yes, the Palma ratio is increasingly used by governments and international bodies, including the OECD and the United Nations, to analyze and report on income distribution. Its clear interpretation and policy relevance make it a valuable tool for monitoring inequality and informing social and economic policies.