Imagine a tiny country, no bigger than your neighborhood, with $100 billion in assets. From just this information, it sounds like a great place to live. When you learn that only four people live there, it sounds even better - until you find out that three of them have a net worth of $0 each. Income distribution was the missing factor in the initial evaluation. The Gini coeffcient was specifically designed to measure this factor, which has implications for the economic health and national policy of a nation. This article will show you how to interpret and apply the Gini index.

Interpreting the Gini

The index is based on the Gini coefficient, a statistical dispersion measurement that ranks income distribution on a scale between 0 and 1. The measure has been in use since its development by Italian statistician Corrado Gini in 1921. It can be used to measure the inequality of any distribution, but is commonly associated with wealth.

In the example noted above, the Gini index would register a reading of 1, which indicates perfect inequality. If everyone had exactly the same amount of money, the index would register a reading of 0. The number can be multiplied by 100 in order to express it as a percentage.

The Gini coefficient for a country is often displayed visually using a graph called the Lorenz curve, as depicted below. On the x-axis the percentage of the population is displayed that earns what total percent of income (the y-axis).

Example of Lorenz Curve
Example of Lorenz Curve.

Gini In the Real World

Statistics for The World Factbook produced by the U.S. Central Intelligence Agency cite a range from about .22 to .63. Europe generally posts relatively low numbers. The United Kingdom came in at around .32 (2012), the United States at .45 (2007).

While low numbers represent greater equality, low numbers aren't always a perfect indicator of economic health. Nations such as Sweden, France and Iceland all cluster in the .20s, as do a host of former Soviet nations. In the former nations, the numbers are close because residents generally have a high standard of living, while in the latter the close numbers suggest a relatively equal distribution of poverty.

(For more information on how quality of life is quantified, read Genuine Progress Indicator: An Alternative Measure Of Progress.)

Even in affluent countries, the Gini index measures net income, not net worth, so the majority of a nation's wealth can still be concentrated in the hands of a small number of people even if income distribution is relatively equal. Consider that significant holdings of non-dividend paying stock, for example, could give an individual a low income but a high net worth.

Wealth Inequality, World Bank
Wealth Inequality, World Bank.

Tracking Trends

Seeing a single number provides a picture of the distribution at a given point in time, while tracking the trends provide a picture of the direction in which a nation is moving. In the United States, for example, the numbers are rising and have been doing so since the late 1960s, according to the U.S. Census Bureau. The rich truly are getting richer. This trend is reflected in the phenomenon of the disappearing middle class, as income distribution increases at the top end of the scale, forcing those in the middle toward the lower end of the scale. According to a March 2007 article in The New York Times, based on IRS data released in 2007, income inequality increased significantly in 2005 in the U.S. In fact, the top 10% of income earners reached a level of income share that had not been recorded since before the Great Depression.

(Be sure to check out Losing The Middle Class, which provides additional insight into this trend.)

Implications For National Policy

The Gini index can help nations in their effort to track poverty levels. Noting that the income distribution in a nation is becoming more unequal can allow government officials to delve into the issue and determine its causes. In addition, the Gini index can be compared to gross domestic product (GDP) figures. If GDP increases, some take this to mean that the people in a country are doing better. However, if the Gini index is rising as well, it suggest that the majority of the population may not be experiencing increased income. In the case of income inequality, governments will sometimes redistribute wealth through social programs and taxation policies.

(For related reading, see What is GDP and why is it so important?)

The Bottom Line

While the Gini index may seem, at first glance, to be an indicator of a fairly abstract concept, in many cases net income has a direct effect on quality of life. A look at some of the world's poorest areas provides a glimpse of slums and poverty that few of us want to experience firsthand, and offers a striking contrast to the living conditions of the rich.

If the gap between rich and poor continues to increase, the evaluation of this income gap is likely to becoming more important. Knowing the Gini index numbers is no panacea, but this measure does provide a way to quantify and track the direction a in which a society is moving, which may open the door for dialogue and potential solutions.