Contradictory Trends in Global Income Inequality: A Tale of Two Biases

Abstract

Did global income inequality rise or fall over the last decades of the twentieth century? The answer depends on how cross-country income comparisons are made. Exchange rate comparisons suggest that inequality rose whilst the purchasing power comparisons of the Penn World Table suggest it fell. We show that both measures of real incomes lead to biased international income comparisons. Exchange rate comparisons ignore the relative price of non-tradables, whilst the fixed price method underlying the Penn World Table is subject to substitution bias. The contradictory trends are due to growing dissimilarity between national price structures increasing the degree of bias in each method. When we correct the income data to eliminate bias we find no compelling evidence of a significant change in world inequality.

Global inequality recalculated and updated: the effect of new PPP estimates on global inequality and 2005 estimates

“…Weighted international inequality (Concept 2 inequality) also uses national GDPs per capita but weights them by populations of the countries. 13 It thus begins to approach global inequality (inequality calculated across world individuals) because the number of people who live in various countries is taken into account even if they are all assumed to have the average income (GDP per capita) of their country. This assumption is abandoned in global inequality (or Concept 3) which calculates inequality across world citizens, taking in principle everybody's actual income into account.…”

“…and reduce the price level in rural areas by an estimated 20% (see [38], p. 138)" ( [23], p. 61). 13 Note that the use of the term "international" here is not accidental. Concept 1 and 2 inequalities are truly those between national mean incomes, and not between individuals.…”

“…It is worth mentioning that these estimates of PPPs are obtained by using a particular approach to the index number problem aggregation called EKS (Eltöte, Köves and Szulc) and that this aggregation produces, in principle, different PPPs from the alternative aggregations such as GearyKhamis (used by Penn World Tables) or Afriat, recently studied by Dowrick and Akmal[13] and Ackland et al[1].…”

World Income Distribution: Which Way?

“…This means that a so-called substitution bias is built into the P$ estimates. Dowrick and Akmal [2001] provide income estimates corrected for this bias, which suggest smaller inter-national differences in incomes than indicated by FX$ income data, but larger than indicated by the P$ data. There are many additional, unresolved problems with the P$ estimates from the ICP, such as measuring quality differentials of products and valuing non-marketed services [Deaton, 2001;Rao, 2002].…”

“…It is somewhat surprising, however, that very little space has been devoted to assessing the P$ data used throughout the literature on world income distribution. The main exceptions are Dowrick and Akmal [2001] and Dikhanov and Ward [2002], who derive income data corrected for substitution bias -while still finding the inter-national income distribution to be largely unaltered over time (see also Dowrick and Quiggin, [1997]). …”