Definition
The Palma Ratio is a measure used in economics to gauge income inequality within a nation’s population. It is calculated by dividing the total income of the richest 10% by the total income of the poorest 40%. The ratio is named after Gabrial Palma, a Chilean economist, who found that the middle class income tends to be remarkably stable across nations, while inequality often stems from the top and bottom income tiers.
Key Takeaways
- The Palma Ratio is a measure of income inequality, comparing the richest 10% of a population to the poorest 40%, developed by economist Gabriel Palma.
- It is particularly useful in analyzing income distribution in countries where the middle class’s income share remains relatively stable, allowing for more focused comparison between the highest and lowest earners.
- The Palma Ratio offers a more precise and sensitive analysis of extreme wealth and poverty than other measures of inequality, such as the Gini coefficient, particularly in countries with high income disparity.
Importance
The Palma Ratio is a significant financial term as it provides a measurable perspective on income inequality within a national economy.
It contrasts the total income of the richest 10% population with the poorest 40%, sidestepping the issues encountered by measures like the Gini coefficient, which are sensitive to changes in the middle-class income.
Named after Chilean economist Gabriel Palma, this ratio is important because it specifically focuses on the extremes of income distribution.
Many economists favor the Palma Ratio because it provides a clearer picture of wealth discrepancies and illustrates the actual scale of the economic divide.
It is also useful in formulating policies to address income inequality.
Explanation
The Palma Ratio is a crucial economic tool that plays a significant role in understanding the income or wealth inequality within a nation. Instead of comparing the extremes of wealth distribution, it compares the wealthiest 10% with the poorest 40%, thereby providing a comprehensive representation of the economic disparities in a society.
It focuses on this 10/40 demarcation as these respective sections of the society often retain their economic status, while the middle class fluctuates. Thus, the Palma Ratio provides a precise calculation for policy makers and analysts to devise strategies for rectifying this skewed wealth distribution and enhancing economic inclusivity within the nation.
The purpose of the Palma Ratio lies in its capacity to display the level of income inequality in an easily interpretable and practical manner; it corresponds with policy implications directly. The Palma Ratio aids in monitoring and dictating economic policies, helping to create justifiable policy prescriptions to tackle inequality.
Governments and international bodies concerning political economy, social welfare, and development studies use this ratio to understand a nation’s economic wellbeing. By making economic inequality a visible issue via quantification, the Palma Ratio plays an instrumental role in fostering sustainable development and greater economic equity.
Examples of Palma Ratio
The Palma Ratio is a measure of income inequality within a geographic area, focusing on the ratio of the income share richest 10 percent to the poorest 40 percent. Here are three real-world examples:Chile: According to a 2017 report by the United Nations Economic Commission for Latin America and the Caribbean, Chile had a Palma Ratio of
This means the richest 10% of the population in Chile controlled nearly three times the income held by the poorest 40%.South Africa: South Africa is known for its high income inequality. A 2015 World Bank study found that South Africa had a Palma Ratio of
1, making it one of the countries with the highest ratio at that time.Sweden: Contrarily, Sweden, known for its egalitarian society, has a low Palma Ratio. According to a report from Statistics Sweden, in 2019, the Palma Ratio of Sweden was
This means that the richest 10% of the population roughly has the same income as the bottom 40%. Note: It’s important to check the most updated figures as these ratios change over time.
FAQs about Palma Ratio
What is the Palma Ratio?
The Palma Ratio is a measure of income inequality within a society. Named after Chilean economist Gabriel Palma, it compares the gross income share of the richest 10% in a society to the poorest 40%.
Why is Palma Ratio significant?
Unlike other measures of income inequality, the Palma Ratio is less influenced by the middle class and gives more importance to the tails of the distribution, i.e., the very rich and very poor. It acknowledges the argument that changes in these extreme groups are what really matter.
How is Palma Ratio calculated?
The Palma Ratio is calculated by dividing the total income of the top 10% by the total income of the bottom 40%. The closer the ratio is to 1, the closer a society is to having perfect equality.
What is a good Palma Ratio?
A lower Palma Ratio suggests a well-distributed income and a more equitable society. However, specifying a “good” or ideal Palma Ratio may vary depending on societal and economic factors of a given country.
How does the Palma Ratio differ from the Gini Coefficient?
While both the Palma Ratio and the Gini Coefficient measure income inequality, they focus on different parts of the income distribution. The Gini Coefficient measures inequality across the entire income distribution, while the Palma Ratio focuses on the extremes of the distribution, the richest 10% and the poorest 40%.
Related Entrepreneurship Terms
- Income Inequality: The significant disparity in the distribution of income among a population.
- Gini Coefficient: A measure of inequality of a distribution, a value of 0 expressing total equality and a value of 1 maximal inequality.
- Wealth Distribution: Comparison of the wealth of various members or groups in a society.
- Economic Development: The process by which the economic well-being and quality of life of a nation, region or local community are improved.
- Top 10% of Income Earners: The portion of population who earns significantly more than the median income, often used in wealth inequality studies in relation with the rest of the population.
Sources for More Information
- Investopedia: This comprehensive site covers a wide range of financial and investing topics, including the Palma Ratio.
- The Balance: Known for clear, practical advice, this source may have articles or explanations about the Palma Ratio.
- Encyclopedia Britannica: This reputable source hosts a vast amount of information and may contain detailed explanations on the Palma Ratio.
- World Bank: This international organization provides resources on global economic issues and may have reports or articles about the use of the Palma Ratio in economic analysis.
