How is inequality defined and measured?

Economic inequality is of concern to citizens: 81% of Europeans believe that income gaps are too wide and 78% believe that governments should take more action to reduce them (Eurobarometer, 2022).1 In this Dossier, we will analyse how inequality has evolved over the last few decades, both globally and in Spain. Before we start, however, we will review the main metrics used to track this evolution, as well as the different levers that can be harnessed to promote a more equitable distribution of income.

Income is the main variable that determines individuals’ economic prosperity, hence it is used to analyse economic inequality. One of the most commonly used metrics is the Gini index, due to its simplicity and ability to summarise income dispersion in a single figure. This index takes values between 0 (perfect equality) and 100 (maximum inequality), which facilitates the comparison between different countries and periods. The Gini index is very informative, but it has its limitations. For example, it does not provide detailed information on income distribution at the extremes of the distribution. To get a more complete picture, it can be helpful to combine this metric2 with others, such as income ratios for different percentiles of the distribution or the percentage of total income that is received by the 1% of the population with the highest incomes. This latter indicator focuses on how incomes are concentrated at the top end of the distribution, thus giving us a window into extreme inequality. It is also important to emphasise that it is not just income inequality that influences economic well-being. Wealth inequality, for example, may differ from income inequality, but it is also relevant.

A different level of income can be the result of a different level of effort, education and training or entrepreneurship. In a meritocratic society, it is reasonable that those who invest more time and resources in their education and training, or those who take business risks, receive greater financial rewards. However, greater income inequality can also result from opportunities not being evenly distributed, which can act as a break for the social elevator. Moreover, this second reason can be particularly harmful for social cohesion. The perception of injustice and the lack of social mobility can lead to resentment and a mistrust in institutions.

Economic inequality can also lead some people to make inefficient decisions given their preferences and skills. People with low incomes often face severe restrictions in their ability to access the information and resources needed to make decisions in relation to both employment and their education and training. For instance, they may not have the time to look for the best job opportunities or to invest in their education, due to the need to work long hours to meet their basic needs. This situation not only perpetuates inequality, but it also results in an inefficient allocation of human resources, which can adversely affect overall economic growth. Thus, while some income inequalities may be both justifiable and beneficial to the economy, it is crucial to address excessive inequalities or those arising from a lack of opportunities, in order to nurture a just and cohesive society.

Traditionally, policies aimed at reducing inequality have been distinguished into two groups: those that act before a person enters the labour market and begins to generate income, and those that act directly on income distribution. Redistribution measures – mainly implemented through progressive taxation policies and a catalogue of public subsidies such as unemployment benefits, furlough benefits and a minimum guaranteed income, among others – reduce inequality by directly modifying income inequality. In contrast, public policies that aim to reduce inequality ex ante are those which promote equal opportunities and employability. Education, employment and social policies contribute to greater social mobility and are of increasing importance. For example, in the sphere of education, early action through interventions in early childhood and primary education helps to achieve greater equality of opportunities. There is a third type of lever that is also gaining prominence, in this case due to the consequences for inequality that technological change and globalisation have produced in some cases. These are the measures that act directly on what Rodrik and Stantcheva call the production stage.3 Specifically, these are policies aimed at boosting productivity, innovation and, ultimately, growth in the sectors most affected by these secular trends, such as support for R&D or competition policies.

In short, in order to achieve an inclusive form of prosperity, public policies must act in multiple spheres in the so-called pre-production, production and post-production stages (see chart) and they must make use of a variety of tools to this end. A holistic approach to public policies is needed in order to reduce existing inequalities and to try to prevent them from being perpetuated over time and, in doing so, to promote a more equitable and sustainable economy.