The Palma ratio is a measure of income or wealth inequality that compares the share held by the richest 10% of a population with that of the poorest 40%. It's a straightforward way to understand how wealth is distributed within a society.
Understanding the Palma Ratio
The Palma ratio was inspired by Chilean economist Gabriel Palma. It contrasts the extremes of the wealth distribution, focusing on the top and bottom ends, rather than more complex calculations. According to the reference provided from May 18, 2023:
The Palma Ratio compares the income or wealth share of the top 10% of the population (the richest) to the income or wealth share of the bottom 40% of the population (the poorest). The ratio is named after Chilean economist Gabriel Palma, who inspired its development.
How is it Calculated?
The Palma ratio is calculated by dividing the income or wealth held by the richest 10% of the population by the income or wealth held by the poorest 40%.
- Formula: Palma Ratio = (Income or Wealth of Richest 10%) / (Income or Wealth of Poorest 40%)
Practical Insights and Examples
A higher Palma ratio suggests a more unequal distribution of wealth. For example:
- If the richest 10% holds 50% of the wealth and the poorest 40% holds 10%, the Palma ratio would be 5 (50% / 10% = 5). This indicates a significant wealth gap.
- If, however, the richest 10% holds 25% of the wealth and the poorest 40% holds 20%, the Palma ratio would be 1.25 (25% / 20% = 1.25), indicating a more equitable wealth distribution.
Why Use the Palma Ratio?
- Simplicity: It's easier to understand and calculate compared to more complex inequality measures like the Gini coefficient.
- Focus on Extremes: The Palma ratio highlights the disparity between the richest and poorest, which are often the areas of most concern.
- Policy Implications: It can help policymakers pinpoint where interventions might be needed to address economic inequality.
Table: Palma Ratio and Inequality
| Palma Ratio | Interpretation |
|---|---|
| Low | More equitable distribution |
| Medium | Moderate inequality |
| High | Significant inequality |
Strengths of the Palma Ratio
- Focus on Key Groups: It directly addresses the income gap between the most wealthy and most vulnerable populations.
- Practical Understanding: Provides a clear and intuitive measure of economic disparity.
Limitations of the Palma Ratio
- Ignores Middle 50%: It doesn’t consider the income or wealth distribution of the middle 50% of the population.
- Simplicity: While an advantage, its simplicity might oversimplify the complexities of income and wealth distribution.
The Palma ratio offers a quick and useful metric for assessing income or wealth inequality by focusing on the wealth or income share of the richest 10% relative to the poorest 40% of a population, providing a clear, though not exhaustive, picture of wealth distribution within a society.
