Comparing Living Standards around the World

Gross Domestic Product (GDP) measures the wealth of a nation and, therefore, the combined wealth of all its people, but it does not indicate how that wealth is distributed. Because the distribution of wealth has a large effect on macroeconomics, macroeconomists are interested in how inequality varies around the world. The United States has the highest GDP in the world; China has the second-highest. Nonetheless, there is a large difference in the standard of living between the average American and the average Chinese. And even with the highest GDP in the world, the United States does not have the highest standard of living. Some indication of the standard of living can be found by dividing the GDP by the number of people in the country. This yields a measure called GDP per capita.

GDP Per Capita = GDP/Population

GDP per capita statistics can be found at the World Bank.

However, GDP per capita gives only a rough estimate of the differences in the standard of living among nations, because it gives no indication of how the wealth of a nation is distributed. In most countries, wealth is distributed very unevenly, primarily because income earned from work is taxed most heavily, while income earned from investments or received from gratuitous transfers, in the form of gifts or inheritances, income that accrues mostly to the wealthy, is taxed much less. Additionally, having more money makes it easier to make even more money through investments, because unlike work, the amount earned from investments has little relation to the amount of time spent in investment activities.

Sample of GDP Per Capita 2017 Statistics

Large Geographic Regions

Purchasing Power Parity

GDP per capita does not give a complete picture of the standard of the living, because the foreign exchange rate does not account for how a basket of goods and services is priced in local currency. For instance, looking at only GDP per capita for the United States and for China would give the impression that the typical American enjoys a standard of living 7 times greater than that of a Chinese citizen. However, products and services are generally cheaper in China, so even though the average Chinese citizen earns considerably less than the average American, the discrepancy in living standards is not nearly so great.

Hence, to measure the standards of living among nations, it is also necessary to determine how much the GDP per capita would buy in that country. Purchasing power parity (PPP) is the measure used to determine the amount of currency needed to purchase a specified basket of goods and services.

The PPP is calculated to cover 3 categories: individual items, intermediate categories, and larger categories used in calculating the Gross Domestic Product. For instance, the intermediate category for Coke would be soft drinks and concentrates, while a larger category would be food. For individual items, a ratio is calculated using the respective currencies of the country being compared. For instance, if it costs €2.3 for a liter of Coke in France and $2 for a liter of Coke in the United States, then the PPP for Coke in France compared to the United States = 2.3/2 = 1.15. So, €1.15 in France must be spent for each dollar spent in the United States for Coke. The PPP for the larger categories are weighted to reflect how much is actually spent in those categories, to reflect the true purchasing power of the local currency in terms of what people actually buy.

Although PPP is difficult to measure, the Economist magazine publishes a Big Mac Index as a rough indicator of PPP, which is the price, in local currencies, to buy a Big Mac hamburger at the many McDonald's restaurants located throughout the world, and compares this to the United States dollar (USD). The Big Mac Index shows what the implied PPP is in USD, equal to the price in local currency divided by the price in the United States, and compares this to what the actual exchange rate is. None of the exchange rates shown in the latest index shows purchasing power parity, although some come close, which could simply be a coincidence.

Many PPP statistics can be found on the website of the Organisation for Economic Co-operation and Development (OECD), and of the International Monetary Fund.

Comparing Living Standards over Time

Macroeconomists also like to compare living standards over time. While comparing GDP per capita over time is easy enough, it does not account for quality improvements. For instance, computers today have much more capability, and yet are cheaper, even in nominal dollars, than computers sold 10 or 20 years ago. Even the quality of cars has improved more than their prices, especially if the prices are discounted by inflation. Although government agencies try to account for some of the quality improvements in their statistics, it would be difficult to measure all gains in quality.

Human Development Index (HDI): Measuring Quality of Life Based on Life Expectancy, Education, and GNI Per Capita

Another measure of quality of life is the Human Development Index (HDI), which measures quality of life based on life expectancy at birth, education, and gross national income per capita, adjusted in PPP dollars. The educational component is measured as the mean number of years of education for adults at least 25 years of age and the expected number of years that children will remain in school. The GNI per capita, like, and equal to, GDP per capita, measures the amount of income per person if the national income were distributed equally. Although the HDI does not measure how income is actually distributed, some indication of its distribution is provided by the measures of education and life expectancy, since both measures are higher for wealthier people than for poorer people. Other related indexes, based on the same information sources, include:

Much of the information used to compile these indexes are based on government statistics.

Gini Coefficient: Measuring Inequality

Even if a nation does have a high GDP per capita, it does not mean that the income is distributed fairly. One measure of inequality is the Gini coefficient, developed by the Italian statistician - and former fascist - Corrado Gini in 1912, building on the work of American economist Max Lorenz, who published a graphical representation of total equality - a straight diagonal line on a graph - in 1905. The Gini ratio is derived from the difference between this hypothetical line and the actual line based on people's incomes.

The Gini coefficient measures inequality, ranging from 0, which is perfect equality to 1, perfect inequality, where one person has everything. Countries vary widely in their Gini coefficients. For instance, in 2012-13, the UK's Gini ratio for income inequality was 0.332, as measured by the Office for National Statistics. Individual cities vary in their equality – London is the most unequal, as most large cities are, while Sunderland is most equal. The Scandinavian countries — Denmark, Finland, Norway, and Sweden — have very low Gini coefficients averaging about 0.27, because wealth is redistributed through taxes.

The Gini coefficient is graphed schematically by the Lorenz curve, which plots the percentage of households against the percentage of national income that they earn. In the graph, the Lorenz line of equality goes from 0 to 1. The straight-line means that given any percentage of households, they will earn the same percentage of national income. But the Lorenz curve bulges inward because no society is truly equal. Indeed, many countries are very unequal. The curve always starts at 0 because 0% of the households would have 0% of the income; likewise, the curve terminates at 1 because 100% of the population must receive 100% of the income. The closer that the Lorenz curve is to the line of inequality, the more equal the distribution of wealth within the nation. The Gini coefficient is simply a number indicating how close the Lorenz curve is to the line of equality:

Diagram illustrating how the Gini coefficient is calculated, showing the light of equality and the Lorenz curve.

Gini Coefficient = A/(A + B)

A and B are the areas above and below the Lorenz curve respectively. So, the closer that the Lorenz curve is to the line of equality, the smaller the area of A, the larger the area of B, and the smaller the ratio, which is, of course, the Gini coefficient.

The Lorenz curve bulges outward at 1st, because as the percentage of the poorest increases, the percentage of income that they earn does not increase nearly so much. At the top of the spectrum, the exact opposite occurs; the curve starts moving rapidly toward the line of equality because it starts including people with more wealth, causing the income to increase more rapidly than the percentage of households considered, until it reaches 100% for both income and population. For instance, in the United States, since the top 1% receives 20% of the income, that means that the bottom 99% receives only 80% of the income, so the curve is still far from the line of equality even when 99% of the population is included.

The Gini coefficient is a simple numerical measure of inequality, allowing comparisons among countries and across time. There are also other measures of inequality that are commonly used, such as the percentage of income earned by the top 1%, which in the United States is 20% and rising.

Another measure of inequality is the decile dispersion ratio, which measures the ratio of a specific percentage of the richest people compared to that same specific percentage of the poorest people. A common percentage is 10%, where the income of the top 10% of the highest earners is compared to the bottom 10% of the poorest. So, for instance, the top 10% earned more than 11 times what the bottom 10% earned in the United States.

Another method of measuring inequality is the Palma ratio, which is the ratio of the income of the richest 10% of the population over the bottom 40%, which shows better than the Gini coefficient the changes in wealth in the top 10% over the bottom 40%.

The Cause of Inequality

Inequality in money often results from inequality in abilities or opportunities, but much of inequality is the result of the unequal distribution of money through unfair tax laws and other political methods of redistributing the wealth. For instance, politicians pass laws to enrich themselves and their cronies, or they simply confiscate property, or use other methods indicative of political corruption. This is especially true in many African nations and other Third World countries. Iran and Venezuela have enormous resources of oil and gas, yet most of those people live in abject poverty. Indeed, some politicians want to enrich themselves so badly, that they are willing to kill many people to maintain their power and their wealth. Kim Jong-un of North Korea, for instance, is building nuclear weapons and the missiles to carry them to protect his despotism.

Unfair tax laws are a major method of redistributing the wealth, usually from the poor and middle-class to the wealthy, since many politicians are wealthy themselves and the wealthy have money to influence the politicians, a situation that exists in all economies, including modern economies! Even in modern economies, most of the tax burden is placed on working income, while earned income and gratuitous transfers, income that accrues mostly to the wealthy, are taxed much less. Furthermore, more money allows people to earn even more money, by investing it. Finally, not only are investments taxed less, but investments do not require the time and effort that work requires.

Of course, laws could be passed to make tax laws fairer. A simple way to do this is to apply the same progressive, marginal tax rate that is applied to working income, including employment taxes, to all income. It is obvious that taxing investments and gratuitous transfers less allows the wealthy to accumulate ever greater portions of the national income. Furthermore, the heavy tax burden on work is even heavier than the tax rate would imply, since the marginal utility of money for poorer people is much greater than the marginal utility of money for rich people, simply because the poor need the money to pay for food, shelter, health insurance, and other basic necessities of life, whereas the rich already have plenty of money for those purposes and simply spend it to impress their other rich friends, such as buying art for more than $100 million apiece! Additionally, allowing poor people to keep more of their money would also benefit the economy most, since they would spend the money more readily than if it were given to rich people. After all, who do you think would spend more of $1 billion in tax breaks: 10 million people who receive $100 apiece in tax breaks or 1 person who receives the entire $1 billion? But, alas, one thing rich people do spend money on is corrupting politicians, so that they pass laws that favor them over everybody else. And that is a major source of inequality!

Although some inequality results from differences in ability, technology greatly magnifies those differences, because technology allows a few people to reach a worldwide audience, allowing them to accrue a fortune. For instance, celebrities and star athletes earn a lot of money, because technology allows them to profit from a worldwide audience. But if they were born in the Middle Ages, they would all be peasants. After all, how much could a singer earn if there was no Internet, no way to record sound, no way to transmit sound, such as with loudspeakers. Even the development of musical instruments required the efforts of many people over many years. Moreover, people living in the Middle Ages would not even have time to listen to a live musical performance, and even if they did have the time, it would have to be a local venue, since people could not travel very far in those days. Technology allows us people to earn an enormous money wealth, but they had nothing to do with creating the technological infrastructure that allow them to accrue such wealth. It was a free gift from society, so it can be argued that they should be willing to pay more in taxes. Inequality will decline markedly, and the poor and the middle class could be happier, if the tax burden were shifted from the poor and the middle class to the wealthier members of society, by taxing work the least, taxing investments a little more, since little time is required to make investments, and taxing gratuitous transfers the most, especially since there is no deadweight loss in taxing gratuitous transfers.