Income in poor countries overestimated

Ingvild Almås of the Norwegian School of Economics (NHH) believes that incomes in poor countries are systematically overestimated in traditional economics research. She launches a new method for measuring income in the April edition of American Economic Review. In Norwegian

26.04.2012 - Knut André Karlstad (translated by Douglas Ferguson, Allegro)

Almås's article in the journal is based on the work she did in connection with her doctorate, which she was awarded at NHH in 2008. The topic of her dissertation was economic inequality.

'For example, it is not obvious how an income in Tanzania can best be compared with an income in Norway. You can use exchange rates. Then there are so-called price-adjusted or purchasing power-adjusted measures. The problem is that both these methods result in systematic errors,' Almås explains.

These errors lead to unclear and often contradictory conclusions when comparing incomes between different countries. If, for example, you base the comparisons on exchange rate-based measures, you will conclude that the inequality between poor and rich countries has increased in recent years, while, if you use purchasing power-based measures, you will reach the opposite conclusion in most cases.

Launches a new method

The principles used to compare incomes in the two methods are as follows: If you are going to compare the average income in the USA and China using an exchange rate-based measure, you find the average income in China and convert it into US dollars. Purchasing power-adjusted measures are used to try to take account of the fact that the price levels in the two countries differ. This means that a shopping basket of selected goods in China will not cost the same as the same basket in the USA if you measure the price in, for example, dollars.

As a way of solving the measurement problem, Almås is launching a new method for measuring economic inequality.

'Existing measures are based on figures from the national accounts at the macro level. My idea is to carry out very detailed studies,' she explains.

It is an established fact in the literature in the field that the proportion of a household's budget that is spent on food is lower the higher the household's income. This means that the richer you are, the less you will spend, relatively speaking, on food. This is called Engel's law. Almås finds that households in the USA spend 18% of their budget on food on average, while the corresponding proportion in developing countries is more than 50%.

'To simplify, we could say that if you tell me what proportion of your budget you spend on food, I can tell how big your income is. The good thing about this is that I can ask you about your budget percentage instead of asking about your whole income. The good thing about the method is that budget percentages are not dependent on the overall price level in the country in the same way that income will be,' Almås says.

In the article, the researcher has used detailed information at household level: how much do households consume of eggs, milk, flour and other household goods. The main idea is that, if you use the budget percentage as a method as well as detailed household information, then some of the measurement problems are avoided.

Seven years' work

In practice, Almås's research argues that it is necessary to carry out very detailed studies to obtain a more correct picture of income distribution in the world.

Ingvild Almås has had her work published in the April edition of the prestigious American Economic Review, one of the most reputed economics journals in the world. And that is not all - she is also the first Norwegian woman ever to be sole author of an article in the journal, and the first researcher from NHH to be sole author, regardless of gender.

'It's terrific, really wonderful. It is the result of seven years' work, however. The idea came to me when I was on a trip to a cabin with a friend in summer 2003, when I wrote the outline and application for my doctorate,' she tells us. She adds that the article would probably never have enjoyed quite as much success without important guidance from her main supervisor, Bertil Tungodden. She has also had good help from her secondary supervisor Jo Thori Lind at the University of Oslo and colleagues at the Department of Economics. Almås has been a guest researcher at Princeton University in the USA, but she is now back as an associate professor at NHH, where she is continuing her research on economic income distribution.