The Young Person's Guide to the Theil Index: Suggesting Intuitive Interpretations and Exploring Analytical Applications

Abstract

Growing interest in inequality has generated an outpouring of scholarly research and has brought many discussions on the subject into the public realm. Surprisingly, most of these studies and discussions rely on a narrow set of indicators to measure inequality. Most of the time a single summary measure of inequality is considered: the Gini coefficient. This is surprising not only because there are many ways to measure inequality, but mostly because the Gini coefficient has only limited success in its ability to generate the amount and type of data required to analyze the complex patterns and dynamics of inequality within and across countries. Often, in defense of the use of the Gini coefficient, it is argued that this popular indicator has a readily intuitive interpretation. While from a formal point of view most measures of inequality are closely interrelated, at an intuitive level this interrelationship is rarely highlighted. This paper suggests an intuitive interpretation for the Theil index, a measure of inequality with unique properties that makes it a powerful instrument to produce data and to analyze patterns and dynamics of inequality. Since the potential of the Theil index to generate rich data sets has been analyzed elsewhere (Conceicao and Galbraith, 1998), here we will focus on the intuitive interpretation of the Theil index and on its potential for analytical work. The discussion will be accompanied throughout with empirical applications, and concludes with the description of a simple software application that can be used to compute the Theil index at different levels of aggregation of the individuals that compose the distribution.

JEL Classification: J31