The Roles of Location and Education in Income Inequality: An Analytical Framework

Abstract

This study develops a two-stage hierarchical inequality decomposition method as an analytical framework for the examination of the roles of rural/urban location and education in income inequality. It compares this method with a non-hierarchical inequality decomposition method. In the two-stage hierarchical inequality decomposition method, a hierarchical structure of a country is considered, where individuals are classified first into the rural and urban sectors and then into several education groups. Using the Theil indices, overall income inequality is decomposed hierarchically into the following three components: the between-sector, within-sector between-group, and within-sector within-group inequality components. The between-sector component evaluates income disparity between the rural and urban sectors, while the within-sector between-group component evaluates income inequality among the education groups, but adjusted for rural-urban differences in the structure of educational attainment. The within-sector within-group component assesses inequality within the education groups. In the non-hierarchical inequality decomposition method, overall income inequality is decomposed simultaneously but non-hierarchically based on individual attributes. In the context of location and education, overall income inequality, as measured by the Theil indices, is decomposed non-hierarchically into the following four components: the between-sector, between-group, location-education interaction, and within-sector within-group inequality components. The location-education interaction component assesses the extent of rural-urban differences in the income disparity among the education groups. It can take a negative value. Based on nation-wide household surveys, this study also presents the results of hierarchical and non-hierarchical inequality decomposition analyses for Indonesia and the Philippines