Inequality Adjusted Income Growth By THOMAS DEMUYNCK† and DIRK VAN DE GAER‡ †CES, Katholieke Universiteit Leuven campus Kortrijk and SHERPPA, Ghent University, ‡SHERPPA, Ghent University and CORE, Universite´ Catholique de Louvain Final version received 14 July 2011. We introduce and characterize a new measure of aggregate income growth that allows us to give more weight to individuals with lower individual income growth. Our measure includes several important meas- ures of directional mobility encountered in the literature. The empirical application compares the measure of income growth between the USA and Germany, and finds that giving more weight to individuals with lower income growth reverses the ranking. INTRODUCTION This paper provides an axiomatic characterization of a new measure of aggregate income growth. Our measure differs from other measures of income growth in two respects. First, the unit of analysis in our measure is given by the growth rates of the individual incomes within the population. In this respect, we disagree with the common view that aggregate income growth should be defined as the change of an aggregate income statistic, such as, for example, the growth of mean or median income. Second, our growth measure takes into account the inequalities among individual income growth rates. Combining these two ideas, we characterize a rank-dependent growth measure that gives more weight to individuals who experience lower individual income growth. Our empirical application demonstrates that the sensitivity with respect to inequality in individual income growth is crucial to rank the inequality adjusted growth rates of the USA and Germany. This research challenges the conventional viewpoint that income growth in a society should be evaluated on the basis of a change in some aggregate income variable, such as mean or median income. Indeed, from a micro perspective, the unit of analysis should be the individual (or household) and not a representative aggregate of the whole population. In order to understand our perspective, it is necessary to make a distinction between aggregate income growth, which measures income growth for a country, population or society as a whole, and individual income growth, which is the growth experienced by a single individual. By definition, individual income growth depends only on the individ- ual’s income in the initial and final period. Having established this distinction, we believe that it is, for example, more informative to look at the average of individual income growth than to look at the growth of average income. 1 The example in Table 1 motivates our point of view. The table presents initial and final incomes for a three-person society in four hypothetical situations. The initial income distribution is determined by the vector x. We assume that this vector is the same in every situation. The final income distribution in situation k = 1,…, 4 is labelled by y k . Finally, the table provides information on the ratios of final to initial incomes g k in each of the four cases, representing the relevant measure of individuals’ income growth. The bottom row gives the same statistics for the means. Let us start by comparing the two processes x ! y 1 and x ! y 2 . The bottom row shows that the growth of mean income is almost twice as large in the latter than © 2012 The London School of Economics and Political Science. Published by Blackwell Publishing, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main St, Malden, MA 02148, USA Economica (2012) 79, 747–765 doi:10.1111/j.1468-0335.2012.00931.x