Why The Free Market Doesn’t Prevent Racism

In economics textbooks there is a simple story told about racism. It explains how the free market punishes prejudice of any kind and instead builds an environment where all people compete equally regardless of their background. The explanation is simple – any business that refused to serve certain customers would earn less profit than a more tolerant rival. If you refuse to hire the most competent job applicant due to their race, gender, sexuality etc then they will work for your competitors or set up their own business and undercut you.

Economists don’t mean anything bad when they teach this theory as fact, they probably just want to apply economic theory to real life to show its relevance to students. They probably think it has a positive message by depicting discrimination as irrational. However, what they don’t realise is the darker implications of the theory. You see, if the free market eliminates racism, then there is no need for the state to be involved. If the free market is left alone, then all racism will completely disappear, in fact we don’t need to take any action against discrimination because the market does it for us. If there are any differences in pay or employment based on race, then they must be due to skill and productivity, they can’t be due to bigotry. Libertarians used this very argument to propose repealing anti-discrimination Civil Rights legislation and you hear similar arguments to oppose laws mandating bakers must sell to gay couples or that women must receive the same pay as men.

Yet it should be obvious that this theory isn’t true. Anti-discrimination legislation was brought in for a reason, before that time racism and sexism were rampant. There were numerous areas in America that refused to serve black people and countless businesses that operated in a way that economic theory calls irrational. Private businesses refused to serve black customers even when there was no legal obstacles, such as with the Greensboro Sit-ins. How was this possible?

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Why would a private business refuse potential customers?

The essential point is that discrimination should be not studied in isolation, but rather on a broad societal level. Instead of viewing one single racist, we should examine the situation where racism is prevalent. If most of your customers are racist and don’t want to be served by non-white people, then it is economically rational to only employ white people. Your staff may also prefer to work with people from the same background and may even experience a productivity boost due to discriminatory hiring.

This can even be the case if the staff is not overtly racist, for example, while in America, I worked in a business that only hired Irish people. As a result, there was an immediate connection between the staff and a co-operative working environment. This degree of trust is a possible explanation for why ethnicities tend to cluster in certain occupations and businesses often hire family members. An employer wants an employee they can trust to work hard even when not supervised, but it’s difficult to know if someone is trustworthy before they are hired. Ethnic and family bonds provide this trust.

A major problem for hiring employers is a lack of information about potential employees. There is no way to know to properly asses the skills and suitability of a candidate until they actually start working. So instead they use proxies to estimate the candidate’s suitability. This can include the school they attended, the area they are from, whether they have a recommendation and if they seem like hard workers. But all of these proxies can be tainted by prejudice. Somewhere may be judged to be a “good” neighbourhood because it is inhabited by the dominant race and being inhabited by a despised minority can be enough to deem a neighbourhood “bad”. Likewise for schools, which in a segregated society act as ethnic markers especially if they are no visible signs. Or they simply use crude ethnic stereotypes as a proxy, especially in a society with low education and therefore lacking more reliable measures.

Business can discriminate without even realising it. Traditionally the main way of hiring staff was through personal connections and recommendation from existing staff (because official interview procedures are long and time consuming). Naturally these recommendations would come from friends and family, which in a segregated society would usually be of the same ethnic group. Interviews are based on non-tangible experiences, which makes them prone to biases. If someone subliminally thinks black people are untrustworthy, they then may project this prejudice onto a candidate while still believing they are judging them as an individual.

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There is a principle known to employers called the 70-20-10 principle, which is a rough rule of thumb that 70% of skills are learned on the job, 20% from co-workers and 10% from education. As so much of the necessary skills are learned on the job, most new hires are near useless and must be trained in everything. Even jobs with the same title and job description can be very different in different companies. Each business has its own system, its own process as well as personal networks such as knowing who to contact in regard to each possible scenario. All this means that there is not a huge difference between job applicants regardless of race or gender, which means a discriminatory business is not suffering a heavy penalty.

Racism doesn’t just affect people at the hiring stage, it begins long before then. Racial minorities often have poorer quality of schools and lack resources that give wealthier children an advantage (such as private tutoring or funds for college). Lack of savings is both a result and cause of poverty, as it hampers investment in self-development and training. Higher crime rates can further deplete meagre savings and destroy investment. If they live in areas of high unemployment and with weaker social networks then they are less likely to get work experience. In fact, their social networks could be more of a hinderance than a help if their friends and family are in poverty and need support. Small differences can quickly widen to become an insurmountable gap.

Discriminated groups can only set up competing businesses if all groups are equally wealthy, which is never the case. If a minority group is disproportionately poor, then it probably lacks the capital to set up a business or to access credit. If they can’t get hired in the first place, then how do they obtain the skills and experience necessary to run the business? If they are stereotyped as dangerous and criminal, then customers will be less likely to go to their neighbourhood to do business. All start-ups suffer from high failure rates due to the large initial costs and need to build a customer base from scratch, while competing with established rivals. Adding prejudice to the list of challenges shows why competition isn’t a simple solution.

A society can unintentionally be discriminatory if the initial structure was racist. Imagine a situation where the majority group controls all the wealth, political power, runs all the businesses etc while the minority group has nothing (they could be recent immigrants or liberated slaves). Even if the majority group doesn’t intend to discriminate, decades later they could still maintain a lion’s share of the wealth. If society is segregated and they only hire people they personally know, then few if any of the minority group could even get in the door. If only the majority group is earning experience and building contacts, then they will be the only choice for promotion and higher positions. As the minority group slides into poverty, they are even less likely to be hired due to stereotypes of being dangerous and lazy. They get caught in a negative feedback loop and poverty cycle.

It is an unfortunate fact of life that some groups suffer racism and discrimination. Economists may have good intentions in arguing this is irrational, but economics must explain how the world is, not how it should be. There are situations where bigotry is profitable and there is a good reason why we needed anti-discrimination legislation in the first place.

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14 thoughts on “Why The Free Market Doesn’t Prevent Racism”

  1. I agree with most of your ideas on your subjects. However, this one I don’t. To begin with. All men are Not created equal. We are differently the same. We all have our discrimination-s. Because, we have our likes and dislikes. That’s what makes us human. It’s not just about race. It’s about everything. Our likes and dislikes. There are many people that have over came poverty without help. The Asians are a people like such. The violence and the lawlessness. Because, of discrimination and poverty. Does not hold water here. A lot of these, problems, that we people have. Are not being solved. Or, not being solved the right way. You have said, “God did not create the earth, for humans” I agree. Why not cut down on human population. We don’t belong here. It’s a cruel world. Less humans would live better. This idea, is not popular with a majority of people. Don’t have to kill humans. Just don’t keep reproducing. Until, the population is at a good level (much smaller). There is more to this. However, I need say no more. People have minds of their own. Think for yourselves, in a down to earth, logical way. You might just get somewhere. Even after all these many centuries. That humans have been Around!!!

      1. This is true. Asian discrimination was mainly the Anti-Chinese act and the sordid history of the railroads. Some states had anti-miscegnation laws against the Chinese and Filipinos but, otherwise, Asians were classified as a Honorary Aryan. They couldn’t marry white people but had most of the rights as a white person. They were allowed to go to white schools but, had to live in black neighborhoods.

        1. Thx Lisa! For the post!—It’s like someone said a long time ago. Way before this country was around. People are ashamed of things that they shouldn’t be ashamed of. And, not ashamed of things they should be ashamed of.—[(°¿°)—(*¿*)]—

  2. You raise some excellent points that are certainly worth considering. However, I feel obligated to caution against looking to government to combat racism. While there are examples of governments doing the right thing, instances of when they did something horrific are legion. An example that comes to mind is how the same US government that has many anti-discrimination laws in place is also responsible for mistreating Native Americans.

    Governments are, more often than not, reflections of the attitudes of the country’s populace. In pre-WWII Germany (for example), people noticed that Jews had a tendency to be wealthier than the general populace, and they got resentful. Couple that with how Russia had a disproportionate number of Jews in their government at the time, and one can start to follow the logic of the average German at the time. I’m not justifying what happened, I’m just explaining some of the reasons why history played out as it did.

    There are also examples of government’s inaction having a positive effect. An example of this is when Brazil decided to stop returning run-away slaves to their masters. The plantation owners soon discovered they didn’t have the resources to both keep their slaves and make a profit on their plantations. Thus, slavery ended in Brazil.

    So kudos for pointing out that economics doesn’t necessarily end discrimination. But neither does government or even ‘good’ laws/regulations. The answer is now as it has always been; in people’s hearts and minds. And the way to improve those is through education (mind), and good parenting to teach compassion/empathy (heart).

    1. I’m not really sure what your point is. Yes, the government can discriminate against people . . . so what? This article discusses the private market, not the state. It’s undeniable that the main anti-discrimination force in society is the state through Civil Rights legislation etc.

      Your comment about Jews in Germany is odd and the one about Brazil is incorrect. Slavery was abolished by legislative action, so I don’t know why you count that as an example of government inaction.

  3. Another example of economic thinking mired in Neverland. How could anyone make the original argument and not notice that it does not conform to reality? I know the “handy excuse” is “we’ve never tried really free markets,” but this is egregious. If accepting the business of a racial minority costs you a greater number of customers because of that, the argument fall apart immediately. And that agrees with reality.

    Gosh, using the arguments of economists, Wells Fargo bank would never cheat their customers, nor would investment banks put their interests above their customers. Right….

  4. Yes, if most of potential majority customers are racist, and would only go to a business that doesn’t serve minority customers, with most of the remainder being indifferent, the free market could well force a business to refuse serving minority customers.

  5. Ok, let me start with the person that says Asians are less discriminated against today . Than a long time ago. So this study says. To begin with. I am a Caucasian my ancestors are from Ireland and England. Other words, I am white. If I was a black or a Jew or anyone else. I would be and talk Exactly the same as I do now. For example; If I was a black person. I would Never live in an all black neighborhood. In this country(USA). Nor, any other country. I fully realize, that it is just human nature. That I side, with my own race. I use my own head. I am not going to put up with, stupid white people. That are violent criminals, that are going to give me a hard time. Back to the Asians. There is a lot of white people, today in the USA. That do not like Asians. I have been all over this country. And, I know from first hand. That this is true. Asians, for one thing. Have some of the smartest people in the world. They do not get into as much trouble as a whole. As other races. It is a fact, of science. Or any other true facts. To close. Look, I don’t want to debate anything with anyone. I don’t get anything for it. I don’t need the money, neither. Although, I will take it. Science says: Human nature never changes. Realize your weaknesses, and be better by it. After all, if you think for yourselves. You just might be able to find true happiness. In a very sorry world, as this one. For at least, humans anyway!!!—(*¿*)—;)—:)

  6. There is something the majority of commenters and author is missing. The majority of white people back then used EVERY source of power to kneecap African-Americans and their businesses from prospering. Jim Crow banned white people from eating in black restaurants. If they did, they were fined, sent to prison or lynched and assassinated too. Look at what happened to Viola Gregg Liuzzo, Paul Guihard, Rev. James Reeb, and Jonathan Myrick Daniels.

    African-Americans were denied the right to loans, the right to education, to read or write. The few wealthy African-Americans that were able to open businesses were razed in race riots like the Tulsa race riots, Rosewood race riots, and the Wilmington race riot. They couldnt go to the police to complain because the police were the ones who did this. Part of economics is based on people being rational actors with access to all available information to determine opportunity costs and risks. If you are cut off from that, you cant make rational decisions.

    They were forced to pay poll taxes, go through grandfather clauses, illegal literacy tests, and sometimes, after all that, licenses were still withheld. They complained to the employers to fire their African-American workers and then have them arrested by the police dept for loitering. They campaigned to the mayor to shut down business or pressure newspapers not run ads. If all of that didnt stop them, cross-burnings and lynchings were the next option.

    The free market doesn’t prevent racism nor solve all of the problems l listed. These things happened in real life and the fact that libertarian wish to undo these significant changes are why African-American libertarians are few in numbers.

    1. Once again Lisa! I agree with you! This is kind of complicated. Free trade will not solve . Racial problems, by itself. However, it can be a tool to help. For example: If someone makes good cars. With competitive prices. Who cares who makes them? Look at all the business the Japanese are getting and have been getting. Same with the Chinese. Why can’t it be the same with people of color? It can! Lisa, these are just words. Action speaks louder than words. Too much and too many drugs! I know a lot of people don’t want to hear it! I did not make this world! It’s not my fault, the world is the way it is. Sometime ago, I tried to figure out how I or someone could make everything Fair in this world for all human beings. Guess what? It can’t be done, by anyone. This is not a f air world, it never was and probably will never be. It is a Requirement that anyone that wants to be happy, Accept! When I was a little kid. My parents made me go to church with them. I thought that would be pretty cool to be like Jesus, and love everybody. But, I don’t think that anymore. I don’t believe just blindly anymore. Because, I am not the smartest person in the world. I think for myself. I have answers that I am more than happy with. I hate to say. I do not have faith in the human race. I do have faith in myself and All the good people in the world. And, Lisa if you are mad at the world or anyone else or anything. I am with you all the Way!!! The Way of the True Heart!!! With great people like us. There is no racial barriers!!!

    2. An after note to Lisa’s comment: These things that you mention are very bad. And, I have a lot I could say about such. I believe in Good over Evil. These creeps are part of the human race. That cause this kind of hateful violent crime. They Always, end up on the bottom. Even though it may take some time for their destruction. As long as the human race is in existence, they will exist with it. It does say something about human nature. There is a lot to say about this. This is not the place for this. It is just too extensive. However, again: This country with all of it’s white people. Is not as bad as what you have mentioned. I think most people. Of all races want to do the right thing. They are just not very smart. Look here: This world was born that way. It does not know how to do better. Because, if it could it would. The same with individuals. If they could do better they would. That does not mean, that people should not learn nor practice to be better. Including, and especially getting along with our brothers and sisters of all races. The number one scientist of the 20 century. Einstein wrote to a fellow scientist that he thought: that mankind has a need to hate and destroy. Look at the things they do. For example they wiped out the smallpox disease. Yet, This country and Russia has stockpiled smallpox. As a weapon of mass destruction. That’s the way “they” do. They have no class! Maybe, they don’t care what people like me say about them. But, I truly believe. It’s just a belief. That it is going to be over with one day. Not too terribly far in the future. Global warming might do it. If not Something Cosmic comes this way. No more humans! No more murder! No more war! At least, when it comes to humans. Better for the planet. And, better for All humans!!! No more for me to say!!! Thank You!!!—;)—:D—!!!

  7. I appreciate your blog and your interest in and willingness to engage on the topic. I also appreciate that the comments stayed civil, even though there were disagreements. That alone is an accomplishment. Thanks

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