Can Discrimination Thrive in a Free Market?

The Issue:

A traditional economics approach to discrimination holds that the free market will punish firms that discriminate. In theory, a business that refuses to employ people on the basis of their race, gender, religion or other characteristics deprives itself of a broader pool of talent and therefore is likely to have to pay higher wages or settle for lower-quality workers. Similarly, there is an argument that a business that refuses to serve specific groups limits its potential customer base. Competitors who are not limited by these restrictions would have higher profits and, eventually, drive the discriminator out of business. Following this logic, many economists, most famously Milton Friedman, argued that government intervention was not needed to stop discrimination since the market would solve the problem. However, when discrimination is driven by consumers' preferences to not interact with certain groups of people, this reasoning no longer holds. In this case, discrimination is economically rational and can persist in a free market. The discrimination in public accommodations experienced by Black Americans prior to the Civil Rights Act of 1964 illustrates this. A historical analysis shows that federal policy was required to overcome the pervasive discriminatory practices of that time.

While the market may punish firms who discriminate, the market is powerless  when consumers are the ones who value discrimination.

The Facts:

• Before the passage and enforcement of the 1964 Civil Rights Act, African Americans could not eat in many restaurants, or stay in many hotels or motels, or received a lower class of service than White Americans at establishments that served the public at large. There was variation in the types of discrimination that African Americans faced in public accommodations. While hotels discriminated at the extensive margin (not serving Black customers at all), other businesses practiced intensive discrimination, accommodating Black customers but at a lower level of service. For example, a clothing store would sell to Black patrons but they were not allowed to try on items to see if they fit nor would they be allowed to return purchases. Restaurants might only offer Black customers take-out orders and they were not allowed to eat in the restaurant. Black Americans traveling to a large city in the United States could find themselves unable to find a single hotel that would rent them a room and, in their travels, they found that no gas station along the route would allow them to use the restroom. These forms of discrimination impeded the economic lives and freedoms of Black Americans.
• Contrary to current perceptions, discrimination of Black Americans in public accommodations didn't just happen below the Mason-Dixon line. For example, more than 90% of hotels in the United States in the 1950s refused to have Blacks stay the night, according to historian Mia Bay. One rich source of information that captures the nature and extent of discrimination in public accommodations experienced by Black Americans are national directories of businesses that provided safe and dignified service to Black patrons. The most famous are the Negro Motorist Green Books, published by Harlem postal worker Victor Green and his associates, which were travel guides for Black travelers published from 1936 to 1966. These directories listed hotels, gas stations, restaurants, and other businesses that were friendly towards Black clientele. The Green Books (and their competitors) had a wide distribution among Black Americans in the middle of the 20th Century — reaching over two million consumers at their peak — because being in the wrong place could range from being very uncomfortable to having dire consequences. In new research using the location of the businesses in the Green Books, we find that, consistent with the nationwide practice of de facto racial discrimination, the majority of Green Book listings were actually outside of the South. Even in Northeastern states, where some anti-discrimination laws were in place starting in the 1950s, there were thousands of Green Book listings. The existence of such listings make it clear that Black patrons could not take service for granted even outside of the South. As a share of businesses, however, Green Book businesses were relatively rare. This made finding such businesses all the more important for Black consumers. 
• How could such widespread discrimination happen in a market economy? While the market may punish firms who discriminate, the market is powerless  when consumers are the ones who value discrimination. If consumers have discriminatory tastes, they are willing to pay for discrimination. And the profit maximizing firm will make more profit by being discriminatory. In this case, the market offers no solution at all—in fact, discrimination is profitable. This was the concern of businesses during the years of lunch-counter sit-ins and other protests against racial discrimination. Business owners worried that serving Black customers on an equal basis with whites would alienate white customers who harbored racial prejudices and that the losses from white consumers could outweigh the gains from serving Black customers. In North Carolina, for example, businesses worried that “if they served all races on an integrated basis … they will lose a sufficient percentage of their present patronage to the nonintegrated…establishments [and] cause a presently profitable [business] to operate at a loss.”
• The market solution when discrimination is driven by the tastes of consumers is neither a fair nor just one, and market intervention is needed to end this practice. This is one reason why businesses (some begrudgingly) supported non-discrimination ordinances. It was not only that it forced them to treat all customers equally, it also required their competitors to do the same. State laws banning racial discrimination in public accommodations began to surface in about the middle of the 1950s. The federal ban on racial discrimination in public accommodations, which came with the Civil Rights Act of 1964, eliminated the opportunity to profit from this type of racial discrimination and ended the need for Green Books — just one edition was published after the Civil Rights Act. Interestingly, research from Gavin Wright finds that the fears by business owners that providing equal access to services to all consumers would lead to profit loss proved unfounded. Wright finds that retail sales in the South actually increased quite substantially following the passage of the Civil Rights Act, as the blanket ban prevented white consumer defection from desegregated firms.