Many people believe that only government intervention prevents rampant discrimination in the private sector. Economic theory predicts the opposite: market mechanisms impose inescapable penalties on profits whenever for-profit enterprises discriminate against individuals on any basis other than productivity. Though bigoted managers may hold sway for a time, in the long run the profit penalty makes profit-seeking enterprises tenacious champions of fair treatment.

To see how this works, suppose that male and female hot-dog salesmen are equally productive and that bigoted stadium concessionaires prefer to hire men. The bigger demand for male employees will raise men’s wages, meaning that the concessionaires will have to pay more to hire men than they would to hire equally productive women. The higher wages for men cause employers who insist on all-male workforces to be higher-cost producers. Unless customers are willing to pay more for a hot dog delivered by a man than by a woman, higher costs mean smaller profits.

Concessionaires interested in maximizing their profits will forgo prejudice, hire women, reduce their costs, and increase their profits. Even if all concessionaires collude in refusing to hire women, new woman-owned firms can exploit their cost advantage by selling hot dogs for less, an effective way to take away customers. Unless government steps in to protect the bigots from competition, market conditions will end up forcing firms to choose between lower profits and hiring women. Though it may take decades, lower costs for female labor will result in the expansion of equal-opportunity employers. This will increase the demand for female labor and increase women’s wages. Some antiwomen owners may contrive to remain in business, but competition will make their taste for unfair discrimination expensive and will ensure that less of it will occur.

An example of the effect of market penalties on prejudicial hiring occurred in South Africa in the early 1900s. In spite of penalties threatened by government and violence threatened by white workers, South African mine owners sought to increase profits by laying off high-priced white workers in order to hire lower-priced black workers. Higher-paying jobs were reserved for whites only after white workers successfully persuaded the government to place extreme restrictions on blacks’ ability to work (see apartheid). Market penalties for discrimination also mitigated the effects of prejudice in the McCarthy era when profit-maximizing producers defied the Motion Picture Academy’s blacklist and secretly hired blacklisted screenwriters.

Although government intervention often blunts the market mechanisms that penalize bigotry, people who unequivocally support such intervention often do so because they believe that unfair discrimination exists whenever outcomes for a particular group differ from those of the population as a whole. Economist Thomas Sowell calls the idea that “various groups would be equally represented in institutions and occupations were it not for discrimination . . . the grand fallacy of our times.”1 People differ in their tastes, aptitudes, and childhood experiences, in the skills they acquire from their extended families, and in the geography they must adapt to. People who have lived in cities for generations are less likely to become farmers. Those whose families have spent generations in rural areas may be less likely to move to the city and earn the higher wages associated with urban life. The children of military officers are more likely to choose military careers than the children of Quakers. People subscribing to the grand fallacy ignore these details, preferring instead to ascribe many occupational differences to discrimination. Determined to equalize the representation of various protected groups in all spheres of social activity, they support government-sanctioned discrimination as long as it fosters their version of equality.

In the real world, distinguishing discrimination based on productivity from discrimination based on prejudice can be difficult. A business will want to hire an additional employee only if the additional revenue yielded as a result of hiring this new employee equals or exceeds his wages. This revenue is affected by his marginal output, which depends both on his ability and on the tools he has to work with. The additional product will sell for whatever price consumers are willing to pay.

If a concessionaire at a baseball stadium sells hot dogs for a dollar each and makes ten cents per sale, at a wage of five dollars per hour he will hire another hot-dog seller only if the new seller can sell at least fifty hot dogs per hour. If the concessionaire keeps all revenues in excess of his costs, he will naturally prefer employees who can sell more than fifty hot dogs an hour. Suppose the concessionaire notices that his highest producers are young males with little body fat who wear track-meet T-shirts. Suppose he also notices that the majority of those who failed to meet the fifty-hot-dogs-per-hour standard were overweight women. Faced with a choice between an overweight woman and a male runner, a rational employer would hire the man.

An exceptionally motivated overweight woman might outperform the average male runner, of course. Unfortunately, without requiring extensive physical examinations, the cost of which could wipe out much of the profits from hot-dog sales and make any hiring moot, the manager cannot separate exceptional overweight women from ordinary ones.

Lacking information about individuals, the concessionaire bases his decision on the average characteristics of the groups with which he has had experience. Most of his employees will be young, lean, fit, and male. Economists call this “statistical discrimination.” The employer’s workforce will look the same whether the manager discriminated fairly on the basis of real differences in productivity (no overweight woman is likely to cover as much area as a young male runner), fairly on the basis of incomplete information (the overweight woman was exceptionally fit but the manager did not know it), or unfairly on the basis of managerial taste (the employer dislikes female employees).

Early studies of labor force discrimination typically calculated expected pay or advancement for different groups after controlling for factors thought to affect productivity, such as schooling, hours worked, and years in the labor force. Unexplained differences were generally attributed to unfair discrimination. But as is so often the case, adjustments are limited to factors that can be measured, and the omitted variables often contained important information.

In a 2005 paper on wage differentials in American labor markets, June O’Neill and Dave O’Neill provide a vivid example of how omitted information can change conclusions about discrimination in wage studies. Simple comparisons of group wages for American men suggest that Japanese, Asian Indian, and Korean men earn 15 to 25 percent more than white non-Hispanic men. Black and American Indian men earn 25 percent less. A naïve interpretation of these earnings gaps would suggest that employers discriminate against whites and blacks and in favor of Asians. But using the National Longitudinal Survey of Youth, an exceptionally detailed data set, the O’Neills show that Asian men in the United States have above-average educations. When education is taken into account, the earnings gap between Asians and whites vanishes, and the black/white wage gap shrinks substantially because whites, on average, have more education than blacks. Adding geographic location shrinks the black/white wage gap further because a much larger proportion of black men live in the South, and southern wage levels tend to be lower for everyone. Adding individual achievement test scores, which are a measure of educational quality, erases the black/white wage gap for college graduates. Agreeing with James Heckman, the O’Neills quote Heckman’s conclusion that “most of the disparity in earnings between blacks and whites in the labor market of the 1990s is due to differences in the skills they bring to the market, not to discrimination in the market” (O’Neill and O’Neill 2005, p. 33; Heckman 1998, p. 101).

Studies of woman’s wages that conclude women are discriminated against in U.S. labor markets are also misleading when they suffer from the bias caused by omitted information. The gap between male and female wages narrowed from about 40 percent in 1970 to about 24 percent in 2003. Claims that the 24 percent difference results from bigotry typically ignore the fact that as a group women are more likely to work part time, choose careers in lower-paying fields, work for government or a nonprofit, and have fewer years of labor market experience than men of the same age. These differences could all create a wage gap and may reflect choices made to accommodate family responsibilities. Researchers who adjust for standard factors such as education, experience, and line of work find no significant difference between the earnings of men and women who never married and never had a child.

Like those who subscribe to Sowell’s grand fallacy, people seeking unmerited advantages for various groups often pressure government to legalize discrimination in their favor. They justify officially sanctioned discrimination by pointing to past wrongs—often past instances of officially sanctioned bigotry such as slavery—and claim that justice can be served only by more official discrimination, this time in their favor. But officially sanctioned discrimination harms innocent individuals, many of whom may not even have been living when past wrongs were committed. It denies advancement to those who work hard, favoring instead those who can claim membership in an officially protected group. It may also serve to protect group members who behave badly. These policies exacerbate social friction. In extreme cases, as when hiring quotas were based on caste membership and Sinhalese extraction in India and Sri Lanka, the grievance caused by such unfairness can lead to civil war.

Proponents of legalizing unfair discrimination often claim that the policies they propose are costless. But the experience of American students admitted to competitive colleges and universities under racial preferences shows that there are costs, and that some of these costs are borne by the very people whom discrimination is supposed to benefit. Some U.S. minority groups produce relatively few academically excellent students due to differences in family structure, deficiencies in K–12 education, and recent immigration. Claiming that they seek to rectify unfair societal discrimination, elite American colleges and universities have spent decades manipulating their admissions processes to ensure that entering classes contain a certain proportion of students from these minority groups. Even though the academic preparation of these preferential admissions is substantially below that of the average student admitted from other population groups, the schools that practice prejudicial admissions imply that these students will succeed if they matriculate. Overmatched academically, the supposed beneficiaries of official discrimination have dropout rates that are triple those of other students. This is a tragic result given that most of them would be perfectly capable of succeeding at less demanding schools. The preferential admissions also fail bar exams and medical licensing exams at much higher rates. Those who do graduate may have their confidence eroded by questions about whether they owe their success to discriminatory policies.

Because official discrimination costs politicians little if the discrimination is politically acceptable, government officials unconstrained by considerations of profit can afford to turn a blind eye to the damage unfair discrimination causes. They often sanction damaging official discrimination to please politically powerful interest groups. At the turn of the century, for example, American blacks began to compete for previously all-white jobs. Racial animosity increased. Whites had the voting power. Thomas Sowell reports that federal civil service hiring rules were amended to require a photograph of the applicant and to allow the hiring official to choose between the three top performers on civil service tests. The number of blacks in federal employment plummeted and remained low until the civil rights movement led to affirmative action sixty years later. But even at the height of segregation, businesses in the South, by contrast, often resisted laws requiring discrimination (see sidebar).

Rather than reducing discrimination, many of the U.S. government policies adopted since segregation have simply changed the groups discriminated against. Along with real or implied hiring quotas, the restrictions created under affirmative action blunt the market mechanisms that make discrimination expensive. Barriers to hiring and firing make employers less likely to try out types of people with whom they have little experience. Minimum-wage laws and union wage scales keep wages higher than market wages, reducing the number of people employers wish to hire while simultaneously attracting more applicants. When this happens, bigots pay less for turning away applicants who match their productivity requirements but not their tastes.

The Market Resists Discrimination

The resistance of southern streetcar companies to ordinances requiring them to segregate black passengers vividly illustrates how the market motivates businesses to avoid unfair discrimination. Before the segregation laws were enacted, most streetcar companies voluntarily segregated tobacco users, not black people. Nonsmokers of either race were free to ride where they wished, but smokers were relegated to the rear of the car or to the outside platform. The revenue gains from pleased nonsmokers apparently outweighed any losses from disgruntled smokers.

Streetcar companies refused, however, to discriminate against black people because separate cars would have reduced their profits. They resisted even after the passage of turn-of-the-century laws requiring the segregation of black people. One railroad manager complained that racial discrimination increased costs because it required the company to “haul around a good deal of empty space that is assigned to the colored people and not available to both races.” Racial discrimination also upset some paying customers. Black customers boycotted the streetcar lines and formed competing hack (horsedrawn carriage) companies, and many white customers refused to move to the white section.

In Augusta, Savannah, Atlanta, Mobile, and Jacksonville, streetcar companies responded by refusing to enforce segregation laws for as long as fifteen years after their passage. The Memphis Street Railway “contested bitterly,” and the Houston Electric Railway petitioned the Houston City Council for repeal. A black attorney leading a court battle against the laws provided an ironic measure of the strength of the streetcar companies’ resistance by publicly denying that his group “was in cahoots with the railroad lines in Jacksonville.” As pressure from the government grew, however, the cost of defiance began to outweigh the market penalty on profits. One by one, the streetcar companies succumbed, and the United States stumbled further into the infamous morass of racial segregation.

From Jennifer Roback, “The Political Economy of Segregation: The Case of Segregated Streetcars.” Journal of Economic History 56, no. 4 (December 1986): 893–917.

About the Author

Linda Gorman is a senior fellow at the Independence Institute in Golden, Colorado. She was previously an economics professor at the Naval Postgraduate School in Monterey, California.

Further Reading

Friedman, Milton. Capitalism and Freedom. Chicago: University of Chicago Press, 1962.
Heckman, James. “Detecting Discrimination.” Journal of Economic Perspectives 12, no. 2 (1998): 101–116.
O’Neill, June E., and Dave M. O’Neill. “What Do Wage Differentials Tell Us About Labor Market Discrimination?” NBER Working Paper no. 11240. National Bureau of Economic Research, Cambridge, Mass., 2005.
Scanlon, James P. “Illusions of Job Segregation.” Public Interest 93 (Fall 1988): 54–69.
Sowell, Thomas. Preferential Policies: An International Perspective. New York: William Morrow, 1990.
Sowell, Thomas. Race and Economics. New York: Longman, 1975.
Thernstrom, Stephan, and Abigail Thernstrom. America in Black and White, One Nation, Indivisible. New York: Simon and Schuster, 1997.


Advanced Treatment

Becker, Gary S. The Economics of Discrimination. 2d ed. Chicago: University of Chicago Press, 1971.



1. Thomas Sowell, “The Grand Fallacy: Equating Male-Female Differences in Salary with Discrimination,” Capitalism Magazine, July 21, 2004, online edition: