<p>In many models, we assume that firms simply want to maximize profits, and there are no externalities. If these assumptions are true, then a free market will be racism-free, gender-blind etc, etc. However, this is not the case in the real world. People that own and operate firms not only want to maximize profits, often they also have all kinds of biases, including social biases like racism, sexism, etc; as well as cognitive biases, for example when they want to make the firm as big as possible even if that is not profitable. In all cases, this biases necessarily mean forgoing profits. For example the paper you cite. Ross Levine has other papers on the topic.</p>

<p>However, the question of segregation is broader than this. For some type of relationships, "segregation" can make economic sense. For example, if you have a common resource, like a lake that provides some fishes, limiting who has access to such lake to only people who take care of the lake and does not overfish it, can have clear advantages, and be socially efficient. </p>

<p>In short, segregation can be the result of a friction, like cognitive or social biases. This is not a market failure, properly speaking, but it entails some inefficiencies, so in that sense, it does not make "economic sense". But you can also have segregation, being the optimal response to a situation that involves externalities (like in the example of the lake). This segregation can make "economic sense" in that it is individually rational, and it may or may not be socially efficient. </p>

<p>Consider an example where it is likely not socially efficient. Suppose there is a big proportion of people who are racist, and you own a restaurant. Let's assume you are not racist and you only care about maximizing profits. It is perfectly reasonable to think that you will deny service to people based on race if that will make your racist costumers more likely to visit your restaurant. This segregation makes "economic sense" even though it might not be socially efficient in some way or desirable (the social welfare can be measured in many ways). Notice that I needed to assume that your other customers somehow have negative externalities from you selling to racial minorities. </p>

CC BY-SA 4.0
2019-04-24T10:02:30.633Z
That all makes sense. I suppose I thought that, whilst individual people/firms would have different externalities on top of their profit motive, in aggregate the profit motive would be the most powerful driver as it would be the only one shared by all (or almost all, as there may be a handful of people who are happy to just break even), so overall the situation would gradually tend towards being 'racism-free, gender-blind etc, etc.' That said, I imagine this would only happen above a certain size threshold, which is unlikely to happen in, say, a small rural township in the Deep South.
08915bfe02
CC BY-SA 4.0
2019-04-25T05:11:38.220Z
Yes, this non-monetary incentives can be very prevalent. Studies have shown, however that people do respond to economic incentives, for example when it gets too expensive to be racist, say it’s hard to find workers except those from a racial minority, people do start hiring more minorities, etc. So the monetary incentives are still present, and markets can help get us close to a more equalitarian society.
Regio
CC BY-SA 4.0
2019-05-22T07:15:28.167Z
"In many models, we assume that firms simply want to maximize profits, and there are no externalities. If these assumptions are true, then a free market will be racism-free, *gender-blind* etc, etc." (emphasis by me) So there is no price discrimination for non-transferable goods like health insurance?
Giskard
CC BY-SA 4.0
2019-05-22T07:21:20.023Z
Some papers: [Strategic Price Discrimination in Compulsory Insurance Markets](https://www.jstor.org/stable/41959179?seq=1#page_scan_tab_contents), [Unisex Insurance Pricing](https://link.springer.com/chapter/10.1007/978-1-137-57479-4_5)
Giskard
CC BY-SA 4.0
2019-05-22T18:05:11.493Z
@Giskard wouldn't insurance markets where segregation based on (gender correlated) risk is possible be considered *two* separate free markets? AFAIK products in a perfectly competitive markets are supposed to be uniform in characteristics and price.
Maarten Punt
CC BY-SA 4.0
2019-05-22T20:23:27.370Z
@MaartenPunt Not sure I get your point. So there won't be price discrimination in these insurance market(s), companies will be gender-blind?
Giskard
CC BY-SA 4.0
2019-05-23T17:44:56.330Z
@Giskard ah yes I suppose, my apologies didn't think that one through. One could though then take your argument a step further and make a similar case for say age or race provided of course that different age groups or races have different risk profiles and those can be observed. Quite a slippery slope that but I guess that makes the answer then: seggregation may make sense if it's a near perfect predictor of another unobservable characteristic (such as risk profile)
Maarten Punt
CC BY-SA 4.0
2019-04-22T03:13:35.207Z
2019-04-22T03:13:35.207Z
Regio
<p>Models have been constructed that show, at least, how discrimination can rationally self-perpetuate.  For instance, in <em><a href="https://en.wikipedia.org/wiki/The_Elusive_Quest_for_Growth" rel="nofollow noreferrer">The Illusive Quest for Growth</a></em>, <a href="https://en.wikipedia.org/wiki/William_Easterly" rel="nofollow noreferrer">William Easterly</a> describes a model in which employers maintain discrimination through rational expectations, implying that government policy is needed to disturb the perverse equilibrium (<a href="https://abridge.me.uk/doku.php?id=the_elusive_quest_for_growth#increasing_returnsleaks_matches_and_traps" rel="nofollow noreferrer">paraphrased</a> from "Increasing Returns: Leaks, Matches and Traps"):</p>

<blockquote>
  <p>Easterly extends this idea of traps to explain variation in income by geography and race purely on the basis of a difference of initial conditions, because under increasing returns variation tends to be self-reinforcing. He proposes a race model in which whites begin as high-skill and blacks low-skill. If there is any segregation in economic enterprise between the races then it may be rational for whites to seek education and blacks to not. Furthermore, if there are costs associated with uncovering the true educational level of a particular worker, it may be rational for a white employer to only select whites rather than pay to discover the true educational level, on the basis that the probability that a white is high-skill is high, and for a black, it is low. If white employers are known to use this policy, then it will be rational for whites to pursue education and for blacks not to: even without a legal or geographical divide, the perpetuation of a racial income disparity can be rationally self-reinforcing.</p>
</blockquote>

CC BY-SA 4.0
2019-05-24T18:07:29.943Z
2019-06-10T21:31:36.663Z
2019-06-10T21:31:36.663Z
Dan
<p>Its typical that cultural changes happen slowly then suddenly. People's general view about something will change, and at some point something that was seen as normal by most people is now seen by a substantial fraction of people as bad behavior. Inevitably, some of these people call for that bad behavior to be punished by government. However, naturally as more and more people see that behavior as bad, fewer and fewer people do it. This cycle accellerates the process and eventually slows as the vast majority of people conform to the new norm (most humans are great conformists).</p>
<p>Inevitably, this means that the government takes credit for the societal change, even tho the government action trailed the bulk of that societal change and simply rode its coattails.</p>
<p>Racial segregation is exactly that kind of thing. Its impossible to say if government action to desegregate actually sped things up or improved things in the long run. Certainly in the short run it sped things up, but in the process created much backlash.</p>
<p>I don't find William Easterly's opinion about stickiness of discrimination to be particular convincing. There will always be outliers that slowly chip away at incorrect discrimination (eg methods that are less efficient at choosing good employees).</p>
<p>To the core question, discrimination does not involve externalities, nor either of <a href="https://governology.substack.com/p/the-role-of-government-part-1" rel="nofollow noreferrer">the other two types of market failures</a>. So discrimination will not cause any permanent inefficiency. Segregation is different. Usually, ratial segregation was a government policy and that most certainly causes market distortions that lead to inefficiencies. But this is not a market failure, rather a government failure. Voluntary segregation does not have the same problems. One must wonder why it was necessary to use the force of government to ensure segregation if discrimination is so sticky like William Easterly asserts. It seems obvious that it is not sticky and the powers that be thought they could only keep the status quo by forcing it on their people - even fellow white people who might otherwise congregate with blacks.</p>
<p>The fact of the matter is that any behavior that is consistently less efficient will eventually be driven out of the market. Businesses who are willing to have black customers or hire black employees gain an advantage over other businesses. This provides strong economic and social incentives to change behavior and beliefs.</p>
<p>In situations where the discrimination is not invalid but is instead a useful tool (like when not hiring someone who has track record of showing up to work drunk), then the discrimination of course has economic incentives to not only persist, but propagate.</p>

CC BY-SA 4.0
2023-08-31T15:45:29.137Z
2023-08-31T15:45:29.137Z
B T
<p>A central tenet of libertarianism is the notion of free association–being able to socialise and enter into contracts with people of your choosing, with the corollary of being able to <em>refuse</em> to do those things too. The obvious criticism of this would be that one could then refuse to sell to people based on their skin colour, sex, orientation, etc., which has a historical precedent pretty much all over the globe. <strong>Does this make economic sense, though, or does it represent a market failure?</strong></p>

<p>To my non-economist eyes it looks pretty cut and dry. Say Alice has a widget store and decides to only sell to people in group A. Bob also has a widget store and sells to both groups A &amp; B. Surely Bob should have a significant economic advantage here, allowing him to lower prices and stay competitive with Alice? Even if some group A customers would refuse to shop at Bob's, presumably more would be attracted to Bob's store for its lower prices?<a href="https://www.aeaweb.org/articles?id=10.1257/app.20150241" rel="nofollow noreferrer">1</a></p>

<p>Even if social or legal pressures meant everyone had to segregate, would this not present a gap in the market to be filled by group B store-owners, who would then sell to the underserved group Bs, with prices presumably more in line with group B incomes (if they are also economically disadvantaged compared to group A), and with the profits more likely to be redistributed amongst other group B businesses?</p>

<p>It's a cliche that the libertarian answer to everything is that 'the market will fix it', but this does seem like a sitation where that should happen, unless government pressure countered market forces (e.g. if it was made illegal for group Bs to even open their own stores or buy stock from wholesalers willing to sell to them). <strong>Would the libertarian counter-claim be, then, that the existence of economic segregation can only occur when backed by state force?</strong></p>

<p><a href="https://www.aeaweb.org/articles?id=10.1257/app.20150241" rel="nofollow noreferrer">1</a> However, <a href="https://www.aeaweb.org/articles?id=10.1257/app.20150241" rel="nofollow noreferrer">this paper</a> does suggest that '[d]iscriminators are on average willing to forego 8 percent of their earnings to avoid a coworker of the other ethnic type'.</p>

CC BY-SA 4.0
2019-05-22T07:13:54.810Z
@Ubiquitous Not sure if this is price discrimination. It does not seem like the segregationist would have several stores, one for each segregated type. This seems more like refusal to deal/serve. (Gender based discrimination in insurance markets is different, there your tag is valid.)
Giskard
CC BY-SA 4.0
2019-05-22T08:01:51.123Z
@Giskard you are right. I removed the tag.
Ubiquitous
<market-failure><discrimination>
Does segregation make economic sense?
08915bfe02
# Does segregation make economic sense?

(Asked by: username_0 on 2019-04-21)

A central tenet of libertarianism is the notion of free association–being able to socialise and enter into contracts with people of your choosing, with the corollary of being able to *refuse* to do those things too. The obvious criticism of this would be that one could then refuse to sell to people based on their skin colour, sex, orientation, etc., which has a historical precedent pretty much all over the globe. **Does this make economic sense, though, or does it represent a market failure?**

To my non-economist eyes it looks pretty cut and dry. Say Alice has a widget store and decides to only sell to people in group A. Bob also has a widget store and sells to both groups A & B. Surely Bob should have a significant economic advantage here, allowing him to lower prices and stay competitive with Alice? Even if some group A customers would refuse to shop at Bob's, presumably more would be attracted to Bob's store for its lower prices?[1](https://www.aeaweb.org/articles?id=10.1257/app.20150241)

Even if social or legal pressures meant everyone had to segregate, would this not present a gap in the market to be filled by group B store-owners, who would then sell to the underserved group Bs, with prices presumably more in line with group B incomes (if they are also economically disadvantaged compared to group A), and with the profits more likely to be redistributed amongst other group B businesses?

It's a cliche that the libertarian answer to everything is that 'the market will fix it', but this does seem like a sitation where that should happen, unless government pressure countered market forces (e.g. if it was made illegal for group Bs to even open their own stores or buy stock from wholesalers willing to sell to them). **Would the libertarian counter-claim be, then, that the existence of economic segregation can only occur when backed by state force?**

[1](https://www.aeaweb.org/articles?id=10.1257/app.20150241) However, [this paper](https://www.aeaweb.org/articles?id=10.1257/app.20150241) does suggest that '[d]iscriminators are on average willing to forego 8 percent of their earnings to avoid a coworker of the other ethnic type'.

**Tags:** market-failure, discrimination

> **Comments:**
> **username_1**: @username_2 Not sure if this is price discrimination. It does not seem like the segregationist would have several stores, one for each segregated type. This seems more like refusal to deal/serve. (Gender based discrimination in insurance markets is different, there your tag is valid.)  
> **username_2**: @username_1 you are right. I removed the tag.  

---

## 3 answers

### Answer by username_3 on 2019-04-22. Score: 1

In many models, we assume that firms simply want to maximize profits, and there are no externalities. If these assumptions are true, then a free market will be racism-free, gender-blind etc, etc. However, this is not the case in the real world. People that own and operate firms not only want to maximize profits, often they also have all kinds of biases, including social biases like racism, sexism, etc; as well as cognitive biases, for example when they want to make the firm as big as possible even if that is not profitable. In all cases, this biases necessarily mean forgoing profits. For example the paper you cite. Ross Levine has other papers on the topic.

However, the question of segregation is broader than this. For some type of relationships, "segregation" can make economic sense. For example, if you have a common resource, like a lake that provides some fishes, limiting who has access to such lake to only people who take care of the lake and does not overfish it, can have clear advantages, and be socially efficient.

In short, segregation can be the result of a friction, like cognitive or social biases. This is not a market failure, properly speaking, but it entails some inefficiencies, so in that sense, it does not make "economic sense". But you can also have segregation, being the optimal response to a situation that involves externalities (like in the example of the lake). This segregation can make "economic sense" in that it is individually rational, and it may or may not be socially efficient.

Consider an example where it is likely not socially efficient. Suppose there is a big proportion of people who are racist, and you own a restaurant. Let's assume you are not racist and you only care about maximizing profits. It is perfectly reasonable to think that you will deny service to people based on race if that will make your racist costumers more likely to visit your restaurant. This segregation makes "economic sense" even though it might not be socially efficient in some way or desirable (the social welfare can be measured in many ways). Notice that I needed to assume that your other customers somehow have negative externalities from you selling to racial minorities.

> **Comments:**
> **username_0**: That all makes sense. I suppose I thought that, whilst individual people/firms would have different externalities on top of their profit motive, in aggregate the profit motive would be the most powerful driver as it would be the only one shared by all (or almost all, as there may be a handful of people who are happy to just break even), so overall the situation would gradually tend towards being 'racism-free, gender-blind etc, etc.' That said, I imagine this would only happen above a certain size threshold, which is unlikely to happen in, say, a small rural township in the Deep South.  
> **username_3**: Yes, this non-monetary incentives can be very prevalent. Studies have shown, however that people do respond to economic incentives, for example when it gets too expensive to be racist, say it’s hard to find workers except those from a racial minority, people do start hiring more minorities, etc. So the monetary incentives are still present, and markets can help get us close to a more equalitarian society.  
> **username_1**: "In many models, we assume that firms simply want to maximize profits, and there are no externalities. If these assumptions are true, then a free market will be racism-free, *gender-blind* etc, etc." (emphasis by me) So there is no price discrimination for non-transferable goods like health insurance?  
> **username_1**: Some papers: [Strategic Price Discrimination in Compulsory Insurance Markets](https://www.jstor.org/stable/41959179?seq=1#page_scan_tab_contents), [Unisex Insurance Pricing](https://link.springer.com/chapter/10.1007/978-1-137-57479-4_5)  
> **username_4**: @username_1 wouldn't insurance markets where segregation based on (gender correlated) risk is possible be considered *two* separate free markets? AFAIK products in a perfectly competitive markets are supposed to be uniform in characteristics and price.  
> **username_1**: @MaartenPunt Not sure I get your point. So there won't be price discrimination in these insurance market(s), companies will be gender-blind?  
> **username_4**: @username_1 ah yes I suppose, my apologies didn't think that one through. One could though then take your argument a step further and make a similar case for say age or race provided of course that different age groups or races have different risk profiles and those can be observed. Quite a slippery slope that but I guess that makes the answer then: seggregation may make sense if it's a near perfect predictor of another unobservable characteristic (such as risk profile)  

---

### Answer by username_5 on 2019-05-24. Score: 1

Models have been constructed that show, at least, how discrimination can rationally self-perpetuate. For instance, in *[The Illusive Quest for Growth](https://en.wikipedia.org/wiki/The_Elusive_Quest_for_Growth)*, [William Easterly](https://en.wikipedia.org/wiki/William_Easterly) describes a model in which employers maintain discrimination through rational expectations, implying that government policy is needed to disturb the perverse equilibrium ([paraphrased](https://abridge.me.uk/doku.php?id=the_elusive_quest_for_growth#increasing_returnsleaks_matches_and_traps) from "Increasing Returns: Leaks, Matches and Traps"):

> Easterly extends this idea of traps to explain variation in income by geography and race purely on the basis of a difference of initial conditions, because under increasing returns variation tends to be self-reinforcing. He proposes a race model in which whites begin as high-skill and blacks low-skill. If there is any segregation in economic enterprise between the races then it may be rational for whites to seek education and blacks to not. Furthermore, if there are costs associated with uncovering the true educational level of a particular worker, it may be rational for a white employer to only select whites rather than pay to discover the true educational level, on the basis that the probability that a white is high-skill is high, and for a black, it is low. If white employers are known to use this policy, then it will be rational for whites to pursue education and for blacks not to: even without a legal or geographical divide, the perpetuation of a racial income disparity can be rationally self-reinforcing.


---

### Answer by username_6 on 2023-08-31. Score: 0

Its typical that cultural changes happen slowly then suddenly. People's general view about something will change, and at some point something that was seen as normal by most people is now seen by a substantial fraction of people as bad behavior. Inevitably, some of these people call for that bad behavior to be punished by government. However, naturally as more and more people see that behavior as bad, fewer and fewer people do it. This cycle accellerates the process and eventually slows as the vast majority of people conform to the new norm (most humans are great conformists).

Inevitably, this means that the government takes credit for the societal change, even tho the government action trailed the bulk of that societal change and simply rode its coattails.

Racial segregation is exactly that kind of thing. Its impossible to say if government action to desegregate actually sped things up or improved things in the long run. Certainly in the short run it sped things up, but in the process created much backlash.

I don't find William Easterly's opinion about stickiness of discrimination to be particular convincing. There will always be outliers that slowly chip away at incorrect discrimination (eg methods that are less efficient at choosing good employees).

To the core question, discrimination does not involve externalities, nor either of [the other two types of market failures](https://governology.substack.com/p/the-role-of-government-part-1). So discrimination will not cause any permanent inefficiency. Segregation is different. Usually, ratial segregation was a government policy and that most certainly causes market distortions that lead to inefficiencies. But this is not a market failure, rather a government failure. Voluntary segregation does not have the same problems. One must wonder why it was necessary to use the force of government to ensure segregation if discrimination is so sticky like William Easterly asserts. It seems obvious that it is not sticky and the powers that be thought they could only keep the status quo by forcing it on their people - even fellow white people who might otherwise congregate with blacks.

The fact of the matter is that any behavior that is consistently less efficient will eventually be driven out of the market. Businesses who are willing to have black customers or hire black employees gain an advantage over other businesses. This provides strong economic and social incentives to change behavior and beliefs.

In situations where the discrimination is not invalid but is instead a useful tool (like when not hiring someone who has track record of showing up to work drunk), then the discrimination of course has economic incentives to not only persist, but propagate.


---

