Freeman

ARTICLE

Capitalism: Discrimination's Implacable Enemy

Free Enterprise Has an Anti-Discrimination Effect

AUGUST 01, 1998 by JOHN HOOD

John Hood is president of the John Locke Foundation, a nonprofit think tank in North Carolina, and the author of The Heroic Enterprise: Business and the Common Good (Free Press), from which this article is adapted.

Do racial minorities, women, and other groups need the government to protect them against prejudice and discrimination? To hear some prominent social commentators tell it, American business has a shameful record on social equality. Corporate boards lack significant minority representation. Minority consumers are underserved, and minority and female workers are underpaid. Minorities and women can’t get financing to start their own businesses. “In most fields, there is a level beyond which people of color cannot rise,” said Stephen Carter, the well-known author and law professor.[1] Similar complaints about the economic prospects of women have been popularized in recent years by such authors as Susan Faludi and Gloria Steinem.

This picture of the private sector as an arena of continued discrimination, inequality, and despair for everyone in society except white men is often repeated, presumed accurate by reporters and politicians, used to defend government affirmative action programs—and completely wrong. Not only is there great news to report for the economic accomplishments and prospects of previously downtrodden groups in America, but this good news is due almost totally to the triumph of commercial values over alternative values that have in the past put fear, racism, and insularity ahead of business success and profit.

The cornucopia of good news about social equality and American business overflows with little-noticed facts about our recent economic past. For example:

  • American women were forming small businesses at twice the rate of men in the early 1990s. Businesses owned by women now employ more people than do all the firms in the Fortune 500 combined.[2] If the trends of the 1980s and early 1990s continue, women will own half of all U.S. businesses by the year 2000.[3] Similarly, the number of businesses owned by members of racial and ethnic minorities more than doubled from 1982 to 1994.[4]
  • Before the Second World War, only 5 percent of American blacks had middle-class incomes. Today, the figure is about 60 percent.[5] From 1981 to 1991, the total income of blacks grew 38 percent, faster than the growth rate for the incomes of the white population. Almost half of all black households own their own homes.[6]
  • Measured correctly, there is no evidence of significant discrimination in bank lending against prospective minority homebuyers.[7]
  • Among full-time, college-educated workers, about the same percentage of blacks and whites have executive, administrative, or managerial jobs.[8]

Naturally, racial stereotypes, invidious discrimination, and animus still exist in America. But it is important to understand the role profit-seeking businesses play in combating these lingering problems. For corporate managers, excluding potential workers or customers because of race, gender, or other group characteristics means sacrificing future productivity and sales. It simply stands to reason that the wider you cast your net for employees or consumers, the better off you will be. To do anything less is to fail in your responsibility to the owners or shareholders.

Gary Becker, Nobel laureate in economics and a professor at the University of Chicago, pointed out the anti-discrimination effect of free enterprise in 1957, and has been restating his conclusion ever since. The key, he says, is competition. Screening out job applicants because of their group means reducing the chances of hiring the best worker, who may well go to work for a competing firm. Similarly, screening out whole groups of consumers means giving up sales to competitors. “Competition forces people to face costs, and therefore reduce the amount of discrimination when compared with monopolistic situations,” Becker said.[9] So racism and discrimination are, over time, much more likely to persist in monopolistic institutions (like governments themselves) rather than in businesses.

Indeed, one might argue that without the largely unconscious pressure of the business sector on social attitudes, there would be a great deal more racism and social inequality. For governments, charged with protecting societies from their external or internal enemies, loyalty to one’s group and the distrust of others is a virtue. It maximizes the physical safety of the society and protects its land from encroachment. But for traders the greatest rewards lie in trusting strangers, who are the source of new products and new ideas. That means seeking out and embracing people who are different from you—the more different they are, the more likely they are to have something of value to you. The social benefits of trade—of breaking down barriers between groups in the interest of mutual economic gain—have been enjoyed by every group in American society. Past immigrants, recent immigrants, racial minorities, religious minorities, and many others have sought and obtained in the marketplace what they did not have and could not achieve through politics or social activism.

Race, Gender, and Entrepreneurship

As mentioned, the number of businesses owned by racial minorities and women has been increasing rapidly in recent decades. Not only has the number of firms grown, but their share in the national economy has, too. Just from 1991 to 1995, for example, the combined revenue of the Black Enterprise 100 for industrial/service companies and auto dealers grew by 63 percent to $11.7 billion.[10] A third of the roughly 6.5 million enterprises with fewer than 500 employees were owned or controlled by women in 1994.[11]

Entrepreneurship has been a traditional route out of poverty for American minority groups of all sorts. Jewish, Greek, Cuban, and Japanese immigrants, for example, overcame prejudice and social barriers by entering occupations and markets ignored by native-born Americans, making themselves indispensable to the growth and development of the economy. As generations of immigrants gained economic success, their children and grandchildren pursued higher education, befriended and married individuals outside their own groups, and gradually obtained social tolerance and acceptance.[12]

Even within the artificially restricted markets left to them by Jim Crow segregation, some American blacks of the late nineteenth and early twentieth centuries were able to find opportunities for economic success. Arthur G. Gaston was born in 1892 in a log cabin his grandparents, former slaves, built in rural Marengo County, Alabama. After the early death of her husband, Gaston’s mother moved to Birmingham in 1900 to be a cook for A.B. and Minnie Loveman, founders of what would later become the state’s largest department store chain. Young Gaston, an admirer of Booker T. Washington, worked a number of odd jobs, including selling subscriptions for the local black newspaper. Later, he moved to Mobile and became a bellhop. After serving in the army during World War I, Gaston came home and took a job at the Tennessee Coal and Iron Co. Always looking for opportunities, he began selling box lunches (prepared by his mother) and peanuts and lending money to workers at the TCI plant. He started a burial society for the workers, too, which eventually acquired a mortuary and became Smith and Gaston Funeral Directors. In 1932, the burial society was incorporated as Booker T. Washington Insurance Co.[13]

New ventures followed. Gaston started a business college for black clerical workers in 1939, bought a cemetery in 1947, opened the Gaston Motel in 1954, and started the Citizens Federal Savings Bank in 1957 to lend money to blacks excluded from lending markets by segregation. Active in the civil rights movement and numerous civic and community organizations, Gaston kept adding to his business holdings during the 1960s, 1970s, and 1980s, buying radio stations and opening his own construction company. In 1994, Black Enterprise named A.G. Gaston, then 102 years old, as the magazine’s Entrepreneur of the Century. In Gaston’s view, his business success has enabled him to advance the cause of racial equality just as his hero Booker T. Washington had predicted. “Money has no color,” Gaston said. “If you can build a better mousetrap, it won’t matter whether you’re black or white, people will buy it.”[14]

Color-Blind Customers and Employers

The entrepreneurial explosion among women and members of minorities in the past few years has demonstrated that consumers, both households and businesses, will generally buy from anyone who can supply a high-quality product or service at a low price. The same might be said about American employers, who have discovered that businesses that want to compete effectively cannot afford to discriminate against workers because of race, sex, or other such characteristics. Indeed, having a workforce of people who meet high standards of quality and performance and bring differing backgrounds and perspectives to their jobs is often a recipe for success.

Vigorous political debates about such subjects as affirmative action and comparable worth obscure what is actually occurring in the American economy today: the gradual elimination of discriminatory hiring and firing practices, as well as rising levels of compensation and respect for minority and female workers. According to economist Howard R. Bloch of George Mason University, 70 to 85 percent of observed differences in income and employment among American racial and ethnic groups disappear when you adjust the numbers for factors such as age, education, and experience. “That’s been shown by studies dating back to the mid-1960s,” Bloch said. “And you can’t even be sure that the residual gap is due to discrimination. It could be due to factors we haven’t controlled for.”[15]

In measurements of accumulated household wealth, as contrasted with annual income, minorities have also made tremendous gains. A Federal Reserve Bank of St. Louis study in 1989 found that observed differences between whites and minorities were no longer statistically significant once age and education were taken into account. “Members of minority groups are typically younger than whites, and therefore have had less time to accumulate assets,” noted the author, John C. Weicher of the Hudson Institute.[16]

Similarly, apparent pay gaps between men and women don’t prove the lack of “equal pay for equal work,” as many critics allege. June O’Neal, head of the Congressional Budget Office, noted that when earnings comparisons are restricted to men and women with similar experience and life situations, the differences are small, particularly among today’s young people. Among people 27 to 33 who have never had a child, the earnings of women are close to 98 percent of men’s.[17] Even for broader groups of men and women, today’s pay gaps mostly reflect the impact of such factors as women’s shorter average working week and women’s choice of careers that allow for greater flexibility should they wish to bear and rear children later on. Full-time working women also have, on average, less work experience than comparable males, again affecting their value to firms and thus their compensation.[18]

Progress toward more equal treatment of workers began long before the state and federal governments passed laws governing hiring. Thomas Sowell, a senior fellow at the Hoover Institution and the author of numerous books on affirmative action, notes that the number of blacks in higher-paying, professional occupations was increasing rapidly before the passage of the 1964 Civil Rights Act.[19] Several studies have found that the convergence of economic opportunities for blacks and whites, and men and women, began before World War II.[20] Harvard economist Richard Freeman has found that blacks and whites with similar backgrounds and education had essentially achieved pay equity by 1969.[21]

Many explanations for the pay convergence among American workers lie in the social changes wrought by an innovative business sector. Technological innovation in our economy, for example, has not only made us all collectively better off but also had the side effect of promoting greater pay equality. The substitution of machinery for human labor has reduced the value of physical strength and increased the value of mental acuity and social skills—which are distributed more evenly between sexes. At the same time, labor-saving devices in the home have given married women more freedom to pursue education and employment. Household chores that previously consumed hours of tedious work are now performed in whole or in part by electrical appliances or by outside contractors.[22] The result has been a revolution in time and family responsibility that is difficult to overstate.

If the logic of business success works against unfair and capricious treatment of workers on the basis of race or sex, then it virtually mandates that companies with the desire to maximize revenue not discriminate against potential customers. The fact that some businesses have done so, and continue to do so, reflects only that they are run by people who put their own personal biases above profit. Flagstar Cos., Inc., which operates Denny’s and Hardee’s restaurants throughout the south and west, is clearly not one of these businesses, despite some well-publicized cases of discrimination in the early 1990s.

In 1991, reports began to trickle in to Flagstar CEO Jerry Richardson of racial discrimination at some of his Denny’s restaurants in California. Some black customers charged that they were denied service, while others said they were forced to prepay for food unlike white customers. Richardson immediately fired managers who had discriminated, apologized to offended customers, and instituted programs to train managers and workers with respect to racism. In a restaurant chain with thousands of employees across many states, it would have been impossible not to inadvertently hire some racists. The key issue was how company management saw its responsibility to correct problems as they arose. “It makes no sense that we would condone racism,” said Richardson. “Denny’s needs all the customers it can get.”[23]

The Redlining Controversy

The efforts of corporations to cultivate regular customers among minority groups has been largely obscured in the public mind by the lingering controversy over “redlining” by banks, insurers, real estate agents, and similar types of businesses. Discussion of redlining is complicated by the fact that historically, some lenders and insurers were clearly willing to forgo the business of blacks and others to reinforce a social consensus of segregation in their communities. But this despicable—and economically unwise—practice would seem to be extremely rare today, despite incessant claims by activists and the media that redlining remains the rule.

The problem is that studies purporting to show discrimination in bank lending or insurance focus almost exclusively on rejection rates for loans and policies. These rejection rates often do, indeed, differ significantly among racial groups in studies. But these studies ignore many important factors that provide a more plausible explanation for the apparent disparity than does racism.[24] Sometimes the studies promoted so widely by the mass media, like the celebrated 1992 Federal Reserve Board of Boston study purporting to show higher black rejection rates than those of whites with similar incomes, are simply invalid; that study contained transcription and mathematical errors, inappropriate generalizations, and the skewing of average results by a few exceptional cases.[25]

Ironically, higher rejection rates are often found for those very institutions, including minority-owned banks, that are trying to extend credit in inner-city and minority neighborhoods, since banks in predominantly white areas are more likely to receive applicants from a smaller, more select group of minorities with better-than-average financial resources, work histories, or business prospects. When a bank opens a branch in a minority community, it will necessarily reject more minority applications than before.[26]

It is the personal characteristics of loan applicants—the items in their financial history likely to communicate to potential lenders the likelihood that their loans will be repaid—that explain virtually all racial or ethnic disparities. The most important measure of discrimination is not rejection rates, which are affected by a host of racially neutral factors, but instead the rates at which customers of different races or communities default on their loans. If households or businesses in black areas tend to default at lower rates than those in white areas, that would be evidence of discrimination, since blacks would seem to have to meet higher credit standards than whites do to get loans. On the other hand, if the default rates of blacks are higher, that would suggest discrimination in favor of them. In reality, the available evidence on default rates suggests that there is no significant difference between households and businesses of predominantly white and predominantly minority communities, suggesting that the latter are not being “redlined.”[27] Other studies that have tried to identify actual racial discrimination by interviewing loan applicants have often failed to find any significant evidence of it.[28]

It is important to understand the role of profit-seeking business in eliminating disparities in income and economic opportunity that are based on racism and sexism. For groups kept from realizing the American dream by the prejudices and failures of the past, the best hope for progress in the future is an economy populated with companies whose managers put performance and profitability first.


Notes

  1. Stephen Carter, “The Glass Ceiling for Blacks Is All Too Real,” Fortune, November 2, 1992, p. 124.
  2. “Women Entrepreneurs: ‘A Pretty Big Game,’” Nation’s Business, August 1992, p. 53.
  3. E. Holly Butler, “Female Entrepreneurs: How Far Have They Come?” Business Horizons, March/April 1993, p. 59.
  4. James Overstreet, “Minority businesses riding a wave of success,” USA Today, October 25, 1994, p. 4B.
  5. Peter Drucker, “The Age of Social Transformation,” The Atlantic Monthly, April 1994, p. 62. Of course, this increase in income potential isn’t due solely to the actions of firms, since minority workers are employed by government and nonprofits as well as by businesses.
  6. Paul Klebnikov, “Showing Big Daddy the Door,” Forbes, November 9, 1992, p. 150.
  7. Benjamin Zycher and Timothy A. Wolfe, “Mortgage Lending, Discrimination, and Taxation by Regulation,” Regulation, vol. 17, no. 2, 1994, pp. 61–71.
  8. John Leo, “Our Addiction to Bad News,” U.S. News and World Report, June 5, 1995, p. 20.
  9. Peter Brimelow and Leslie Spencer, “When Quotas Replace Merit, Everybody Suffers,” Forbes, February 15, 1993, p. 80.
  10. Angela G. King, “Black-Owned Businesses: Lean But Healthy,” USA Today, May 10, 1995, p. 4B.
  11. Wendy Zellner, “Women Entrepreneurs,” Business Week, April 18, 1994, pp. 104–105.
  12. John Sibley Butler, Entrepreneurship and Self-Help Among Black Americans: A Reconsideration of Race and Economics (Albany, N.Y.: State University of New York Press, 1991), pp. 1–33.
  13. Harold Jackson, “True Grit,” Black Enterprise, June 1994, pp. 230–34.
  14. Ibid.
  15. Brimelow and Spencer, p. 86.
  16. John C. Weicher, “Getting Richer (at Different Rates),” The Wall Street Journal, June 14, 1995, p. 10A.
  17. June Ellenoff O’Neill, “The Shrinking Pay Gap,” The Wall Street Journal, October 7, 1994, p. 12A.
  18. Christina Hoff Sommers, “Figuring Out Feminism,” National Review, June 27, 1994, p. 34.
  19. Elizabeth Wright, “Preferential Policies: An International Perspective,” Associates Memo, Manhattan Institute for Policy Research, August 2, 1990, p. 3.
  20. See, for example, Mary C. King, “Occupational Segregation by Race and Sex, 1940–88,” Monthly Labor Review, April 1992, pp. 30–36.
  21. Brimelow and Spencer, p. 86.
  22. These Are the Good Old Days, 1993 Annual Report, Federal Reserve Bank of Dallas, 1994, pp. 7–8.
  23. Andrew E. Serwer, “What To Do When Race Charges Fly,” Fortune, July 12, 1993, p. 95. Allegations of discrimination continue, however, according to reports published in May of this year.
  24. Zycher and Wolfe.
  25. Stan Liebowitz, “A Study That Deserves No Credit,” The Wall Street Journal, September 1, 1993, p. A14.; see also Joseph Blalock, “Testing Fair Lending,” Savings and Community Banker, June 1994, pp. 44–48.
  26. See Jeff Taylor, “Ratings Present Misleading Picture,” Consumers’ Research, October 1992, p. 23; and Tim W. Ferguson, “The Next Lender Wave: Mortgage Bias,” The Wall Street Journal, May 25, 1993, p. A15.
  27. Jonathan R. Macey, “Banking By Quota,” The Wall Street Journal, September 7, 1994, p. A14.
  28. See George J. Benston and Dan Horsky, “The Relationship Between the Demand and Supply of Home Financing and Neighborhood Characteristics: An Empirical Study of Mortgage Redlining,” Journal of Financial Services Research.

Filed Under : Capitalism, Entrepreneurship, Competition

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