Friday, May 7, 2010

The market solves racism

One more reason to love the free market: it ends racism. Does this sound ridiculous? Probably at first but hear me out. I just read Economic Facts and Fallacies by Thomas Sowell which addresses this very issue. Its an excellent read that deals with many of the misconceptions associated with the free market, but by far my favorite part was when he addressed how the free markets solve the problem of racism.

There is some confusion in dealing with labor in the market, but what's important to realize is that labor is just like any other product that is bought and sold on the market. Let's assume that we have an economy with two groups of people: purple and green. We'll also assume that both the purple and the green people have the same qualifications so that the labor of purple people and green people are substitute goods. Let's also assume that we have two employers who make cars, one who is racist against green people and one who is indifferent. The racist employer is willing to go out of his way and discriminate against the green people in hiring. We'll also assume that the market set the wages of both groups of people at the same wage, $8/hr.

Some of you sharp Microeconomics AP students will realize exactly what this is. This is a change in consumer tastes. If a portion of the consumers, employers in this case, believe that a given product is worse than another product, then regardless of the truth of that statement, the 'worse' product will be cheapened while the 'better' one will be made more expensive. Now because the racist manager has increased the demand for the labor of purple people and decreased the demand for the labor of green people, the wage of the purple people move up from $8/hr to $9/hr, while the wage of the green people fell from $8/hr to $7/hr.  Now we have an employer who only hires purple people at $9/hr while the other one, reacting to the drop in the wage of the green people, hires only green people at $7/hr. The employer who only hired green people now has lower costs then the purple manager and is thus able to sell cars at a lower cost to the market. The market, which doesn't have any way of differentiating between cars except by pricing, then chooses only to buy goods from the non-racist employer, while the other employer is priced out of the market to be replaced by another. If the other employer is racist then the cycle continues until all of the successful employers do not differentiate between races and then the market equalizes all wages to $8/hr once again.

This works fine, unless there is a minimum wage. Let's say for practical purposes the government set the minimum wage at $9/hr. Now there is no longer the cost to being racist. Instead of there being a price difference between the cars produced the prices are the same, and the racist employers do just as well economically as the indifferent one's. Sounds real good in theory, right? The question then becomes does this bare out in practice.

The most convincing example of this in the book involved the country of South Africa. During apartheid, the government essentially enforced racism. There were laws on the books that required construction crews to have a certain minimum ratio of whites to blacks. This caused a significant drop in the wages of blacks as the demand for their labor decreased. The most successful foremen, who were able to outbid the more expensive companies, were those who violated this law and hired an 'unacceptable' ratio of blacks to whites. They were fined, but continued to do so anyways which meant that even with a cost associated with indifference, it was still better for them to hire more blacks than legally allowed.

To conclude, the free market solves the problem of racism, while price controls, like the minimum wage, allow people to indulge their prejudices at no cost to them.

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