[AL ADVISORS emerinsky '.. Irmas Professor of Public Interest Law, Legal Ethics, icai Science (of Southern California i. Epstein ker Hail Distinguished Service Professor of Law ■ of Chicago Gikon Meyers Professor of Law and Business University Eva Stern Professor of Law and Business University Krier en DeLano Professor of Law of Michigan „ Neumann, Jr. of Law ruversity School of Law Tverud Garner Anthony Professor c University Law School Warren eb Professor of Law niversity S ADVISORS imsworth jormack Professor of Law University j. Hazard, Jr, ofessor of Law of Pennsylvania blfman Professor of Law niversity economic analysis of law sixth edition Richard a. Posner Judge, U.S. Court of Appeals for the Seventh Circuit; Senior Lecturer, University of Chicago Law School I I J i i ASPEN i PUBLISHERS 1185 Avenue of the Americas, New York, NY 10036 www.aspenpublishers.com Chapter 1 The Nature of Economic Reasoning This book is written in the conviction that economics is a powerful tool for analyzing a vast range of legal questions but that most lawyers and law students—even very bright ones—have difficulty connecting economic principles to concrete legal problems. A student takes a course in price theory and learns what happens to the price of wheat when the price of corn falls and to the price of grazing land when the price of beef rises but does not understand what these things have to do with free speech or accidents or crime or the Rule Against Perpetuities or corporate indentures. This book's design is to anchor discussion of economic theory in concrete, numerous, and varied legal questions; the discussion of economic theory in the abstract is confined to this chapter. §1.1 Fundamental Concepts Many lawyers still think that economics is the study of inflation, unemployment, business cycles, and other mysterious macroeconomic phenomena remote from the day-to-day concerns of the legal system. Actually the domain of economics is much broader. As conceived in this book, economies is the science of rational choice in a world—our world—in which resources are limited in relation to human wants.1 The task of economics, so denned, is to explore the implications of assuming that man2 is a rational maximizer of his ends in life, his satisfactions—what we shall call his "self-interest." Rational maximization should not be confused with conscious calculation. Economics is not a theory about consciousness. Behavior is rational when it conforms to the model of rational choice, whatever the state of mind of the chooser (see §1.3 infra on the meaning of "rational" in economics). And self-interest should not be confused with selfishness; the happiness (or for that matter the misery) of other people may be a part of one's satisfactions. To avoid this confusion, economists prefer to speak of "utility" (discussed further in the next section of this chapter) rather than of self-interest. §1.1 1. See Gary S. Becker, The.Economic Approach to Human Behavior (1976), and for criticism of so broad a definition of economics, Ronald H. Coase, Economics and Contiguous Disciplines, 7 J. Leg. Stud. 201 (1978). 2. And woman too, of course. Throughout this book, the ' 'masculine" pronouns are used in a generic rather than a gendered sense. The book devotes more space to issues of particular concern to women (see, e.g., Chapter 5) than is typical in economic analyses of law. The Nature of Economic Reasoning Fundamen $ d 1 IX. 1 1 X i f X 1 1 \ 1 t 1 I 1 1 1 1 q2 «, Figure 1.1 Quantity Central to this book is the further assumption that man is a rational utility max-iraizer in all areas of life, not just in his "economic" affairs, that is, not only when engaged in buying and selling in explicit markets. This is an idea that goes back to Jeremy Bentham in the eighteenth century, but it received little attention from economists until the work of Gary Becker in the 1950s and 1960s.3 The concept of man as a rational maximizer of his self-interest implies that people respond to incentives—that if a person's surroundings change in such a way that he could increase his satisfactions by altering his behavior, he will do so. From this proposition derive the three fundamental principles of economics. The first is the inverse relation between price charged and quantity demanded (the Law of Demand). If the price of steak rises by 10£ a pound, and if other prices remain unchanged, a steak will now cost the consumer more, relatively, than it did before. Being rational and self-interested, the consumer will react by investigating the possibility of substituting goods that he preferred less when steak was at its old price but that are more attractive now because they are cheaper relative to steak. Many consumers will continue to buy as much steak as before; for them, other goods are poor substitutes even at somewhat lower relative prices. But some purchasers will reduce their purchases of steak and substitute other meats (or other foods, or different products altogether), with the result that the total quantity demanded by purchasers, and hence the amount produced, will decline. This is shown in Figure 1.1. Dollars are plotted on the vertical axis, units of output on the horizontal. A rise in price from pl to pt results in a reduction in the quantity demanded from q1 to q2. Equally, we could imagine quantity supplied falling from q1 to q2 and observe that the effect was to raise the price of the good from jb, to p% Can you see why the causality runs in both directions? This analysis assumes that the only change occurring in the system is the change in relative4 price or in quantity. Yet if, for example, demand were increasing at the 3. See Becker, note 1 supra, ch. 1 (1976); Richard A. Posner, Frontiers of Legal Theory 54-57 (2001). 4. If the price level is, rising for all goods (i.e., if there is inflation), there is no quantity effect (why not?). lie Reasoning Fundamental Concepts 5 utility max-t only when joes back to ;ntion from ies that peo-such a way do so. From ' demanded other prices , than it did nvestigating /as at its old ive to steak, hem, other t some pur-ts (or other quantity de-his is shown m the hori-■ demanded ql to q2 and 3an you see the change asing at the j 54-57 (2001). ity effect (why same time that price was rising, the quantity demanded and supplied might not fall; it might even rise. (Can you graph an increase in demand? If not, see Figure 9.5 in Chapter 9.) The analysis also assumes away the possible impact of a change in relative price on incomes. Such a change might have a feedback effect on the quantity demanded. Suppose that a reduction in a person's income will cause him to buy more of some good.6 Then an increase in the price of that good will have two immediate effects on consumers of the good: (1) Substitutes will become more attractive; (2) consumers' wealth will be reduced because the same income now buys fewer goods. The first effect reduces demand for the good, but the second (under the assumption that it is an inferior good) increases the demand for it and might conceivably, though improbably, outweigh the first.6 The wealth effects of a change in the price of a single good are unlikely to be so great as to have more than a negligible feedback effect on demand; in other words, the substitution effects of a price change ordinarily exceed the income or wealth effects. So the latter can usually be ignored. The Law of Demand doesn't operate just on goods with explicit prices. Unpopular teachers sometimes try to increase class enrollment by raising the average grade of the students in their courses, thereby reducing the price of the course to the student. The convicted criminal who has served his sentence is said to have "paid his debt to society," and an economist would find the metaphor apt. Punishment is, at least from the criminal's standpoint (why not from society's, unless the punishment is in the form of a fine?), the price that society charges for a criminal offense. The economist predicts that an increase in either the severity of the punishment or the likelihood of its imposition will raise the price of crime and therefore reduce its incidence. The criminal will be encouraged to substitute other activity. Economists call nonpecuniary prices "shadow prices." The consumers in our steak example—and the criminal—were assumed to be trying to maximize their utility (happiness, pleasure, satisfactions).7 The same is presumably true of the producers of beef, though in the case of sellers one usually speaks of profit maximization rather than of utility maximization. Sellers seek to maximize the difference between their costs and their sales revenues, but for the moment we are interested only in the lowest price that a rational self-interested seller would charge. That minimum is the price that the resources consumed in making (and selling) the seller's product would command in their next best use— the alternative price. It is what the economist means by the cost of a good, and suggests why (subject to some exceptions that need not trouble us here) a rational seller would not sell below cost. For example, the cost of making a lawn mower is the price the manufacturer must pay for the capital, labor, materials, and other resources consumed in making it. That price must exceed the price at which the resources could have been sold to the next highest bidder for them, for if the 5. This would be what economists call an "inferior" good. Technically, a good is inferior if a reduction in the consumer's income will not have a proportionately negative effect on his purchase of the good. A consumer is apt to change the composition of his diet in favor of potatoes and against caviar if his income falls, but, especially if his income falls a lot, he may not actually buy more potatoes than he did before. A "normal" good is one the demand for which is proportional to income; and a good is "superior" if a fall (rise) in income will cause a proportionately greater fall (rise) in the consumption of the good. 6. This is the Giffen paradox; but no well-authenticated real-world example of a "Giffen good" has been found. 7. We shall examine the concept of utility more critically in the next section. 6 The Nature of Economic Reasoning manufacturer had not been willing to beat that price he would not have been the high bidder and would not have obtained the resources. We postpone the complication that is introduced when the sellers of a resource price it higher than its alternative price. A corollary of the notion of cost as alternative price is that a cost is incurred only when someone is denied the use of a resource. Since I can breathe as much air as I want without depriving anyone of any of the air he wants, no one will pay me to relinquish my air to him; therefore air is costless.8 So is a good with only one use. (Can you see why?) Cost to the economist is "opportunity cost"—the benefit forgone by employing a resource in a way that denies its use to someone else. Here are two more examples of opportunity cost: (1) The major cost of higher education is the forgone earnings that the student would have if he were working rather than attending school; this cost exceeds the tuition cost. (2) Suppose the labor, capital, and materials costs of a barrel of oil total is only $2, but because low-cost oil is being rapidly depleted, a barrel of oil is expected to cost $20 to produce in 10 years. The producer who holds on to his oil for that long will be able to sell it for $20 then. That $20 is an opportunity cost of selling the oil now—although not a net opportunity cost, because if the producer waits to sell his oil, he will lose the interest he would have earned by selling now and investing the proceeds. Suppose, however, that the current price of oil is only $4 a barrel, so that if the producer sells now, he will have a profit of only $2. If he invests the $2, it is unlikely to grow to $20 (minus the then cost of production) 10 years hence. So he is better off leaving the oil in the ground. The scarcer that oil is expected to be in the future, the higher the future price will be, and therefore the likelier the oil is to be left in the ground, which will have the effect of alleviating a future scarcity. This discussion of cost may help dispel one of the most tenacious fallacies about economics—that it is about money. On the contrary, it is about resource use, money being merely a claim on resources.9 The economist distinguishes between transactions that affect the use of resources, whether or not money changes hands, and purely pecuniary transactions—transfer payments. Housework is an economic activity, even if the houseworker is a spouse who does not receive pecuniary compensation; it involves cost—primarily the opportunity cost of the houseworker's time. Sex is an economic activity too. The search for a sexual partner (as well as the sex act itself) takes time and thus imposes a cost measured by the value of that time in its next-best use. The risk of a sexually transmitted disease or of an unwanted pregnancy is also a cost of sex—a real, though not primarily a pecuniary, cost. In contrast, the transfer by taxation of $1,000 from me to a poor (or to a rich) person would be costless in itself, that is, regardless of its secondary effects on his and my incentives, the (other) costs of implementing it, or any possible differences in the value of a dollar to us. It would not diminish the stock of resources. It would diminish my purchasing power, but it would increase the recipient's by the same amount. Put differently, it would be a private cost but not a social one. A social cost diminishes the wealth of society; a private cost rearranges that wealth. 8. That is not to say that clean air is costless, cf. §3.7 infra. 9. Noneconomists attach more significance to money than economists do. One of Adam Smith's great achievements in The Wealth of Nations was to demonstrate that mercantilism, the policy of trying to maximize a country's gold reserves, would impoverish rather than enrich the country that followed it. Other common misconceptions about economics that this book will try to dispel is that it is primarily about business or explicit markets, that it is pro-business, that it is heardess, that it slights nonquantifiable costs and benefits, and that it is inherently conservative. lomic Reasoning Fundamental Concepts have been the ne the compli-ligher than its ä incurred only as much air as will pay me to 1 only one use. he benefit for-one else. Here ;her education ng rather than : labor, capital, ;ost oil is being i 10 years. The t for $20 then. it a net oppor-the interest he pose, however, ;r sells now, he to $20 (minus ving the oil in he higher the n the ground, fallacies about rce use, money between trans-jes hands, and t economic ac-niary compen-worker's time, well as the sex of that time in nwanted preg-y, cost. In con-i rich) person on his and my erences in the s. It would di-s by the same s. A social cost h. dam Smith's great olicy of trying to y that followed it. hat it is primarily a nonquantifiable Competition is a rich source of "pecuniary" as distinct from "technological" i externalities—that is, of wealth transfers from, as distinct from cost impositions on, imcorisenting parties. Suppose A opens a gas station opposite B's gas station and as a i esult siphons revenues from B. Since B's loss is A's gain, there is no diminution in overall wealth and hence no social cost, even though B is harmed by A's competition and thus incurs a private cost. The distinction between opportunity costs and transfer payments, or in other words between economic and accounting costs, helps show that cost to an economist is a forward-looking concept. "Sunk" (incurred) costs do not affect a rational actor's decisions on price and quantity. Suppose that a life-sized porcelain white elephant cost $1,000 to build ($1,000 being the alternative price of the inputs that went into making it) but that die most anyone will pay for it now that it is built is $10. The fact that $1,000 was sunk in making it will not affect the price at which it is sold, provided the seller is rational. For if he takes the position that he must not sell it for less than it cost him to make it, the only result will be that instead of losing $990 he will lose $1,000. This discussion of sunk costs should help explain the emphasis that economists j&acc on the ex ante (before the fact) rather than ex post (after the fact) perspective. Rational people base their decisions on expectations of the future rather than mt regrets about the past. They treat bygones as bygones. If regret is allowed to rado decisions, the ability of people to shape their destinies is impaired.10 If a party ■br whom a contract to which he freely agreed turns out badly is allowed to revise the terms of the contract ex post, few contracts will be made. The most celebrated application of the concept of opportunity cost in the eco-usamic analysis of law is the Coase Theorem.11 The theorem, slightly oversimplified—for necessary qualifications see §3.6 infra—is that if transactions are costless, Ae initial assignment of a property right will not affect the ultimate use of the ■Moperty. Suppose a farmer owns his land and ownership entitles him to prevent -fee desuuetion of the crop that he grows on the land by sparks from an adjacent -railroad's locomotives. The crop is worth $100 to him. The value to the railroad of jnimpeded use of its right-of-way is much higher, but at a cost of $110 it can install ^asrk arresters that will eliminate the fire hazard and then it can run as many trains Kit wants without injuring the farmer's crop. On these assumptions, the real value ddtihe crop to the farmer is not $100 but somewhere between $100 and $110, since Htazxr price below $110 the railroad would prefer to buy the farmer's property right ■fail to install the spark arresters. The farmer can realize the higher value of the ■atop'only by selling his property right to the railroad; he will do this; and as a result sis land will be shifted into some fire-insensitive use, just as if the railroad had mmcd it. Similarly, if the railroad initially has the right to the unimpeded use of be right-of-way, but the farmer's growing a crop produces more value than the spark Kesters cost, the farmer will buy the right to use his land free of spark damage «1 so again the land will be put to its most productive use regardless of the initial asffignmen t of rights. Tht* forces of competition tend to make opportunity cost the maximum as well ssELuaimum price. (Can you see why our farmer-railroad example is an exception .£@t Ii is not the emotion of regret that is irrational, but acting on the emotion rather than letting be bygones. Regret is a form of self-evaluation and is valuable in improving future conduct ("I tJew York's t deaU pri-el T. Dowl-'economic Lomic welJ-rmitted to it because ' If so, can >r gravitate scriminate »r example lave a rule it couldn't is doctrine i as private nts? Could :e national d486 (7th ies are im-.less acting h the eco-istent? See 5 J. Law & ucturc im-jmpetition D. Enrich, . State Tax on state taxa- §27.1 The Taste for Discrimination Some people do not like to associate with the members of racial, religious, or ethnic groups different from their own and will pay a price to indulge their taste. Thus, although there are pecuniary gains to trade between blacks and whites—to blacks working for whites (or vice versa), whites selling houses to blacks, and so forth— much as there are pecuniary gains to trade among nations, by increasing the contact between members of the two races such trade imposes nonpecuniary, but real, costs on those members of either race who dislike association with members of the other race. These costs are analogous to transportation costs in international trade, which also reduce the amount of trading. There is nothing inefficient about this, but the wealth effects can be dramatic. Assume that whites do not like to associate with blacks but that blacks are indifferent to the racial identity of those with whom Lhey associate. The incomes of mariy whites will be lower than they would be if they did not have such a taste.1 They forgo advantageous exchanges: For example, they may refuse to setl their houses to blacks who are willing to pay higher prices than white purchasers. But the racial preference of the whites will also reduce the incomes of die blacks, by preventing them.from making advantageous exchanges with whites; and the reduction in the blacks' incomes will be proportionately greater than the reduction in the whites' incomes. Because blacks are only a small part of the economy, the number of advantageous exchanges that blacks can make with whites is greater than the number of advantageous transactions that whites can make with blacks. The white sector is so large as to be virtually self-sufficient; the black sector is much smaller and more dependent on trade with the white. The international trade analogy can help clarify the point. The United States constitutes so large an aggregation of skills, resources, and population that it could survive a substantial reduction of its foreign trade in relative comfort. Switzerland could not. Its markets are too small and its resources too limited to permit it to achieve economies of scale and of specialization without trading with other countries. The position of the black minority in the United States is similar to that of Switzerland in the world economy. §27.1 1. Souk: whites—those who are not piejudkvd-if other whites wen: not prejudiced (why?). -willhave highervinGomes than.they would 681 682 Racial Discrimination Although discrimination is consistent with competition, just as a reduction in international trade due to higher costs of transportation would be no evidence that international markets were not competitive,-there, are economic forces at work in competitive'-'-tti^rkcts -that ••tendMo-. minimise discrimmation*. In a market of many sellers the intensity of the prejudice against blacks will vary. Some sellers will have only a mild prejudice against them. These sellers will not forgo as many advantageous transactions with blacks as their more prejudiced competitors (unless the law interferes). Their costs will therefore be lower, and this will enable them to increase their share of the market. The least prejudiced sellers will come to dominate the market in much the same way as people who are least afraid of heights come to dominate occupations that require working at heights: They demand a smaller premium.2 This is not to say thai discrimination is bound to disappear completeh. without need for government intervention, provided only diat markets are competitive. Some discrimination is efficient (see §11.7 supra and §27.5 infra) and will therefore persist whether or not a firm's owners or managers have any taste for discrimination. So will (or may) discrimination that reflects the tastes of consumers rather than of sellers, consumers do not face competitive pressures to change their tastes. But notice that, the smaller the discriminated-against group, the less harmed the members of the group will be by less than complete discrimination by the majority. Can you see why? The tendency for the market to be dominated by firms with the least prejudice against blacks is weaker under monopoly. The single seller in the market will be, on average, as prejudiced as the average, not as the least prejudiced, member of the community. True, any monopolies that are freely transferable (such as patents) are likely to come into the hands of the least prejudiced. A monopoly that requires association with blacks is less valuable to a prejudiced owner; he suffers either a reduction in his pecuniary income by forgoing advantageous transactions with blacks or a nonpecuniary cost by making such transactions. Therefore the less prejudiced will tend to purchase monopolies from the more prejudiced. But not all monopolies are freely transferable. If the monopoly is regulated, the market forces working against discrimination are weakened further. One way to evade a profit ceiling is by substituting nonpecuniary for pecuniary income, since the former is very difficult for a regulatory agency to control; and one type of nonpecuniary income is freedom from associating with the people against whom one is prejudiced.3 Labor unions that have monopoly power may reduce the effectiveness of competition in minimizing discrimination. A monopolistic union, by increasing wages above the competitive level, creates excess demand for the jobs in which these wages are paid. If the union controls the jobs, it will have to allocate them somehow. It could auction off vacancies as they occur or permit members to sell their union membership, or it could adopt nonprice criteria, such as nepotism or, as unions once did, membership in the white race. The members of the union took a part of their monopoly profits in the form of freedom from a type of association they found distasteful.4 • 2. For evidence that blacks in fact benefit from competition among employers, see Price V. Fishback, Can Competition Among Employers Reduce Governmental Discrimination? Coal Companies and Segregated Schools in West Virginia in the Early 1900s, 32 J. Law & Econ. 311 (1989). ■3. For evidence, see Armen A. Alchian & Reuben A. Kessel, Competition, Monopoly, and the Pursuit of Money, in Aspects of Labor Economics 157 (Nat'l Bur. Econ. Research 1962). 4. An alternative explanation suggested earlier is that race is an inexpensive method of rationing ial Discrnninalia« School Segregation 683 a reduction, j 10 evidence i xrces at worfcj riarket of roanf1 sellers will base * many advaiita-(unless die Jaw rem .to increase d dominate übe eights come to rand a smaller ear completed* Lrkets are cod*-infra) and wiH e any taste for s of consumers o change their le less harmed ination by the least prejudice narket will be, d, member of ich as patents) y that requires offers either a isactions wiüi 2 the less prej-d. But not all liscrimination tuting nonpe^ ' a regulatory l from associ- mess of corn-easing wages h these wages somehow. It I their union or, as unions ook a part of n they found Thus government policy, which is responsible for profit controls on monopolists and for strong labor unions, may increase discrimination above the level that would exist in an unregulated market. And these are not the only government polices that have an adverse effect on racial minorities. Another is the minimum wage.5 §27.2 School Segregation In Brown v. Board of Education,1 the Supreme Court invalidated state laws requiring or permitting racial segregation of public schools. The Court held that segregated education was inherently unequal because it instilled a sense of inferiority in black children. The analysis in the preceding section suggests an economic as distinct from a psychological basis for rejecting tire notion of separate but equal. Segregation reduces the opportunities for valuable associations between races, and these associations would be especially valuable to the blacks because of the dominant position of the whites in the society. The Court had recognized this point in Sweatt v. Painter,2 which held that blacks could not be excluded from state law schools. The Court pointed out that black students in a segregated law school would have no opportunity to develop valuable professional contacts with the students most likely to occupy important positions in the bench and bar after graduation. It rejected the argument that this disadvantage was offset by the disadvantage to white students of being barred from association with black law students, noting that the blacks' weak position in the profession made such associations less valuable to white students. If our earlier analysis is correct, the laws invalidated in Brown that forbade local school districts to operate integrated schools made discrimination greater than it would have been in the absence of such laws—but perhaps not much greater. While the federal courts, the Department of Justice, and other agencies were eventually able to compel the southern states to stop enforcing their segregation laws, many whites were willing to pay the additional costs necessary to perpetuate school segregation. They sent their children to segregated private schools or moved to school districts containing few black residents. The Supreme Court had made discrimination more costly but since die white population valued such discrimination highly, the effect of the Court's action on the amount of discrimination was for many years small'"(it may still be small). Further, since the white population controlled the public finance of the states, it could deflect the force of the Court's action, in part at least, by reducing appropriations for public education and by subsidizing private education through tuition grants and tax credits. These measures made it cheaper for parents to shift their children to segregated private schools. •iceV. Fishback, parties and Seg- and the Pursuit ^d of rationing access and thereby increasing the net gains from monopolizing the labor supply. See §11.9 supra. Either explanation has the same consequences for the welfare of the excluded blacks. 5. See §11.7 supra; Harold Demsetz, Minorities in the Marketplace, 43 N.C.L. Rev. 271 (1965). Does the analysis in this section suggest an economic reason why the disemployment effects of the minimum wage might be concentrated on the members of a minority that is discriminated against rather than on the members of the majority? §27.2 1. 347 U.S. 483 (1954). 2. 339 U.S. 629 (1950). 684 Racial Discrimination Economic analysis might be helpful in the design of desegregation decrees, which in the 1990s are still enforced and contested. Suppose a court wants to promote the integration of the public schools of a community that practiced segregation in the past (and can therefore be placed under a remedial decree), without causing so much "white flight" that black children will derive no benefit from the decree. From the standpoint of white parents who for whatever reason regard the presence of black children as a detriment to their own children, any desegregation decree will operate as a tax. The higher the tax, the more likely the white parents are to incur the costs of moving to another school district or sending their children to private school. The court can minimize this effect (and thus maximize the benefit of the decree to blacks) by (1) imparting as broad a geographical scope to the decree as possible, so that the costs to the white families of relocating are maximized, (2) imposing as many of the costs of the decree as possible on blacks rather than whites, as by busing black children rather than white children, and (3) limiting the fraction of any school that is black, since the desegregation "tax" on whites rises with the ratio of black to white children in the school. Even if black children benefit greatly from integrated education, it does not follow that they might not benefit even more from alternative strategies. For example, the Supreme Court in Brown, rather than invalidating public school segregation, might have exploited the value that southern whites attached to segregation by requiring, as a'condition of maintaining segregated schools, that the southern states devote much larger sums to the education of blacks than had been their practice. Blacks conceivably might have been better off under such an arrangement even if the Brown decision had received prompt and wholehearted compliance. Imagine a community composed of 200 blacks and 800 whites, where the averagt income of the blacks is $5,000 and of the whites $10,000. Assume that the eliuii nation of segregated education would increase the pecuniary and nonpecunian income of the blacks by an average of $2,000 (ignore the lag between .change*! educational conditions and better employment). The black community would therefore gain $400,000 from desegregation. But suppose the whites in the com munity would be willing to pay an average of $1,000 apiece not to integrate lb* schools. They would therefore be willing to spend $800,000 on better rdmuiKM: for the blacks as the price of continued segregation, and let us assume that evrarf dollar so spent would benefit blacks by one dollar. Then this expendituic isoisM increase the blacks' incomes by $400,000 more than integration would increase a. This alternative strategy would not work for all segregated public faciliti es. Bh*dks cannot be compensated for the insult implicit in a regime of racially scgre rest rooms and drinking fountains by a judicial decree requiring the state to spenjl as much money on the black as on the white facilities. Yet if the segregatedfac"*"^ are truly equal in quality, this would lend plausibility to the criticism that.the. decision denied freedom of association to whites at the same time that itpron freedom of association of blacks, and that there is no neutral principle by whidtjj choose between the associational preference of whites and blacks.3 Butecon analysis suggests an important distinction: Because blacks are an economic mil the per capita cost to them of the whites' prejudice is much greater than, them to the whites. Well, but what has this point to do with efficiency? And howl applicable to segregated rest rooms and drinking fountains? 3. Herbert Wechsler, Toward Neutral Principles of Constitutional Law, 73 Harv. L. Rev. 1 (ISEBlS §27.3 l.Bi 2. Shelley v. The Requirement of State Action §27.3 The Requirement of State Action 685 The Fourteenth Amendment, which was enacted primarily for the benefit of racial minorities, provides that no state shall deny anyone the equal protection of its laws or deprive anyone of life, liberty, or property without due process of law. Economic analysis can help clarify the issues involved in distinguishing state from private action. Three levels of state involvement in. discrimination can be distinguished: a law or other official action that orders discrimination; discrimination by a public enterprise; state involvement in private enterprises that practice discrimination but not in the decision of the enterprise to discriminate. Both the first and second levels of state involvement were involved in the Brown case, but they were not distinguished. The Court invalidated laws requiring all public schools in a state to be segregated. Such laws may be presumed to enact the prejudices of the more prejudiced half of the population and thus to produce greater discrimination than if the decision to segregate were left to individual public school districts. The Court also invalidated state laws permitting local school districts to segregate at their option. When the decision to segregate is left to each local school district it is not so obvious that the result will be a different amount of discrimination from what there would be if all education were private; but probably there will be more. A public school system is a nontransferable monopoly (private education, because it costs the consumer as distinct from the taxpayer more than public education, is not a good enough substitute for the latter to deprive a public school district of all its monopoly power), and we saw earlier that nontransferable monopolies may be expected to discriminate more, on average, than competitive firms or freely transferable monopolies. Since most governmental services are in the nature of nontransferable monopolies, this point has general application to public agencies. The analysis is different when the decision to discriminate is made by a private individual or firm, even though the state is involved to some extent in the private activity. The question should be whether the state's involvement makes discrimination more likely. Where that involvement takes the form of public utility or common carrier regulation, then, as we saw earlier, the likelihood that the firm will discriminate is indeed greater. The state also maintains an extensive system of land title recordation and is otherwise deeply involved in the regulation of land use. But this does not increase the probability that a white homeowner will refuse to sell his house to a black buyer because of distaste for association with blacks. The foregoing analysis suggests a different definition of state action from what the courts have employed. It would prohibit racial discrimination by trade unions, for the governmental policies that have fostered the growth of monopolistic unions have thereby increased the likelihood that they would practice racial discrimination. But it would not forbid discrimination by the private concessionaire in a public office building,1 unless the public authority had encouraged the concessionaire to discriminate. An interesting question is presented when the state involvement takes the form of legal enforcement of a private decision to discriminate. May racial covenants be enforced?2 May the City of Macon as trustee of the park donated by Senator Bacon §27.3 1. But see Burton v. Wilmington Parking Authority, 365 U.S. 715 (1961). 2. Shelley v. Kraemer, 334 U.S. 1 (1948). 686 Racial Discrimination Ant comply with the racial condition in the gift?3 Does the equal protection clause forbid recourse to civil and criminal trespass remedies by shopkeepers who do not want black customers? It is hard to believe that without properly rights there would be less discrimination. There might be more, especially in communities where the taste for discrimination was widespread, since without legally protected property rights more economic activity would be directed either by political decision or by threat of violence. It is true but trivial that if the state enforced all private decisions except those to discriminate, the cost of discrimination would be higher and the incidence lower. A more interesting point is that the effect of enforcing a racial condition in the restrictive covenant and charitable gift eases would be to create more discrimination than the members of society want today. To return to the international trade analogy, it is a little as if nations had agreed in the nineteenth century that they would never permit trade to be conducted other than in sailing ships. This is an instance of the broader concern discussed in Chapter 18 that a perpetual condition in a deed or gift may cause resources- to be employed inefficiently if an unforeseen contingency, in this case a decline in the taste for discrimination, materializes. But it is fortuitous whether the result of a perpetual condition is more discrimination than contemporaries want or less. Were there a secular increase rather than decline in racial discrimination, enforcing racially motivated deed or gift restrictions (such as a provision in a foundation charter declaring the purpose of the foundation to be to promote racial integration) might produce less discrimination than contemporaries wanted. 527.4 Antidiscrimination Laws Federal laws forbidding private discrimination in the sale and rental of real estate, in employment, and in restaurants, hotels, and other places of public accommodation are sought to be justified first as necessary to eliminate the effects of centuries of discriminatory legislation and second as promoting interstate commene. The second justification strikes many people as contrived, yet makes economic sense. Discrimination reduces transactions between blacks and whites and many of the transactions that are prevented would be in interstate commerce, even narrowly defined. The first justification is plausible but indefinite. Any deprivation from which black people suffer today could be due in part to past discrimination resulting from discriminatory laws or other governmental policies. If black children on average perform less well than whites even in northern schools, it maybe due to. the -. fact that the financial return to education for black people has traditionally been low because of particularly severe employment discrimination against educated blacks, which may have been influenced by the discriminatory governmental policies of the southern states from which many northern blacks originated. This kind of argument provides the strongest justification for reverse discrimination, discussed in the next section. Economic analysis helps explain the variance in compliance with anti-discrimination laws. If the interracial associations brought about by such a law are slight, 3. See Evans v..Newton, 382 U.S. 296 (1966); §18.2 supra. icnimnalw Antidiscrimination Laws 687 ion clause vho do not lere would where the d property ision or by xepl (hose ence lower, don in the rimination trade aisai-they would m instance dition in a anforeseen ializcs. But rimination lan decline dons (such sndation to in contem- real estate, accommo :cts of cen-commerce. economic nd many of •n narrowly ation from m resulting Iren on av-due to the mally been t educated nental poli-'.. This kind lation, dis- iti-discrimi-' are slight, the cost of association even to prejudiced people will be low and they will not be willing to incur heavy costs in the form of punishment for, or legal expenses of, resisting compliance in order to indulge their taste. It is not surprising that there has been general compliance with laws forbidding people to refuse on racial grounds to sell real estate, although few resources have been allocated to enforcing these laws. Unless the seller plans to stay in the neighborhood, his association with a black purchaser is limited to negotiating the sale (and a broker does that anyway). Most housing-discrimination cases, therefore, involve rentals rather than sales. The association between a hotel owner and staff on the one hand and the guests of the hotel on the other are impersonal except where the establishment is very small— and for this reason small establishments were exempted from the public accommodations law—so again it is not surprising that widespread compliance was rapidly and easily achieved. School integration is different. Not only is the association among school children intimate and prolonged but to the extent that black children, for whatever reason, on average perform worse in school than white children, integration may involve costs to whites over and above the nonpecuniary costs imposed by an undesired association. Laws forbidding discrimination in employment involve interesting questions of proof, of statutory purpose, of remedy, and of efficacy. A firm may have no black employees, even if it is located in an area with a large black population, for reasons unrelated to discrimination by either the management of the firm or the white workers. There may be no blacks with the requisite training or aptitude, or blacks may not like the type of work, or they may simply be unaware of job openings at the firm. If an employer is forced to hire unqualified blacks, *pay them a premium to induce them to do a type of work that they do not likefeor adv^fuse. in the • black'' community openings for jobs in which very few blacks are interested, the firm incurs costs greater than the benefits to the blacks who are hired. The unqualified black employee imposes productivity losses that he does not recoup in higher wages. The premium paid to the black employee who does not like to work in this type of job is a cost to the firm but not a benefit to the black employee; it just offsets the nonpecuniary cost of the job to him. Advertising job openings in the black community may not confer a benefit commensurate with its costs if the advertising fails to generate a significant flow of qualified applicants. Since most of the additional costs probably will be passed on to the firm's customers, these methods of improving the welfare of black people are regressive as well as inefficient. Laws forbidding job discrimination (see also §11,9 supra) are cosdy even when they are applied to employers who in fact discriminate. The employer may have to pay a higher wage to those white workers who have both a taste for discrimination and attractive alternative employment opportunities in firms that do not have black employees. If they lack such opportunities, the elimination of discrimination may impose no pecuniary costs—by hypothesis the workers have no choice but to accept association with blacks—but it will impose nonpecuniary costs in the form of an association distasteful to the whites. And the costs are unlikely to be offset by the gains of black workers for whom jobs in the firm are superior to their alternative job opportunities or by the economic advantages that increased trading with blacks brings to the firm and hence to its customers; if there were such offsetting gains, the blacks would probably have been hired without legal pressure (why?). So far in this discussion it has been assumed that, whatever the costs of antidiscrimination laws, the intended beneficiaries benefit. But they may not. The first and lesser point is that blacks pay as consumers and as workers their proportionate 688 Racial Discrimination share of any costs that antidiscrimination laws impose on firms. However, they share these costs with whites, whereas the benefits accrue only to them. Second, the more it costs firms to employ black workers, the greater the efforts firms will make to minimize their employment of blacks. For example, they will be less inclined to locate their plants or offices in areas of high black population—especially if, as under the disparate-impact theory of discrimination, they will be more vulnerable to charges of discrimination the larger the black population in the area in which their plants and offices are located. What should be the remedy in a case in which an employer is adjudged to have discriminated? Economic analysis suggests that the employer should be required to pay the damages of the person discriminated against, perhaps doubled or trebled to facilitate enforcement in cases in which the damages are small. This will both compensate and deter and seems preferable to an injunctive remedy requiring the employer to hire a specified number or percentage of blacks. The injunction will force him to lay off white workers or, what amounts to the same thing, to favor black over white job applicants until the quota fixed in the decree is attained. By imposing costs on white employees who may be untainted by discrimination in order to improve the condition of black workers, such an injunction operates as a capricious and regressive tax on the white working class. The analysis is more complicated if the employees share responsibility with the employer for the discrimination. The employees may have barred blacks from their union. Or the employer may have discriminated only because of his workers" taste for discrimination—he himself being free from it. (Indeed, from an economic standpoint, who is more likely to harbor discriminatory feelings—the white employer or the white employee? What is the appropriate remedy in a case in which employee responsibility for the discrimination is proved?) Suppose an employer pays white workers more than black workers in the same job classification. Should the measure of damages be the difference between the two wage rates? What if any weight should be given to the possibility that if the employer had had to pay the same wages to whites and blacks, he would have employed fewer workers of both races? Should the employer be allowed to defend by showing that part of the wage difference is a return to the white workers* grcak'i investment in education? If only a few employers in a labor market discriminate, can it be argued that no difference in wages between black and white workers could be due to discrimination, whatever the employer's taste? One might suppose that the number of antidiscrimination suits would fall over time, as prejudice diminished among sellers in competitive markets. Actually the number has increased. Does this refute the economic theory of discrimination? Not at all. Apart from the fact, noted earlier and explored in the next section, that prejudice and discrimination are not synonyms, there is the fact that, as more and more blacks are hired, the composition of antidiscrimination claims shifts from refusals to hire to discharges. Discharge suits are more lucrative for plaintiffs because damages are based on mid-career rather than ordinarily lower entry-level salaries, because the former are more likely to exceed opportunity cost (why?), and because there are more dimensions along which an employer can discriminate against an employee than against an applicant (e.g., harassment, failure to promote* inferior working conditions). So a decline in employment discrimination can actually produce an increase in employment discrimination suits!1 §27.4 1. On whether the net effect of employment discrimination laws has been beneficial to blacks, > scrinunatioti Reverse Discrimination 689 ■, they share i, the more ill make to inclined to ;cially if, as vulnerable ;a in which ^ed to have required to I or trebled is will both quiring the mction will ig, to favor ittained. By nination in perates as a ity with the s from their >rkers' taste i economic ; white erase in which in the same >etween the > that if the would have d to defend :ers' greater iscriminate, >rkers could i\d fall over actually the nation? Not ection, that is more and shifts from >laintiffs be-■ entry-level (why?), and liscriminate to promote, tion can ac- :ficial to blacks, 527.5 Reverse Disciiniinatioii1 It is often urged that blacks should be given preferential treatment—for example, that law schools should set lower admission standards for blacks than for whites even if the admission criteria provide unbiased estimates of black academic performance. Many law schools do this. Is such reverse discrimination a fundamentally different animal from the old-fashioned discrimination against blacks? To answer this question will require us to go behind the assumption heretofore employed that discrimination is simply a result of taste and inquire more closely into its causes. Racial discrimination has a number of possible causes. Sheer malevolence and irrationality are factors in many cases. Discrimination is sometimes anticompetitive—this appears to have been a factor in the internment during World War II of California's Japanese residents and has been a frequent factor behind antisemi-tism—and sometimes exploitive, as in slavery. Race enters as a convenient factor identifying the members of the competing or exploited group. Another factor, however, is the costs of information. To the extent that race or some attribute similarly difficult to conceal (sex, accent, etc.) is positively correlated with the possession of undesired characteristics, or negatively correlated with desired characteristics, it is rational for people to use the attribute as a proxy for the underlying characteristic with which it is correlated ("statistical discrimination"). If experience has taught me (perhaps incorrectiy)2 that most Mycenaeans have a strong garlic breath, I can economize on information costs by declining to join a club that accepts Mycenaeans as members. Although I might be forgoing valuable associations with Mycenaeans who do not have a strong garlic breath, this opportunity cost may be smaller than the information cost that more extensive sampling of Mycenaeans would entail. Discrimination so motivated has the same basic character (its distributive effects may of course be different) as a decision to stop buying Brand X toothpaste because of an unhappy experience with a previous purchase of it, albeit the next experience with the brand might have been better. The fact that some racial discrimination is efficient does not mean that it is or should be lawful. On utilitarian grounds it. may well be unjust, even if efficient, (explain). It is likely, however, to be offensive. Suppose, for example, that all airplane hijackers were■: members of a particular ethnic groups but that onlv a small percentage, of the members of the group were airline hijackers.;-it would be a rational police strategy to use "ethnic profiling" whereby only members of the group in question, would be searched before being permitted to board an aircraft. But then the -entire:cost of airport searches of innocent persons/would be borne by members of one ethnic group.s As this example illustrates, from a pure efficiency standpoint the type of discrimination that is motivated purely by information costs (the type usually called by economists "statistical discrimination") might, if sub- see the judicious discussion ia John J. Donohue III tfejames HecWani-Coritinuous Versus Episodic Change: The Impact of Civil Rights Policy on the Economic'Status of Blacks, 29 J. Econ. Lit.:.1603 (1991).. They find few such benefits outside the South. §27.5 1. See also §11.9 supra. 2. Because of the difficulty of establishing property rights in information, people may have inadequate incentives to investigate even the average characteristics of the groups they deal with. What are the policy implications if this proposition is accepted? 3. See Amy Farmerfe Dek Terrell; Crime Versus Justice: Is There a Trade-off?, 44J. Law & Econ. 345 (2001). 690 Racial Discrimination Prob jected to the balancing approach often used in constitutional cases (see §28.2 infra) , result in upholding some racial discrimination on efficiency grounds (depending, however, on the weight placed on the distributive costs of discrimination). An alternative to balancing is to argue that what is forbidden by the Fourteenth Amendment and other antidiscrimination measures is precisely the use of race as a proxy for underlying personal characteristics. This principle has the many appealing characteristics of a simple rule (see §20.3 supra), compared with a rule—^ really a standard—merely forbidding unreasonable discrimination. But a possible corollary of the suggested principle is that reverse discrimination is unconstitutional, because it is based on the use of race as a proxy for underlying personal characteristics. The rationale for preferential admissions of blacks to law school is not that blackness per se is a desirable characteristic but that it is a proxy for characteristics relevant to the educational process or to performance in the legal pro^ fession—characteristics such as a background of deprivation, empathy for the disadvantaged, etc. Blackness is used as the criterion for preference in order to economize on search costs. The result, it can be argued, is to confer capricious benefits on middle-class blacks in much the same way that discrimination against blacks based on the characteristics of many poor blacks has imposed capricious burdens on the middle-class blacks who lack these characteristics. A subtler point is that reverse discrimination brings about a capricious redistribution of income among blacks, just as discrimination against blacks does. To the extent that employers find it costly to assess the quality of an individual worker, black workers in a particular line of work who are as good as white workers in diat line will find it difficult to separate themselves from the affirmative-action hires and will therefore be assumed to be of the average quality of black workers in the line of work—an average dragged down by the affirmative-action hires. In the language * of game theory, there will be a pooling equilibrium in which below-average black workers will benefit at the expense of above-average ones. : * Information costs also help explain why 'reverse- discrimination is so unpopular. Every time a white male fails to gain admission to a college that is known to practice reverse discrimination, or isn't hired by an employer known to practice it, there is some probability that he has lost this valuable opportunity because of reverse discrimination. The probability, however, will often be much less than one. Suppose four people apply for a job. Three are white and one is black, and the black is hired. Even if all the whites are better than the black, who was hired solely because of his race, we know that two of the three whites would not have gotten the job even if the employer did not discriminate. The two may not know who they are; all three whites, therefore, will believe that they may have been hurt by reverse discriminar tion. Each is, as it were, a probabilistic victim of the practice. Evaluate this argument: reverse discrimination is a fair policy so long as the number of persons actually harmed by it is no greater than the number of persons harmed by direct discrimination. Would your answer be different if for "fair" the word "efficient" were substituted? Suggested Readings 1. Gary S. Becker, The Economics of Discrimination (2d ed. 1971). 2. John J. Donohue III, Is Tide VII Efficient?, 134 U. Pa. L. Rev. 1411 (1986). 3 natii 4. Law 5. Rev. 6. and 7. Rev. 8. 9. P> 1. Is it; econ diffe ing? 2. fault< defai simil: that t prop< Woul lost? 3. 4. : profe fore t poliq 5. locati prem 6. < for bl he hi) than 1 fewer wheth wheth any w most i 7. 1 to do Problems 691 3.-- 8c Peter Siegelman, The Changing Nature of Employment Discrimination Litigation, 43 Stan. L. Rev. 983 (1991). 4. Amy Farmer & Dek Terrell, Crime Versus Justice: Is There a Trade-off?, 44 J. Law&Ecpn. 345 (2001). 5. Edmund S. Phelps, The Statistical Theory of Racism and Sexism, 62 Am. Econ. Rev. 659 (1972). 6. Tomas Philipson, Desegregation and Social Monopoly Pricing, 4 Rationality and Society 189 (1992). 7. Richard A. Posner, The Efficiency and the Efficacy of Title VII, 136 U. Pa. L. Rev. 513 (1987). 8. Thomas Sowell, Civil Rights: Rhetoric or Reality? (1984). 9. Discrimination in Labor Markets (Orley Ashenfelter & Albert Rees eds. 1973). Problems 1. This chapter has suggested a neutral principle for forbidding discrimination. Is it an economic principle? Can one argue that discrimination is inefficient? In economic terms, are the costs of interracial associations, given prejudice, any different from the crop damage caused by the interaction of railroading and farming? 2. Suppose a number of blacks bought homes on land contracts and later defaulted on the contracts. They claim that they should not be held liable for the default because they were forced to pay higher prices than white purchasers of similar property, as a result of discrimination against blacks. The developers reply that the blacks should be grateful that they were willing to sell them such desirable property. What light can economic analysis shed on the issues in such a litigation? Would the welfare of blacks as a whole be increased or reduced if the developers lost? 3. Can it be argued that racially restrictive covenants might increase efficiency? 4. Suppose that a law school that found that its black graduates had lower lifetime professional earnings than whites because of racial discrimination decided therefore to impose higher admission requirements on blacks than on whites. Could this policy be defended as enhancing efficiency? 5. Black males have a shorter life expectancy than white males. Discuss the al-locative and distributive effects of rules forbidding life insurance companies to vary premium rates on the basis of the race of the insured, 6. Compare two forms of reverse discrimination: In one the employer sets a quota for black employees and hires only blacks until the quota is reached; in the other he hires without discrimination but he gives his black employees greater seniority than his white employees, so that when and if economic conditions require layoffs fewer blacks than whites will be laid off. Consider whether it makes a difference whether the employer is public or private, whether there is or is not a union, and wheflier the policy of granting superseniority to blacks is adopted before or after any whites affected by it are hired. Which combination of attributes produces the most inefficient discrimination, which the least inefficient? 7. Employers who wish to discriminate against blacks but are forbidden by law to do so may look for a proxy characteristic possessed by more black than whites 692 Racial Discrimination and use that as the basis for personnel decisions. The proxy might be some level of educational attainment. If you were an employer, would you be more concerned about being forbidden to use the proxy or required to have a specified fraction of black employees? See Shelly J. Lundberg, The Enforcement of Equal Opportunity Laws Under Imperfect Information: Affirmative Action and Alternatives, 106 QJ.E. 309 (1991).