Freakonomics Radio - 480. How Much Does Discrimination Hurt the Economy?

Episode Date: October 28, 2021

Evidence from Nazi Germany and 1940’s America (and pretty much everywhere else) shows that discrimination is incredibly costly — to the victims, of course, but also the perpetrators. One modern solution is to invoke a diversity mandate. But new research shows that’s not necessarily the answer.

Hi, this is Killian. Nice to meet you. Killian Huber is an economics professor at the University of Chicago. His specialty? I study how shocks to individual firms and individual households affect the economy more broadly. He recently published a paper, along with two co-authors, that tries to answer a pair of important questions. The first question is, what are the effects of discrimination on the economy more broadly? This question is even more pressing in the midst of a global reckoning around discrimination. And the second question? The second question is, what types of individuals are most important in the economy?

So what if you lose highly qualified, highly skilled top executives, top managers? How does that affect the economy? You might think Huber was asking these questions in the context of the so-called great resignation. That's the trend driven by the COVID-19 pandemic of people quitting their jobs to find something more meaningful. But no, that is not the context Huber was thinking about. He was thinking about discrimination in the 1930s in Germany, discrimination against Jewish business executives. Jews were generally very well integrated into the top levels of the German economic system. They ran all types of firms, firms that we still know today, you know, BMW, Daimler-Benz, Allianz.

These are all firms that had still know today, you know, BMW, Daimler-Benz, Allianz. These are all firms that had important Jewish executives. Deutsche Bank, still the largest bank today, had a Jewish CEO called Oskar Wassermann. But in 1933, the Nazis came to power. The Nazi ideology was extremely perverse. One element of that perversion was a complete and ultimately violent discrimination against Jews. Once the Nazis came to power in early 1933, firms started dismissing their Jewish managers relatively quickly. By mid to late 1933, around a third of the Jewish managers had already left their firms. By 1938, virtually no Jewish individuals remained in the German economy. Just how central had Jews been to the German economy?

So the Jewish population share in 1930s Germany before the Nazis came to power was just under 1%, around 0.8%. But Jewish individuals held around 15% of senior management positions in 1932. So way larger than their population share. In Berlin, about 5% of the population were Jewish, but Jews paid over 30% of the taxes in the city. The story of Jewish accomplishment in early 1930s Germany could have been told one way, as an astonishing triumph of a tiny minority. But Adolf Hitler turned it into a thoroughly different story, one of the most grotesque

manifestations of human hatred. Many of those Jewish business executives and their families would be murdered in German concentration camps, part of a Nazi genocide that would total at least 6 million Jews. Given the enormity of the Holocaust, you might think that a researcher like Killian Huber would study something more noteworthy than how the removal of these Jewish executives affected the German economy. But that's exactly what he was interested in in for two reasons. One is that Huber grew up in Germany. I actually left Germany when I was 13. I moved to India and then to England. The second reason is simply that Huber studies the economics of discrimination.

And while the Nazi purge of Jewish business executives may be a particularly heightened example, it is hardly the only example. In Uganda in the 1970s, Asians made up less than 1% of the population, but they owned 90% of businesses. That's 9-0% of businesses, and they paid 90% of tax revenue. In 1972, all of them were expelled by Idi Amin, the dictator at the time. There are plenty of even more recent examples. So in Turkey, for example, several thousand top managers who follow the cleric Fethullah Gülen were expelled, had to leave the country. In the UK, immigrants were being blamed for

economic troubles. In the US, there was also a movement against certain immigrant groups. For example, Trump enacted a ban on travel from Muslim majority countries. Today on Freakonomics Radio, what did Huber learn about the effects of discrimination on the German economy? So this is the amazing thing. Also, the Jews in Germany, while a tiny minority, were an established presence who were removed from the economy. What about when a minority isn't allowed to participate in the economy at all? The Ford business is a white man's business, and we do not want any Negroes in it. One way to fight discrimination today is to create diversity policies.

How is that working out? This paper is not meant to bash any sort of mandated diversity policies, but just to highlight one potential negative consequence. The economics of discrimination. It's even thornier than you'd think. This is Freakonomics Radio, the podcast that explores the recorded forms of what today we call discrimination, although the phrase antisemitism is actually a misnomer. Semites are people who shared a common language a couple millennia ago, including Jews and Arabs and many others. So an antisemite should theoretically also discriminate against the more than 400 million Arabs in the world today. Instead, the term is reserved for Jews, of whom there are only about 15 million.

So when we say anti-Semitism, we should really just say anti-Jewish. Anti-Jewish sentiment has a long and infamous history. Expulsions and exiles, periods of relative peace and prosperity punctuated by scapegoating and brutal assault. In the modern era, the scapegoating has often arisen from a simple question. How can this tiny minority produce such an outsized share of successful individuals in business, science, and elsewhere. Jews today make up about one-fifth of 1% of the global population, but account for more than 20% of all Nobel Prizes. And remember what Killian Huber told us about the German economy before

the Nazi takeover. Jewish managers held around 15% of senior management positions, so way larger than their population share. How can this be explained? One factor is that education and literacy have always been central to the Jewish experience. So a lot of research has been devoted to the question of why Jewish individuals often tend to have higher education levels

than others. We don't, I think, have a complete answer to this. Some people believe that it might be about a culture of reading the Torah, a culture of engaging with scripture that might be more important in Judaism than in other cultures. There's also a propensity toward analytical reasoning, whether derived from religious tradition or Jewish culture. There's also a propensity toward analytical reasoning, whether derived from religious tradition or Jewish culture. There is an underlying acknowledgement in Judaism that life is complicated, that the world is in need of repair, and that the proper way to engage with an idea is, in the words of one ancient Jewish sage, to turn it and turn it for everything is in it.

In a book called Genius and Anxiety, How Jews Changed the World, 1847 to 1947, the author Norman Lebrecht puts forth another possible explanation for the high level of Jewish achievement. Jews in the 19th century and the first half of the 20th century, he writes, are gripped by a dread that their rights to citizenship and free speech will be revoked. Great minds are driven by a need to justify their existence in a hostile environment and to do it quickly before the next pogrom. Whatever the case, at the beginning of the 20th century in Germany, there were a great

many Jews at the highest levels of industry, academia, the arts, and elsewhere. Killian Huber, when he began his research, wasn't aware of this. Yes, I was surprised to learn that Jewish individuals were in so many important positions. And I was also surprised how quickly large firms turned on them. Hitler came to power at a time of deep political and economic upheaval in Germany. In the aftermath of Germany's defeat in World War I, the Allies had imposed heavy reparations. That burden now intersected with a worldwide recession, sending Germany even further into distress.

When Hitler and other angry Germans started looking around for internal scapegoats, the Jews provided a familiar target. As long as you had a Jewish grandparent, as long as you had what they would call Jewish blood, you would have been targeted by the Nazis. Which quickly led to the removal of even the top executives of the most successful German firms, if they happened to be Jewish. So this wasn't the Nazi government directly becoming involved, but this is where the firms preemptively adopting Nazism and anti-Semitism and pushing out these individuals. So, you know, Oskar Wasserman, he had to leave by June 1933. Wasserman, remember, was the CEO of Deutsche Bank.

The Nazis came to power in late January 1933, so there's a huge turnaround in attitudes after the Nazis came to power. And so if you converted to Christianity, if you're intermarried with Christians, if you really were in no way a religious Jew anymore, the Nazis would still target you. And these people were all expelled from their positions and often died horribly in the Holocaust. You write that the Nazi government did not pass any laws that explicitly forced private firms to dismiss Jewish employees before 1938. Nonetheless, many Jewish managers lost their positions as early as 1933. Can you explain that further? Was it just base anti-Semitism? Were firms trying to preemptively appease the Nazis?

There was legislation earlier that forced Jews out of the public sector. And many firms used that legislation as a pretext to dismiss their Jewish employees. They said, look, clearly the government doesn't want Jewish employees anymore, so we also don't want them. We want to be in line with the government ideology. But there was also a lot of general enthusiasm for the Nazi movement. And it's perhaps not too surprising if you think of recent extreme political movements, where suddenly it became okay to say things and think things that perhaps before it wasn't okay to say. Do you feel, I mean, this is a personal and maybe even rude question, but do you feel that a research project like this for you was born so far after the fact

is still to some degree a penance for having been born German? I don't think Germans are guilty when they were born after what the Nazis did, but I think there's a responsibility. And I think part of studying this certainly feels like, you know, taking on the responsibility of understanding what happened and trying to make sure something like that never, ever happens again, no matter what. The sudden removal of Jewish business executives in Germany was, in essence, a perverse sort of natural experiment

that allowed Huber and his co-authors, Volker Lindenthal and Fabian Waldinger, to address a couple issues that economists are always thinking about. First, what are the effects of discrimination on the economy in general? And second, how much does a given senior executive actually matter to the success of a firm? I often use the sports analogy. You can think of, you know, the NBA, Giannis plays for the Bucs. How important are these individuals to team performance versus they just play for good teams and that's why their teams do well? That's something we can look at here in the context of business. If you take away the best manager, how will that affect the performance of the firm? Is

the firm strong enough on its own or does it really need that top human capital? Perhaps managers don't matter because you can teach any idiot to run a firm. Or do you maybe need to have some natural ability, some raw talent to start with to get to the very top? To answer these questions, you would need a lot of data. So this is the amazing thing.

There are records that contain detailed information you would need a lot about their career history. And then we can connect those names to information from other sources, from historians or from original Nazi sources that identified who would have been called Jewish by the Nazis at the time. You Germans and your record keeping, it really comes in handy, doesn't it? Yes, it's somewhat sad to say, because obviously the purpose of this record keeping was, you know, very evil, but it did help us for scientific purposes later on. The published paper is called Discrimination, Managers and Firm Performance, Evidence from Aryanizations in Nazi Germany. So in the paper, we analyze firms that were directly harmed by discrimination

because they lost their Jewish managers. And we show that firms were unable to replace the top characteristics of dismissed managers. So in particular, the number of managers with a lot of experience in the firm, the number of managers with higher education degrees, such as a master's or a PhD, and the number of managers with many connections to other firms fell significantly when the Jewish managers left the firms. So the Jewish managers who were expelled had valuable characteristics that were hard to replace. But how did their expulsion affect the firms? We find that this ended up affecting the real performance of these firms. Share prices of companies that expelled Jewish managers fell sharply

once they dismissed the managers and stayed low for at least 10 years. So it's not just the shock of getting rid of the CEO. That's right. So it's not just a transition effect in the sense that you might struggle for a year or two while you're trying to find a replacement. Up to 10 years later, these firms are still doing worse than competitors. So there seems to be a really persistent effect of losing top managers. We also find that it's not just the share prices. We find that profits went down. We find that efficiency of the firms went down.

And to give you a number, the share price of the average affected firm declined by about 10% to 12% after 1933, which is a huge effect. You write that German GNP, gross national product, fell by 1.8 percent as a result of this Jewish removal, which, you know, on the one hand is huge. On the other hand, how relevant was GNP during a war like this? When the Nazis came to power, the war was still relatively far away. The Nazis came into power on an economic agenda. People wanted unemployment to go down. They wanted to achieve recovery from the Great Depression that had plagued the global economy. And so economic factors were relatively important at the time. And so our paper, in a sense, goes to show that the Nazis harmed their economic agenda by expelling some of the best people in the economy. Do you have any thoughts on what the long-term effects of this Jewish cleansing were for Germany? Because after the war, Germany rebuilt its economy and its economy has been generally very robust these last 70, 80 years. There were very few Jews left in the country. What does that say about

either Germany or doing business without a big crop of its senior leadership? So to me, it suggests that Germany probably would have done even better if it had not lost that amazing human capital of Jews. The fundamental drivers of economic growth are ideas, innovation, good people. And these are the ones that clearly weren't quite there to the same extent anymore. When this kind of racial or ethnic or other cleansing happens, and unfortunately, there are many examples around the world throughout history, including this century, it still goes on, it wouldn't seem that the goal is usually an economic one, right? It's discriminatory or political or religious or whatnot. So the perpetrators probably aren't even thinking

about the long-term economic consequences. Should they be? Should your findings perhaps serve as an incentive to rethink this kind of discrimination? Or is that a ridiculously Pollyannish way of thinking about how the world works? Well, one way I think about it is that often these extremist politicians have the reputation of being good for the economy, that somehow getting rid of immigrants or getting rid of a minority might actually help the economy. And I think our paper clearly shows that that's complete nonsense. We don't mean to suggest that economic losses are the most serious thing about the Holocaust. The horrible loss of human life and the horrible suffering is clearly the first order shocking thing about Nazi discrimination. But we're economists and we study the economy.

So you've measured the effect of the removal of a discriminated class. How do you measure the omission of a discriminated class when some group is not allowed to even enter the economic or political or cultural mainstream in the first place? There's work by Gary Becker, who was at the University of Chicago. And his theory suggests that whenever people have some dislike of a subgroup, that will have economic effects. In particular, it will harm the discriminated, but it will also harm the discriminators economically because the discriminators are foregoing economic benefits from interacting with that discriminated group. For example, if you're not willing to hire highly talented women or highly talented black people in the U.S., then you're missing out on their talent,

and therefore your firm and your country is going to do worse. This theory of Gary Becker's came to be known as taste-based discrimination. Another model of discrimination is called statistical discrimination. The idea there is that an employer infers certain qualities about an individual based on their subgroup, like race, gender, sexual orientation, or religious affiliation. I asked Huber how these different models of discrimination, taste-based and statistical, intersect with his research. Yeah, so we think of our setting as an extreme case of taste-based discrimination, where people just forego all economic logic and just really dislike a group

and therefore exclude them from the economy. Is there any sense of whether taste-based or statistical is more damaging? So these are very sensitive questions that you're asking me. In the US, all types of discrimination is illegal. And so even if you believe for good reasons you are discriminating, you're not allowed to do that. And so people have sometimes sold statistical discrimination as a softer or rational form of discrimination, but neither of them are okay.

I'm hesitant to put a good versus bad label on them because for moral reasons and for legal reasons, in fact, they're both very dangerous. It's just that there's an economic motivation to one and non-economic motivation to the other. Coming up after the break, we put these theories of discrimination to the test in America.

I think it was the first time white America felt compelled to root for a black man. And if you want to hear another totally different story about the German economy, the modern German economy, check out episode number 304 from the Freakonomics Radio archive. It's called What Are the Secrets of the German Economy and Should We Steal Them? You can hear every Freakonomics Radio episode on any podcast app for free, along with the other shows we make.

No Stupid Questions, People I Mostly Admire, and Freakonomics MD. I'm Stephen Dubner. We'll be right back. There are many forms of discrimination and many channels. So if you're trying to measure the economic costs of a discriminatory act, you need to consider the particulars. The expulsion of Jewish business executives in Nazi Germany was an abrupt reversal of the status quo. The fact that it was abrupt allowed Killian Huber to isolate and calculate the impact. For an economist like Huber, this alignment of timing and data is relatively rare.

So you need a large shock to attitudes about a minority. And then you need people to act on these changes. And you need to make sure that you can then trace how these changes in attitudes ultimately affected firms and affected people in the economy. More common, however, are forms of discrimination that prevent a discriminated group from fully assimilating into society and the economy altogether. Consider, for instance, the story of the great American boxer Joe Louis. He was a black man born in Alabama who moved with his family to Detroit when he was about 12. Joe Louis became an obsession for me and remains so. That is Zilke Maria Weineck. I'm a professor of comparative literature and German

studies at the University of Michigan. And what does a German studies and conflict professor have to do with Joe Lewis and discrimination in America? I was dreading that question. I came to Joe Lewis because I was co-writing a book with Stefan Szymanski about sports in Detroit. Szymanski is a sports economist, by the way, also Vynek's colleague at Michigan and her partner as well. I was a lot more interested in Detroit and in the narratives around sport because sport is really the biggest global cultural practice. And we in cultural studies, I think, have neglected it to our peril. As you can perhaps tell from her accent, Weineck, like Killian Huber, is German.

I grew up in Münster in northwest Germany. I came to America in 1987, first to Johns Hopkins and then to the University of Pennsylvania, got married, had kids, got stuck in this country, and then had the great good luck to land this job at the University of Michigan, where I have been since 1998. The book she and Szymanski wrote is called City of Champions, a history of triumph and defeat in Detroit. Weineck's research led her to this conclusion. Joe Lewis is without a doubt the most important athlete Detroit has ever produced.

In examining the history of sports in Detroit, Weineck found that sport was in constant collision with race and with industry, especially the auto industry. Detroit was shaped by successive waves of migration and immigration, beginning with migrations from Eastern Europe and from Germany, and then later the great migration from the American South to the American North. The big player in this whole development was without a question Henry Ford and his $5 a day promise to his workers. And what was new and unheard of was

that Ford actually paid the same wages to black workers as to white workers. Joe Lewis's family came to Detroit because of Ford's wages. And Joe Lewis himself worked briefly, I think as a stock boy at the River Rouge plant. But what Joe Lewis was primarily was a boxer at a time when boxing was the most popular sport in the world. By his mid-20s, he had become the heavyweight champion of the world, a title he'd hold for nearly 12 years. He was known as the Brown Bomber, and he was an icon. He was so deeply beloved, particularly in the Black community. I don't think there's any precedent. I'm not sure anybody has ever reached that level of affection since.

Joe Louis was clearly embraced by white America as well as an exceptional athlete. Because the men's record, which is a great thing about sports, you can't argue with that kind of success, right? Joe Louis is a two-fist fighter. And he stands six feet tall. One reason Joe Louis became so popular in America was because of a pair of fights he had with Max Schmeling from Nazi Germany. The first fight took place relatively early in Lewis's career in 1936. It was at Yankee Stadium in New York and Schmeling won in a 12th round knockout. The rematch took place in 1938, again at Yankee Stadium. By now, Lewis was the heavyweight champion. By now, the Nazi regime

had overtaken Austria and was well on its way to war. Inside Germany, the purge of Jewish business executives, scientists, and others was also well underway. Schmeling himself apparently did not embrace Nazism, but this nuance was lost in the buildup to the second Schmeling-Lewis fight. Max Schmeling was seen as not just Hitler's favorite boxer, but practically as an embodiment of Hitler's regime. In America, it was very heavily sold as a democratic pluralism versus a fascism fight. In Germany, that was actually not the case because the Nazis were heinous, but they were not all stupid.

And they knew that Joe Louis had a very good chance of winning this. I am Louis, right and left to the head, I'm left to the jaw, I'm right to the head. 70,000 people in Yankee Stadium, 100 million people listening on the radio. Biggest sports event to date ever. And it's over in two minutes and four seconds. Five, six, seven, eight. The men are in the ring. The fight is over on a technical knockout. First round knockout.

Lewis not just winning, but Max Schmeling being transported to the hospital post-haste. And in a later interview, Lewis will say that Max Schmeling was the only opponent he ever wanted to hurt. I think it was the first time white America felt compelled to root for a black man. The celebrations were just enormous. Tallulah bankhead, you know, screaming her head off and Woody Guthrie cables in. Everybody's watching this, right? Absolutely everybody. The celebrations in black neighborhoods last for days.

So Joe Louis was an American hero, and he kept the world heavyweight title for another 10 years. By 1948, he wanted to hang up his gloves. The war was over. Louis was in his mid-30s. So what did the world's most beloved athlete want to do for his second act? So his idea was he wanted to sell Fords. Ford was one of his first jobs, and he wanted to open his own Ford dealership. As Vynik learned in her research, Joe Lewis met personally with Henry Ford II, who was by now the company's CEO. Lewis

now lived in Chicago, and that's where he wanted to open a dealership. Ford then deputizes his general sales manager, Walker Alonzo Williams, to test the waters and to get the reactions of dealers and general managers. To test the waters because Joe Lewis would be the first Black person to run a Ford dealership. And a file of these responses were in Williams' estate. With the help of an archivist at the Benson Ford Research Center, Vynik was able to track down this file. Its existence was apparently unknown to any previous biographers of Joe Lewis.

And so I get this file and you open the PDF and the stench rises from your computer screen. The file included 32 memos from Ford dealers and district managers around the country. They were responding to a question from Ford headquarters. I think the question was, we have had an inquiry from Joe Lewis, who seeks to open a Ford dealership in Chicago. What is your reaction? Do you think this would set a precedent? What's so interesting in the responses, and I'll read you some of them, that every single one understands that the question is, should we let a black man sell Fords? As opposed to, should we let Joe Louis open a dealership? Is that what you mean?

Exactly. As opposed to, is Joe Louis a good car salesman? Or is Chicago a good market right now? People don't even pretend it's about anything other than race. Here, from the archive, are some of the excerpted responses. The Ford business is a white man's business, and we do not want any Negroes in it. Another one. The writer is bitterly against the possibility of the appointment of Negro dealers and lacks words to express his feelings against the idea. Here's another one. If we wish to pioneer a principle of American democracy in business of the nature of an appointment of this kind, it is my opinion that this is not the proper time nor the proper party

involved. I assume Joe Lewis didn't get a Ford dealership. He did not get a Ford dealership, you'll be surprised to hear. Neither did any other black men until the Civil Rights Act passed. Now, there may have been other reasons to deny Joe Lewis a Ford dealership besides the fact he was black. But the rejections, at least the ones that found their way into the archive, were united in their focus on race. I asked Weineck whether Ford or the other big three automakers discussed having black dealers if only to appeal to black buyers. What a lot of these guys say is, look, there are no black dealers. Well, also, a black buyer is going to go.

Also, a lot of the dealerships hired black salesmen, which would be kept off the lot, which would operate off-site, would exclusively deal with black clients. But appointing a black dealer is, of course, a different thing, because a dealer is not just an employee, he's an employer. And Joe Louis, I will die in that hell, would have sold a lot of cars. He would have cornered the black market in the Midwest and beyond. I mean, you have your basic economic theory that says discrimination is stupid, it's bad for business, right? This goes back to the Gary Becker theory of discrimination.

When firms discriminate, they're leaving money on the table. There's also the theory that diversity creates opportunity. Killian Huber again. There is, in fact, some theoretical work by colleagues of mine that suggests that a large share of U.S. economic growth in the last century was due to the removal of barriers facing women and facing black people and getting to the economic positions that their talents deserve. It is, of course, hard to say what sort of economic position any one person might achieve. Joe Louis was one of the best boxers ever. You could imagine his athletic afterlife would have been much better if he'd simply been white. As it was, he fell deep into debt to the IRS, especially, and drug addiction. In his last years, he worked as a greeter at Caesar's Palace in Las Vegas, and he died in 1981.

He was 66 years old. What always gets me really in the gut is that Max Schmeling, Hitler's favorite boxer, did extremely well, lived to a very old age. But not only that, he was awarded the Coca-Cola franchise for northern Germany. So if you think of the iconic American products, you probably have Ford right up there. And then you have Coca-Cola at the very top. So the former Nazi boxer gets to sell Coca-Cola, becomes immensely rich, dies at a very ripe old age,

whereas the proponent of democracy, American pluralism, an apple pie, dies poor, unhealthy, and as a greeter at Caesar's Palace. Did you have conversations with anyone at Ford once you discovered these letters? I have not had conversations with Ford themselves. I would very much like to talk to Ford about naming a plant, a building, or something after Joe Lewis in a kind of belated act of reparations for this really horrendous file. Do you think that would be a successful act of reparations, or would it feel like window dressing? I mean, they literally turned the guy down. I'm in a business where we have to think that symbols matter, right? That symbolic acts do matter. They can never

substitute for actual reparations. I'm not saying, oh, name a plant after Joe Lewis and you're done. I think in the end, of course, Ford can change this, and Ford can change this by investing. By investing in Black dealerships, you need a lot more capital now to start a dealership because they're so much bigger than they used to be. Ford could also make sure that Black-owned dealerships are placed in the best locations where they actually have the best chance of succeeding.

According to the National Association of Minority Auto Dealers, fewer than 2% of Ford dealerships have a Black owner. Barely 5% are owned by any minority. A recent paper by three economists looked at discriminatory hiring within Fortune 500 companies. They found that five of the top 10 discriminatory firms were auto retailers. These days, of course, many firms and institutions are trying to undo and reverse the discrimination that's been standard operating procedure for most of history. Many institutions have adopted a DEI program that stands for diversity, equity, and inclusion. This can often include a diversity mandate with set targets for minority hires. This suggests a fundamental economic question. If discrimination can be

costly for firms, what sort of benefits are created by diversity? This is a good question. Sophie Calder-Wang is an economist at the Wharton School at the University of Pennsylvania. She and two co-authors, Paul Gompers and Kevin Wong, recently published a study examining this question. The particular setting is an MBA program at Harvard Business School. From 2013 to 2016, they ran a course which asked students to form small teams of entrepreneurial startups. What is curious is that the first time they launched this class, instead of asking people to form their own teams, the course administrator had this idea of why don't we just sort people

into teams using a computer algorithm so that we can make sure every team have a balanced ratio of men to women, of minorities and whatnot. In 2014, 2015, they scrapped the computer algorithm and said, people, you can form your own teams by your own choice. Thank you, HBS, for setting up a beautiful experiment for me, right? I mean, it is very close to the real world, even though it is a class and not an actual startup. It's as close as you could get, really, yeah? Yeah, obviously, there are some differences, but, you know, they actually get graded by a panel of judges, which is comprised of their own section leader, their

faculty advisor, and a number of industry judges who are actually practitioners in VC and entrepreneurship. So the grades should give you some resemblance of what actually matters in these fundraising rounds in startups. And what sort of startup ideas are they coming up with? Folks come up with businesses that are pretty similar to a typical early stage startup, but less fleshed out. So Uber for X, Y, and Z, let's say. Yeah, exactly. Exactly. Airbnb for dogs. What Calder Wang would be measuring then was the performance of groups that were assembled by the algorithm versus groups where the members chose themselves.

The Harvard Business School data that she analyzed covered four years of students. So this was basically a thousand students each year. So four thousand students in total. Each team is about five to six people, so you wind up with something like a thousand teams, which in the realm of firm level outcomes is a decent sample. I know in the world of big data, a thousand is tiny. But in the world of most academic experiments, this is gigantic. Yeah, exactly. How do you control for intelligence and talent and connections? We control, for lack of a better word, the ranking of their undergraduate institutions.

We control for whether they have worked in the startup sector before. And to the extent that you think a certain demographic group is just disproportionately more prepared than other groups, we actually can also control for just a fraction of, say, white students. What about GMAT scores? Are you including that? If you can help me convince the administration to share with us the GMAT scores, we're working on that because we want to make sure the errors are not biased. The student population was a relatively diverse mix of men and women from various ethnic and racial backgrounds. Calder Wang found that when students could choose collaborators for themselves, the groups were

significantly less diverse than when the algorithm created intentionally diverse groups. Given how human beings work, you probably don't find this surprising. So how did the organically chosen groups perform compared to the randomly assigned groups, or what Calder Wang calls the forced diversity groups. What we find in the randomly assigned cohort, one standard deviation increase in diversity leads to about 15% degradation in their performance. Whereas in the organic formation teams, one standard deviation increase in diversity is only about three to five percent degradation in performance. So we're talking about a three to five times difference, right? Yes, yes. In other words, when people were allowed to choose on their own. When people are allowed to choose on their own, diverse teams perform just fine.

The problem lies when you are forced to work together in a diverse team. And that's why I manufactured this word of forced diversity as opposed to organic diversity. We always have this notion that diversity might lead to better performances. And we were actually fairly annoyed because we found the coefficient to be negative. What are we to make of this finding? I mean, what are the mechanisms by which those teams do worse? So what we are finding is when people are matched with teams that are the same in terms of both gender and ethnicity, these teams do much better than teams that mismatch on both dimensions or on either dimensions, actually. It's not like one subgroup is the biggest culprit as far as we can

tell. Now, I'm sure communication is a component to it, but at that point, I'm also guessing. I have to say, when I read your research, and then I read, let's say, the Wall Street Journal, talking about how American firms in particular are moving toward what I guess I would now call, thanks to you and your research, forced diversity, right? Yeah. So let me just read you here. An analysis released in June found that nearly 75% of new independent directors at companies in the S&P 500 are women or belong to a racial or ethnic minority. So that's a massive jump. Furthermore, NASDAQ has recently required that listed companies need to meet certain minimum targets for the gender and ethnic diversity of their boards or explain in writing why they aren't doing so. Now, I think most people would look at that movement and say, well, it's about time, right?

Too much business has been too white and male for too long at the exclusion of other groups who want to be there. But when I read your paper, I think, uh-oh, things might not turn out the way people are hoping they turn out. And maybe all we're getting here is window dressing that's going to lead to bad results that's going to have a backlash. So what do you predict? This paper is not meant to bash any sort of mandated diversity policies, but just to highlight one potential negative consequence, we clearly have inequality in outcome, but in an attempt to address the inequality of outcome, I think we're a little bit lazy to think about what is the cause that actually lead to the inequality of the outcome. So these board policies that, you know, required increased

representation from women or from underrepresented minorities is an attempt to change the outcome without being very thoughtful in understanding the cause and to actually remove the cause. I would like to spend more time to think about not necessarily how to achieve equality of outcome by manipulating the outcome, but rather to unearth the path towards us achieving some form of equality or opportunity and to find out what changes in the existing institutions and the framework can be done to achieve that. I'm curious about your own views on this research, especially what drew you to this topic in the first place. For me, it's a little bit personal.

As a woman, I'm naturally interested in gender diversity. I've worked in the corporate sector. Prior to grad school, I worked briefly slash unsuccessfully as an investment banker at Goldman. And I very much admire the efficiency and the business savviness exhibited by the firm. But on the other hand, it struck me as a corporate environment that is very challenging for the woman to thrive. The nature of the work is such that it is inherently a very difficult trade-off. The underlying challenges of child care, for example. So an economist like Claudia Golden, the labor economist in examining the gender pay gap, she's noted that a lot of the pay gap is due to, you know, sorting, occupational sorting. So a female lawyer, rather than maybe becoming a partner in a top-tier firm because of the demands that make it very difficult to have a family,

will sort into, let's say, general counsel. I'm curious for you, did you sort into academia for a similar reason? I wouldn't deny it. It's not that I work any less harder in academia. To be honest, I feel like it was a process for someone who is an immigrant, who is not white, whose first language is not English, to fit into a fast-moving corporate environment. I was sitting across the table from numerous 80-year-old banking CEOs. I find it very difficult to convince them why this proposal makes any sense

for them. Where did you grow up, Sophie? I was born in China. I went to school there until about middle school and then a few years in India before immigrating to the United States. So let's say we assume that the presence of someone like you, you yourself, Sophie Calderwang, would be beneficial to an investment bank because not only do you bring a different set of experience, but you have a different perspective. And banking is, you know, it does involve humans to a large degree. So if I want to think holistically, and I really do believe that diversity is good from a moral perspective and a business perspective, which many people now at least profess to believe those two things. But I hear you saying that personally for you, it was very

difficult. And empirically, you've shown that forced diversity, at least, is not very successful. What's to be done? That is the million, billion dollar question and the moral question. Not all the, like, the right work is the easy work. So some work is going to be hard and you may not see direct impact immediately. Sophie Calderwang has written another paper that gives some reason for optimism. In an analysis of venture capitalists, and that's a field that is overwhelmingly male, she found that parenting more daughters leads to an increased propensity to hire female partners. She also found that greater gender diversity,

not forced by an algorithm, but driven by the experience of having a daughter, improves deal and fund performances. Obviously, we can't require everyone to parent daughters and go through the challenges of that. But you could require every CEO to adopt a baby that is of a different ethnic background than themselves, right? You could require the CEO to spend a weekend doing something that they normally would have never thought of doing, right? I mean, there is a limit to what you want to require, but I think an awareness and a willingness to walk in another person's shoes

is a great display of sympathy and understanding, even if it's not about performance. I thought back to Killian Huber's research about the Jewish business executives in Germany, expelled first from their jobs, then their homes, many of them ultimately murdered by the Nazis. It is a highly imperfect parallel to compare that campaign of brutality to the sort of discrimination that has shaped our labor markets. Still, I asked Huber whether his research suggests any policy thoughts for the modern era. I think there's an underlying theme that comes out of our research, but also

more generally economic research in recent years. And that theme is good people are really important. And to a large extent, what drives economic growth is the presence of good people. And so whatever governments can do to try and stimulate good people into coming up with good ideas will be key. I also asked Huber how he had been taught about the Nazi era in school. So the Nazi period, the Holocaust, World War II, plays a large role in German education, and rightly so.

I asked the same question of Silke Maria Weineck, who also grew up in Germany. It was absolutely central to almost every curriculum, whether it was literature or history or social studies. It was everywhere. Germany took it extremely seriously at the time I went to school. People are extremely aware and it defines the culture of modern Germany to a large extent. When I came to America, a lot of Americans assumed that Germany would have buried this history and that only treat it as something that's in the history books, but try and live with the history, wrestle with it, and try and make it come alive in all its horrible form. You learn about a lot of the parallels that appear between Nazi Germany discrimination and modern discrimination,

and perhaps you can contribute to preventing those horrendous types of discrimination in the future. Thanks to Killian Huber, Zilka Maria Vainik, and Sophie Calder-Wang for sharing their research and insights today. Thanks also to the archivist Sam Rood for sharing with Vainik that file of letters about Joe Lewis. We always value feedback from you, so let us know what you think of this or any episode. We are at radio at Freakonomics.com. Coming up next time on the show.

They have cronyism, systemic financial risk, excessive materialism, ecological crisis stemming from overconsumption. We look at some deep parallels between the U.S. and China, especially when it comes to corruption. We should understand the relationship between China and the U.S. not as a clash of civilizations, but as a clash of two gilded ages. That's next time. Until then, take care of yourself and if you can, someone else too.

Freakonomics Radio is produced by Stitcher and Renbud Radio. This episode was produced by Zach Lipinski. Our staff also includes Allison Craiglow, Greg Rippin, Joel Meyer, Trisha Bobita, Mary Duduk, Ryan Kelly, Jasmine Klinger, Emma Terrell, Lyric Bowditch, Eleanor Osborne, Our theme song is Mr. Fortune by The Hitchhikers. All the other music was composed by Luis Guerra. You can get the entire archive of Freakonomics Radio on any podcast app if you want to read a transcript or the show notes. That's at Freakonomics.com. As always, thanks for listening. The Freakonomics Radio Network. The hidden side of everything. Stitcher.