On discrimination

I don’t recall where I first encountered Gary Becker’s work on Discrimination, but it must have been at least 7 years ago. I remember that it helped turn me from a statist to a near-Libertarian. Recent developments in India have led me to think again on this topic, and a long discussion with a friend helped me realize that I had failed to fully appreciate the nuances of Becker’s insight. I had long thought that his contribution was akin to that of the little girl in "The Emperor's New Clothes"- to make people see the obvious.
If you happen to know more on this matter than me (and that cannot be hard!), add your comments. Here is Becker himself.
As I understand it, Becker’s main point is that discrimination is costly. If I employ a person X when Y would have done a better job, I punish X but I also incur a cost- the additional output I would have enjoyed had I hired Y. If I do not incur such a cost, I cannot be said to be discriminating (except on ability!). In a competitive market, a firm that has a taste for discrimination would be out-competed by firms that do not discriminate. Hence, discrimination must fade away.
What did NOT strike the youthful me, ever optimistic as I used to be, is that this requires markets, and efficient ones at that. I did not ask the obvious questions- does this result always hold? If not, when might it break down?
I can now appreciate at least a couple of fairly obvious issues that could potentially spell trouble for this story:

• What happens when the customers themselves have a taste for discrimination (such as when a customer would rather not be served by a salesman of a particular community or race), and these customers are collectively very wealthy compared to customers who do not wish to discriminate on this basis? Would an equilibrium be set up where both the inequality and the discrimination survive?
• What happens when employees would rather not work with people from a particular race or community? When the employer legitimately fears that his other employees would shirk so much that the superior performance of his new hire would be rendered naught? Or even be driven down as a result of harassment by the other employees?

Does this mean that it is possible for discrimination to survive more or less indefinitely? Heck yeah- we Indians managed to practice one form of discrimination for a very long time indeed.

Does it mean that we would be fools to rely on markets for escape from these barriers? No, I don't think so. I just think that this indicates the issue is not as simple as I once thought. I think our markets were insufficiently developed. Becker's model required that the market be impersonal- that buyers and sellers could not collude to enforce norms regarding who they hired and at what rates. It required that that states stay out of the market place and not place their forces at the service of those who seek to maintain the status quo. In a country like pre-20th century India, where most people lived in very small villages and had little choice in where they could work, who they could purchase their essentials from, and who they could borrow from, where the state stood ready to punish anyone who challenged the status quo, none of these conditions were met. It was a very stable equilibrium indeed.

I think it is, instead, a lesson in how unnatural good markets are, and how many norms have to be left behind even to arrive at a position where people are profit maximizing. Its too often argued that the impersonality of markets is a strike against them, and that profit has overtaken all other considerations in matters of business- but it is the entirely too personal nature of traditional societies that makes it possible for participants to make decisions that do not maximize profits, and that again allows discrimination to survive.