It’s no secret that there is a massive wealth gap between Black and white households, especially in the U.S. A survey from the U.S. Federal Reserve last year found that the median net worth of Black households was $44,900, compared with $285,000 for white ones. The bigger mystery has been how to close that gap.

A recent approach by policymakers has been to encourage wealth generation via entrepreneurship. One way they’ve tried to do that is by increasing Black entrepreneurs’ access to capital. Like the wealth gap, there is also a credit supply gap, and some policy wonks worry this is because of creditor discrimination towards Black business owners.

But as Rotman assistant professor of economic analysis and policy Eugene Tan shows in a new paper, policymakers should actually be a lot more worried about consumer discrimination towards Black-owned businesses.  

Tan and his co-author, Brock University’s Teegawende Zeida, came to this conclusion after taking a deep dive into the Kauffman Firm Survey (KFS), which tracked U.S. firms formed in 2004 and followed them until 2011.

Tan had been looking at KFS data since grad school and had always found it strange that much of U.S. policy aimed at Black business owners focused on providing subsidized credit. He points to the federal government’s Small Business Administration (SBA) in particular, which provides various supports to entrepreneurs and small businesses. One of the SBA’s biggest line items is insurance for minority business owners who might default on their debt. “There wasn’t any real evidence for doing that,” says Tan. 

Instead, there seemed to be more evidence for studying consumer discrimination and trying to find ways to fix it, which is partly what Tan and Zeida did. 

Using the KFS data, the researchers created a framework for identifying the differences in borrowing costs and product markups of Black- and white-owned businesses. Based on their most conservative estimates, Tan and Zeida found that while Black-owned businesses faced about 10 per cent higher borrowing costs, they faced 41 per cent lower markups. In effect, Black-owned businesses charged 41 per cent less than businesses owned by a white person.

That lower markup number suggests lower consumer demand for goods sold by Black businesses, which can be largely explained by consumer discrimination, Tan says. Their evidence is based on several correlations.

First, in areas with large Black population density, Black-owned businesses saw significantly smaller markup differences than their white-owned counterparts, which makes sense as these areas would have less discrimination towards Black-owned businesses.

Another correlation is based on political leanings. Research shows that the Republican Party doesn’t tend to support the political interests of Black voters as much as the Democratic Party. Tan and Zeida interpret this as racial animosity and expected it to also show up in Republican voters’ lack of support for Black-owned businesses, which is indeed what they found. In areas where there were more Republican voters, there were larger differences between the markups of Black- and white-owned businesses than in areas where there were more Democrat voters.

In contrast, the researchers didn’t find evidence that the differences in borrowing costs were based on racial animosity by creditors. Instead, the credit cost differences seem to be based on wealth and risk differences between Black and white entrepreneurs.

“Black business owners just tend to have less wealth, and so banks are going to charge you higher interest because you have less collateral,” says Tan. “And that is what we saw. Once we controlled for wealth, most of our results on the capital cost side disappeared.”

Tan and Zeida also found that those capital cost differences disappeared four years after Black entrepreneurs opened their businesses, whereas the differences between markups remained throughout the entire eight-year sample period.

This doesn’t mean policymakers should stop trying to boost Black entrepreneurs access to capital, says Tan. Those programs could eventually help level the playing field, “but early on we don’t see credit as being a big deal because Black-owned businesses are not very profitable to begin with. Instead, if we start by addressing these consumer-side problems, then they have an actual consumer base to build on.”

The impact of addressing those consumer problems could be huge. Tan and Zeida estimate that the markup gap could translate to a 1.71 times difference in the market value of Black- and white-owned firms. In other words, reducing those differences in consumer demand could lead to serious reductions in the racial wealth gap.

As for how policymakers and others might reduce those differences, Tan has a few ideas.

For one, governments should look at their procurement policies. Tan and Zeida found that in areas of the U.S. where there was more government procurement, Black-owned businesses tended to grow faster and bigger. Markup differences were also lower in these areas.    

“Right now, we actually see the Biden administration trying to promote a larger share of procurement going towards Black minority businesses, and so based on our evidence, that actually makes a lot of sense,” says Tan.

He also says there should be more time and money spent on networking opportunities and business training for Black entrepreneurs so that they can try to adapt their practices and widen their reach.    

One specific helpful tip could be to actually market one’s business as Black-owned, says Tan. A recent study in the U.S. found that when restaurants were labelled as “Black owned,” they saw increased customer engagement and performance. They also saw an increase in positive online reviews left by white customers.  

“It’s this kind of information that should be communicated and shown to Black-owned businesses,” says Tan. “Understandably, they might not believe it if you just tell them, which is why showing real evidence is so important.”