Disadvantages of Free Enterprise Economy

Just like any other kind of system used in regulating the economy, the free enterprise economy has its own share of advantages and disadvantages or negative impacts. The free enterprise economy is always associated with economic prosperity and the rationale behind this economic system is that unrestricted competition brings about equal opportunity for all.

The problems come about when the two main aspects of this economy which are supply and demand, bring about situations that financially exploit consumers and producers. Furthermore, the problems have effects on the economy as a whole, resulting in recession, inflation, and unemployment.

In the world today, every economy has a combination of freedom and government regulation as history has revealed that going 100 percent in either direction brings about more harm than good, meaning that despite the advantages that each may have, there are more disadvantages. With this, the need to find a balance where the needs of a company and those of individuals can come together in profitable ways for everyone.

The free enterprise economy functions in response to the laws of supply and demand and supply. The characteristics include profit motive or self-interest to work towards optimizing the buying and selling platforms and private ownership.

An important factor is that the process brings about high competition levels, however, this can also bring about a decrease in the amount of choice that is available for the average consumer which is one of the disadvantages of the free enterprise system. While it fosters innovation and efficiency, it also marginalizes those that are not able to maintain appropriate levels of productivity.

It is for this reason that income inequality tends to occur more often in the economies that adopt this system. Below, we take an in-depth look at the disadvantages of free enterprise economy.

See also: Disadvantages of free market economy

Profit motive and self-interest

One of the disadvantages of the free enterprise economy is the profit motive. It is the motive for success in such an economy. The objective that every business has here is to earn as much profit as possible. In this case, one will see an organization deciding to sacrifice the safety of workers, compromise environmental standards, and act without a sense of ethics because there are no controls in place to govern their behaviors. The ends in this case will always justify the means when it comes to a company’s survival in this economy.

Even with the presence of a partial free enterprise economy, several examples are evident throughout the history of this disadvantage. For example, companies like WorldCom and Enron made attempts to mislead their customers as well as government regulators. Also, the incident on Deepwater Horizon was proven to be one of the most significant environmental disasters in the history of the United States due to cost-cutting measures like the use of substandard cement. So, the fact that wealth enjoys prestige in society, erosion of human values results.

Market failures

Another significant disadvantage of the free enterprise economy is market failure. Looking at this, market failures can bring about severe recessions and ongoing economic consequences. If this economy starts losing control, then the consequences that result as an outcome can be quite severe. For example, two incidents in the United States brought about long-term financial hardships for families, the Great Depression in the 1930s and the Great Recession from the real estate market crash in 2008. Failures have the tendency to devastate the lives of millions of households which in turn will result in lost income, unemployment, and homelessness.

The reason why this disadvantage occurs is the lack of control over the behavior of excessive profit-seeking. Here, instead of creating investments that provide slow and steady gains, capitalists usually prioritize short-term profits. Therefore, highly leveraged assets, loose credit, and the absence of government intervention bring about a higher risk of failure.

Another thing to note in the free enterprise economy is that if large businesses fail, everyone else will. In situations whereby companies become the vehicle that drives economic development in a society, then the largest contributors become too big to fail. If for any reason these organizations were to go out of business, then jobs and money that would immediately get removed would be devastating to families as well as other companies. Also, it could be enough to trigger the entire collapse of the economic systems that are used.

This disadvantage is another reason why workers are the most risk-takers in this system. In some societies, government bailouts might exist which is an option not given to the average household. Companies can lay off workers at any time and for any reason, paying attention to only high-value customers if that is where their profits exist.

Limited product choices

Although the free enterprise economy tends to provide a variety of choices to consumers, it can provide limited product choices at the same time. This disadvantage results from the fact that organizations do not pursue the development of products unless there is a potential for profit that is available. By implication, limitations in the range of goods and services offered to consumers can exist locally, nationally, and internationally. The limited product choice-related disadvantage can have an impact on specific groups of customers more than others used on household income and other factors.

If sending goods or providing services to a rural community is too expensive, then a free enterprise economy suggests that the best decision is to withdraw from that area. This means that there will always be communities that will miss out on innovative ideas because they do not help the bottom line as much.

The possibility of going out of business

The possibility of going out of business is an alarming drawback related to the free enterprise economy. In this, those who cannot produce will be cast aside or aggressively taken over by larger companies. The free market economy places more emphasis on the ability of an individual to innovate.

This implies that able-bodied workers always have a top priority in a society that has this structure dominant therein. On the other hand, children, the disabled, the elderly, and every other person who cannot maintain their quota will have a secondary status.

Even if one gets sick or injured in the course of carrying out his work, he can move from top to bottom of the economic ladder at any time unless he has adequate finances saved up to support himself. In essence, this economy does not make provision for a social safety net unless there is a process that can make them profitable.

See also: Crony Capitalism (Cronyism)

Consumption required for survival

A free enterprise economy requires consumption for survival. To explain this further, if people decide to save up their money rather than spend it on goods and services, then this economic system will struggle to survive or stay alive.

This means that households have to be in the habit of buying or selling for growth to be in place. Without any purchasing activities, there will be fewer employment opportunities available for the average person. This of course is regarded as a disadvantage because, without continuous consumption, there will be no production. Only consumed goods and services are produced.

It is for this reason that the greatest share of wealth accumulation occurs in the top 1 percent of a free enterprise economy. These are the households that have access to their needed resources without any worries with regard to income shortages that usually arise because only entry-level jobs are available.

Income and social inequalities

Equality does not always imply equal opportunities for everyone. The levels of wealth that a family can achieve will dictate the number of chances individuals receive when they attempt to complete goals and dreams. Any individual who is born into a household that struggles with poverty will find fewer opportunities to create the success that they want to see. Households with wealth on the other hand may have unlimited opportunities to achieve something similar.

In essence, some people have automatic success rewards because of their family history in the free enterprise economy. A single moment to achieve success is not the same as a lifetime of opportunities.

This disadvantage is prominent in the free enterprise economy because it is based on the legal right to own private property and the ability to pass on wealth to future generations. Capitalists argue that the free enterprise economy (or the capitalist society) is fair because individuals gain rewards for their hard work. But oftentimes, people are rich simply because they inherit wealth or are born into a privileged class. With this, this form of an economy not only fails to create equality of outcome, but it also fails to provide equality of opportunity. With this, inequality brings about division in society and resentment.

An unequal society is, therefore, an unequal society is stagnant. Remember that in a free enterprise economy, businesses and individuals own and control the means of production and distribution of goods and services in society. This means that few wealthy entities have control over the entire nation’s production.

In other words, a major component of the nation’s wealth will rest in the hands of these few entities. The other classes of people are working in these entities to survive from one paycheck to another which is a comparatively very small portion of the profits that these entities generate.

In simple terms, the group of individuals that own means of production earns more compared to those that possess little or no means of production. This setup inevitably brings about the unequal distribution of wealth and income in society. In countries with free enterprise economies, there are usually two classes, those that have and those that do not have. Such division can result in conflicts that come in the form of strikes, lockouts, and industrial disputes in the economy as capitalists generally exploit poor laborers. The issue of labor exploitation is another disadvantage that will be discussed.

Alters the governing priority

The fact that the free enterprise economy alters the priority of governing is another important disadvantage that should be noted. Since the government does not have full control over the decision-making process of organizations, it must generate income and structure from other resources. It is for this reason that the taxation of residential income is typically higher than that of corporate profits in capitalist economies.

Also, the fact that much emphasis is placed on innovation with this structure makes the allocation of resources always go toward whatever threat might exist to put a company out of business.

Instead of making provision for resources to families that promote better health and wellness, corporate longevity now becomes the government’s top priority. By implication, the worker is the one who takes on the most risk and receives the least amount of reward.

Monopoly power

Free enterprise economies promote the idea of monopolization. Although competition never goes completely in such economies, the goal of each business is to eliminate as much of its competitors as possible. In an instance whereby one company or organization provides the most goods or services in their industry, there is the option to set higher profit levels while reducing innovation because consumers will no longer have choices.

With this, the ultimate goal of this structure runs counter to the benefits that are often discussed when looking at this option in contrast to socialism and communism. Once the government sets laws that forbid the creation of monopolies, then society will no longer benefit from a 100 percent free market system.

Private ownership of capital gives firms the ability to gain monopoly power in product and labor markets. The disadvantage related to this is that when firms have monopoly power, they are bound to exploit their position to charge higher prices.

Monopoly makes it impossible for buyers to have alternative sellers and when markets are dominated by such, they cannot be considered free. Some markets nevertheless, naturally lend themselves to the formation of monopolies, usually those that involve large startup costs or complex proprietary technology. In the economic history of the United States, railroads and telephones began as monopolies.

Another disadvantage related to monopolies aside from raising prices is that it reduces job opportunities. In a competitive market, consumers can take prices for granted. They are aware that they are not charged weird prices that lead to high profits for businesses. If this was really the case, competitors will soon arrive and compete for the profits down to a rate of return similar to elsewhere in the economy.

Thomas Sowell, however, said in his book “Basic Economics” that monopolies bring about a decrease in competition, control prices, and thus bring about distortions in markets. The monopolist would earn a rate of return that is necessary to attract the capital required, but there is no competition in place to drive down prices.

The real harm of monopolies, therefore, is not that consumers pay more for goods within an economy, this is simple wealth redistribution. Rather, at a higher artificial price, there is a demand for fewer goods that are produced than at a lower market price. Thus, a monopolist produces less output with the same resources that are available.

See also: What caused the industrial revolution?

Restrains wages

Instead of encouraging wages to grow, the free enterprise economy restrains wages. Although it is possible for organizations to survive when they provide innovative resources to their core demographics, this process is not applicable to their employees. Therefore, this disadvantage has the most impact on employees. In periods of economic downturn, it is the wages of the workers that have the first hit because labor is the most expensive budget item for the average company. This restrains of wages is a way that some businesses could artificially trigger as a way of reducing their salary requirements.

In the United States, it took over thirty years for the middle class to experience an increase in the value of their salaries. Presently, some households are still earning less than what was available in the 1980s. It is for this reason that a completely free enterprise struggles to survive on its own. This weakness related to this economic structure extends to the fact that only the wealthy can continue to move forward at some point and eventually, almost all the wealth is concentrated in the hands of a few designated people.

Consumer exploitation

One of the greatest disadvantages of the free enterprise system is consumer exploitation. While this economic system works towards satisfying the demands of consumers by providing products and services through the use of readily available supply, this pattern can be interrupted and then result in consumer exploitation.

The capitalist economic system gives room for producers to purposely withhold supply from entering the marketplace thereby causing consumers to pay higher prices. The system also tends to limit the access that consumers have to suitable alternative products. Artificial hikes in prices based on predictive modeling are not regulated which makes consumers to be at the mercy of the companies that are controlling these goods. In this case, wealth enjoys prestige in society while human values are eroded.

Exploitation of labor

One critical disadvantage of the free enterprise economy is the fact that the exploitation of labor is paramount. Usually, firms under this economic structure are profit-motivated for producers in the marketplace. With this, producers look out for the lowest costs in all parts of the production system including laborers. Sometimes in questionable conditions, laborers are expected to work for low pay and with as few benefits as possible. In cases where the government attempts an intervention, producers are liable to outsource work to other laborers who meet their low-cost needs. In this case, employees are always at the bottom of the food chain and experience the hardest hit by this practice.

This is not different in cases where monopolies emerge in the free market economic system. The decrease in job opportunities is worsened by the monopolist’s power to treat employees in an ill manner. Capitalists believe that if an employer does not reinvest his profits but rather makes a profit by lowering wages and increasing work hours, the best employees will lead and go search for a new employer. They also say that this is the safeguard of capitalism. In a monopoly, however, it is more difficult for an employee to get a job elsewhere. With this, employees get more opportunities to take advantage of workers.

Having looked at this point, it is evident that laborers are most disadvantaged under this economic structure. Employers get excessive work from their employees and pay poor salaries to them. In this case, business owners will become richer while laborers suffer ultimately. Such situations will result from the free enterprise system since there is little or no government intervention. Furthermore, there will be less stability in the industry and class struggles between employers and employees.

An increased barrier to entry

Theoretically, the free enterprise system should give room for the easiest entry into business and industry by new producers or business owners. However, the system only favors producers who have large amounts of existing capital, be it money or material. This reflects a great disadvantage of new entrants with small amounts of existing capital in the industry.

Monopolies result thereby allowing producers to exploit consumers by charging prices that are far above prices that the free market would allow. As a result of this situation, new businesses find it very difficult to enter the industry when top producers already have the advantage.

Potential of corruption

Corruption is a disadvantage that is peculiar to the free enterprise system and this can arise due to the amount of capital and potential for profit involved. The motive to generate the highest profits and maximize the value generated from the capital is capable of birthing unethical behavior, questionable business practices, and illegal actions by producers. Additionally, an individual or company that prospers can soon take over the market thereby limiting competition. Consumers are usually the ones who suffer the most from corrupt practices.

This point summarizes the disadvantages of consumer exploitation, the emergence of monopolies, labor exploitation, and the profit motive. Furthermore, it has been argued that human values have been corrupted by the capitalist system, and intrinsic motivations replaced with economic incentive-based motivation. Meaning that people do something because it is rewarding and satisfying for its own sake rather than the promise of some external reward. Society then becomes more selfish, individualistic, and ultimately fragile.

Externalities

The negative effect that this structure has on the environment is a vast disadvantage. We have looked at profit motive and self-interest which pushes capitalists to go to the extreme of it if the government does not intervene. Hence, non-suitable negative effects will be seen on the environment such as air pollution and water pollution. These negative effects can bring about major disasters since they are generally ignored until they become serious.

In the capitalist economic system, social benefits are ignored. In essence, a free market fails to pay attention to externalities. To be precise, a profit-maximizing capitalist firm always ignores negative externalities such as pollution that arises from production which is detrimental to standards of living. Goods that possess positive externalities such as health, public transportation, and education are underprovided thereby leading to inefficient allocation of resources.

Therefore, one cannot ignore the fact that the government’s provision of certain public goods and services is essential for maximizing the potential of a free enterprise society

Wastage of resources

Resources are not properly allocated for productive use under the free enterprise system thereby leading to wastage. This is a great disadvantage in this economic structure resulting from the basic profit motive rather than social welfare.

See also: What is market power? Examples, sources, and types

Economic instability

It is usually a pleasant experience to live in a free enterprise society during economic expansion. When the economy begins to contract, there is a higher chance for a recession to occur thereby increasing the unemployment rate. The wealthier class of people can withstand this period because they can go back to their wealth reserves to fetch wealth that can help them maintain their quality of life. Low-income earners do not have the privilege to enjoy that luxury.

Sometimes, the growth rate can be slow even though the free enterprise economy works automatically. As the economy progresses, there is usually no complete or all-around development because some industries tend to develop faster than others.

When there is a recurring business cycle, this economy can be unstable and there are times when economic activities will slump. With the disadvantage related to economic instability, firms may be at risk of closing down if prices fall. With this, workers will be rendered unemployed. The bottom line is that the free enterprise system does not always stay on the growth pattern.

Last Updated on November 2, 2023 by Nansel Nanzip Bongdap