In this article, we see the definition of a free enterprise economy, a comprehensive explanation of what it implies, examples of free enterprise economies, the characteristics that best define the economy, its history, and its goals.
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What is a free enterprise economy?
A free enterprise economy, also known as a free market economy, is an economy where prices, products, and services are determined by market forces rather than the government. In this economy, businesses and services are free of government control. Alternatively, the free enterprise system could refer to an ideological or legal system in which private measures are the primary regulators of commercial activities. The opposite of a free enterprise economy is a centrally planned, controlled, or command economy.
The argument for a free enterprise economy is on the basis of the belief that government interference in business activities and the economy pose hindrances to growth. With this, the aim is to increase economic freedom, market efficiency, financial security, consumer rights, financial stability, and economic opportunities. Although the free enterprise system grants more freedom compared to other economic systems, a higher risk of several economic crises exists without government interference.
Both in principle and practice, property rights, voluntary contracts, and competitive bidding for goods and services in the marketplace are the elements that define free markets. This is the opposite of public property ownership, coercive activity, and fixed or controlled distribution of goods and services.
In Western countries, free enterprise has a close relationship with laissez-faire capitalism and philosophical libertarianism. It is for this reason that capitalism is also known as a free enterprise economic system. Inasmuch as these terms are used interchangeably, they may differ in that capitalism refers to a method by which scarce resources are produced and distributed while the free market refers to a set of legal rules with respect to commercial interaction.
A scholar, Friedrich Hayek, went further to explain that free enterprise economies are not unplanned or unregulated, instead, planning and regulation come as a result of the coordination of decentralized knowledge among several specialists, not bureaucrats.
It is valid to state that the capitalist economic system gave rise to free enterprise economies. These economies are so-called because the system provides individuals the opportunity to make their own economic decisions, and be free from government constraints. These are the most important features that make the economic system stand out. So, aside from private ownership of property, the system allows gives individuals the right to make their own choices in purchasing goods, selling their commodities, their labor, and participating in the business structure.
How does the free enterprise system work?
A free enterprise economy works when private individuals participate in economic activities for personal gain. In this economy, someone sees a need and then creates businesses that meet that need. These needs are the problems that need to be solved and in business, they are seen as opportunities. Also, other individuals accept jobs to work with the company while others buy the products.
In the free enterprise system, each stage is dependent on someone being motivated to act and reap the benefits of their efforts. So, the activities of each person participating in this economy are driven by competition to sell the most product, get paid the highest wage, and bring about an improvement in a personal standard of living. Here, individual freedom is only checked in instances of disagreements. In this case, the role of the government should be that of an arbiter, settling disputes regarding contract and property disputes to prevent cheating by one party to unfairly gain an advantage over the other.
Free enterprise economies are therefore economies where private individuals have the right to form companies, buy, and sell competitively in the market with minimal government interference. The idea is that people do not need the government to regulate or correct the market. As earlier stated, individuals have the right to conduct businesses as they see fit based on the needs they see around them. In other words, private individuals are the ones who decide the goods and services to be produced and which to be purchased.
A government is not the one to tell anyone the kind of business to start, the product they must sell, or how to run the company in a free enterprise system. For example, the United States is based on free enterprise while government regulations are meant to provide some checks and balances instead of allowing a pure laissez-faire style of capitalism. The nature of this system is defined by the existence of a large private sector with the ability to engage in production and trade. A free enterprise system cannot exist without businesses competing with one another in the marketplace.
A brief history of the free enterprise system
The first written reference to free enterprise systems may have appeared in China in the fourth or fifth centuries B.C., when Laozi, or Lao-tzu, argued that governments hampered growth and happiness by interfering with individuals.
Legal codes that resembled free enterprise systems did not become common until much later. Between the 16th and 18th centuries, England was the birthplace of modern free markets. This expansion occurred concurrently with, and most likely contributed to, the first industrial revolution and the creation of modern capitalism. Historically, the English legal system was devoid of international trade obstacles, tariffs, entrance hurdles in most sectors, and restrictions on private commercial transactions.
During the 18th and 19th centuries, the United States likewise employed a primarily free-market legal framework. However, in current times, the United States and the United Kingdom are better categorized as mixed economies. Singapore, Hong Kong, and Switzerland are more representative of free enterprise.
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Characteristics of free enterprise economy
- Private property ownership
- Economic freedom
- Economic incentives
- Competitive markets
- Limited government role and intervention
- Profit motives
- Voluntary exchange
The cornerstone of a free enterprise system is personal freedom, therefore, being able to partake in economic activities in accordance with personal freedom is a critical element. The above-mentioned are the characteristics of a free enterprise economy.
The concept of private property ownership is an important characteristic of a free enterprise economy, it implies that individuals are free to own and make decisions with regard to the use or sale of land, personal property, and other assets. Instead of making use of or renting government property, individuals have control over their own property. In other words, consumers have the right to acquire private property. This may be in the location in which they desire to acquire property and personal or financial limitations should not pose restrictions.
Economic freedom has to do with the right to pursue financial gains. This characteristic includes the right to start a business, search for employment at a specific company, invest capital or funds as desired, quit a job, and other economic activities. Also, consumers have the ability to choose who to transact with which is only possible if there are multiple market suppliers. Also, they have the right to choose what they want to pay with a corresponding agreement on part of the seller for the transaction to take place.
Economic incentives are another component take makes up the characteristics of the free enterprise economy. This refers to the ability to make individual financial decisions and these decisions can be powered by certain motivations. These financial decisions can include choosing to acquire a higher-paying skill, moving to another geographical location to get a job that best meets their financial needs, etc.
As earlier stated, a free market economy has to possess the competition feature to stand. Every individual has different personal preferences and goals. While some want a simple lifestyle, others prefer to live in luxury. For example, some like chocolate ice cream while others like strawberry and so on. Looking at these personal preferences and goals, a competitive market makes alternatives available to consumers rather than many copies of the same product.
Businesses compete against one another to offer products and services that consumers want in a free enterprise system rather than the government dictating the commodities that can and cannot be sold.
In essence, buyers and sellers compete in a free enterprise system. Here, buyers attempt to acquire goods for lower prices as well as more favorable terms while others make attempts to sell goods for higher prices. Market equilibrium exists when the two parties agree to come together.
Limited government role and intervention
The major characteristic that defines the free enterprise economy is the limited government role and intervention. However, this does not mean that the economy is totally free of government. The government still has a role to play in the enforcement of rules of fair play in the economy, enforcing contracts, and ensuring that consumers are not exploited or defrauded. This simply points out that the government serves as a referee.
The goal of every individual in a free enterprise economy is to make money. Therefore, there exists the right to buy and sell goods for personal profit. In this case, there are fewer restrictions on achieving this compared to other restrictive forms of economies.
Voluntary exchange is another important feature of the free enterprise system. Here, consumers have the right to make choice with regard to whether to exchange goods or not. So, no one can force anyone into trade and no one is obliged to consume any products. With this, free enterprise is also called free trade.
6 Goals of free enterprise system
- growth opportunities
The above-mentioned are the six goals that the free enterprise system aims at achieving.
The overarching purpose of a free enterprise is liberty. This is the freedom of choice, the freedom to express oneself through the development of whatever product that you desire, or the freedom to charge or pay for whatever you desire.
By enabling markets to self-regulate, inefficient enterprises are potentially at risk of extinction since market players would not pick them and government policy will not subsidize them to keep them alive. Furthermore, there may be fewer processes or procedures to follow in a free firm.
A free enterprise strives to be self-sustaining by having markets based on consumer preferences. Instead of monetary or fiscal policy dictating economic circumstances, the long-term goal of free enterprise is to have consumers shape the economy in a more predictable, stable manner than a government may be able to.
Every individual in a free enterprise should believe that their goods and rights are protected. This means having complete control over what they make, what they sell their goods for, and what they can consume or acquire.
At the heart of the free enterprise is the idea that individuals should be able to pursue profit-making opportunities without interference from the government. This means that when given more freedom, every individual has a greater chance of success.
In a free enterprise, each individual should have the same rights as everyone else. In a free enterprise, no one is given preferential treatment or exceptional conditions; every market player is subject to the same regulations and does not profit from government action.
Related: Free Enterprise vs Capitalism Differences and Similarities
Advantages of free enterprise economy
One of the advantages of the free enterprise economy is that the market encounters no bureaucracy under a free enterprise system. Processes are potentially more efficient and may be less expensive administratively to conduct a firm and connect with customers. This is especially true in highly regulated sectors, where more competition may cause costs to move elsewhere.
Market participants are typically given more freedom and flexibility. Entrepreneurs are not bound by official policy or told what items must be produced. One of the cornerstone theories of free capitalism is that the finest firms will develop to continue to fulfill market demand, whereas those that fail will cease to exist because they no longer have a marketplace.
Instead of government policy determining how resources are allocated, a major benefit of free enterprise is that customers have a stronger influence on the economy. The customer sets a good’s final price, which items are required in a market, and which goods fail or succeed. It is the responsibility of a free enterprise corporation to comprehend these consumer preferences and change its operations accordingly.
Disadvantages of free enterprise economy
There are certain drawbacks to seemingly limitless freedom. First, under a free enterprise system, things that are not typically lucrative to create will not be produced. This is due to the fact that there is no economic incentive for a company to make these things (unless there were government aid or a stipend). This may include restrictions on where things can be delivered. For example, government subsidies may partially subsidize the distribution of telecommunications services to remote regions; without this financing, such towns may not obtain service.
Profit maximization may lead to negative behavior in a free firm. Consider the case of Enron, which failed to comply with public reporting regulations, ending in financial catastrophe. When there are little or no norms to observe, companies within a free enterprise may put worker safety, environmental standards, or ethical behavior on the line in order to make more money.
Finally, a free enterprise does not include bailouts. This means that economic downturns are theoretically more severe because public monies cannot be utilized to assist failing organizations that would generate significant ripple effects if they failed. This is especially true in today’s linked society where a huge bankruptcy can have a severe financial impact on businesses all across the world.
Free enterprise scenario
Consider the distinctions between Apple Inc., a publicly traded corporation, and SunGard Data Systems, a private company. Because both firms conduct business in the United States, neither is actually free to operate.
Still, take for example, that each firm is looking to raise funds. The Securities and Exchange Commission has highlighted requirements that Apple must follow as a public corporation in order to sell further shares and be listed on public markets. This includes complying with public reporting and filing requirements. SunGard Data Systems, on the other hand, may raise capital more freely (though still restricted) as a private company because it is subject to fewer government restrictions.
The 2008 Global Financial Crisis is another example of free enterprise (or lack thereof). In reaction to the economic disaster, Congress approved the use of the Troubled Asset Relief Program (TARP) emergency money for troubled financial institutions.
Governments would not interfere to help faltering enterprises in a completely free market. Instead, these businesses would be allowed to fail, enabling the market to settle and other market participants to join the sector to seize the newly vacated market opportunity.
Free enterprise economy examples
- United States
- New Zealand
- United Kingdom
A brief detail is given below regarding how these countries are free enterprise economies.
In general, the United States is an excellent example of a free market economy. Individuals are free to form firms, purchase and sell items at market pricing, and sell their own labor with minimal restrictions or impediments to economic activity. This contrasts with severely regulated or state-controlled economies, such as Cuba’s or North Korea’s Communist regimes, where the state controls basically all economic activity and markets do not operate freely. Most economies lie somewhere between complete market freedom and absolute governmental control.
Sweden is said to be another example of a free enterprise economy. Although it has high taxes and a robust system of social welfare that the government provides, it still ranks very highly in terms of economic freedom. Also, Sweden features strong protection of property rights, judicial effectiveness, and government integrity alongside business freedom and international trade.
Japan as an industrialized nation is another remarkable example of a free market economy, it is the world’s second-biggest. Its economy is extremely efficient and competitive in areas related to foreign commerce, while productivity in protected industries such as agriculture, distribution, and services is far lower. After the world’s greatest rates of economic development were experienced by the Japanese economy from the 1960s through the 1980s, it slowed down in the early 1990s when stock and real estate values collapsed.
Japan’s pool of industrial leadership and technicians, well-educated and hardworking labor force, high savings and investment rates, and vigorous promotion of industrial growth and international commerce all contributed to the country’s mature industrial economy. Japan has few natural resources, thus trading helps it earn the foreign currency it needs to buy raw materials for its economy.
Japan’s long-term economic prospects are favorable, and the country has mostly recovered from its worst spell of economic stagnation since World War II. In the 1990s, Japan’s real GDP increased at a rate of approximately 1% per year, compared to nearly 4% per year in the 1980s. After more than a decade of stagnation, Japan’s economy is currently experiencing its longest postwar boom. Real growth in 2005 was 2.7%, while it was 2.2% in 2006.
Canada’s economic freedom score is 76.6, ranking it 15th in the 2022 Index and because of this, it is listed as a critical example of a free enterprise economy. Canada is placed first among thirty-two nations in the Americas area, and its total score is higher than the regional and global norms.
Over the last five years, Canada’s economic growth has slowed, eventually going negative in 2020, however, recovery looks to have returned in 2021. Economic freedom in Canada peaked in 2011 and has been steadily diminishing since then. Weakening by score declines in government expenditure and fiscal health, Canada has registered a 1.9-point total loss of economic freedom during 2017 and has dropped farther into the top half of the “Mostly Free” category. The rule of law is robust, but government expenditure is high.
Canada is the second-largest country in the world by land mass and has its 10th-largest economy. Its market-oriented economic system looks closely like that of the United States and the leading sectors are the automotive and other manufacturers. Also the forest products, minerals, and petroleum. Three-quarters of its products of Canada are exported to the United States and the U.S.-Mexico-Canada Agreement (USMCA) that came into force in 2020 is vital to the flourishing economy of Canada.
It is also important to note that through the enforcement contracts, the law protects property rights and anticorruption laws are enforced rigorously. However, numerous investigations have brought about concerns with regard to corruption, illegal financing, and kickbacks in the construction industry as well as in public procurement.
New Zealand is another example of the free enterprise system since it has an open economy based on free market principles. It features sizable manufacturing and service industries, in addition to a highly efficient agriculture industry. Exports of products and services account for almost one-third of actual GDP spending.
Stronger economic performance is ultimately about an economy that grows regularly and sustainably to support greater living standards for all New Zealanders.
The Treasury has the unique capacity to give a holistic view of economic growth by including studies of institutions, macroeconomics, microeconomics, and the economy as a whole, which is supplemented by contributions from other government departments.
With a free market economy, the United Kingdom’s economy received a 78.4 grade in the most recent freedom score, ranking it seventh in the world and third among other European nations in 2021. With this score, it is valid to add it to the list of free enterprise economy examples. Another distinguishing feature of the British economy is its free market.
An open market is one in which there are little or no constraints on free market activity. Because of its open market, the United Kingdom is an essential gateway for export-oriented economies such as those of East Asian nations. This has resulted in a major investment in commerce and local manufacturing from nations such as the United States and Japan.
Other examples of free enterprise economies include Hong Kong, Australia, and Ireland as they share common features of economic freedom, private property ownership, profit motive, and competition in the market. Because the private sector has some levels of ownership and control of means of production, these free enterprise economies usually have a high GDP and experience economic growth.
One should note that in reality, no country in the world is purely capitalist or has a purely free enterprise economy. In other words, these economies exist as theoretical concepts rather than tangible realities. This means that every economy has a combination of free enterprise and centrally planned economies thereby making them mixed economies.
For example, the United States is said to be a free market economy. Although it allows companies to set prices as well as negotiate wages, the government establishes parameters that include minimum wages as well as antitrust laws that have to be adhered to. Furthermore, the U.S. government has several regulatory bodies such as FCC, SEC, FDA, and EPA that can intervene in markets or firms. Also, most countries have some forms of taxation and impose trade controls such as quotas and tariffs.
Does the free enterprise system favor the rich or the poor?
Theoretically, the free enterprise system gives individuals of all economic classes the opportunity to make their best economic choices without any form of interference. This implies that the economic structure should neither penalize the poor nor help the rich.
The subject matter with regard to whether a free enterprise system is ideal has become a significant controversy both in politics and economics. In general terms, free market economies experience higher rates of economic growth alongside greater prosperity thereby improving the quality of life for both the rich and the poor.
However, many feel that free enterprise economies bring about the exploitation of the poor by the rich as highlighted in the disadvantages. Therefore, the system is often perceived to be unfair if consumer protection and a generous social safety net in terms of anti-poverty programs do not accompany it.
It depends, as with so many things. Nobody is forced to do anything in a free market, and transactions are entered into voluntarily. Economists believe that free markets, through the price mechanism, competition, and the forces of supply and demand, can most efficiently allocate goods and capital to where they are most productive. The problem with free markets, however, is that they can lead to inequalities, especially when there is information asymmetry.
While economic theory presupposes perfect knowledge, in practice, sellers or producers typically know significantly more about what they are selling than consumers or purchasers. Furthermore, economists believe that markets have “perfect” competition among buyers and sellers, but we know that larger enterprises have greater clout in their marketplaces and that wealthy customers may bid up the cost of essentials, particularly during times of crisis.
As a result, customers are more likely to be duped, and sellers are more likely to cut shortcuts or conduct fraud. The solution to these issues is some level of government action or regulation to assure the quality of what is offered, protect customers from fraud, and maintain fair competition.
Related: Arguments Against Capitalism
Video: What is a free enterprise economy?
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