Free Enterprise: Definition, How It Works, Origins, and Example

What Is Free Enterprise?

Free enterprise, or the free market, refers to an economy where the market determines prices, products, and services rather than the government. Businesses and services are free of government control. Alternatively, free enterprise could refer to an ideological or legal system whereby commercial activities are primarily regulated through private measures.

Key Takeaways

  • Free enterprise refers to business activities that are not regulated by the government but are defined by a set of legal rules such as property rights, contracts, and competitive bidding.
  • The argument for free enterprise is based on the belief that government interference in business and the economy hampers growth.
  • A free enterprise legal system tends to result in capitalism.
  • A free enterprise aims to increase freedom, market efficiency, consumer rights, financial security and stability, and economic opportunities.
  • Though free enterprise grants more freedom, there is higher risk of more several economic crises without government intervention.

Free Enterprise

Free Enterprise As Law and Economics

In principle and in practice, free markets are defined by private property rights, voluntary contracts, and competitive bidding for goods and services in the marketplace. This framework is in contrast to public ownership of property, coercive activity, and fixed or controlled distribution of goods and services.

In Western countries, free enterprise is associated with laissez-faire capitalism and philosophical libertarianism. However, free enterprise is distinct from capitalism. Capitalism refers to a method by which scarce resources are produced and distributed. Free enterprise refers to a set of legal rules regarding commercial interaction.

Another definition of free enterprise is in terms of economics and was offered by the Nobel-winning economist Friedrich Hayek. Hayek described such systems as "spontaneous order." Hayek's point was that free enterprise is not unplanned or unregulated; rather, planning and regulation arise from the coordination of decentralized knowledge among innumerable specialists, not bureaucrats.

The Origins of Free Enterprise

The first written intellectual reference to free enterprise systems may have emerged in China in the fourth or fifth century B.C., when Laozi, or Lao-tzu, argued that governments hampered growth and happiness by interfering with individuals.

Legal codes resembling free enterprise systems were not common until much later. The original home of contemporary free markets was England between the 16th and 18th centuries. This growth coincided with, and probably contributed to the first industrial revolution and birth of modern capitalism. At one time, the English legal code was completely free of international trade barriers, tariffs, barriers to entry in most industries, and limitations on private business contracts.

The United States also used a largely free-market legal approach during the 18th and 19th centuries. In modern times, however, both the United States and the United Kingdom are better classified as mixed economies. Countries such as Singapore, Hong Kong, and Switzerland are more reflective of free enterprise.

The opposite of a free enterprise economy is a planned, controlled, or command economy.

Characteristics of Free Enterprise

In the absence of central planning, a free enterprise legal system tends to produce capitalism although it is possible that voluntary socialism or even agrarianism could result. In capitalist economic systems, such as that of the United States, consumers and producers individually determine which goods and services to produce and which to purchase. Contracts are voluntarily entered into and may even be enforced privately; for example, by civil courts. Competitive bidding determines market prices.

The U.S. economic system of free enterprise has five main principles: the freedom for individuals to choose businesses, the right to private property, profits as an incentive, competition, and consumer sovereignty.

  • Economic Choice: In a free enterprise, consumers have the ability to choose who to transact with. This is only possible if there are multiple market suppliers. Consumers also have freedom to choose what they want to pay, although a seller must agree to this price for a transaction to occur.
  • Right to Private Property: In a free enterprise, consumers have the right to acquire private property. This may be in the location in which they want to acquire property and should not be restricted by personal or financial limitations.
  • Profit Motive: In a free enterprise, the goal is to make money in a freely-flowing society. Individuals have the right to buy and sell goods to personally profit, though there are less restrictions on doing so compared to other restrictive forms of economies.
  • Competition: In a free enterprise, buyers and sellers compete. Buyers attempt to acquire goods for lower prices or more favorable terms, while sellers attempt to sell goods for higher prices. Market equilibrium is met where these two parties agree to come together.
  • Voluntary Exchange: In a free enterprise, consumers have the right to choose to or not to exchange goods. Individuals can not be forced into trade or be required to consume any products.

Free enterprise may also be referred to as free trade or free market.

Goals of Free Enterprise

There are a number of goals in which a free enterprise society hopes to achieve. When a free enterprise society in fully operational, consumers often have freedom, efficiency, stability, security, growth opportunities, and justice.

  • Freedom: The overriding goal of a free enterprise is freedom. This is the freedom of choice, freedom to express oneself through the creation of any product you'd like, or freedom to charge or pay what you prefer.
  • Efficiency: By allowing markets to regulate themselves, inefficient companies are theoretically at-risk of being eliminated as market participants will not choose them and government policy won't fund them to keep them alive. In addition, there may be less processes or procedures to transact in a free enterprise.
  • Stability: A free enterprise strives to be self-sustaining by having markets rooted in consumer preference. Instead of monetary or fiscal policy dictating economic circumstances, the long-term goal for free enterprise is to have the consumers shape the economy in a more predictable, stable manner than a government may be able to.
  • Security: In a free enterprise, every individual should feel their goods and rights are protected. This means having the ultimate choice on what to make, what to sell goods for, and what they're allowed to consume or acquire.
  • Growth Opportunities: At the heart of free enterprise is the notion that individuals should be able to pursue profit-making opportunities without government limitation. This means every individual has greater potential for success when given greater flexibility.
  • Justice: Each individual should have the same rights as everyone else in a free enterprise. There is no favoritism or special circumstances granted to certain people in a free enterprise; every market participant faces the same rules without benefit from government policy.

Advantages and Disadvantages of Free Enterprise

Pros of Free Enterprise

In a free enterprise, the market faces no bureaucracy. Processes are theoretically more efficient and may be administratively less expensive to operate a business and interact with consumers. This is especially true in highly regulated markets, though increased competition may shift costs elsewhere.

Market participants are usually allowed greater expression and flexibility. Entrepreneurs aren't constrained by public policy or dictated on what goods need to be produced. A cornerstone theory of free enterprise is that the best companies will innovate to continue to meet market demand, while companies that fail will cease to exist as they no longer have a place in the market.

Instead of government policy deciding how resources are allowed, a free enterprise's large benefit is that consumers have a greater voice in the economy. The consumer determines the ultimate prices of a good, which products are needed in a market, and what goods fail or succeed. It is up to a firm in a free enterprise to understand these consumer preferences and adjust their operations accordingly.

Cons of Free Enterprise

Seemingly unlimited freedom does come with its disadvantages. First, goods that are generally not profitable to manufacture will not be produced in a free enterprise. This is because there is no economic incentive for a firm to produce these goods (unless there were government aid or stipend). This may also include limitations on where goods are delivered. For example, government funds may partially pay for telecommunication services to be distributed to rural areas; without this funding, those communities may not receive service.

A free enterprise may also spur unfavorable activity due to prioritization of profits. Consider the example of Enron where the company did not follow public reporting regulation, resulting in financial ruin. When there are little to no rules to follow, entities within a free enterprise may sacrifice worker safety, environment standards, or ethical behavior in favor of making more money.

Last, a free enterprise doesn't come with bailouts. This means economic downturns are theoretically more severe, as public funds can't be used to aid failing institutions that would cause major ripple effects by dissolving. This is especially true in today's interconnected society where one large bankruptcy could negatively financially impact firms around the world.

  • Less bureaucratic

  • May be less expensive to operate a business

  • Allows for greater entrepreneurial freedom

  • Prioritizes consumer demand and preferences

  • May result in unprofitable products being dissolved

  • May restrict where goods are distributed to

  • May entice illicit behavior due to prioritizing profits

  • May result in greater market crashes due to no bailouts

Example of Free Enterprise

Consider the differences between two companies: Apple Inc., a public company, and SunGard Data Systems, a private company. Because both companies transact within the United States, neither is truly in a free enterprise environment.

Still, imagine each company wants to raise capital. As a public company, the Securities and Exchange Commission has outlined regulations that Apple must meet to sell additional shares and be listed on public exchanges. This also includes meeting public reporting and filing requirements. On the other hand, with fewer restrictions in place as a private company, SunGard Data Systems may raise capital more freely (yet still restricted) as it does not experience as many government restrictions.

Another example of free enterprise (or lack thereof) is the 2008 Global Financial Crisis. In response to the economic calamity, Congress authorized the use of the Trouble Assets Relief Program (TARP) emergency funds for distressed financial institutions. In a truly free enterprise, governments would not intervene to aid struggling businesses. Instead, these companies would be allowed to fail, allowing for the market to resolve itself with new market participants entering the space to claim the newly vacated market opportunity.

What Is the Main Goal of Free Enterprise?

The main goal of free enterprise is to allow citizens to dictate market and decide the value of trade. Instead of relying on government intervention or public policy, free enterprise's main goal is to allow markets to move themselves without constraint, self-discovering efficiencies and inaccuracies.

What Is the Main Benefit of Free Enterprise?

Some may argue the main benefit of free enterprise is freedom. In one sense, individuals may transact with little to no restricting barriers, especially those set by policy or trade regulation. In another sense, individuals are allowed to creatively express and transact based on a seemingly endless range of consumer choices.

What Is the Difference Between Capitalism and Free Enterprise?

Free enterprise and capitalism are related, though the two terms are different. Free enterprise refers to how a free market system has minimal barriers regarding the exchange of wealth or transacting of goods and services. On the other hand, capitalism is primarily centered on the creation of that wealth or production of those goods. Both relate to an individual initiating their own decisions with fewer market mechanisms governing the control of their resources.

What Is the Difference Between Socialism and Free Enterprise?

Whereas free enterprise is the notion around letting goods and services freely generate market results on their own, socialism is focused on governing how resources are distributed. These government policies may dictate how resources are used, who receives goods, or what pricing mechanisms certain market participants may face.

The Bottom Line

Free enterprise refers to an economic concept where markets are not governed by policy. Instead, market participants set pricing, do not face export or regulation requirements, and have more freedom in choosing how they transact. Though free enterprise is rooted in granting individuals more freedom, market failures may be more devastating without government intervention.

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  1. United States Treasury. "Troubled Assets Relief Program (TARP)."