A capitalist system and a free market system are both economic environments that are based on the law of supply and demand.

They both are involved in determining the price and production of goods and services. On one hand, capitalism is focused on the creation of wealth and ownership of capital and factors of production, whereas a free market system is focused on the exchange of wealth, or goods and services.

Some key features of capitalism include the competition between companies and owners, private ownership and motivation to generate a profit.

In a capitalistic society, the production and pricing of goods and services are determined by the free market, or supply and demand, however, some government regulation may occur.

On the other hand, a private owner in a capitalist system can have a monopoly on the market and prevent free competition.

• History of Free Market Capitalism
• What does Free Market Capitalism mean?
• Is Free Market Capitalism good?
• Is the United States a Free Market Capitalism?
• What Countries have Free Market Capitalism?
• What’s wrong with Free Market Capitalism?

History of Free Market Capitalism

Capitalism came about following feudalism, which took place during medieval Europe. Feudalism was a European system where military service is traded for land. This was the primary economic system in Europe in the 16th and 17th centuries.

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Then came about the Dutch East India Company, which was founded in 1602. This was the first public company and marked a shift toward capitalism. The major economists that developed theories surrounding capitalism include Adam Smith and Karl Marx.

Adam Smith theorizes that capitalism is part of natural human behavior that is aligned in trade and commerce. Marxism says that capitalism is an unusual system that could be replaced with a superior system. Marx believes that capitalism is essentially powerful people taking control.

What does Free Market Capitalism mean?

A system of economics that minimizes government intervention and maximizes the role of the market. According to the theory of the free market, rational economic actors acting in their own self interest deal with information and price goods and services the most efficiently.

Government regulations, trade barriers, and labor laws are generally thought to distort the market. Proponents of the free market argue that it provides the most opportunities for both consumers and producers by creating more jobs and allowing competition to decide what businesses are successful.

Critics maintain that an unfettered free market concentrates wealth in the hands of a few, which is unsustainable in the long term. In practice, no country or jurisdiction has a completely free market.

Is Free Market Capitalism good?

The U.S. economy is essentially a free market economy – an economic market that is run by supply and demand – with some government regulation. In a truly free market, buyers and sellers conduct their business without any government regulation, but there is a continuing debate among politicians and economists about how much government regulation is necessary for the U.S. economy.

Those who want less regulation argue that if you remove government restrictions, the free market will force businesses to protect consumers, provide superior products or services, and create affordable prices for everyone. They believe that the government is inefficient and creates nothing but a big bureaucracy that increases the cost of doing business for everyone.

Those who argue that government regulations are necessary to protect consumers, the environment and the general public claim that corporations are not looking out for the public’s interest and that it is precisely for this reason that regulations are required.

In this article, we consider the pros and cons of a completely free market versus a market with some government regulation.

Free Market Economy

In its purest form, a free market economy is when the allocation of resources is determined by supply and demand, without any government intervention.

Supporters of a free market economy claim that the system has the following advantages:

• It contributes to political and civil freedom, in theory, since everybody has the right to choose what to produce or consumer.
• It contributes to economic growth and transparency.
• It ensures competitive markets.
• Consumers’ voices are heard in that their decisions determine what products or services are in demand.
• Supply and demand create competition, which helps ensure that the best goods or services are provided to consumers at a lower price.

Critics of a free market economy claim the following disadvantages to this system:

• A competitive environment creates an atmosphere of survival of the fittest. This causes many businesses to disregard the safety of the general public to increase the bottom line.
• Wealth is not distributed equally – a small percentage of society has the wealth while the majority lives in poverty.
• There is no economic stability because greed and overproduction cause the economy to have wild swings ranging from times of robust growth to cataclysmic recessions.
• Assumptions required for free markets to operate well are inconsistent with reality such as the myth of perfect and symmetric information, rational actors, and costless transactions.

Triumphs and Tribulations

There are several historical examples that suggest that the free market works. For example, the deregulation of AT&T, which previously functioned as a regulated national monopoly, in the 1980s provided consumers with more competitive long-distance telephone rates.

Also, the deregulation of U.S. airlines in 1979 provided consumers with more choice and lower air fares. The deregulation of trucking companies and railroads also increased competition and lowered prices.

Despite its successes, there are also several historical examples of free market failure.

For example, since the cable industry was deregulated in 1996, cable TV rates have skyrocketed; according to a 2003 report by the U.S. Public Interest Research Group (PIRG), cable rates increased by more than 50% between 1996 and 2003. Clearly, in this case of deregulation, increased competition did not reduce prices for consumers.

Another example of free market failure can be seen in environmental issues. For example, for years the oil industry fought and defeated laws requiring double-hull oil tankers to prevent spills, even after the single-hulled oil tanker Exxon Valdez spilled 11 million gallons into Prince William Sound in 1989.

Similarly, the Cuyahoga River in Northeast Ohio was so polluted with industrial waste that it caught fire several times between 1936 and 1969 before the government ordered a $1.5 billion cleanup.

As such, critics of a free market system argue that although some aspects of the market may be self-regulating, other things, such as environmental concerns, require government intervention.

The Regulated Economy

Regulation is a rule or law designed to control the behavior of those to whom it applies. Those who fail to follow these rules are subject to fines and imprisonment and could have their property or businesses seized.

The United States is a mixed economy where both the free market and government play important roles.

A regulated economy provides the following advantages:

• It looks out for the safety of consumers.
• It protects the safety and health of the general public as well as the environment.
• It looks after the stability of the economy.

The following are disadvantages to regulation:

• It creates a huge government bureaucracy that stifles growth.
• It can create huge monopolies that cause consumers to pay more.
• It squashes innovation by over-regulating.

Some historical examples that show how well regulation works include the ban on DDT and PCBs, which destroyed wildlife and threatened human health; the establishment of the Clean Air and Water Acts, which forced the cleanup of America’s rivers and set air quality standards; and the creation of the Federal Aviation Administration (FAA), which controls air traffic and enforces safety regulations.

Several historical examples of regulatory failures include:

• In response to the Sarbanes-Oxley Act of 2002 (SOX), an act written in response to accounting scandals, many companies decided it was too cumbersome to list in the United States and decided to do their initial public offerings (IPOs) on the London Stock Exchange (LSE) where they didn’t have to worry about Sarbanes-Oxley.
• The coal industry has so many regulations that it is more profitable to ship coal overseas than to sell it domestically.
• Many labor and environmental regulations force businesses to move jobs off shore, where they can find more reasonable regulations

Finding a Balance

There is a delicate balance between an unregulated free market and a regulated economy. The following are some examples in which it appears that the U.S. has struck a good balance between the two:

• The Federal Deposit Insurance Corporation (FDIC) was created after the Great Depression. The FDIC insures depositors’ money so that even if banks fail, the depositors won’t lose their deposits.
• The Securities and Exchange Commission (SEC) regulates the stock markets, ensures honest disclosure on all stock transactions and fights insider trading.
• The ban on CFCs prevents the destruction of the ozone layer

Several ways in which the economy has become out of balance as a result of deregulation include:

• The deregulation of the savings and loan (S&L) industry in 1982 led to fraud and abuse, causing the federal government to spend billion to stabilize the industry after many S&Ls went under.
• Improperly trained crews led to the near meltdown of a nuclear reactor at Three Mile Island, which released radiation into the air and water. Gordon MacLeod, the secretary of state for Pennsylvania, was fired for voicing his concerns about the lack of oversight of the nuclear industry and the inadequate preparedness of the state to respond to such emergencies.
• The lack of adequate regulation of silicone breast implants led to a situation in which manufacturers knew that the implants leaked but continued to sell them anyway, leading to a settlement of $4.75 billion to 60,000 women affected in 1994.

Is the United States a Free Market Capitalism?

The United States is considered the world’s premier free-market economy. Its economic output is greater than any other country that has a free market. The U.S. free market depends on capitalism to thrive. The law of demand and supply sets prices and distributes goods and services. 

That fits right in with the overarching vision for American democracy. The Founding Fathers said in the Declaration of Independence that each American should have an equal opportunity to pursue their personal vision.² That pursuit drives the entrepreneurial spirit that capitalism needs.

But the reality of the economy in America is more complex, involving a mixture of free-market capitalism and state intervention.

State Intervention in the Economy

The U.S. Constitution allows the government to use central planning in areas of vital importance to the nation’s growth. That includes defense, telecommunications, and transportation.

In 1935, the Social Security Act extended the definition of general welfare. It included unemployment compensation, retirement income, and aid for mothers with dependent children. It was part of FDR’s New Deal to get America out of the Great Depression.

Since then, Congress has extended the general welfare clause to many other areas, the largest of which focus on seniors, children, and national defense.

The federal budget reflects these priorities. The most significant budget item is Social Security benefits at $1.15 trillion in Fiscal Year 2021. The nation’s second-largest priority is health care. Medicare costs $722 billion and Medicaid costs $448 billion in FY 2021.

The third-largest area is military spending. It’s $934 billion in FY 2021. That’s if you add Overseas Contingency Operations to the Defense Department base budget. Also included are defense support departments such as Homeland Security, the FBI, and the Veterans Administration.

As a result, many worry that America is becoming a socialist welfare state. Others warn that the country is a slave of the military-industrial complex. Still others want the government to increase interventions in some areas.

America Is a Mixed Economy

The United States is a mixed economy, and many would say it is better for it. They would point out that it’s difficult to coordinate a national defense plan in a truly free market. Likewise, a society without any government intervention may leave vulnerable members of society without a safety net.

This would go against the constitutional mandate that everyone have the right to pursue happiness. Becuse of these tensions, America blends the free market with a command economy.

In a command economy, the government uses a central plan to manage prices and distribution. Countries that follow communism use the command economy. So do some monarchies, fascists, and other totalitarian regimes.

When people think of a command economy, they call to mind Russia, China, Cuba, North Korea, or Iran. But even these countries have adopted many of the characteristics of a free market economy. They must compete against market pricing throughout the world. Engaging the free market gives them the flexibility to succeed in a globalized economy.

Threats to America’s Free Market Status

Deficit spending threatens the U.S. status as a free-market country. Federal revenue doesn’t cover spending. Each year the deficit adds to the debt. This happens when the debt-to-GDP ratio is more than 100% because the national debt is more than the country’s annual economic output.

When the debt-to-GDP ratio extends beyond the World Bank’s recommended max of 77%, investors often become reluctant to invest in the country by buying its debt. Yields rise, increasing interest rates. That can slow economic growth in the long run.

Economists debate the solution to the deficit problem, but one way to address it is through spending strategically to stimulate the economy, creating more jobs and increasing production while reducing overall expenses.

For instance, a 2011 report by the Political Economy Research Institute found that $1 billion in military spending added 11,200 jobs, while $1 billion in education spending created 26,700 jobs.

More jobs equal more spending, so the argument goes, which raises production and decreases the debt-to-GDP ratio and stimulates the free market.

The dance between the free market and government intervention has always been a delicate one in the U.S. Economists and politicians will continue to debate the Founding Fathers’ vision, and policies will change with different administrations.

One thing is for sure though: America’s system will continue to mix elements of free-market and command economies as long as there are any social programs in place to promote the general welfare.

What Countries have Free Market Capitalism?

Free market economies, capitalism, and the USA have traditionally gone hand-in-hand.

If you grew up inside the confines of America, you would think that it is the only place in the world where capitalism exists. These days, capitalism does exist in the Land of the Free, but as taxes and regulations increase, it is dying away.

That’s not to say that there aren’t a lot of capitalist-minded people in the US. There are many capitalists in the United States who choose to deal with the limitations, but American culture has long ceased to be capitalist.

So, where are the world’s strongest free market economies? Here are a few examples:

1. China

While personal freedom is not part of the equation in China, capitalism is rampant. And, for the most part, China does capitalism better than the US — in fact, better than most countries. While China is still communist, it is more “by name only” at this point.

In recent years, China has shown itself to be more recession-resistant than most countries as well. While the US government likes to claim it is “for the people” and influenced by individuals, it usually acts in its own interests. As such, very little change takes place that will actually benefit the market.

In China, the system is designed to encourage entrepreneurship. There is also a general cultural affinity toward capitalism. It is the same in places like Vietnam. Though it sounds ironic, these are the places where people work very hard and are interested in money and in starting businesses.

That naturally creates free market economies.

The government tolerates it because they recognize it’s the only way to go. Sure, tolerance is not as good as wide open arms, but it’s better than actively working against the free market culture and saying “You didn’t build that.”

Plus, the Chinese government has the ability to move more quickly as it is not tied to the comforting but useless “checks and balances” that Americans claim keep them free.

While special interests dominate the democratic government in America, China has no place for this kind of gridlock. Yes, the government in China can run roughshod over citizens, but it can also be more adaptive and reform quickly without being weighed down by corporate bribes.

2. Hong Kong

Traditionally billed as the world’s freest economy, Hong Kong remains one of the most capitalist countries and strongest free market economies. It’s almost non-existent tariffs and small government are a recipe for capitalist success.

Although it is technically a “Special Administrative Region” of China, it stands on its own as an independent free market. Hong Kong’s gross domestic product (GDP) per capita of over $40,000 is one of the highest in the world, more than four times higher than China’s.

There are signs that crony-capitalism is now creeping into the city-state. However, it still possesses a more capitalist culture, where business is the priority. In addition, it is one of the best and easiest places to open up an offshore company.

3. Singapore

Like Hong Kong, Singapore’s capitalism is under siege with growing cronyism. However, the small island country still needs to be mentioned in a discussion of the strongest free market economies. Like China, the government is not big on personal freedom, but it is fundamentally pro-business and adaptive to changes in the market.

Singapore has also become the “Switzerland of Asia” for banking (now much better than Switzerland). The rules are much less restrictive in Singapore vs. the United States.

For example, you can transport up to S$30,000 (about US$24,000) in or out of the country without any questions being asked. (Compare this with the US’s $10,000 limit). You can also buy and sell gold and silver bullion in Singapore tax-free.

4. Macedonia

Located in the Balkans, to the south of Serbia, Macedonia has made great strides toward free-market policies in the past decade. The country is an increasingly pro-business area with 0% tax zones, free trade zones, and a 10% corporate tax. Additionally, it only takes two days to start a business in Macedonia and no minimum capital is required.

The country is working to become more transparent and to create a more flexible labor market after years of unemployment.

The Heritage Foundation notes that while property rights and corruption are still a concern in the country, there has been notable success in trade freedom, regulatory efficiency, and fiscal freedom. Because of these reforms, there is a growing entrepreneurial sector in Macedonia.

Foreign and domestic investors are treated equally and, if you’re willing to start a business and hire local workers, you can become a Macedonian citizen after just one year. The program is targeted specifically at entrepreneurs who can invest at least €400,000 for a minimum of three years.

Macedonia is one of many Eastern European countries that are embracing free-market principles as they strive for greater growth and development.

The leader and trend-setter in this area is, of course, Estonia, which adopted free-market policies as soon as it was out of the grasp of communism. Capitalism has worked well for Estonia and the many countries that have followed its example.

5. Georgia

Most people think of Georgia as either a backwoods communist state in Eastern Europe or a backwoods state in the USA. The former view would be incorrect. Here’s what the previous president of Georgia had to say in 2010:

“Georgia is the world champion in economic reforms. No other country and no other government in the world has done as much as the Georgian government did to improve doing of business and for creating opportunities”

             -Mikhail Saakashvili, former President of Georgia, 8 November 2010 (Georgia 2010)

Structural reforms have included privatization, competitive flat tax rates, and modernization of the regulatory environment.

These are some of the world’s strongest free-market economies. While they may not look it on paper (and shouldn’t be confused with overall levels of freedom), these are countries where capitalism is still embraced. Keep these countries in mind in your quest to keep your money and your business safe and secure.

What’s wrong with Free Market Capitalism?

Despite its ubiquity, many economists criticise aspects of capitalism and point out is many flaws and problems. In short, capitalism can cause – inequality, market failure, damage to the environment, short-termism, excess materialism and boom and bust economic cycles.

1. Inequality

The benefits of capitalism are rarely equitably distributed. Wealth tends to accrue to a small % of the population. This means that demand for luxury goods is often limited to a small % of the workforce. The nature of capitalism can cause this inequality to keep increasing. This occurs for a few reasons

• Inherited wealth. Capitalists can pass on their assets to their children. Therefore, capitalism doesn’t cause equality of opportunity, but those born in privilege are much more likely to do well because of better education, upbringing and inherited wealth.
• Interest from assets. If capitalists are able to purchase assets – bonds, house prices, shares, they gain interest, rent and dividends. They can use these proceeds to buy more assets and wealth – creating a wealth multiplier effect. Those without wealth get left behind and may see house prices rise faster than inflation.
• The economist Thomas Piketty wrote an influential book Capital in the Twenty-First Century, which emphasised this element of capitalism to increase inequality. As a general rule, Picketty argues wealth grows faster than economic output. He uses expression r > g (where r is the rate of return to wealth and g is the economic growth rate.)

2. Financial instability/economic cycle

Capitalism relies on financial markets – shares, bonds and money markets but financial markets have a tendency to cause booms and busts. In a boom period, lending and confidence rise, but frequently markets get carried away by ‘irrational exuberance‘ causing assets to the spike in value.

But, this boom can quickly turn to a crash when market sentiment changes. These market crashes can cause economic downturns, recession and unemployment. At various times, capitalism has suffered prolonged recessions (the 1930s), periods of mass unemployment and a decline in living standards.

3. Monopoly Power

In a free market, successful firms can gain monopoly power. This enables them to charge higher prices to consumers. Supporters of capitalism argue only capitalism enables economic freedom. But, the freedom of a monopoly can be abused and consumers lose out because they have no choice.

For example, in industries like tap water or electricity supply, which are a natural monopoly, consumers have no alternative but to pay the prices charged by consumers. In the Nineteenth Century, monopolies like Standard Oil bought our rivals (often with unfair competitive practices) and then became very profitable.

4. Monopsony

Monopsony is market power in employing factors of production. For example, firms can have monopsony power in employing workers and paying lower wages. This enables firms to be more profitable but can mean workers don’t share from the same level of proceeds as the owners of capital.

It explains why with increasing monopsony power we have seen periods of stagnant real wage growth while firms profitability has increased (2007-17 in UK and US)

5. Immobilities 

In a free market, factors of production are supposed to be able to easily move from an unprofitable sector to a new profitable industry. However, in practice, this is much more difficult. E.g. a farmworker who is made unemployed cannot just fly off to a big city and find a new job.

He has geographical ties to his birthplace; he may not have the right skills for the job. Therefore, in capitalist societies, we often see long periods of structural unemployment.

6. Environmental costs and externalities

In capitalist economies, there is limited government intervention and reliance on free markets. However, market forces ignore external costs and external benefits. Therefore, we may get over-production and over-consumption of goods that cause harmful effects to third parties.

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This can lead to serious economic costs – pollution, global warming, acid rain, loss of rare species; external costs that damage future generations.

7. Encourages greed/materialism

The nature of capitalism is to reward profit. The capitalist system can create incentives for managers to pursue profit over decisions which would maximise social welfare. For example, firms are using theories of price discrimination to charge higher prices to consumers who want to jump the queue.

This makes sense from the perspective of maximising profit. However, if we have a society, where the rich can pay to jump a queue at a Fairground – or pay to see Congressman quicker – it erodes social norms and a sense of ‘fair-play’.

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Bottom Line

Free market economics aren’t perfect, but neither are completely regulated economies. The key is to strike a balance between free markets and the amount of government regulation needed to protect people and the environment. When this balance is reached, the public interest is protected and private business flourishes.