Free enterprise
By Nigel Ashford
“To be controlled in our economic affairs is to be ... controlled in everything.”
Friedrich Hayek
What is free enterprise?
Free enterprise is the economic system based on the voluntary exchange
of goods and services, in which the people determine their own economic
affairs, by deciding where they work, or invest, how to spend or save
the fruits of their labour, and with whom they trade. The people are free
to make these decisions in a free enterprise society because a framework
of law allows citizens to own property, to exchange what is theirs
(including their own labour) and to enter into legally binding contracts.
This governance of laws allows individuals to co-operate to their mutual
benefit by forming legal associations to conduct their commerce, including
corporations, partnerships and not-for-profit organisations.
Government has a role to play in protecting people’s property and
enforcing their contracts so that people may trade with one another with
confidence, but in a free enterprise society, that role is strictly limited.
Economic barriers to free enterprise, such as taxes, regulation and government
spending, are kept to a minimum in this society.
Trade and exchange have been an integral part of every human civilisation,
and a limited recognition of the value of these activities was a key
factor in how the West grew rich. It was in those areas where the power
of church and state waned and where there were competing sources of
authority, that a degree of economic freedom allowed people to prosper
and their numbers to grow. In the Italian city-states of the Renaissance,
in the seventeenth century Dutch Republic and above all in England
and her American colonies, the people’s relative economic liberty made
these nations centres of commerce. It was not until the final quarter of
the eighteenth century, however, that a Scottish economist named Adam
Smith pioneered a systematic theory of how free enterprise worked. In a
book entitled The Wealth of Nations, Smith sought to explain the prosperity
that had grown up in England since the advent of its limited, constitu-
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tional monarchy in 1688. The book went into print in 1776, the same year
as the Declaration of American Independence and greatly influenced the
founding fathers of the United States, whose rebellion Smith supported.
This idea of an economy which largely ran itself, without the supervision
of a centralised government, in time transformed economic thinking
in the West. Smith’s new theory challenged the economic practice of
the day — a system of mercantilism by which monarchs and ministers
closely directed the economy. The old economic order was based on the
idea that the source of a nation’s wealth lay in its stock of gold, silver
and precious metals. Commerce was thought best conducted by granting
monopolies to guilds and corporations. Laws were passed to suppress
wages and keep prices high, and a complex web of high taxes and duties
were levied to finance the military adventurism which governments pursued
to plunder the resources of other nations, and enslave their people.
Smith turned these ideas on their head, demonstrating that the wealth of
nations was derived from a division of labour which allowed people to
specialise at providing the consumer with what he wanted. Money, he
argued, was only of value in terms of what it could buy. Competition
increased purchasing power and therefore created prosperity.
Free enterprise raises workers’ wages
The ideas that led Adam Smith to advocate free trade, cheap government
and open markets, are still raising the living standard of working
people today. It is the nations that embraced these ideas, such as the
USA, which have enjoyed the greatest latitude that worker’s wages have
risen to the highest levels on Earth. By contrast, those nations that have
experimented with government planning have failed to lift people out of
poverty and hunger. Free enterprise raises workers’ wages by stimulating
people’s willingness and ability to produce that which their fellow man
requires. That is the principal reason why it takes fewer man hours to
earn enough money to buy a television, an automobile or a personal
computer in the USA than it does in Russia. It is productivity, not hard
work, that matters. People in poor countries usually labour long hours
but their ability to provide the consumer with what he wants and their
rewards for doing so are limited by the intervention of government. Free
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enterprise raises people’s real wages because there are powerful incentives
to serve consumers who can easily communicate what they want.
Free enterprise satisfies consumers
In a free enterprise economy, people are able to serve customers thanks
to the price mechanism. This vast communications network of rising
and falling prices tells workers and investors where consumer demand is
increasing and where it is decreasing. Higher consumer demand for a
particular product pushes up prices, increasing profits to investors. These
increased profits attract more investment, and push up wages to attract
more workers into that line of work. So society produces more of what
the consumer wants, and as the supply of a particular good or service
increases, the long-term price to the customer will fall. The built-in
incentives of the free enterprise system ensures that society’s resources are
diverted to satisfying the wants of consumers, and away from those areas
of production that are meeting less urgent needs. In this system, the
consumer is sovereign, dictating where and how society’s resources are
used, by deciding how his income is spent or saved. That income, in
turn, will be higher to the degree to which that individual is supplying
society with the goods and services that it demands.
Free enterprise cuts the cost of living and creates new products
Free enterprise is a discovery process which allows people to discover what
the customer wants. The freedom to buy and sell allows goods and services
to come onto the market, that people are then free to embrace or reject as
they like. Free enterprise allows entrepreneurs to innovate with new ideas
for new products and to refine existing products. The price mechanism
then signals to workers and investors whether these new products are wanted
or not. Initially, new products like Video Cassette Recorders, microwave
ovens or cellular telephones are expensive, and only accessible to the rich,
but as products are tried, tested and modified, and as more capital is invested
in their development, the price falls. This way, the luxuries of the wealthy
few become the necessities of the many. And as a free enterprise society
produces an ever increasing array of goods and services, so the price of those
products as a proportion of people’s income falls, cutting the cost of living.
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Free enterprise encourages productivity
The incentives inherent to the free enterprise economy also foster
productivity by tapping into people’s willingness to serve others better
than any other economic system that has yet been devised by man.
Because people are free to keep the fruits of their labour and take risks
in a system of free enterprise, the rewards for serving the consumer are
greater than in alternative economic systems. A system of slavery, in
which the individual is forced to labour for others, or a planned economy,
where government organises production, destroy the incentives to
produce. Taxes perform that function too. Taxes are like prices; they are
the price - or penalty - paid for engaging in economic activity. The more
government taxes investment and work, the lower the rewards for work
and investment will be. And if the rewards for work and investment fall,
there will be less work and investment as a result. Taxes are an economic
barrier that limits the number of people taking part in the activity that is
taxed. Taxes on work and investment will also exclude some people from
working or investment altogether. Regulation has the same effect. By
raising the costs of production, prices are artificially raised, increasing
living costs and placing goods out of the reach of the poor.
Free enterprise lifts people out of poverty
Far from enriching a wealthy few, the dynamism of the free enterprise
system can be seen most vividly in the way it eliminates poverty more
rapidly than other economic system. Whilst economic freedom does
inevitably lead to a degree of inequality in people’s incomes and wealth,
attempts to go further and to redistribute income and wealth from the
wealthy to the less well off shrinks the economy, destroying economic
opportunity for those who need it the most. Attempts to use government
to determine people’s incomes and wealth creates an arbitrary society
in which access to political power determines people’s income and
wealth. This sort of inequality is more harmful to the poor than inequalities
of wealth and income under free enterprise, because free enterprise
rewards people with high incomes only as long as they serve the customer
better than others. It allows people to serve their own interests
only insofar as they use their property and labour to serve the interests
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of others. Free enterprise maximises the opportunities of the poor to get
out of poverty and makes society a cheap place to live in.
Free enterprise creates jobs
Critics of free enterprise often point to business cycles in the West in
which periods of economic expansion are interrupted by recessions
which cause unemployment to rise. The fluctuations of the business
cycle played a key part in communist propaganda during the Cold War,
but it should be noted that the communist world only avoided such
cycles by maintaining a permanent economic stagnation which left living
standards far lower than those achieved in the West. In fact, economic
recessions and depressions are caused by inflation resulting from
government expanding the supply of money and credit faster than the
growth of the economy. Increasing the supply of money relative to the
supply of goods and services eats away at the value of money, causing
inflation which increases unemployment when people discover that the
currency is losing its value. The solution is not to do away with free
enterprise, but rather to take the supply of money out of the hands of
government. Some unemployment is caused not by inflation, but by
taxes and regulations on work which cause a mismatch between the
supply of labour and consumer demand. In a free enterprise economy
there is always work available because the demands of consumers are
never exhausted.
Free enterprise guards the environment
Just as free enterprise has multiplied the range of goods and services
available and brought them down in price, so it has increased the supply
of nature’s resources and made the world’s energy and resources cheaper
over time. This effect is the key to understanding why air and water
quality is improving in economies like that of the USA whilst communism
left societies scarred by pollution and despoliation. It is also an
important reason why those people who enjoy the most economic freedom
have a longer life-expectancy at birth. Wealthier is healthier. The
free enterprise system has created the wealth which has made possible
the discovery of new sources of energy and more efficient uses of natural
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resources. The private ownership of natural resources has also protected
and enhanced the environment because private owners have an interest
in the long-term preservation of resources and are therefore better stewards
than the state. Free enterprise has maximised the freedom of the
ultimate resource - mankind - to solve the problems created by new
technologies, and it has also enabled billions more people with their
ingenuity and creativity to live and prosper in a world which once could
only support a fraction of their number.
Without free enterprise, there can be no democracy
Finally, free enterprise is a necessary, although not a sufficient, condition
for democracy and the civil liberties which we associate with political
freedom. This is because you cannot control an economy without controlling
people. Once economic decisions are taken out of the hands of
the millions of individuals who work, invest, save and spend and are
instead made by a central authority, it becomes necessary to coerce individuals
to fit in with the state’s plan. The power that this places in the
grasp of government makes it possible to punish those who do not do
what those in authority require. The fact that power is concentrated in
the state means that opposition to the government’s plans is extremely
difficult and dangerous. In a free enterprise society where the means of
production are privately owned, there are always alternative employers
and privately funded trade unions, political parties, pressure groups,
newspapers, radio and television stations and places of assembly and worship.
As Leon Trotsky explained: “When the state is the sole employer,
opposition means death by slow starvation.”
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Reading
Milton Friedman, Capitalism and Freedom, London, University of
Chicago Press, 1962, chapters 1, 2.
Milton & Rose Friedman, Free to Choose, London, Secker & Warburg,
1980, chapters 1, 2.
Friedrich Hayek, The Road to Serfdom, London, University of Chicago
Press, 1976 (1944).
Henry Hazlitt, Economics in One Lesson, New Rochelle NY, Arlington
House, 1979.
Peter Saunders, Capitalism: A Social Audit, Buckingham, Open
University Press, 1995.
Adam Smith, The Wealth of Nations, Indianapolis, Liberty Press, 1981
(1776).
Questions for thought
1. Why is the free market superior to state socialism?
2. How can you make free markets more acceptable?
3. How can you extend markets in your country?
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