The terms capitalist economy and free market economy are often used interchangeably but there are differences, at least in the theories that underpin them. In both, the law of supply and demand is allowed to determine the goods and services that are produced and the prices that are charged for them.
Both capitalist and free market theory focus on the ownership of capital and the factors of production by private individuals rather than a government. Free market theory goes further. It maintains that the exchange of goods and services should be largely unhampered by government interference or regulation.
In effect, the free market view leans more towards libertarianism, which holds that the government that governs least governs best.
Key Takeaways
- Capitalism is the creation of wealth and the ownership of capital, production, and distribution by individuals.
- A free market system can be seen as a stricter type of capitalism in which government is denied a role in regulating commerce.
- In both theories, the law of supply and demand is the primary motivation for the production and distribution of goods and services.
Capitalism
Capitalism is an economic system that maintains that the production of goods and services should remain in the hands of private individuals and businesses, not governments. In order to be successful, these individuals will produce the goods and services needed by the public, at the prices that the public is willing to pay.
The law of supply and demand will determine what goods are produced and the quantities of them that are produced. Competition among businesses will ensure quality and affordability. The drive for greater market share will encourage innovation.
By contrast, in a planned economy, production and prices are controlled by the government through central planning. The government determines which products are needed, and the prices and quantities that must be supplied for the greater good.
Capitalism is one form of a free market economy. As such, it relies on the property rights of individuals. These rights are protected by the use of contracts and tort law. If ownership is transferred, individuals voluntarily sell, gift, or transfer the property.
Free Market
Free market economies are defined by a lack of government intervention and regulation. Few or no rules and regulations apply to the production, sale, or purchase of goods and services. These decisions are made by business owners in response to supply and demand rather than government objectives.
The term “free market capitalism” refers to an economy that puts no or minimal barriers in the way of privately owned businesses. Matters such as worker rights, environmental protection, and product safety will be addressed by businesses as the marketplace demands.
In modern times, no country runs purely under free market principles. Modern democracies impose regulations regarding product safety, working conditions, pollution standards, and other matters that touch on people at work and at home.
In the U.S. and Europe, the government also intervenes with fiscal and monetary policies to jump-start the economy or slow it down. These policies are meant to keep the economy in equilibrium and avoid extremes in inflation or deflation. They are meant to influence supply and demand in a direction that is beneficial to the public at large.
The opposite of a free market economy is a planned, controlled, or command economy. The government controls the means of production and the distribution of wealth, dictating the prices of goods and services and the wages workers receive. Communism is an example of a command economy.
Key Differences
A free market system can exist only within a capitalist society. The ownership by individuals of the means of production is assumed. Their profit motive is seen as the most efficient means of regulating supply and demand and encouraging innovation.
Free market theory goes a step further in emphasizing that government intervention and oversight harm the system.
A free market system is ruled entirely by demand and supply, and there are few or no government regulations or price controls. A transaction occurs when the buyer and the seller agree on a price.
In a capitalist system, the free market dominates, but some government regulation and oversight may occur. The profits of capitalist endeavors are subject to taxation to fund services that are vital to the public but not profitable as business ventures. Highways and mass transit systems are examples.
Capitalism is a system of economic production. Things are produced by workers who are hired by business owners (capitalists) in return for wages. Markets are systems of economic distribution: who gets which things and how much of them?
What Is Free Market Capitalism?
“Free market capitalism” is a melding of the two terms. It implies a system that is not only capitalist but is free of government restraints that are imposed for the good of a commonwealth. Those restraints are seen as interfering with the exchange of goods and services between a seller and a buyer.
Examples may include regulations, monetary policies, fiscal policies, and subsidies. They also include taxes, which fund the implementation of those policies and regulations.
There has been a great deal of debate about whether free-market capitalism is good or bad for a nation and its people. The debate dates back to the mid-1800s, when capitalism began to flourish in developed nations:
- Advocates argue that private ownership combined with the open, unregulated exchange of goods and services is a fair and efficient way to sustain economic growth and progress. They believe that nothing can replace the motivational power of personal incentives, individual freedom, and open competition.
- Critics counter that free-market capitalism promotes inequality, concentrating and keeping power in the hands of a minority, who then exploit the majority. This side of the debate states that it prioritizes individual profit above the wider society’s well-being, dividing people into haves and have-nots.
In the real world, the most prosperous and advanced countries in the world have capitalist economies but their free market ideals are modified to avoid exploitation of the many by the few. They have adopted some socialist characteristics and elements of controlled economies for the benefit of the entire population. Subsidized health care and public education are examples.
One could argue that the U.S.—widely seen as an avatar of a free market capitalist system—achieved its 20th-century heights of power and prosperity only after the expansion of government controls, social programs, and oversight agencies via the New Deal of the 1930s and the Great Society of the 1960s.
Economies Examples
No totally pure free market exists. It is a concept rather than a tangible reality. Most countries have a mixed economy or mixed economic system.
The United States
The U.S. is a highly capitalist country whose economy embodies the essence of a free market. However, it cannot be considered a 100% pure free market.
The U.S. has federal and state minimum wages to protect workers from exploitation. It has antitrust laws to prevent monopolies from price-gouging. It has regulations governing corporate behavior. It imposes business taxes and fees to fund the implementation of these laws.
The conservative think tank Heritage Foundation’s 2023 Index of Economic Freedom, which ranks nations on a 100-point scale, gives the U.S. a score of 70.6, which places it in the second-tier “mostly free” category (the U.S. ranks 25th on the overall list). Only four countries are deemed “free” based on government size, regulatory efficiency, open markets, and rule of law. They are Singapore, Switzerland, Ireland, and Taiwan.
Singapore: The No. 1 Free Market Economy
Heritage’s top spot goes to Singapore; with a score of 83.9, it was ranked the freest in the world in 2023 for the fourth year in a row.
Though no country is 100% unregulated, Singapore is as close as it comes. The government is very pro-business and open to global investment. Legislation is lax. The corporate tax rate is a low 17%.
The people who live and work there live long lives and enjoy a consistent rise in wages—the gross domestic product (GDP) per capita is among the highest in the world.
Repressed Markets
At the other end of the spectrum, some countries are considered repressed (as the Heritage Foundation puts it). These nations have virtually no economic freedoms. The most repressed, according to the 2023 rankings, are North Korea, Cuba, and Venezuela at the bottom of the list.
Georgia, the small country that was once part of the Soviet Union, has made great strides over the years when it comes to becoming more of a free market. Focusing on flat-tax rates and privatization, the country ranks 35th in 2023 when it comes to economic freedoms, with an overall freedom score of 68.7. Its score in 1998 was 47.9.
What Does Free Market Capitalism Mean?
An economy is capitalist if private businesses own and control the factors of production. A capitalist economy is be a free market capitalist economy if the law of supply and demand regulates production, labor, and the marketplace with minimal or no interference from government.
In a true free market, companies sell goods and services at the highest price consumers are willing to pay while workers earn the highest wages companies are willing to pay for their services. The government does not seek to regulate or influence the process.
What Is an Example of a Capitalist Economy?
New Zealand is a prime example of a capitalist economy. This wealthy country in the Asian Pacific region has systematically deregulated and privatized many industrial and professional sectors since the 1980s.
New Zealand’s judicial system recognizes and enforces private property interests and contracts. Government subsidies are low, and an open, liberal attitude to global trade and investment is well-established. Tariffs are low on imports and exports, which comprise around 50% of New Zealand’s GDP.
Is the U.S. a Free Market?
Yes, the U.S. is largely—but not completely—a free market. It is a capitalist nation. Private ownership of property and production predominates, and the laws of supply and demand largely rule the economy.
However, it has some socialistic elements: The government has a role in economic affairs, monetary policy, and social welfare.
The U.S., strictly speaking, is a mixed economy: Some aspects of it are free and unfettered, while others are state-controlled or highly regulated.
The Bottom Line
There are distinctions between capitalism and a free market system, at least in theory.
Capitalism is an economic system that promotes the creation and ownership of capital and wealth. A free market system is a capitalist system that focuses on the unfettered exchange of goods and services, with little or no interference by government.
But this is pure theory. Most nations today have accepted some elements of various economic principles to put into practice. They include measures to address the needs of the public at large.