Mixed Economies and Free Enterprise in the US

Lyndon B. Johnson Space Center

Led in the design and development of the first space shuttle.
Space exploration is an example of an activity first undertaken by the government.

Objectives

Explain the rise of mixed economic systems.
Explain how government actions affect a circular flow model of a mixed economy.
Compare the mixed economies of various nations along a continuum between centrally planned and free market systems.
Describe the role of free enterprise in the United States economy.

Key Terms

laissez faire
private property
intellectual property
mixed economy
economic transition
privatization

Mixed Economies

Most economies today blend a market system with elements of government involvement.
Governments step in to provide for defense or fulfill other needs.

Why Government Gets Involved in the Economy

Every economic system has inherent problems in addressing the three basic economic questions.
Traditional economies have little potential for growth or change.
Centrally planned economies stifle innovation, do not adequately meet consumer needs, and limit freedom.
Even free market economies have drawbacks.
Adam Smith believed the free market would provide the greatest benefit for consumers and raise the standard of living.
Smith favored laissez faire, the doctrine that government generally should not intervene in the marketplace.
Even Smith acknowledged the need for a limited degree of government involvement.
Government intervention has increased for several reasons:
- Some needs of modern society would be difficult to meet in the marketplace (e.g., national defense, highway systems).
- Governments supply some needs to achieve equity and ensure that all members of society can benefit (e.g., public schools, mass transit).
- The Fifth and Fourteenth amendments to the Constitution protect private property, which is a fundamental element of the American economic system.
- Laws require businesses to give honest information to consumers and block firms from preventing competition and fixing prices.
- Some governments tax individuals and businesses to fund pension payments for retired workers, those who cannot work because of disabilities, and others.

Mixed Economy Definition

A mixed economy is an economic system that has some market-based elements and some government involvement.
The degree of government involvement varies from nation to nation.

Balancing Government Involvement and Economic Freedom

Every society must assess its values and prioritize its economic goals.
Some goals are better met by the open market, others through government action.
Societies must evaluate the opportunity cost of pursuing each goal.
Examples of questions to consider: Are you willing to pay taxes to fund the army? To give money to the unemployed? To give all people an education?

Circular Flow Model of a Mixed Economy

Government enters the circular flow and interacts with resource owners, firms, and households.

Government Actions in the Factor Market

Firms purchase land, labor, and capital from households in the factor market.
Governments also purchase these factors.
Example: The U.S. government pays nearly 3 million employees over $150 billion$ a year for their labor.
State and local governments also employ large numbers of people.

Government Actions in the Product Market

Governments purchase goods and services from firms in the product market.
Examples: Government offices need telephones and computers. Printing money requires paper and ink. Governments buy services like consulting and waste removal.
The vast majority of these purchases are made from private firms.
Governments also provide certain goods and services by combining the factor resources they have purchased.
Examples: Governments have used concrete, steel, and other products to build nearly 4 million miles of roads.
Governments provide police and fire protection, education, and health care services as well.

Government Actions Transferring Money

Governments collect taxes from both households and businesses.
Governments then transfer some of this money to businesses and individuals for a variety of reasons, such as providing funds to save a failing industry or making payments to disabled workers.
In recent years, the United States government has paid out over a trillion dollars in Social Security and Medicare benefits annually.
Examples of Government Transfer Payments in 2009:
- Social Security: $664 billion$
- Medicare: $500 billion$
- Unemployment Insurance Payments: $130 billion$
- Federal Education and Training Assistance Payments: $57 billion$
- Food Stamps: $55 billion$
- Veteran's Benefits: $51 billion$

Mixed Economies Today

Most modern economies are mixed economies.
Governments are involved to some degree, but some are involved more deeply than others.

Mixed Economies with Heavy Government Involvement

North Korea represents one extreme of the continuum.
The government owns all property and all economic output.
State-owned industries produce 95 percent of North Korea's goods.
Imports are almost totally banned, and production by foreign companies is forbidden.
In China, government long dominated the economy.
But in recent decades, China's leaders have loosened their control of the economy, allowing more private ownership of farms and businesses.
They have also become more willing to permit foreign firms to invest and operate in China.
Like many nations that relied on central planning in the past, China is now going through an economic transition, a period in which a nation moves from one economic system to another.
In China's case, the transition involves privatizing state-owned firms.
Privatization means selling enterprises operated by the government to individuals.

Mixed Economies Tending Toward Free Markets

Singapore has one of the world's freest markets.
The government encourages foreign trade and investment while imposing few regulations on commercial activity.
This has resulted in strong and steady economic growth in recent years.
Hong Kong is another example of a far-eastern free market powerhouse.
Hong Kong is a special administrative region of China.
The Chinese government allows Hong Kong to operate largely under a free market economic system.
The government protects private property and rarely interferes in the free market.

The Economy of the United States

The foundation of the United States economy is the free market.
The United States free enterprise system is characterized by individual or corporate ownership of capital goods.
Investments in firms are made in a free market by private decision.

The Role of the Government

The American government keeps order, provides vital services, and promotes the general welfare.
Federal and state laws protect private property.
The marketplace operates with a limited degree of government regulation.
There are some limits government places on business use of private property (e.g., local laws may allow businesses to operate only in certain areas and not in a residential district).
A company planning to shut down a facility may not freely do so if it has 100 or more employees.
Federal law requires such a firm to give employees 60 days warning if that shutdown will result in job loss.
Some Americans argue that there is a need for more government services and stricter regulation of business.
Many others, however, say that the government already intervenes too much in the economy.
They call for relaxation of existing regulations, arguing that government rules drive up the operating and administrative costs of businesses, making them less efficient and less competitive.

Overall Economic Freedom

Households and businesses in the United States enjoy a high level of economic freedom with a few limits.
Individuals can choose what kind of work they want to do and where they want to live.
Entrepreneurs have the freedom to launch and expand businesses.
Both new and existing businesses have the ability to engage in whatever business they want and operate where they want.
The banking industry still operates under relatively few restrictions compared to most other nations.
The United States economy is open.
Foreign investment is encouraged.
So, too, is free trade, although the government does protect some domestic industries and does retaliate against trade restrictions imposed by other nations.
Foreign-owned banks have few restrictions in addition to those on domestic banks.

Benefits of Free Enterprise

Basic Characteristics of Free Enterprise

American entrepreneurs begin new businesses that earn profits, create jobs, and offer new goods and services.
The American free enterprise system makes it possible for people who have ideas and persistence to start businesses and make them successful.

Opportunity

Considered the United States to be a "land of opportunity," where anyone from any background might achieve success.
There are over 27 million businesses in America, including 6 million that are owned by members of minority groups.
America enjoys many advantages in resources: open land; large reserves of natural resources; and a large, talented labor supply.
American tradition of free enterprise-the social and political commitment to giving people the freedom and flexibility to try out their business ideas and compete in the marketplace.

Incentives

Lower prices and higher wages are incentives for consumers and workers to act in certain ways. An incentive is a reward or a cost resulting from specific behavior. For firms, a major incentive is profit.
Incentives often involve money, although they can be nonmonetary.
Incentives are often positive, in the form of rewards, but they can also be negative, in the form of costs or penalties.

Profit Motive

The American economy rests on recognition of the profit motive as a key incentive.
The profit motive drives individuals and businesses to make decisions that improve their material well-being.
Reliance on the profit motive has several benefits:
- It forces business owners to exercise financial discipline, because they are responsible for their own success or failure.
- It encourages entrepreneurs to take rational risks and rewards innovation by letting creative companies grow.
- It also improves productivity by allowing more efficient companies to make more money.

Competition

Businesses must compete both domestically and internationally for consumers' money.
Competition serves to regulate the free market by keeping prices from rising too high.
Competition encourages businesses to improve the quality of their products in order to attract consumers.
Competition affects quantity. More competition usually means that businesses produce less, while less competition allows businesses to produce a greater quantity and, therefore, potentially earn a larger market share.

Open Opportunity

The American economy also benefits from a tradition of open opportunity, the principle that anyone can compete in the marketplace.
This allows economic mobility up or down: no matter how much money you start out with, you can end up wealthier or poorer depending on how your business performs.

Legal Equality

Commitment to legal equality-the principle that everyone has the same legal rights.
Legal equality benefits the economy by maximizing a country's use of its human capital. Countries that restrict the legal rights of women or minorities lose the productive potential of a large portion of their society.

Private Property Rights

Private property is the cornerstone of the free enterprise system. Private property rights give people the right to control their possessions and use them as they wish.
Personal ownership provides an incentive for property owners to use property wisely and conserve resources.

Economic Freedom

The right of free contract allows people to decide what agreements they want to enter into.
The right of voluntary exchange allows consumers and producers to decide what, when, and how they buy and sell.
Voluntary exchange, in turn, encourages competition, which benefits consumers by providing a larger variety of goods at reasonable prices.
Variety of goods and responsive prices, then, are key benefits of the free enterprise system.

Key Roles in the Free Enterprise System

The Role of the Consumer

A basic principle of the free enterprise system is that consumers have the freedom to make their own economic choices.
Through voluntary exchange, consumers send a signal to businesses, telling them what and how much to produce. Consumers also send a signal when they do not buy a good or service.
Consumers can also make their wishes known by joining an interest group, a private organization that tries to persuade public officials to act in ways that benefit its members.

The Role of the Entrepreneur

Entrepreneurs decide how to combine resources-land, labor, and capital-to create new goods and services.
By starting new businesses, entrepreneurs fuel economic growth.
Without the profit motive, entrepreneurs would have little incentive to face the challenge of creating and producing new goods and services.

Economic Freedom and the Constitution

The economic freedoms that American consumers and producers enjoy are an important benefit of the U.S. free enterprise system and a source of patriotism, or love of one's country.
Economic freedom plays a dual role in the promotion of a free society. According to Milton Friedman:

Economic freedom plays a dual role in the promotion of a free society. On the one hand, freedom in economic arrangements is… an end in itself. In the second place, economic freedom is also an indispensable means toward the achievement of political freedom.
Rights that allow people to engage in business activity are written into the framework of our nation, the Constitution. Perhaps the most important of these is the constitutional recognition of property rights.

Property Rights

The government has the power to seize property for its own use. To prevent this and ensure economic security, early American leaders protected private property under the Bill of Rights.
The Fifth Amendment states that "no person shall be… deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation."
The Fourteenth Amendment, ratified in 1868, extended the same limitations to the state governments.
These due process clauses prevent the government from taking property from its owner except when there is a public reason:
-Example: Eminent domain.
The government must pay the person the fair value of the property that has been taken. This protection applies to businesses as well as to individuals.

Taxation

Constitution also spells out how government can tax individuals and businesses. Congress has the power to tax only in the ways the Constitution allows.
Article I gives Congress the power to levy taxes. Requires that direct taxes be apportioned to states according to population.
The Sixteenth Amendment, ratified in 1913, first gave Congress the right to set direct taxes based on income. Under current law, both individuals and corporations must pay federal income tax.

Contracts

The Constitution guarantees people and businesses the right to make contracts, which are legally binding agreements between people or businesses.
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Article I, Section 10 prohibits the states from passing any "Law impairing the Obligation of Contracts."
Individuals or businesses cannot use the political process to be excused from their contracts. No legislature can pass a law changing the terms of someone's business agreement.

The Limited Role of Government in the Marketplace

The government plays a limited but important part in the American free enterprise system.
The government's primary role is to carry out its constitutional responsibilities to protect property rights, contracts, and other business activities.
Government takes other actions to promote the public interest, or the concerns of society as a whole.
Government has passed laws to protect us from economic problems that affect us all, such as pollution or unsafe foods and medicines.
Information and Free Enterprise

Public health, Safety, and Well-Being

Consumers cannot make informed choices if they do not have basic information about the products they are buying.
educated consumers make the free market system work more efficiently. Important roles in the economy is to make sure that it protects consumers' rights and that producers provide consumers with information.

Public Disclosure Laws

Congress has passed public disclosure laws, which require companies to give consumers important information about the products or services that they offer.

Government Protecting Consumers:

The Federal Trade Commission Act says that advertisements cannot be deceptive.
The Truth-in-Lending Act requires businesses offering loans to disclose certain information to consumers before they sign a loan agreement.
The Consumer Financial Protection Bureau, established by the Consumer Financial Protection Act of 2010, oversees financial laws that protect consumers.
The bureau provides financial education to consumers and makes sure people receive clear information about the risks involved with using financial services.
The government sets manufacturing standards, requires that drugs be safe and effective, and supervises the conditions in which foods are produced to make sure they are sanitary.

Major Federal Regulatory Agencies:

Agency:

Food and Drug Administration (FDA): 1906. Sets standards for food, drugs, cosmetics
Federal Reserve System (FED): 1913. Regulates banking, manages money supply
Federal Deposit Insurance Corporation (FDIC): 1933. Insures deposits, regulates certain bank practices
Federal Aviation Administration (FAA): 1958. Regulates matters related to civil aviation
Environmental Protection Agency (EPA): 1970. Enacts policies to protect health, the environment
Occupational Safety and Health Administration (OSHA): 1970. Enacts policies to protect health and safety of workers
Consumer Product Safety Commission (CPSC): 1972. Enacts policies to reduce risks from consumer products
Nuclear Regulatory Commission (NRC): 1974. Regulates civilian use of nuclear materials
Transportation Security Administration (TSA): 2001. Oversees security in airports, transport systems
Consumer Financial Protection Bureau (CFPB): 2010. Oversees consumer financial products, such as mortgages

Negative Effects of Regulation

Government regulation can be controversial and sometimes has negative effects on businesses. Business owners said that the rules were costly to implement, cutting into profits and slowing growth.
Oil and gas companies argued that the Obama's administration's federal rule on fracking on public lands would negatively affect jobs, increase costs, and slow energy development.
The airlines and telephone companies, said that government rules and regulations stifled competition, resulting in prices that were unnecessarily high.
Growth in government oversight of industry also raised government spending, because the government had to hire workers to do the tasks involved in instituting and carrying out the new rules.

Todays government

Today, the government works to balance concerns raised by businesses with the need to protect the public.