The Destruction of the Free-Market Economy in America


It is truly amazing how few Americans today have any understanding of what constitutes a true free-market economy. Politicians of both the left and the right continually refer to our “free-market” system as if there was such a thing. Somehow, by some strange twist of logic and semantics, liberals, while rejecting capitalism, claim to be in favor of “free enterprise.” Conservatives fare no better. They rejected a true free-market economy a long time ago and are now where socialist thought and policies were sixty years ago. The fact is we do not have a “free-market” economy in the United States, nor do we have “free enterprise,” and we certainly don’t have anything approaching true “capitalism.” What we do have is something that can be called a “mixed” economy on its way to becoming totally socialistic.

Now let’s get down to defining terms so we clearly understand what we’re talking about. Since I am going to spend some of this discussion explaining what a free-market economy is, let’s get the terms “socialism” and “mixed economy” out of the way so we have something for comparison.

Socialism and the Mixed Economy

Generally speaking, socialism is a political-economic theory that advocates collective or government ownership of the means of production and distribution of goods and the practice of government centralized economic planning. This is, of course, an over simplification because contained within the theory of socialism are some important concepts regarding rights, freedom, values and so on. Also, there are differences regarding some particulars within various socialistic theories: for instance, some socialists claim that all personal property should be held in common while others allow for a small measure of personal ownership of personal goods. Some socialist theories, such as National Socialism (Nazism) and certain forms of fascism allow for some private ownership of the means of production and distribution but under heavy government regulation and control.

A “mixed” economy is somewhat of a philosopher’s nightmare. It has no precise definition and appears, more or less, to be a transitional phase between a true free-market economy and a totally socialist economy. It also involves some centralized economic planning which varies depending on the degree of transition. The rhetoric of private property is still maintained but government regulation and control of private property becomes increasingly vigorous as the mixed economic system moves toward socialism. The rhetoric of individual rights is maintained but in practice individual rights are continually curtailed. An economy in the midst of the transition is increasingly expanding a welfare state where wealth is in the process of being redistributed. From a theoretical standpoint, there is no organized, consistent set of principles to the concept of a “mixed” economy and, from a practical standpoint, the economic system may be at any point along a spectrum from a true free-market to a total socialistic economy. To call such a mixed system “free” at all is to insult the real meaning of freedom or liberty. This should explain, at least in part, why it’s a philosophic nightmare.

The United States has had a “mixed” economy now for a hundred years or so, depending on where one wants to precisely put the historical benchmark. I personally put that benchmark at 1887, the passage of the Interstate Commerce Act. While it is true that the United States has never really had a totally free market economy (or laissez-faire capitalism, if you prefer), prior to 1887 the economy was almost totally free of any government regulation or control. It was as close to a free-market system as any society has ever had. Later in this discussion we’ll take a look at the 1887 legislation and the disasters it has led to in our economic and political life. But first, let’s take a look at the real free-market economy, the only system that can truly be called a free enterprise system.

A Free-Market Economy

A true free-market or free enterprise system is the economic part of a social system based on the recognition of individual rights, including personal rights and property rights, in which all property is privately owned. In such a system, all human relationships are voluntary and no individual or group of individuals may initiate the use of physical force against others. Individuals deal with one another by discussion, persuasion, and contractual agreement. This economic arrangement is protected by a government whose major task is the protection of individual rights. This government exists only by the consent of the people within a geographical area and the people are sovereign while the government is not. The specific structure of such a government is the political part of a free social system and need not concern us at this point.

Within a free-market economy there are no government controls or regulations. If such controls or regulations exist, how can an economy be said to be free? A free market means that individuals interact voluntarily and by individual choice. Individuals are free to trade and the economic value of an individual’s work or products is determined by the voluntary consent of those who are willing to trade their work or products for what another individual has to offer. This is basically what is meant by the law of supply and demand.

Within a free-market economy, every individual must pay his own way. An individual can only claim what he has earned and he can put those earnings to whatever use he wants. He can use his earnings to produce more, he can spend it on himself and his family, he can give it away, or he can fritter it away in any way he wants. The free-market economy depends on the profit motive, which is an individual’s incentive to work in order to gain something for himself. There is no free lunch.

Obviously this is just a brief discussion of what constitutes a free-market economy. But it gives you an idea of the basics and shows you the contrast between a free-market economy and a socialistic economy. Any free economic system that becomes “mixed” will ultimately become a socialistic economic system. Any socialistic economic system will end in disaster. That’s because socialism is not only bad in practice; it is also bad theory. Think for a moment. Name one country in the entire world where socialism is practiced that has a sound, growing economy and which is not in some sort of terrible economic trouble.

The only thing that can be said at this time regarding the United States is that, because we still have enough remnants of a “free” economy, we have not yet experienced all the disasters which are a result of a completely socialistic economy. But time is getting short. The attempt, for instance, on the part of the federal government to take over health care and almost 17% of the economy, shows the trend going on in the United States. This is still being seriously considered even though other countries with socialized medicine, such as Canada and England, are having disastrous results with their socialistic medical programs.

The Beginning of the Disaster

We can always disagree about the specific point at which some historical event or social trend actually begins. We seldom disagree, however, about the event or trend itself. As I have said, fully realizing that some could argue that the demise of the free market in America began earlier, the beginning of the downfall of free enterprise in this country, as far as I am concerned, was the passage of the Interstate Commerce Act in 1887. I would agree that certain ideas and proposals prior to that date set the stage for the congressional action of 1887. Ideas and proposals, however, are not overt actions or public policies.

After the War between the States, the railroads in this country experienced tremendous expansion. On May 10, 1869, the famous “golden spike” was driven into the ground at Promontory Point, Utah, marking the place at which the Union Pacific and Central Pacific railroads were finally joined in transcontinental bliss. Not long afterward, there were other transcontinental railroads and the United States had railroads going everywhere and covering the country from coast to coast. Competition was fierce and, because railroads rates were low, the railroad entrepreneurs complained about cutthroat competition. Some companies went into bankruptcy, others were taken over, some just went out of business. This was, of course, the working of a free economy.

The railroad barons did not like this situation and attempted to improve their position by joining together, fixing rates, and dividing the market. These various agreements, however, never lasted as one after the other would violate the agreement, hoping to gain an advantage. Problems began to arise when some customers of the railroads began to complain about the discriminatory pricing taking place; some shippers had to pay more than others and they were unhappy.

One has to remember that the railroad business at that time was the major economic enterprise in the country, was highly visible, and intimately connected with the financial interests of Wall Street. The railroads were important to the farmers in the Midwest who accused them of monopolistic practices because of high freight rates. The railroads were attacked by the Grange movement in the 1870s, as well as by the Greenback party, the Farmers’ Alliance, and other groups. These complainers began agitating for government control of freight rates. The Populist Party even called for government ownership of the railroads. The free market would have solved these problems in time as the principles of competition and supply and demand kicked in and took hold. They were not, however, given the chance.

It is important to keep in mind that many people do not like competition, particularly when it hits them in the pocketbook. There are many people who do not like to operate in a free marketplace. And some, notice I say some, railroads were like that. As the public campaign against the railroad industry mounted, some railroad barons realized they could turn the whole situation to their advantage. A few of these barons realized they could use the federal government to enforce their price fixing agreements and market sharing agreements and protect them from state and local governments. So some of these businessmen joined with the “reform” movement and supported the movement toward government regulation.

It is important to notice at this point that these so-called businessmen, some of the unhappy railroad barons, intellectually left the free-market philosophy and joined the movement toward a government regulated economy. These entrepreneurs were no longer “capitalists,” nor were they supporters of “free” enterprise, because now they were asking, even demanding, special protection for their industry. It is also important to notice that it was not the free market which would provide them with special protection and privileges, but the government. This special “favor” would come about, not as a result of capitalism or the free market, but as a result of government legislation. The legislation was the establishment of the Interstate Commerce Commission in 1887 and the attack against a free-market economy or free enterprise was on the way.

Thomas Cooley, a railroad lawyer, was the first commissioner of the ICC. Sound like yesterday’s news? Of course, if the railroad interests were really serious they would have one of their own appointed to head the controlling government body. The railroads needed to be sure that their interests were taken care of; in the meantime, the “reformers” had gone on to other crusades. Not only that, the commission immediately began to solve some problems the reformers and railroad barons were complaining about. It raised the rates for shipping, making the customers unhappy, and began to increase its control over the industry, thanks to a cooperative Congress.

Then along came the invention of the internal combustion engine, the automobile, and (heaven help us!) trucks that could haul freight as well as, if not better, than the railroad. The Interstate Commerce Commission (controlled by railroad interests) had kept railroad freight rates artificially high and the trucking industry began to grow tremendously because of the high cost of railroad transportation. The trucking industry was very competitive and, at the time, unregulated. Actually, anyone with a yen to drive a truck and enough money to buy one could go into business instantly. A real example of the free market at work!

But guess what? The railroads didn’t like the competition. As a result of much lobbying, the trucking industry was brought under the control of the Interstate Commerce Commission. Congress passed the Motor Carrier Act in 1935 and gave the ICC control over the truckers. This was, of course, not to protect the consumers. It was to protect the railroads. So much for the free-market economy.

The creation of the Interstate Commerce Commission was the first stake driven into the heart of the free-market economic system. That, you recall, was in 1887. But more was to come. The fight against capitalism and a free-market economy was to be waged on other fronts as well. And this monstrous change in the free market system is haunting us today. As a matter of fact, it haunted us not so long ago when a change was made in the interest rates and the Mexican peso bailout was executed by President Bill Clinton.

The Federal Reserve System

Now we come to the second stake driven into the heart of the American free-market economic system. At the time it appeared as “innocent” and “necessary” as the Interstate Commerce Act and subsequent interferences with the economy have been.

On December 23, 1913, Congress passed the Federal Reserve Act, which established Federal Reserve Banks, gave the government power to print “notes” (currency), established a system for member banks to exchange their gold deposits for government “notes,” and a long list of regulations which gave the government virtual control over the entire money system. That Act set up the central banking system for the United States.

The Act created twelve regional Federal Reserve banks supervised by a Federal Reserve Board, currently chaired by Alan Greenspan. All national banks must belong to the system. State banks may belong if they meet certain requirements. Member banks hold the bulk of the deposits of all commercial banks in the country.

The Board of Governors of the Federal Reserve System is composed of seven members appointed to staggered 14-year terms. These members are named by the president of the United States, who also names one of the governors as chairman. The main function of the Federal Reserve System is monetary policy, which it controls using three tools: reserve requirements, the discount rate, and open market operations.

From 1913 to the present, the United States was in no way a free-market economy. The first stake had been driven in 1887 with the passage of the Interstate Commerce Act, which had permitted the federal government to begin to interfere in the national economy. Some semblance of a free-market economy, however, remained. With the passage of the Federal Reserve Act, the next and fatal stake was driven and the free-market economy was a thing of the past.

Although the Federal Reserve System is called “Federal,” it is privately owned. It has also never received a meaningful audit from an independent, outside source. The System makes its own policies and is not subject to the President or to the Congress or to the People.

The Federal Reserve System was originally set up to protect and promote the interests of international bankers and financiers. They benefitted because the System is the overseer and supplier of reserves, it gave their banks access to public funds in the Treasury (that is, tax money from the people), enhancing their capacity to lend and collect interest. They also gained control over the nation’s money supply and interest rates. The System is also authorized to create money and thus inflate money whenever it wants to. In other words, the Federal Reserve Act gave virtual control over the economic life of this nation to the private bankers and financiers who then profit enormously and often at the public’s expense.

The “justification” for establishing the Federal Reserve System was the alleged “instability” of the free-market economy. Every 20 years or so from 1840 to 1913, the country was hit by sharp downturns of the economy that were known as “panics.” These downturns, however, are a normal part of any true free economy. Ordinarily they don’t last very long and the natural laws of supply and demand and so forth straighten things out rather rapidly. In fact, prior to the creation of the Federal Reserve System, in the period between 1840 and 1913, the country experienced the most spectacular and sustained economic growth in American history.

Contrary to what has been fed to the public by the government and most economists, the American economy has been much less stable since the establishment of the Federal Reserve System. Downturns have been far more severe in terms of lost output and unemployment. In the 20 years before 1913, only 1,748 banks failed. In the 20 years after the creation of the Federal Reserve System in 1913, more than 15,500 banks failed. And, of course, there was the Great Depression. The Federal Reserve System did not prevent that.

There were other things that contributed to the destruction of the free market economy such as going off the gold standard, the implementing of a personal income tax, the passage of antitrust legislation, and the creation of the framework for the welfare state and its redistribution of wealth on principles diametrically opposed to the concept of a free-market economy. The period from 1887 to the present day is a dramatic illustration of the lesson which we just don’t seem to learn: you can’t have freedom and security at the same time. Every time you demand some security from the government, you must give up some freedom to the government.

Consider what has been done to the free-market economy in America in just a little over a hundred years:

  • The federal government entered the money business, in competition with other minters and warehousers.
  • The federal government then outlawed all competitors and claimed a monopoly on the money system.
  • The federal government established a Federal Reserve System which gave it the power to hold everyone’s gold in its vaults and issue receipts far in excess of the gold it had on deposit.
  • The federal government made it illegal for people to get their own gold back and declared paper money (“fiat” money) to be the legally recognized money of our country.

This was probably the most protracted theft in history. The federal government has virtually all the gold and can print paper money at will. It is in total control of the money system. The free-market economy is essentially destroyed. The American people lost their free market to the international bankers and financiers and they lost their sovereignty to the politicians and bureaucrats in their employ. It is a sad state for a country which began with such promise. The Founding Fathers have undoubtedly turned over in their graves.

The Natural History of Government Intervention
A Real or Fancied Evil is Identified
There are Demands to do Something About It
A Coalition is Formed of Reformers and Interested Parties
The Incompatible Objectives of the Members of the Coalition are Glossed Over
For instance, consumers may want low prices while producers may want high prices
The Coalition gets Congress to Pass a Law
The Law Grants Power to Government to do Something
Interested Parties Work to Make Sure Power is Used for Their Benefit
Reformers go on to new causes
They Generally Succeed Which Leads to New Problems
The Scope of Intervention is Now Broadened to Meet New Problems
Government bureaucrats will arrange things so that even the original special interests may not benefit
In the End the Effects are Precisely the Opposite of the Reformers and do not Achieve the Objective of the Special Interests
The activity is now so firmly established and so many vested interests are connected that repeal of the law is inconceivable
New Government Legislation is Called for to Deal with the Problems Created by the Initial Legislation
A New Cycle of Intervention Begins

Based on a discussion in: Milton and Rose Friedman, Free to Choose (New York: Harcourt Brace Jovanovich, 1980), p. 201.

Dr. Jonathan Dolhenty was the Founder and President of The Center for Applied Philosophy and the Radical Academy and is Honorary Philosophy Editor at Self-Educated American.