The key ingredient to a free market economy is freedom.
To maximize economic efficiency, many forms of regulation have been imposed on various markets over the years, with varying short-term effects. In the long run, everything seems to slide toward market failure, however. As regulation is imposed, market forces adjust toward an equilibrium state, defined in part by the external influences of regulations. The equilibrium state itself is changed in character, as external regulatory influences create inequalities of opportunity, prompting regulators to pursue an egalitarian market by adding yet more regulation. A vicious cycle is born, and the economy fights nature.
It is basically the case that the entire field of economics (particularly macroeconomics) centers around the study of “natural” economic forces, and tends to advocate working in accord with those forces for maximum market efficiencies. Concepts such as price floors (e.g. minimum wage legislation) and artificial scarcity (e.g. enforcement of copyright and patent restrictions) are considered anathema to economic efficiency, where efficiency refers to the generation of wealth, socioeconomically system-wide.
There are those who consider such theories of economic efficiency to be worthless because they are based on unproven theories — without realizing that “proof” in this case refers to logical validity, and is indeed demonstrable for economic theories, and that in the “real world” all we can do is show a preponderance of evidence. Such evidence has been shown, to the extent possible, for the efficiencies of (free) market economies. Market failures in mixed economies are often blamed on free market principles, of course, based on profound misunderstandings of what constitutes a free market. For a hint, realize that every time someone blames a market failure state in the US economy on free market principles, (s)he is referring to an economy that is in fact almost unrecognizably distant from a true free market.
There is, however, one emerging example of free market forces at work in a modern economic system: the economic system that is emerging on the Internet. We see here a burgeoning, evolving system wherein open source software development, large-scale social cooperation, and free flow of data through a distributed system that does not impose regulative restrictions on the ability of individuals to enter the market are all contributing to a growth of a free-market system the likes of which we have never before encountered.
This phenomenon is not universal within the Internet, by any stretch, as the concerns and regulations of the material world encroach upon it. It is, however, pervasive enough, and it is growing quickly enough, that the influence between meatspace and cyberspace does not flow in only one direction (thanks for the link, Assaf). Witness, for instance, the tilting of the balance of economic power ever more toward electronic communication, in a distributed and egalitarian fashion, in certain markets: engineering work is accomplished ever-increasingly via distributed networks, communications industries are shifting toward Internet leverage in a way that favors the individual user, news and knowledge dissemination are ever-more the realm of independent and open efforts, and so on. Amazon is opening its APIs (for a relatively small fee) to entrepreneurs, encyclopedic knowledge and news are available via the projects of the Wikimedia Foundation, and software development is increasingly the realm of enthusiasts rather than worker-drones. Enterprise support software becomes ever more the realm of free online services that garner profits for their creators via noncoercive means, such as a simple advertising banner as opposed to licensing fees and the implicit threat of copyright infringement lawsuits.
Next time you hear someone talking about how regulation is necessary to be able to support a given industry, think about how the lessons of the Internet’s evolving economies can apply to the matter. Think about how success for a company is best served by leveraging natural market forces (as reddit does) rather than by trying to fight them.
This wasn’t nearly as well-written as what I conceived last night, but hopefully it gets the point across.