A centrally planned economy, also known as a command economy, is an economic system where a government body makes economic decisions regarding the production and distribution of goods. Centrally planned economies are different from market economies, where these decisions are the result of thousands of choices by producers and consumers.
The production of goods and services in planned economies is often done by state-owned enterprises, although independent companies may sometimes be incorporated into economic planning. Prices, wages, and production schedules are typically set by a centralized bureaucracy.
KEY TAKEAWAYS
- In a centrally planned economy, major economic decisions are made by a central authority such as the government.
- Centrally planned economies are different from market economies where large numbers of individual consumers and profit-seeking private firms operate most or all of the economy.
- Central planning allows the government to marshal society’s resources for goals that might not be achieved by market forces alone.
- Central planning is commonly associated with socialist or communist forms of government.
- Other countries might resort to central planning in times of war or national emergency.
Centrally Planned Economy
Understanding Centrally Planned Economies
Central planning is frequently associated with Marxist-Leninist governments such as the Soviet Union, North Korea, and East Germany. For most of their history, market activity was extremely limited in these countries, and the government directed economic activity through state-owned enterprises.
After the second world war, many socialist countries chose to adopt economic planning in order to focus resources on government priorities that may not be adequately served by market forces alone. Moreover, since these countries were ideologically opposed to private enterprise, central planning also helped eliminate capitalist modes of production.
While central planning is typically associated with socialist or communist political systems, many other countries may enact elements of economic planning in times of war or national emergency. For example, many countries implemented rationing systems during the world wars in order to prevent shortages and control the prices of essential goods.
There are few countries that can truly be described as a command economy today. Even in North Korea, the private sector performs more economic activity than the state.1
Theory of Central Planning
Advocates of central planning believe that the government can direct economic investment more efficiently than private actors, especially towards social goals with lower potential for profits. Moreover, since the planning authority has more resources than any single company or business, government projects can also benefit from economies of scale that make government projects more productive in the long run.
However, in order to coordinate among different producers and resources, central planning typically requires a highly educated technical bureaucracy. This creates something of a paradox for socialist countries, since the bureaucrats may take the role of a de facto ruling class.
Criticism of Centrally Planned Economies
The concept of central planning is subject to heavy criticism, especially from scholars in the Austrian school of economics. One major critique, associated with Friedrich Hayek, is that central planners cannot efficiently respond to supply and demand. In a market economy, businesses respond to price signals by increasing or decreasing the production of their goods.
In a planned economy, there are no price signals, so planners cannot accurately forecast which products will be needed or adapt to changing conditions. This means that there may be unnecessary shortages or surpluses of certain goods.
Another critique is that command economies may be less efficient, due to the lack of competitive pressures. While private companies must avoid waste in order to remain profitable, enterprises in a command economy have no pressure to earn profits or reduce expenses.
Examples of Centrally Planned Economies
Central planning is typically associated with the formerly communist countries of Eastern Europe and the Soviet Union, as well as the contemporary governments of Cuba, China, and parts of Asia. In each of these examples, the state acted as the principal manufacturer, distributor, and employer in almost all sectors of the economy.
Almost all of these countries abandoned central planning in favor of a capitalist or mixed economic model starting in the 1980s. In some cases, such as in China, the privatization of state assets, combined with an influx of foreign investment, resulted in extremely rapid economic growth.
Which Countries Have a Centrally Planned Economy?
While central planning once dominated Eastern Europe and a large part of Asia, most planned economies have since given way to free market systems. China, Cuba, Vietnam, and Laos still maintain a strong degree of economic planning, but they have also opened their economies to private enterprise. Today, only North Korea can be accurately described as a command economy, although it also has a small degree of underground market activity.
How Are Economic Decisions Made in a Planned Economy?
In a planned economy, important economic decisions are made through a combination of political or administrative bodies. Typically, this involves local administrators communicating their capacity and needs to central authorities, who use that information to create a nationwide economic plan. This plan may go through several rounds of revision before it is submitted to the government or legislature.
Do All Socialist Countries Have a Planned Economy?
While socialist economies are typically associated with central planning, several socialist countries incorporated market price signals or private enterprise into their economic systems. Examples include market socialism in the former Yugoslavia, the Socialist Market Economy in Vietnam, or the economic reforms in China under Deng Xiaoping.