Understanding Centrally Planned Economies: Features, Pros, and Examples

What Is a Centrally Planned Economy?

A centrally planned economy, also known as a command economy, is an economic system in which 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

• Centrally planned economies are directed by a central authority that makes key economic decisions.
• These economies often involve state-owned enterprises managing the production and distribution of goods.
• Critics argue that central planners struggle to match supply and demand due to a lack of price signals.
• Some socialist countries have incorporated elements of market pricing and private enterprise into their systems.
• Few true command economies remain, with most countries adopting mixed economic models involving private enterprise.

Investopedia / Ryan Oakley

How Centrally Planned Economies Operate

Central planning is often linked to Marxist-Leninist governments like the Soviet Union, North Korea, and East Germany. In these countries, market activity was limited, and governments controlled the economy through state-owned enterprises.

After World War II, 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.

Important

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.

The Case for 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.

Challenges and Criticisms of Central Planning

Central planning faces strong criticism, especially from economists in the Austrian school. A major critique, linked to Friedrich Hayek, is that central planners can’t efficiently respond to supply and demand.

In a market economy, businesses respond to price signals by increasing or decreasing the production of their goods. Meanwhile, 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.

Historic and Modern Examples of Centrally Planned Economies

Central planning is linked to former communist countries in Eastern Europe, the Soviet Union, and current governments like Cuba and China. In these cases, the state was the main manufacturer, distributor, and employer in nearly all sectors.

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.

The Bottom Line

Unlike market economies, where producers and consumers influence the economy, centrally planned economies depend on a government to make key economic decisions about goods and services. Centrally planned economies can efficiently divert resources towards social goals and achieve economies of scale, but they often face inefficiencies due to a lack of market signals and competitive pressures.

Historically, centrally planned economies have been associated with socialist and communist governments, notably in the Soviet Union, North Korea, and Cuba. A substantial criticism of central planning is its inability to respond dynamically to changes in supply and demand, resulting in potential shortages or surpluses. Few examples of centrally planned economies remain, as most have moved to mixed models with private enterprise.