What is a Centrally Planned Economy?

A centrally planned economy is an economic system in which a single authority, such as a government, makes economic decisions regarding the manufacturing and the distribution of products. Centrally planned economies are the flip-side to market economies, in which such decisions are traditionally made by businesses and consumers, rather than by central authorities.

Centrally-planned economic mandates surrounding the production of goods and services are often executed by state-owned enterprises, which are government-created legal entities that engage in commercial activities on a government's behalf. In centrally planned economies, which are sometimes referred to as "command economies", all prices are controlled by bureaucrats.

Key Takeaways

  • In a centrally planned economy, major economic decisions are made by a single central authority.
  • Centrally planned economies stand in contrast to market economies where large numbers of individual consumers and profit-seeking private firms operate most or all of the economy.
  • Centrally planned economies have been heavily criticized by economists as suffering from various economic problems related to poor incentives, informational constraints, and inefficiency.
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Centrally Planned Economy

Understanding Centrally Planned Economies

Most developed nations have mixed economies that combine aspects of central planning with the free market systems promoted by classical and neoclassical economists. The majority of these systems skew heavily toward free markets, where governments intervene only to implement certain trade protections and coordinate certain public services.

Theory of Central Planning

Advocates of centrally planned economies believe central authorities can better meet social and national objectives by more efficiently addressing egalitarianism, environmentalism, anti-corruption, anti-consumerism and other issues. These proponents think the state can set prices for goods, determine how many items are produced, and make labor and resource decisions, without necessarily waiting for private sector investment capital.

Central economic planning naysayers believe central entities lack the necessary bandwidth to collect and analyze the financial data required to make major economic determinations. Furthermore, they argue that central economic planning is consistent with socialist and communist systems, which traditionally lead to inefficiencies and lost aggregate utility.

Free market economies run on the assumption that people seek to maximize personal financial utility and that businesses strive to generate the maximum possible profits. In other words: all economic participants act in their own best interests, given the consumption, investment, and production options they face before them. The inherent impulse to succeed consequently assures that price and quantity equilibrium are met and that utility is maximized.

Problems With Centrally Planned Economies

The centrally planned economic model has its fair share of criticism. For example, some believe governments are too ill-equipped to efficiently respond to surpluses or shortages. Others believe that government corruption far exceeds corruption in free market or mixed economies. Finally, there is a strong sense centrally planned economies are linked to political repression, because consumers ruled with an iron fist aren't truly free to make their own choices.

Examples of Centrally Planned Economies

Communist and socialist systems are the most noteworthy examples in which governments control facets of economic production. Central planning is often associated with Marxist-Leninist theory and with the former Soviet Union, China, Vietnam, and Cuba. While the economic performance of these states have been mixed, they've generally trailed capitalist countries, in terms of growth.

[Important: While most centrally planned economies have historically been administered in authoritarian states, participation in such an economic paradigm theoretically can be elective.