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What is a 'Centrally Planned Economy'

A centrally planned economy is an economic system in which the state or government makes economic decisions rather than the these being made by the interaction between consumers and businesses. Unlike a market economy — in which private citizens and business owners make production decisions — a centrally planned economy controls what is produced and the distribution and use of resources. State-owned enterprises undertake the production of goods and services.

BREAKING DOWN 'Centrally Planned Economy'

Centrally planned economies are also called command economies. In these kinds of economies, prices are all controlled, the government sets plans for the future and the economy is handled by bureaucrats. There is generally no reward for taking an economic risk and corporations are not allowed to fail. 

Most developed nations have mixed economies that combine aspects of central planning with the free market systems promoted by classical and neoclassical economists. Most of these systems skew heavily toward free markets, with government interventions only for certain trade protections and coordination of certain public services.

Theory of Central Planning

Centrally planned economies assume that the market does not work in the best interest of the people and that a central authority needs to make decisions to meet social and national objectives. These justifications are often made on the grounds of egalitarianism, environmentalism, anti-corruption or anti-consumerism, which proponents of central planning do not consider that the free market adequately addresses. The state can set prices for goods and determine how much is produced, and it can focus labor and resources on industries and projects without having to wait for investment capital from the private sector.

Opponents of economic planning do not believe that a central entity has the capacity to collect or analyze the financial data required to make major economic determinations. They argue that socialist and communist systems lead to inefficiencies and lost aggregate utility.

Free market economies are founded on the assumption that people seek to maximize personal financial utility and firms are profit-seeking. Each economic actor acts in its own best interest given the consumption, investment or production options before it. In this way, these economic actors assure that price and quantity equilibrium are met and that utility is maximized. Central planning has a different motivation at its core, relying instead on moral obligation and membership within a community.

Problems With Centrally Planned Economies

There are several general criticisms regarding centrally planned economies. Those opposed say that governments just don’t have the ability to properly predict the future, and therefore, cannot come up with proper plans for the economy. These kinds of economies are also considered inflexible, in that there is a degree of difficulty when it comes to responding to any surpluses or shortages. Because the government is responsible for making economic decisions, it’s believed that there is a greater likelihood of corruption that does not necessarily come with a free market or mixed economy. Finally, there is the sense that with a centrally planned economy, comes more political repression — because consumers are not able to freely make choices, the government rules with an iron fist. 

Examples of Centrally Planned Economies

Communist and socialist systems are the most noteworthy examples in which governments control the factors of economic production. Central planning is often associated with Marxist-Leninist theory and the former Soviet Union, China, Vietnam and Cuba. The economic performance of these states have been mixed, though they generally trailed more capitalist countries in terms of growth. Historically, most centrally planned economies have been administered in authoritarian states, though participation in such an economy could theoretically also be elective.

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