What is a Centrally Planned Economy?
An economy is a framework within which we perform various economic activities such as production, distribution, and consumption. A Centrally Planned Economy is an economy in which a central authority of the country, usually the government, owns and controls the majority of the resources of production and distribution. It does all major decision-making in the economy and provides guidance and answer to the central problems of an economy: What to produce, how to produce, and for whom to produce. By doing so, the central authority aims to protect and promote the overall welfare of society and its constituents.
Countries such as Russia, North Korea, and China are examples of such economies. However, in recent years, they, too, have started adopting a liberal approach and encouraging private sector participation.
- What is a Centrally Planned Economy?
- Features of Centrally Planned Economy
- Advantages of Centrally Planned Economy
- Disadvantages of Centrally Planned Economy
- Summary: Centrally Planned Economy
Features of Centrally Planned Economy
Central Ownership of Means of Production
In such an economy, the government owns the means of production, such as land, plant, machinery, etc. There is no private ownership of these means of production. Instead, the government promotes an ideology in which the factors of production have collective ownership. Hence, no individual can build wealth nor pass it on to his heirs. The general public can just own consumer durables for personal usage.
Centrally planned economies have a central planning authority. They effectively allocate resources according to their availability and as per the national priorities. Also, they dictate the investment, production, pricing, and distribution channels, thus having control over the consumption in the economy too.
The key objective of such an economy is the promotion of social welfare. It does not mean that such economies do not focus on generating revenues and profits. But social welfare is the priority, and profit maximization is secondary.
No role of Demand and Supply Equilibrium
An important characteristic of such an economy is that the pricing for key sectors is not set according to the demand and supply patterns for any good or service in the economy. The Central Planning Authority instead decides it.
Therefore, major economic laws, such as the law of demand and supply, and arriving at the corresponding equilibrium price and quantity for goods and services become redundant and useless in such economies.
Equal Distribution of Income
A centrally planned economy aims to maximize the equitable distribution of income and wealth in a society. There is no concept of ownership of property and inheritance, which are the key reasons for inequality in society.
Absence of Class Conflict
Every person is a co-worker, and there are no separate classes of bosses, workers, and laborers in such economies. Hence, everyone treats each other respectfully, and there is no class conflict. Peace and harmony prevail in society.
Advantages of Centrally Planned Economy
Let us now go through some of the advantages of such an economy.
Efficient Allocation of Resources
A government is in a better position to allocate the scarce resources of an economy in a much better way to derive maximum utility out of them. It can prioritize investment in areas that require more attention towards achieving national goals, such as defense. Also, it can afford to make large-scale investments and enjoy the benefits of economies of scale and scope, thus bringing down the cost per unit of production.
Promotion of Social Well-Being
A centrally planned economy works for the overall well-being of society. Unlike free market economies in which the market participants work for their self-interest, centrally planned economies work for public welfare. Profit-making is the secondary goal.
Prevention of Monopolies
The government owns all the major resources of production and distribution in such economies. No private player can own them. This helps to curb the growth of monopolies in the essential goods and services sector. There is automatic price check and control, and private players cannot overcharge and exploit the consumers.
Eliminates Inequality and Unemployment
Everyone is a co-worker in such economies who work for the government or facilities that it controls. This helps to build a society supporting equality and justice, where everyone is treated fairly. Also, the government is in charge of production and ensures employment for all. Hence, such economies witness very low levels of unemployment.
Disadvantages of Centrally Planned Economy
A Centrally Planned Economy has several disadvantages as well. Let us have a look at them.
Absence of Demand and Supply Equilibrium
One of the biggest shortcomings of a centrally planned economy is that the market prices and supply quantity are not based on the equilibrium point of demand and supply. The government decides the pricing and quantity to supply. This results in inefficiencies in the market. Since the supply price is fixed, there is no motivation to improve the quality or increase efficiency and reduce the cost of products and services on the supply side.
Also, the buyers cannot buy larger quantities of those goods whose supply quantity is fixed or limited by the government. They cannot exert pressure on the suppliers to lower the prices and benefit from it.
Red Tape and Bureaucracy
Such economies may suffer from red-tapism and lengthy bureaucratic processes for project approvals and implementation. The government controls all the investment and production processes, which may waste a lot of time getting small things done in the economy. Moreover, the planners may respond slowly to shortages and surpluses in the economy. This will result in inefficiencies and wastage.
Ignorance of Customer Preferences
The Central planning agencies may not have knowledge of the current tastes and fashion and what the customers want as per the changing times. This may result in the supply of products and services of outdated technology and fashion.
Also, there is no incentive to innovate and provide newer and better quality goods and services to the customers. The real losers will be the customers in such a situation.
No Incentive to Perform Better
The government treats and pays people in such economies equally, irrespective of their performance. Lack of competition results in inefficiency in performance.
Also, such economies do not promote private ownership of resources and wealth creation. Hence, there is no incentive for individuals to perform well and excel in their respective fields. Even a person with extraordinary skills cannot build wealth for himself. He will not be getting rewards according to what he deserves. Such an economy favors average people and performance.
Summary: Centrally Planned Economy
Very few nations of the world are purely centrally planned economies in the present world. The present era of globalization has made governments across the world to look at the entire world as one market. Hence, even countries like China which were strictly closed economies with strict controls, are now opening up to modern industries and liberalization. Countries are now moving towards being a mixed economy- a mix of capitalism along with some level of central planning.
- Mixed Economy – Meaning, Characteristics, Advantages, and Disadvantages
- Free Market Economy – Meaning, Features, Advantages, and Limitations
- Principle 6: Markets are Usually a Good Way to Organize Economic Activity
- Principle 7: Governments Can Sometimes Improve Market Outcomes
- Central Problems of an Economy
- Financial Globalization – Meaning, Benefits, and Criticisms