A planned economy or directed economy is an economic system in which the state or government manages the economy. Its most extensive form is referred to as a command economy, centrally planned economy, or command and control economy. In such economies, the state or government controls all major sectors of the economy and formulates all decisions about their use and about the distribution of income. The planners decide what should be produced and direct enterprises to produce those goods. Planned economies are in contrast to unplanned economies, such as a market economy, where production, distribution, pricing, and investment decisions are made by the private owners of the factors of production based upon their own and their customers' interests rather than upon furthering some overarching macroeconomic plan. Less extensive forms of planned economies include those that use indicative planning, in which the state employs "influence, subsidies, grants, and taxes, but does not compel." This latter is sometimes referred to as a "planned market economy."
A planned economy may consist of state-owned enterprises, private enterprises directed by the state, or a combination of both. Though "planned economy" and "command economy" are often used as synonyms, some make the distinction that under a command economy, the means of production are publicly owned. That is, a planned economy is "an economic system in which the government controls and regulates production, distribution, prices, etc." but a command economy, while also having this type of regulation, necessarily has substantial public ownership of industry. Therefore, command economies are planned economies, but not necessarily the reverse (example: USA economy during World War II or Nazi Germany's private ownership yet use of the Four Year Plan could construe them as a planned economy in the wide sense, but not necessarily a command economy, while the Soviet Union with public ownership would be a command economy).
Important planned economies that existed in the past include the economy of the Soviet Union, which was for a time the world's second-largest economy, China during its Great Leap Forward, and India, prior to its economic reforms in 1991 . Beginning in the 1980s and 1990s, many governments presiding over planned economies began deregulating (or as in the Soviet Union, the system collapsed) and moving toward market-based economies by allowing the private sector to make the pricing, production, and distribution decisions. Although most economies today are market economies or mixed economies (which are partially planned), planned economies exist in some countries such as Cuba, North Korea, and Myanmar.
Advantages of economic planning
Supporters of planned economies cast them as a practical measure to ensure the production of necessary goods—one which does not rely on the vagaries of free markets.
A planned economy can ensure the continuous utilization of all available resources. If isolated and unresponsive to consumer demand, a planned economy does not suffer from a business cycle. Under an ideally administered planned economy, neither unemployment nor idle production facilities should exist beyond minimal levels, and the economy should develop in a stable manner, unimpeded by inflation or recession.
Long-term infrastructure investment can be made without fear of a market downturn (or loss of confidence) leading to abandonment of the project. This is especially where returns are risky (e.g. fusion reactor technology) or where the return is diffuse (e.g. immunization programs or public education).
Conformance to a grand design
While a market economy maximizes wealth by evolution, a planned economy favors design. While evolution tends to lead to a local maximum in aggregate wealth, design is in theory capable of achieving a global maximum. For example, a planned city can be designed for efficient transport, while organically grown cities tend to suffer from traffic congestion. Critics would point out that planned cities will suffer from the same problems as unplanned cities, unless reproduction and population growth is subject to strict control, as in a closed city.
Meeting collective objectives by individual sacrifice
A planned economy serves collective rather than individual needs: under such a system, rewards, whether wages or perquisites, are to be distributed according to the value that the state ascribes to the service performed. A planned economy eliminates the individual profit motives as the driving force of production and places it in the hands of the state planners to determine what is the appropriate production of different sets of goods.
The government can harness land, labor, and capital to serve the economic objectives of the state. Consumer demand can be restrained in favour of greater capital investment for economic development in a desired pattern. The state can begin building a heavy industry at once in an underdeveloped economy without waiting years for capital to accumulate through the expansion of light industry, and without reliance on external financing. This is what happened in the Soviet Union during the 1930s when the government forced the share of GNP dedicated to private consumption from 80 percent to 50 percent. While there was a significant decline in individual living standards, the state was able to meet some of its "economic objectives."
Comparison with capitalist corporations
Taken as a whole, a centrally planned economy would attempt to substitute a number of firms with a single firm for an entire economy. As such, the stability of a planned economy has implications with the Theory of the firm. After all, most corporations are essentially 'centrally planned economies', aside from some token intra-corporate pricing (not to mention that the politics in some corporations resemble that of the Soviet Politburo). That is, corporations are essentially miniature centrally planned economies and seem to do just fine in a free market. As pointed out by Kenneth Arrow and others, the existence of firms in free markets shows that there is a need for firms in free markets; opponents of planned economies would simply argue that there is no need for a sole firm for the entire economy.
Disadvantages of economic planning
Some who oppose comprehensive planned economies argue that some central planning is justified. In particular, it is possible to create unprofitable but socially useful goods within the context of a market economy. For example, one could produce a new drug by having the government collect taxes and then spend the money for the social good. On the other hand, opponents of such central planning say that "absent the data about priorities conveyed through price signals created by freely acting individuals, [it is questionable] whether determinations about what is socially important can even be made at all." Opponents do not dispute that something useful can be produced if money is expropriated from private businesses and individuals, but their complaint is that "it’s far from certain that those monies could not have been spent better" if individuals were allowed to spend and invest as they wished according to their own wants.
We can see things of value being produced by the state taxing and using those funds to undertake projects which are believed to be social goods, but we cannot see what social goods have not been produced due to wealth taken out of the hands of those who would have invested and spent their money in other ways according to their own goals. These opponents of central planning argue that the only way to determine what society actually wants is by allowing private enterprise to use their resources in competing to meet the needs of consumers, rather those taking resources away and allowing government to direct investment without responding to market signals. According to Tibor R. Machan, "Without a market in which allocations can be made in obedience to the law of supply and demand, it is difficult or impossible to funnel resources with respect to actual human preferences and goals."
If the government in question is democratic, democratically-determined social priorities may be considered legitimate social objectives in which the government is jusitified in intervening in the economy. It must be noted that to date, most if not all countries employing command economies have been dictatorships or oligarchies -- few or none were democracies. Many democratic nations, however, have a mixed economy, where the government intervenes to a certain extent and in certain aspects of the economy, although other aspects of the economy are left to the free market.
Lack of incentive for innovation
Another criticism some make of central planning is that it is less likely to promote innovation than a free market economy. In the latter, inventors can reap huge benefits by patenting new technology, so there is arguably much more incentive to innovate. Conversely a planned economy can deliver vast national resources into research and development if it gets the idea that a particular field is critical to its interests, usually military technology. The Soviet Union's ability to maintain fierce competition versus the United States during the space race and cold war, despite its smaller economy, is an example of this.
Infringement on individual freedoms
The top down structure of a centrally planned economy dictates a hegemonic operating culture - whereas in a free market economy several models of operating can compete simultaneously in a manner similar to organisms in an ecosystem.
Critics also hold that certain types of command economies may require a state which intervenes highly in people's personal lives. For example, if the state directs all employment then one's career options may be more limited. If goods are allocated by the state rather than by a market economy, citizens cannot, for example, move to another location without state permission because they would not be able to acquire food or housing in the new location, as the necessary resources were not preplanned.
Likewise, because of the state's controls over an individual's personal choices, critics contend that central planning intrinsically results in a top-down, dictatorial state where politicians and bureaucrats use the state to achieve their own ends, which are in turn described as the "social" objectives of the state. In essence, critics contend that socialism has nothing to do with the preferences of the individuals that comprise a society, but rather the abstract goals of some group.
This criticism is supported by Rummel's Law which states that the less freedom a people have, the more likely their rulers are to murder them. R. J. Rummel's top three examples of 20th century "Megamurders" were Soviet Russia, People's Republic of China and Nazi Germany, all planned economies with limited individual freedom.
The Road to Serfdom is a book written by Friedrich Hayek and critical of collectivism, presenting the argument that a central planned economy must ultimately result in tyranny. An idea similar to this is the idea of the iron cage presented even earlier by Max Weber in The Protestant Ethic and the Spirit of Capitalism.
Suppression of Economic Democracy and Self-Management
Centrally planning is also criticized by elements of the radical left. Libertarian socialist economist Robin Hahnel notes that even if central planning overcame its inherent inhibitions of incentives and innovation it would nevertheless be unable to maximize economic democracy and self-management, which he believes are concepts that are more intellectually coherent, consistent and just than mainstream notions of economic freedom. As Hahnel explains, “Combined with a more democratic political system, and redone to closer approximate a best case version, centrally planned economies no doubt would have performed better. But they could never have delivered economic self-management, they would always have been slow to innovate as apathy and frustration took their inevitable toll, and they would always have been susceptible to growing inequities and inefficiencies as the effects of differential economic power grew. Under central planning neither planners, managers, nor workers had incentives to promote the social economic interest. Nor did impending markets for final goods to the planning system enfranchise consumers in meaningful ways. But central planning would have been incompatible with economic democracy even if it had overcome its information and incentive liabilities. And the truth is that it survived as long as it did only because it was propped up by unprecedented totalitarian political power.”
A planned economy creates social conditions favoring political corruption. Particularly, command economies have been notoriously corrupt. First, centralized decision-making predisposes planners to abuses of power. Second, the inherent inefficiency of plans drawn with insufficient information creates a need for bypassing or subverting the official decision-making process. For example, the Soviet Gosplan could not create plans that were feasible, and other means were used to meet the quotas. A gift economy featuring corruption, blat, developed. The Chinese guanxi is somewhat similar.
In the 20th century, most planned economies were implemented by states that called themselves socialist. Also, the greatest support for planned economics comes from socialist authors. For these reasons, the notion of a planned economy is often directly associated with socialism. However, they do not entirely overlap. There are branches of socialism such as libertarian socialism, that reject a centralized state, and all of these tendencies reject economic planning as well and instead favour decentrialised collective ownership of the economy and property.
Furthermore, planned economies are not unique to Communist states. There is a Trotskyist theory of permanent arms economy, put forward by Michael Kidron, which leads on from the contention that war and accompanying industrialisation is a continuing feature of capitalist states and that central planning and other features of the war economy are ever present.
Transition from a planned economy to a market economy
The shift from a command economy to a market economy has proven to be difficult; in particular, there were no theoretical guides for doing so before the 1990s. One transition from a command economy to a market economy that a few consider successful is that of the People's Republic of China, in which there was a period of some years lasting roughly until the early 1990s during which both the command economy and the market economy coexisted, so that nobody would be much worse off under a mixed economy than a command economy, while some people would be much better off. Gradually, the parts of the economy under the command economy decreased until the mid-1990s when resource allocation was almost completely determined by market mechanisms.
By contrast, the Soviet Union's transition was much more problematic and its successor republics faced a sharp decline in GDP during the early 1990s. While the transition to a market economy proved difficult, many of the post-Soviet states have been experiencing strong, resource-based economic growth in recent years, though the levels vary substantially. However, a majority of the former Soviet Republics have not yet reached pre-collapse levels of economic development.
Transition from a market economy to a planned economy
Government market regulation
Central governments are tempted to solve problems quickly by introducing additional market regulation. Once such regulation is introduced, it is rarely removed, ratcheting towards a gradual increase in government power and a constraint on the mechanism of the free market. Usually, big business has an advantage over small business in a strongly regulated market, because big business can cope with the bureaucracy and small business cannot take advantage of adaptivity.
The process of wealth condensation results in a small number of people controlling large sections of the economy.
The British East India Company is an example of government-granted monopoly.
American Telephone & Telegraph (formerly Bell Telephone Company), was regarded as a natural monopoly until it was broken up by the U.S. Department of Justice in 1974. This is an example of United States antitrust law being used to discourage centralization of corporate power.
Amalgamated trade unions
Small trade unions have limited power, especially against larger international corporations. Amalgamation of trade unions leads to an industry-wide group with more bargaining power but less individual interest in any particular worker. Such a union will bargain directly with government on an industry-wide basis and thus create a form of central planning that is distinct from typical (Laissez-faire) capitalism.
Similar economic models
A palace economy may be considered as a subsistence economy augmented with elements of a command economy.