What is planned economy?

The planned economy (also called central administration economy) is a form of economy in which all essential decisions with regard to the allocation of scarce resources for the production of goods and services are made by the state or a central authority. The concept of the planned economy is diametrically opposed to that of the market economy.

In this lesson we describe the most important characteristics of a central administration economy and also look at the behavior of the individual actors and in particular the state. Finally, you can check your knowledge with a few exercise questions.

Synonyms: Central Administration Economy | Command economy | Command economy

Why should you know the planned economy?

According to growtheology, the planned economy is a form of economy that was able to acquire great importance, especially in the course of the 20th century, and which shaped the economic history of this time accordingly. Until 1990, the planned economy was the common form of economy in most of the socialist states that were under the influence of the former Soviet Union.

The main features of the planned economy

In a planned economy, the entire economic process is planned, directed and administered by a central authority. This authority, usually the state, always follows its economic and political goals.

The entire production is subordinate to the state planning authorities. It decides which company produces which goods and who receives these goods in what quantity.

Companies and households have little, if any, leeway to make decisions. In order to emphasize the difference to a market economy more clearly, the German economist Walter Eucken coined the term “Zentralverwaltungswirtschaft”. It is based on the fundamental assumption according to which the price mechanism and thus the interplay of supply and demand can be replaced by the specifications of a central authority.

Planned economy: State-controlled economy

Deficiencies in the planned economy

Compared to the various forms of the market economy, the planned economy has a number of deficiencies, which is why in this context there is often talk of a shortage economy. These deficiencies meant that the central administration economy could not prevail in the long run.

  • Lack of democracy
  • Lack of technological advancement
  • Lack of information
  • Lack of flexibility
  • Lack of control signals
  • Lack of self-determination

Lack of democracy

In a planned economy, individual freedom of action and movement are perceived as a disruptive factor that the state tries to push back. Central planning makes the totalitarianism of a one-party system a prerequisite at the political level and collectivism at the socio-political level. This is proven by the historical examples (including the GDR, see below), which were one-party systems, oligarchies or dictatorships.

planned economy

Lack of technological advancement

The lack of technological and organizational progress is based on the fact that planned economies do not generate competition comparable to that of a market economy, from which the need for innovation and improved problem solving arises.

Lack of information

According to Friedrich August von Hayek (1899-1992), the planning departments of a central administration economy can never have access to all the information relevant to decision-making, which concerns the abilities and needs of individual individuals.

Due to incorrect and insufficient information, it is not possible to work out sensible planning and as a result, wrong or inefficient decisions are always made.

Lack of flexibility

Due to the strict guidelines given by the central authority with regard to the economy, it is difficult or even impossible for the individual actors to react flexibly to changed circumstances. The scope for decision-making is limited and affects both dynamism and the ability to innovate.

Lack of control signals

According to Ludwig von Mises, the lack of private property in a central administration economy means that no market prices can be established for the means of production.

As a result, it cannot be determined whether an economic option is actually suitable for increasing consumer prosperity. According to Mises, this would run the risk that more urgent needs would remain unsatisfied, as the scarce means of production were already being used for other options.

Lack of self-determination

According to the economist Wilhelm Röpke, planned economies contradict the ideal of self-responsible and self-determined people.

Central administration economy in the former GDR

The central administration economy was also the type of economy of the GDR. The production and distribution of consumer goods and food took place on the basis of five-year plans. Companies from industry, trade, handicrafts and agriculture were forcibly “socialized” and consequently incorporated into state-owned companies.

In the course of time, more and more state-owned enterprises (VEB), agricultural production cooperatives (LPG), trade organizations (HO) and production cooperatives of the crafts (PGH) took the place of private companies.

The generally high level of employment and job security contrasted with very low productivity. The coverage of needs with certain foods and consumer goods was often inadequate.

 

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