American Business


Centrally planned economy

A centrally planned economy is an economic system where the factors of production (resources) are controlled by the state. Resource allocation plans and decisions are made by the central government and then promulgated through government agencies. Regional managers allocate resources to production managers and collective farms, which are given output goals. Centrally planned economies require significant government bureaucracies to control resource allocation, coordinate information flows, and measure performance.

Centrally planned economies are considered synonymous with communism but are also associated with fascism and socialism. Centrally planned economies contrast with capitalism, where most resources are controlled privately. Many U.S. politicians equate capitalism with democracy. Capitalism is an economic system, while democracy is a political system. Dr. David Korten of Stanford University, a critic of globalization, argues that, “Contrary to its claims, capitalism’s relationship to democracy and to the market economy is much the same as the relationship of a cancer to the body whose life energies it expropriates.” Korten suggests the American democratic political system has been overrun by rogue capitalism, focusing on “money and materialism over life itself.”

Like capitalism, centrally planned economies are associated with a political system—in this case a single-party system—yet most European countries have a social democrat political party, advocating democracy but greater collective control and allocation of resources. There are probably no purely capitalist or centrally planned economies. The differences among countries are a matter of the degree of control and allocation of resources made privately versus centrally.

As of 2004, the major centrally planned economies in the world are Cuba and North Korea. In both countries, powerful leaders direct and control a central government making most decisions regarding resource allocation. Because of its international isolation, much less is known about North Korea than Cuba. In 2003 there were reports of severe food shortages in North Korea and fears of widespread starvation.

In 2002 Jimmy Carter became the first former American president to visit Cuba. In his farewell address, President Carter called for ending the American economic blockade of Cuba and increasing the freedom and rights of Cuban citizens. Cuba is a good example of the problems associated with centrally planned economies. When Cuban president Fidel Castro came to power in the early 1960s, he and his supporters overthrew the corrupt and dictatorial but pro-American Battista regime. Cuban resources, primarily land and tourism, were controlled by a wealthy elite, whereas communism advocates collective control of resources for the benefit of all of society. Castro had widespread support among Cuban citizens, because the vast majority of Cubans had few resources and a poor standard of living.

After taking control of the government, Castro nationalized major industries in Cuba, mostly sugarcane plantations and rum factories. This infuriated the owners of these resources, in particular the Bacardi Rum family and the Boston-based United Fruit Company. Wealthy Cubans fled the country, and as the government seized control of the factors of production, many poor Cubans saw improved access to health care, education, and, initially, food supplies. But the major problem with centrally planned economies is efficiency. Private enterprise provides incentives for owners and managers to use resources efficiently and manage resources for long-term viability. If a business prospers, the owners profit, so efficient planning and allocating is desirable.

In a state-run enterprise, managers are given goals. If they achieve those goals, they may get some small bonus, a vacation at a government-run resort, or a larger apartment, but they do not get a share of any profit from achieving or exceeding the goal. Numerous stories report state farms being incredibly inefficient, but workers on the farms, given small plots of land for their own use, generate significant output which they then sell crops for their personal benefit. State-run enterprises also create rigidity. The Wall Street Journal once reported about the instructions given to a greenhouse manager near Moscow for his winter crop. He told the reporter he could grow a lot of cabbage but instead was told to grow tomatoes—so he did, using huge amounts of energy to heat the greenhouses.

Similarly, it was not long before the Cuban economy declined due to inefficiency, government bureaucracies, and U.S. sanctions. (Until 1961 Cuba was a larger trading partner with the United States than Mexico.) To support the Cuban economy, Castro entered into a barter agreement with the Soviet Union, trading sugar cane for oil. Before long the Soviet Union was subsidizing the Cuban economy for as much as $5 billion annually. In return, Cuba allied itself politically with the Soviets and provided troops in cold war-era regional conflicts.

With the collapse of the Soviet Union in 1989, Soviet subsidies ended and the Cuban economy plummeted. Declining world sugar prices also hurt Cuban efforts, and before long the Castro government began allowing various private enterprises, but this meant attracting investors, one of the problems with centrally planned economies. Since Cuba had nationalized private enterprises in the 1960s and not compensated the owners, foreign investors were reticent about dealing with the Castro government. Eventually Spanish investors led hotel and tourism investments, and individual Cubans were allowed to create some private businesses, including transportation and other services. At first Cuban college graduates were not allowed to participate, based on the argument that they had benefited from an education provided by the state and therefore should contribute their services to the state. Desperate for foreign exchange earnings, the Cuban government allowed all citizens to create private enterprises.

Centrally planned economies replace market systems with government systems. Market systems are chaotic, often ruthless, and impersonal, but they send signals to produce more of this and less of that. Private control, rather than collective control, provides incentives for business owners to manage their resources effectively and efficiently. While Cuba and North Korea remain the major examples of centrally planned economies, the Central European countries of the Warsaw Pact provide numerous examples of the problems involved in transitioning from a centrally planned economy to a market-based system.

The change from central planning to a market system requires addressing many issues including

  • removal of price controls on necessities, usually food, housing, transportation, and utilities 
  • transfer of control of state-run enterprises to private enterprise 
  • changes in the legal system defining and enforcing property rights 
  • unemployment and underemployment 
  • control of monetary policy
  • privatization of finance and credit 
  • promises made by the state to retirees, military and others 
  • educating consumers and citizens about private enterprise 

As the list suggests, the task is daunting. Some countries have adjusted better and more rapidly than others.

Further reading

Korten, David C. “Life after Capitalism.” International Institute for Sustainable Development website. Available on-line. URL: