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Why planned economies fail

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Anuj Narkhede
Anuj Narkhede
I am a student pursuing an MBA from the Indian Institute of Technology, Jodhpur. I have a background in Civil engineering with masters in urban planning from CEPT, University, Ahmedabad

Command economy, which is also known as the planned economy, is the type of economy in which prices, income, production, investment, etc. everything is determined centrally by the government. In a command economy, the government only decides the solution of three fundamental economic problems: what to produce; how to produce; and for whom to produce. In command economies, private sector enterprises don’t exist, and all the laborers and workers are employed by the government only, which controls the salaries and wages. Few famous command economy examples are the Soviet Union, North Korea, Cuba, and socialist countries like Venezuela.

In market economies, goods are produced by producers that decide the prices at which they want to sell his product. As there are multiple producers of one type of product, there exists a perfect competition in the market. Due to this perfect competition, producers have to sell their product on the prices determined by the market, which will be affordable to most people in that economy. Producers cannot sell their product at extremely high prices in the market economy as no one will purchase their product, hence prices remain under control.

On the other hand, there is the only public sector in the command economy that produces the goods and decides its prices. The motive behind production in a planned economy is not to gain maximum profit but to distribute the resources equally. Prices are made affordable by the government so that everyone can afford to buy.  There will be a significantly lesser gap between the wealthy and the poor as everybody is treated equally. There is negligible unemployment in planned economies. This concept of the planned economy seems ideal on paper. Still, in reality, there are many disadvantages with the planned economy concept, which is why very few countries have planned economy today.

Today there are very few command economies left in the world. Cuba and North Korea are the command economies still in the 21st century. But even these countries are not purely command economy as they have black markets which are out of government control but still the government control most of the economic goods and resources.

The primary reason due which planned economies fail is the lack of information regarding market demand. In a market, economy firms produce goods that are in more demand. If they are producing something out of demand, they review their economic plan and stop their production quickly to prevent themselves from getting out of business. In a planned economy, the government response is very slow to stop producing goods with very lesser demand as they need to make decisions for the entire country and not for small firms. Hence many government enterprises operate their business in the loss. This is one of the reasons for the collapse of the Soviet Union. The Soviet Union was a huge nation where people in different regions have different necessities and demands. Hence it was impossible to get perfect information there.

As multiple producers are competing to increase their market share in the market economy, they need to produce a product that will be better than their rivals. This leads to innovation in technology for product betterment. There is only a public sector production monopoly in planned economies that sell their products to the entire country without any competition. This prevents them from improving their product quality and efficiency.

During the Soviet Union time and even today in North Korea or Cuba, the picture of empty shelves in supermarkets and people forming long queues outside the store just to get the bottle of milk is very common. As in the planned economy, there is inefficiency in production and a lack of information about the market demand. It creates a shortage of necessary goods or a surplus of unnecessary products. Whereas in the market economy, there won’t be any shortage or surplus of goods as multiple producers are involved in producing the same goods with higher efficiency considering market conditions.

By and large, the key difference in which planned economies fails to achieve the same efficiency as the market economy is the lack of information and inefficacious decision-making framework on questions of what, how, and for whom to produce.

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Anuj Narkhede
Anuj Narkhede
I am a student pursuing an MBA from the Indian Institute of Technology, Jodhpur. I have a background in Civil engineering with masters in urban planning from CEPT, University, Ahmedabad
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