The Economic Question - centrally-planned economy versus free-market economy approaches

How do the two types of economies function, and which one is better? Is the free-market economy which we all contribute to really the best option?

The debate on whether a centrally-planned economy or a free-market economy is better has been ongoing for decades. But what are the differences between the two, and which one is truly the best option? This article explores the functioning of both economies and examines examples of successful and unsuccessful implementations of each. From Cuba's switch from a free-market to a centrally planned economy, to Switzerland's thriving free-market economy despite a lack of natural resources.

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Centrally-Planned Economy

In a centrally planned economy, the government makes the choices about how to best invest land, labour and capital to make the most efficient use of scarce resources. In a planned economy, the central body, or government, makes decisions on behalf of the population, to try and promote economic well-being for all, as well as emphasising equity and sustainability. Sustainability can be prioritised in a planned economy because there is less of a profit incentive for individuals, so a more long-term, societal goal, such as reducing carbon emissions, can be reached.

In terms of answering the economic question, the central body will aim to share out goods and services in a fair manner, often aiming to achieve not only equity but equality, following communist principles. Different governments prioritise different industries, but the general trend amongst planned economies is an emphasis on agriculture and, due to the political aspect, the military and weapons production. The means of production are usually consistent throughout the nation, as the government creates a nationwide economic plan to optimise efficiency.

After the Cuban revolution and break from the US, the Communist Cuban government under Fidel Castro nationalised almost every major industry in the country, including the telecommunications industry, farmland, and oil refinements by 1960. Cuba went from being a free market, to a centrally planned economy. The Cuban government’s response to the economic question was to prioritise the industry that Cuba could export – the sugar industry. After the revolution, the US had placed an embargo on trade with Cuba, so the nation turned to the USSR, who offered to trade Cuban sugar with infrastructure, machinery, and petroleum. As Cuba was a planned economy, the government was able to make choices on what to produce based on the political situation and trade opportunities. However, the Cuban economy also suffered from this totalitarian approach, as when the USSR disbanded in 1991, the GDP of Cuba dropped by over 35% due to their reliance on trade, leading to widespread unemployment and starvation. This graph shows the exports in dollars, from Cuba during the period. The dramatic drop in the 90s is evident on the graph, after trade with the USSR came to a halt, and it shows the extreme effect of the governmental and political decision to rely on Soviet trade

As in the case of the USSR, the PCR, and North Korea, all planned economies, the Cuban government focussed their efforts on their military and weapons production. However, this trend can be regarded not because of having a planned economy, but because of the politics surrounding the hostility shown towards Communist countries by the West. Cuba and North Korea both responded to poverty in contrasting manners, Cuba opening to tourism and allowing foreign investment, compared to North Korea cutting themselves off entirely from the rest of the world. This demonstrates a natural consequence of a centrally planned economy, where economic decisions made are often extreme, as they apply to all companies in certain industries within the nation, in contrast to free market economies, where different businesses may make different decisions.

It is evident that centrally planned economies are often greatly tied up with the communist ideology. This can negatively affect the economy, as the extremity of the communist beliefs can cause clashes with other countries, leading to limits on trade partners, and worries about national safety, resulting in a dominant military. Therefore, although hypothetically, a planned economy has the opportunity to focus on sustainability and equity, in the current world, these aims can be skewed by politics.

However, the strong ideology is key to the functioning of a planned economy, as it provides a moral incentive for people to work, a sense of community purpose to motivate people, as a planned economy cannot rely on monetary incentive in the same way as a free-market economy can.

Due to the impact of opposing ideologies and the Cold War on world economies, the planned economy model has not had a chance to be fully tested, as no country is every completely government-controlled, and the few countries that are tightly controlled, such as North Korea, have cut themselves off from the world for political reasons. Therefore, the true effects of a planned economy, in a world where they are not excluded from global trading, must remain hypothetical for the present.

Free-Market Economy

A free-market economy is driven by profit incentive, with enterprises and customers interacting on a supply and demand basis to efficiently determine what products should be produced. Due to this dynamic, change in the factors of production, as well as change in demand, will result in a change to the goods and services on offer, resulting in a highly efficient system, with little waste. Government intervention often occurs to ensure that elements such sustainability are being considered, and to improve economic wellbeing.

The economic question is not necessarily considered by individuals, but rather the goods and services offered are chosen by demand, and the means of production are chosen by companies looking to make the highest profits. Different goods and services are marketed to different customers, and those who contribute to the economy will gain from it, as they can use their wages to purchase other goods, as part of the circular flow of income.

Switzerland is a free-market economy, and one of the most successful in the world, with the second highest GDP per capita. This is the case despite the fact that its geographical location places it at an extreme disadvantage, being landlocked and lacking in natural resources. In terms of factors of production, their natural capital is limited, their labour expensive, and their land is unsuitable for building cheap infrastructure. However, their economy thrives, following a free-market plan. Private businesses, such as banks, and pharmaceutical companies generate a lot of profit by providing their goods and services on an international scale, bringing money back into the Swiss economy. Although Switzerland may lack the land, labour and capital elements of production, their entrepreneurship is fostered through the sense of neutrality and security which the government fosters. Therefore, although the government does not intervene to a large degree in the Swiss economy, the image the government creates for Switzerland is fundamental to encourage risk-taking, and innovation in business, essential to increase efficiency, and generate profit. This image also increases the global landscape for Swiss companies, so that ones such as Novartis, UBS, and Credit Suisse can thrive by increasing their range of customers.

The private nature of Switzerland’s economy is evident in the fact that it has one of the most expensive healthcare systems in the world, costing about 12% of the GDP, with the US the only country spending more on healthcare out of all the 37 Organisation for Economic Cooperation and Development member countries. As a result of this, its pharmaceutical companies are some of the best in the world, the profit incentive encouraging efficiency, and the supply and demand model ensuring that the companies can specialise their goods and services to the customers’ desires. The bar chart demonstrates the GDP of the leading pharmaceutical companies worldwide, and is dominated by US and Swiss companies, which thrive in free-market economies, clearly making popular choices on what to produce, and how.

Conclusion

If we place a hypothetical dystopian planned economy next to a dystopian free-market economy, each system would have a different method of improving efficiency. The following flow charts illustrate an example of how this would look in each economy.

Planned economy:

improved education system → better educated population → more efficient and able workforce → improved efficiency

Free-market economy:

monetary incentive for innovation → new technologies produced → more efficient and faster means of production → improved efficiency

Therefore, both planned and free-market economies would have different approaches to the economic question, but in the right environment, both have the potential to thrive, increase production possibility, and produce a highly efficient economy. 

Bibliography:

World Bank. “World Bank Group - International Development, Poverty, & Sustainability.” World Bank, 2021, www.worldbank.org/en/home.