Pitfalls of Central Planning: 3 examples where it led to chaos
What do the erosion of the Aral Sea basin, China's property crisis, and 1970s USA energy problems have in common?
Hi there,
Today's article is about the consequences of Central Planning.
Central planning is a system wherein a central authority dictates what goods will be produced, what it will be used for and to whom it will be sold. We will explore this concept further in the article.
Economic systems across the world vary widely, ranging from state/central planning to free markets, blending in policies which have elements of communism, socialism, and capitalism.
Our education often simplifies these structures, labeling economies as either centrally planned or market-driven, communist, socialist, or capitalist.
However, what I have realized is that there is a spectrum; North Korea is on the extreme end of planned economies, while Russia and China are relatively less so but still firmly state-ruled economies. India falls in the center, leaning towards the planned economy side, while Japan, USA, and Hong Kong are relatively more mixed economies.
It's crucial to note that almost every country, North Korea being a notable outlier, functions as some kind of a mixed economy. This means they integrate varying levels of free enterprise within their frameworks of state planning.
Understanding a country's position on the economic spectrum is crucial, as planned economies tend to adopt protectionist policies. Such protectionist policies are marketed as measures to defend national interests or to protect the poor, yet they are harmful to the economy.
So how can you figure out if a policy is protectionist?
A good question to ask is- will this policy distort the market price of the good within the country? If yes, chances are it is a protectionist policy.
What is Central Planning, and Why Does Soviet Russia Come to Mind?
A planned economy runs on the premise that the officials at the top have the necessary information and the know-how to manage the economy in the best way possible.
The bureaucracy decides how to allocate limited resources within the economy; what to produce, how much to produce, and for what purpose—effectively gutting private enterprises.
This often leads to shortages of basic goods as resources are diverted to industries deemed important by the State. Consequently, giving rise to black markets where higher prices are charged, and the quality of goods is questionable.
Governments often justify such control as a means to close the financial gap with rival nations.
“We are fifty or a hundred years behind the advanced countries. We must make good this distance in ten years. Either we do it, or we shall go under.”- Joseph Stalin, General Secretary of the Communist Party of the Soviet Union in a speech in 1931 pushing for a significant increase in industrial output.
The idea is compelling—a strong central authority steering the nation, propelling it to catch up with and surpass its rivals. It's a nationalistic narrative that rallies citizens to align with the leader's vision.
Yet, history has demonstrated time and again the adverse effects of central planning on the people.
We can see this play out in Soviet Russia with something as commonplace as a pair of jeans.
In the 1960s, Levi's 501 jeans were one of the most coveted items in Russia’s black market. By 1981, buying a pair meant paying the equivalent of an engineer’s monthly salary. American denim, valued for its softness compared to the coarse workwear produced by Russian textile manufacturers, became a symbol of the soft power wielded by Western culture.
So why does central planning fail?
The best answer to this question comes from "I, Pencil" by Leonard E. Read.
Writing from the perspective of a humble pencil, the author describes the complex journey of the pencil's creation: the numerous processes that its raw materials undergo, the hundreds of hands that touch these materials, and the technical expertise involved in its manufacture. Through this narrative, the author illustrates that there is no grand manager micro-managing every detail—like a puppeteer with dolls.
Instead, the pencil is made because individuals are responding to market prices.
Prices serve as incentives for people to invest their labor and time in making the pencil. The money a worker makes for his labour is used to buy whatever he/she wants—groceries, clothing, property, and so on.
Introduce a price ceiling on pencils, and suddenly the incentive falters; workers then prefer to apply their skills to produce something that pays better. Leading to a shortage in pencils.
Here is an excerpt
“I, Pencil, simple though I appear to be, merit your wonder and awe, a claim I shall attempt to prove. In fact, if you can understand me—no, that’s too much to ask of anyone—if you can become aware of the miraculousness which I symbolize, you can help save the freedom mankind is so unhappily losing.”
This analogy extends beyond the humble pencil, shedding light on the broader repercussions of price controls—be it on movie tickets, medical stents, or the rents in Mumbai. Such interventions often backfire, breeding a fresh set of challenges. Do read the linked articles for a deeper understanding of the unintended consequences of misguided policies.
Below are 3 examples where central planning went terribly wrong:
1. Focus on increasing cotton output leads to erosion of the Aral Sea basin
The disappearance of the Aral Sea is one of the greatest man-made disasters of our time.
Cradled between Kazakhstan in the north and Uzbekistan in the south, the Aral Sea was once the world's fourth-largest lake, providing sustenance and jobs for local communities.
However, from the 1960s onward, it began to shrink, nearly vanishing by the 2010s.
Soviet planners aimed to capitalize on the high demand for cotton by expanding its production around the Aral Sea area. To facilitate this growth, water was siphoned off from the Amu Darya and Syr Darya rivers—lifelines that formerly fed into the Aral Sea.
Over the 70’s and 80’s Soviet planners continued to increase the land devoted to cotton production demanding more and more water.
In peak harvest season - groups of urban dwellers including factory workers, soldiers, and university students were forced to work on collective farms. They labored under the harsh sun reaping cotton to meet targets.
As years passed, the water level dwindled, the flow from the two rivers ceased, and the Aral Sea shrank, eventually vanishing.
The consequences have been devastating. Millions of people living in the vicinity of the sea have had their health and livelihood destroyed, and the damage to the region will continue for generations.
The destruction of the Aral Sea ecosystem reveals the perilous consequences of a single-minded focus on meeting production quotas mandated by distant rulers—a clear example of how such narrow, shortsighted central planning can lead to disaster.
Read more here→ “Louder than Words”: A Profile of the Destruction of the Aral Sea and Its Consequences
2. Perverse incentives lead people to risk their savings buying property in China
The Chinese real estate bubble has been caused by numerous factors.
Banks relaxing credit restrictions to encourage land purchases, local governments enhancing their revenue by selling land parcels, and citizens' belief that the government would prevent a market collapse, leading them to continue investing in property development.
However, with an oversupply of apartments and the rising cost of money, there exists a mix of perverse incentives driven from the top.
The government's push to raise GDP figures by ramping up economic activity created an illusion of wealth fueled by construction. Deep-seated issues in the housing market remained neglected and left unaddressed.
By late 2023, ~96% of China’s urban households owned at least one home, far exceeding the 65% homeownership rate in the U.S.
If Chinese citizens had access to—and confidence in—alternative investment options like stocks, bonds, or foreign markets, perhaps their capital wouldn't have been so heavily concentrated in real estate.
As Raghuram Rajan wrote in Fault Lines: How Hidden Fractures Still Threaten the World Economy:
“Politicians love to have banks expand housing credit… It pushes up house prices, making households feel wealthier, and allows them to finance more consumption. It creates more profits and jobs in the financial sector as well as in real estate brokerage and housing construction. And everything is safe—as safe as houses—at least for a while.”
3. USA battles an energy crisis of its own making
In 1973, the Organization of Arab Petroleum Exporting Countries declared that they would cut oil production by 5% and would continue to do so every month until Israel withdrew from the West Bank, Gaza, and Jerusalem.
A few days later, members agreed to stop oil sales to the USA to pressure it to withdraw support for Israel.
Panic gripped the global oil market, OPEC raised the price of a barrel—which three years earlier had been $1.80—to $11.65. In 2023 dollars, that meant going from $14 a barrel to $80 a barrel.
The U.S. government's reaction to the 1973 oil crisis was to implement price controls and promote allocation laws as part of a strategy to manage shortages, combat inflation, and shield citizens from economic strain. Unfortunately, this approach backfired dramatically.
Oil companies, grappling with the surge in global prices, reduced imports and restricted supply to retailers.
The aftermath was chaotic: endless lines snaked around gas stations, The President asked everyone to lower their thermostats by six degrees to save on heating fuel and in a telling sign of the era, even the White House Christmas tree donned an austere look.
What is critical to note though is that the embargo did not create the long gas lines.
Rather, it was the domestic price controls that prevented oil companies from passing on the increased cost of imported crude to consumers at the pump, resulting in those extensive lines. Unable to pass on the higher costs oil companies reduced oil imports.
Moreover, although the embargo was aimed at America, the global structure and interconnectedness of the market meant that there was enough supply to go around. As once oil is in a tanker, no one could control where it goes. Anyone could buy the oil in it for the highest price.
The production cutbacks were real but short-lived. Within a month and a half, the Saudis cancelled their promised monthly 5% cutback and the rest of the Petroleum Exporting Countries followed.
The main reason for the gas lines was the inability of markets to respond, owing to government regulation of the prices of oil and natural gas. The market had little flexibility to adjust, thus causing an imbalance.
It served as another example of central control on prices leading to disarray in the free market and chaos for the common man.
These examples show us that we should consider the second order consequences of our actions.
While a purely capitalistic economy may not be the perfect solution, the pitfalls of central planning are evident and significant.
Sometimes the government not doing anything is better than spending taxpayer money. Read here to understand more about When is Government Intervention required as per public policy analysts.
I would appreciate it if you shared this with others who might find it interesting. It helps the newsletter grow and keeps me motivated.
Filtered Kapi #53