An economy in which the basic functions of reaource allocation are carried out by a centralized administrative process, as opposed to a price mechanism. Decisions on the total outputs of all goods in the economy are taken by an administrative body, and these decisions may reflect to varying degrees the wishes of consumers and the perceived need to expand particular sectors of the economy more rapidly than others, e.g. heavy industry, armaments industries or export industries. At this stage, of course, consistency must be achicved between outputs of final products and outputs of the intermediate products required to produce them. Similarly, the total requirements for land, labour and capital must not exceed the total amount available. The ‘plans’ or output programmes are then communicated to the individual production units – factories, plants and farms – and these units are expected to fulfil their plans with the rcsources which have been allocated to them; indeed, incentives otten exist for output plans to be over-fulfilled, since this represents greater productivity of resources than was envisaged in the plan. Income distribution is determined centrally, since wages and salaries are set by the administrative machinery (there are, of course, no rent, profit or interest earners apart from the state). This extreme form of centralized economic organization is most closely approached in the former U.S.S.R. and China, but even these economies do not correspond perfectly to the description given above since there are certain important sectors, notably agriculture, in which private enterprise and some elements of a market mechanism still operate. A planned system was the most obvious form of economic organization for any economy which wanted to eliminate the characteristics of the capitalist economy. In addition, it permits the economy to be run in a way which corresponds to particular objectives, e.g. the rapid expansion of defence and heavy industrial sectors at the expense of consumer goods. Such political imposition of priorities is rather more difficult in a capitalist system. Finally, an administrative process of allocation may be the only way to secure economic development in an economy which does not possess the necessary institutions, skills and mores for a capitalist system to work. On the other hand, the major defects of a centralized system (assuming one <loes not regard the absence of private enterprise as in itself a defect) lie in its possible inefficiency as a means of allocating resources. In any industrialized economy the scale of the problem is very large. Inevitably, the planning process requires a large bureaucracy with the resulting problems of securing administrative efficiency faced by any large organization. Costly mistakes may occur, and the rigidities in the system may mean that they remain long uncorrected. Because the system is not sensitive to the detailed wishes of consumers, a planned economy is probably better suited to an economy attempting to industrialize rapidly than to a high mass-consumption economy.
Reference: The Penguin Dictionary of Economics, 3rd edt.