Element 3.9: Stay Away from Central Planning

“The man of system . . . is apt to be very wise in his own conceit. . . . He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might choose to impress upon it.  If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder.”⁽¹¹³⁾

As previously discussed, governments can often coordinate the provision of public goods—that is, those relatively few goods for which it is difficult to limit consumption to paying customers—better than markets can. Many people might also argue that government officials can manage most or all of the economy better than can markets. Since the Bolshevik Revolution in 1917, numerous proponents of central planning claim that the general populace would be better off if government officials used taxes, subsidies, mandates, directives, and regulations to centrally plan and manage the key sectors of the economy. Central planning replaces markets with government allocation. It can involve direct command and control, as under the old Soviet system. It can also occur when elected political officials create strong incentives to substitute their preferences for those of consumers, investors, and entrepreneurs that are directed by market forces.

It is easy to see why central planning has appeal. Surely, it makes sense to plan. Are not elected officials and government experts more likely than business entrepreneurs to represent the “general welfare” of the people? Won’t government officials be “less greedy” than private businesses? The attractiveness of central planning among those who lack familiarity with public choice theory and its implications for the operation of the political process is understandable. Economic logic, however, indicates that central planning will almost always be inefficient. Five major reasons explain why this is the case.

First, central planning merely substitutes politics for market decisions. Real-world central planners (and the legislators who direct them) are not a group of omniscient selfless saints. Inevitably, the subsidies and investment funds allocated by planners will be influenced by political considerations. Think how this process works even when decisions are made democratically.

Expenditures will have to be approved by the legislature (for example, the Congress of the United States). Various business, unionized labor, and other special interests will lobby for investment funds and subsidies. Legislators will be particularly sensitive to those in a position to provide campaign contributions or to deliver key voting blocs. This process will favor older firms with more lobbying experience and political influence, even if they are economically weak, over newer growth-oriented firms. In addition, legislative committee chairs will often block various programs unless other legislators agree to support projects that benefit their constituents and favored interest groups (that is, “pork-barrel” projects). Given this incentive structure, only a naive idealist would expect this politicized process to result in less waste, more wealth creation, and a better allocation of investment funds than would markets. It is not just managers who lack incentives to achieve the greatest efficiency. Workers who are guaranteed jobs and are paid the same regardless of how hard they work have an incentive to minimize their effort. The Soviet reality was captured in the old phrase: “They pretend to pay us and we pretend to work.” (Another well-understood Soviet expression was “Anyone who does not steal from the state steals from his family.”)

Second, the incentive is weak for government enterprises and agencies to control expenditures and supply goods efficiently. Rather than building their agencies by meeting their clients’ needs, they rely on the government budget. That directors of government organizations will be motivated to pursue a larger budget should come as no surprise. A larger budget will provide funding for expansion, salary increases, additional spending on clients, and other factors that will make life more comfortable for the managers. Managers of government enterprises and agencies, almost without exception, will try to convince legislators that their activities are producing goods or services that are enormously valuable to the general public and, if they were just given more money, they would do even more marvelous things for society. Moreover, they will argue, if the funding is not forthcoming, people will suffer and the outcome will be disastrous. It will be difficult for legislators and other government planners to evaluate such claims.

Furthermore, the incentive is weak for directors and managers of public-sector enterprises to produce efficiently and keep costs low. Unlike private owners, public sector managers do not gain much from improved efficiency and lower costs. There is nothing comparable to private-sector profit that provides evidence that a government agency or enterprise is well managed. In the private sector, bankruptcy eventually weeds out inefficient producers, but in the public sector, there is no parallel mechanism that forces unsuccessful programs to be shut down. In fact, poor performance and failure to achieve objectives are often used as arguments for increased government funding! For example, the police department will use a rising crime rate to argue for additional law-enforcement funding. If the achievement scores of students are declining, for example, public school administrators will use this failure to argue for still more funds. Given the strong incentive of government enterprise managers to expand their budgets, and the weak incentive to operate efficiently, government enterprises can be expected to have higher per-unit costs than comparable private firms.

Third, there is every reason to believe that investors risking their own money will make better investment choices than central planners spending the money of taxpayers. Remember, an investor who wants to profit must discover and invest in a project that increases the value of resources. The investor who makes a mistake—that is, whose project results in losses—will bear the consequences directly. In contrast, the success or failure of government projects seldom exerts much impact on the personal wealth of government planners. Even if a project is productive, the planner’s personal gain is likely to be modest. And if the project is wasteful—if it reduces the value of resources—this failure will exert little negative impact on the income of planners. They may even be able to reap personal gain from wasteful projects that channel subsidies and other benefits toward politically powerful groups, who will then give their agency or enterprise added political support. Given this incentive structure, there is no reason to believe that government planners will be more likely than private investors to discover and act on projects that increase society’s wealth.

Fourth, the efficiency of government spending will also be undermined because the budget of an unconstrained government is something like a common pool resource. When money and resources are owned in common, there is little motivation to consider the future. As we saw in element 2.1, however, private ownership provides a strong motivation to take the future effects of current decisions into consideration. For example, fish in the ocean are owned in common until someone catches them and, as a result, many species are on the verge of depletion because of overfishing. Everyone in the fishing industry would be better off if the fish were harvested less rapidly so there would be more opportunity for their populations to rebound. On the other hand, because of the common ownership, each fisherperson knows that fish not caught today will be harvested by someone else tomorrow. Thus, there is little incentive for anyone to reduce today’s catch so more fish will be available in the future.

Similarly, when interest groups are “fishing” (that is, lobbying political planners) for government spending, they have little incentive to consider the adverse consequences of higher taxes and additional borrowing on future output. The proponents of each spending project may recognize that future output would be greater if taxes were lower and private investment higher. But they will also recognize that if they do not grab more of the government budget, some other interest group will. Given these incentives, inefficient spending projects and perpetual budget deficits are an expected result. We saw in Element 3.6 the growing problem of the United States’ chronic government budget deficits.

Fifth, there is no way that central planners can acquire enough information to create, maintain, and constantly update a plan that makes sense. We live in a world of dynamic change. Technological advances, new products, political unrest, changing demand, and shifting weather conditions are constantly altering the relative scarcity of both goods and resources. No central authority will be able to keep up with these changes, politically assess them, and/or provide enterprise managers with sensible instructions. Government planners have neither the information nor the incentive to plan efficiently.

Central planning often generates unintended secondary effects and outcomes that differ substantially from what was promised. As Adam Smith indicated more than two and a half centuries ago, individuals have minds of their own, what Smith calls “a principle of motion.” (See the quotation at the beginning of this element.) Because citizens have minds of their own, their actions often generate unanticipated secondary effects. Examples abound. When the Chinese government instituted a one-child policy in the 1980s, potential parents disproportionally aborted female fetuses, leading to a massive gender-imbalanced population. As a result, males now constitute nearly 60 percent of the Chinese population under age 35. Now the PRC faces an inverted demographic triangle with not nearly enough population growth to support an aging population increasing at an alarming rate. The PRC does have an old age pension scheme but funding it will become more and more difficult. Moreover, a young married couple, each the child of a one-child family, will face the burden alone without the help of siblings to care for two sets of aging parents. An unintended consequence of the one child policy is that it could eventually mean “the end of China’s comparative advantage of cheap skilled labor as well as the daunting challenge of caring for its rapidly aging population.”

Secondary effects have also led to undesired planning outcomes in the United States. In the early 1990s, Congress requested that housing planners take action to increase home ownership among those in the middle-and lower-income brackets. Government planners responded by lowering down payment requirements and credit standards needed to obtain a mortgage loan, actions that encouraged people to take out larger loans than they could afford. With time, this led to progressively more serious unintended consequences: rising mortgage defaults and foreclosure rates, the bankruptcy of several lending institutions, a financial crisis, and the severe recession of 2008–2009, essentially a domino effect felt by the economies of many countries around the world.

Central planning outcomes can also be affected by conflicts among the central planners of various nations. The efforts of governments world-wide to phase out the use of fossil fuels provide vivid examples. When the Biden administration assumed the presidency in 2021, it eliminated construction of key pipelines, prohibited fracking (a process that extracts more oil and gas than conventional drilling) on government lands, and terminated drilling in a slice of Alaska’s Arctic National Wildlife Refuge. It imposed regulations to curtail the use of fossil fuels while expanding subsidies for wind and solar energy. Although the costs of wind and solar energy have come down over the years, both wind and solar still rely heavily on subsidies. Also, they are less reliable than oil and gas and must always have backup power from other sources such as fossil fuels.

As a result of these policies, the cost of energy-intensive production in the United States rose. At the same time, Chinese central planners were following policies designed to keep energy costs low. In 2021 and 2022, the Chinese were building two coal-powered plants per week. While coal is relatively cheap, it is the dirtiest of the major fossil energy sources. Thus, while the U.S. central planners were increasing energy costs, the Chinese were reducing them. As a result, energy-intensive production shifted from the United States, which has high costs but low carbon-dioxide emissions, to China, which has low costs but much higher emissions. Worldwide carbon dioxide emissions increased—an outcome that was the opposite of what the U.S. planners intended. Moreover, the reductions in U.S. output of petroleum pushed the world price of crude oil and natural gas higher, thereby enriching the treasuries of petroleum exporters such as Russia, providing it with additional funding for its war against Ukraine. The world is complex and therefore outcomes often differ from the intentions of the planners.

Central planning almost always leads to entrenchment of political power. This is true even when the policies are counterproductive. Consider the case of Venezuela. The central planning policies of the Socialist Party led to a two-thirds reduction in the output of the nationalized petroleum industry, hyperinflation, increasing poverty, and falling living standards. In recent years, four million people, more than 10 percent of the population, have left the country. Nonetheless, the Socialist Party continues to maintain its dominant political position.

The Great Leap Forward, a pivotal period in China's history characterized by ambitious economic goals, ultimately resulted in disaster. Scholars like Li and Yang⁽¹¹⁴⁾ argue that this catastrophe stemmed from significant shortcomings in central planning. The government's focus on achieving rapid industrialization, at the expense of agriculture, led to a misallocation of resources and unrealistic production quotas. The consequences of these central planning failures were devastating, culminating in the Great Chinese Famine of 1959–1961. This famine claimed the lives of an estimated 20 to 50 million people, making it one of the deadliest famines in human history. The Great Leap Forward is viewed as a failure of central planning.

During the 1970s and 1980s, many intellectuals and media sources believed that government planning and “industrial policy” provided the keys to economic growth. Economists Paul Samuelson and Lester Thurow were among the leading proponents of this view. They argued that market economies faced a dilemma: They would either have to move toward more government planning or suffer the consequences of slower growth and economic decline. The collapse of the Soviet system and the poor performance of the Japanese economy have largely eroded the popularity of this view.

What are the implications of public choice and the record of government planning? Nobel laureate F. A. Hayek provides the answer to this question. In his acceptance speech for the Nobel Prize, F. A. Hayek stated:

“If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate growth by providing the appropriate environment, in the manner in which the gardener does this for his plants.”⁽¹¹⁵⁾

In other words, the economy is far too complex to be micromanaged. Instead, as stressed in Part 2, the best strategy to achieve growth and prosperity is the establishment of sound institutions and long-range policies. These will create an environment in which individuals pursuing their own interests will undertake productive, wealth-creating activities.