Markets, Planning, or Something in Between?

Start Here: Everyone Plans

A family sits down in January and plans the year: rent, a used car, saving for a child’s tuition. A small contractor plans which jobs to bid on and how many workers to hire. Walmart plans which products go to which of its stores, down to the day. Planning is everywhere in a market economy. People who make plans also change them when prices move, when a better offer appears, or when they learn something new.

Now picture a different kind of plan. In 1928 the Soviet Union adopted its First Five-Year Plan, which called for rapid industrialization and a drastic cut in private business. A central board called Gosplan turned the goals of the Communist Party into specific targets for the whole country: how much steel, how many tractors, how much grain. It is the same word, “plan,” but a very different thing. One is a plan you choose for yourself and can change. The other is one plan for everyone, set by the state.

Friedrich Hayek, who later won the Nobel Prize in economics, put the point this way in 1945:

Real economies don’t sort neatly into two boxes. Most mix markets and government in different ways, so it helps to ask three separate questions about any economy:

The answers don’t line up on one left-right line. A country can have state-owned giants and market prices, or open markets and little political freedom. This reading follows three steps. Measure It sets out the words and places real countries on the three questions. Explain It asks why systems perform so differently, starting with what a planner would need to know. Weigh It turns to the values behind the choice of a mix. Earlier readings on trade, on who should decide, and on profits and losses introduced the ideas used here; this one puts them to work on whole economies.

Measure It: What Are We Comparing?

1 The words

People argue past each other when they use the same words for different things. These are the terms this reading uses:

• Market economy. Most firms are privately owned, and prices set in markets guide what gets produced. Government sets rules, enforces contracts, taxes, and provides some services.
• Central planning. The state owns most firms and farms, and a central authority sets what to produce, how, and for whom. Prices are set by the planners, not by buyers and sellers.
• Market socialism. Firms are owned by workers or the public, but they buy and sell in markets.
• Social democracy. A market economy with high taxes and a large welfare state that pays for health care, pensions, and other benefits.
• State capitalism. The state acts as an owner and investor inside a market economy. In the words of Britannica, the state “functions in a manner akin to a business enterprise,” with decisions “driven by its political goals.” State-owned firms control more than 70 percent of the world’s oil and gas reserves. The term came back into wide use after the 2008 financial crisis.

China shows how these can combine. Economist Yong Wang, in a study published by the U.S. International Trade Commission, describes state-owned firms that hold monopolies in “upstream” industries such as energy, telecommunications, and banking, while “downstream” industries that sell to consumers are open to private competition.

2 Measuring economic freedom

Two widely used indexes try to measure how much an economy relies on markets. The Fraser Institute’s Economic Freedom of the World report scores countries on the size of government, the rule of law and property rights, sound money, freedom to trade with other countries, and regulation. The Heritage Foundation’s Index of Economic Freedom measures similar things. Both come from market-oriented research institutes, which is worth knowing when you read them.

In the 2025 Fraser report, with data for 2023, the top ten were Hong Kong, Singapore, New Zealand, Switzerland, the United States, Ireland, Australia and Taiwan (tied), Denmark, and the Netherlands. Venezuela was among the bottom ten. In Heritage’s 2025 index, Singapore ranked first.

Read the indexes with care. A survey of the research by Jakob de Haan, Susanna Lundström, and Jan-Egbert Sturm found that how an index weights its parts can change the results, and that a link between economic freedom and growth does not by itself show which causes which. Rich countries may find it easier to afford secure property rights and stable money. The indexes are a useful first look, not a final verdict.

3 The map

The table places seven economies on the three questions. Notice how often the answers split.

Singapore ranks near the top of both economic freedom indexes while the state owns big firms and most of the housing. Denmark taxes more than almost any rich country and still ranks among the ten most economically free. China and the United Arab Emirates run on market prices with little political freedom. Ownership, prices, and political freedom are three different questions.

Explain It: Why Do Systems Perform So Differently?

4 Calculation and discovery

In 1920 the Austrian economist Ludwig von Mises asked a question that critics of markets had not answered: how would planners know whether a project was worth doing? His answer was blunt: “Where there is no free market, there is no pricing mechanism; without a pricing mechanism, there is no economic calculation.”

Here is the problem in plain terms. Suppose planners must choose between two ways to build a bridge. One uses more steel and fewer workers; the other uses more concrete and more workers. Which is cheaper? In a market economy, prices for steel, concrete, and labor answer that question, because each price reflects how much people value those resources in every other use. If the state owns all the steel mills and cement plants and there is no market for them, there are no such prices. The planner can count tons and hours but cannot compare their costs.

Hayek added a second point in 1945. The knowledge an economy runs on is not in any one place. It is spread across millions of people as “knowledge of the particular circumstances of time and place”: which machine is about to break, which customer wants what, which warehouse has room. No central board can collect it all, and much of it can’t be written down. Prices pull that scattered knowledge together. When a shortage drives up the price of tin, people economize on tin without knowing why.

Hayek’s third point, in a 1968 lecture, goes further. He called competition “a procedure for discovering facts which, if the procedure did not exist, would remain unknown or at least would not be used.” The point is not that planners lack a fast enough computer. Much of the information a planner would need does not exist yet. Nobody knows the best way to make a product, or whether people want it, until someone tries and buyers respond. Decision researchers Sarah Lichtenstein and Paul Slovic reach a similar conclusion about consumers: “in many situations we do not really know what we prefer; we must construct our preferences as the situation arises.” You may not know you want a new kind of phone, food, or job until it is in front of you. A plan can’t be built around preferences people haven’t formed yet.

Defenders of socialism did answer. In 1936 the Polish economist Oskar Lange proposed market socialism: the state would own firms, but planners would set prices by “trial and error,” raising a price when there was a shortage and lowering it when there was a surplus, while managers followed simple rules. Critics, including Hayek, replied that Lange’s planners would still need the information only markets create, and that managers of state firms who don’t own anything have little reason to take risks, try new products, or cut losses.

5 Incentives and the soft budget

Information is half of the story; incentives are the other half. The Hungarian economist János Kornai coined the term “soft budget constraint” to describe what he saw in planned economies: a state firm that loses money gets bailed out, given more credit, or allowed to raise its prices. Kornai, Eric Maskin, and Gérard Roland explain that when managers expect to be rescued, losses stop disciplining them. In a market economy, a firm that keeps losing money eventually closes, and its workers, buildings, and machines move to uses people value more. The reading on profits and losses called losses the signal to stop. A soft budget turns that signal off.

Soft budgets are not only a problem of planned economies. They appear wherever governments rescue failing firms, banks, or local governments. What made central planning different was that nearly every firm in the economy worked this way.

6 Natural experiments

The strongest evidence comes from places where history divided one people into two systems, and from large countries that changed course.

• Germany. After World War II, Germany split into a market economy in the West and a planned economy in the East, with the same language and culture. By early 1989, according to economists at the German Institute for Economic Research, East Germany trailed West Germany by “some 50 percent” in both productivity and real living standards, a gap that had widened for three decades.
• Korea. Before 1945, Korea was one country under Japanese rule, and the area that became North Korea was somewhat richer. After the division, the North adopted central planning and the South built a market economy. By 2022, output per person in the South was more than 25 times that of the North.
• China. Under Mao Zedong’s central planning, China stayed poor. After reforms began in 1978, farmers were allowed to sell surplus crops, private firms were allowed to grow, and foreign trade opened. Nicholas Lardy of the Peterson Institute concludes that China’s growth came “primarily because of the freeing of the private sector and the shrinking of the state.” The World Bank estimates that close to 800 million fewer people in China lived on less than $1.90 a day over 40 years, nearly three-quarters of the world’s reduction in extreme poverty over that period.
• India. For four decades after independence, India relied on import substitution, large state firms, and a “License Raj” in which firms needed government permission to enter an industry, expand, or import machinery. After a balance-of-payments crisis in 1991, the government abolished industrial licensing for all but 18 industries, cut the average tariff from 72.5 percent in 1991–92 to 24.6 percent by 1996–97, and opened the door to foreign investment. Output per person rose from about $2,060 in 1991 to about $7,770 in 2022, nearly fourfold. The World Bank estimates that extreme poverty fell from 27.1 percent of Indians in 2011 to 2.6 percent in 2023, though it notes that better survey methods explain part of the latest drop.

Economists debate the timing in India. Dani Rodrik and Arvind Subramanian find that growth sped up around 1980, more than a decade before the big reforms, after the government became friendlier to existing businesses. Arvind Panagariya replies that liberalization was already under way in the 1980s, that growth in that decade was “fragile and unsustainable,” and that the deeper reforms of the 1990s made faster growth last. Both sides agree that India grew faster after it moved away from the tight controls of earlier decades; they disagree about which moves mattered most.

No natural experiment is perfect. The two sides of each divide differed in more than their economic systems, including their allies and the aid they received. But the pattern is the same in every case, and the size of the gaps is hard to explain any other way.

The record also includes famines. In the Soviet Union in 1932 and 1933, between about 5 and 10.8 million people died after forced collectivization of farms and heavy grain requisitions. Economists Andrei Markevich, Natalya Naumenko, and Nancy Qian find that the higher death rate in Ukraine was “due to state policy.” In China, during the Great Leap Forward of 1958 to 1962, an estimated 36 million people died. In both cases, the state kept taking grain from the countryside as people starved, and people had no way to vote, protest, or leave.

Collapse can happen without a full central plan. Venezuela relied on a large state role in its economy and ranks near the bottom of the economic freedom indexes. Its real output fell about 75 percent from 2013 to 2021, which the International Monetary Fund called “the single largest economic collapse for a non-conflict country in almost half a century.”

WATCH The Soviet Union: An Experiment in Marxism and Stages of Central Planning and Marxism in the Soviet Union (Marginal Revolution University, about 3 and 6 minutes)

WATCH The Reality of Socialism: Poland (Fraser Institute, a market-oriented think tank, 6 minutes. Poles who lived through central planning describe shortages, lines, and the shift to markets after 1989)

7 The in-between cases

Most of today’s debate is not about Soviet-style planning. It is about the mixes in between.

The Nordic countries. Denmark and Sweden are often called socialist, but they are market economies with large welfare states. Denmark’s taxes equal 45.2 percent of GDP, the highest in the OECD, yet it ranks among the ten most economically free countries. Sweden grew rich before its welfare state became large: output per person rose about fivefold from 1870 to 1950. Economist Andreas Bergh concludes that Sweden became rich because of well-functioning market institutions and that its income equality came before the expansion of the welfare state. In 1970, Sweden was the fourth richest country in the OECD. By the late 1990s it had fallen to the bottom third, a decline economist Assar Lindbeck links to the “pronounced centralisation” of its economic system in the late 1960s and early 1970s. Reforms in the 1980s and 1990s were followed by a revival. Both sides have a point here: a large welfare state can coexist with prosperity, and these are not planned economies.

Singapore and the United Arab Emirates. Both are open, low-tax markets in which the state is a large owner and investor. In Singapore, government-linked companies produced about 12.9 percent of GDP in 1998, according to the Singapore Department of Statistics. A study by International Monetary Fund economists Carlos Ramírez and Ling Hui Tan found that these companies were rewarded by investors with a valuation premium of more than 20 percent over comparable private firms. The United Arab Emirates, a federation of seven emirates, invests its oil wealth through huge state funds. These cases raise a real question: is it private ownership that matters most, or competition, open trade, and hard budgets that make even state firms answer to profit and loss?

Market socialism in practice. Yugoslavia tried worker-managed firms that sold in markets. Economist Saul Estrin finds that the system seemed to work until the late 1970s, then slid into stagnation, debt, inefficiency, and inflation. Worker-owned firms can thrive inside a market economy, though. Mondragon, a federation of cooperatives in Spain’s Basque Country, had more than 70,000 workers and €11.2 billion in sales in 2024. The difference is that Mondragon’s cooperatives compete in markets and face losses, while Yugoslavia’s firms could count on soft budgets.

China. China grew after it let markets in, yet the state still owns banks and key industries and directs credit toward its priorities. Did China grow because of the state, or despite it? Lardy’s evidence points to the private sector as the main engine. Justin Yifu Lin of Peking University, a former World Bank chief economist, argues instead that a “facilitating state,” one that builds infrastructure and uses industrial policy to help promising industries compete, was essential. Barry Naughton of the University of California, San Diego, finds that China grew rapidly for nearly three decades after 1978 before it adopted large-scale industrial policy around 2006. The debate continues.

Weigh It: What Kind of Mix?

Every real economy is a mix of markets and government. The choices are about how much, and which parts. Evidence can tell us a lot about what each mix produces. It can’t settle which values should count most.

“My plan” or “our plan”? Some modern socialists, such as the sociologist Erik Olin Wright, argue for democratic planning: decisions made by voters, workers, and communities, not by distant bureaucrats. A plan chosen by vote, they say, is our plan, not one imposed from above. The reply has two parts. A majority’s plan is still not my plan; the people who lose the vote must live by it. And a vote does not create the knowledge Hayek and Mises described. Voters, like planners, can’t know the prices and preferences that markets discover. Supporters of markets point out that a market lets many plans exist at once: you can follow yours while your neighbor follows hers.

What Economics Adds

LISTEN Who Won the Socialist Calculation Debate? on EconTalk, February 17, 2025, with transcript. Economist Peter Boettke explains Mises’s and Hayek’s arguments to host Russ Roberts and asks whether computers and AI could overcome the limits of planning.

LISTEN When Bricks Were Rubles on Planet Money, NPR, April 1, 2022, with transcript. After the Soviet Union collapsed, rubles lost value and firms paid each other in bricks and IOUs, revealing how a few oil, gas, and mining industries had propped up the rest of the planned economy.

READ THE ORIGINAL The Use of Knowledge in Society and Economic Calculation in the Socialist Commonwealth (Friedrich Hayek’s 1945 essay, free at the Library of Economics and Liberty, and Ludwig von Mises’s 1920 essay)

Key Terms in Plain Words

Market economy

An economy where most firms are private and market prices guide production.

Central planning

A system where the state owns most firms and a central authority decides what to produce.

Market socialism

Worker or public ownership of firms that buy and sell in markets.

Social democracy

A market economy with high taxes and a large welfare state.

State capitalism

The state as a major owner and investor inside a market economy, pursuing political goals.

State-owned enterprise

A firm owned and controlled by the government.

Economic calculation

Comparing the costs and benefits of different uses of resources, which requires prices.

Knowledge problem

Hayek’s point that the knowledge an economy needs is scattered across millions of people.

Discovery procedure

Hayek’s description of competition as a way to find out facts no one knew.

Soft budget constraint

Kornai’s term for firms that expect to be rescued when they lose money.

Natural experiment

A real-world split that lets us compare similar groups under different rules.

Economic freedom index

A score of how much an economy relies on markets, property rights, and open trade.