Closed Economy

What is Closed Economy?

A closed economy is a type of economy where the import and export of goods and services don’t happen, which implies that the economy is self-sufficient and has no trading activity from outside economics. The sole purpose of such an economy is to meet all the domestic consumers’ needs within the country’s border.

In practice, there are no countries with closed economies at present. Brazil has the closest to the closed economy. It has the least import of goods compared to the countries from the rest of the world. It is impossible to meet all the goods and service demands within the domestic boundary. With globalization and technology dependency building and maintaining such economies can be a herculean task. It can be considered that India was a closed economy till 1991 and so were the other countries across the globe. At present, it is not quite possible to run a closed economy.

The need for raw materials is important and plays a vital role in the final product, this makes the closed economy inefficient. The government can shut down any particular sector from the international competition through the use of quotas, subsidies, tariffs, and making it illegal in the country. They have no or limited economic relationship with other economies.

Examples of Closed Economy Countries

The following are examples of a closed economy Countries

  • Morocco and Algeria (excluding oil sales)
  • Ukraine and Moldova (Despite late export sector)
  • Most of Africa, Tajikistan, Vietnam (closest to the closed economy)
  • Brazil (if imports are to be neglected)

Open and Closed Economy National Income Formula

Income calculation in the closed and open economy.

Closed Economy

Y = C + I + G

Closed Economy

Where,

  • Y – National income
  • C – Total consumption
  • I – Total investment
  • G – Total government expenditure

Open Economy

Y = Cd + Id + Gd + X

Where,

  • Y – National income
  • Cd – Total domestic consumption
  • Id – Total investment in domestic goods and services
  • Gd – Government purchases of domestic goods and services
  • X – Exports of domestic goods and services

Importance of Closed Economy

  • With globalization and international trade, it is impossible to establish and maintain a closed economy. The open economy has no restrictions on imports. An open economy carries the risk of depending too much on imports. The domestic players will not be able to compete with international players. To tackle this the governments use quotas, tariffs, and subsidies.
  • Resource availability across the globe varies and is never constant. Thus depending on this availability, an international player will find out the best place to procure a particular resource and come up with the best price. Domestic players who have constraints to globalize will not be able to produce the same product at a price at par or discount compared to an international player. Thus domestic players will not be able to compete with the foreign players and the government uses the above options to provide support to domestic players and also reduce dependency on imports.

Reasons for Closed Economy

There are a few reasons a country might choose to have a closed economy or other factors that will facilitate the maintenance and building of a closed economy. It is assumed that the economy is self-sufficient and doesn’t require any import outside domestic borders to meet all of its demands from consumers.

  • Isolation: An economy might be physically isolated from its trading partners (consider an island or a country surrounded by mountains). The natural boundaries of a country will factor this reason and lead the economy towards a closed one.
  • Transit Cost: Due to physical isolation the transportation cost of goods will be highest leading to high transit costs. It doesn’t make sense in trade if the price of goods is increased due to the high overheads of transport and thus the economy tends to close in such cases.
  • Government Decree: Governments might close down borders for taxes, regulations purposes. Thus they will decree the trade with other economies. Violations will be punished. The government will try to support its domestic producers and tax international players to generate revenue.
  • Cultural Preferences: Citizens might prefer to contact and trade only with citizens, this will lead to another barrier and facilitate a closed economy. For example when McDonald’s came to India, people opposed the outlets claiming they use beef in their dishes and it was against culture.

Advantages

Some of the advantages are as follows:

  • It is isolated from neighbors, so there is no fear of coercion or interference.
  • Transit costs will be usually very less in the closed economy.
  • Taxes on goods and products will be less and controlled by the government, less burden for consumers.
  • Domestic players need not compete with the outside players and price competition is less.
  • The self-sufficient economy will create proper demand for domestic products and agricultural products and producers will be compensated appropriately.
  • Price fluctuations and volatility are easily controllable.

Limitations

Some of the limitations are as follows:

  • The economy will not grow if they are short of resources like oil, gas, and coal.
  • The consumer will not get the best price for commodities compared to global prices.
  • In case of emergencies, the economy will be hit severely as most of its production is only domestic.
  • They must be able to meet all of its domestic demand internally, which is a difficult task to accomplish.
  • They will have restrictions on goods and services to be sold and thus the opportunity for the consumers in such markets is more.
  • Isolated economies can be looked down upon by the developing nations and globally such an economy can expect a limited aid when the need comes.

Conclusion

No doubt the closed economy has its advantages but in today’s era where the world is converging to one, with the degree of globalization, dependency on resources, and technology it is highly impossible to have a closed economy and still grow. On the other hand, a completely open economy is also highly volatile as its dependency on imports is high. it is advisable to build a hybrid of two economies such that the dependency is moderate and domestic players also get support from the government.

Both open and closed economy are theoretical concepts in today’s world, a country should adapt accordingly to tilt towards either of them depending on its current situation and keeping in mind the prevailing factors. For an economy to grow, the government should design a hybrid economy aptly to help its domestic producers without exploiting its consumers.

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