A closed economy is a self-contained economic unit that has no business or trading relations with anyone outside of that unit. Usually referring to a nation or area of common currency (but can, in general, refer to any system of self-reliance), the relatively closed system would be characterized by a small amount of exposure to external markets, as opposed to the relatively open economy. The latter allows large movements of goods and services, intellectual property, financial capital, and foreign exchange across its borders. Policy tools such as import and import quota, tariffs, monetary or fiscal policy, exchange rate controls, and controls on capital are some of the means whereby a national government might try to influence the degree of openness of its economy. However, no economy is perfectly open or closed.
The closed economy is in part a theoretical construct for developing some types of macroeconomic models and theories. The theory, having been worked out under these simplified conditions, can be expanded to take into account the effects of international transactions. Openness, then, depending on one's theoretical perspective, may or may not alter many of the established policy precepts of a closed economic system. Much of what is generally referred to as macroeconomics is based on closed systems, whereas international economics studies what happens when closed economies are opened up to international cooperation and competition.
In the real world, the comparatively closed economies are associated with authoritarian political regimes or with low levels of economic development by capitalist standards. Overall, the global trend for several decades has been toward greater openness, as world capitalist production, distribution, and exchange have become increasingly integrated along international and interregional lines. Some notable phenomena include
Debates over NAFTA and, before it, the U.S.-Canada Free Trade Agreement centered around the effects of allowing the free movement of capital across Canada, the United States, and Mexico, with the relative openness or closedness (and, perhaps, political independence itself) of these geographic economic units at stake. It is important to note that while such agreements create symbolic "free trade" and openness, often certain industries within countries continue to be tightly protected for years after the agreement is signed. This has been most recently the case with NAFTA, in which the United States has fought vehemently to protect selected industries from Mexican competitors, even while political leaders continued to extol the benefits of free trade. Despite these nuances of interpretation, trade pacts such as NAFTA and, more importantly, GATT are effecting palpable shifts toward greater openness between world economies.
As the existence of various trading blocs suggests, the extent of an economy's self-reliance (or closedness) can be relative. A national economy may be considered open because it engages in significant cross-border trade, but if all of its trade is conducted with only a few members of tightly integrated economic bloc, the group might function collectively as a closed system. Similarly, as seen in cases of industry protectionism, an economy may be generally open, but particular segments within it may represent de facto closed systems.
To illustrate how much more open world economies have become, one might consider the growth of U.S. foreign trade. Foreign trade made up only a small portion of U.S. gross national product (GNP). But from 1960 to 1990, exports and imports as a percentage of GNP rose from around 5 percent to over 15.5 percent, indicating that the United States could no longer be analyzed as if it were a closed system. In dollar volume, exports and imports increased by over 24 times while GNP increased only tenfold.
Hillier, Brian. The Macroeconomic Debate: Models of the Closed and Open Economy. New York: Blackwell, 1991.
Irwin, Douglas A. Against the Tide: An Intellectual History of Free Trade. Princeton, NJ: Princeton University Press, 1996.