Following its accession to power in 1975, the communist government imposed a harsh, Soviet-style command economy system, replacing the private sector with state enterprises and cooperatives; centralizing investment, production, trade, and pricing; and creating barriers to internal and foreign trade.

Within a few years, the Lao Government realized its economic policies were preventing, rather than stimulating, growth and development. No substantive reform was introduced, however, until 1986 when the government announced its "new economic mechanism" (NEM). Initially timid, the NEM was expanded to include a range of reforms designed to create conditions conducive to private sector activity. Prices set by market forces replaced government-determined prices. Farmers were permitted to own land and sell crops on the open market. State firms were granted increased decision-making authority and lost most of their subsidies and pricing advantages. The government set the exchange rate close to real market levels, lifted trade barriers, replaced import barriers with tariffs, and gave private sector firms direct access to imports and credit.

In 1989, the Lao Government reached agreement with the World Bank and the International Monetary Fund on additional reforms. The government agreed to expand fiscal and monetary reform, promote private enterprise and foreign investment, privatize or close state firms, and strengthen banking. In addition, it also agreed to maintain a market exchange rate, reduce tariffs, and eliminate unneeded trade regulations. A liberal foreign investment code was enacted and appears to be slowly making a positive impact in the market. The pace of reform slowed during the Asian financial crisis in 1997-98, from which Laos has yet to fully recover. Currently, completion of several hydroelectric power projects is a key Lao objective to increase revenue through selling electric power to its neighbors.

These reforms led to economic growth and increased availability of goods throughout most of the 1990s. However, the Asian financial crisis, coupled with the Lao Government's own mismanagement of the economy, resulted in spiraling inflation and a steep depreciation of the kip, which lost 87% of its value from June 1997 to June 1999. Tighter monetary policies brought about greater macroeconomic stability in FY 2000 when inflation dropped to less than 1% per month. The economy continues to be dominated by an unproductive agricultural sector operating largely outside the money economy and the public sector continues to play a dominant role. Tourism is a growing industry and important source of foreign exchange.