Command Economy: Definition, How It Works, and Characteristics

Command Economy

Investopedia / Dennis Madamba

What Is a Command Economy?

A command economy is a key aspect of a political system in which a central governmental authority dictates the levels of production that are permissible and the prices that may be charged for goods and services. Most industries are publicly owned.

The main alternative to a command economy is a free market system in which demand dictates production and prices.

The command economy is a component of a communist political system, while a free market system exists in capitalist societies.

Key Takeaways

  • In a command economy, the central government dictates the level of production of goods and controls their distribution and prices.
  • Proponents of command economies argue government control rather than private enterprise can ensure the fair distribution of goods and services.
  • In a free market system, private enterprises set production and price levels based on demand.

Understanding Command Economy

Cuba, North Korea, and the former Soviet Union all have command economies. China maintained a command economy until 1978 when it began its transition to a mixed economy that blends communist and capitalist elements. Its current system has been described as a socialist market economy.

The command economy, also known as a planned economy, requires that a nation's central government own and control the means of production.

Private ownership of land and capital is nonexistent or severely limited. Central planners set prices, control production levels, and limit or prohibit competition within the private sector. In a pure command economy, there is no private sector, as the central government owns or controls all business.

In a command economy, government officials set national economic priorities, including how and when to generate economic growth, how to allocate resources, and how to distribute the output. This often takes the form of a multi-year plan.

Arguments Against Command Economies

Any capitalist would argue that command economies face at least two major problems: first is the incentive problem and second is an information vacuum among the central planners making all the decisions.

The Incentive Problem

The incentive problem starts at the top. Policymakers, even in a command economy, are all too human. Political interest groups and the power struggles between them will dominate policymaking in a command economy even more than in capitalist economies because they are not constrained by market-based forms of discipline such as sovereign credit ratings or capital flight.

Wages are set centrally for workers, and profits are eliminated as an incentive for management. There is no apparent reason to produce excellence, improve efficiency, control costs, or contribute effort beyond the minimum required to avoid official sanction.

Getting ahead in a command economy requires pleasing the party bosses and having the right connections rather than maximizing shareholder value or meeting consumer demands. Corruption tends to be pervasive.

The incentive problem includes the issue known as the tragedy of the commons on a larger scale than is seen in capitalist societies. Resources that are commonly owned are effectively unowned. All of their users (or workers) lack any incentive to preserve them. Things such as housing developments, factories, and machinery wear out, break down, and fall apart rapidly in a command economy. 

 The Information Vacuum

The problem of economic calculation in a command economy was first described by Austrian economists Ludwig von Mises and F. A. Hayek. Central planners must somehow calculate how much of every product and service should be produced and delivered.

In a free market system, this is determined in a decentralized manner through the interaction of supply and demand. Consumers shape demand by the products and services they buy or don't buy. Producers respond by creating more of the products and services that consumers demand.

Moreover, all of these factors are quantifiable. At every step of the supply chain, someone is keeping count of the number of avocados, pairs of blue jeans, and lug wrenches that are in demand out there.

In a command economy, central planners should, at least initially, have a grasp on the basic life-or-death needs of the population in terms of food, clothing, and shelter. But without the forces of supply and demand to guide them, they have no rational method to align the production and distribution of goods with consumer wants and preferences.

Over time, the incentive and economic calculation problems of a command economy mean that resources and capital goods are wasted, and the society is impoverished.

Arguments in Favor of Command Economies

Proponents of command economies argue that they allocate resources to maximize social welfare, unlike in free-market economies, where this goal is secondary to maximizing private profit.

Command economies may have better control of employment levels than free-market economies. They can create jobs to put people to work when necessary, even in the absence of a legitimate need.

Lastly, command economies are seen as better able to take decisive, coordinated action in the face of a national emergency or crisis such as a war or natural disaster. Although, even market-based societies may curtail property rights and greatly expand the emergency powers of their central governments during such events, at least temporarily.

What Are the Characteristics of a Command Economy?

Command economies are controlled from the top by government planners. In general, this includes:

  • Public ownership of major industries
  • Government control of production levels and distribution quotas
  • Government control of prices and salaries

Monopolies are common in command economies as they are considered necessary to meet the goals of the national economy.

How Does a Command Economy Differ From a Free-Market Economy?

In a free-market economy, private enterprises determine their levels of production in response to the law of supply and demand.

In a command economy, the decision is dictated by government.

Few free-market economies today operate entirely on the principle of laissez-faire. A government may use public policies and regulations to encourage the production of a product, such as fuel-efficient cars.

And some command economies have loosened their control. China's economic boom did not begin until it created its own blend of socialist ideology and capitalist enterprise.

How Do Central Plans Work in a Command Economy?

Communist nations with command economies are prone to introducing multi-year plans that are expected to result in improved conditions for all its people. China has had no fewer than 14 five-year plans, with the current one ending in 2025.

Central plans generally set goals for each industry and establish strategies for every sector. Industries are required to participate in government objectives such as reducing carbon emissions or revitalizing rural economies.

Article Sources
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  1. Congressional Research Service. "China’s Economic Rise: History, Trends, Challenges, and Implications for the United States," Page 4.

  2. Mises Institute. "The End of Socialism and the Calculation Debate Revisited."

  3. Congressional Research Service. "China’s Economic Rise: History, Trends, Challenges, and Implications for the United States," Page 5.

  4. Congressional Research Service. "China’s 14th Five-Year Plan: A First Look."

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