What is a Command Economy
A command economy is a system where the government, rather than the free market, determines what goods should be produced, how much should be produced and the price at which the goods are offered for sale. It also determines investments and incomes. The command economy is a key feature of any communist society. Cuba, North Korea and the former Soviet Union are examples of countries that have command economies, while China maintained a command economy for decades before transitioning to a mixed economy that features both communistic and capitalistic elements.
BREAKING DOWN Command Economy
Also known as a planned economy, command economies contrast with free market economies, in which the prices of goods are services are set by invisible forces of supply and demand. A central tenet of a free market economy is that the government does not intervene in the workings of the market by setting prices, limiting production or hampering competition within the private sector. In a command economy, there is no competition, as the central government controls all business.
Other Characteristics of a Command Economy
A command economy also sets its own national priorities, including how and when it generates economic growth or when and if it will go to war.
The government that runs a command economy will also own monopoly businesses, or entities that are considered necessary in order to meet the goals of the national economy. In these cases, there is no domestic competition in those industries. Examples include financial institutions, utility companies and the automotive sector.
Finally, all the laws, regulations and other directives are set by the government according to the central plan. All businesses follow that plan and its targets, and cannot respond to any free market forces or influence.
Drawbacks of Command Economies
Command economies are unable to efficiently allocate goods because of the knowledge problem, or the central planner's inability to discern how much of a good should be produced. Shortages and surpluses are common consequences of command economies. The government is disconnected from the body of consumers, whose needs are fluid rather than static. As a result, the entity that controls the means of production faces constant difficulty responding to ever-changing demand across various sectors in a timely manner. Moreover, the central planner in a command economy sets prices strictly based on revenue needs, resulting in pricing that is almost always inefficient with regard to output and demand.
A free-market price system, on the other hand, signals to producers what they should be creating and in what quantities, resulting in a much more efficient allocation of goods. Further, the same body of consumers that feeds the demand for goods and services controls the means of production through private enterprise. As a result, no knowledge gap exists, and producers can respond to changing consumer demands much more efficiently.
Arguments in Favor of Command Economies
Command economies retain their supporters. Those who favor this market system argue that command economies allocate resources to maximize social welfare, while in free-market economies, this goal is secondary to maximizing profit. Additionally, proponents allege that command economies have better control of employment levels than free-market economies, as they can create jobs to put people to work when necessary, even in absence of a legitimate need for such work.
Command Economies vs. Socialism
Many people believe that economic planning and communism are similar to socialism. But the two concepts are not equivalent. However, a big proponent of socialism involves replacing capital markets with some type of economic planning, so that producers can control the surplus product.