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.

Key Takeaways

  • A command economy is when government central planners own or control the means of production, and determine the distribution of output.
  • Command economies suffer from problems with poor incentives for planners, managers, and workers in state-owned enterprises.
  • Central planners in a command economy are unable to rationally determine the methods, quantities, proportions, location, and timing of economic activity across an economy without private property or the operation of supply and demand.
  • Proponents of command economies argue that they are better for achieving fair distribution and social welfare over private profit.
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Command Economy

Understanding Command Economy

Also known as a planned economy, command economies have as their central tenet that government central planners own or control the means of production within a society. Private ownership or land, labor, and capital is either nonexistent or sharply limited to use in support of the central economic plan. In contrast with free market economies, in which the prices of goods and services are set by supply and demand, central plans in a command economy set prices, control production, and limit or entirely prohibit competition within the private sector. In a pure command economy, there is no competition, as the central government owns or controls all business.

Other Characteristics of a Command Economy

In a command economy, government officials set national economic priorities, including how and when to generates economic growth, how to allocate resources to production, and how to distribute the resulting output. Often this takes the form of multi-year plans that span the entire economy.

The government that runs a command economy operates 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 manufacturing 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

With economic power consolidated in the hands of government planners and in the near or total absence of markets to communicate prices and coordinate economic activity, command economies face two major problems in efficiently planning the economy. First is the incentive problem, and second is the economic calculation or knowledge problem.

The incentive problem works in a few ways. For one, central planners and other policy makers in a command economy are all too human. Public Choice economists starting with James Buchanan have described the many ways in which state officials making decisions in their own interest can impose social costs and deadweight losses, which are clearly harmful to the national interest. Political interest groups and the power struggles between them over resources will tend to dominate policy making in a command economy even more so than in mixed or mostly capitalist economies because they are not constrained by market-based forms of discipline such as sovereign credit ratings or capital flight, so these harmful effects can be greatly increased.

Problems with incentives in a command economy also extend well beyond the central planners themselves. Because pay and wages are also centrally planned, and profits are attenuated or eliminated entirely from any role in driving economic decisions, the managers and workers of state-run enterprises have little or no incentive to drive efficiency, control costs, or contribute effort beyond the minimum required to avoid official sanction and secure their own place in the centrally planned hierarchy. Essentially, the command economy can dramatically expand principle-agent problems among workers, managers, producers, and consumers. As a result, getting ahead in a command economy means pleasing the party bosses and having the right connections, rather than maximizing shareholder value or meeting consumer demands, so corruption tends to be pervasive.

The incentive problems faced by a command economy also include the well known issue of the tragedy of the commons, but at a larger scale then in capitalist societies. Because all or most productive capital and infrastructure is commonly owned or state owned in a command economy and not owned by specific individuals, they are effectively unowned resources from the users' perspective. So all users have an incentive to extract as much use value as quickly as they can from the tools, physical plants, and infrastructure they use and little or no incentive to invest in preserving them. Things such as housing developments, factories and machinery, and transportation equipment will tend to wear out, break down, and fall apart rapidly in a command economy and not receive the kind of maintenance and reinvestment they require to remain useful.    

The problem of economic calculation in a command economy was first described by Austrian economists Ludwig von Mises and F. A. Hayek. Setting aside any problematic incentives, the practical question of the who, what, where, when, and how of economic organization is a monumental task. Central planners must somehow calculate how much of each good and service in the economy to produce and deliver; by who and to whom; where and when to do so; and which technologies, methods, and combinations of specific types of productive factors (land, labor, and capital) to use. Markets solve this problem in a decentralized manner through the interaction of supply and demand based on consumer preferences and the relative scarcity of various goods and productive factors.

In a command economy, without secure property rights or free exchange of economic goods and productive factors, supply and demand can not operate. Central planners are left with no rational method to align the production and distribution of goods and productive factors with consumer preferences and the real scarcity of resources. Shortages and surpluses for consumer goods, as well as productive resources up and down the supply chain, are the common hallmark of this problem. Tragic and paradoxical situations tend to crop up, such as bakery shelves standing empty and people going hungry while grain spoils in warehouses because of plan-mandated regional storage quotas, or vast numbers of trucks being built and then standing idle to rust because not enough trailers are available at the time.

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

Arguments in Favor of Command Economies

Command economies retain their supporters. Those who favor this 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 the absence of a legitimate need for such work. Lastly, command economies are widely believed to be superior for taking decisive, coordinated action in the face of national emergencies and crises such as wars and natural disasters. Even mostly market-based societies will often curtail property rights and greatly expand emergency powers of their central governments during such events at least temporarily.