Command Economy, Its Characteristics, Pros, and Cons

Five Traits of a Command Economy

© The Balance 2018

A command economy is where a central government makes all economic decisions. Either the government or a collective owns the land and the means of production. It doesn't rely on the laws of supply and demand that operate in a market economy. A command economy also ignores the customs that guide a traditional economy. In recent years, many centrally-planned economies began adding aspects of the market economy. The resultant mixed economy better achieves their goals.

Five Characteristics of a Command Economy

You can identify a modern centrally planned economy by the following five characteristics:

  1. The government creates a central economic plan. The five-year plan sets economic and societal goals for every sector and region of the country. Shorter-term plans convert the goals into actionable objectives. 
  2. The government allocates all resources according to the central plan. It tries to use the nation's capital, labor, and natural resources in the most efficient way possible. It promises to use each person's skills and abilities to their highest capacity. It seeks to eliminate unemployment.
  3. The central plan sets the priorities for the production of all goods and services. That includes quotas and price controls. Its goal is to supply enough food, housing, and other basics to meet the needs of everyone in the country. It also sets national priorities. These include mobilizing for war or generating robust economic growth.
  4. The government owns monopoly businesses. These are in industries deemed essential to the goals of the economy. That includes finance, utilities, and automotive. There is no domestic competition in these sectors.
  5. The government creates laws, regulations, and directives to enforce the central plan. Businesses follow the plan's production and hiring targets. They can't respond on their own to free market forces. (Source: Bon Kristoffer G. Gabnay, Roberto M Remotin, Jr., Edgar Allan M. Uy, editors. Economics: Its Concepts & Principles. 2007. Rex Book Store: Manila.)

A command economy has a few advantages, although they come with a few important disadvantages as well.

Advantages

  • Can manipulate large amounts of resources for large projects without lawsuits or environmental regulatory issues.

  • An entire society can be transformed to conform to the government's vision, from nationalizing companies to placing workers in new jobs after a governmental skill assessment.

Disadvantages

  • Rapid change can completely ignore society's needs, forcing the development of a black market and other coping strategies.

  • Goods production is not always matched to demand, and poor planning often leads to rationing.

  • Innovation is discouraged and leaders are rewarded for following orders rather than taking risks.

Advantages

Planned economies can quickly mobilize economic resources on a large scale. They can execute massive projects, create industrial power, and meet social goals. They aren't slowed down by lawsuits from individuals or environmental impact statements. 

Command economies can wholly transform societies to conform to the government's vision. The new administration nationalizes private companies. Its previous owners attend "re-education" classes. Workers receive new jobs based on the government's assessment of their skills. 

Disadvantages

This rapid mobilization often means command economies mow down other societal needs. For example, the government tells workers what jobs they must fulfill. It discourages them from moving. The goods it produces aren’t always based on consumer demand. But citizens find a way to fulfill their needs. They often develop a shadow economy or black market. It buys and sells the things the command economy isn't producing. Leaders' attempts to control this market weakens support for them.

They often produce too much of one thing and not enough of another. It's difficult for the central planners to get up-to-date information about consumers' needs. Also, prices are set by the central plan. They no longer measure or control demand. Instead, rationing often becomes necessary.

Command economies discourage innovation. They reward business leaders for following directives. This doesn’t allow for taking the risks required to create new solutions. Command economies struggle to produce the right exports at global market prices. It's challenging for central planners to meet the needs of the domestic market. Meeting the needs of international markets is even more complex.

Examples

Here are examples of the most well-known countries with command economies:

  • Belarus: This former Soviet satellite is still a command economy.The government owns 80% of the country's businesses and 75% of its banks. 
  • China: After World War II, Mao Tse Tung created a society ruled by Communism. He enforced a strictly planned economy. The current leaders are moving toward a market-based system. They continue to create five-year plans to outline economic goals and objectives.
  • Cuba: Fidel Castro's 1959 revolution installed Communism and a planned economy. The Soviet Union subsidized Cuba’s economy until 1990. The government is slowly incorporating market reforms to spur growth.
  • Iran: The government controls 60% of the economy through state-owned businesses. It uses price controls and subsidies to regulate the market. This created recessions, which it has ignored. Instead, it devoted resources to expanding its nuclear capability. The United Nations imposed sanctions, worsening its recessions. The economy improved once the nuclear trade deal ended sanctions in 2015. 
  • Libya: In 1969, Muammar Gaddafi created a command economy reliant upon oil revenues. Most Libyans work for the government. Gaddafi had been instituting reforms to create a market-based economy. But his 2011 assassination halted these plans.
  • North Korea: After World War II, President Kim Il-sung created the world's most centrally-planned economy. It created food shortages, malnutrition, and several bouts of mass starvation. Most state resources go into building up the military. 
  • Russia: In 1917, Vladimir Lenin created the first Communist command economy. The Russian people were ready for a radical change, having suffered starvation during World War I. Joseph Stalin built up military might and quickly rebuilt the economy after World War II. The Soviet State Planning Committee, or “Gosplan,” has been the most-studied command economy entity. The USSR was also the longest-running command economy, lasting from the 1930s until the late 1980s. Then, the state transferred ownership of the largest companies to oligarchs

In 2018, command economies like China, Russia, and Iran have shifted toward more economic freedom, while North Korea and Cuba still remain economically repressed.

Below you can see a world ranking countries by level of economic freedom, from the most free to the most repressed.

Development of the Theory 

Viennese economist Otto Neurath developed the concept of a command economy after World War I. Neurath proposed it as a way to control hyperinflation. The phrase “command economy” comes from the German word "Befehlswirtschaft.” It described the fascist Nazi economy. (Source: John Eatwell, Murray Milgate, Peter Newman, "Problems of the Planned Economy," 1990. p 58.)

But centrally planned economies existed long before Nazi Germany. They included the Incan empire in 16th century Peru and the Mormons in 19th century Utah. The United States used a command economy to mobilize for World War II.  (Source: John Gary Maxwell, "The Civil War Years in Utah." University of Oklahoma Press. 2016. "Inca Government and Economy." Early Civilizations in the Americas Reference Library, edited by Sonia G. Benson, et al., vol. 1: Almanac, Vol. 1, UXL, 2005, pp. 179-198. World History in Context.) 

The Bottom Line

A command economy does not allow market forces like supply and demand to determine what, how much, and at what price they should produce goods and services. Instead, a central government plans, organizes, and controls all economic activities, discouraging market competition. Its goal is to allocate resources to maximize social welfare. 

The main advantage is that the government can rapidly move resources and transform the structure of society to achieve a national goal. But there is not much room for innovation. As a result, China, Russia, and Vietnam have veered away from a pure command economy. They've combined elements from both command and free market economies.