What Is a Command Economy?

Command Economies Explained

Illustration of 5 characteristics of a command economy

The Balance

A command economy is one in which 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 and it ignores the customs that guide a traditional economy.

Learning how these economies work, such as their pros and cons, can help give a better sense of how different economies operate and interact with each other.

Definition and Examples of a Command Economy

A command economy is one based on complete control by the government. A variety of administrative efforts, such as commands, laws, and national goals, are used to coordinate complex social and economic systems.

In other words, command economies are authoritarian economic structures in which a political or social hierarchy is solely responsible for making decisions about the economy. The decisions made by these leaders are followed by players throughout the economy, all the way down to individual laborers.

Examples of Command Economies

Consider these examples of 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 wide swathes of the economy through a mix of direct and indirect state control. This control has created inefficiencies and recessions, and sanctions from the international community worsened these hardships. These sanctions ended in 2015 under a nuclear trade deal, before being reimposed by the U.S. in 2018 after President Trump pulled out of the deal.
  • Libya: The Libyan economy is almost entirely dependent upon the oil and gas sector, and most Libyans work for the government.
  • North Korea: For decades, North Korea has had one of the world's most centrally-planned economies. The U.S. government considers North Korea's industrial capital stock to be nearly beyond repair due to mismanagement, underinvestment, and material shortages. Citizens of North Korea face ongoing famine and starvation issues.
  • Russia: In 1917, Vladimir Lenin and the Russian Revolution created the first Communist command economy. The Union of Soviet Socialist Republics (USSR) was also the longest-running command economy, lasting from the 1930s until the late 1980s. Since the fall of the USSR, the Russian state has transferred ownership of the largest companies to oligarchs

Some centrally-planned economies, like China and Russia, have begun adding aspects of the market economy, and this creates a mixed economy. Other economies, like North Korea and Cuba, remain economically restrained.

How Command Economies Work

In a modern, centrally planned command economy, the government creates a central economic plan. The government may establish a five-year plan, for example, that sets economic and societal goals for every sector and region of the country. Shorter-term plans convert the goals into actionable objectives. 

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.

Command economies aim to use each person's skills and abilities to their highest capacity. By doing so, a command economy also seeks to eliminate unemployment.

The central plan sets the priorities for the production of all goods and services. That includes quotas and price controls. The goal is to supply enough food, housing, and other basics to meet the needs of everyone in the country. The central plan also sets national priorities on issues like mobilizing for war.

The government owns monopoly businesses in industries deemed essential to the goals of the economy, including finance, utilities, and automotive sectors. There is no domestic competition in sectors that become part of the command economy.

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.

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.

While the word stems from Nazi Germany, centrally planned economies existed long before that. Any time a government imposes control over industries rather than letting market forces dictate economics, then that's an example of a command economy. Even the U.S., which traditionally values free-market economics, has used aspects of command economies, such as directing materials to war efforts during World War II.

Economic Freedoms Around the World

Below you can see national rankings by the level of economic freedom, from the freest to the most repressed.

Pros and Cons of a Command Economy

Pros
  • Speed

  • Unity

Cons
  • Ignores consumer preferences

  • Inefficiencies

  • Innovation is discouraged

Pros Explained

  • Speed: 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. 
  • Unity: Command economies can wholly transform societies to conform to the government's vision. The new administration can nationalize private companies and impose laws on citizens as needed to ensure that the entire country works in unity toward a specific goal. Workers may receive new jobs based on the government's assessment of their skills and how they can best work in unity with other aspects of the economy.

Cons Explained

  • Ignores consumer preferences: This rapid mobilization often means command economies mow down other societal needs. For example, the government tells workers what jobs they must fulfill, and this discourages them from moving. The goods produced aren’t always based on consumer demand. However, citizens find a way to fulfill their needs and desires, and this often results in a shadow economy or black market that buys and sells things the command economy isn't producing. Leaders' attempts to control this market weakens support for them.
  • Inefficiencies: Command economies often produce too much of one thing and not enough of another. It's difficult for central planners to get up-to-date information about consumers' needs. Meeting the needs of international markets is even more complex, so command economies struggle to produce the right exports at globally competitive market prices.
  • Innovation is discouraged: Command economies reward business leaders for following directives. This system doesn’t allow for taking risks required to create new solutions.

Key Takeaways

  • A command economy is one in which the central government plans, organizes, and controls all economic activities to maximize social welfare. 
  • Command economies, as opposed to free-market economies, do not allow market forces like supply and demand to determine production or prices.
  • Command economies threaten to stifle innovation, and they often create inefficiencies, which is why former prominent command economies like China and Russia have become mixed economies by incorporating more free-market forces over time.