It is said that every economy in the world is unique in some way or another. No two economies are identical. However, these economies do share many of the same features and characteristics. So, economists have been able to identify four different types of economy; traditional economy, command economy, market economy and mixed economy.
A command economy is the opposite of a free market economy. In a command economy system, there is one centralized power, which in most cases is the government. So, the government makes all decisions regarding the economy. It will decide which goods and services will be produced, in what quantities. The price will also be determined by such centralized power and not by market forces.
A command economy is a characteristic trait of a communist country. Countries like Cuba, China, and the previous USSR are practical examples of this command economy system. Such economies are also known as Planned Economies because the government plans all the forces of the economy, nothing is decided by the free market.
In such a planned economy there cannot be any competition. The government has a monopoly in almost all the businesses and sectors. All businesses follow the regulations and instructions of the government and are not influenced by the forces of the economy.
One of the biggest disadvantages of such a command economy is that the government cannot plan or provide for all its citizen’s individual needs. And so, this often leads to rationing. In an ideal world under such a command economy the government should be able to provide a living to all its citizens. However, the reality is different.
Instead of an economy based on tradition, a command system is based on goals passed down from a central ruler or ruling class. In a command economy, the ruling class or government makes all of the economic decisions, such as what goods and services will be produced, how much they should be sold for, and how much workers will be paid for producing them. Modern day examples can be found in many Communist countries, like North Korea and the former Soviet Union.
Other examples, albeit much older, include the medieval feudal system, where the lord provided the land for growing crops. In return, vassals were allowed to live on the land while providing labor and soldiers to the lord. In theory, this economic system may be beneficial if the government has the best interest of its people in mind. However, command economies can also devolve into wide-scale inequality and corruption.
- Public ownership of major industries.
- Government control of production levels and distribution quotas.
- Government control of prices and salaries.
Whereas a command economy is based around a central body, a market economy is a system where pricing decisions are decentralized. When we call something a market, we’re talking about anything that brings buyers and sellers together. For instance, e-commerce is a type of market where people are able to use the Internet to buy and sell goods.
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.1
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.