Command Economy

What is the Definition of a Command Economy?

In economics, the command economy—often used interchangeably with the term “planned economy”—refers to an economic system in which the government controls the goods and services produced, the quantity produced, resource allocation (i.e., capital spending), production methods, and the pricing at which the products and services are distributed.

In simple terms, a command economy is an economic system where the central government has the right to oversee all decisions regarding the production, distribution, and consumption of goods and services.

In a command economy, the government is the primary decision-maker, determining what goods and services should be produced, in what quantities, and at what prices.

The following list contains the common characteristics of a command economy from a high level:

• Government Determines Economic Priorities
• Limited Individual Sovereignty (and Economic Freedom)
• No (or Limited) Competition between Businesses
• Consumers have Limited Choices (Fewer Options)
• Government Decides Production and Resource Allocation
• Government Sets Prices of Goods and Services
• Businesses are Not for Individual Profit (i.e. Serves the State)

Centralized planning aims to allocate resources in a way that maximizes social welfare and minimizes economic disparities.

By controlling production and distribution, the government can theoretically ensure that goods and services deemed as basic necessities are available to all citizens, regardless of their income or social status

The distinct attribute of a command economy is the level of involvement by the central government (or the state) in deciding the overarching direction and strategic initiatives that underpin a country’s economic structure.

The command economy stands in stark contrast to the free market economic system, where competition and the supply and demand market forces determine the production output and prices of goods and services.

Command economies are closely tied with the political system of communism, which is based on the objective of eliminating the discrepancy between socioeconomic class by creating a society in which everyone has their fair share of the benefits of labor and the state controls all resources, property, and wealth in the country.

The total production (output) and pricing in a country with a command economy revolve around decisions made at the discretion of the central government (or state), which possesses complete control over the country’s economic decisions — contrary to the occasional governmental intervention observed in other countries, such as the United States (US), which is classified as a mixed economy.

Karl Marx, a political theorist widely recognized for coming up with the foundational principles of communism, argued for the “common ownership of the means of production”.

Marx was a vocal critic of capitalist economies for a variety of reasons, but the disproportionate concentration of wealth in society, in particular.

What is the Purpose of a Centrally Planned Economy?

In a command economy, the government (or state) is positioned as the primary decision-maker, especially for choices pertaining to economic activity.

The government, or central authority, can determine what specific goods and services should be produced, in what quantities, and at what prices.

Centralized planning aims to allocate resources and is oriented toward maximizing social welfare and fairness while minimizing economic disparities.

By controlling production and distribution, the government can theoretically ensure that essential goods and services are available to all consumers in a country, irrespective of their income level or social status.

The command economy is centrally planned with a structure designed to efficiently and fairly meet the needs of a country, inclusive of all constituents.

The economic system is characterized by the central government’s control over all major aspects of economic activities, including the means of production (or production decisions), distribution channels, and pricing mechanisms.

The core economic objective of a command economy is to ensure that all individuals who reside in a country have access to the goods and services deemed necessary by the central authority.

The public ownership innate to a planned economy is intended to impede the gradual accumulation of wealth, concentrated in the hands of a few, thereby promoting social equality.

According to command economy proponents, the government is entitled to control the means of production (e.g., factories, farms, and natural resources).

Why? By eliminating private ownership, the government can direct economic activities toward achieving national goals, such as industrialization, infrastructure development, and social welfare programs.

Command economies can prevent mass unemployment, often a feature of capitalist economies (and the free market political system).

Note: The purpose of a command economy stated in the current section is from the perspective of command economy proponents. The positive effects on the economy, such as a higher employment rate, which proponents of command economies argue for, might not materialize, as confirmed by historical precedence.

What are the Characteristics of a Command Economy?

A command economy, or planned economy, is characterized by the central government’s control over all major aspects of economic activities.

The key characteristics of a command economy are as follows:

• Centralized Planning ➝ The central government is self-imposed with the right to plan and direct most— if not all—economic activities from a centralized location. The decisions at the discretion of the central government include deciding the long-term strategy of the country with regard to production, setting near-term and long-term production goals to compete in trade, allocating resources per instructions, and determining the distribution of goods and services.
• State Ownership ➝ The central government, or “state”, owns and controls the means of production, most notably property such as land and factories, as well as other resources. The concept of private property is either limited or non-existent in a command economy, as government ownership prevails.
• Fixed Price Structure ➝ In a command economy, the prices for goods and services are set by the central government rather than the supply and demand market forces. While the intent is to control inflation and ensure affordability for all consumers, the outcome of such policies—which neglect the free market and the necessity of competition—is most often an imbalanced, unstable economy that undergoes periods of hyperinflation (or deflation).
• Limited Consumer Choice ➝ Consumers in command economies have limited options as the government decides the producers and what products are available in the market. The artificial restrictions placed by the government are the reason why command economies often face shortages and surpluses since the government, rather than the supply and demand in the market, determines the products and services produced, the means of production, and the prices of goods.
• Lack of Competition ➝ There is practically no competition among businesses in a command economy, considering the government controls (and closely monitors) internal and external economic activities—which, in theory—can potentially stifle innovation and efficiency with regard to production (i.e. less output).
• Loss of Individual Sovereignty ➝ Since the central government decides on behalf of individuals and businesses, the loss of individual sovereignty and constraints often reduces motivation to undertake risk and pursue activities with the potential to create economic value and benefit society as a whole, which often coincides with limited entrepreneurship.

What is a Pure Command Economy?

In a pure command economy, the central government has complete ownership and control of all business activities and resources, so all means of production are publicly owned.

In other words, the central government (or government authority) owns the right to control the economic activities and priorities in entirety.

However, akin to how a pure free market economy can be theorized about but not achieved, the same rule applies to a pure command economic system. The central planners might have control from a high level on most major economic decisions, but complete control over an entire country is not feasible.

For example, a country categorized as a command economy is not capable of controlling its currency’s exchange rate or the prices at which the securities issued by the government (e.g. government bonds) are priced in the capital markets.

Why? The yield and price of a bond are determined by the market (supply-demand), not by government controls.

Command Economy: What are the Pros and Cons?

Command Economy Advantages

• Low Unemployment ➝ The government can ensure that everyone has a job by controlling employment directly. The centralized control allows the government to allocate jobs to all citizens, theoretically reducing unemployment to near zero.
• Social Welfare ➝ The government can prioritize social welfare over profit, providing essential services like healthcare and education at low or no cost. This focus on social welfare aims to ensure that all citizens have access to necessary services, promoting equality and improving overall quality of life.
• Economic Stability ➝ Centralized control can theoretically prevent economic cycles of boom and bust, leading to more stable economic conditions. By managing production and prices, the government can maintain steady economic growth and avoid the volatility often seen in free-market economies.

Command Economy Disadvantages

• Economic Inefficiency ➝ Central planning often leads to inefficient resource allocation, as the government may not have accurate information about consumer needs and market conditions. In effect, the outcome is oftentimes a surplus (i.e. overproduction of some goods) and shortages of others (i.e. not enough production of certain goods), which creates “waste” and inefficiency.
• Misaligned Incentive Structure ➝ The absence of competition reduces the incentive for businesses to innovate and improve their products and services. Without the pressure of market competition, there is minimal motivation for efficiency or technological advancement, which can stifle economic growth and development.
• Limited Freedom (Individualism) ➝ Citizens have limited economic freedom, considering the government controls most aspects of their economic life, including employment and consumption choices. The absence of personal and economic freedom (including the profit motive) can lead to dissatisfaction and a lack of motivation among individuals and businesses.
• Significant Costs ➝ Command economies can come with substantial costs, especially for countries with minimal allies or existing tensions with surrounding countries. For such countries like North Korea, the government must allocate a significant portion of its budget to its military to mobilize resources in preparation for wartime or other geopolitical conflicts.

List of Countries with Command Economy

The following list contains examples of countries that formerly had or currently have a command economy.

Command Economy vs. Free Market: What is the Difference?

A command economy and a free market economy represent two distinct approaches to managing economic activity, each with its unique set of principles.

• Centralized vs. Decentralized Economy ➝ In a command economy, the government or a central authoritative entity makes all economic decisions, including what goods and services are produced, how they are produced, and at what prices they are sold. The centralized structure, where the government has a disproportionate level of control over the economy, aims to achieve social goals and economic objectives, such as reducing inequality and ensuring employment. However, the party that determines the definition of equality and what is “fair” is the government. In contrast, a free market economy—which is closely tied to the concept of capitalist economies—is reliant on individual sovereignty and the private sector to make economic decisions based on supply and demand. Prices in a free market are determined by supply and demand market forces (and competition) without government intervention, promoting efficiency and innovation via competition.
• Private Ownership vs. State Ownership (Public) ➝ The ownership of resources is another difference between the command and free market economies. In a command economy, the government owns and controls the means of production and decides the allocation of resources. In effect, state ownership (or public ownership) provides the government with the right to direct resources toward achieving its social and economic goals, which, to reiterate, were set by the government itself. On the other hand, in a free market, resources are owned by private individuals and businesses. The private sector controls production and distribution, driven by the profit motive. The decentralized ownership inherent to a free market economic system—contrary to centralized ownership—encourages entrepreneurship and allows market forces to allocate resources efficiently.
• Profit Motive vs. Prioritization of Social Welfare ➝ The motivation and incentives present in an economy differ significantly between command and free market economies. In a command economy, the primary motivation is to achieve social goals and economic objectives, while profit comes second, exceptions aside. The prioritization of social welfare can lead to reduced inequality and guaranteed employment but often results in inefficiency and a lack of innovation from the absence of competition. Conversely, in a free market economy, the private sector is driven by the profit motive. Individuals and businesses act in their self-interest and undertake risk to reap the reward if the outcome is favorable. Since businesses compete to meet consumer demands and adjust to constantly meet their changing preferences, the focus is to maximize profits — but to achieve said objective requires understanding consumers and their needs (“pain points”) to offer a product that provides value to their end market. However, the drawback to the focus on profit maximization can lead to significant income and wealth disparities at the expense of neglecting social welfare over the long run.
• Consumer Preferences vs. Government Objectives ➝ Consumer choice and price setting further highlight the differences between these economic systems. In a command economy, consumer preferences are often disregarded as the government decides what products are available, leading to potential shortages and surpluses. Prices are set by the government to control inflation and ensure affordability, which can result in price distortions and inefficiencies. In contrast, a free market economy offers consumers a wide range of choices, with their preferences directly influencing what is produced. Because the prices of goods and services are determined by supply-demand, the long-term effect is a net positive, as that will contribute to more efficient resource allocation, where the pricing reflects the “fair value” of goods and services.

Command Economy vs. Mixed Economy: What is the Difference?

Command economies prioritize social welfare and equality, while mixed economies aim to balance efficiency, innovation, and social welfare.

Most modern economies nowadays operate as mixed economies, including the United States (U.S.), United Kingdon (UK), Norway, and Germany.

In a mixed economy, prices and production levels are contingent on supply and demand, but the government might intervene at times to regulate prices, provide subsidies, or impose taxes if deemed necessary.

Command economies are characterized by centralized control and public ownership, whereas mixed economies blend market mechanisms with government intervention to achieve a balance between efficiency and social welfare.

The noteworthy benefits of a mixed economy are the economic efficiency and innovation driven by competition in the private sector, the provision of public goods and reduction of economic inequalities through progressive taxation and social welfare programs, and the flexibility to adapt to fluctuations in economic conditions via governmental intervention (e.g. raising or lowering the market interest rate).

• Government Control vs. Limited Intervention ➝ A command economy is characterized by the central government’s complete control over all significant components of a country’s economic activities. In an economic system based upon central planning, the government determines what goods and services are produced, the methods of production, and the distribution mechanisms, including setting production targets, prices, and wages.
• Central Planning vs. Profit Motive ➝ Economic decisions in command economies are made by central planners who aim to allocate resources in a manner that maximizes social welfare, which takes precedence over profits. In contrast, a mixed economy blends elements of free market and command economies, featuring a combination of private enterprise (i.e. supply-demand, competition) and limited government intervention. Competition is perceived as a critical factor in promoting economic growth, including entrepreneurship.
• Production Control vs. Supply Demand (Competition) ➝ In a command economy, the government exercises complete control over production decisions, whereas, in a mixed economy, production is primarily driven by market forces with a limited degree of government intervention.
• Private vs. Private + Public Ownership ➝ Command economies feature public ownership, while mixed economies combine private and public ownership. The means of production, such as factories and resources, are owned by the state, with government ownership either non-existent or restricted in a command economy.
• Price Control vs. Market-Based Pricing ➝ The government sets prices in a command economy, whereas in a mixed economy, prices are determined by supply and demand with some regulatory oversight.

Command Economy Example: Venezuela

The country of Venezuela is a real-life example of a modern command economy (or planned economy), where the government exerts significant control over economic activities, including production, pricing, and distribution of goods and services. Centralized control has led to various economic challenges and crises over the years.

The Venezuelan government first implemented price controls in 2003 under President Hugo Chávez, in an effort to counter inflation and protect the low-income class.

The aforementioned price controls were expanded and reinforced under President Nicolás Maduro. The government set prices for approximately 400 basic food items and other essential goods, including rice, cooking oil, coffee, sugar, powdered milk, cheese, and tomato sauce.

In 2014, the Fair Prices Law was enacted, creating the Superintendence for the Defense of Socio-Economic Rights (SUNDDE) — which established price controls and “profit caps” for goods and services.

The price controls were originally intended to make essential goods affordable, yet the outcome was that prices were often insufficient to cover production costs — resulting in widespread shortages and the subsequent removal of certain items from the market.

Price controls led to widespread scarcity of basic goods, as many products became unavailable in official markets, forcing consumers to turn to black markets where goods were sold at significantly higher prices (i.e. scarcity value).

The economic hardship for many Venezuelans was exacerbated, as they had to spend hours in queues to buy rationed goods or pay inflated prices in the black market.

The lack of competition and government control over production resulted in lower-quality products and limited variety.

Why? The producers of goods and services had minimal incentive to innovate or improve their products, which led to a stagnant market where consumer needs were not adequately met.

In response to the uncertainty of product availability, consumers resorted to hoarding whenever goods were available, further aggravating the widespread shortages.

Combined, Venezuela soon after experienced hyperinflation, with the consumer price index reaching 193% in 2023, which was actually a decrease from prior years — illustrating the poor conditions of the Venezuela economy.

The hyperinflation was driven by a multitude of factors, including the following:

• Negative Impact of Price Controls
• Depreciating Currency (Devaluation of Currency)
• Unfavorable Exchange Rate (FX)
• Monetization of the Public Deficit (“Money-Printing”)

^{Venezuela’s Economy Is Growing Again After Steep Decline [Source: International Monetary Fund (IMF)]}

Since 2013, Venezuela has continued to suffer from a long-standing recession, with its gross domestic product (GDP) contracting substantially.

The reliance on oil exports and the decline in oil prices further compounded the economic challenges. The economic crisis led to high unemployment rates and increased poverty.

Even after multiple hikes in the minimum wage, real wages have not kept up with the inflation rate, severely reducing the purchasing power of consumers and increasing food insecurity (i.e. limited access to food).

The Venezuelan government has attempted to mitigate the economic crisis through various measures, including social spending funded by oil revenues. However, efforts have often been undermined by corruption, mismanagement, and the inefficiencies inherent in a command economy — albeit the country has made positive progress in recent times.

The Venezuelan bolívar—the official currency of Venezuela—underwent several redenominations in the face of hyperinflation.

• Bolívar Fuerte (VEF) ➝ The bolívar fuerte (VEF) was introduced in 2008, replacing the original bolívar at a rate of 1,000 VEF to 1 VEF in response to the inflation.
• Sovereign Bolívar (VES) ➝ In 2018, the sovereign bolívar (VES) replaced the bolívar fuerte at a rate of 100,000 VES to 1 VES.

Even after these changes, the currency continues to lose value rapidly, with the exchange rate reaching 3,640,690 VEF per 1 USD, per recent conversion rate data.

• USD to VEF Exchange Rate ➝ 1 USD = 3,640,825.01 Venezuelan Bolívares (or 1 VEF = 0.000000274663 USD)
• USD to VES Exchange Rate ➝ 1 USD = 36.4058 Venezuelan Bolívar (or 1 VES = 0.027466302 USD)

^{Venezuela Hyperinflation Economic Data (Source: Bloomberg)}

The economic downfall of Venezuela illustrates the challenges and pitfalls of extensive government intervention in economic activities.

While the intent behind implementing price controls and centralized planning was to protect the poor and ensure affordability, the result has been widespread scarcity, hyperinflation, and economic hardship for the population.

The lack of competition and innovation, coupled with bureaucratic inefficiencies, has further limited consumer choice and exacerbated the economic crisis.

In closing, the ongoing economic and political turmoil has led to a significant humanitarian crisis, with millions of Venezuelans fleeing the country in search of better living conditions.

^{Economic Crisis — Fleeing Venezuela (Source: Mercy Corps)}