A command economy is where economic decisions are planned out in detail by a central government authority. The plan is implemented through laws, regulations and directives. Businesses follow production and hiring targets instead of individually and freely responding to the laws of supply and demand. Central planners seek to replace the forces that operate in a free market economy, and the customs that guide a traditional economy, to attain specific societal goals.
The concept of a command economy was developed by Viennese economist Otto Neurath as a method to control the hyperinflation after World War I. The phrase comes from the German "Befehlswirtschaft" and was initially used to describe the Nazi economy. However, centrally planned economies were in existence before then, including the Incan empire in 16th century Peru, the Mormons in 19th century Utah, and even the U.S. during World War II mobilization. (Source: Richard Erickson and Barry Ickes, Review of Economic Design, "A Model of Russia's Virtual Economy,", 2001, 6, 185-214.)
Characteristics of a Command Economy
A modern centrally planned economy can be identified by the following five characteristics:
1. The government creates a central economic plan for all sectors and regions of the country. It typically starts with a five-year plan to set the overriding economic goals. This is broken down into shorter-term plans to convert the goals into actionable objectives. The goal of the five-year plan is to generate robust economic growth, increase production efficiency and best utilize scarce resources. For the most part, a command economy needs a political system that is also centrally planned.
2. The government allocates all resources according to the central plan. The goal is to use the nation's capital, labor and natural resources in the most effective way possible. This pretty much eliminates unemployment by promising to use each person's skills and abilities to their highest capacity.
3. The central plan sets the priorities for production of all goods and services. The goal is to supply enough food, housing and other basics to meet the needs of everyone in the country. In addition, it may have other priorities, such as mobilizing for war or increasing the nation's economic growth.
4. The government owns a monopoly business in industries deemed important to the goals of the economy. This usually includes finance, utilities, and automotive. There is no domestic competition in these industries.
5. The government creates the laws that regulate economic activity. These include regulations, directives and wage/price controls to implement the central plan. (Source: Bon Kristoffer G. Gabnay, Roberto M Remotin, Jr., Edgar Allan M. Uy, editors. Economics: Its Concepts & Principles. 2007. Rex Book Store: Manila)
Command Economy Advantages
Centrally planned economies are great at mobilizing economic resources quickly, effectively and on a large scale. They can execute massive projects, create industrial power and attain imperative social goals. They are able to override individual self-interest, and subjugate the welfare of the general population, to achieve a greater agreed-upon goal for the society at large.
Command economies are also good at wholly transforming societies to conform to the planner's vision, as in Stalinist Russia, Maoist China and Castro's Cuba. For example, the command economy in Russia built up an effective military might and quickly rebuilt the economy after World War II.
Command Economy Disadvantages
This rapid mobilization often means command economies mow down other societal needs. For example, workers are often told what jobs they must fulfill and are even discouraged from moving. However, people won't ignore their own needs for long. They often develop a shadow economy, or black market, to buy and sell the things the command economy isn't producing. The efforts of leaders to control this market can ultimately weaken support for the central planning authority.
Instead of leading to efficiency, command economies often produce too much of one thing and not enough of another. That's because it's difficult for the central planners to get up-to-date information about consumers' needs. In addition, prices are set by the central plan, and so can't be used to measure or control demand. Instead, rationing often becomes necessary.
Command economies are not good at stimulating innovation. Businesses are focused on following directives, and are discouraged from making any autonomous decisions.
Centrally planned economies also have trouble producing the right exports at global market prices. It's difficult for the various planning sectors to coordinate with each other, not to mention foreign countries' needs.