Command Economy: Advantages and Disadvantages

How a command economy compares to a free market economy

Fact checked by Kimberly OvercastReviewed by Robert C. KellyFact checked by Kimberly OvercastReviewed by Robert C. Kelly

A command economy is one in which a centralized government controls the means of production. This has both advantages and disadvantages when compared to a free-market economy, in which supply and demand dictate output and prices.

Command economies are associated with socialist and communist nations, whereas free-market economies are associated with capitalism.

In reality, no economy is purely free-market nor entirely controlled by a government. Modern economies exist along a spectrum with certain aspects favoring one type or the other. For example, in Europe, some critical industries may be government-owned and run. In China, the communist government has allowed special free-trade zones and cities to proliferate.

Even the United States, the beacon of capitalism, can be considered a mixed economy, with private enterprise and government both playing important roles.

Key Takeaways

• A command economy is one in which a centralized government controls the means of production and determines output levels.
• Command economies stand in contrast to free-market economies, in which the law of supply and demand determines output and prices.
• Command economy advantages include low levels of inequality and unemployment.
• Disadvantages of command economies include a lack of innovation and efficiency.

An Overview

In a command economy, the government determines what is produced, how it is produced, and how it is distributed. Private enterprise does not exist. The government employs all workers and unilaterally determines their wages and job duties as well as the prices of products.

There are benefits and drawbacks to command economy structures. Command economy advantages include low levels of inequality and unemployment and the common objective of replacing profit as the primary incentive of production.

Command economy disadvantages include a lack of competition, which can lead to a lack of innovation and efficiency.

The Advantages of a Command Economy

Less Inequality

Because the government controls the means of production in a command economy, it determines who works where and how much they are paid. This power structure contrasts sharply with a free market economy, in which private companies control the means of production and hire workers based on business needs, paying them wages set by market forces.

In a free-market economy, the law of supply and demand dictates that workers who have unique skills in high-demand fields receive high wages for their services, while low-skill individuals in fields that are saturated with workers settle for meager wages if they can find work at all.

Low Unemployment Levels

Unlike the invisible hand of the free market, which cannot be manipulated by a single company or individual, a command economy government can set wages and job openings to achieve the unemployment rate and wage distribution that it sees fit.

Common Good vs. Profit Priority

The motivation for profit drives most business decisions in a free market economy. It is a non-factor in a command economy.

A command economy government can tailor products and services to benefit the common good without regard to profits and losses. For example, most true command economy governments, such as Cuba’s, offer free, universal healthcare coverage to their citizens.

The Disadvantages of a Command Economy

Lack of Competition Inhibits Innovation

Critics argue that the inherent lack of competition in command economies hinders innovation and keeps prices from resting at an optimal level for consumers.

Although those who favor government control criticize private firms that esteem profit above all else, it is undeniable that profit is a motivator and drives innovation.

At least partly for this reason, many advancements in medicine and technology have come from countries with free-market economies such as the United States and Japan.

Inefficiency

Efficiency is compromised when the government acts as a monolith, controlling every aspect of a country’s economy.

The nature of competition forces private companies in a free market economy to minimize red tape and keep operating and administrative costs to a minimum. If they get too bogged down with expenses, they earn lower profits or need to raise prices to meet expenses. Ultimately, they are driven out of the market by competitors capable of operating more efficiently.

Production in command economies is notoriously inefficient as the government feels no pressure from competitors or price-conscious consumers to cut costs or streamline operations. They also may be slower to respond—or may be completely non-responsive—to consumer needs or changing tastes.

What Are the Pros and Cons of a Free Market Economy vs. a Command Economy?

Because a command economy is centrally planned, its pros include efficiency, theoretical equality between citizens, a focus on the common good rather than profit, and low or non-existent unemployment.

Some of the potential cons include a lack of efficient resource allocation, lack of innovation, and poor planning that ignores the needs and preferences of the population.

Free market economies are the opposite. They encourage innovation, efficient resource allocation, and competition. Businesses must meet the needs of consumers or be replaced.

The cons of a free market include a prioritization of profits over all else, including worker welfare.

How Does a Command Economy Benefit and Harm People?

A command economy benefits its citizens because the government ensures that all individuals are employed. The welfare of the nation’s workers is prioritized over profit.

It is harmful because the needs and wants of the nation’s citizens may go unmet.

Furthermore, an absence of rewards for individual achievement leads to a lack of innovation and, often, poor-quality products.

What Are the Benefits of Moving from a Command Economy to a Market-Based System?

The benefits include higher quality goods, better pricing, efficient allocation of resources, and rewards for individuals who are willing to take risks.

The Bottom Line

Command economies appear to come with many advantages, including low or non-existent unemployment, equality amongst citizens, and a focus on the welfare of the worker as opposed to profits.

Despite these advantages, command economies have proved to be inefficient. The absence of incentives causes a lack of innovation, while the needs and wants of the nation’s consumers are not met.

Read the original article on Investopedia.