Definition of command economy: A economic model, in contrast to capitalism, in which all decisions over which goods and services are produced and in what quantity is centrally controlled, typically by a government authority which owns all aspects of production.
What is a command economy?
A command economy is a centrally-run economy, in which an elite group of economy planners make all the key economic decisions in the country.
Command economies are closely linked to the political ideology of communism, under which all resources are publicly owned.
A command economy could only feasibly operate within a communist political system because only through public ownership could a government organisation exert effective control over all aspects of production.
You’ll see a command economy used as a theoretical type of economy in the best economics books, as there are no true command economies in the real world.
What are the advantages of a command economy?
The advantage traditionally attributed to a command economy is that centralised planning can ensure that there is sufficient supply of necessary goods, such as food, water and housing. In a system of capitalism, the prices of highly demanded goods in short supply can exclude poorer citizens from enjoying that good.
The history of soaring real house price growth in the UK is a good example of market failure which could be solved through a command economy through an order to produce enough homes to meet demand and stabilise prices.
However, just because a command economy wants to produce more of a good, this doesn’t guarantee that it will happen.
In fact, it’s quite curious that the short history of command economies have been littered with such a high rate of starvation and famine.
China, North Korea and the Soviet Union all suffered from systemic famine in the 20th Century while operating economies that could be described as partial command economies.
The disadvantages of a command economy
There are many drawbacks for a command economy:
Administrative burden. When a village requires only 20 basic goods for the happiness of its citizens, the number of economic decisions required is relatively small.
However, there are literally millions of products and services available in modern economies, being effortlessly matched to millions of consumers who each have a unique set of preferences. It would require a government department of almost unlimited size to recreate the volume of economic decisions being made on a day to day basis.
Poorer decision making. It is possible to isolate specific examples of where an enforced supply quota may have been helpful in a top-down manner (such as forcing housebuilders to build more houses).
But the truth is that a centralised government department would have neither the live information nor the market expertise to be able to make economic decisions with the effectiveness as individual employees, consumers and businesses currently make.
Waste. Command-led supply chains are often charged with causing much waste. An example can be found in China, where government subsidies incentivised steel makers to build too much capacity. This led to an oversupply of steel by these factories, which flooded the global markets with a surplus of unwanted steel.
In a command economy, companies are incentivised to happily participate in creating an oversupply because it keeps them busy and higher output may be financially rewarded. These are the kinds of perverse incentives which can cause negative economic outcomes.
How is the phrase command economy used in a sentence?
“In a command economy, a centralised government authority exerts influence through its ownership of all elements of production.”
How does the definition of command economy relate to investing?
- Political instability
- Weaker rule of law
- Risk of expropriation
These risks all overlap with the idea that you may be purchasing the equities of a company which could be under the authority of a more centralised regime. This regime could make economic decisions which undermine the success of the firm you’ve invested in.