Shock therapy (economics)
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In economics, shock therapy is the sudden release of price and currency controls (economic liberalization), withdrawal of state subsidies, and immediate trade liberalization within a country, usually also including large-scale privatization of previously public-owned assets.
Overview
Shock therapy is an economic program intended to transition a planned economy or developmentalist economy to a free market economy through sudden and dramatic neoliberal
reform. Shock therapy policies generally include ending price controls,
stopping government subsidies, moving state owned industries to the
private sector and tighter fiscal policies, such as higher tax rates and
lowered government spending.[1]
The term was popularized by Naomi Klein. In her 2007 book The Shock Doctrine, she argues that neoliberal free market policies (as advocated by the economist Milton Friedman) have risen to prominence globally because of a strategy of "shock therapy".[2].
She argues these policies are often unpopular, result in greater
inequality and are accompanied by political and social "shocks" such as
military coups, state sponsored terror, sudden unemployment and the
suppression of labor. Johan Norberg of the Cato Institute
criticized the book, saying that the concept of shock therapy is
falsely attributed to Friedman. According to Norberg, Friedman's quote
("Only a crisis—actual or perceived—produces real change") is taken out
of context and misinterpreted.[3] Klein's response argues that Norberg is "vastly inflating the role I attribute to Milton Friedman."[4]
The economist Jeffrey Sachs
(sometimes credited with coining the term) says he never picked the
term "shock therapy", does not much like it, and asserts that the term
"was something that was overlaid by journalism and public discussion"
and that the term "sounds a lot more painful in a way than what it is".
Sachs' ideas on what has been referred by non-economists as "shock
therapy" were based on studying historic periods of monetary and
economic crisis and noting that a decisive stroke could end monetary
chaos, often in a day.</ref name=PBS/>
The first instance of shock therapy was the neoliberal reforms of Chile in 1975,[5] carried out after the military coup by Augusto Pinochet. The reforms were based on the liberal economic ideas centered on the University of Chicago.
The term is also applied to Bolivia's case. Bolivia successfully tackled hyperinflation in 1985 under President Victor Paz Estenssoro and Minister of Planning Gonzalo Sánchez de Lozada, using Sachs' ideas.[citation needed] In particular, Sachs and Sanchez de Lozada cited West Germany
as inspiration where, during 1947–48, price controls and government
support were withdrawn over a very short period, kick-starting the
German economy and completing its transition from an authoritarian post-War state.[citation needed]
Economic liberalism
rose to prominence after the 1970s and liberal shock therapy became
increasingly used as a response to economic crises, for example by the International Monetary Fund (IMF) in the 1997 Asian Financial Crisis.[citation needed]
Liberal shock therapy became very controversial, with its proponents
arguing that it helped to end economic crises, stabilise economies and
pave the way for economic growth, while its critics (like Joseph Stiglitz) believed that it helped deepen them unnecessarily[6] and created unnecessary social suffering.[citation needed]
In Russia and other post-Communist states, neoliberal reforms based on the Washington Consensus resulted in a surge in excess mortality[7][8] and decreasing life expectancy,[9] along with rising economic inequality and poverty.[10] The Gini ratio increased by an average of 9 points for all former socialist countries.[10] Some countries that used shock therapy (e.g., Poland, Czech Republic) did better than those that did not.[citation needed] The average post-communist country had returned to 1989 levels of per-capita GDP by 2005,[11] although some are still far behind that.[12] To further cloud understanding, China made its highly successful transition in a gradualist fashion.[citation needed] According to William Easterly, successful market economies rest on a framework of law, regulation, and established practice[13]
that cannot be instantaneously created in a society that was formerly
authoritarian, heavily centralised, and subject to state ownership of
assets.[14] German historian Philipp Ther asserted that the imposition of shock therapy had little to do with future economic growth.[15]
History
West Germany 1948
Though the term shock therapy only came into existence after Bolivia's actions in 1985, both Gonzalo Sánchez de Lozada (the architect of the policy in Bolivia) and Jeffrey Sachs (its economic architect) were heavily influenced by West Germany's reforms in 1948.[citation needed]
Background
Germany ended the European Theatre of World War II with its unconditional surrender on the 8 May 1945.
It faced war damage to its economy and the problems of mass migration
due to the expulsion of ethnic Germans from areas east of the
Oder-Neisse Line.[citation needed]
April 1945 to July 1947 saw the Allied occupation of Germany implement Joint Chiefs of Staff directive 1067 (JCS 1067).
This directive aimed to transfer Germany's economy from one centred on
heavy industry to a pastoral one to prevent Germany from having the
capacity for war. Civilian industries that might have military
potential, which in the modern era of "total war" included virtually
all, were severely restricted. The restriction of the latter was set to
Germany's approved peacetime needs, which were set on the average
European standard. To achieve this, each type of industry was
subsequently reviewed to see how many factories Germany required under
these minimum level of industry requirements. In May 1946, the first
plan stated that German heavy industry must be lowered to 50% of its
1938 levels by the destruction of 1,500 listed manufacturing plants.
Restrictions on steel followed.[citation needed]
It soon became obvious that this policy was not sustainable.
Germany could not grow enough food for itself and malnutrition was
becoming increasingly common. The European post-war economic recovery
did not materialise and it became increasingly obvious that the European
economy had depended on German industry.[16]
In July 1947, President Harry S. Truman rescinded on "national
security grounds" the punitive JCS 1067, which had directed the U.S.
forces of occupation in Germany to "take no steps looking toward the
economic rehabilitation of Germany." It was replaced by JCS 1779, which
instead stressed that "[a]n orderly, prosperous Europe requires the
economic contributions of a stable and productive Germany."[17]
By 1948, Germany suffered from rampant hyperinflation. The currency of the time (the Reichsmark) had no public confidence, and thanks to that and price controls, black market trading boomed and bartering proliferated. Banks were over their heads in debt and surplus currency abounded.[18]
However, thanks to the introduction of JCS 1779 and the first
Allied attempts to set up German governance, something could be done
about this. Ludwig Erhard,
an economist, who had spent much time working on the problem of post
war recovery, had worked his way up the administration created by the
occupying American forces until he became the Director of Economics in
the Bizonal
Economic Council in the joint British and American occupied zones
(which later, with the addition of the French occupied territory, became
the basis for West Germany). He was placed in charge of currency reform
and became a central figure in events that were to follow.[citation needed]
Economic reforms
In
spring of 1948, the Allies decided to reform the currency. In
preparation for this, a new central bank system was established in West
Germany with independent Land Central Banks and the Bank deutscher
Länder with headquarters in Frankfurt am Main.[citation needed]
Currency reform took effect on June 20, 1948, through the introduction of the Deutsche Mark to replace the Reichsmark
and by transferring to the Bank deutscher Länder the sole right to
print money. Each person received a per capita allowance of 60 DM,
payable in two installments (40 DM and 20 DM) and business quota of 60
DM per employee.[citation needed]
Under the German Currency Conversion Law
on 27 June, private non-bank credit balances were converted at a rate
of 10 RM to 1 DM, with half remaining in a frozen bank account. Although
the money stock was very small in terms of national product, the
adjustment in the price structure immediately led to sharp price
increases, fuelled by the high velocity of money through the system. As a
result, on 4 October, the military governments wiped out 70% of the
remaining frozen balances, resulting in an effective exchange of
10:0.65. Holders of financial assets (including many small-time savers)
were dispossessed and the banks' debt in Reichsmarks was eliminated,
transferred instead into claims on the Lander and later the Federal
Government. Wages, rents, pensions and other recurring liabilities were
transferred at 1:1.[citation needed]
On the day of the currency reform, Ludwig Erhard announced, despite the reservations of the Allies, that rationing would be considerably relaxed and price controls abolished.[18]
Results
In the
short term, the currency reforms and abolition of price controls helped
end hyperinflation. The new currency enjoyed considerable confidence and
was accepted by the public as a medium of payment. The currency reforms
had ensured that money was once more scarce, and the relaxation of
price controls created incentives for production, sales and earning this
money. The removal of price controls also meant shops filled up with
goods again, which was a huge psychological factor in the adoption of
the new currency.[18]
In the long term, these reforms helped set the stage for the Wirtschaftswunder (German for economic miracle) in the 1950s.[citation needed]
Chile 1975
Chile's reforms under the government of Augusto Pinochet are held as the origin of neoliberal shock therapy.[citation needed]
Economic reforms
The government welcomed foreign investment and eliminated protectionist trade barriers, forcing Chilean businesses to compete with imports on an equal footing, or else go out of business. The main copper company, Codelco, remained in government hands due to the nationalization of copper completed by Salvador Allende,
however, private companies were allowed to explore and develop new
mines. Copper resources were, however, declared "inalienable" by the
1980 Constitution.[citation needed]
In the short term, the reforms stabilized the economy.
In the long term, Chile has had higher GDP growth than its neighboring countries, but with a noticeable increase of Gini index [19]
Bolivia 1985
The term shock therapy originates from Bolivia's tackling of hyper-inflation in 1985, and was thought to have been coined by the media.[citation needed] On 29 August, just three weeks after the election of Víctor Paz Estenssoro as President, and the appointment of Gonzalo Sánchez de Lozada,
the architect of shock therapy, as Planning Minister, Decree 21060 was
passed. This decree tackled all aspects of the Bolivian economy and
ended the hyper-inflation.[citation needed]
Background
Between
1979 and 1982, Bolivia was ruled by a series of coups, counter-coups,
and caretaker governments, including the notorious dictatorship of Luis García Meza Tejada.
This period of political instability set the stage for the
hyperinflation that later crippled the country. In October 1982, the
military convened a Congress elected in 1980 to lead choose a new Chief
Executive.[20] The country elected Hernán Siles Zuazo,
under whose term the galloping hyperinflationary process started. Zuazo
received scant support from the political parties or members of
congress, most of whom were eager to flex their newly acquired political
muscles after so many years of authoritarianism. Zuazo refused to take
extra-constitutional powers (as previous military governments had done
in similar crises) and concentrated on preserving the democracy instead,
shortening his term by one year in response to his unpopularity and the
crisis racking his country.[21] On 6 August 1985, President Víctor Paz Estenssoro was elected. He appointed his President of the Senate, Gonzalo Sánchez de Lozada, as Planning Minister with a mandate to fix the economy.[citation needed]
Prelude to Decree 21060
Decree 21060
was the famous decree that covered all aspects of the Bolivian economy,
later referred to as shock therapy. In the run-up to the decree, Gonzalo Sánchez de Lozada recalls what the new government set out to do:
People felt you couldn't stop
hyperinflation in a democracy; that you had to have a military
government, an authoritarian government to take all these tough steps
that had to be taken. Bolivia was the first country to stop
hyperinflation in a democracy without depriving people of their civil
rights and without violating human rights.[22]
In the three weeks between the inauguration of the President and decree 21060, he notes:
We spent one week saying, "Do we
really need to do something? Do we really need radical change?" and then
another week debating shock treatment versus gradualism. Finally, we
took one week to write it all up.[22]
Once they had decided to act, de Lozada recalls that
there was a big discussion whether
you could stop hyperinflation or inflation, period, by taking gradual
steps. Many people said you had to take it slowly. You have to cure the
patient. Shock treatment means you have a very sick patient [and] you
have to operate before the patient dies. You have to get the cancer out,
or you have to stop the infection. That's why we coined the phrase that
inflation is like a tiger and you have only one shot; if you don't get
it with that one shot, it'll get you. You have a credibility that you
have to achieve. If you keep to gradualism, people don't believe you,
and the hyperinflation just keeps roaring stronger. So shock therapy is
get it over, get it done, stop hyperinflation, and then start rebuilding
your economy so you achieve growth.[22]
It is notable that de Lozada viewed shock therapy as an issue of
political credibility, and less an economic issue as Sachs, its economic
pioneer, did. Like Sachs, he was strongly influenced by the German
government in 1947, but noted that they, like the new Bolivian
government of Victor Paz, were a new government that acted decisively in
the first 100 days, resolving the economic situation.[citation needed]
Decree 21060
Decree 21060 included the following measures:
- Allowing the peso to float.
- Ending price controls and eliminating subsidies to the public sector.
- Cutting two thirds of the employees of the state oil and tin
companies. Freezing the pay of the remaining employees and public sector
workers.
- Liberalising import tariffs by imposing a uniform 20% tariff.
- Stopping the payment of foreign debt under a deal negotiated with the IMF.
Results
In
the short term, the decree smothered hyperinflation. Within a few
months, inflation had dropped to between 10 and 20 percent. The crash of
the tin market in October of the same year and the reforms led to an
estimated unemployment rate of 21.5 percent by 1987 (the unemployment
rate had risen steadily from 5.5 percent in 1978 to 10.9 percent in
1982, 15.5 percent in 1984, and 20 percent in 1986).[citation needed]
Post-Communist states
The
next important chapter in the history of shock therapy was the collapse
of communism in Europe in 1989. This left many post-communist states in
central and eastern Europe with centralised authoritarian economies
that had to transition to decentralised, market-orientated capitalist
economies.[citation needed]
Inspired by Bolivia's example, and advised by institutions like the International Monetary Fund and individuals like Jeffrey Sachs, many countries chose shock therapy to shake off the economic lethargy of the communist
era and transition to the capitalist systems. These transitions provide
an interesting and important view into shock therapy and its
consequences, especially when contrasted with China, which began a gradualist transition (the opposite of the shock therapy approach) in 1978 under Deng Xiaoping.
Advocates of shock therapy view Poland
as the success story of shock therapy in the post-communist states and
point out that shock therapy was not applied appropriately in Russia,
while critics point out that Poland's reforms were the most gradualist
of all the countries and compare China's reforms with those of Russia[6] and their vastly different effects.
Background
After
the failure of the Communist government in the elections of June 4,
1989, it became clear that the previous regime was no longer legitimate.
The unofficial talks at Magdalenka and then the Polish Round Table talks of 1989 allowed for a peaceful transition of power to the democratically elected government.
The economic situation was that inflation was high, peaking at
around 600%, and the majority of state-owned monopolies and holdings
were largely ineffective and completely obsolete in terms of technology.
Although there was practically no unemployment in Poland, wages were
low and the shortage economy
led to a lack of even the most basic foodstuffs in the shops. Unlike
the other post-communist countries, however, Poland did have some
experience with a capitalist economy, as there was still private
property in agriculture and food was still sold in farmers' markets.[22]
In September 1989 a commission of experts was formed under the
presidency of Leszek Balcerowicz, Poland's leading economist, Minister
of Finance and deputy Premier of Poland. Among the members of the commission were Jeffrey Sachs, Stanisław Gomułka, Stefan Kawalec and Wojciech Misiąg.
The commission prepared a plan of extensive reforms that were to enable
fast transformation of Poland's economy from obsolete and ineffective
central planning to advanced capitalism, as adopted by the states of
Western Europe and America.[citation needed]
Balcerowicz Plan
On October 6 the program was presented on public television and in December the Sejm passed a packet of 11 acts, all of which were signed by the president on December 31, 1989. These were:
- Act on Financial Economy Within State-owned Companies,
which allowed for state-owned businesses to declare bankruptcy and ended
the fiction by which companies were able to exist even if their
effectiveness and accountability was close to none.
- Act on Banking Law, which forbade financing the state budget deficit by the national central bank and forbade the issue of new currency.
- Act on Credits, which abolished the preferential laws on credits for state-owned companies and tied interest rates to inflation.
- Act on Taxation of Excessive Wage Rise, introducing the so-called popiwek tax limiting the wage increase in state-owned companies in order to limit hyperinflation.
- Act on New Rules of Taxation, introducing common taxation for
all companies and abolishing special taxes that could previously have
been applied to private companies through means of administrative
decision.
- Act on Economic Activity of Foreign Investors, allowing foreign companies and private people to invest in Poland and export their profits abroad.
- Act on Foreign Currencies, introducing internal exchangeability of the złoty and abolishing the state monopoly in international trade.
- Act on Customs Law, creating a uniform customs rate for all companies.
- Act on Employment, regulating the duties of unemployment agencies.
- Act on Special Circumstances Under Which a Worker Could be Laid Off,
protecting the workers of state firms from being fired in large numbers
and guaranteeing unemployment grants and severance pay.
Privatization of companies was left until later.
Results
In the short term, the reforms smothered the building hyperinflation before it reached high levels,[23] ended food shortages, restored goods on the shelves of shops and halved the absence of employees in the work place.[24]
However, the reforms also caused many state companies to close at once,
leaving their workers unemployed, and government statistics show this
change as unemployment rose from 0.3% in January 1990 (just after the
reforms) to 6.5% by the end of that year,[25] and a shrinking in the GDP for the next two consecutive years by 9.78% in the first and 7.02% (see main article).
In the long term, the reforms paved the way for economic
recovery, with the GDP growing steadily to about 6–7% between 1995–7,
falling to a low of 1.2% in 2001 before rising back up to the 6–7%
region by 2007,[26] often led by small service businesses, long suppressed by the Communist government.[27]
However, despite GDP indicating prosperity for Poland, the unemployment
rate continued to rise steadily, peaking at 16.9% in July 1994 before
steadily falling down to a low of 9.5% in August 1998 before rising once
more to a high of 20.7% in February 2003, from which it had fallen
until the year 2008.[25]
During the early years, the unemployment rate is thought to have been
lower due to many of those claiming unemployment working in the grey
(informal) economy, although this can account for no more than 5% of the
unemployment rate.[27]
The long-term results of shock therapy point to both a rise and a fall[citation needed]
in living standards. Ownership of consumables (cars, TVs, VCRs, washing
machines, refrigerators, personal computers, etc.) boomed, as did
consumption of fruit and vegetables, meat and fish.[27] However, the huge economic adjustment Poland underwent created massive anxiety.[27]
Applications
This section records all known applications of shock therapy in the world not mentioned under the history section above.
New Zealand
The economic reforms of New Zealand's 1984 Labour government, collectively known as Rogernomics (after New Zealand Finance Minister Roger Douglas), constitute an example of shock therapy.[28] In this case, the previous economic direction and management of Rob Muldoon
was portrayed as leading the country into a desperate fiscal crisis,
and this crisis was the continued reason given for the necessity of
economic shock policies. The 'shock' element of the New Zealand
experiment, can be considered as such, because the Labour Party
initially complied with its policies, not withdrawing its support until
later in Roger's term.
Post-Soviet
Since the USSR's dissolution, the post-Soviet states faced many problems. Poverty in the region had increased more than tenfold.[29] The economic crisis that struck all post-Soviet countries in the 1990s was twice as intense as the Great Depression in the countries of Western Europe and the United States in the 1930s.[30][31]
However, it has not been established whether these adverse outcomes were due to the general collapse of the Soviet economy
(which began before 1989) or the policies subsequently implemented or a
combination of both. Some research suggests that the very fast pace of
'shock therapy' privatization mattered, and had a particularly harsh
effect on the death rate in Russia.[32]
Sachs himself resigned from his post as advisor, after stating that he
felt his advice was unheeded and his policy recommendations were not
actually put into practice.[33][34]
In addition to his criticism of the way in which Russian authorities
handled the reforms, Sachs has also criticized the U.S. and the IMF for
not providing large-scale financial aid to Russia, which he felt was
integral to the success of the reforms.[35]
Poland
Poland has been cited by some[according to whom?]
as an example of the successful use of shock therapy, though this is
disputed. When economic liberalism came to this nation, the government
took Sachs' advice and immediately withdrew regulations, price controls
and subsidies to state-owned industries. However, with respect to the
privatization of the state sector (which may or may not be considered as
part of shock therapy depending on the definition being used) the
change was much more gradualist. Whereas many economic factors were
immediately applied[clarification needed],
privatization of state-owned enterprises was delayed until society
could safely handle the divestiture, as contrasted with the 'robber baron' state of affairs in Russia.
Productivity increased although at the same time unemployment
rates rose as well. As of 2008, the GNP was 77% higher than in 1989.[36]
Moreover, inequality in Poland actually decreased right after the
economic reforms were implemented, although it rose back up again in
later years.[37][38] Today, although Poland is confronted with a variety of economic problems, it still has a higher GDP than during communist times, and a gradually developing economy.[39] Poland was converging towards the EU in regards to income level in 1993–2004.[40]
Theory
This section presents the various theories that are used to explain shock therapy and its effects.
Hyperinflation
Jeffrey Sachs
first proposed shock therapy when he noticed that most periods of
hyperinflation had been ended in a decisive stroke, often in a day.[22]
Therefore, it is important to look at the theoretical basis for
hyperinflation to understand why Sachs noticed shock therapy proved so
successful in fighting it.
There are two main models used to explain hyperinflation, the confidence model and the monetary model. Hyperinflations see a rapid increase in the money supply and the velocity of money. Either one, or both of these together, is the root cause of hyperinflation and in both models, one follows from the other.
In the confidence model, some event, or series of events,
such as defeats in battle, or a run on stocks of the specie that back a
currency, removes the belief that the authority issuing the money will
remain solvent—whether a bank or a government. Because people do not
want to hold notes that may become valueless, they want to spend them in
preference to holding notes that will lose value. Sellers, realizing
that there is a higher risk for the currency, demand a greater and
greater premium over the original value. War is one commonly cited cause
of crisis of confidence, particularly losing in a war, as occurred
during Napoleonic Vienna, and capital flight, sometimes because of
"contagion" is another. In this view, the increase in the circulating
medium is the result of the government attempting to buy time without
coming to terms with the root cause of the lack of confidence itself. A
crisis of confidence is particularly damaging to a fiat currency
(i.e. most modern currencies), a currency whose value is unrelated to
any physical quantity, as fiat money is typically backed by future tax
revenues and its (typically exclusive) acceptability to the government
for payment of taxes and charges.
In the monetary model, hyperinflation is a positive feedback
cycle of rapid monetary expansion. It has the same cause as all other
inflation: money-issuing bodies, central or otherwise, produce currency
to pay spiraling costs, often from lax fiscal policy, or the mounting
costs of warfare. When businesspeople perceive that the issuer is
committed to a policy of rapid currency expansion, they mark up prices
to cover the expected decay in the currency's value. The issuer must
then accelerate its expansion to cover these prices, which pushes the
currency value down even faster than before. According to this model the
issuer cannot "win" and the only solution is to abruptly stop expanding
the currency. Unfortunately, the end of expansion can cause a severe
financial shock to those using the currency as expectations are suddenly
adjusted. This policy, combined with reductions of pensions, wages, and
government outlays, formed part of the Washington Consensus of the 1990s.
Ending hyperinflation depends on which model is the main cause.
In the confidence model, the method of ending hyperinflation is to
change the backing of the currency—often by issuing a completely new
one. Also, if possible, any action that restores confidence in the
government can help end the hyperinflation (e.g. the psychological
effect of food in the shops after shortages in most hyperinflations, the
election of a new government both capable of and dedicated to tackling
the problem). In the monetary model, the issuer of the currency must
stop expanding the currency.
Shock therapy as an artificial economic shock
A shock
in economics is defined as an unexpected or unpredictable event that
affects an economy, either positively or negatively. Recessions are
often modelled as negative economic shocks in which the current state of
the economy is untenable and the economy tries to restore itself to a
new equilibrium position. In the short-run,
as the economy adjusts to the shock but before it reaches the new
equilibrium, the shock often causes productivity to fall, unemployment
rise,[41]
and closure of firms that are now non-viable in the new environment.
The new environment enables new kinds of businesses and people must
learn new skills and exploit new opportunities to achieve long-run equilibrium.
Shock therapy can be largely understood by thinking of it as an artificial shock imposed by government policies. Neoclassical theory
provides a very useful tool in trying to describe an artificial shock
theoretically, in that neoclassical theory provides an idealised view of
an economy based on certain assumptions, most of which are made true
through market institutions (often but not necessarily provided by the
government), law, culture or historical practise, and is very useful in
explaining most situations (especially in modern Westernised economies).
Even when some of the assumptions required for neoclassical theory are
not in place resulting in an imperfect market
and the results of neoclassical theory becoming distorted or failing,
comparing the result with neoclassical theory can prove useful. Other,
slightly different formulations of economic thought strive to describe
shocks, the most important of which is economic liberalism.
Neoclassical shocks
In
neoclassical theory, large negative shocks cause unemployment in the
short run, and the larger the shock, the larger the unemployment. As a
result, large shocks can lead to grave social problems, political unrest
and, in the worst cases revolution. However, the market is already
adjusting itself to return to the new equilibrium, causing job creation
and opportunities. If there is no interference to prevent the markets
adjusting to the new equilibrium, the markets immediately correct
themselves with new firms and full employment, providing workers can
acquire the new skills to exploit these new jobs, or are able to move to
areas where they can find new employment.
In response to a shock created by bad government policies, sudden
market liberalisation can allow the free markets to reach the
equilibrium that the bad government policies prevented them reaching. If
the response originates in the markets or other external factors,
government intervention slows the free market's path to optimal recovery
and liberalisation of the economy speed recovery. However, if the shock
is large—causing social and political conditions that destroy or
prevent the recovery (e.g., revolution)—government intervention to slow
the recovery using gradualist policies and spreading the pain is
justifiable.
Imperfect market shocks
The most important type of nearly neoclassical shock is due to market failure and imperfect markets.
Sudden free market liberalisation in the absence of free market
institutions (as was the case in post-Communist states) or in which a
Western-style economy is unnecessarily liberalised (e.g. cutting police
budgets, removing regulation) are both examples of imperfect market
shocks.
The nature of the imperfect market shock depends on what
assumption of the perfect market is voided. The most important
assumption for all markets is the idea of property rights.
The free market doesn't just depend on the exchange of commodities, but
on the rights to use them in particular ways for particular amounts of
time. Markets are institutions that organize the exchange of control of
commodities, where the nature of the control is defined by the property
rights attached to the commodities. Property rights are the most
important because they can have the most dramatic effect on the results,
and are thought to be behind the most important causes of market
failure.[citation needed]
Another important assumption is perfect competition,
which has many smaller assumptions tied to it. These include perfect
information, no barriers to entry and many competitors. Again, there are
different imperfect markets depending on what assumption is relaxed.
Many competitors assumes that there is more than one firm
producing any commodity. In the event of large-scale privatisation of a
state-owned company as part of shock therapy, privatising such a company
without waiting for a competitor creates a monopoly where the company
can use its pre-eminent position to create barriers to entry, control
prices and maintain its monopoly.[6]
Also, in post-authoritarian systems with fragile legal and democratic
systems, such pre-eminent companies can also influence the government
and the legal system to help maintain its monopoly.
Perfect information assumes that prices and product quality is known to all consumers and producers. The idea of imperfect information (most commonly called information asymmetry)
has many ramifications for markets. The most important one concerning
shock therapy is international trade and financial liberalisation.
Because international banks possess better information about other
international firms than they do about local firms in a country (and
local banks possess better information about other local firms),
liberalisation of trade and finance never leads to an even playing field
for local firms if international investment is high.[6] Hernando de Soto Polar
also notes that in conjunction with imperfect property rights, local
firms may not be able to access foreign capital when borrowing against
their own capital, which may have imperfect property rights (his
so-called dead capital), while local lenders know more about the conditions under which something is owned and can be borrowed against.
Imperfect market failure in Russia
Prominent economist Joseph Stiglitz
ties all these ideas together to explain the reason why shock therapy
failed in Russia. Through the idea of property rights, Stiglitz uses the
idea of Adam Smith's invisible hand
to explain that, in the presence of severe corruption, a lack of
institutionalized law and order and artificially depressed exchange
rates, the free market created by shock therapy in Russia created a race
to the bottom to asset strip the country and remove the capital abroad,
rather than the mutually beneficial race to control the market in
commodities that would otherwise happen. Competition meant that if the
nominal owner of the capital didn't asset strip the capital first,
someone else would.[6]
Likewise, with the previously large Soviet nationalised industries
being privatised quickly created a situation where major markets
operated in a monopoly owned by a few individuals (the Russian oligarchs) who had links with the government of Boris Yeltsin.
Illusionary shock
Illusion
therapy refers to the imposition of shock economic policies on economy
in a way that the society doesn't feel the shock or assumes that the
dramatic change in policies is not as shocking or radical as it is in
the real world.[42]
The situation of "illusion" can be created using a wide range of
sociopolitical tools and techniques including information blackout on
national statistics, imposing repeated false news shocks before the
final shock (to decrease the social sensitivity or to habituate the
people to the future shock), spreading misinformation, rewarding the
society with interim exogenous rents and promoting them as the benefits
of the shock, etc. Illusion therapy is used to soften or elude the
potential social backlash during the shock. The first experience of
illusion therapy has been documented after the implementation of Iran's
subsidy reform project.[42]
People
Economic plans
See also
References
External links
Mongolia
Poland
Shock therapy
Languages
Kenton, Will. "Shock Therapy". Investopedia. Retrieved February 15, 2021.
Klein, Naomi (2007). The Shock Doctrine: The Rise of Disaster Capitalism. Henry Holt and Company. ISBN 9781429919487.
Norberg, Johan. "The Klein Doctrine: The Rise of Disaster Polemics" (PDF). Cato Institute. Retrieved August 28, 2008.
Kelin, Naomi. "One Year After the Publication of The Shock Doctrine, a Response to the Attacks". Klein Lewis Productions. Retrieved February 15, 2021.
Grandin, Greg (2006). Empire's Workshop: Latin America, the United States, and the Rise of the New Imperialism. Henry Holt and Company. ISBN 9781429959155.
Joseph Stiglitz, Globalization and Its Discontents, Penguin 2003
Privatisation 'raised death rate'. BBC, 15 January 2009. Retrieved 24 November 2018.
Rosefielde, Steven (2001). "Premature Deaths: Russia's Radical Economic Transition in Soviet Perspective". Europe-Asia Studies. 53 (8): 1159–1176. doi:10.1080/09668130120093174. S2CID 145733112.
Ghodsee, Kristen (2017). Red Hangover: Legacies of Twentieth-Century Communism. Duke University Press. pp. 63–64. ISBN 978-0822369493.
Scheidel, Walter (2017). The Great Leveler: Violence and the History of Inequality from the Stone Age to the Twenty-First Century. Princeton University Press. p. 222. ISBN 978-0691165028.
Appel, Hilary; Orenstein, Mitchell A. (2018). From Triumph to Crisis: Neoliberal Economic Reform in Postcommunist Countries. Cambridge University Press. p. 36. ISBN 978-1108435055.
Milanović, Branko (2015). "After the Wall Fell: The Poor Balance Sheet of the Transition to Capitalism". Challenge. 58 (2): 135–138. doi:10.1080/05775132.2015.1012402. S2CID 153398717. So,
what is the balance sheet of transition? Only three or at most five or
six countries could be said to be on the road to becoming a part of the
rich and (relatively) stable capitalist world. Many of the other
countries are falling behind, and some are so far behind that they
cannot aspire to go back to the point where they were when the Wall fell
for several decades.
Hernando de Soto Polar, The Mystery of Capital, Basic Books 2000
Easterly, William: The White Man's Burden: Why the West's Efforts to Aid the Rest Have Done So Much Ill and So Little Good (Penguin, 2006)
Ther, Philipp (2016). Europe since 1989: A History. Princeton University Press. ISBN 9780691167374.
See Morgenthau Plan for the variety of sources supporting this position when discussing the effect of the implementation of JCS 1067.
Conferences: Pas de Pagaille!, Time Magazine, July 28, 1947.
"Circulation of the Deutsche Mark – from currency reform to European monetary union" (PDF). Archived from the original (PDF) on July 18, 2011. Retrieved 2012-08-01., Deutsche Bundesbank Monthly Report March 2002, Bundesbank.de. Accessed June 13, 2010. Archived May 15, 2013.
"The Political Economy of Income Inequality in Chile Since 1850".
See also article for Bolivia
See also article for Hernán Siles Zuazo
Up for Debate: Shock Therapy: Bolivia, Poland, Russia. Same Policies-Different Results – Interviews with Gonzalo Sanchez de Lozada (former President of Bolivia), Moisés Naím, Jeffrey Sachs, Polish economist Leszek Balcerowicz, Yegor Gaidar (former Prime Minister of Russia), Mikhail Gorbachev (former President of Russia), Joseph Stiglitz – who are influential figures in the world of shock therapy, PBS
"An Attempt to Assess the Effects of the Balcerowic Plan" (in Polish). Archived from the original on February 8, 2012. Retrieved 2011-11-28.. Archived May 15, 2013
Poland Living With Shock Therapy, Time Magazine, June 11, 1990
Unemployment rate 1990–2013 Archived 2010-09-11 at the Wayback Machine, Polish Central Statistics Office
GDP growth for Poland 1996–2007, accessed August 2010
Jeffrey Sachs, Shock Therapy in Poland: Perspectives of Five Years Archived 2010-06-10 at the Wayback Machine, Tanner lectures (April 6 and 7, 1994), University of Utah
Holmes, J. W (1995). Toward Better Governance - Public Service Reform in New Zealand (1984-94) and its Relevance to Canada. Office of the Auditor General of Canada. ISBN 978-0662231677.
Study Finds Poverty Deepening in Former Communist Countries, New York Times, October 12, 2000
See “What Can Transition Economies Learn from the First Ten Years? A New World Bank Report”, in Transition Newsletter, pp. 11-14.
Who Lost Russia?, New York Times, October 8, 2000
"Did Privatization Increase the Russian Death Rate?" R.M. Schneiderman, New York Times, January 15, 2009
"Russia's Tumultuous Decade" by Jeffrey D. Sachs, The Washington Monthly
Sachs Blames Lack of IMF Support for Reformers' Defeat, The Moscow Times, January 25, 1994
Sachs, Jeffrey (14 March 2012). "What I did in Russia". Jeffsachs.org. Archived from the original on 2013-03-16. Retrieved 22 May 2019.
Suomen Kuvalehti 23/2009
Michael P. Keane and Eswar S. Prasad. "Poland Inequality, Transfers, and Growth in Transition". Retrieved December 23, 2006.
Pierella Pacia Marcin J. Sasinb and Jos Verbeek. "Economic growth, income distribution and poverty in Poland during transition" (PDF). Retrieved December 23, 2006.
Central Intelligence Agency. "Economy of Poland". Retrieved May 9, 2006.
Matkowski, Z., Prochniak, M. "Real Economic Convergence in the EU Accession Countries". International Journal of Applied Econometrics and Quantitative Studies. Euro-American Association of Economic Development (3): 5–38.
Sean Masaki Flynn, Economics For Dummies, John Wiley & Sons, 2011, ISBN 0-7645-5726-2
Atashbar, T. (2012). "Illusion therapy: How to impose an economic shock without social pain". Journal of Policy Modeling. 34: 99–111. doi:10.1016/j.jpolmod.2011.09.005.
