Shock therapy (economics)
In economics, shock therapy is a group of policies intended to be implemented simultaneously in order to liberalize an economy, including liberalization of all prices, privatization, trade liberalization, and stabilization via tight monetary policies and fiscal policies. In the case of post-communist states, it was implemented in order to transition from a planned economy to a market economy. More recently, it has been implemented in Argentina by the administration of Javier Milei.
Overview
Shock therapy is a program intended to economically liberalize a mixed economy or 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, privatizing state-owned industries, and tighter fiscal policies, such as higher tax rates and lowered government spending. In essence, shock therapy policies can be distilled to price liberalization accompanied by strict austerity.The first instance of shock therapy was the neoliberal reforms of Chile under Pinochet, carried out after the military coup by Augusto Pinochet. The reforms were based on the liberal economic ideas centered on the University of Chicago, which became known as the Chicago Boys. 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 the ideas of the young Harvard economist Jeffrey Sachs.
Economic liberalism rose to prominence after the 1960s and liberal shock therapy became increasingly used as a response to economic crises, for example by the International Monetary Fund in the 1997 Asian financial crisis. Shock therapy has been controversial, with its proponents arguing that it helped to end economic crises, stabilized economies, and paved the way for economic growth, while its critics including economist Joseph Stiglitz believed that it helped deepen them unnecessarily and created unnecessary social suffering.
In post-Soviet Russia and other post-Communist states, neoliberal reforms based on the Washington Consensus resulted in a surge in excess mortality and decreasing life expectancy, along with rising economic inequality, corruption, and poverty. Isabella Weber of the University of Massachusetts said: "As a result of shock therapy, Russia experienced a rise in mortality beyond that of any previous peacetime experiences of an industrialized country." The Gini ratio increased by an average of 9 points for all post-Communist states. The average post-Communist state had returned to 1989 levels of per-capita GDP by 2005, although some are still far behind that. In Russia, the average real income for 99 percent of people was lower in 2015 than in 1991. According to William Easterly, successful market economies rest on a framework of law, regulation, and established practice, which cannot be instantaneously created in a society that was formerly authoritarian, heavily centralised, and subject to state ownership of assets.
German historian Philipp Ther asserted that the imposition of shock therapy had little to do with future economic growth in Europe. Notable proponent Jeffrey Sachs has stated that he believes shock therapy should be accompanied by debt forgiveness.
Theory
Origins of the term "shock therapy"
The term was popularized by Naomi Klein. In her 2007 book The Shock Doctrine, she argues that neoliberal free market policies have risen to prominence globally because of a strategy of "shock therapy". 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 exploitation of labour.The economist Jeffrey Sachs 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.
Pace of privatization
Shock therapy proponents Sachs and Lipton argued in 1990: "The great conundrum is how to privatize a vast array of firms in a manner that is equitable, swift, politically viable, and likely to create an effective structure of corporate control." They recommended that the pace "must be rapid, but not reckless", and should "probably be carried out by many means". In the view of shock therapy proponents, trade liberalization requires domestic price liberalization first; thus a "big bang" in price liberalization underlying both privatization and trade liberalization forms the "shock" in the moniker "shock therapy".In practice, the rapid application of shock therapy proved generally disastrous in the post-Soviet states.
Departure from "the invisible hand"
Although economists have sometimes referred to shock therapy "creating" markets, Isabella Weber contends that shock therapy does not in fact create such new structures or institutions. She writes that the hope among shock therapy proponents is instead that the destruction of a command or planned economy would automatically result in a market economy and that expectation was that after the command economy or planned economy was "shocked to death", the "invisible hand" might emerge.According to Weber, expectations that a market economy would emerge following the imposition of shock therapy differ from Adam Smith's original metaphor of the "invisible hand" and interprets Smith as thinking that the market as emerging slowly as the institutions that facilitate market exchange develop, and with the "invisible hand" the price mechanism could emerge.
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. The first experience of illusion therapy has been documented after the implementation of Iran's subsidy reform project.History
West Germany, 1948
Background
Germany ended the European Theatre of World War II with its unconditional surrender on the 8 May 1945. April 1945 to July 1947 saw the Allied occupation of Germany implement Joint Chiefs of Staff directive 1067. This directive aimed to transfer Germany's economy from one centered 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.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. 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 "n orderly, prosperous Europe requires the economic contributions of a stable and productive Germany."
By 1948, Germany suffered from rampant hyperinflation. The currency of the time 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. 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.
Economic reforms
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.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, fueled 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 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. 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.
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 scarcer, 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.As would later also occur in the post-Soviet states, shock therapy resulted in redistribution from the bottom-up, benefiting those who held non-monetary assets. Although Erhard's price liberalization excluded rents and essential goods, it still caused an increase in inflation and resulted in a general strike. A turn from a free market to a social market economy followed under the Jedermann Programm, and by late 1948 "the German transition followed a dual-track pattern with a planned core and a market-coordinated periphery."