shock therapy

shock therapy

shock therapy: see electroconvulsive therapy.
In economics, shock therapy refers to the sudden release of price and currency controls, withdrawal of state subsidies, and immediate trade liberalization within a country, usually also including large scale privatization of previously public owned assets. Prominent economist Jeffrey Sachs was among the foremost proponent of shock therapy for several emerging economies although others have traced the concept back even further. Occasionally the term is used to refer to any significant program of pro-market reforms, such as those instituted in Chile in 1975.


According to Professor Sachs, shock therapy traces its roots from the economic liberalization program undertaken by post-war West Germany in the late 1940s. During 1947 and 1948, price controls and government support were withdrawn over a very short period. These reforms had the effect of kick starting the West German economy resulting in the Wirtschaftswunder. Germany had previously had a highly authoritarian and economic interventionist government and seemingly overnight threw off these restrictions and became a developed market economy.

In Latin America, these types of free-market reforms gained momentum during the 1980s due to a severe debt crisis that began in August 1982.


As a result, during the early 1990s Sachs recommended to the newly emerging economies of Eastern Europe, the former Soviet Union and Latin America that they too release all price controls, subsidies, sell off state assets and float their currencies in order to shake off the economic lethargy of the communist era. The shocks took the form of sudden drastic radical changes to the structure and incentives within economies. As a consequence of reforms, Poland and other countries reached a level of economic development consistent with the membership in the European Union.


Some people (such as Naomi Klein in her book The Shock Doctrine) consider the effects to be primarily negative, such as long-term unemployment rates ranging from 20-40%, increased crime rates, dramatic increases in poverty, declines in the standard of living and increased class struggle. Others judge that the effects have been positive, or that the theory was inadequately applied. It should be noted that the subjects of Klein's book, except possibly for Yeltsin's reforms in Russia, have little to do with Shock Therapy as defined above, or as promoted by Sachs .

What is not in doubt is that sudden changes to economic structure and incentives require changes to behaviour, financial flows and the structure of the economy that are not as rapid as the shocks that initiate them. It takes time for firms to be formed and built up; it takes time for human capital to change (to acquire the skills) to exploit new circumstances. Critics say that a developed Western economy rests upon and tends to take for granted a framework of law, regulation and established practice (including between parts of the domestic and international economy) that cannot be instantaneously created in a society that was formerly authoritarian, heavily centralised and subject to state ownership of assets. Even re-defining property law and rights takes time.


Poland has been cited as an example of the use of shock therapy. When democracy came to this central European 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, 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. Today, although Poland is confronted with a variety of economic problems such as double-digit unemployment, it still has a higher GDP than during communist times, and a gradually developing economy. Inequality in Poland actually decreased right after the economic reforms were implemented, although it rose back up again in later years. Poland was converging towards the EU as regards the income level in 1993-2004.

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