Was Shock Therapy Really a Shock?

By Marangos, John | Journal of Economic Issues, December 2003 | Go to article overview

Was Shock Therapy Really a Shock?


Marangos, John, Journal of Economic Issues


The shock therapy model derived its name from Poland's stabilization and liberalization program, initiated on January 1, 1990, which became known as "shock therapy" or "big bang." The countries that followed with the shock therapy approach were Czechoslovakia (starting January 1991), Bulgaria (February 1991), Russia (February 1992), Albania (July 1992), Estonia (September 1992), and Latvia (June 1993). In summary, the shock therapy model was a neoclassical model of transition advocating the immediate implementation of the necessary reforms to establish a free market economy.

The shock therapy model of transition, the dominant model of transition, was attractive to transition governments, international financial institutions, and mature market economies due to its simplicity and narrow transition policies recommended. "Get prices right" and the remaining elements of a market capitalist system would, more or less, fall into place was an antithesis to an institutionalist approach to transition. The shock therapy approach abstracted from the more insightful and complicated institutionalist dimensions of the transition process.

The transition process was characterized by uncertainty and the absence of any historical paradigms. Hence the Economist's metaphor about the transition process was that there was no known recipe for unmaking an omelette ("No Halfway House" 1990, 18). Few economists attempted to approximate the initial conditions of centrally administered economies with the stabilization programs initiated in the mature market economies. For example, Jeffrey Sachs (1993, 3) argued "the prototypical case in Europe that I will refer to is that of Spain, which in many ways provides a kind of guidepost to the path that the economies of Eastern Europe should follow." Sebastian Edwards (1992, 131) argued "the large number of stabilisation attempts in Latin America during the last four decades provides a wealth of lessons-both positive and negative-on different aspects of anti-inflationary programs." Or, "an analogy is presented by what Central and Eastern Europe encountered just after World War I" (Aslund 1992, 26).

The attempt to approximate any of the initial conditions of the centrally administered economies with the experience of any mature market economy was, in my view, unwise. The stabilization programs initiated in mature market economies assume a well-functioning market with developed institutions and the dominance of private property and inflexible prices and wages in the short run and forward-looking economic actors motivated by individual material incentives. The initial conditions of centrally administered economies-such as the dominance of state property, central control of the whole economy, and the encouragement of non-material incentives-did not approximate the conditions of any mature market economy. As such, the experience of mature market economies was irrelevant for the transition process.

The Arguments in Favor of Shock Therapy

The shock therapy model highlights the interdependence and mutually supportive and interactive character of economic relationships, implying that reforms should be introduced simultaneously. Fragmented changes would have been ineffective. As one Polish economist argued, "you don't try to cross a chasm in two jumps" (Sachs 1990, 19). The program has been described as a "leap to a market economy" (Sachs and Lipton 1990, 48) and a "jump to a market economy" (Sachs 1993).

According to the shock therapy model, restructuring could not have taken place without an effective pricing system, and an effective pricing system could not have existed without a convertible currency. In turn, a convertible currency was impossible without opening the economy to international competition, and international competition could not have been effective without restructuring. The idea that there was a choice between doing one radical measure or another was simply misleading. …

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