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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 Chile in 1975.

Application

As a result, during the early 1990s Sachs recommended to the newly emerging economies of Eastern Europe, the former Soviet Unionmarker and Latin America that they end all price controls and 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.

Results

Sudden changes to economic structure and incentives require changes to behavior, 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.

Ex-USSR

Since the USSR's collapse, the post-Soviet states faced many problems. Among other things, provision of healthcare and social services had declined, life expectancy had fallen, and the GDP was halved. Poverty in the region had increased more than tenfold. 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.

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. Sachs himself resigned from his post as advisor, as he felt that his advice was unheeded and his policy recommendations were not actually put into practice.

Poland

Polandmarker has been cited as an example of the successful 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 Russiamarker.

Productivity increased although at the same time unemployment rates rose as well. As of 2008, the GNP was 77 % higher than in 1989. Moreover, inequality in Poland actually decreased right after the economic reforms were implemented, although it rose back up again in later years. 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. Poland was converging towards the EU as regards the income level in 1993-2004.

New Zealand

The economic reforms of New Zealand's 1984 Labour government, collectively known as Rogernomics, constitute an example of shock therapy. In this case, the previous economic direction and management of Robert 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.

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