The Role of Shock Therapy in Transitions to a Market Economy

1. The Role of Shock Therapy in Transitions to a Market Economy By: Laura Witherspoon

2. Research Question • How do political, economic, and social landscapes factor into transitions from central planning to market economies? • Can shock therapy be an effective approach?

3. Theoretical Considerations • Definitions of ‘market economy’ and ‘central planning’ • In the 1980s-1990s, shock therapy was the prevailing method for economic transitions because it was based on the popular neo-liberal school of thought • External factors • Bretton Woods institutions • Pressure from the West

4. Hypothesis • Shock therapy can be an efficient means of establishing market economies IF the appropriate institutions of governance exist and are supported by civil society, there is a concurrent change in the political environment, and reforms are implemented consistently and devotedly. • HOWEVER, the speed of transition should not be the primary focus of studies about economic transitions, but rather the conditions above!

5. Methodology • More qualitative than quantitative • Based primarily on an array of literature highlighting the arguments & theories about economic transitioning • Main arguments draw from the following authors: Andrei Shleifer, Vladimir Popov, and Thomas Wolf(among many others) • Case study contrasting Russia and Poland • A few tables to empirically explain theories

6. Poland • Partial market-oriented reforms since 1950s • Reflect Poles’ positive attitudes & habituation toward reform • Communism ended with diplomatic negotiations • Established laws for competition, bankruptcy, venture capital, property rights and banking • Extensive privatization & FDI fostered capitalist spirit • 85% of state owned enterprises were sold in 1991 • 60% of market was foreign-controlled • IMF enacted programs to maintain economic stability • Rewarded for use of shock therapy (debt was forgiven!)

7. Russia • No tradition of market-oriented reforms • Popular opposition to private property • Communism ended with a failed coup d’état by communist govt officials (fundamentally un-democratic) • In 1992: prices decontrolled, ruble floated, budget cut, voucher privatization program initiated • 2/3 of state owned enterprises transferred to 40 mil. citizens • But, govt shifted leadership who called for protectionism • IMF programs designed to reduce inflation failed because policies were implemented inconsistently • Also, rent seeking was severely prohibitive

9. Shock Therapy Approach • “In Poland, there was much in society that the shock therapists were willing to use as building blocks for reform during this primarily destructive phase. This was not the case in Russia. Hence, after the initial, primarily destructive, burst of shock therapy had accelerated the breakdown of the mechanisms of government that had begun in the Gorbachev years, there was much less on which to build a recovery”

10. Shock Therapy Approach • “The controversy [is] more about the attempted use of a shock therapy approach to ‘install’ institutions – where it might more aptly be called a ‘blitzkrieg’ approach” - Stiglitz

11. Conclusions • The following factors determine outcome of economic transitions: • Existence & strength of governing institutions • Political change, is the market ‘depoliticized’? • Habituation of civil society to reforms • Dedication and swiftness with which reforms are implemented • Shock therapy itself is not the problem, but rather the circumstances in which it is enacted • If all of the above are satisfied, shock therapy can work