THE ISSUE OF SHOCK THERAPY

By Elmir Badalov

DEFINITION 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.

There are two types of shock therapy. The first was championed by economist Milton Friedman and which later became absorbed into the group of ideas that formed neoliberalism. The second was championed by economist Jeffrey Sachs.

The important chapter in the history of shock therapy was the collapse of communism in Europe in 1989. This left many post-communist states in central and eastern Europe with centralised authoritarian economies which needed to transition to decentralised market-orientated capitalist economies.

RADICAL REFORM PROGRAM:A BIG BANG

The Radical program for market economic reforms was supported by three powerful groups.

Jeffrey Sachs,Stanley Fischer,Lawrence Summers,David Lipton

Leszek Balcerowicz,Vaclav Klaus,Yegor Gaidar,Mart Laar,Einars Repse

International Monetary Fund,World Bank,major Western governments(their ministries of finance and central banks)

WASHINGTON CONSENSUS Fiscal discipline is needed Among public expenditures,discretionary subsidies

should be minimized,and education,health,and public investment should be priorities

The tax base should be broad,and marginal text rates ought to be moderate

Interest rates should be market-determined and real interest rates positive

Exchange rates should be competitive Foreign trade policy should be rather liberal Foreign direct investment is beneficial but not a

high priority

BALCEROWICZ’S REFORM PROGRAM Macroeconomic stabilization Deregulation Privatization Reinforcing the Social Safety Net

GRADUAL REFORM PROGRAMS Gradualists thought the old communist economy

and state failure. Gradualists downplayed the economic crisis after

communism, Gradualists refused to accept that the

communist state was highly corrupt or even kleptocratic

Radical reforms considered the transition a risky that could fail

Gradualists wanted to stimulate output through demand management

The dominant argument for a more gradual approach was the evident economic successes of the Chinese model of communist reform.22

THE CHINESE MODEL Mikhail Gorbachev mistakenly started with

democratization he should have begun with economic reforms instead.

Experimentation was better than full-scale reforms,

The champions of Chinese reform agreed that it was right to start the reform with agriculture and small enterprises and leave the large industrial enterprises in state hands

Most propenents of the Chinese model favored gradual price liberalization and opening of the economy

China was that right in carrying out a far-reaching decentralization,but the SU failed to do so.

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WESTERN ARGUMENTS FOR GRADUALISM

Przeworki’s Political Economy Theoratical Political Economy Disorganization Instutions First

RENT SEEKING:THE SCOURGE OF TRANSITION

Gorbachev’s first significant reforms was a partial liberalization of foreign trade in 1986

These early foreign trade reforms also introduced up to 3000 so-called currency coefficents

In January 1988,the Soviet Law on State Enterprises came into force.

With the Soviet Law Enterprises the State Planin Comitee lost control over state enterprise

Soviet Law on Cooperatives legalized all kinds of private enterprise with minimal regulation

Another form of new cooperatives was commercial banks

CRITICISM OF RADICAL REFORM AFTER THE RUSSIAN FINANCIAL CRASH Consistent policies,combining liberalization of

markets,trade and new business entry with reasonable price stability,can achieve a great deal

An efficient response to market processes requires clearly defined poverty rights

Major changes in social policy must complement the move to the market

Institutions that support markets arise both by design and from demand

International integration can help lock in successful reforms

REFERENCES Aslund, Anders (1995), How Russia Became a

Market Economy. - The Brookings Institution, Wash.,D.C., 1995.

Popov, V. (1998a), Investment in Transition Economies: Factors of Change and Implications for Performance. - Journal of East-West Business , Vol. 4, No. 1/2, pp.47-98.

http://www.pbs.org/wgbh/commandingheights/shared/minitextlo/ufd_shocktherapy_full.html

http://www.studenci.pl/ekonomia/makro/semeko04.html

Anders Aslund,How Capitalism Was Built: The Transformation of Central and Eastern Europe

Thanks for

Attention