shock therapy economics

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.

As shock policy, the term was coined by economist Milton Friedman. In time, it became absorbed into the group of ideas about economics, that are sometimes referred to as economic liberalism. The economist Jeffrey Sachs coined the expression of shock therapy. The alleged difference between the two shock expressions lies only in the degree of economic liberalisation. Sachs' ideas were based on studying historic periods of monetary and economic crisis and noting that a decisive stroke could end monetary chaos, often in a day.^[1]

The first instance of shock therapy were the neoliberal pro-market reforms of Chile in 1975,^[2] carried out after the military coup by Augusto Pinochet. The reforms, dubbed a shock policy at the time by Milton Friedman, were based on the liberal economic ideas centred on the University of Chicago.

The term was truly born after Bolivia successfully tackled hyperinflation in 1985 under Gonzalo Sanchez de Lozada, using Sachs' ideas. In particular, Sachs and Sanchez de Lozada cited West Germany as inspiration where, during a period over 1947–1948, price controls and government support were withdrawn over a very short period, kick-starting the German economy and completing its transition from an authoritarian post-War state.

Economic liberalism rose to prominence after the 1970s and liberal shock therapy became increasingly used as a response to economic crises, for example by theInternational Monetary Fund (IMF) in the 1997 Asian Financial Crisis. Liberal shock therapy became very controversial, with its proponents arguing that it helped to end economic crises, stabilise economies and pave the way for economic growth, while its critics (like Joseph Stiglitz) believed that it helped deepen them unnecessarily^[3] and created unnecessary social suffering.

Sachs' ideas were applied to the post-communist states in their transition to capitalist systems with very mixed results. Some countries that used shock therapy (e.g., Poland, Czech Republic) did better than those that did not. To further cloud understanding, China made its highly successful transition in a gradualist fashion. One opinion^[4] is that successful market economies rest on a framework of law, regulation, and established practice^[5] that cannot be instantaneously created in a society that was formerly authoritarian, heavily centralised, and subject to state ownership of assets.