Shock therapy is the belief that the best way to fix a broken economy is to implement radical changes and introduce new market oriented policies, in one fell swoop whatever the short term cost. Shock therapy is associated with the economist Jeffrey Sachs who advocated free market reforms for Eastern European countries like Poland and Russia in the early 1990s. (Sachs actually disliked term ‘shock therapy’ arguing it was coined by media and makes it sound more painful that it needed to be)
Shock therapy is different to a more gradual approach which seeks to make incremental changes and transition.
Shock therapy generally refers to policies used for making a transition from a Command (state controlled) economy to a mixed economy. However, shock therapy might also refer to
- Policies to reduce inflation quickly.
- Policies to reduce budget deficit.
- Policies to restore competitiveness and reduce current account deficits.
Shock Therapy policies involves
- Price liberalisation – ending price controls
- Ending government subsidies
- Privatisation. Selling state owned industries to the private sector. It is hoped that under private control, firms will have more incentives to be efficient and cut costs.
- Tightening of fiscal policy – higher tax rates, lower government spending to reduce budget deficit and control inflation.
Benefits of Shock Therapy
- It is considered a quicker method to overcome economic inefficiency and deal with wasted resources.
- With firm leadership, people know what to expect and make efforts to deal with the new situation. For example, if you want to control inflation, it is important to change expectations. Sticking to strict anti-inflationary policies, will help bring down inflation expectations and make it easier to achieve.
- Stretching out economic reform, can prolong the old difficulties.
- Jeffrey Sachs, a key supporter of shock therapy, argued it was harder to make the leap to a market economy in two stages. Privatisation, price liberalisation and control of inflation are complementary policies.