Shock Therapy

Shock therapy is a financial theory that believes that sudden and dramatic change in national economic policy can turn a state-controlled economy into a free-market one. The name, shock therapy refers to the concept of quite literally shocking, or shaking up, the economy, with sudden and dramatic economic policies that affect prices and employment.

Characteristics of shock therapy include the ending of price controls, the privatization of publicly-owned entities and trade liberalization. Shock therapy is intended to cure economic maladies such as hyperinflation, shortages and other effects of market controls in order to jump-start economic production, reduce unemployment and improve living standards.

Shock therapy can entail a rocky transition while prices increase from their state-controlled levels and people in formerly state-owned companies lose their jobs, creating citizen unrest that may lead to forced changes in a country's political leadership. The opposite of shock therapy, gradualism, indicates a slow and steady transition from a controlled to an open economy, which is, in general, considered to the more responsible and effective strategy for improving an economy.

In general, polices that support shock therapy will involve:

• Ending price controls
• Stopping government subsides
• Moving state-owned industries to the private sector
• Tighter fiscal policies, such as higher tax rates and lowered government spending
• Shock therapy could also include policies to reduce inflation, reduce a budget deficit or polices that reduce current account deficits and restore competitiveness.

Economist Jeffrey Sachs is widely associated with shock therapy. He developed a plan of shock therapy for post-communist Poland in 1990, for post-communist Russia in 1992 and for several other countries, including Bolivia and Chile. Boliva, in particular, in 1985, did have success as a result of shock therapy in ending a period of hyperinflation. Poland also initially did seem to benefit from shock therapy as inflation was controlled, but it saw a sharp rise in unemployment that peaked at 16.9%. Sachs did not like the term shock therapy, which he said was coined by the media and made the reform process sound more painful than it actually was.

There are those who support shock therapy for its purported benefits that include:

• A more efficient method to solve economic imbalances
• Set clear expectations for consumers

On the other hand, those who oppose shock therapy see many cons to its use, such as:

• Creating a swift and sufficient income inequality
• Rise in unemployment
• Economic overwhelm