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. Last Updated: 07/27/2016

Shock Therapy: Did It Ever Get Applied?

Boris Fyodorov, never a man to hide his light or his views under a bushel, once chided me publicly for writing in the Financial Times that he was seeking to reintroduce a program of "shock therapy" after it had been set aside, in the middle of 1992. In so doing, he was making the same point as Professor Jeffrey Sachs -- and others, including the International Monetary Fund -- that far from having had a malign effect upon the Russian economy it had never been tried.

Since it is now common parlance in Russian politics and in commentary about policies, to say that shock therapy has finally been derailed, it is worth examining whether Fyodorov was right. Unfortunately for my careless claim, he was.

If economic reform is again to come on to the agenda -- it seems to be off it now -- then the policies which make up "shock therapy" should be understood.

It was applied, most famously, by Leszek Balcerowicz, deputy prime minister in charge of finance in the Polish government, who stabilized the zloty in January 1990 at a stroke by fixing it at a certain rate against the dollar and making it clear that the central bank would defend it. He could do this because he was promised $1 billion by the IMF as a "defense fund" -- which was never used as there was no run on the currency.

At the same time, Balcerowicz introduced relatively tight budget policies which slashed most areas of state spending. By doing so, he put enormous pressure on his domestic producers, who found that their exports were losing their price competitiveness at the same time as they could no longer count on a flow of soft credits from the state.

The policy had nothing to do with privatization -- which actually began rather late in Poland because of arguments within the coalition government on the method and the pace of the program. However, by forcing the zloty to become a hard currency, he succeeded, at the cost of rapidly rising unemployment and falling real incomes, in setting the base for a recovery which is now one of the most powerful in Central Europe.

Poland is of course a different case from Russia: It had a private, though not particularly efficient, agricultural sector, a large and active emigrant community abroad, a more open economy and a much more comprehensively discredited Communist Party. It also had, in Solidarity, a group which was able to provide a political-social cohesion for the society which came up from the workers themselves, and which retained some of their loyalty in the face of worsening conditions.

Shock therapy is designed to make statist economies into capitalist ones, but it is neutral about whether the capitalism is the kind operated by a social democratic government or a liberal-conservative one. That depends on a separate series of decisions, mostly to do with the level of personal and corporate taxation and the choice people make about how much in the way of tax-funded social and health service the state will provide.

It is true that, in the late 1980s, a number of states began to cut back relatively hard in the scope of their welfare states due to burgeoning costs and the limits of taxation the electorate was prepared to bear.

A capitalist economy which emphasizes its "social" side has at least as much need to have firm rules of the game in place -- since it assumes a continuing and high surplus which it can distribute. The Russian economic debate often tries to ignore that inescapable fact by proposing -- usually implicitly -- that there is a way to the "social" market which is, first, relatively pain-free and second, which avoids the hardest decisions.

There is not. Just as the way to a social democracy is by taking great care to fix in place the rules of democracy, so the way to a social market is to establish the rules of the market. In Russia, this is going to be an even longer haul than we thought.

John Lloyd is Moscow bureau chief for the Financial Times.