How Shocking Was Shock Therapy?

In 2007 Naomi Klein got quite a bit of attention and mostly favorable comment for her book, Shock Doctrine. It promulgated that global elites used periods of crisis around the world to force damaging neoliberal policies derived from the Chicago School and Washington Consensus upon unhappy populations that suffered greatly as a result. This was “shock therapy” that was more like destructive electroshock than any sort of therapy. There is a lot of truth to this argument, and it highlighted underlying ideological arguments and outcomes.

The argument largely seems to hold for the original poster boy example in Chile with the Pinochet coup against the socialist Allende regime. A military coup replaced a democratically government. While Chile was experiencing a serious inflation, it was not in a full-blown economic collapse. The coup was supported by US leaders Nixon and Kissinger, who saw themselves preventing the emergence of pro-Soviet regime resembling Castro’s Cuba. Thousands were killed, and a sweeping set of laissez-faire policies were imposed with the active participation of “Chicago Boys” associated with Milton Friedman. In fact, aside from bringing down inflation these reforms did not initially improve economic performance, even as foreign capital flowed in, especially into the copper industry, although the core of that industry remained nationalized. After several years the Chicago Boys were sent away and more moderate policies, including a reimposition of controls on foreign capital flows, the economy did grow quite rapidly. But this left a deeply unequal income distribution in place, which would largely remain the case even after Pinochet was removed from power and parliamentary democracy returned.

This scenario was argued to happen in many other nations, especially those in the former Soviet bloc as the Soviet Union disintegrated and its successor states and the former members of the Soviet bloc in the CMEA and Warsaw Pact also moved to some sort of market capitalism imposed from outside with policies funded by the IMF and following the Washington Consensus. Although he has since expressed regret for this role in this, a key player linking what was done in several Latin American nations and what went down after 1989 in Eastern and Central Europe was Jeffrey Sachs. Klein’s discussion especially of what went down in Russia also looks pretty sound by and large, without dragging through the details, although in these cases the political shift was from dictatorships run by Communist parties dominated out of Moscow to at least somewhat more democratic governments, although not in all of the former Soviet republics such as in Central Asia and with many of these later backsliding towards more authoritarian governments later. In Russia and in many others large numbers of people were thrown into poverty from which they have not recovered. Klein has also extended this argument to other nations, including South Africa after the end of apartheid.

Having said all that it must also be recognized that in some parts of the book Klein overstated her argument even to the point of including outright false information:

The case that really sticks out in this regard is Poland, arguably especially important as it was the place where the term “shock therapy” was first used. As it turns out, many observers have an inaccurate perception of what happened there, with Klein’s account not helping. It is understandable that many might be misled given that it was the Polish finance minister during the worst of the crisis and shock in 1990-91 when economic output fell sharply and unemployment rose, Leszek Balcerowicz, who coined the term and said that it was being applied in Poland. But this turns out to be an exaggeration, with much of what he wanted with the support of Jeffrey Sachs and the IMF at the time not happening due to an election in 1993 that threw out the shockers and mitigated the policies substantially. The upshot ultimately was that Poland ended up performing better than any other of the former socialist transition economies of the former Soviet bloc, becoming in fact one of the best economic performers in the entire continent of Europe, the only nation there not to go into recession in 2009 and now further ahead than any of the others economically. While inequality and unemployment are somewhat higher than in 1989, they are not dramatically so while many other economic variables are strongly better. The unemployment rate in August 2018 was 3.4%, higher than the less than 1% of 1989 but lower than in the US or most other European nations. The Gini coefficient is now somewhere in the .32 to .34 range, higher than ..25-.28 of 1989, higher than in Sweden or the Czech Republic but about the same as in Germany and much lower than in Russia, the US, or China.

The vast majority of the population is unequivocally better off economically now than in 1989. Comparing 2013 to 1989 as a ratio, real per capita GDP in Poland was 2.98, higher than any Soviet bloc transition economy aside from Turkmenistan (whose data is unreliable), with Russia at 1.44, the Czech Republic at 1.68, Hungary at 2.17, and Moldova at 0.82, now Europe’s poorest economy falling below Albania at 2.55. Poland suffered an inflation rate of 6905 in 1989 but this is was brought down fairly rapidly and is now barely above zero. It had the least level of graft of any of these economies as of 2013, There has been major environmental cleanup, especially in its southwestern corner, formerly part of the “dirty triangle,” one of the most polluted locations ever on this planet. The ratio of measured happiness between 2013 and 1989 is 1.44, higher than in any of the other transition nations.

A particularly controversial issue is that of the poverty rate in Poland, for which there are competing measures. Depending on the measure, the poverty rate in the 1980s was probably in the 5-10% range. In 2012, 6.7% of the population was below a living wage level, while alternative measures had it at around 11% or even as high as 16%. The poverty rate certainly rose sharply as did income inequality in the crisis years of 1990-91, but then fell and rose again before falling afterwards. A low point after the transition was 2003, the year before Poland entered the EU and began receiving substantial agricultural subsidies that helped the poor largely rural southeastern region long marked by small unproductive farms (Poland had mostly private farm ownership throughout the communist period), with by one measure the poverty rate possibly getting as high as 24%.. This is a point where Naomi Klein’s analysis basically went completely off the rails. Her story on Poland basically stops with 2003, which can be understood given her book came out in 2007. But she claims a poverty rate in 2003 of 59% (pp. 241-242), and declares strongly that the economic quality of life in Poland had completely collapsed. This is simply false, a wild exaggeration,

So, how did Poland end up doing so well, actually one of the best performing economies in Europe over the last quarter century? Crucial is that in fact it did not follow through on important parts of its supposed shock therapy, although most people (including Naomi Klein) do not seem to know this. Very important was that it did not undo its generous social safety net, especially its generous pension system. This was a central issue in the 1993 election, with both Blacerowicz and Sachs unhappy about this outcome. I remember well the 1994 ASSA convention at which Sachs gave a major speech in which he basically whined about this election outcome and essentially accused the Polish people of being a bunch of spoiled brats for wanting to hang onto their supposedly overly generous pension system. I note that he has since changed his tune and now recognizes the stabilizing and human nature of maintaining a decent social safety net in these economies.

The other area where Poland did not follow through on its shock policies involved privatization, which was supposed to be rapid and complete. It was not and has never been completed. Indeed, today Poland has the highest rate of state-owned production in its economy at around 30% of GDP of any OECD economy, another little-known fact. Privatization was resisted, especially because of fear of German companies taking over Polish firms, and what privatization that happened tended to be gradual, with a large part of the private sector consisting of brand-new firms owned by Poles, arguably the most dynamic part of the economy. In this areas, Poland actually resembles China substantially, a comparison made by a number of careful observers. The current populist government of the Law and Justice Party has if anything tightened restrictions on foreign ownership of banks and land, if not having engaged in any outright renationalization as we have seen in Russia and Hungary.

Given that much of the shock therapy program did not happen or did not do so shockingly, where was there shock therapy. This did indeed happen with respect to macro policy, driven by the problem of getting the incipient hyperinflation that had developed by 1989 in largely market socialist Poland under control. This did involve sharp pain with falling output and rising unemployment and poverty in 1990-91, but Poland was the first of the Soviet bloc transition economies to turn around, with most still having declining output in 1994 and quite a few until well after that. The pain in Poland was sharp, but it was short, and the longer run state has outperformed the others and put Poland far above where it was in 1989.

The politics of all this has been quite complicated and involved some important and curious twists and turns. From 1989 on there has been a broad “left-right” split with probably the most important constant in this being attitudes towards the Roman Catholic Church in famously devout Poland, with being pro-Church being on the right, with people coming out of the old Communist Party veing on the left. But the positions on economic policy regarding these groups have changed over time. in the 1989-93 period, the supporters of the shock therapy were on the right, although including the workers of the Solidarity movement. However, by now the rightist Law and Justice Party that is in power and attacks its rivals for being leftover communists and also strongly opposed Russia (in contrast to the populist rightist regime of Orban in Hungary who is friends with Putin), has in it populism become more the defender of both the social safety net and supporting the state-owned enterprises compared to the supposedly crypto-communist left, now out of power.

Needless to say, there is much discussion about how it is that Poland has been by so many measures so economically successful, yet since 2015 has come to be ruled by a reactionary populist party that has been restricting media and judicial independence, although it may be that it is going to hold back on some of this compared to Russia, Hungary, and Turkey. I think two things are important. One is that although Poland avoided going into recession in 2009 (largely due to staying out of the euro and also being strongly linked into the supply chains of neighboring Germany), its growth rate has slowed in more recent years while remaining positive, something happening throughout all of Eastern Europe, which has stopped catching up to Western Europe. And the second is that the frame of reference has changed. Whereas Poland has done well compared to its formerly socialist neighbors, the population now compares themselves to those in Western Europe, especially neighboring Germany, whom they are clearly well behind. Many young Poles have left for the West, with a cliché in the Brexit debates in UK being about the supposed problem of “the Polish plumber” coming in to take away British jobs. The Poles may be much happier than they were 30 years ago, but the bloom is off the rose as the transition has been long over. Where they will end up is unclear.

A final irony is that for all his advocacy in 1989-93 (and later as Director of the Polish central bank) for the hardline version of shock therapy many think happened in Poland, Balcerowicz himself at one point advocated something pretty much like what came to pass, a gradual privatization and maintaining most of the social safety net while advocating shock monetary policies to bring inflation under control. This was before the transition started and the Communist Party was still in control. Indeed, I met him in this period and heard him advocate pretty much this approach, which he also advocated in print. It was 1988 and I was teaching summer school at the University of Wisconsin-Madison when he showed up in town as part of a general wandering around the US talking to people and giving talks. We had some beers on the famous Union Terrace there by beautiful Lake Mendota. I confess thinking him a naive dreamer with all his plans for Poland that at the time seemed so unlikely and utopian. But that was one of those lessons for me: one should never discount a wandering prophet without position. He can end up running the show and making at least some of his dreams become reality.

Barkley Rosser