Shock Therapy in Poland: Perspectives of Five Years

Shock Therapy in Poland: Perspectives of Five Years JEFFREY SACHS THE TANNER LECTURES ON HUMAN VALUES Delivered at University of Utah April 6 and 7, 1994 JEFFREY SACHS is Galen L. Stone Professor of Interna- tional Trade at Harvard University, Faculty Fellow at the Harvard Institute for International Development, and a Research Associate of the National Bureau of Economic Research. He was educated at Harvard University, where he received his Ph.D. in 1980. Sachs serves as an economic advisor to several governments in Latin America, Eastern Europe, the former Soviet Union, and Asia, and has also been a consultant to the IMF, the World Bank, the OECD, and the United Nations Development Program. He is a member of the Harvard Society of Fellows and the Fellows of the World Econometric Society. His numerous pub- lications include Poland’s Jump to the Market Economy (1993), Macroeconomics in a Global Economy, coauthored with Felipe Larrain (1992), Peru’s Path to Recovery, coauthored with Carlos Paredes (1991), Global Linkages: Macroeconomic Interdependence and Cooperation in the World Economy, coauthored with Warwick McKibbin (1991), and Economics of Worldwide Stagflation, coauthored with Michael Bruno (1985). The collapse of communism in Eastern Europe in 1989 and in the Soviet Union in 1991 are watershed events in world history. Naturally, the real import of these monumental events has been especially hard to judge in their immediate aftermath. Each suc- ceeding year, we gain important new perspectives on their mean- ing. This is certainly true in the economic realm, where debates about the transition from communism to market economy have been especially lively and contentious. As the economic advisor to the Solidarity movement in Poland in 1989, I urged Poland to undertake a rapid transition to “normal” capitalism, on the model of Western Europe. When the first post-Communist government in Poland came to power in August 1989, the new economic leader, Deputy Prime Minister Leszek Balcerowica, adopted a radical strategy for the rapid transformation of Poland to a market economy. This strategy has subsequently won the somewhat misleading sobriquet of “shock therapy.” The strategy has been widely debated since its inception in Poland on January 1, 1990. It has been adopted, in modified form, in much of the rest of Eastern Europe and the former Soviet Union, includ- ing Russia after 1991.1 (For an earlier description of Poland’s reforms, see Sachs 1993. For a conceptual overview of “shock therapy,” see Sachs 1994c.) With five years of experience of economic reform in Eastern Europe, the strategy can be more clearly understood and evaluated. The strategy seems to be winning the test of time. Not only have 1 My own direct role as economic advisor to the post-Communist governments has included Poland, 1989-91; Yugoslavia, 1989-90, before its breakup; Slovenia, since 1991; Russia, 1991-94; Estonia, 1992; Mongolia, since 1991; Kyrgyzstan, 1993. In addition I have led several cross-country studies of the reforms, for the World Institute for Development Economics Research (WIDER) of the United Nations, in Helsinki, 1989-92; the National Bureau of Economic Research, 1992- 93; and the Harvard Institute for International Development (HIID), since 1993. [267] 268 The Tanner Lectures on Human Values the early “shock therapy” countries — especially Poland and the Czech Republic — outperformed most of the other countries, but the idea of radical, comprehensive transformation to a market economy is increasingly being adopted in countries that earlier shunned the strategy. The newly elected president of Ukraine, Leonid Kuchma, recently declared his intention to lead such a reform effort in his country. The passage of five years has been particularly important in placing the events in Eastern Europe and the former Soviet Union (hereafter EEFSU) in a clearer international context. In the economic dimension, we can see that the changes in the post-Communist countries of Eastern Europe and EEFSU are part of a powerful and deep trend of global economic integration. “Globalization” was of course already apparent in 1989, but the strength of the forces of global integration are even more clear today. Shock therapy, in the sense of a rapid, comprehensive, and far- reaching program of reforms to implement “normal” capitalism, makes particular sense in view of the global trends. The world economy is undergoing a process of “deep integration,” in which countries are linked not merely by international trade, but also through networks of production, finance, and shared economic institutions. Almost no country in the world dares to stand aloof from these trends. For countries that have been cut off from the world economy for decades, such as Poland and the other post-Communist countries, it makes special sense to deepen the new links with the global market economy as rapidly as possible. This is for three main rea- sons. First, the global system provides an invaluable road map for reforms. Second, the global system provides an opportunity to borrow technology, capital, and management techniques, to help catch up economically after decades of falling behind. Third, with many other countries and regions also trying to rejoin the world economy, the post-Communist countries are in international com- petition for capital, foreign direct investment, and export markets. [SACHS] Shock Therapy in Poland 269 Going slowly means ceding necessary investment and markets to other countries and regions. This paper reviews the basic logic of the “shock therapy” approach, both in general conceptual terms and in specific applica- tion in several countries. Why was it adopted ? How has it worked ? What are the real social costs to reform, and how can they be held to a minimum? How can reformers avoid becoming dangerous “social planners,” substituting a new unrealistic vision for the old failed Communist vision? And, finally, what are the real economic prospects for the post-Communist countries, and how do those prospects depend on actions of the Western countries as well as the reforming countries themselves ? THE REVOLUTION OF 1989 The leaders of the Revolution of 1989 in Poland, Czechoslo- vakia, and other countries in Eastern Europe had an outward- looking agenda from the start. They saw the revolutions in their countries as the opportunity to rejoin the mainstream of Western Europe. The great rallying cry of 1989 was “Return to Europe.” When I first made my own economic proposals for Poland in the summer of 1989, they were billed by Polish Solidarity leaders and the media as the chance for Poland to become a “normal” country in Europe in a short period. This was the main reason why radical, comprehensive economic reform measures could be acceptable in Poland and the other countries of the region. The politicians and the general public understood intuitively that a “shock therapy” approach was not simply another utopian scheme of economic reform, but rather was a quick route to a relatively clear target. In 1989, that clear target was Western Europe. There was already a general, if unexpressed, con- sensus in the society that whatever would reintegrate these countries fastest with Western Europe should be adopted. While “shock therapy” has been attributed to the technocrats, it was Poland’s political leaders in Solidarity that insisted on the 270 The Tanner Lectures on Human Values approach. They understood that the collapse of communism gave an opportunity for decisive steps of reintegration with Western Europe and that these steps should be taken as rapidly as possible. When one of the Solidarity leaders asked me to prepare a draft economic reform plan in July 1989, his instructions were for me to be radical in conception, indeed to formulate a plan to “jump to a market economy.” I, of course, had been urging a similarly radical approach in previous months and believed it to be technically feasible. Shock therapy has been widely attacked by many intellectuals as being yet another “constructivist” system of social engineering, trying to replace one dogma with another. This is mistaken, and practical politicians could already see the difference in 1989. Whereas Lenin had also advocated a kind of “shock therapy” in 1902 in his fateful and disastrous What Is to Be Done? his version of “shock therapy” was to create a new world that had never existed. Poland’s shock therapy was relentlessly down-to-earth by contrast. The main idea was to create institutions of the kind already in existence, and with proven merit, in Western Europe. Leszek Balcerowicz said it best, when he declared in 1989, “We are too poor to experiment. If the rich countries want to experiment, let them. For us, it is better to take proven models.” While the 1989 revolutions were outward-looking from the start, there is one sense in which the outward vision was too lim- ited. The outward orientation extended to the United States and especially to Western Europe, but not much to other parts of the world. The great challenge, therefore, was seen as a regional one: to reintegrate with Western Europe. Such a priority makes emi- nent sense, but Eastern Europe cannot afford to stop there. Its main competitors, for example, in attracting foreign direct investment are in Latin American and East Asia, countries with comparable levels of living standards, infrastructure, and labor-market skills. Eastern Europe must therefore best understand how to position itself in the international, not merely the interregional, economy. [SACHS] Shock Therapy in Poland 271 THE CONTENTS OF SHOCK THERAPY The people in Poland and the rest of Eastern Europe had a searingly realistic picture of the failures of Communist economics and the need for fundamental change of the economic system. Nonetheless, large parts of the population misjudged the detailed character of the economic crisis confronting their countries.

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