January 1992: Shock Therapy and the Sequencing Dilemma
January 1992. A former Soviet republic with 52 million people inherits about 4,500 state-owned enterprises, a collapsed rouble-based trade network and a budget deficit near 20 per cent of GDP. Annual inflation has crossed 2,500 per cent; factory managers are bartering steel for bread. The IMF offers a $24 billion standby arrangement on conditions: free most prices immediately, cut the deficit to 5 per cent of GDP, liberalise trade, and privatise large enterprises through citizen vouchers before October. A rival group of economists argues for sequencing - stabilise and build courts, tax administration and banks first, sell large firms slowly to strategic investors, and index pensions. Parliament was elected before independence and is hostile; pensioners have already lost their savings; the next election is due in 1996. The president wants a one-page decision with the risks on both sides stated honestly, because whichever path is taken will be judged by whether the country becomes a market democracy or an oligarchy with elections.
1. Which path would you recommend, and by what explicit criteria would you judge the choice?
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Four criteria should drive the decision: whether a step is reversible if it goes wrong; whether the institutions needed to make it work will exist in time; who bears the immediate loss and whether they can politically retaliate; and whether delay hands advantages to incumbents who will then block reform forever.
Judged that way, the answer is a split decision, not a single shock. Price liberalisation and trade opening should go first and fast: they end shortages, are hard for old elites to capture and create the constituency for reform. Macroeconomic stabilisation is also urgent, but the deficit target should be met through cutting untargeted enterprise subsidies rather than through pension arrears, because arrears destroy the legitimacy the programme needs.
Large-scale privatisation is the step to slow down. Voucher sales at speed, without commercial courts, bankruptcy law or functioning banks, transfer assets to enterprise insiders and to whoever controls the voucher funds - the exact oligarchic outcome the president fears. Selling large firms slowly, with open tenders and foreign participation, is less politically popular but more likely to produce owners who must answer to a market. Small firms and shops should be privatised immediately, since here speed is safe.
Conclusion: fast on prices and trade, medium on stabilisation with a protected social floor, slow and transparent on large privatisation - the IMF's timetable is a negotiating position, not an economic law.
2. How should the government handle the legitimacy problem - wiped-out savings, a hostile parliament, an election in four years?
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Legitimacy is a material variable, not a public-relations one. A programme that the electorate reverses in 1996 delivers nothing.
Three concrete measures follow. First, index pensions and protect a basic consumption basket - the standard objection is fiscal cost, but the alternative is arrears that force the central bank to print, which restores inflation and destroys the stabilisation itself. Second, make the losses visible and the gains traceable: publish who receives privatised assets, publish the tariff and price decisions, and give parliament an oversight committee, so that anger has a channel other than street protest. Third, sequence the painful steps away from election years where possible: decisions taken in 1992–93 can be absorbed before 1996, whereas a second price shock in 1995 would be electorally fatal.
The trade-off must be stated plainly: transparency slows the programme and hands ammunition to opponents, but secrecy produces a programme that survives only until the next vote. A reform that must be revoked has an effective life of four years; a slower reform that is owned by parliament can compound for twenty. On the facts of this case, parliament's hostility is an argument for negotiating the package inside the legislature, not for bypassing it by decree - the latter converts an economic dispute into a constitutional one.
3. 'Shock therapy failed.' Assess this claim by separating design, implementation and context.
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Design. The programme combined sensible elements (price and trade liberalisation) with fragile ones (voucher privatisation without courts, a fixed nominal anchor without reserves). Later 'loans-for-shares' style transfers were not an accident of implementation; they followed from the decision to privatise fast in the absence of institutions that could value assets. The design error was the assumption that markets are created by removing the state rather than by building the state's regulatory capacity.
Implementation. Customs, tax administration and courts were staffed by the same officials who had run the plan, and privatisation was administered by ministries with a stake in the outcome. Corruption is a genuine explanatory factor, but it also existed in slower reformers, so it cannot carry the whole weight.
Context. Seventy years without markets, a simultaneous collapse of the trading bloc, and a state that lost its revenue base overnight are not conditions any textbook programme was written for. Where a credible external anchor existed, outcomes were better, which suggests context plus institutions explain more than speed alone.
Assessment: the claim is too crude. The better verdict is that rapid liberalisation delivered supply and ended shortages, while rapid privatisation without institutions manufactured the oligarchy. The lesson for any late reformer is sequencing and state capacity, not that gradualism is superior - several slow reformers ended up with worse outcomes and no reform at all.