“Shock Therapy” Leads to Disaster

The frantic US privatization policy endangers democratization of Iraq

By Joseph E. Stiglitz

[The Nobel Prize winner for economics and former chief economist of the World Bank teaches at Columbia University in New York. This article originally published in the Austrian derStandard, February 26, 2004 is translated from the German on the World Wide Web, derstandard.at/druck.asp.]

After the fall of the Berlin Wall, a development to the market economy began in the economies of Eastern Europe and the former Soviet Union that was accompanied by heated debates. One option was called “shock therapy” – the fast privatization of all state assets and the abrupt liberalization of trade, prices and capital flows – while the other aimed at a gradual liberalization of the market. The latter would guarantee the establishment of a constitutional state parallel to the market economy.

Today far-reaching agreement exists that the shock therapy has failed on the plane of micro-economic reforms and that countries like Hungry, Poland and Slovenia that followed a gradual transition to privatization reconstructed their infrastructures better than those who took a liberalizing course right from the start. Countries that decided for shock therapy experienced falling incomes and rapidly increasing poverty.

Social indicators as for example life expectancy reflect the desolate gross domestic product statistics. More than a decade after the beginning of the transition phase, many post-communist countries have not yet reached the income level that previously prevailed. Even worse, the prognoses for the development of stable democratic and constitutional conditions seem depressing for most countries that relied on shock therapy.

This experience suggests that one should think twice before attempting shock therapy again. The Bush administration supported by several carefully chosen Iraqis forces Iraq toward an even more radical form of shock therapy than in the former Soviet world.

Advocates of shock therapy actually argue that its failure refers back to too little shock, not to an exaggerated haste – too much shock and not enough therapy. Thus the Iraqis should adjust better to an even more brutal dosage.

The Russians for decades obviously lacked the opportunity for entrepreneurial activity. Under the rule of the Baath party, commercialization and entrepreneurship were suppressed in Iraq in a comparable way. However Iraq is clearly disadvantaged compared to Russia and many ex-CP states on account of its geographical situation. None of Iraq’s neighbors thrive economically while many post-communist countries were direct neighbors of the European Union. The continuing instability in the Middle East will deter foreign investors (outside the oil sector).

Combined with the continuing occupation, these factors make a rapid privatization very problematic. The low prices realized through privatization of state assets will increase the suspicion that the occupiers and their collaborators force a wrongful sellout on the country. Without a corresponding legitimacy, possible buyers will be scared about the security of their property rights. This will depress prices even more. In addition, the buyers of such privatized assets may only hesitatingly invest in them and instead exploit them financially instead of creating additional prosperity.

If the prospects for Iraq are as depressing as my analysis suggests, all international contributions to a reconstruction advanced by the US may have no more effect than throwing money out the window.

This does not mean that the world should abandon Iraq. However the international community should use its money for humanitarian purposes like hospitals and schools instead of supporting American plans.

The World Bank and other institutions that consider assisting in the form of credits face even greater problems since a further increase of the enormous debts of Iraq could aggravate the situation.

In a word, the dream of the American invaders of Iraq was the creation of a stable, prosperous and democratic Middle East. However America’s economic program for rebuilding Iraq lays the foundations for poverty and chaos.