How do we think about the shock therapy approach to economics?

Markets need institutions that cannot be built at the speed of a decree

Question: How do we think about the shock therapy approach to economics?
Position‹2 of 2: Shock therapy doesn't work
Argument1 of 2›: Markets need institutions that cannot be built at the speed of a decree

The argument

The central objection to shock therapy is not that liberalisation is undesirable but that most of what makes a market work is not the absence of controls. Prices allocate resources well only against a background that has to exist first. Contracts must be enforceable, which requires courts that function and judgements that are collected. Property must be secure enough that an owner will invest rather than strip. Banks must be able to assess a borrower, which requires accounts that mean something and a supervisor able to close an insolvent lender. Firms must be able to fail, which requires a bankruptcy procedure that reallocates assets rather than freezing them. Critics argue that each of these is a slow institutional achievement, built through legislation, staffing, training and the accumulation of practice, and that none of it can be produced by removing a restriction. Where controls are abolished before that background exists, the argument runs, the resulting allocation is not determined by productivity. It is determined by who holds information, who holds relationships with officials, and who can enforce a claim privately when no court will. Assets move to whoever is best placed to capture them, which is a different group from whoever would use them best, and the pattern of ownership this produces is extremely durable because those who acquire assets cheaply acquire with them the means to resist later correction. On this account the shock is real and the therapy is largely absent. What is created is not a market but an unsupervised scramble, and the institutions that were supposed to arrive afterwards turn out to be harder to build once a class with an interest in their weakness has been established by the reform itself.

Premises

[P1]Prices allocate resources efficiently only where contracts are enforceable, property is secure, credit can be assessed and insolvent firms can be wound up. [P2] Each of those conditions is an institutional achievement requiring law, staffing, training and accumulated practice, and cannot be produced by removing a control. [P3] Where controls are removed before those conditions exist, assets move to whoever can capture them rather than to whoever would use them most productively. [P4] Those who acquire assets in such conditions gain the means to resist the later construction of the institutions that would constrain them. [C] Rapid liberalisation therefore produces an unsupervised scramble rather than a market, and makes the missing institutions harder to build than they were before.

Counter-arguments

Proponents answer that the institutional argument has no plausible sequence behind it. Courts, supervisors and bankruptcy regimes are built to serve transactions, and a state asked to construct them before any market exists has neither the demand nor the constituency to do it well. They add that the administered economy was not a neutral waiting room: delay allows the same insiders to entrench themselves while still holding formal authority, so the capture the argument fears can occur at any speed. The real question is whether institution-building is faster inside a liberalised economy or outside one, and proponents believe the record favours the former.

Rejecting the premises

[Rejecting P2] Institutions are built to serve transactions, so the sequence the argument implies is not available: a state asked to construct courts, supervisors and insolvency regimes before any market exists has neither the demand nor the expertise to build them well. [Rejecting P4] Capture is not a consequence of liberalisation specifically, since insiders holding formal authority in an unreformed economy entrench themselves just as effectively and have longer to do it. [Rejecting C] Calling the outcome an unsupervised scramble rather than a market describes the first years of a transition and treats them as the permanent result, which assumes the institutions never arrive.