The Shock Doctrine: The Rise of Disaster Capitalism

by Naomi Klein

  The theory of economic shock therapy relies in part on the role of expectations in feeding an inflationary process. Reining in inflation requires not only changing monetary policy but also changing the behavior of consumers, employers and workers. The role of a sudden, jarring policy shift is that it quickly alters expectations, signaling to the public that the rules of the game have changed dramatically—prices will not keep rising, nor will wages. According to this theory, the faster expectations of inflation are driven down, the shorter the painful period of recession and high unemployment will be. However, particularly in countries where the political class has lost its credibility with the public, only a major, decisive policy shock is said to have the power to “teach” the public these harsh lessons.*

  Causing a recession or a depression is a brutal idea, since it necessarily creates mass poverty, which is why no political leader had until this point been willing to test the theory. Who wants to be responsible for what Business-Week described as a “Dr. Strangelove world of deliberately induced depression”?32

  Pinochet did. In the first year of Friedman-prescribed shock therapy, Chile’s economy contracted by 15 percent, and unemployment—only 3 percent under Allende—reached 20 percent, a rate unheard of in Chile at the time.33 The country was certainly convulsing under its “treatments.” And contrary to Friedman’s sunny predictions, the unemployment crisis lasted for years, not months.34 The junta, which had instantly taken to Friedman’s illness metaphors, was unapologetic, explaining that “this path was chosen because it is the only one that goes directly to the sickness.”35 Friedman concurred. When asked by a reporter “whether the social cost of his policies would be excessive,” he responded, “Silly question.”36 To another reporter he said, “My only concern is that they push it long enough and hard enough.”37

  Interestingly, the most powerful criticism of shock therapy came from one of Friedman’s own former students, André Gunder Frank. During his time at the University of Chicago in the fifties, Gunder Frank—originally from Germany—had heard so much about Chile that when he graduated with a PhD in economics, he decided to go see for himself the country his professors had portrayed as a mismanaged developmentalist dystopia. He liked what he saw and ended up teaching at the University of Chile, then serving as an economic adviser to the government of Salvador Allende, for whom he developed a great respect. As a Chicago Boy in Chile who had defected from the school’s free-market orthodoxy, Gunder Frank had a unique perspective on the country’s economic adventure. One year after Friedman prescribed maximum shock, he wrote a rage-fueled “Open Letter to Arnold Harberger and Milton Friedman” in which he used his Chicago School education “to examine how the Chilean patient has responded to your treatment.”38

  He calculated what it meant for a Chilean family to try to survive on what Pinochet claimed was a “living wage.” Roughly 74 percent of its income went simply to buying bread, forcing the family to cut out such “luxury items” as milk and bus fare to get to work. By comparison, under Allende, bread, milk and bus fare took up 17 percent of a public employee’s salary.39 Many children weren’t getting milk at school either, since one of the junta’s first moves had been to eliminate the school milk program. As a result of this cut compounding the desperation at home, more and more students were fainting in class, and many stopped going altogether.40 Gunder Frank saw a direct connection between the brutal economic policies imposed by his former classmates and the violence Pinochet had unleashed on the country. Friedman’s prescriptions were so wrenching, the disaffected Chicago Boy wrote, that they could not “be imposed or carried out without the twin elements that underlie them all: military force and political terror.”41

  Undeterred, Pinochet’s economic team went into more experimental territory, introducing Friedman’s most vanguard policies: the public school system was replaced by vouchers and charter schools, health care became pay-as-you-go, and kindergartens and cemeteries were privatized. Most radical of all, they privatized Chile’s social security system. José Piñera, who brought in the program, said that he got the idea from reading Capitalism and Freedom.42 George W. Bush’s administration is usually credited with pioneering “the ownership society,” but in fact it was Pinochet’s government, thirty years earlier, that first introduced the idea of “a nation of owners.”

  Chile was now in bold new territory, and free-market fans the world over, accustomed to debating the merits of such policies in purely academic settings, were paying close attention. “Economics textbooks say that’s the way the world should work, but where else do they practice it?” marveled the U.S. business magazine Barron’s.43 In an article headlined “Chile, Lab Test for a Theorist,” The New York Times noted that “it is not often that a leading economist with strong views is given a chance to test specific prescriptions for a very sick economy. It is even more unusual when the economist’s client happens to be a country other than his own.”44 Many came for an up-close look at the Chilean laboratory, including Friedrich Hayek himself, who traveled to Pinochet’s Chile several times and in 1981 selected Viña del Mar (the city where the coup had been plotted) to hold the regional meeting of the Mont Pelerin Society, the brain trust of the counterrevolution.

  The Myth of the Chilean Miracle

  Even three decades later, Chile is still held up by free-market enthusiasts as proof that Friedmanism works. When Pinochet died in December 2006 (one month after Friedman), The New York Times praised him for “transforming a bankrupt economy into the most prosperous in Latin America,” while a Washington Post editorial said he had “introduced the free-market policies that produced the Chilean economic miracle.”45 The facts behind the “Chilean miracle” remain a matter of intense debate.

  Pinochet held power for seventeen years, and during that time he changed political direction several times. The country’s period of steady growth that is held up as proof of its miraculous success did not begin until the mid-eighties—a full decade after the Chicago Boys implemented shock therapy and well after Pinochet was forced to make a radical course correction. That’s because in 1982, despite its strict adherence to Chicago doctrine, Chile’s economy crashed: its debt exploded, it faced hyperinflation once again and unemployment hit 30 percent—ten times higher than it was under Allende.46 The main cause was that the piranhas, the Enron-style financial houses that the Chicago Boys had freed from all regulation, had bought up the country’s assets on borrowed money and run up an enormous debt of $14 billion.47

  The situation was so unstable that Pinochet was forced to do exactly what Allende had done: he nationalized many of these companies.48 In the face of the debacle, almost all the Chicago Boys lost their influential government posts, including Sergio de Castro. Several other Chicago graduates held prominent posts with the piranhas and came under investigation for fraud, stripping away the carefully cultivated facade of scientific neutrality so central to the Chicago Boy identity.

  The only thing that protected Chile from complete economic collapse in the early eighties was that Pinochet had never privatized Codelco, the state copper mine company nationalized by Allende. That one company generated 85 percent of Chile’s export revenues, which meant that when the financial bubble burst, the state still had a steady source of funds.49

  It’s clear that Chile never was the laboratory of “pure” free markets that its cheerleaders claimed. Instead, it was a country where a small elite leapt from wealthy to super-rich in extremely short order—a highly profitable formula bankrolled by debt and heavily subsidized (then bailed out) with public funds. When the hype and salesmanship behind the miracle are stripped away, Chile under Pinochet and the Chicago Boys was not a capitalist state featuring a liberated market but a corporatist one. Corporatism, or “corporativism,” originally referred to Mussolini’s model of a police state run as an alliance of the three major power sources in society—government, businesses and trade unions—all collaborating to guarantee order in the name of nationalism. What Chile pioneered u
nder Pinochet was an evolution of corporatism: a mutually supporting alliance between a police state and large corporations, joining forces to wage all-out war on the third power sector—the workers—thereby drastically increasing the alliance’s share of the national wealth.

  That war—what many Chileans understandably see as a war of the rich against the poor and middle class—is the real story of Chile’s economic “miracle.” By 1988, when the economy had stabilized and was growing rapidly, 45 percent of the population had fallen below the poverty line.50 The richest 10 percent of Chileans, however, had seen their incomes increase by 83 percent.51 Even in 2007, Chile remained one of the most unequal societies in the world—out of 123 countries in which the United Nations tracks inequality, Chile ranked 116th, making it the 8th most unequal country on the list.52

  If that track record qualifies Chile as a miracle for Chicago school economists, perhaps shock treatment was never really about jolting the economy into health. Perhaps it was meant to do exactly what it did—hoover wealth up to the top and shock much of the middle class out of existence.

  That was the way Orlando Letelier, Allende’s former defense minister, saw it. After spending a year in Pinochet’s prisons, Letelier managed to escape Chile, thanks to an intensive international lobbying campaign. Watching from exile the rapid impoverishment of his country, Letelier wrote in 1976 that “during the last three years several billions of dollars were taken from the pockets of wage earners and placed in those of capitalists and landowners…concentration of wealth is no accident, but a rule; it is not the marginal outcome of a difficult situation—as the junta would like the world to believe—but the base for a social project; it is not an economic liability but a temporary political success.”53

  What Letelier could not know at the time was that Chile under Chicago School rule was offering a glimpse of the future of the global economy, a pattern that would repeat again and again, from Russia to South Africa to Argentina: an urban bubble of frenetic speculation and dubious accounting fueling superprofits and frantic consumerism, ringed by the ghostly factories and rotting infrastructure of a development past; roughly half the population excluded from the economy altogether; out-of-control corruption and cronyism; decimation of nationally owned small and medium-sized businesses; a huge transfer of wealth from public to private hands, followed by a huge transfer of private debts into public hands. In Chile, if you were outside the wealth bubble, the miracle looked like the Great Depression, but inside its airtight cocoon the profits flowed so free and fast that the easy wealth made possible by shock therapy-style “reforms” have been the crack cocaine of financial markets ever since. And that is why the financial world did not respond to the obvious contradictions of the Chile experiment by reassessing the basic assumptions of laissez-faire. Instead, it reacted with the junkie’s logic: Where is the next fix?

  The Revolution Spreads, the People Vanish

  For a time, the next fix came from other countries in Latin America’s Southern Cone, where the Chicago School counterrevolution quickly spread. Brazil was already under the control of a U.S.-supported junta, and several of Friedman’s Brazilian students held key positions. Friedman traveled to Brazil in 1973, at the height of the regime’s brutality, and declared the economic experiment “a miracle.”54 In Uruguay the military had staged a coup in 1973 and the following year decided to go the Chicago route. Lacking sufficient numbers of Uruguayans who had graduated from the University of Chicago, the generals invited “Arnold Harberger and [economics professor] Larry Sjaastad from the University of Chicago and their team, which included former Chicago students from Argentina, Chile, and Brazil, to reform Uruguay’s tax system and commercial policy.”55 The effects on Uruguay’s previously egalitarian society were immediate: real wages dropped by 28 percent, and hordes of scavengers appeared on the streets of Montevideo for the first time.56

  Next to join the experiment was Argentina in 1976, when a junta seized power from Isabel Perón. That meant that Argentina, Chile, Uruguay and Brazil—the countries that had been showcases of developmentalism—were now all run by U.S.-backed military governments and were living laboratories of Chicago School economics.

  According to declassified Brazilian documents just released in March 2007, weeks before the Argentine generals seized power, they contacted Pinochet and the Brazilian junta and “outlined the main steps to be taken by the future regime.”57

  Despite this close collaboration, Argentina’s military government did not go quite as far into neoliberal experimentation as Pinochet had; it did not privatize the country’s oil reserves or social security, for instance (that would come later). However, when it came to attacking the policies and institutions that had lifted Argentina’s poor into the middle class, the junta faithfully followed Pinochet, thanks in part to the abundance of Argentine economists who had gone through the Chicago program.

  Argentina’s newly minted Chicago Boys landed key economic posts in the junta government—as secretary of finance, president of the central bank and research director for the Treasury Department of the Finance Ministry, as well as several other lower-level economic posts.58 But while the Argentine Chicago Boys were enthusiastic participants in the military government, the top economic job went not to one of them but to José Alfredo Martínez de Hoz. He was part of the landed gentry that belonged to the Sociedad Rural, the cattle-ranchers’ association that had long controlled the country’s export economy. These families, the closest thing to an aristocracy that Argentina possessed, had liked the feudal economic order just fine—a time when they didn’t have to worry about their land being redistributed to peasants or the price of meat being lowered to make sure everyone could eat.

  Martínez de Hoz had been president of the Sociedad Rural, as had his father and grandfather before him; he also sat on the boards of several multinational corporations, including Pan American Airways and ITT. When he took up his post in the junta government, there was no mistaking the fact that the coup represented a revolt of the elites, a counterrevolution against forty years of gains by Argentina’s workers.

  Martínez de Hoz’s first act as minister of the economy was to ban strikes and allow employers to fire workers at will. He lifted price controls, sending the cost of food soaring. He was also determined to make Argentina once again a hospitable place for foreign multinationals. He lifted restrictions on foreign ownership and in the first few years sold off hundreds of state companies.59 These measures earned him powerful fans in Washington. Declassified documents show William Rogers, assistant secretary of state for Latin America, telling his boss, Henry Kissinger, shortly after the coup that “Martínez de Hoz is a good man. We have been in close consultations throughout.” Kissinger was so impressed that he arranged to have a high-profile meeting with Martínez de Hoz when he visited Washington “as a symbolic gesture.” He also offered to make a couple of calls to help along Argentina’s economic efforts: “I will call David Rockefeller,” Kissinger told the junta’s foreign minister, a reference to the president of Chase Manhattan Bank. “And I will call his brother, the Vice President [of the United States, Nelson Rockefeller].”60

  To attract investment, Argentina took out a thirty-one-page advertising supplement in BusinessWeek, produced by the PR giant Burson-Marsteller, declaring that “few governments in history have been as encouraging to private investment…. We are in a true social revolution, and we seek partners. We are unburdening ourselves of statism, and believe firmly in the all-important role of the private sector.”*61

  Once again, the human impact was unmistakable: within a year, wages lost 40 percent of their value, factories closed, poverty spiraled. Before the junta took power, Argentina had fewer people living in poverty than France or the U.S.—just 9 percent—and an unemployment rate of only 4.2 percent.62 Now the country began to display signs of the underdevelopment thought to have been left behind. Poor neighborhoods were without water, and preventable diseases ran rampant.

  In Chile, Pinoc
het had a free hand to use economic policy to eviscerate the middle class, thanks to the shocking and terrifying way in which he had seized power. Although his fighter jets and firing squads had been enormously effective at spreading terror, they had turned out to be a public relations disaster. Press reports about Pinochet’s massacres sparked a worldwide outcry, and activists in Europe and North America aggressively lobbied their governments not to trade with Chile—a distinctly unfavorable outcome for a regime whose reason for existence was to keep the country open for business.

  The newly declassified documents from Brazil show that when Argentina’s generals were preparing their 1976 coup, they wanted “to avoid suffering an international campaign like the one that has been unleashed against Chile.”63 To achieve that goal, less sensational repression tactics were needed—lower-profile ones capable of spreading terror but not so visible to the prying international press. In Chile, Pinochet soon settled on disappearances. Rather than openly killing or even arresting their prey, soldiers would snatch them, take them to clandestine camps, torture and often kill them, then deny any knowledge. Bodies were thrown into mass graves. According to Chile’s truth commission, established in May 1990, the secret police would dispose of some victims by dropping them into the ocean from helicopters “after first cutting their stomach open with a knife to keep the bodies from floating.”64 In addition to their lower profile, disappearances turned out to be an even more effective means of spreading terror than open massacres, so destabilizing was the idea that the apparatus of the state could be used to make people vanish into thin air.

  By the mid-seventies, disappearances had become the primary enforcement tool of the Chicago School juntas throughout the Southern Cone—and none embraced the practice more zealously than the generals occupying Argentina’s presidential palace. By the end of their reign, an estimated thirty thousand people had been disappeared.65 Many of them, like their Chilean counterparts, were thrown from planes into the muddy waters of the Rio de la Plata.