and while much of the economy is privately owned, the state has not changed its
role accordingly. Total Russian employment is thought to have fallen by about 10%
from 1992 to 1997. In civilian government it rose by 50-70 percent. A bloated
bureaucracy and unwieldy tax system have pushed more and more activity into barter
and "virtuality," and they have driven a widening gap between what the state wishes
to spend and the revenue it can collect.
In a sense, Russia's transition has always been a struggle between the two forces in
Russia's transformation. The first supports grassroots entrepreneurship and a healthy market
democracy. While the second seeks to favor the top-down solutions that have failed in the
past. The macroeconomic problems that ended in the collapse of August -- the dwindling tax
revenues, the rising domestic debt and declining reserves -- all of these were only byproducts
of this deeper structural dynamic, a dynamic that is still being played out.
Indeed, one might argue that the economic costs of this struggle were the less important
ones -- at a time when more Russians are dying each year of tuberculosis than even contract it
in the United States, and only 54 percent of 16-year-old males can be expected to survive to
60. This, compared to 83 percent in the US today and 56 percent in western Russia a hundred
years ago.
III. The Way Forward
Where does Russia go from here? Three core lessons suggest themselves.
First, building a successful market economy in Russia is not about ideology. It's about
what works. Put it another way: as Deng might have said, it doesn't matter what color the cat
is, but it does have to be able to catch mice. Yes, a market economy in Russia must be one
that can work for Russia. But the laws of gravity work the same way on either side of the
Urals -- and so do the laws of arithmetic.
Second, and related, reform has to begin with transforming the role of the state. In
everything from budgetary policy, to regulation and upholding rule of law, to the relationship
between center and periphery, the state's role needs to be fundamentally different and it needs
finally to garner public trust.
Third, progress will come from the bottom-up. In many ways, the Soviet system was a
top-down system that got dismantled the same way. This points to the same structural
dynamic I discussed earlier. The challenge is to free the forces of bottom-up growth from the
tyranny of top-down decay. The irony is that this will take a stronger state -- but, again, one
with a very different role.
The prospects for such growth may be less bleak than they seem. The failures of recent
years will continue to take a heavy economic and human toll. But the scale of the
devaluation, the spare capacity in the economy, and Russia's vast, underutilized human
capital -- all imply great scope for import-substitution and catch-up growth. We perhaps can
see some of this potential already being grasped in the Russian goods now arriving in Russian
shops.
The challenge is to free this potential from the dead hand of macroeconomic collapse
and ineffective state institutions. That means, among other things:
Stabilization
The Russian authorities have no easy stabilization choices. It is always tempting -- in
such situations -- to believe that more heterodox routes are possible and desirable. Unable to
borrow domestically or abroad, there is now huge and understandable pressure on the
authorities to print money. But Russia's failure to grow these past years did not come from a
shortage of roubles. And it did it not come from a lack of optimism in the drafting of budgets.
The budget for this year proposed by Prime Minister Primakov aims for stringency. But
for the government to be credible it needs to set budgets that will stick. With the exchange
rate already well below -- and inflation already well ahead -- of the level assumed in the
budget, "virtual revenue" is not enough. What is needed are genuine and realistic cuts in the
deficit.
The prescriptions for achieving this are not new but they will work. They include:
extracting more revenue from the energy sector, reductions and reallocation of spending out
of agricultural and industrial subsidies and into health and social spending. There should also
be immediate action to extend the reach of the tax system to the barter economy: such as tax
collection on an accrual basis, and finally and permanently eliminating the use of tax offsets.
Tax Reform
Nothing has been more important to the course of Russian reform than its tax system --
and nothing has been harder to change. To encourage growth and support fiscal stability,
Russia needs a tax system that supports the government and legitimizes enterprise. That
means reform that raises revenues, and can increase simplicity and predictability. But,
hardest of all, it also means reform that can command the political support to be put into
action.
To be sure, it is easier to suggest how the tax system should be reformed than how it
might be agreed. At this stage it may well be that what is politically possible in the way of
increasing federal revenues will still fall short of what it now wants to spend. This points
strongly toward a new allocation of spending and revenues between the center and regions.
The budget now before the Duma does contain some helpful steps. But, when one thinks
about the kind of measures that are proven to raise revenues, and one considers the budget --
it is not encouraging that several key tax changes it proposes -- particularly the changes to
VAT -- look firmly to be headed in the wrong direction.
Bank Restructuring and Financial Sector Regulation
With so much of the private financial system under water -- the crisis has ironically
given Russia a golden opportunity to start afresh in building a system that can do the job that
the Russian economy desperately needs it do. Namely, turning domestic savings into
investment capital for viable small and medium-sized businesses.
No one should doubt the potential. The European Bank for Reconstruction and
Development's Russia Small Business Fund has now lent around $250 million to Russian
small and micro businesses. Its repayment rates -- at more than 95 percent -- are higher than
for most banks in the United States. More broadly, giving a greater welcome to foreign banks
-- with all their capital, expertise and confidence -- could make an important contribution.
Of course, the history of bank clean-ups shows that governments cannot ever truly start
afresh. In this regard the development of a solid bank restructuring plan is a major step
forward. But it needs to be implemented in a fair and transparent way -- within a legal
framework that makes current owners responsible for their losses before scarce public money
is used. To date there is little sign of this taking place.
e Goal: A Positive Climate for Investment
If there is a broader end goal of all these efforts -- it is to create finally in Russia an
environment in which business and investment can flourish and the country's vast human and
physical potential can be realized.
That means: sound money, the rule of law, fair tax laws and enforcement; private
ownership and free land markets; independent courts that enforce laws and contracts; strong
banks that safeguard peoples' savings and channel those savings to productive private
investment; securities markets that deter fraud and protect legitimate investor rights; social
spending targeted to those really in need, and it means the prevention of hidden,
anti-competitive ties between government and business interests. In many of these areas
foreign investors may have an important role to play -- both in the setting of high examples
and in the demand that certain core standards are met.
Let me add here that Prime Minister Primakov deserves credit for succeeding where
previous governments had failed, by passing production sharing agreement legislation. This
is a crucial step forward for the energy sector and for future foreign investment within it. But
clearly, it is one of many such steps that are needed, economy-wide -- and one that will
depend a great deal on its implementation.
IV. The Role of the International Community and the United States
Talk of "who lost Russia" misses the point. Russia was never ours to lose, and it is
certainly not ours to re-win. What has always been true -- what remains true today -- is that
the United States and the international community have an enormous economic and strategic
stake in a stable and prosperous new Russia. We will continue to act in any way appropriate
to further that goal. Our support is conditioned only by our realism -- and by our prudence.
Three imperatives for the international community stand out:
First, resuming engagement with the IMF. We continue to believe that Russia has a
great deal to gain from close contact with the IMF -- both in terms of the technical and
financial resources it can offer and the broader credibility it can bestow. Yet we will not be
striving for a program on any terms. The IMF focus on deficit cutting as a core element of
Russia's economic program -- and, especially, constructive efforts to raise tax revenues -- is
not just reflexive orthodoxy. It is the right policy for Russia. It is neither feasible nor
desirable for Russia to incur major new debts to finance large deficits.
Second, it must be frankly admitted that Russia will not, under any realistic scenario, be
in a position to service all of its foreign debt in 1999. The international community should be
prepared to work with Russia on realistic solutions, but it has to be in the context of a strong
economic program supported by the IMF and Russian respect for the principle of
comparability of treatment of creditors.
Finally, we must and we will seek wherever possible to lend weight to the positive
transforming forces in Russia today and to weaken the forces of corruption and distrust. So
many aspects of corruption grows out of regulatory and legal failings -- failings that
successive IMF and World Bank programs have sought to correct. We hope and expect that
this structural side of official support for Russia will play an even larger role in the future.
On a bilateral level, legal reform and the battle against corruption have long been a
central focus of Vice President Gore's work with the Russian Prime Minister and President
Clinton's dialogue with President Yeltsin. For our part Treasury have worked closely with
Russian law enforcement for the past 2-3 years to help curb money laundering and this
coming year we are looking to beef up these efforts and extend them to other kinds of
financial crime.
V. Concluding Remarks
Russia's transition comes at a time of global transition -- the transition to a post-
industrial economy. It cannot be an accident that communism, planning ministries
throughout the developing world and large corporations run by command and control all ran
into a brick wall in the same decade and had to be restructured. Across America and across
the world, new technologies and closer economic integration have forced profound changes
in the way economic and financial life is organized. It is a striking reflection on this move to
a post-industrial society that Microsoft today has a greater market capitalization than the
entire American steel, auto and aerospace sectors combined.
It is certainly true that in this new global economy, the market punishment for bad
policies comes more quickly and takes a harsher form. But the reverse is also true: that good
policies are rewarded that much more quickly. That is the positive lesson for Russia that can
be gleaned from experiences in Mexico and elsewhere.
It is not a time for predictions and certainly -- it is not a time for excessive optimism.
Russia faces difficult decisions in the months ahead and upcoming legislative and
presidential elections will probably not make them any easier. But they will give the Russian
people the opportunity to address one of Russia's fundamental problems -- the lack of a
consensus on Russia's true way forward.
To repeat, the United States stands ready to support Russians on the path to a stable and
prosperous market democracy. But the choice is for Russia and Russia alone to make. Thank
you.