FROM THE OFFICE OF PUBLIC AFFAIRS

I am pleased to attend the Annual Meeting of the EBRD Board of Governors for the first time. I am delighted to use this occasion to extend a warm welcome to President Koehler and to express appreciation to Charles Frank for filling in during the search for a new president. We have been colleagues in the past and, as a personal matter, it is a pleasure to work with them again.

Although the EBRD's management transition now is complete, the past year has been one of dramatic change for the Bank involving difficult setbacks for many of its borrowers. We call on the EBRD and its borrowers to rise to these challenges: to promote sound governance, to move reforms forward because of, not in spite of, current economic difficulties, and to help the people of Southeast Europe cope with the crisis in Kosovo. Thoughtful and proactive approaches to these issues today will advance the region's transition, a process essential to improving the quality of life in borrowing countries to the benefit of us all.

Now I will reflect on the relevant lessons of recent developments for the EBRD's borrowers, as well as on how the EBRD can best help its borrowers respond.

Regional Developments and Lessons

It is difficult to avoid the conclusion that the environment for economic transition in which the EBRD operates has become more unforgiving. Investor jitters about emerging market economies have led to increased scrutiny of financial vulnerabilities and economic risks in the region served by the EBRD, as well as elsewhere. Events in Russia have rocked markets and continue to introduce significant uncertainties in investors' assessments of other countries in the region.

The external financial environment is not the only one which has hardened. There is increasing evidence that where reforms have been delayed the tolerance for ongoing hardships is diminished. The risk is that the citizens in these countries will blame reform for what is really the consequence of a failure to reform, or to reform more completely. Change brings dislocation and uncertainty; unless it produces tangible positive results for broad segments of society, it will be met with increasing resistance.

Half-reforms themselves create entrenched interests and political and economic barriers to further reform. For example, when privatization shifts ownership to former state managers intent, at best, on preserving old ways and, at worst, on asset stripping. The result of half reforms is resistance to: market-opening measures, increased competition, better corporate governance, protection of the rights of minority shareholders, accountability for managerial performance, and improvements in firm accounting and disclosure. In sum, the battle that emerges is one between rent-seekers and reformers, and, in many ways, it becomes easier for rent-seekers to gain political support.

In this regard, countries face the challenge not only of designing the reform program itself, but also the challenge of designing an effective political strategy. Looking around the region, increased effort should be focused on political strategy. This means, for example, devising politically saleable tax reforms which trade off lower rates for broader coverage; making explicit linkages between increased spending on health and education and cuts in subsidies to loss-making enterprises; pursuing financial reforms which help to make more capital available to small and medium-size enterprises while making less available to large nonviable enterprises. In the most fundamental sense, it means working toward a more responsible and responsive political system, where the executive branch discusses the merits of economic reforms with the parliament.

There is no substitute for political systems that are transparent and accountable, and institutions headed by people with the political authority to act. Countries can import financial structures and technical expertise to some degree, but they cannot import political will.

Do the recent crises demonstrate the failure of the market transition model or that it is inapplicable to some countries? I would argue that recent experience instead forces economists to look at the deeper context in which economic and financial policies are formulated and implemented. Is the slow transition progress of some countries in the region as being due to the absence of experience with capitalism, weak rule of law, or fragile market institutions? Does it point to historical and cultural factors as well? We should look to an even more basic deficit: the absence of a broadly shared and well functioning social contract. At all levels, trust of government is built on whether it can deliver the goods. This basic trust must be established if corruption and cronyism are to be overcome. This is what President Koehler referred to as building a strong state.

I also would like to highlight some bright spots in the region. Judging by the relatively brief and mild contagion effects on Poland and Hungary, I am encouraged that investors have placed these, and some other countries in the region in fundamentally better risk categories. These assessments have survived both financial and civil unrest in the region. Bulgaria has continued to move from crisis to the establishment of real credibility. Meanwhile, the Slovakian authorities are beginning to focus on needed fiscal and external adjustments and structural reforms.

We hope that with the intensive engagement of the IMF and the World Bank the Romanian government can launch a new program combining both fiscal and structural reforms. Ukraine's government has also addressed fiscal reform more resolutely. This momentum must spread to embrace structural reforms.

More recently, the brutal expulsion of the Kosovar Albanians has created a humanitarian catastrophe of enormous proportions in Southeastern Europe and sent an economic shock wave through the region. It is self-evident that neighboring countries cannot manage these multiple challenges, but need substantial outside assistance. In this context, the Clinton Administration intends to make a request to Congress for a supplemental budget increase for neighboring countries. It includes funds for refugee and security assistance, as well as emergency balance of payments support for those countries strongly impacted by these events. Our support, combined with that of the European Union, other donors, and importantly the international financial institutions, should provide substantial help in dealing with pressing problems that threaten to overwhelm the capacity of these governments to cope. Continued commitment to, and implementation of, economic and financial reform is essential to the reestablishment of stability and growth. Kosovo's neighbors must not add a failure to deliver on the promise of reform to the immense costs of this conflict.

This crisis also raises the pressing question of how the EBRD can help. Although EBRD's activities are not aimed at providing humanitarian assistance, we look to Management to think creatively about how it can help the people of Southeast Europe -- by accelerating its project pipeline; supporting infrastructure projects that enable providers of humanitarian assistance to better reach affected peoples; and creating micro and small lending and trade facilities.

EBRD Operational Priorities

Turning to the EBRD's own operational priorities, we believe EBRD's original conception -- as an instrument of democratization -- remains its principal source of value-added. The EBRD must seek transparency and accountability from its borrowers, both public and private.

For the public sector, transparent economic governance instills accountability, promotes the efficient allocation of a country's resources, and fosters market confidence. Transparency allows a society to construct the necessary checks and balances which can help prevent cronyism, directed credit mechanisms, wasteful budgetary expenditures, and acute financing problems. Reliable and available economic, financial and budgetary data are essential elements of transparent governance. The intense financial pressures facing Russia, Ukraine, and Romania highlight that sound fiscal choices, made transparently, and that prioritize productive government spending over unproductive spending, are essential to promoting the transition to a market-based economy. Governments should recognize that sovereign borrowings are never a substitute for adequate tax collection systems. Key to creating a culture of voluntary tax compliance is confidence on the part of the public that fiscal choices are transparent and contribute to the material well-being of the population. Thus, sound and transparent governance is critical to a country's economic development. For this reason, we believe the Bank must exercise selectivity in its choice of public sector borrowers.

The U.S. vision of the EBRD is an institution principally focused on private sector development to foster the transition of the countries in the region to democratic and market-oriented societies. To this end the EBRD should:

• continue to focus on high-impact projects, especially in early transition countries;

• engage governments in clear dialogue about the underpinnings necessary for a strong investment climate;

• enhance coordination with other IFIs and bilateral donors to strengthen institutional and governance frameworks; and

• seek to raise standards of corporate governance through its investments.

In fulfilling its mandate, the Bank, for its part, also must be transparent with the public, member governments, and other IFIs about its own operations. The EBRD should be a model for openness, improve its own information disclosure policy, and provide more information on its country assistance and sector strategies as well as on projects in its pipeline. However, promoting public participation is only part of the process, the EBRD must also seek to incorporate, as appropriate, public feedback into project design.

The Bank must focus on areas where it can provide both positive transition impact and additionality, such as financial sector reform, capital market development, and corporate governance. We recognize EU accession is an important objective in most Central European countries, which affects these countries' investment decisions and priorities. However, as aspiring members of the European Union, these countries should, in theory, enjoy access to international capital markets; infrastructure projects in advanced transition countries are more properly financed through market borrowings.

Core Labor Standards and Environment

We would like the EBRD to focus on two other issues in the coming year: supporting core labor standards and promoting cleaner, more efficient energy production and use through out the region. First, we ask that the Bank follow through on the U.S. request to assess labor issues and reforms, including core labor standards, as part of its country strategies. The World Bank has committed to do this pursuant to the IDA-12 replenishment agreement as has the African Development Bank. The U.S. supports the Declaration on Fundamental Principles and Rights at Work, ratified by the ILO in 1998. The Declaration commits all ILO members to support the core labor standards of free association and collective bargaining and prohibitions against exploitative child labor, forced labor, and discrimination in employment. Given that all EBRD member countries voted in favor of the Declaration, the Bank should develop an internal screening mechanism to ensure that its projects do not violate core labor standards.

Second, the EBRD needs to take better account of local and regional environmental impacts of energy use in its project selection and development. At the end of the day, it does not make sense to cut corners on power plant emission standards only to face higher health care costs. To this end, the Bank should promote investments in: supply-side and demand-side energy efficiency, cleaner fossil fuels and combustion processes, and renewable energy to combat global climate change.

Conclusion:

In sum, we urge the Bank to remain engaged and its borrowers to move reforms forward even in difficult times. Together we can build market economies and democratic societies that provide people in the region with the opportunities to improve their lives. We have confidence in President Koehler's ability to guide the EBRD in moving us closer to this goal.