FROM THE OFFICE OF PUBLIC AFFAIRS

Thank you. It is a pleasure to be here to discuss Russia's economic future with so many of the people who are helping to shape it.

We meet after a week of surprises. Kremlin-watchers will debate what last week's events tellus about where Russia is heading. But in the financial markets' calm reaction we already have apowerful symbol of how far Russia has come. After years of reform, it is becoming a place wherepolitical surprises are not necessarily economic ones; where personalities can matter less thanpolicies; where, you might say, Kremlinologists parse not the party line, but the bottom line.

Credit where credit is due. Russia has weathered the recent storms well. The authorities haveraised interest rates -- not once, but twice, in November and more recently in February -- inresponse to Asian shockwaves. And now yields on domestic GKOs are hovering around 30percent: a good deal lower than they were last summer and well below the 45 percent-plus peakof early February. In the meantime, Russia has clocked up another year of exchange rate stability,and inflation now hovers at or below 10 percent year on year -- compared to 48 percent in 1996.

It is because Russia has managed these pressures so effectively that my focus today is not on near-term questions of monetary management but the much longer term questions of institutionalreform in Russia -- questions that go to the kind of capitalism Russia is trying to build.

I. The Evolution of Russian Capitalism

Many people invoke what might be called a "stages of capitalism" theory in thinking about thedevelopment of a market system in Russia and other emerging economies. This notes that highlyconcentrated ownership and public-private collusion -- what we might now call "crony capitalism"-- has historically been a more or less inevitable part of moving toward mature market institutions.Thus, the United States in the second half of the 19th century is often compared to the development of Russian capitalism in the final decade of this one.

It is certainly true that modern market institutions take time to develop: removing a pricecontrol is easier than building a sound judicial system; unifying an exchange rate is easier thansevering old ties between government and business. But the notion that there are stages ofcapitalist development that must be negotiated should not be grounds for complacency. Norshould it be allowed to slow the progress toward fostering strong market institutions -- inparticular, the strong protection of shareholder rights -- that will best promote investment andgrowth.

Russia aspires to rapid convergence -- to achieving growth rates higher than we everexperienced in the United States. If it is to have a prospect of achieving that rapid growth it isgoing to need to progress faster in establishing market institutions than we ever did. What ismore, the world in which Russia is emerging is now altogether different:

• today's economies are different: they are economies built on the rapid flow ofinformation; on decentralized decision-making; on taking anonymous individuals at their word;
• the expectations of the populace are different, especially in Russia and other transitioneconomies. In the 19th century Americans had only the most minimal conceptions of the state'srole. Today, people in these countries have very different demands and expectations. They havespent years in a system in which public schools, public health and infrastructure and the provisionof other public goods is taken for granted -- and, in a global economy, people are well aware ofother governments' ability to provide these things.
• finally, and most critically, we live today in a hotter money world than we have ever donebefore -- one in which investors choose governments, governments do not choose investors. In acompetitive global economy, countries will prosper long-term by building transparentmarket-based systems that can attract foreign capital and -- most important -- ensure all thecountry'sresources are allocated to the highest return use.

Markets are important. But they are not enough. The central challenge facing Russia is makegovernment a constructive force in the economy and society. That will mean ensuring thatgovernment can deliver those things that markets depend on -- but markets alone cannot provide. In particular, only the government can enforce the law. Strong and transparent enforcement oflegitimate law is a critical imperative to building a strong civil society -- and, we are learning, anequally critical imperative for achieving sustained growth.

The kind of system Russia needs to build -- the kind of system many reformers have beentrying to build -- is a system that would emphasize transparency and a clear separation betweenthe state and private enterprise. It would foster independent judiciaries, effective bankruptcyprocedures and other formal mechanisms for enforcing contracts and upholding the law. And itwould establish the rigorous accounting standards and protection of shareholder rights thattoday's global investors expect.

II. A Dangerous Alternative: the Risks of Relationship-Based Finance in Russia

In recent years an alternative has often been touted to the kind of transparent, rights-basedeconomic system that I have just described. Instead, many have pointed to a so-called "Asian"approach to government and finance as one better suited to achieve rapid growth in Russia. Suchan approach would favor centralized coordination of activity over decentralized market incentivesand would involve government targeting of particular industries; a reliance on relationship-drivenfinance rather than capital markets; and on informal rather than formal enforcement mechanisms,

This "model" undoubtedly caricatures the experience of actual existing Asian economies. And it leaves some very important, universal fundamentals out: not least, high levels of savingsand education, sound macroeconomic policy and an effective bureaucracy. Indeed, economistshave found it difficult to establish how far these "Asian" features contributed to Asia's justlyadmired miracle. But one lesson of recent events is clear: these policies can bring a countryenormous difficulties down the road.

The dangers of an emphasis on insider interests can only increase when a country lacks -- as inthe case of Russia -- most of the other, universal fundamentals that the Asian economies enjoyedfor so long. In short, in the wake of the Asian crises, there could be no worse news to come outof Russia than that after years of throwing off one defunct economic model, it was on the verge ofentrenching another questionable one.

II An Agenda for Action

All of these considerations point to building a true open market economy in Russia bystrengthening three roles of government in particular: collecting taxes; developing an effectivefinancial system; and entrenching the rule of law.

1. Fiscal reform

Oliver Wendell Holmes famously said that taxes are the price we pay for civilization. In thatsense, Russia has in many ways been living on borrowed time. As President Yeltsin and othershave clearly recognized, at less than 9 percent of GDP, the amount of tax revenues the federalgovernment was able to collect last year is at odds with the role the government and its electorateenvision for the state -- indeed, cannot credibly sustain the operations of the most minimal state.

There have been important steps in the right direction in recent months, in efforts to makebudgeting more transparent, to achieve much higher rates of tax collection and to advance theenactment a new tax code. But an all-time high (of R57.8 billion, or $9.6 billion) in wage arrears last month and doubts about the ability to repeat January and February's impressive revenuecollection rates underline the need to keep up the momentum for change.

The long-term costs of an inability to raise taxes efficiently and balance the books are clear toall in Russia:

• in the reduced investment caused by continued high interest rates;
• in the greater vulnerability to external shocks due to continued dependence on foreignlending;
• in the stunted development of small businesses, a sector that has played a vital role insuccessful transitions elsewhere, but has been constrained in Russia by the inefficiency anduncertainty associated with the tax system. Anders Aslund has noted that Russia has only oneofficially registered enterprise for every 60 citizens, as compared with around one in ten in Polandand Hungary;
• and, worst of all, in a reduced faith in government and possible creation of a nationwideculture of nonpayment.

By signing the 1998 budget and signaling both tax reform and reducing arrears as majorpriorities for the new cabinet President Yeltsin has encouraged greater confidence that the futurecourse of Russian fiscal policy will be less perilous. But following through on these priorities --and all the other elements of the fiscal action plan negotiated at the end of last year -- will becritical to finally achieving strong investment and growth. And it will be critical to preservinginvestor confidence at a time when patience for such vulnerabilities is in short supply the worldover.

2. Financial sector strengthening

While Russia lacks the high levels of foreign debt and other weaknesses we have seen inThailand and elsewhere, it shares with them the problem of a weak banking sector. This carries acost in the markets today by increasing perceived market risks. But the highest penalty is morelong-term -- in slower growth due to the inability to intermediate the long-term credit needed forrapid investment.

By any reckoning in its first years of reform Russia has been overbanked and under regulated.As a result, credit decisions and portfolios remain shackled to a short-term horizon, with only anamount equal to 10 percent of GDP last year in lending to the nonfinancial sector. Meanwhile borrowers are stuck trying to fund working capital and investment funds from other sources --notably arrears.

Russia's central bank has made real progress in recent months toward putting a strongerlong-term system in place: for example, in the creation of a special regulatory division formonitoringlarge banks, in the passing of a new bankruptcy law; and in continued progress towardconsolidating and liquidating many weak banks.

In this context we will especially welcome the central bank continuing to implement its1997-99 schedule for gradually tightening prudential norms for risk and liquidity, with the overallgoalof reaching Basle standards for most banking norms by the end of the century. And we lookforward to seeing Russia follow through on the commitment to introduce international accountingstandards by year-end. If one were writing a history of the American capital market I wouldsuggest to you that the single most important innovation shaping that capital market was the ideaof generally accepted accounting principles.

3. Entrenching an Effective Rule of Law

The benefits of fostering high levels of transparency can be seen across the spectrum ofreforms that will be needed to entrench effective government in Russia. As we have seen againand again in the emerging market economies in recent years, governments can gain powerfulinsurance against market setbacks simply by giving people clarity -- not just about the intent ofpolicy but in its execution. By the same token, governments who surprise investors once with thediscovery that policy has not been quite what it seemed lose precious credibility.

The same will hold true in the government's completion of the privatization program, in thereduction and regularization of regulation and the basic definition and protection of propertyrights -- including shareholder rights -- all major priorities if Russia is a develop an environmentto foster and attract investment. Once again, the challenge here is not simply to uphold theserights -- but to be seen to do so.

In this context the open and competitive bidding process leading to the sale of Svyazinvestlast year was rightly been hailed as a turning point. Equally encouraging was Dmitry Vasiliev, thechairman of the Federal Commission for the Securities market's recent successful defense ofminority shareholders in Sidanco, the oil firm, against the company's attempt to dilute their stake.

And yet, the very publicity attached to these two events shows the need to continue thisprogress so that fears of an entrenched "gangster capitalism" in Russia can finally to be laid torest. Russians must have faith that Joseph Proudhon was wrong -- property is not theft. And theymust be able to see with their own eyes the profound difference between being for capitalism, onthe one hand, and being for help to capitalists on the other.

III The Road Ahead

It has long been said that Russia -- along with nearly all the transition economies -- has passedthe point of no return. The market is here for the duration. But there remains the question ofwhich kind of market it will be. And there is no inevitability about the development of the kind oftransparent, rule-based system that will best promote growth. Any vacuum created by weakgovernment institutions and a partial rule of law is likely to be filled with the development of othermechanisms and other ways of doing business.

What is required is a positive determination to establish he institutions of an open, free marketeconomy -- one that can finally deliver the rapid and broad-based growth in living standards theRussian people deserve. President Yeltsin sounded many of the same themes a year ago in hisState of the Federation Address and again in this year's address in February. In these election-freeyears he and his new team will have a rare opportunity to make good on that agenda. It is inRussia's interest, it is in the United States' interest, and it is in the world's interest that 1988 bethe year that this opportunity is finally seized. Thank you.