Thank you. A great deal has happened in Russia since your last conference. Now more than ever, perhaps, it will pay to retain a sense of perspective. A year ago, few might have predicted the events of last summer. But the problems leading to the crisis were well known and cause for concern -- in Washington as they were in Moscow. We need to remember this in considering which policy approaches have been discredited by August 17 -- and which have not.

Let me spend my time today talking about the roots of the Russian collapse and the implications of the crisis, both for Russian policy makers and for the international community.

I. Lessons of the Crisis

Few serious observers ever said that the path to a market democracy in Russia would be easy. But in retrospect it is fair to say that the enormity of the task was underappreciated -- even by those with experience of transition elsewhere.

• First, as Richard Pipes reminds us, the West -- and most of Central and Eastern Europe -- has a tradition of private property dating back to the Middle Ages. In Russia this was weakly rooted even before Communism and consummately destroyed after.
  
• Second, the USSR was a more heavily militarized economy than any CEE country or even China, with a higher share taken up by heavy industry under tight central control. This added a deeper conceptual problem to reform. Realizing new opportunities to add value is one thing: ending subsidized value destruction, on a national scale, quite another.
  
• Third, there has perhaps been the ironic handicap of Russia's natural wealth. As in so many similarly placed countries, these riches may have been a curse in disguise. As was true before 1991, they have diverted activity into seeking rents rather than creating value -- and, with hindsight, they have helped to defer a day of economic reckoning.

For all of these reasons, Russian reformers have struggled more than anyone might have anticipated with the creation of the intangible infrastructure of modern market economy -- at the core of which are private property rights, enforceable contracts and the rule of law. Marti Weitzman once said that the difference between communism and capitalism is that in communism, the buyers bribe the sellers -- and in capitalism, the sellers bribe the buyers. It is not clear today which category Russia falls into. But it is clear that it does not work.

August 17 was not inevitable. Had the Asian crisis not reduced confidence among emerging market investors, had the oil price not fallen so dramatically -- the crisis of 1998 might not have taken place. Even in July, significant progress was being made, and this progress underpinned the decision to offer additional international support. It was a calculated gamble -- and it was, in my view, a gamble worth taking. Yet we were under no illusions. As Herb Stein says, "if something cannot go on forever, it will stop."

II. The Two Opposing Forces in Russian Reform

Recent events will cast a shadow over the Russian landscape for a long time to come. Looking at Russia today, it is easy to see only gloom. But the crisis must not blind us to the enormous positive changes that eight years of reform have brought:

• Russia has a democracy -- imperfect, perhaps, but not now seriously threatened -- and a free press in which Moscovsky Komsomolets can print biting political cartoons on its front page and Izvestia amuses its readers nominating an "oligarch of the year."
  
• Russia is now open; people know what happens in the markets and systems beyond their borders have access to the ideas and products that the world has to offer.
  
• Russia has dramatically downsized its military and is no longer channeling one fifth of its national resources into maintaining it. In 1997 Russian military spending was only 1/7 of its Soviet era peak in 1988 and 2/5 of its level in 1992.
  
• And the Russian economy is no longer a creature of command and control, with around 70 percent of all economic activity now generated by the private sector.

  In all of these achievements Russia's reformers can feel justly proud. However, each has come with a larger failure:

  • the ballot box and a free press have replaced one-party rule, but other elements of a civil society have not taken root -- the rule of law, independent judiciaries, or the broad-based political parties that make for a true democratic politics.
    
  • Russia's borders are open to the rest of the world. But the economic side of integration has been distorted by the lack of lasting economic stability and credible institutions. The result is an openness that has encouraged too little long-term foreign investment to come in -- and too much domestic wealth to fly out.
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  • the economy is no longer in a state of constant mobilization, but too much of the rusting military-industrial complex has lived on as economic deadweight, draining the nation's financial and human resources amid a web of barter and unpaid bills.
    
  • 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.
    

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