Speech

Managing Director of the International Monetary Fund
at the
Moscow Institute of International Affairs
Moscow, April 2, 1997

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Thank you, ladies and gentlemen. It is an honor and a pleasure to address the Moscow Institute of International Affairs.

As you know, I have come to Moscow for discussions with the new government team on Russia’s economic reform program. I am here to listen to the government’s views about the problems it faces and the strategy it envisages for working out a program that would bring about the decisive change required by President Boris Yeltsin in his recent impressive address to the Federal Assembly, and that would warrant international support. Needless to say, I have been looking forward to meeting with the Russian authorities at this stage—so that, together, we can take stock of the reasons behind this striking contrast between the considerable progress that has been achieved in the five years since Russia began its economic transformation, and the acute problems that still stand in the way of Russia’s achieving its enormous economic potential.

I know quite well that the situation is difficult, and that frustrations, loss of heart, and even anxiety have developed here in many circles. Mirroring this, doubts and "wait and see" attitudes have also appeared abroad. Progress has been so slow at times that the unwavering support of the IMF to the Russian reform effort since the outset has been interpreted by some as reflecting unusual political complacency or sheer misjudgement. But now it is time to show that this pessimism is misplaced. After having triumphed over a year full of traumatic uncertainty, Russia once again has availed itself of a window of opportunity. For your friends abroad—and you know of the world’s enormous interest in what is going on in Russia—this should be the time for a new and decisive start, as this is a moment when success is within reach. Is this just wishful thinking? No, rather it is confidence based on the progress your country has made in its economic transformation, and on the determination of the government in facing the challenges that remain. Let me elaborate on these achievements and challenges, and then turn to how the IMF can support Russia at this crucial juncture.

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ACHIEVEMENTS

It is important not to lose sight of the tremendous economic progress that Russia has made in the last few years—in stabilizing its economy, and in taking many of the difficult first steps needed to transform it into a modern and efficient structure that can compete on world markets and respond to the needs of the Russian people.

As regards stabilization, the achievements are impressive: inflation has been cut from an average of 30 percent per month in 1992 to 1-1½ percent in recent months, and the exchange rate has stabilized. Underlying these achievements is the fact that the enlarged government deficit, including the regional governments and extra budgetary funds, has been substantially reduced: from 19 percent of GDP in 1992 to about one-third that level last year. Moreover, as the deficit has been brought under better control, the central bank has been able to move away from financing the budget deficit and to focus instead on its proper objective: that is, achieving greater price stability. I would like here to pay tribute to the remarkable work of the CBR in winning the battle against hyperinflation and in gaining solid credibility in the family of the world’s central banks.

And what of the progress in transforming the Russian economy into an efficient market economy? Here, too, substantial headway has been made. Since January 1992, most prices have been decontrolled, central planning has been abolished, and state orders have been substantially reduced. Moreover, two-thirds of the economy is now in private hands. Though painful, these adjustments are essential in helping to ensure that Russian industry becomes more efficient and redirects its production to meet the needs of Russian consumers.

At the same time, reforms aimed at reintegrating Russia into the world economy are also supporting this transformation. Now that trade barriers have been reduced, and the ruble trades freely and can be readily converted into foreign exchange, the door has been opened to international trade and competition and to the transfer of technology, skills, and capital from other industrial countries. The response has been striking. Since 1993, Russia’s foreign trade has increased by over half. Moreover, Russia’s recent Eurobond offerings have been well received.

Let us also bear in mind that Russia has accomplished all of this while dealing with the tremendous burdens inherited from the previous system, including: a host of large unprofitable industrial enterprises; a crumbling economic infrastructure; and a huge external debt. Viewed from this perspective, the extent of Russia’s achievements during the last five years is all the more striking, accompanied as it has been by the consolidation of democratic institutions, as demonstrated by the elections held in 1995-1996.

CRISIS OF THE STATE

Some people, I realize, would be surprised by this talk of impressive achievements. They would point to the mass of unpaid wages and pensions, collapsing public services, and the decline in production, protest in the street, and the atmosphere of increasing lawlessness and say: "This is not progress; this is a crisis." I would agree that Russia is indeed in a state of crisis. But the crisis is not the inevitable result of Russia’s economic transformation, as somewould have it; it is a crisis that has to do, in part, with the role of the state. The state of crisis is a crisis of the state. True, not many had anticipated how difficult and protracted the process of the transformation of the state would be after some 70 years of the Soviet regime, and how dependent the economic transformation would be on the renewal of the state.

There are two aspects to this crisis of the state. On one hand, the government needs to have the necessary resources to carry out its basic responsibilities, such as ensuring law and order, establishing a stable and just legal framework, paying for the goods and services it consumes, and providing basic social services with a particular attention to the neediest in society. On the other hand, the state should not display such activism in other areas that it impedes the functioning of the market economy—for example, by complicating economic decision-making via a complex web of taxes and tax exemptions, regulations and controls. Nobody has put that in a more striking way than the president himself; I quote his Address: "the state interferes in the economy where it shouldn’t, while where it should, it does nothing." Unless there is a very clear understanding about what the proper role of the state is, it will not be able to discharge its proper functions, and Russia risks being mired in this economic no-man’s-land between a centrally planned system and a fully functioning market economy. In this no-man’s-land, extremism and cynicism can only flourish, putting reform at risk and frustrating people. How could we not but understand and sympathize with all those who are hurt by these perverse developments? How could we take issue with all those who say they do not recognize Russia and the values it has developed over the centuries in this state of affairs?

Let me then dwell on the relationship between the state and economic reforms, not only because this is your central challenge today, but also because it reflects a universal problem which brings the issues of governance to the forefront of the IMF and World Bank agenda today. It would be overly ambitious for me to try to comment on all aspects of this complex issue. So I will focus on three problems that are of particular economic and social importance and that illustrate the need for simultaneous reform of the state and the economy: one, the delay in the resumption of economic growth; two, the non-payment of taxes and the government’s corresponding wage and pension arrears; and three, corruption. All of these problems are intertwined, and all reflect this ambiguity about the proper role of the state. Let me say a few words about each and what, seen by your friends abroad, they could imply for Russia’s economic policy agenda.

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THREE PROBLEMS TO BE ADDRESSED

First, growth. The resumption of growth in production and real incomes has been slow to materialize. This is a disappointment, but then the opposite would have been quite a surprise! The delay, alas, is not hard to explain. Part of the explanation can be found in the experience in other transition economies. Even the most successful among them have encountered a noticeable lag between the time when stabilization takes hold and when economic growth actually resumes. Poland, for example, embarked on a rigorous andcomprehensive program of stabilization and reform in 1990 and had substantially reduced inflation by the following year. Nevertheless, it was not until 1992 that the economy began to register some modest growth. At the other end of the spectrum of countries in transition, the sad experience of Bulgaria can also be mentioned, particularly as a new government is now taking courageous steps to make up for lost time. There the policy choice was perversely not to choose, and so to allow a huge gap to develop between stated intentions and policies implemented. The result has been a vicious circle in which weak policies have resulted in poor performance and a loss of confidence, which in turn has deepened the crisis, exacerbated hyperinflation, and led to an eventual economic and financial collapse, that we are now trying to help the authorities to repair. This has been a tremendously unfortunate development. Indeed, a more positive assessment can be made when observing the broad range of experiences of countries in transition: growth has been the strongest in countries that made early progress with macroeconomic stabilization and moved fastest with structural reform. What about Russia? Here macroeconomic stabilization and structural reform began later and took hold more slowly; inflation only dropped to more manageable levels last year. It is not surprising, then, that growth has also been slower to materialize.

For the rest of the explanation, one needs to take a closer look at the current environment for private sector activity. A thriving market economy requires a level playing field on which the private sector can operate. And one of the most fundamental responsibilities of government in a market economy is to ensure that the playing field is, indeed, level. To achieve this, the government must establish a set of fair and transparent rules that apply equally to one and all, and ensure that these rules are fully enforced. Within such a framework, private investment can flourish, new businesses can spring up, and all enterprises have strong incentives to operate fully within the law. Regrettably, Russia’s declining rate of domestic investment, sluggish pace of foreign investment, and rising share of activity in the "gray" economy are all clear signs that such a framework is not yet in place.

How can this be corrected? The answer lies in completing the institutional reforms needed to support an efficient market economy. Let me mention three of the most critical areas of reform.

First, a simple and transparent regulatory system—so that businesses won’t waste precious time and resources trying to find out what the rules are and how to comply with them; so that new firms can enter the market without complication or being driven underground; and so that foreign investors are encouraged to bring their capital, technology, and skills to Russia.

Second, an effective legal and judiciary system that protects property rights, enforces contracts, and helps create an atmosphere of law, order and personal security—so that domestic and foreign investors will expand their businesses and create new ones, confident that their property, their investments, and their employees are secure.

And third, a tax system that is simple and broad-based, with limited exemptions and fairly low and uniform rates—so that companies and individuals will not be discouraged fromtrying to fulfill their tax obligations; so that the tax system can be more easily enforced; and so that the government receives the revenues it needs to carry out its responsibilities. There is an old Russian saying that sums up this objective quite succinctly: "Collect one thread from everyone and you will have a shirt for a naked person." Indeed, if everyone paid taxes, everyone would have less tax to pay, and the government would have the resources it needs.

This brings me to the second issue I would like to discuss: the non-payment of taxes and the crisis this has caused in the government’s ability to pay wages and pensions and provide basic government services. The government must have the resources to meet its obligations. The alternatives are simply unacceptable: either that the country cannot afford to pay its public servants or keep their offices warm, educate its children, supply its hospitals, or care for its elderly; or that the government spends resources it does not have, only to see the budget deficit rise, inflation surge, and the country’s hard-won stabilization gains melt away. Yet the crisis of non-payment of taxes is serious. It is the closest thing to the crisis of democracy, as democracy is from its very origin the free consent of citizens to submit to taxes and to accept that the state’s role is to collect them. When the state fails to do this, it runs the great risk of encouraging anarchy or dictatorship, or both. This is why we wholeheartedly support the absolute priority given by the government to the solution of this problem.

What is the problem? It is certainly not that enterprises have no money to pay taxes. In fact, they are collecting VAT and excise taxes from their customers on the government’s behalf; this is not their own money, but government money that they frequently fail to turn over to the tax authorities. One problem is that the tax system, tax concepts, accounting rules, and administrative procedures simply have not kept pace with the transition to a market economy, and the courageous efforts of many civil servants to do their job are bearing little fruit.

Another problem is the exceedingly close relationship between the government and a number of large enterprises, which allows many to benefit from explicit or implicit tax exemptions, to exploit flaws in the tax system to avoid paying taxes—and even to engage in tax evasion. This non-payment of taxes is, in fact, a double-edged sword. With one edge, it cuts off the roots of fiscal stability by denying the government the revenues it needs to meet its obligations to employees, pensioners, and all who depend on government services. Moreover, government’s failure to meet its own financial obligations makes it all the more difficult for others to pay their taxes and seems to legitimize arrears elsewhere in the economy. Obviously, this creates a vicious circle of non-payment.

The other edge of the sword is just as sharp: the opportunity for some to avoid paying taxes cuts off the roots of output growth—by encouraging companies to seek tax profits instead of greater efficiency and higher production; by raising the tax burden on small- and medium-scale entrepreneurs who cannot extract tax privileges; and by encouraging the latter to try to escape the tax net by remaining small fish in the vast sea of the gray economy.

What should be done? This is not a problem that can be solved overnight, as the solution implies changes in laws, in administrative practices, and in the attitude and behaviorof many in business and government. Certainly, the answer is not to continue cutting back on government expenditure, although some cuts may be required in the very short term and expenditure restructuring is needed in several sectors. The answer is to increase the revenues and thereby ensure that the government has the resources it needs to carry out its proper functions. In fact, your government has already devoted a lot of valuable effort to improving tax revenues, and I perceive a renewed impetus for reform from the team now in place. But it remains surprising that not a single bankruptcy has yet occurred among major tax offenders as would have been the case in a properly working market economy. Exceptional as bankruptcy should be, this ultimate sanction must be an option if tax payers’ behavior is to be changed.

We share the government’s view that the first priority must be to change the attitude toward the non-payment of taxes, beginning with the largest tax delinquents. We also agree that there is an urgent need to broaden, simplify, and update the current tax system and the system of tax administration. Over the medium-term, the goal must be to build a tax-paying "culture" based on voluntary compliance with transparent laws that are consistently applied.

Finally, let me turn to the problem of corruption. Of course, this is a problem in many countries, and it is not the inevitable consequence of economic liberalization. Certainly, the old planned economy had its hidden share, despite the powerful law enforcement mechanisms at the state’s disposal. In the first instance, corruption stems in part from the view that those in positions of power should use it for personal gain. This attitude should be seen for what it is: absolutely unacceptable. In its place, I would recommend the advice printed on the official stationery of the government of Hong Kong, one of the most successful economies in the world. It reads: "Corruption rots; report it now."

But the problem of corruption goes beyond the question of attitudes; it also has to do with the role of the state. Corruption is like a yellow flashing light. It warns that instead of guaranteeing a level playing field, the state is interfering in the economy in inappropriate ways. Why this link between corruption and the government’s role in the economy? Because where government regulations are endless and endlessly complex, and where subsidies and tax exemptions are only available to a chosen few, the incentives to seek special advantages and personal favors are enormous—as are the opportunities to grant them. And because when the government fails to ensure a level playing field—by enforcing fair and transparent rules throughout the economy—these opportunities for corruption are frequently exploited.

What is the solution? Of course, there is first a need for high-level political commitment to a law-abiding culture, with a good example being set by the country’s leaders and opinion makers. Here also, once again I should quote the president’s address, which leaves no doubt about his determination to get rid of what he calls "one of the greatest vices of Russian authorities in all echelons." It would be good if other leaders of the world were to use similar frankness! But what is the best strategy to fight corruption? An important element of the answer is to refocus the state’s role in the economy on its basic tasks—among them, guaranteeing a level playing field. This means removing unnecessary government regulations and controls, strengthening the legal system and the enforcement of contracts, reforming the tax system and the civil service, and establishing an arms-length relationship between businessand government. In so doing, the government will also eliminate many opportunities and incentives for corruption. This will also go a long way in uplifting the morale of the honest and committed civil servants.

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Recovery of growth, revenues for a well-prioritized budget, elimination of corruption in the framework of a major effort to modernize the state, these are, no doubt, major and key challenges for your country. No wonder that they are also the cornerstones of the second phase of the three-year EFF program which the IMF is now finalizing with your government. As you know, we embarked on the program at the beginning of last year when uncertainties were even more daunting than they are today. We did so because we recognized that this program—which built on the success of the 1995 Stand-By Arrangement and had been carefully prepared over several months by the government and the Central Bank in close consultation with the IMF staff—had all the potential to "put the Russian economy, at the dawn of the twenty-first century, on a path of strong and enduring growth while paying due attention to the plight of the most vulnerable."

Why would we shy away now from continuing extending our support to Russia? Of course, not everything was perfect in the implementation of the program in 1996, and we have shared your disappointment with the revenue performance, the governance problems, and the slow progress in several structural reforms. But nobody is more mindful of these shortcomings than those now in charge of the destiny of this great country. Nobody is more determined than they to take the bull by the horns and tackle these challenges. So this is also the time for us, in the international community, to go ahead with our support for the completion of your reforms:

- by continuing our uncomplacent but friendly and constructive dialogue on policies;

- by extending, when needed, our technical assistance;

- by resuming our financing and by risking our resources once again in support of your program: a signal the markets expect, a signal your program deserves.

I know that your friends around the world are ready to join us in this effort, not the least our sister institution, the World Bank, with several major loans ready to be put in place this year. But international support can only be a modest—although indispensable—part of this major endeavor. The crucial part remains in the hands of the Russian people, beginning with the key role to be played by the State Duma, namely, to pass laws for the market economy, to ensure that the government’s budget is realistic and ambitious on both the revenue and expenditure sides, and to lead a responsible debate in the country about economic policies and propriety in public life. Beyond the essential role of the Parliament, Russians from every walk of life and of every political stripe will finally decide on the future of their country. They have demonstrated their courage and endurance throughout history and during this long journey toward an economy and state of freedom and responsibility. They must succeed inuniting in a common purpose and working toward the common goal of the creation of a stable and prosperous market economy in which every citizen has opportunities for a better life. To support such an effort, is our "raison d’être". We must do it. It will be done.