http://moscow.usembassy.gov/embassy/statement.php?record_id=142
Russia’s Economic Potential
Ambassador Alexander Vershbow
U.S. Ambassador to the Russian Federation
Moscow, June 21, 2005
I'd like to thank Stephen Jennings and Renaissance Capital for hosting this conference. It is a pleasure to speak to such a large and experienced audience tonight. Since some of you may be new to Moscow, let me tell you a bit about myself before I launch in. I've been serving in Moscow as the United States Ambassador since July of 2001, and I will be completing my tour of duty in the next 4-5 weeks. I have been in and out of Russia since I first came here as a student in 1969, but I have to say that the past four years have seen some remarkable changes. It has been great to be a ringside witness, and even to play a small part in the continuing transformation of this vast and complicated country, and in the development of the growing partnership between our two countries.
The Russian Federation has made great strides since 2001, especially when it comes to its financial affairs. Let me throw out a few facts and figures -- most of which you are no doubt familiar with. The government has been running enviable and substantial budget surpluses for several years. At the beginning of 2001, the central bank's foreign reserves were 28 billion dollars; today they are almost 150 billion dollars -- Russia now has the 6th largest foreign reserves of any country in the world. The so-called Stabilization Fund will soon top 35 billion dollars. Sovereign debt is being repaid early -- Russia already paid off its debts to the IMF, and 15 billion dollars from the stabilization fund will be used this summer to make early repayments to Paris Club creditors. Russia's Sovereign Debt to GDP ratio was already below 24 percent by the end of last year, which puts it far below the European Union's Maastricht criteria level of 60 percent.
The economy itself has also registered some impressive achievements. GDP has more than doubled since 2001, rising from just over 300 billion dollars to a forecast this year of as much as 700 billion dollars. Oil production, the main driver of this economy, has increased from 7 million barrels per day in 2001 to almost 9-and-a-half million barrels per day now. What is perhaps most astounding is the speed in which the Russian economy has gone from default -- only 7 years ago -- to investment grade, from debtor to creditor, and from economic decline to seven straight years of sustained economic growth.
Over the past four years, I have seen the government institute several important economic reforms. The lowering of tax rates for Personal Income, Value Added Tax and the Unified Social Tax (the equivalent of our Social Security-plus- Medicare), has both brought more taxpayers into the formal economy and helped stimulate growth. The decision to create the Stabilization Fund has been instrumental in shielding the Russian economy from the downside of high oil prices. This past winter's monetization of benefits (which removed untold unfunded liabilities from the government's balance sheets) was a painful but necessary reform, allowing for increased efficiency and better allocation of government resources, and requiring recipients to choose which pubic services they value most. I have been impressed by the degree to which the Russian Government has been willing to let the market play a role in social reforms -- staking Russia's path considerably closer to that of the United States than some of Europe's more statist approaches to social welfare.
The bottom line here is that the past four years have seen some stunning advances in Russian economic policy. But as impressive as these reforms have been, they are not enough. By themselves they are unlikely to provide the sustained and broad-based economic growth needed to pull most Russians out of poverty. To achieve broad-based prosperity for all Russians, more must be done. Otherwise, the Russian people will find they are getting only the pain of economic reform and none of the gain.
It is in that spirit that I want to turn now to some areas where I believe improvements are still needed. Here, I have the following five observations: First, no country can thrive in the long run without a fully functioning banking sector; Russia is no exception. Second, while every country has a right to decide where the line is drawn between private and public sectors, the line here seems to zig and zag incomprehensibly at times. Third, corruption, if left unchecked, will eat away at the very heart of this economy; strengthening the rule of law, property rights and corporate governance is critical. Fourth, the private sector is the best driver of diversification away from the commodity sector; the government needs to curb its desire to direct things. Fifth, the arbitrariness and impunity of the tax authorities risk creating a debilitating climate of fear in the business sector.
Let me flesh out these points, one by one.
To begin with, Russia's banking sector is small and dominated by two state-owned banks -- Sberbank and Vneshtorgbank. Public confidence in the banking system is weak. An off-hand statement by a government official last May that some banks would be closed for money laundering fueled a wave of fear that resulted in a near crisis last summer. The mortgage market is tiny. Credit analysis is weak. The current financial system needs help to expand to meet the needs of the Russian economy. It is in Russia's own interest to allow reputable, foreign financial institutions full participation in the financial markets here -- capital is critical to economic development, and it is in short supply. If the government wants to exert tight control over a small financial system, then a small financial system is what it will have -- but this approach has economic costs.
Second, clear lines are needed to separate government from business. It is understandable if a country feels it needs to control certain sectors for national security purposes. At the same time, the rest of the economy should be allowed to develop more or less unfettered by bureaucrats. Our experience in the West shows that even when the intervention of government officials is well intentioned, it is often counterproductive. On a positive note, the Duma began consideration of a law that would significantly reduce the number of activities that require government licensing. Giving businesses the impulse and opportunity to develop and allowing for a more natural allocation of resources by the private sector would boost growth and ensure Russian prosperity -- in other words, let the free market system flourish. As President Putin himself said to an economic forum last week in St. Petersburg, "Excessive state involvement in the economy is hindering business initiative. We know it from our own experience." Russians should listen to their President!
Third, corruption and disregard for the law are like a cancer on the economy. There are three aspects of the problem I would highlight tonight: corruption and weak due process; property rights; and corporate governance.
Over the years, I have come to understand how corruption has taken hold here. Many people do not feel their government properly serves them. In addition, as a by-product of the difficult process of creating a market economy from a command economy, many laws in Russia tend to contradict each other, so that in many cases it is impossible to conduct business and fully comply with the law. This is an invitation for corruption. Notwithstanding the streamlining and lowering of personal income taxes, the sense of most analysts is that many individuals in Russia still don't report anything close to their full earnings and pay their full taxes. There are presumably many businesses, too, that fail to report their true earnings or pay taxes on those earnings. For obvious reasons, survey data on this subject would be unreliable, but I would venture to guess that at best, real legal income is still grossly underreported. A sizeable portion of businessmen in Russia prefer even now to remain in the grey economy -- which only means that, for many, the costs of legal activity are higher than the costs of hiding activity.
The problem is widespread. The courts are perceived as neither consistently fair nor consistently impartial, and businesses won't thrive unless courts decide cases on their merits and on the basis of appropriate application of law. In conversations with representatives of business and think-tanks, I hear that corruption has worsened significantly in the past five years; that it has gotten more efficient and that the individual amounts concerned have gotten larger.
Property rights are still not as firmly grounded in law as they should be here. People are afraid that what they have may be taken away, and the effects are visible even to the casual observer. After several years of independence, why are so many buildings, in a city as wealthy as Moscow, in such a state of disrepair in the center? It is a simple fact that if you feel that your property can be taken away indiscriminately, you are not going to be confident in your ownership of that property; and if you don't own something, you are less likely to invest in it.
Corporate governance has improved, but it is still not where it should be. We still see complaints by minority shareholders of asset stripping and misappropriation by management and majority shareholders. The Federal Financial Markets Service has shown that it is on the side of minority shareholders, but the local business culture does not always show those same sympathies. Trying to seek redress in the courts can be an expensive and uncertain process.
Now for my fourth point: I applaud President Putin's goal of diversifying the Russian economy away from its dependence on the commodity sector, which accounts for 40% or more of GDP. Until this happens, the economy will continue to be vulnerable to exaggerated boom and bust cycles. Russia is a country with talented scientists, engineers, creators and thinkers. Rather than trying to direct economic development, I hope that the Russian Government will choose a path that enables this pool of talent to do what they do best -- to innovate, design and create. It is perhaps the hardest transition for this former command economy, but you have to trust the private sector to allocate resources most efficiently. This, in turn, will spur investment -- both foreign and domestic.
Moving through my list (I am now up to five), it is time to talk about taxes. You undoubtedly understand that the Russian tax authorities are often perceived as a weapon of corruption, extortion and influence. The Yukos/Khodorkovsky cases have certainly contributed to this perception. Of course, tax laws should be enforced. But in most countries, enforcement is usually intended to maximize long-term revenues to the government while allowing the economy to develop. That doesn't always appear to be the approach here. The tax laws need to be clear; they need to be enforced in a fair and equitable manner; the courts need to be consistent in their rulings; and selective prosecution for political or corrupt purposes should not be tolerated.
So, where does this leave me after four years? More than any particular "fix" I have articulated tonight, I am convinced that Russia's long-term economic health depends on the development of effective governmental accountability. What do I mean? Democracy in Russia is still on uncertain footing. Russians are less and less sure about where their country is going. A May poll conducted by the Levada Center suggests that some 43 percent of Russians believe disorder and anarchy are on the rise -- and this over a period when there has been a move to centralize federal power. Extreme centralization of government may help bring wayward governors into line, but it can also obscure the population's real desires and lead to too many decisions being taken by too few people in power. Debate in the Duma now seems to be much less an instrument for real debate -- and for exercising quality control -- over government proposals than it used to be.
My point is simple. Public debate is good, and serves as a necessary check on any government. It helps align economic policy with economic decision-makers in the private sector (like yourselves). I urge you, potential and established investors in Russia, to watch the next Duma and presidential elections closely. They will be a good benchmark for how well the corridors of power in Russia are listening to and taking the advice of its people, its business leaders, its civil society. We take President Putin at his word that he intends to ensure equal access to the media by all opposition politicians. A lively debate is just what Russia needs, together with all the other checks and balances that underpin any normal democracy -- separation of powers, a vibrant political opposition, independent media, and the rule of law.
I have made a number of sharp criticisms of Russia this evening. I make those criticisms as a friend -- someone who has passionately followed this country since I first began to study the Russian language at the age of 15. And I speak for everyone in the Bush Administration -- including the President himself -- when I say that the United States wants Russia to succeed. An economically strong, stable and democratic Russia is in everyone's best interest, and will be a more capable partner in addressing the many common challenges of the 21st century.
Russia has made some significant strides in recent years. When I first visited Russia as a student 36 years ago, it was mired in the communism and economic stagnation of the Soviet Union. As I prepare to leave this summer, I must admit that this country has come much further than I could have ever imagined at that point in time.
This land holds such great potential for its own people and can contribute so much to the rest of the world. It has always had a strong educational base, a wealth of world-class scientists and engineers, a resilient and adaptable population, a thriving cultural community, and bountiful natural resources. And over the past fifteen years, this enormous potential has been only further enhanced as Russia has opened its doors and embraced the free flow of people and ideas that is the foundation of the most successful, prosperous and influential states in the world today.
Almost every day during my four years in Russia, both here in Moscow and on my many travels from Kaliningrad to Vladivostok, I have come into direct contact with this country's most valuable natural resource -- the remarkable Russian people who now have direct stake in helping their country complete its unprecedented transition to become a strong, reliable, democratic state. Their commitment continues to inspire us all, and leaves me confident that whatever short-term setbacks Russia may encounter in that transition, the strategic future of this country is in very secure hands.