Medvedev, who became president last year, is widely seen as being weaker than Putin, now prime minister, and the speech was closely watched for any signs of Medvedev's independence from his powerful mentor.
"In the 21st century, our country again requires modernisation in all areas, and this will be the first time in our history when modernisation will be based on the values and institutions of democracy," Medvedev said.
Speaking to hundreds of officials in the Kremlin's ornate St. George Hall, Medvedev said Russia should become "a society of smart, free and responsible people."
But with Putin seated prominently in the front row, Medvedev cautioned: "Any attempts to rock the boat, destabilise the government and rend society under slogans of democracy will be stopped."
Medvedev called for Russia to diversify away from raw-materials exports and to reduce the state role in the economy, which would undo a key legacy of Putin's 2000-08 presidency.
"We will build a new economy instead of a primitive resource-oriented economy," Medvedev said.
He blasted "state corporations," the government-run behemoths created under Putin that control huge swathes of Russian industry despite criticism that they are opaque and inefficient.
Such companies "have no future," Medvedev said, adding that "inefficient companies must be liquidated."
Medvedev's top economic aide Arkady Dvorkovich said later that one company to be reorganised would be Russian Technologies, a conglomerate led by a close Putin ally, Sergei Chemezov, with assets ranging from cars to arms exports.
On foreign policy, Medvedev signalled that Russia would broadly follow the priorities of Putin's presidency, when Moscow pushed back against US global dominance.
"We will work actively for the United Nations to strengthen its position," he said, calling for multilateral, UN-mediated solutions to standoffs over Iran's and North Korea's nuclear programmes.
He indicated he had no plans to ignore the military, offering new missiles and nuclear submarines from 2010.
"These measures will allow our armed forces and our allies to deal with any threat," he said.
Medvedev laid out a series of other proposals, including a call to relocate residents of struggling Soviet-built "mono-cities" whose economies depend on a single employer.
He said Russia should consider consolidating some of its 11 time zones, an idea seen as a way to tighten Moscow's ties with far eastern regions,
He called for the development of nuclear technology including "engine units capable of powering space flights, even to other planets."
Medvedev also proposed several political reforms aimed at "strengthening democratic institutions" and improving the access of opposition parties to power, particularly in local and regional elections.
"There is one law for all, the ruling party and the opposition," he said.
Under Putin, the United Russia party became a monolith with over two-thirds of seats in the national parliament while other parties were marginalized.
In a sign that Putin is seen as the stronger leader, Forbes magazine put him in third place on its list of the world's most powerful people on Thursday, while Medvedev was ranked 43rd.
Medvedev "is trying to get out from under the shadow of his predecessor," said political analyst Alexander Konovalov, head of the independent Institute for Strategic Assessments.
"He is trying to show that he differs in some ways from Putin and that he has his own perspective and he wants to implement this."
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Image: AFP: Joel Saget.