1.Introduction

Thank you very much for your kind introduction. I am honored to be invited to join the Executive Luncheon Meeting hosted by Hotel Okura.
Let me begin with two remarks. First, a luncheon speech is always a dangerous business. To give you a polite speech would send you all to sleep after meal. To give you an amusing speech would hurt my political integrity. So I would like to minimize both of these risks by cutting my time of speech by 10 minutes, and by increasing that of the question and answer session.
Second, my presentation today may sound too pessimistic about Japan. In fact, when I participated in the panel of World Economic Forum held in Hong Kong, Dr. Claude Smadja, advisor to the WEF, called me as a black sheep in Japanese politics. I am not! I might appear to be pessimistic not only because I feel nobody, of course, including me, has the capacity to comprehend the effects of recent incidents will come to play into global economic downturn, but also because I feel Japan is now facing tremendous challenges.
Yet I am optimistic in the longer run. As I recall my days at Harvard twenty years ago, President Reagan took office in a situation where the U.S. economy had lost its competitive edge and had been saddled with the so called "twin deficits," while Japan' s economy was praised as No.1, and its way of business management and industrial policy was perceived to be a model to be learned. Wherever there is will, there is a way!

2.Short Term Challenges

I would like to start today by discussing the nature of the problems that Japan is now facing. Mr. Junichiro Koizumi became Prime Minister in April 2001. On the basis of policy failures and mistakes during the past decade, he has called for reform, making himself extremely popular among the average Japanese. The specifics of the reform, however, have yet to be set out and put into practice, while his administration have tried to spell out the seven reform programs proposed by the Economic and Fiscal Advisory Council of the Prime Minister's Office.
Although I have committed myself to a full support of his reform, I am not fully sure about quick implementation of his reform. In fact, because Mr. Koizumi's reform plan covers a wide area, i.e., that will affect a wide range of bureaucracy as well as a large number of interests groups that could be hostile to any big change in the status quo. In my view, potential weakness of the Koizumi administration lies in three points. That is, first, reform priority; second, timing and sequencing; and third, reform engine.

3.Reform Priority....Resolution of NPL

Let me describe in details one by one. First, the administration seems to need more deliberation on priority in the reform plan. The history of Japanese politics tells us that one administration can usually accomplish only one big assignment and therefore a leader must set a clear priority on his policy items.
In my view, it is apparent that the Koizumi administration has put more emphasis on fiscal consolidation, symbolized by 30 trillion yen limitation on annual JGB issuance, rather than resolution of non-performing loan problem and industrial consolidation. I believe the latter by far to be the top priority policy issue that is essential for enhancing productivity and profitability of Japanese economy. We also need to give attention to the dynamics of the global economy in implementing reform.
We should start with the recognition of grave magnitude of Japan's non-performing loan problem in the weak banking system. Although the Koizumi administration has announced that it will concentrate on disposal of non-performing loans, in reality they are basically proposing setting a little more than 11.6 trillion yen non-performing loans off the balance sheet within the next two to three years.
This should be only an initial step in disposing non-performing loans accumulated on the balance sheets of Japanese banks. More than 80 trillion yen of so called category II loans, or substandard loans, on a self assessment basis, which is equivalent to 16% of Japan's GDP, concentrates on the real estate, general construction, and retail/wholesale sectors. This magnitude is grave in light of the history of asset babble in the rest of the world, e.g., 3% of GDP in the cases of U.S. in the early 90's. Aggressive workouts of those industries, therefore, must be carried out, where not only institutions like asset management corporations may be used, but also public and private capital injections and, in some cases, nationalization may be further needed to cover huge potential losses in bank's capital. Political commitment is surely required in the process before it becomes too late.
Faced with the pressure from the financial market, the FSA started in November urgent on-site examination of major banks in order to specify large deteriorated borrowers under category II. But market participants have still doubt about the effectiveness of the FSA examination, and so do close colleagues of mine in the Diet.
I have been proposing a financial crisis management plan before lifting the ban on pay-off of bank's time deposits starting April 2002, which consists of three components. By December, we must judge banks' capital shortage based on more stringent asset evaluation standards to be applied in the on-site examination. Let me remind you of the fact that in the case of large retailers, such as Sogo, which was categorized as a substandard company, bankruptcy trustees found that only 5% of the uncollateralized loans could be collected, which indicates how the current FSA standards have been ineffective in gauging assets deterioration and capital shortage of banks.
Then, with restructuring plan of large non-performing borrowers, major banks also must be restructured in terms of both capital and management. Capital can be augmented for a bank by the market, but only two or three hundred billion yen of capital increase for each should not be enough to cover the current shortage on their loss allowances, and public capital injection should be executed while it surely requires capital reduction and management change in the process. Three years ago Japan failed to recognize the fact of banks' capital shortage by creating national fiction that capital injection was to make healthy major banks healthier. We should not repeat the fiction, since we will have no more three years to make believe. The window of opportunity may be closed by the end of March 2002. An ultimate driving force of the process of non-performing loan resolution should be the administration itself, the FSA above all, and METI, as well as MLIT, since in the last decade, private initiatives have failed to solve the problem due to absolute capital shortage in the banking system. In order to facilitate the process, mandatory transfer of so called risk management non-performing loans of major banks into the RCC may be one option, where future realized losses of the loans can be paid by banks' common stocks, which means, further substantive nationalization of major banks may be inevitable. In this regard, the RCC should function as asset management company (AMC) utilized in a bank resolution process in Sweden in the late 1980's, that is, a vehicle to restructure over-indebted companies. Thus, it is undesirable for the RCC to survive as a permanent institution, and I believe the RCC should be closed within next five years.

4.Timing and Sequencing of Reform

Let me turn to the second problem, i.e., timing and sequencing of Koizumi's reform.
Prime Minister Koizumi insists that there will be no economic rebirth without reform, by saying no pains, no gains. This is a clear declaration of departure from the "lost decade" when we have worsened the misallocation of economic resources by accumulating conventional type of public works spending and non-performing assets. Again, I agree with his idea, however, it seems to me that he needs more sophistication.
I think market participants share a consensus that non-performing loan disposition and work-out of ailing industries should come first, and fiscal consolidation should come second. It might be dangerous if the Koizumi administration puts too much political emphasis upon fiscal consolidation. The present unemployment rate of 5.3% indicates that pain has come before non-performing loan resolution ever started, since fiscal consolidation without priority induced Hashimoto risk of fiscal tightening three years ago. Thus, the priority must be established within the cabinet.
Let me briefly talk about my plan of priority in the next 10 years that I proposed early this year, which consists of three steps. In the first two years, although almost one year has already wasted, I think we should concentrate on cleaning up bad assets and corporate and industrial structural reform.
These measures may inevitably entail painful adjustments. More efficient safety net should be designed to put an emphasis on productive policies like on the job training programs, professional education vouchers, and incentives for job change. Instead of simply spending for conventional items, I have been proposing to privatize and sell government assets, including airports, highways, public utilities, government-held real estate and stocks like NTT and JT, wire-wave frequencies, and national universities, on top on that, Toudai, in order for both offsetting deflationary effects through creation of new demand of government sector and financing the cost of establishing a safety net. It seems to me that political discussion over 30 trillion yen limit on annual JGB issuance is out of focus, since if you really desire to invest into potential growing industry such as nano-technologies ecology-automobiles, or bio technologies, in order to enhance productivity of national economy, it is quite rational to sell under-performing national assets. As long as non- performing loan resolution will be executed, fiscal spending should at worst be maintained neutral to the economy.
The following three years should be focused on restoring the primary balance of national government budget by cutting public spending, along with strengthening capital markets and real estate markets.
At this point, I would like to digress briefly by making a comment on monetary policy and inflation targeting. In my view, it is apparent that the monetary ease failed to boost the economy because of malfunctioning of financial intermediaries, that is, accumulation of huge non-performing loans. It might be wise to take further easing after the resolution process in full scale actually moves forward. At this juncture, political pressure to the central bank is not only useless but also harmful, since I think the independence of a central bank measures the degree of maturity of one country's democracy.
Turning back to my plan, the last five years, we will fulfill fundamental reform of social security, pension system, and tax code towards national debt reduction. Our ultimate goal is to prepare a program to maintain long-term sustainable growth driven by private sector economy.

5.Reform Engine

Now, let me turn to a political dimension of Japan today having discussed economic problems. This is the third area where I believe the Koizumi administration should strengthen more in their reform engine, that is, a controlling tower of the reform, or governance issue.
In recent months I have learned three major criticisms against the Koizumi administration. A first one is that the administration has accomplished nothing since he took office. True, in a superficial sense. But we may as well pay more attention to his flexible stewardship in controlling his Ministers. For example, Mr. Koizumi has recently put more pressure on FSA Minister Yanagisawa to expedite the non performing loan resolution. Behind this, I must tell you there are repeated efforts by a group of young Diet members, including us, to convince Mr. Koizumi in this regard.
A second criticism is that Prime Minister Koizumi has been unable to act beyond the framework set by the ruling coalition. In fact, every coalition government since 1993 has been facing this problem, after the LDP lost the majority in the Lower House. The problem he had in the process of legislation against terrorism demonstrated this constraint on the Prime Minister's power. It seems to me, however, that Mr. Koizumi makes every effort to lead the whole Diet members in seeking bipartisanship in the case of important policy decisions such as recent debate over the Lower House election system, national security, fiscal consolidation, and structural reform.
A third criticism is that Mr. Koizumi tends to disregard opinions of LDP Diet members with respect to his reform plan. Indeed, he takes "top down" approach by utilizing his advisory councils under the Prime Minister's Office, but a disparity between Prime Minister's Office and the ruling parties is one of the most striking features in our national governance system.
This is the political reality that Mr. Koizumi now has to face. Japan has yet to established a new effective policy making process, or a new effective governance system after the old "iron triad" model collapsed a decade ago, under which political gurus like Mr. Takeshita and a few intellectual bureaucrats had de facto monopolized national policy making. Under the old regime, not only was policy implementation rapid, but also decision making was faster than is now. A disappearance of guru politics was a progress in democracy, but the subsequent political reality has been such that smaller political gurus fight for their political survival by seeking an ad hoc coalition for policy meddling.
After 1993, when the "iron triad" model collapsed, national policy has been decided on an ad hoc basis. For example, under the Hashimoto administration, younger politicians and bureaucrats played an important role in policy decision as well as policy planning. Under the Obuchi administration, coalition partners of the LDP played a significant role. Under the Mori administration, the Policy Research Council of the LDP headed by Mr. Kamei was instrumental in policy decision making.
In the first eight months of the Koizumi administration, the Prime Minister's Office seems to be influential, but it is too early to tell. Many outside academics and private advisors work in the Prime Minister's Office, but no one can tell who, other than bureaucrats, really shapes an administration's central doctrine on important matters as the imposition of a thirty trillion yen ceiling on annual bond issuance exemplifies. Decisions of the Japanese government have been made on an ad hoc basis during the past decade while the key players changed, depending upon the power structure of each administration. We need more stability in the policy decision making process. That's why to strengthen the reform engine is essential for the Koizumi administration.

6.Proposals

At this juncture, it is essential to institutionalize and strengthen the new system of governance for both policy making and implementation. I have several proposals in my mind.
First, integrate the ruling parties and the government in order to strengthen the leadership of the Prime Minister. This cannot be achieved without decreasing the role of the ruling party's pre-clearance practice of cabinet-sponsored bill before submission to the Diet. At the same time, we may have to pay more attention to democratize the Diet in order to facilitate productive debate and amendments under a more transparent system, thus an establishment of year-round Diet session may be a positive option. The current ordinary Diet session is held only in the first half of the year, and the next year's budget process begins in the second half year. Under this system, the tax council in the ruling party discusses tax code changes only between October and December. Thus, the budget appropriations and tax policy debates in the LDP are held only in the forth quarter, giving bureaucrats the freedom to operate without the constraints of political debate during the rest of the year. Thus, a year-round Diet can be a more accountable system, since it prevents the current tactical scheduling to pass as many as legislations as possible from the stand point of the ruling parties within the limited time frame of the Diet sessions.
Second, strengthen the Prime Minister's Office. It is essential to restore the leadership of the office by increasing the number of expertise-based political appointees and non-bureaucrat advisors within the Prime Minister's Office, and possibly within individual ministries. The current deputy minister and parliamentary vice-minister system may not function well, because politicians can be easily deprived of access to timely, unbiased and sufficient information, let alone new ideas independent of the bureaucracy, needed to make their final decisions. In this point, minister and vice-ministers must form a team in directing bureaucrats. At the same time, ministers can politically appoint whoever they want in each ministry as their assistants, but no minister has done it probably because you have to replace civil servants for the political appointees. Also, an introduction of an advisory committee with full-time membership just like "a Policy Unit" of England at the Prime Minister's Office may deserve serious consideration.
Third, widening the policy-making community. Strengthening the intellectual base of national policy making cannot be achieved without a strong, independent, and diverse think-tank community. Currently, many Japanese think-tanks are affiliates of financial institutions or business associations. We need more independent, strategic thinkers in the think-tank community.

7.Closing Remarks

Before closing my remarks, I would like to state that Japan's policy making process is becoming more democratic in both positive and negative senses. For one thing, due process and disclosure are becoming more essential in the political field. But until a new regime for policy making system is established, the current chaotic situation will continue. Should we be happy about it, or at least accept it as it is? The answer is clearly no. Japan has no time to lose in putting its economy, national security, and society back on the right track, and while the current window of opportunity is open, someone has to lead, to help forge wise and timely policies and see to their effective implementation.
That someone is of course the Prime Minister. Fortunately, we have a tremendously popular prime minister at the moment. The time is ripe for gathering the best and the brightest from both inside and outside the government and mustering their efforts for policy development and implementation. It is of utmost importance to institutionalize a new style of governance that can present and realize the grand vision of the future Japan embraced by the Prime Minister. That model will revitalize not only the Japanese economy, but also the Japanese democracy.

Thank you.