Thank you very much Dean Nye for your kind introduction and thank you, Shimizu san, for allowing me to make a sentimental journey back to Cambridge, lovely second hometown of mine, filled with good memories as well as bitter ones of tough professors at the Kennedy School, with a pile of reading assignments and homework.

Tonight, I am honored to speak to this distinguished group of members of the faculty as well as best students from a variety of countries in the world. "Always thinking globally" is a wonderful tradition of this great school. I am proud of myself being part of the tradition.

1.Japan's lost decade

As I recall my days in the Kennedy School, some 20 years ago, President Ronald Reagan came into office in the midst of the Cold War, when the U.S. economy seemed to have lost its competitive edge and was suffering from the so-called twin deficits. On the other hand, Japan was praised as "No.1" and its competitiveness was perceived to be a model to be learned. In fact, in Professor Vogel and Professor Reich's class I made a presentation on the excellence of Japanese industrial policy at that time. Over the past two decades, however, all this has changed dramatically.

In contrast with the U.S., which reemerged with remarkable productivity growth, Japan, after experiencing the asset price bubble in the late 1980s and subsequent burst, has continued to decline, which already lasted over a decade. That decade was lost in political terms as well. There were seven Prime Ministers before the present Junichiro Koizumi, and their average duration in office was 495 days, too short for a prime minister to deliver his own policy with a strategy based on clearly defined national interests.

2.Pre-revolution atmosphere

After this lost decade, Japan is now filled with pessimism. Sometimes I feel even pre-revolution atmosphere in the society. People have stopped trusting the government when it says that Japan is okay. It is true that the LDP-led coalition government stays in power, but it is because people mistrust the opposition parties as well. People doubt the efficacy of the Japanese system itself.

The past success model of Japan was supported by the so-called "iron triangle," which consists of comfortable relationship among bureaucrats, businessmen, and politicians. This triangle supported the famous Japan Inc., which was best described by Michael Gorbachev of the Soviet Union, when he paradoxically said that Japan was the most successful socialist economy in the world. But in the 1990s, too many policy errors and mistakes were made in Japan just like in many truly socialist countries, which demonstrated that the system did not ensure good performance. With respect to what I consider to be systemic problems of Japan, let me make three points.

First, bureaucratic paralysis is apparent. Our history of banking supervision tells us that prolonged financial crisis is an outcome of what I call "continuity trap" of the bureaucracy. Bureaucrats in the ministries rarely admit their past errors. In the United States and some other countries, errors are more effectively checked by other agencies or legislators. Because of the cozy triangle, however, mistakes tended to be overlooked, or even accumulated in Japan. Recent examples of this include Official Development Aid policy in the Ministry of Foreign Affairs, the cases of Mad Cow Disease or BSE in the Ministry of Agriculture.

Second, political stability has also been lost. Both the ruling and opposition parties are seriously divided within each party over big policy issues, such as national security and privatization of the government services. Legislation that requires a departure from the past policy always threatens a split of the party, and therefore makes politics more chaotic.

Third, economic uncertainty is spreading across the country. Japan's economy has experienced three short-term recessions during the past decade, and financial crises occurred repeatedly during these recession periods. Each recession was, however, followed by a brief and weak recovery. In recent weeks again, an optimism is growing about the economy among Japanese policy makers against the background of inventory cyclical recovery, which benefits the manufacturing sector that accounts for only 25% of GDP. I have to put a caveat against optimism by saying that without fundamental resolution of banking problems, there will be no sustainable economic growth in Japan, which is in fact the same as I said in Washington D.C. in 1999, when the Japanese economy was about to enter the second cyclical recovery for this decade.

3.Competitive Human Resources

All those problems of Japan hinge not so much on capability of human resources as on the management. In fact, I have a strong confidence in potentials of individual Japanese. In the financial market, for example, so many banking professionals left badly managed Japanese banks, joined foreign institutions, and successfully proved their competence, just like Ichiro Suzuki of the Seattle Mariners. It is evident that the sources of problems lie in management that cannot take advantage of talented people.

Besides Ichiro and Ms. Sadako Ogata, former High Commissioner of UNHCR, I have found a number of Japanese who displayed their ability, will and performance. When I went to Afghanistan last December, I met a lot of young Japanese working for humanitarian activities in refugee camps in Mazar-i-Sharif. I came across a 26-year-old Japanese woman who directed non-governmental rescue team of 100 members in Kurdish villages in northern Iraq. The U.S. State Department is about to endow this team a fairly big amount of assistance for their activities of humanitarian support and the U.K. Overseas Department for Aid is also going to approve a comparable amount in consideration of strategic importance of this NGO activities. However, the Japanese Foreign Ministry has continued to refuse to assist, because to support their activity means to show the flag of Japan with respect to Iraq issues. This is another example of a systemic problem in Japan's policymaking and implementation.

It seems obvious to me that the system needs to be changed. Not partial improvements but an overhaul of the system needs to be done. If you ask me in what direction the system must change, I would say that under the new system Ms. Sadako Ogata can play a significant role not only in the international scene but also at home; many "Ichiros" would be tempted to come back to play at home; and you, young ladies and gentlemen, Americans, Japanese and other nationalities, would like to work in the Japanese government or corporations after you graduate from Harvard.

4.Key elements of the new system

Let me now discuss key elements of such a new system. First, we have to clarify the roles of the government in the society. In my view, the government's principal role lies in the establishment of "fair playground," where private initiatives ought to be rewarded properly by the market.

Second, a check and balance mechanism must be installed effectively within the system. I am not merely discussing the check and balance among the legislative, executive, and judicial branches of the government. I am speaking of check and balance mechanism within each branch as well as between the public and private sectors. We know that ambition must be made to counter ambition as James Madison correctly pointed out over two hundred years ago. On the economic front, the government can contribute to this by keeping the market competitive through its antitrust policy, disclosure requirement, and intellectual property rights protection.

Third, coherent law enforcement constitutes a vital part of keeping the playground fair. Fair games can only be ensured by players' respect of the rules. Therefore, informal controls in the old iron triangle, that is, by comfortable relationship between players and judges, must be replaced by formal, transparent law enforcement. In this regard, judicial functions must be strengthened by an increase in the number of lawyers and judges, as well as an improvement in accessibility to legal services. By the same token, Japanese Securities Exchange Commission must be established to secure fair and competitive trading of securities.

Forth, competitive partnership with the rest of the world is also crucial for Japan to promote home market reforms. I think WTO talks and international accounting standard setting will play a vital role. Bilateral Free Trade Agreements also offer a larger playground than home markets and give an additional competitive impact on the domestic market. The FTA can cover a variety of areas, that is not only trade policy but science policy such as genetic engineering and high speed internet, educational policy such as cross-border university credit exchange, as well as health policy such as international remote medical services.

Concluding remarks

With numerous daunting problems, Japan has moved only slowly during the past decade. This is because the problems are of structural nature with no strong political will to fix them. I believe it is of utmost importance to establish a new system of the country. My model, about which I have had only a limited time to discuss today, will revitalize not only the economy of Japan but also its democracy. I also believe that time is becoming ripe, for the people of Japan and a growing number of younger Diet members, through still limited, are becoming increasingly aware of the need for comprehensive change in the system as is illustrated by their increasing support for a review of the Japanese Constitution. At this critical moment in time, I would appreciate it if you help realize my wish that someday not remote in the future in this hall, one of you will make a presentation of Japan's success as a leading model to be learned again.

Thank you