Thank you very much, Mr. Peter Fuchs, for your kind introduction. It always gives me a pleasure to speak at the American Chamber of Commerce in Japan, away from rough scene in the National Diet. Bearing in mind Japan's recent political disarray, I am not so sure if my speech helps your digestion after good meal.

Before I begin, please allow me to raise two disclaimers about the brochure that the ACCJ prepared for this meeting. First, it names me Young Turk. Let me remind you that I am already 51 years old with two sons, and recently one of them told me that he is going to get married. I was shocked, too. Second, the brochure referred to me as future Cabinet Minister or Prime Minister. Well, I am grateful, but this is the third time I was named future Prime Minister. The first time was the virtual LDP Presidential election via internet in 1998. The second time, two months ago, was in the Sunday morning political TV show where dozens of junior and senior high school students selected me as Prime Minister of 2010. Let me remind you of the traditional rule of this town, Nagatacho, that is, at least before Mr. Koizumi became Prime Minister, you are qualified to become a Cabinet Minister after five times elected to the Diet and to become Prime Minister after about ten times, while I have been elected only three times since 1993. This kind of seniority system still persists in every corner of the Japanese society and is one of the daunting impediments against reform in this country.

1.What went wrong with Koizumi administration?

In this sense, Mr. Koizumi was an unprecedented Prime Minister, when he won the race against the background of people's enthusiasm for reform one year ago and he insisted "no pain, no gain." Fourteen months have since passed and surprisingly enough, the Prime Minister's approval rating has dropped from 80% to 40 % or even below that. What went wrong?
Mr. Koizumi has set a wide spectrum of reform items on his agenda, including privatization of government sponsored corporations symbolized by Highway Corporation and postal services reform, fiscal consolidation symbolized by 30 trillion yen cap of JGB annual issuance, non-performing loan resolution, comprehensive tax reform and strengthening national security. So far, however, every item seems to be compromised with so-called "resistance camp" in the LDP or left incomplete, except for an effort for fiscal consolidation.
Let me also point out the fact that, although there are four categories of politically important bills that are still pending in the Diet, none of them is addressing to the most fundamental problem Japan is now facing, nor providing immediate solutions to the Japan's decade-long economic recession.
In short, Prime Minister Koizumi accomplished three things in the first year. First, as you may recall, he strengthened national security legal framework by enabling Self Defense Forces to be sent anywhere on the globe as far as there are fair grounds for anti-terrorism operation assistance. In fact he addressed in much prompter way after the September 11th incident, compared to our response during the Gulf War, thus saved a lot of tax payer's money. Second, he has been putting more emphasis on fiscal consolidation. He succeeded in cutting fiscal spending in FY2002 budget. And third, government sponsored corporations and postal services reform. These three accomplishments are said to have one in common; the bureaucrats in Ministry of Finance are very happy about it.
Since Japan has many challenges to face with, I assume, Mr. Koizumi had to lay down lots of reform items flatly and vaguely, before he ran for the Presidential election in the LDP. What he lacks is apparently a priority among reform items based on well-defined national interests and strategy. Without a clear political priority, bureaucrats always take control the sequence of events. Thus, political leaders have a responsibility to set a priority with long term vision. While I believe Mr. Koizumi is a very attractive leader who has an ability to talk to the nation candidly, he has failed to establish the leadership of his administration since he came up with wrong reform priority under the strong influence of bureaucracy without any long-term strategy.
Under these circumstances, the administration as well as many ruling party politicians is now planning to reshuffle the cabinet, hoping to strengthen their own political clout. I believe Mr. Koizumi should become "New Koizumi" now. In order to accomplish it, he must first renew his policy priority in a correct manner and at the same time, he needs to set up a whole new powerful cabinet, or he may not deserve to sit on his seat.

2.NPL resolution has always been missing link

When establishing a proper reform priority, the key, of course, is to strengthen the economy. The next cabinet must put all political resources into an effort to strengthen private economy. Japan's long-term economic decline, if it really comes, surely undermines the power base and change security landscape not only in Asia but also in the world. Japan's economic disease is a trap of a large country with accumulation of external assets just like U.K. in the 1870s, and U.S. in the 1930s, not the ones like recent Argentina or Russia. So I understand the recent downgrading of sovereign rating by Moody's to be a warning towards Japan's political risks of procrastination in making necessary change. I can also understand bureaucrats in the Ministry of Finance stick to the idea of fiscal consolidation. It could be interpreted as an evidence that Japan is a matured nation where a voice of fiscal soundness does exist in the political process despite serious deflationary pressure.
However, political leaders must take a good look at the disease itself. Japan's economy has experienced three short-term recessions during the past decade after the collapse of the bubble economy. And financial crises repeatedly emerged during recession periods. Each recession was followed by a short and weak recovery mainly supported by inventory build-up in the manufacturing sector together with a great government spending. Overall, the rate of growth of the GDP has been on the downward trend throughout the decade, since 75% of the GDP consists of the non-manufacturing sector, on which huge non-performing assets concentrate. Non-performing loan resolution has always been missing in the past administrations.
Last week, Council on Economic and Fiscal Policy (CEFP) at the Prime Minister's Office released a economic package that not only lacks determination on non-performing loan resolution, but also generates deflationary impacts by itself, since it clearly denies substantial tax cut and commits a substantial spending cut. In reality, the Ministry of Finance is strongly opposed to tax cut based on the doctrine of pay as you go, and no clear consensus on longer term fiscal policy has been reached within the government. Mr. Koizumi has to head to the G8 Summit in a few days with this package that could never be convincing, if not disappointing.
The administration apparently needs to clarify the priority of policy and sequencing of reform plan. I believe, non-performing loan resolution as well as reorganization of heavily indebted industries by far to be the top priority policy issue that is essential for enhancing productivity and profitability of Japanese economy. We must start with the recognition of grave magnitude of non-performing assets.
One year ago, Prime Minister Koizumi announced that his administration would concentrate on disposal of non-performing assets. What was proposed in reality was, however, to set a little more than 12.2 trillion yen of non-performing assets off the balance sheets within the next two to three years. The Financial Services Agency (FSA) disclosed the outcome of the special inspection of major banks on April 12. This inspection covered 149 large indebted companies, the result of which reportedly also adds only as little as 3.7 trillion yen to the narrowly defined disposition target of non-performing loans and increased risk management loans by six trillion yen.
I hoped this special inspection would have been a giant step in order to finalize in disposing non-performing loans accumulated on the balance sheets of Japanese banks. We have to keep the reality in mind that about 80 trillion yen of so called category II loans, or substandard loans, on a self assessment basis, which are equivalent of 16% of GDP, remain, concentrated on real estate, general construction, retail/wholesale and non-bank sectors.

3.We already know

According to the FSA, no major banks are undercapitalized. Today, however, not only banking experts but also average people consider most of the major banks to be undercapitalized and some practically insolvent. People fears that there might be a risk of bank runs as well as capital flight before the lifting of deposit protection next April. Under these circumstances, we always have to be mindful of possible contingencies in the financial system which suffers from weak capital, weak earnings, lack of risk based pricing, and old type governance problem as we witnessed in the Mizuho merger case where ATMs and computer systems clogged.
In order to control the current potential crisis situation, we need the following simple measures that were adopted in as many countries as the U.S., Sweden, and more recently in Korea, Thailand, Malaysia and China. Indeed, some of my friends go so far as to say Japan may have to "Look West" in Asia in searching for appropriate measures.
The answer is also quite simple:

1. Establish stringent rules for evaluation of bank assets, provision sufficiently, and recognize losses
2. Remove non-performing loans off the balance sheet, and if necessary, nationalize banks or inject public capital
3. Revitalize distressed asset markets, by way of tax and legal system improvement

We already know what we must do. The next cabinet can start with strengthening Resolution and Collection Corporation (RCC) to function as Asset Management Corporation to transfer major non-performing assets from major banks.
In 1998, only Japan failed to recognize the fact of banks' capital shortage by creating a fiction that capital injection was to make healthy major banks healthier. We must not repeat this mistake, since we have no more three years to make believe. An ultimate driving force of the process of non-performing loan resolution only rests in the administration itself, the FSA above all, and METI, as well as MLIT. Based on the banking laws, the administration can guide industries correctly towards mandatory transfer of so called risk management non-performing loans of major banks into the RCC, where future losses of the loans can be paid out by banks' common stock, which means, further substantive de facto nationalization of major banks.

4.Why procrastination?

While we already know what must be done, there has been a cause for procrastination. Behind the prolonged crisis lies our governance problem not only in the business sector but also in the political sector. A big problem we are facing is not inability to envision solutions but inability to put them into practice.
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.
First, bureaucratic paralysis is apparent. As I said earlier, 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 past errors they made. In the United States and some other countries, errors are more effectively checked by the other agencies or legislators. Because of the cozy triangle, however, mistakes tended to be overlooked, or even accumulated in Japan.
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.

5.Proposals in policy-making process

This is the political reality that leaders now have to face. Japan has yet to establish a new effective policy-making process or a new effective governance system after the old "iron triangle" model collapsed a decade ago.
At this juncture, it is essential to institutionalize and strengthen the new system of governance by getting back to the basics of the parliamentary cabinet system for both policy making and implementation. I believe a change in policy making system to be the only way to get out of the current political mess under the Koizumi administration. In fact, the National Strategy Headquarter of the LDP, where I serve as a team leader on this subject, proposed several important points as follows.
First, integrate the ruling parties and the government in order to strengthen the leadership of the Prime Minister. Party leaders must join the cabinet. We have to play down the role of the ruling party's pre-clearance practice of cabinet-sponsored bill before submission to the Diet. At the same time, we have to facilitate productive debate and amendments in the Diet under a more transparent system, thus I support an establishment of year-round Diet session.
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, as well as definitely within individual ministries. An introduction of an advisory committee with full-time membership just like "a Policy Unit" of Downing 10 in England deserves serious consideration. The current senior vice minister and parliamentary secretary system functions poorly, because politicians in the ministries can be easily deprived of access to new ideas independent of the bureaucracy.
Third, we have to improve the quality of politicians to restore the trust. This must be the most difficult task. I think the primary election system can be one of the solutions, because under the current system of single seat election system the incumbent candidates always get party tickets, and thus quality of politicians, especially in the LDP, cannot be easily improved.
Fourth, widening the policy-making community. Strengthening the intellectual base of national policy-making cannot be achieved without a strong, independent, and a diverse think-tank community. I am fearful that policymakers in Japan rapidly fall behind in terms of their academic background compared with other countries. So we need more independent, strategic thinkers in the think-tank community.

6.New ideas into new government

If we could successfully incorporate these proposals into the next cabinet, we can establish a priority over the next ten years as follows; in the first two years we will concentrate on cleaning up non-performing assets and corporate, industrial structural reform, along with strengthening capital markets and real estate markets. These measures inevitably entail painful adjustments. 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. As long as non-performing loan resolutions are underway, fiscal policy 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 with legislation like OBRA.
During the last five years, we will step out to the fundamental reform of social security, pension system, and tax codes towards national debt reduction. Our ultimate goal is to prepare a program to maintain long-term sustainable growth driven by the private sector. Under this scenario, party leaders will have to strive as members of the cabinet and you can put new ideas into new government.

7.Conclusions

In conclusion, it seems obvious to me that at this juncture the political system itself 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 many "Ichiros" would come back to play at home. Japan's problems hinge not so much on capability of human resources as on the quality of 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.
The time is becoming ripe for the Japanese people and a growing number of younger Diet members 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. To make these proposals materialize mean a near-revolutionary change in the national governance system. Indeed, not an evolutionary but a revolutionary change needs to be done. I believe that is what Mr. Koizumi aimed at a year ago. That is how he became popular amongst voters. The voters are, in my opinion, more prepared for a drastic reform than politicians are. I hope you continue to encourage those who are more prepared and willing to go ahead.

Thank you.