Thank you, Professor Massey for your kind introduction. It is a pleasure to take this opportunity to address this distinguished group about the issues of U.S.- Japan economic and business relationship towards 21st century.

1.Introduction

Before I begin, let me discuss briefly recent developments in Japanese politics. It has been a remarkable development since the 1st week of November that in both the U.S. and Japan people have been confused about deciding on their own national leaders. Actually some U.S. media have noted that Japan is just like "Florida in Asia." One critical difference is, however, the fact that in Florida people went to the court to decide on the people's will, while in Japan people concerned, namely politicians, went to Ryoutei, Japanese style authentic restaurants. Accordingly, while you can follow the whole process of Florida recount by simply watching CNN, you never understand why Mr. Kato aborted his political efforts abruptly and the Mori administration survived. To be very candid, I don't know either. Maybe Japanese version of C-SPAN needs to broadcast what's going on inside the Ryoutei room.

Mr. Kato's recent political uprising with his final intention to support a non-confidence motion against the Mori cabinet proposed by opposition parties including Communist Party could be perceived as an act of taboo in a party politics in a conventional sense. Why then, did he dare stand up and tried to take such a bold or even adventurous action?

As one of those who were to take the same action as Mr. Kato's, my observations are as follows. First and foremost, he was strongly motivated by his sense of urgency against not just the future of the Liberal Democratic Party, but more importantly, the future of Japan itself. We all wanted to change Japan. Ever since the fall of 1998, our government has been putting most of the efforts to stimulate the economy by debt-financing, not addressing to the fundamental structural problems; heavily-indebted balance sheets of industries, slow economic reforms, serious debt troubles of central and local governments, social security crisis including public pension, and so on. These concerns now put us in a state of uncertainty with our future. Mr. Kato tried to make a breakthrough in a frozen state of the nation. In fact, Mr. Kato was welcomed by huge and wide public support, especially through Internet, for the first time in Japanese politics.

Secondly, however, Mr. Kato was much provoked and escalated his action without well-prepared strategy for victory. When he was finally determined to act for non-confidence motion, considerable number of his colleagues fled away from his camp. This eventually led him to decide at the final moment to abstain from voting.

Surprisingly enough, even after his attempt failed, there are still quite a few supports for Mr. Kato's idea among public opinion. While I have to admit that there is some sense of cynicism that regards Mr. Kato as a symbol of political untrustworthy, a proliferation of political cynicism among people is the most perilous factor towards reform. I think Japanese politics are now moving to a new stage, where our generation should be the driving force towards reform. I think the time has come for us to act beyond old faction line as well as existing party line with the only criteria of action: who is really determined to stand up for Japan with similar ideology as ours to change Japan.

2.Principles in U.S.- Japan Relationship in the 21st Century

Ithink today's main theme of the U.S.- Japan economic and business relationship has a bearing in this Mr. Kato's uprising, because his direct motive is deeply rooted in the trend of globalization. At the outset, I would like to delineate issues of U.S. - Japan economic relations in the context of global economic trends, which can be summarized in three points.

First, China and Russia factor in the globalization context. In my view, U. S.- Japan partnership towards 21st century, on both the economic and national security front should be re-designed in the context of how we can involve China, and may be Russia also, in our system of free market economy. You may recall the history after World War I, when an international exclusion policy against Germany directed by Anglo-Saxon countries finally led to a tragedy of World War II. Accordingly it shall be important for us to involve potentially influential country, namely China and Russia, in the common economic and social systems or values we are enjoying from the viewpoint of a broader strategic picture.

Second, Japan setting a leading model. History tells us that, since the Meiji restoration of 1868, especially so-called "Asian miracle" history of rapid growth after World War II, Japan presented a forefront model for the rest of the Asian countries. Although we must recognize that we have lots of imminent issues on the domestic reform agenda to tackle with, our model should still be significant. It seems to me that after the collapse of economic bubble and political disarray in the 1990's, Japanese people fail to realize how influential Japan has been with its potential power in the international community. I suspect this underestimate might partly reflect the attitude of both countries' governments in recent years. So-called "check book diplomacy" may be a good example. In order to proceed with reform policy, both Washington and Tokyo has to become more constructive in devising policy away from a simple spending-out public money, which the older Liberal Democratic Party still love to see, but we all know by now to be very inefficient.

Third, restructuring for productivity enhancement, rather than down-sizing. Currently corporate profit growth mainly stems from restructuring with cutting back capital and human resources, namely down-sizing, not from productivity growth. That's why economic recovery has been fragile. Some economists still insist that problems of Japan's economy can be restored through macro-economic policy measure of fiscal expenditure and monetary easing, and recently some politicians go so far as to say that even stock market disruptions can be better managed by government intervention and administrative guidance. Not to mention, this is widely off the mark. I think the current market conditions clearly indicate that Japan's economic problem lies in lower rate of expected return that is caused by capital misallocation, such as an accumulation of non-performing assets in both the private and public sector. Thus, Japan's problem can only be addressed by efforts towards productivity enhancement.

3.Competition Policy

The productivity-enhancement reform is now required in every aspect of the economy; namely, private businesses, financial intermediaries, and governmental fiscal policy. Let me start from private businesses.

In the world of private businesses, open competition policy in broad terms should be strengthened in each particular sector for the purpose of enhancing social productivity. This will serve not only foreign companies but also ultimately Japanese consumers.

A well-known example may be telecommunication industry. In the case of U.S. action over lower Internet access charge, most of Japanese people sided with the U.S. against NTT monopoly in the telecommunication market in Japan. I think this picture may not be different in other cases such as large-scale retail stores.

There are quite a few important issues to be fixed concerning regulatory agencies. Ensuring and strengthening the independence of Fair Trade Commission is crucial in promoting competition for the benefit of consumers. I also believe a creation of stronger telecommunication commission that is independent from the Ministry should serve better the competitive telecommunication market.

Second, corporate governance reform may have a sweeping effect to the competition policy. The Japanese Commercial Code has many provisions that affects shareholder's rights and corporate officers' responsibilities that obstruct sophisticated financial transactions including stock splits, flexible stock options, treasury stocks, or pension portability. While the Ministry of Justice has announced to update the Code, we have to ensure its transparent process and its speedy revision. I think the Ministry of Economy and Industry, the former MITI proposing broader reform of the Code, should represent the interests of industrial competition.

4.Stronger Financial Intermediaries

Let me move on to issues of financial sector. As you know, since summer 1998, some progress has been made, for example, two major banks were nationalized and sold to the private, tax payer's money of 7.5 trillion yen were injected to the capital of money center banks, and mega-mergers took place. The fragility of the system, however, still remains. If we are to be conservative in definition, we still have non-performing loan of 80 trillion yen on banks' balance sheets, which is 17% of the GDP, while the banks' net core capital is only 18 trillion yen, and banks earn 5 trillion yen as net profits per year.

Thus, we should face the fact that the Japanese banking system is still critically undercapitalized and therefore, in order to dispose non-performing loans in the process of debt restructuring, bank itself easily may be forced to walk on the verge of failing. I have been insisting that more capital injection or nationalization, which can only be available until March 2001 and 2002 respectively, may critically need to be done in the debt restructuring process.

But even if public capital were injected, it might hardly be sufficient to supply new money into the growing business sector or restructured business unit, as long as the banking channel is clogged with existing non-performing assets. In fact, during the past two years, bank loans decreased by over 10 trillion yen even with the 7.5 trillion yen public capital injection, government bond held by banks dramatically increased by nearly 30 trillion yen, which means bank management assumes extremely higher interest rate risks.

Only an option left for us is the alternative financial intermediaries, namely, to strengthen the capital market. I would like to make four points in this regard.

First, a creation of Japanese version of Securities and Exchange Commission (SEC). As you witnessed since April 2000, Tokyo capital market revealed its fundamental weakness, along with the collapse of fragile so-called "IT stock bubble." It is commonly pointed out that regulations and enforcement of insider trading and stock price manipulation is lax in Japanese capital markets, especially in the case of venture companies, because of their scarce trading volume due to minimum stock per value requirement and small floating stocks due to cross holding of those stocks. In light of the fact that one senior management of a venture company listed on "the Mothers," a newly created capital market at Tokyo Stock Exchange, was actually arrested for corruption, securities law enforcement function must be strengthened immediately.

Second, strengthen private accounting standard setting body. Since April 2001, Japanese corporate accounting standard setting body will be privatized from a governmental agency, and a newly created private body, like FASB in the U.S., will become responsible for Japanese corporate accounting standards. In the past, reputation of government-affiliated accounting council was often sneered for implementing measures so called "accounting cosmetics," such as adoption of historical value methods for bank held securities implemented in 1998. I regret there is still some Nagatacho's voice that calls for a postponement of the implementation of fair market valuation of bank's long term securities holding. Thus, I also think a creation of independent SEC will better serve for the function of private accounting body.

Third, enhance independence of mutual fund industry. Japanese mutual fund industry has long been subsidiaries of powerful securities brokers and dealers. Mutual fund industry was hardly considered as stable financial intermediaries for long-term asset management, unlike in the U.S., especially in terms of proper disclosure and safeguard measures against conflict of interest with fund managers or parent brokers and dealers. Given the world fastest aging society, the mutual fund problem should be addressed in the context of national strategy how to educate individual household investors, along with the introduction of defined contribution pension plan.

Fourth, improve capital gain or loss carry over in the tax system. One of the most important aspects of the economic reform lies in tax reform, especially in the areas of carry over treatment of capital gains or losses. It may be the case not only for equity securities, but also for real-estate investments or for venture capital investments. Let me take real estate for example. In order to dispose huge non-performing assets on the balance sheets of Japanese banks, someone has to buy the assets, e.g., collateral real estates. While those collateral real estate assets generally contain unrealized losses, potential buyers are likely to have real estate assets with unrealized gain. Thus it may be more important as a matter of policy that to facilitate those potential buyers to sell less valuable estate and buy more valuable estate as long as the investment is regarded within the real estate investment. A carry over treatment of capital gain tax can thus be a driving force of the capital investment. Since last year, in the Tax Council at the LDP, I actually proposed UPREIT tax structure that a real estate owner with unrealized gain can contribute their real estate to an investment vehicle in exchange for its equity, without paying tax at the time of the transaction. I believe that tax reform today should induce these household portfolios with surplus savings into capital investment.

These challenges, above mentioned, such as competition policy, legal system reform, capital markets and tax system will be the focus of international pressures to Japan in the next decade. I should note that these challenges benefit not only foreign direct investment to Japan, but also Japan itself, because these reform can be a driving force in order to enhance productivity and rate of social return of "Japan Inc." towards 21st century.

5.Fiscal Consolidation

As a politician, I understand economic reform are likely to inflict short-term pain on people. Also with fiscal consolidation along with prudent fiscal policy as well as local tax reform and national pension system restructuring, it would no doubt meet with serious short-term difficulties. Here is why strong political leadership is now required and indeed, fiscal consolidation reform can only be accomplished with the leadership of Japanese politician who is fully accountable to our voters.

Economics tells us that fiscal consolidation may increase Japan's export and capital outflow to the world. Thus, mutually beneficial approach, including opening measures of our domestic market in both goods and capital, will be the only viable exit strategy for us. As a consequence, both fiscal consolidation and economic reform must be executed simultaneously. And I suppose, in the process of those reforms, U.S. - Japan partnership will become closer. In this context, Free Trade Agreement approach might be effective since it is broad-based, permanent, and mutually beneficial.

Only reciprocally beneficial arrangement can establish mutual trust and can avoid nationalistic and isolated defiant attitude that might be the most perilous to our partnership. Let me make one example. Japanese banks are now restricted in the broader securities activities within the U.S. by the Financial Modernization Act passed in 1999, because of their short of capital adequacy. I think if U.S. authorities permit a localization of capital of Japanese banks operating in the U.S., it may give a good chance to Japanese banks to supply mutually beneficial financial services without substantive harm to the financial system.

Also, in general terms, it may be a good idea to improve communication between legislators of both countries. We must not forget the U.S. and Japan have a long history of partnership since U.S. - Japan Trade Friendship and Navigation Treaty agreed before the Meiji Restoration.

6.Conclusions

I would like to raise one caveat to the new administrations in both countries. That is, policy talks should focus on fundamental philosophy rather than technicality.

When I drafted Financial Revitalization Law in summer 1998, a lot of U.S. officials kindly advised us to introduce the bridge bank scheme in Japan in order to dispose failing banks. However, obsessed with the good advice, many Japanese politicians and bureaucrat stick mainly to legislation of the bridge bank scheme, while they left basic due diligence of non-performing asset undone, because it may have raised political controversy. Therefore, they decided not to, and as a consequence, huge non-performing loans are still on the balance sheets of banks even if banks were nationalized or injected public capital. Indeed, technicality may often induce misperception, especially in the country where politicians and bureaucrats tend to be content with the legislation, but not actual implementation. Let me remind you of the fact that in Japan as well as anywhere else, the taste of the pudding is in the eatery. Sense of mission and philosophy as well as continued tasting is always required.

Finally, I hope the U.S. and Japan will foster mutual cooperation and trust with creative thinking.

Thank you.