(FORTUNE Magazine) – Lee Hsien Loong towers over most of his countrymen. But his height advantage isn't much help this morning in June at Singapore's new sports academy. The 6-foot Lee repeatedly tries to toss a ball through a hoop and misses. "I may have to come here for training," he jokes to an audience of young athletes, most of whom seem relieved to learn that despite his stern reputation, the Premier-in-waiting of Southeast Asia's richest nation is a fallible guy.

The 52-year-old Lee will need many more moments like this to win over Singapore's population. When he became Prime Minister in mid-August, he still had a lot to prove--even after 14 years as deputy prime minister and a lifetime of preparation. First and foremost is whether he can step out of the long shadow cast by his father, Lee Kuan Yew, 81, a quasi-authoritarian leader who practically invented modern Singapore. Many Singaporeans see the younger Lee as a newer version of his tough and uncompromising dad. Even Goh Chok Tong, the popular Prime Minister who served for nearly 14 years between the two Lee regimes, has declared that "some Singaporeans are uncomfortable" with the younger Lee's aloof manner.

Lee himself is aware of the challenge. "I'm not my father," he tells a crowd at a community gathering later that week. "I am not Goh Chok Tong. I am myself, and people will have to take me for what I am and for what I am able to do for them."

Even so, Lee must overcome the appearance of a family dynasty. His father still sits in the cabinet. His wife and brother hold important positions in a country that prides itself on meritocracy. And collectively, family members oversee an estimated $200 billion in accumulated state savings--which Singapore Inc. profitably invests in U.S. corporations, Asian banks, and real estate around the world. While no one accuses the Lees of impropriety, the situation is awkward for the new leader. "It creates an impression that the Lees are controlling Singapore," acknowledges outgoing Premier Goh.

But for all the family drama, the younger Lee faces an even greater test: Singapore's economy, one of the world's most durable success stories, is at a turning point. As Lee admits, "We face much more bracing conditions." Low-cost competition from China, India, and others threatens to undercut manufacturing in Singapore, an island republic home to 7,000 multinational corporations that have invested $57 billion. (General Motors has announced that it is moving its Asia-Pacific headquarters from Singapore to Shanghai.) Foreign Minister George Yeo sums up the problem starkly: "Hundreds of millions of people, smart and energetic, are prepared to do the jobs we have been doing for a fraction of the salary. This has created a situation that no country on earth expected or prepared for."

Adjusting to this profound change in the global economy is creating high anxiety at all levels of society. Lee figures the country must learn to live with an economy likely to average half the 8% annual growth rate of the past three decades. Singaporeans, accustomed to full employment, are worried about a persistent 4.5% jobless rate. They expect the government, which has provided quality housing, a fully funded retirement system, and superb schools, to create secure jobs. Says Lee: "We are acutely aware of the need for new growth strategies."

Lee has an arsenal of ideas for keeping Singapore prosperous, many of which he helped develop when he was deputy prime minister. Singapore has cut its labor costs, land prices, and taxes--becoming the least expensive business center in Asia. It is beginning to attract investments in high-value manufacturing, such as a new Matsushita factory that makes sophisticated flat-panel TV screens. And the country is recovering from its worst slump ever, with an expected GDP growth rate this year of 8% to 9%. Lee is also pushing a shift to creative activities, including entrepreneurial startups, biotech research, even feature film production. (George Lucas recently announced plans to open a digital-animation studio in Singapore, his first outside the U.S.) And Lee is hoping to transform Singapore into a regional center for health care, education, and financial services.

For all those grand plans to work, though, Lee must first rally popular support for overhauling some ingrained national habits. To stimulate creativity needed for the new knowledge industries, he promises to "cut the apron strings" of a nanny state that has nurtured conformity among its four million people. Lifting longstanding bans on bar-top dancing and bungee jumping, Lee says, is only a surface sign that "we are prepared to take the plunge and make even deeper changes in our society." He is even considering a casino to attract more tourists: "You cannot be blocked in and trapped by what you have done in the past."

Inside the government, Lee is wooing support with a softer approach. Instead of swatting down proposals by Parliament members that the government has repeatedly rejected in the past--like a five-day workweek for civil servants--Lee now promises to give everything a fresh look. "Even if he disagrees with something," says Irene Ng, a member of Parliament, "he will change his mind, as long as it is rational."

Rather than emulate his father, who ruled with an iron hand, Lee urges Singaporeans to speak freely. ("Disagreement does not imply rebellion," he says.) In private conversations or in freewheeling Internet discussion groups, young Singaporeans may irreverently refer to the new Premier as "Mini-Lee," but they welcome his promise of a more open society.

One key test of Lee's political skills came before he took over as Prime Minister: Beijing publicly berated him for making a private visit to Taiwan in July. Lee, fully aware of China's prickly attitude about Taiwan, told Beijing in advance of his trip. Like most Asian nations, Singapore maintains unofficial relations with Taipei. Lee's father frequently traveled to Taiwan, and Singapore rents space there to train its armed forces. But Chinese leaders, for the first time, made a fuss. As some observers see it, China tried to bully Singapore into snubbing Taiwan in order to discourage other countries from dealing with it--and to test the younger Lee's resolve. Lee wouldn't kowtow. He says that abandoning his visit to Taiwan "would have undermined our right to make independent decisions."

Lee was trained for potential leadership from early childhood. "He was raised a prince," says one Singaporean who works closely with him. "Not pampered, but pressured to meet his father's demanding standards." For starters, he had to master the languages of polyglot Singapore, a former British colony with an ethnic Chinese majority and significant Indian and Malay populations. Lee attended Chinese-language schools, learned English at home, and studied Malay with a tutor. His outstanding grades won him a government scholarship to Cambridge University, where he achieved the highest honors in math. Lee finished his degree in two years rather than the usual three, then earned a second diploma in computer science before embarking on an eight-year stint with Singapore's army. Extensive training in America broadened Lee's outlook. He spent a year at the U.S. Army's Command and General Staff College in Kansas and later studied economics at Harvard's Kennedy School. As a hard-charging young officer, Lee appeared cocky and rarely at ease. When he was promoted, at 32, to brigadier general and addressed as "B.G. Lee," Singaporeans privately jeered that the initials stood for "Baby God."

A pair of personal crises profoundly shook Lee--and eventually mellowed him. In 1982 his wife, Wang Ming Yang, whom he had met at Cambridge, died of a heart attack three weeks after giving birth to a son. Lee, who keeps a photo of Wang near his office desk, was left to raise a 19-month-old daughter and an infant. Three years later he married Ho Ching, a Stanford-educated engineer and now chief executive of the state investment company Temasek Holdings. They have two teenage sons, and the four children, Lee says, provide a continuing lesson in patience. Lee's second crisis occurred in 1992, when he was diagnosed with lymphoma. The cancer went into remission after chemotherapy, and there has been no recurrence.

Lee has been an elected member of Parliament since finishing active military service in 1984. That meant joining the People's Action Party, which has dominated the country for four decades. Lee Kuan Yew, who believed that divisive politics would imperil national survival, transformed Singapore into a First World economy and a virtual one-party state (82 of 84 seats in the Parliament are controlled by the People's Action Party). The party has stayed in power mainly by delivering benefits, such as home ownership for most Singaporeans, but the government sometimes deters political challengers by filing defamation suits that can bankrupt opponents. Opposition leader Chee Soon Juan, who was hit with such a suit in 2001, says, "Anything that resembles any kind of growing resistance will be very quickly taken care of." Lee argues that the government must take legal action against anyone who makes false charges that undermine public confidence in the regime.

When Lee applied to join the PAP, a party leader warned him, "People are going to say that you are here because of your father." Eager to prove himself, Lee made the most of an assignment to oversee a review of economic policy. It flared into what he calls "a firefighting exercise" when Singapore fell into a recession in 1985. After consulting hundreds of local and international businesspeople, Lee recommended that corporate taxes be slashed from 40% to 25%. (The rate is now 20%.) He also cut employer contributions to Singapore's social security fund. "I was most reluctant to break the mold," he says, "but my committee members said that if you don't do this, you will have no credibility."

In 1990, after his father stepped down, Lee was appointed deputy prime minister, with responsibility for economic affairs. As Finance Minister and head of the central bank, he liberalized Singapore's financial markets to allow more room for foreign institutions and prodded local banks to expand overseas. Instead of seeing China only as an economic rival, he promoted investment there and lured Chinese companies to list on Singapore's stock exchange.

Now his push for knowledge industries is prompting Lee to call for greater diversity of ideas and opinions. Singapore's competitiveness increasingly depends on enlivening the minds of its people--and on preventing a brain drain to more stimulating environments in Australia, Canada, and the U.S. The elite National University of Singapore, for instance, is abandoning its old system of rote learning. "The fundamental issue is the ability of this culture to break away from coordinated thinking," says Philip Overmyer, executive director of the Singapore International Chamber of Commerce. "Innovators want a fun and welcoming place for people who challenge the status quo."

While catering to youth with such activities as free weekend rock concerts, Lee is also looking for ways to attract newcomers. He frets about Singapore's historically low birthrate--the government, which has a plan for just about everything, runs a dating agency called the Social Development Unit and gives baby bonuses to parents--and believes the fastest way to revitalize the country is to "top off" Singapore's population, already one-quarter foreign-born, with greater numbers of young, educated people from Asia and the West. About 30,000 were brought in last year as potential citizens, not just guest workers. "Immigrants will add tremendously to the vibrancy of the place," Lee says. "Without them we will not get the next generation of top talent."

Lee also wants Singaporeans to become more self-reliant. "The government cannot solve all of life's problems," he says. But persuading people to accept the government's guidelines for flexible wages, with about 30% of pay tied to performance, won't be easy. Workers without higher education (about 65%) are afraid of losing out. Matthias Yao, a labor leader, says the jobs being created "are not suitable for older workers who are less technically savvy." Although the government underwrites retraining programs, Lee says individuals must find work for themselves. "What we cannot provide," he says, "is a guaranteed job."

Lee's vision of spirited public debate may be progressive for Singapore, but it is far from Western-style democracy. He wants to give people a greater sense of participation in the country's future without revolutionizing its political system. "We're trying to find a balance," he says. "You have to have a debate and at the end of it not lose the ability to reach a consensus. Not all Asian societies can do that." He adds that a "significant minority" wants to be involved in shaping public policy and "can constructively and profitably do that." Final decisions, though, will be made by the regime. "I'm not running a referendum," Lee says.

Outspoken Singaporeans, a rare species, are skeptical about Lee's version of an open society. Catherine Lim, a linguist and short-story writer, says she expects "small offerings that will add zest to the society without incurring any threat to government authority." Adds Chia Shi Tek, a former member of Parliament: "They've allowed bar-top dancing, but people want to do more than shake their backsides. They want to be consulted, to play a part in making political decisions, and to get away from this Confucian respect for all authority."

While keeping firm political control, Lee is likely to encourage freer expression in both the arts and social mores. The government has stopped reviewing scripts of plays, for example. Sex and the City is being aired on cable TV, homosexuals are no longer barred from the civil service, and local media are a bit bolder in featuring photos of models. But Lee specifically rules out permitting a "crusading press" to set the national agenda. Nor will he provide much room for political opponents, maintaining that "the government has to rebut or even demolish them." Demolish them? "It's no worse than what the New York Times does to some of your political candidates."

Eager to erase the notion of a family dynasty, Goh orchestrated the transition to strengthen Lee's legitimacy. When he took over as Prime Minister from the senior Lee in 1990, Goh was widely considered a seat-warmer for the younger Lee. But he gradually asserted himself and became a popular leader. He prepared Lee with extraordinary public coaching, chiding him last year for appearing to be cold and aloof. "I got all sorts of appeals from people--'Don't leave, don't leave,'" Goh told FORTUNE. "They were very uncomfortable with the man, so I knew that they had the wrong image."

Taking the criticism like a good soldier, Lee says Goh made him aware of a shortcoming that no one else dared mention. "It is better that we talk about this rather than pretend that no one worries about it," says Lee. "When you become Prime Minister, people bow and scrape even more, and you have to make a conscious effort not to allow that to become the norm."

For all that the Lees reject the idea of a dynasty, having so much political and economic power concentrated in one family creates the perception of one. Lee Senior is also chairman of Singapore's Government Investment Corp.--one of the world's largest fund managers, with over $100 billion. (Its performance is a mystery because no public financial reports are issued.) Ho Ching, the Prime Minister's wife, oversees a separate state investment portfolio equivalent to an estimated 13% of the economy. And Lee Hsien Yang, the Premier's younger brother, is CEO of state-controlled Singapore Telecommunications, which had $7 billion in revenues last year.

Lee insists that Singapore operates solely on the basis of merit--otherwise, he says, his government could not retain a civil service and cabinet team widely acknowledged as outstanding. "Why should they be lackeys to a dynasty?" he asks.

Being from a famous family may have helped open doors in Singapore as it did in America for heirs of Henry Ford, but family ties cannot ensure success. The Lees, who excelled at top Western universities, are clearly well qualified for their jobs. Lee Hsien Yang, 46, has built one of Asia's most successful telecom companies by aggressively expanding into Australia, Thailand, the Philippines, Indonesia, and India. "If I'm doing a good job here," he says, "then there's nothing to worry about. If I'm not, then I should be worried whoever I am."

The situation with the Prime Minister's wife is more delicate. Lee initially resisted her appointment as chief executive of Temasek about two years ago. (As head of the Finance Ministry, he would have been his wife's boss.) The government supposedly resolved the problem by assigning supervision of Ho to the chairman of Temasek. Now Lee says he will not determine whether she keeps the job. But having launched an expansion drive through acquisitions, Ho hardly looks ready to leave. One Temasek company, for example, recently bought control of Global Crossing, the financially troubled U.S. undersea-cable operator. Temasek has also acquired stakes in banks scattered around the region from India to South Korea. Judging her overall performance, however, is difficult. The state holding company--with an estimated $60 billion of assets in such companies as Singapore Airlines and SingTel--publishes no financial reports. Ho has stated (without providing dollar figures) that Temasek delivered more than a 13% total annual return, compounded, over the past decade. And she promises a "measured process of opening up and demystifying Temasek" by issuing an annual report, obtaining a credit rating, and eventually floating bonds.

Having the nation's founding father--who also happens to be your father--sitting in the cabinet might seem intimidating to a new Prime Minister, but Lee says he has no qualms: "The public may not see this, but he probably, of all people, is willing to examine fundamental assumptions and turn things upside down." Merely considering a casino in Singapore, for instance, would have been unthinkable during the old man's reign. Insiders say the younger Lee has argued with his father in cabinet meetings and persuaded him to accept his views. The Premier insists that his father, whose new title is "minister mentor," serves as a valued advisor but does not dictate government policy.

Yet late last year Lee Kuan Yew personally intervened in a labor dispute at Singapore Airlines and warned of "cracking heads" if its pilots' union moved toward a strike. The younger Lee says his father was taking care of "old business" he had handled in the past. Goh, who remains in the cabinet as senior minister, says the elder Lee never caused him problems "because I'm not related to him." But it's clear Goh thinks that the senior Lee should retire: "For Lee Hsien Loong to have him in the cabinet, people will say you are being influenced by your father, you are not your own man."

The new Premier, who has spent a lifetime being compared with his father, doesn't sound as if he wants to force the issue. "The saving grace," he says diplomatically, "is that nobody really expects anybody else to be like Lee Kuan Yew, not even the son." Still, he is eager to put his own stamp on Singapore. "To build a nation," the younger Lee says, "you have to do it every generation. You have to rekindle the excitement. That's what we're trying to do."