Trivia: If you save Falco from the enemies chasing him on Cornaria, and then fly through all the stone loops in the lake, Falco will comment on your flying. He will then tell you to follow him and lead you into the waterfall where you fight an alternate boss and go through Lylat System on the red path.
Trivia: If you clear every level with a Gold Medal, you unlock Expert Mode. While playing Expert Mode, Fox can be seen wearing his father's, James McCloud, sunglasses. This also unlocks the Sound Test feature in the main menu where you can scroll through and listen to every sound effect, music piece, and line of dialogue in the game.
Answer: There isn't really an agreed answer to this, and the game leaves it purposely ambiguous. It's entirely possible that James is just a figment of Fox's imagination. It's also possible that his spirit is guiding him or that he's secretly alive. So in truth, any answer would be pure, 100% speculation.
TedStixon