As the new academic year gets underway, the Walter H. Shorenstein Asia-Pacific Research Center’s Corporate Affiliates Program is excited to welcome its new class of fellows to Stanford University:

The United States and European countries can take steps to avoid making the same economic mistakes that Japan committed during the latter's "lost decade," a Stanford economist wrote in a new paper.

The study, published in the IMF Economic Review, describes the reasons Japan was not able to pull out of its long recession in the 1990s, offering some lessons for U.S. and European leaders in the wake of the 2007-09 meltdown.

In particular, the delay in bank recapitalization and the lack of structural reforms in the economic sphere kept Japan from realizing a full recovery, wrote Takeo Hoshi, the Henri and Tomoye Takahashi senior fellow at Stanford's Freeman Spogli Institute for International Studies.

"Bank recapitalization" refers to a governmental reorganization of failing banks, often involving the use of public money to keep them solvent. "Structural reforms" describes how a government might overhaul its economic structures to increase business competition – such as deregulation to cut costs for firms.

The shortcomings in these two policy areas "retarded Japan's recovery from the crisis and were responsible for its stagnant post-crisis growth," said Hoshi, whose co-author was Anil K. Kashyap, an economics professor at the University of Chicago Booth School of Business.

Risky bank lending

Japan's "lost decade" originally referred to the 1990s, though the country has still not regained the economic power it enjoyed in the 1970s and 1980s. Some say Japan has actually experienced two lost decades if the 2000s are counted as well.

Faced with a huge financial crisis at the dawn of its lost decade, Japan had to navigate challenges that other advanced economies had not confronted since the Great Depression, Hoshi and Kashyap wrote.

However, government leaders made mistakes, Hoshi said. One was failure to rehabilitate the banks and another was to misunderstand the nature of the problems afflicting the Japanese economy. For example, much like the United States in 2007-09, the Japanese banks had made many dubious loans to risky customers.

"Instead of recognizing that major structural adjustments were needed, much of the policy response was calibrated under the assumption that Japan faced a simple cyclical problem that could be addressed with indiscriminate fiscal stimulus," wrote Hoshi, the director of the Japan Program at the Walter H. Shorenstein Asia-Pacific Research Center.

For example, on the demand side, monetary policy was not as expansionary as it could have been, he said. Deflation persisted for a long time. And fiscal stimulus packages – such as tax cuts – were inconsistent. Meanwhile, much of Japan's fiscal spending took the form of public works projects that had low productivity.

As for structural reforms, the Japanese government lacked a sense of urgency. For example, even in the reform-minded administration of former Prime Minister Junichiro Koizumi, only eight of the proposed 35 reform initiatives would have directly boosted growth. Of the others, 16 might have indirectly supported growth and 11 would have had no effect on growth, Hoshi said.

Drastic change needed

Unfortunately, some European nations seem to be following Japan's lead, Hoshi said.

"In France, Italy and Spain, bank recapitalization has been delayed and the structural reforms have been slow. Without drastic changes, they are likely to follow Japan's path to long economic stagnation," Hoshi and Kashyap wrote.

The problems that held back Japan seem to be less serious in the U.S., Hoshi said: "Employment protection is low in the United States and the labor market shows high mobility. The regulatory advantage for incumbent firms is smaller than in Europe or Japan and starting new business is relatively easy."

As the researchers noted, the United States and Germany are in a bit better economic shape, partly due to the fact that they did undertake structural reforms sooner rather than later. The U.S. was able to recapitalize its banks more quickly, for example.

Still, five years after the failure of the Lehman Brothers investment bank left the world's financial markets in chaos, the U.S. and Europe are not yet back to what had looked normal before the crisis, according to the research. For instance, employment levels have not reached the levels seen before the 2007-09 crash.

"The U.S. recovery has been tepid despite a number of extraordinary macroeconomic policies (at least in the traditional sense). This suggests that the U.S. economy also has problems, but they are just different from those in Japan and in Europe," Hoshi said.

In the years leading up to the financial crisis, the researchers wrote, U.S. growth was fueled by a consumption boom from rapid housing price increases and rising debt levels.

"In a broad sense, the U.S. economy before the crisis was similar to the Japanese or Spanish economies," noted Hoshi, adding that in Japan, the speculative investment boom in the late 1980s masked structural problems.

Clifton Parker is a writer for the Stanford News Service.

Stanford scholars are urging Japan to take advantage of an upcoming opportunity to show clear, heartfelt remorse for its actions surrounding World War II.

Making such amends will give Japan credibility as it seeks to assume a global leadership role well into the future, they say.

On Aug. 15, Prime Minister Shinzo Abe will publish a short statement to commemorate the 70th anniversary of the end of World War II, which follows similar practices of his predecessors.

Stanford's Walter H. Shorenstein Asia-Pacific Research Center (APARC), which has long advocated wartime reconciliation in Asia, recently issued a 15-page report in English and Japanese featuring eight hypothetical statements suggesting what the Japanese prime minister might say in his August address. The report, which is available in both English and Japanese, was recently made available to academics, media and the general public and has already received interest from the Japanese media.

The wording of Abe's statement will be scrutinized by governments and experts in Asia and around the world, the Stanford scholars say. During WWII, China and Korea, as well as other Asian nations, endured brutal Japanese military occupations.

"Many have been speculating what the (Abe) statement will be like," wrote Takeo Hoshi, director of the Japan Program at the Shorenstein Center, and APARC associate director for research Daniel Sneider in the report.

For example, Hoshi and Sneider asked, will Abe follow the direction set by prior Japanese prime ministers by expressing remorse for the suffering of Japan's Asian neighbors while apologizing for past aggression and colonization? Future collaboration in world affairs is also important, they added.

"We asked our colleagues what they would say in the 70th anniversary statement if they were the prime minister of Japan, and to write their own version of the statement," Hoshi and Sneider wrote.

"Our goal is to understand the diversity of reasonable views on the issue of Japan's responsibility for the cruel and violent war and Japan's role in building a peaceful and prosperous world," Hoshi and Sneider said.

The Stanford experts who wrote the statements included Hoshi and Sneider as well as Alberto Diaz-Cayeros, a senior fellow at the Freeman Spogli Institute for International Studies; Peter Duus, a professor emeritus of Japanese history; Thomas Fingar, a distinguished fellow at the Freeman Spogli Institute; David Holloway, a professor of international history and of political science; Yong Suk Lee, the SK Center Fellow at the Freeman Spogli Institute; and Harry Rowen, a professor emeritus of public policy and management.

For example, Fingar said in his version, "Let us also resolve to make the 80th anniversary of World War II the 10th anniversary of a more cooperative, more inclusive, and more secure region," and Hoshi wrote in his version, "To avoid any potential misunderstandings, Japan needs to recall past failures, remember the suffering of neighboring Asian peoples, and reaffirm the commitment to world peace more than ever."

On the subject of women, Lee's version noted, "The war and Japan's colonial rule created much suffering, but I would like to especially ask forgiveness to the women from many nations who suffered under colonial rule."

In August 2014, the Shorenstein Asia-Pacific Research Center issued a report on a Stanford-hosted dialogue on World War II memories in northeast Asia. Heightened tensions the last few years among the governments of China, Japan and South Korea have revolved around territorial disputes and the way WWII is portrayed in speeches and educational materials.

"Each nation in northeast Asia and even the U.S. has selective or divided memories of the past, and does not really understand the views of the other side," said Stanford's Gi-Wook Shin, director of the Shorenstein center, in a 2014 Stanford news release.

Clifton Parker is a writer for the Stanford News Service.

Responses to the project

Toyo Keizai, a leading Japanese business weekly, published all eight verisons in English and Japanese stating, "we hope this will provide an opportunity to bring about a wide range of discussion."

University of Tokyo professor Tetsuji Okazaki wrote about the project in the Asahi Shimbun (the article is in Japanese and also attached as a PDF below).