Corporate Financing and Governance in Japan: The Road to the Future, and: Cross Shareholdings in Japan: A New Unified Perspective of the Economic System (review)

The Japanese financial crisis of the 1990s (and beyond) remains a puzzling and disturbing topic. How could a system that had only a few years earlier received so much praise have gone so wrong? Why did the Japanese government and industry face the financial crisis with sporadic bouts of reform that were too little and too late? How did this apparently dysfunctional system evolve, and how is it likely to change in the future? Two books, Corporate Financing and Governance in Japan by Takeo Hoshi and Anil Kashyap and Cross Shareholdings in Japan by Mitsuaki Okabe, provide valuable insights into these questions. Although these two books differ greatly in scope and in theoretical and methodological underpinnings, taken together they make for a well-rounded picture of Japan's financial and corporate governance systems and how they changed in the 1990s.

Corporate Financing and Governance in Japan is a masterful account of the origins and evolution of the Japanese financial system. This work is an extremely important contribution, not only to the literature on Japanese corporate finance, but also to research on the institutional history of the Japanese economy. It should be required reading for anyone interested in the history of the Japanese economy and its prospects.

The general argument is that the Japanese financial system must be understood as the product of an evolutionary process, marked by both path dependence and sharp discontinuities. The Japanese financial system looked very different at different periods in history; these differences stemmed from changes in the regulatory environment over time. The authors highlight five distinct periods: the Meiji Restoration to the early Showa period, the wartime economy, the keiretsu-dominated postwar period, a period of gradual deregulation and the Big Bang, and the still uncertain current period.

Hoshi and Kashyap are economists, and their account of the evolution of Japan's financial system is one in which firms make rational choices within a shifting institutional framework. An overarching theme of the book is that firm and bank behavior can be explained by standard economic reasoning, once institutions, particularly the regulatory environment, are taken into account. This approach may not suit readers of all theoretical persuasions, but this volume has much to offer even to those who are not particularly excited by the conclusion that the Japanese economy fits nicely into existing economic models. Hoshi and Kashyap provide plenty of nuanced information on institutions—the prewar stock markets, government mobilization for the war, financial regulation and the banking system in the postwar era, and the Big Bang reforms in the 1990s. The story of how these institutions changed, and how the financial system responded, is well worth reading.

In their portrayal of the sharp differences in the pre- and postwar financial systems, Hoshi and Kashyap thoroughly demolish any argument that the Japanese financial system was shaped by culture (an argument that many Japanese bankers and government officials make even today). In the Meiji period, the financial system was largely equity based, and stock markets looked and functioned much as they did in more market-based, Anglo-American economies. The move away from markets began in the wartime era, due to mobilization for war and a mistrust of private enterprise. In the postwar period, the system of main bank finance, keiretsu groups, industrial policy, and administrative guidance emerged. Market-based finance remained insignificant until a gradual deregulation process began in the 1980s.

Hoshi and Kashyap argue that the roots of the 1990s financial crisis were in this process of deregulation. The government began to loosen controls on capital markets and bond issues as a response to its own growing deficits and need to raise money. Liberalization of capital markets...