The Ronald Reagan moment Japan investors have long fantasized about has finally arrived.

Shinzo Abe’s plan to restore Japan’s economic might draws heavily upon principles long associated with the former U.S. president: welfare-spending cuts, debt-swelling tax reductions for the wealthy and corporations, deregulation, a lowering of trade barriers, and reforms that make it easier to fire workers.

Yet while investors have greeted this supply-side shock therapy with enthusiasm, Japan’s 126 million people may not find its side effects quite so pleasing. As in the U.S., Abe’s reforms could well hollow out the middle class and create the kind of gulf between rich and poor that Japan has long tried to avoid.

Everyone from officials at the U.S. Treasury to punters in London trading pits to salarymen in Osaka are so ecstatic to see a Japanese leader acting boldly that they’ve forgotten to study his strategy. It’s great that Abe wants to shake Japan Inc. out of two decades of complacency. It’s equally important, though, that his fixes are the right ones and are implemented carefully.

Take Abe’s plan to cut the 35.6 percent corporate tax rate ― the second-highest level among Group of Seven nations ― while at the same time doubling consumption taxes. How exactly does Japan hope to encourage households to spend more to boost gross domestic product while raising the cost of consuming? The last time Japan tried something similar, in 1998, tax increases scuttled the recovery from a financial crash eight years earlier.

“To raise the consumption tax while cutting corporate taxes will further shift things in the wrong direction,” says Richard Katz, editor-in-chief of the New York-based Oriental Economist Report. “That does not make sense for a country where consumer spending is chronically weak due to weak consumer income.”

What would make more sense is clamping down on tax-dodging executives. An eye-popping 73 percent of companies in Japan pay no tax, says Nicholas Smith, a strategist at CLSA Asia-Pacific Markets Ltd. in Tokyo. “This breaks into two groups ― companies that are uneconomical and companies that are economical with the truth,” Smith says.

Abe’s labor reforms pose risks, too. Japan should indeed scrap the antiquated practices of lifetime employment and seniority-based promotions while reducing the power of uncompromising labor unions. The country ranks 134th out of 144 nations in terms of ease of hiring and firing, according to the World Economic Forum’s Global Competitiveness Report. Yet Japan lacks a public safety net to catch the hundreds of thousands of workers who could soon be out of a job.

Japan eschewed an American-style unemployment-insurance system because companies never laid off workers. The reason Tokyo spent so much time and money propping up banks in the late 1990s and early 2000s was so they could keep so-called zombie companies afloat and unemployment low. Before Abe helps companies to sack 20,000 workers here and 50,000 there, he must create a social-benefits program and fund extensive job-retraining programs.

Otherwise, Abenomics will only exacerbate Japan’s underappreciated working-poor problem. Among Organization for Economic Cooperation and Development members, Japan ranks fifth in the number of working-age persons living on less than half the average national income. The dynamic began in former Prime Minister Junichiro Koizumi’s day and accelerated with what Japanese call the “Lehman shock” in 2008. Government statisticians are only now catching on to the problem.

Between 2001 and 2006, Koizumi dabbled a bit himself in Reaganomics. Japan’s preference for consensus over conflict meant he moved more gingerly than Reagan did, or than Margaret Thatcher did as Britain’s prime minister in the 1980s. Koizumi’s signature achievement was privatizing the sprawling Japan Post Holdings Co. Ltd., which plans an initial public offering by April 2015.

Yet Koizumi also cut pensions and tweaked labor laws to allow companies to hire more workers on a part-time basis at lower pay and without benefits. That slammed incomes in the middle of the wage spectrum and hit women especially hard. It’s led to many unexpected consequences, including an epidemic of shoplifting among the elderly. Abe’s move to get the Bank of Japan to double the monetary base excites hedge-fund managers but punishes savers who must live on a fixed income.

These changes would be less destabilizing if trickle-down economics actually worked. It would help, too, if Japan had a buoyant startup industry creating scores of new jobs to fill the void. “Japan’s entrepreneurial animal spirits are dormant,” says Jeff Kingston, head of Asian studies at the Tokyo campus of Temple University. Even if Abe complemented Reaganomics with a dash of socialism and financed a venture-capital industry publicly, it would take years to yield results.

Many of Abe’s policies are exactly what Japan needs. Joining the U.S.-led Trans-Pacific Partnership would pump fresh energy through Japan Inc.’s atrophied veins. So would deregulating sectors from energy to medical services to education to agriculture. Yet reforms that should bear fruit in the long run lack the financial cushions and economic checks and balances needed in the short run. Abe must develop a transition plan to keep his strategy from polarizing Japan’s proudly egalitarian society. It’s not as if most Americans are happy with that legacy of Reaganomics. 

By William Pesek

William Pesek is a Bloomberg View columnist. ― Ed.

(Bloomberg)