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The labor force shrank in August to its smallest size since October 1987, when the Nikkei 225 average was 185 percent higher and land prices were 85 percent greater than Friday.

Employers cut payrolls by 160,000 and a further 200,000 workers retired or abandoned efforts to find a job, leaving the seasonally adjusted number of employed at 59.4 million, the Statistics Bureau said Friday.

Separate figures showed industrial production rose 0.8 percent from the previous month, less than all but three of 28 forecasts in a Bloomberg survey.

The data deepen concern that the recovery from the March earthquake will be stunted by manufacturers shifting operations abroad because of gains in the yen, a deterioration in consumer confidence and prospects for higher taxes at home.

The challenges add to the burden of an economy already beset by a shrinking and aging population.

“We’ve seen an acceleration in the hollowing out of industry this year with the yen’s surge and the earthquake,” said Hiroshi Miyazaki, chief economist at Shinkin Asset Management Co. “The government doesn’t have a sense of crisis about the yen and emerging economies are luring Japanese companies away.”

Prime Minister Yoshihiko Noda’s administration said Tuesday it will start implementing measures to cope with the yen’s gains, including subsidies for companies struggling to retain workers.

Finance Minister Jun Azumi said Friday the government plans to bolster funds needed to intervene and lengthen monitoring of foreign exchange market positions until the end of the year, from an initial plan to end the review this month.

“The yen staying around the high 70s could throw cold water on the Japanese economy’s recovery trend,” Azumi said.

“We will take bold actions when needed and we don’t rule out taking any necessary measures while closely monitoring speculative trading.”

Manufacturers including Panasonic Corp. have announced plans to shift operations overseas. Panasonic, one of the world’s largest consumer electronics companies, is moving the headquarters of its $57 billion procurement operation to Singapore from Osaka in the year starting next April, Masaaki Fujita, an executive in charge of the business, said in September.

Exports and retail sales data released in September also missed analysts’ forecasts, casting doubt on whether gross domestic product will rebound as much as forecast this quarter. GDP is expected to grow at a 4.6 percent annual pace in the three months through September, ending three quarters of decline, according to the average forecast of 42 economists surveyed by the government-affiliated Economic Planning Association.

The jobless rate fell to 4.3 percent in August from 4.7 percent as people left the workforce, Friday’s report showed. Household spending decreased 4.1 percent from a year earlier, compared with the median estimate in a Bloomberg News survey for a 2.8 percent drop.

The stagnating economy has also depressed consumer sentiment, with the Economy Watchers survey showing confidence among merchants and others who deal with consumers slipping to 47.3 in August, the first drop since March.

“I’m worried where things will go after this year, when we’ll start to see more of an impact from the strong yen and slowing growth in the U.S.,” said Noriaki Matsuoka, an economist at Daiwa Asset Management Co. Reconstruction won’t be enough to fuel a “V-shaped rebound,” he said.

The government plans to spend a total of ¥19 trillion over five years for rebuilding after the March 11 temblor and tsunami. The Democratic Party of Japan this week proposed a ¥9.2 trillion temporary tax increase and selling of government assets to help pay for the effort.

In a sign that weaker global demand is affecting other Asian markets, South Korea’s industrial production also rose less than economist estimates in August, gaining 4.8 percent from a year earlier, Statistics Korea said Friday. Meanwhile, a gauge of Chinese manufacturing shrank for a third month in September, the longest contraction since 2009, according to the purchasing managers’ index released by HSBC Holdings and Markit Economics.

“Continuing yen strength will prompt companies to factor in a stronger yen in their business planning,” said Takahiro Sekido, a former analyst at the Bank of Japan and now a chief economist at Credit Agricole SA in Tokyo. “The biggest concern is the European debt crisis and the U.S. economy. With uncertain overseas demand,” Japan’s recovery may weaken, he said.

The IMF predicted “severe” repercussions if Europe fails to contain its debt crisis or U.S. policymakers deadlock over a fiscal overhaul. Deepening debt woes in Europe have also put pressure on the yen vs. the euro, threatening to depress earnings at firms like Sony.

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