Tokyo - Fear grows in Japan as the world's second largest economy is hit by the most severe recession in the post-War years after enjoying several years on the economic upswing.

"Japan's economy is falling off a cliff," a Tokyo-based analyst said.

Industrial production in December was down 9.6 per cent compared to the previous month, and a whopping 20 per cent compared to December 2007 as a result of shrinking foreign demand.

And worse, the country's businesses are cutting jobs on an unprecedented scale, raising fears among Japan's workforce and causing economists to speak of a "new dimension" to the crisis.

Japan's upswing of the past few years was carried almost exclusively by exports and investments abroad. But now foreign demand has collapsed, first in the US, followed by China and the rest of Asia, Japan's biggest export markets.

As a result, December exports were down 35 per cent - and worse is still to come. Even household names like Toyota Motor Corp or Sony had to scrap earnings forecasts and cut production. Mass layoffs followed.

The unemployment rate shot up from 3.9 per cent to 4.4 per cent within one month in December, the sharpest monthly increase in 42 years.

Japanese households have been used to their wages shrinking or just not rising during times of crisis. During those times savings were used up, but consumption - and therefore domestic demand - remained relatively stable.

However, those times have changed with the job market becoming increasingly flexible during the 1990s, with every third position now being a temporary job, making it much easier for companies to lay off staff on a large scale quickly.

According to estimates, about 400,000 people working temp jobs lost their positions between October and March.

"This dampens the sentiment like never before," said economist Martin Schulz of Tokyo's Fujitsu Research Institute. Private consumption decreased by 4.6 per cent in December.

The combined economic data caused shock among Japan's economists, as the recession is now fueled not only by sinking global demand but also by unemployment, slowing domestic demand and a return to deflation.

"There's really nothing out there to drive growth," Junko Nishioke of RBS Securities told Japan-based media.

Export-oriented companies like Toyota, meanwhile, reduce their inventories. They have undergone massive restructuring efforts in the past few years, making them highly competitive. They are also among the world's most productive businesses, with the lowest wage costs per unit.

But that will not save them as long as foreign demand remains in the doldrums, as domestic demand is insufficient to kick-start the economy.

An end to the crisis is not in sight.

But Japan's true resources are in its domestic markets. The country has enormous capital reserves, which are well hidden under mattresses or in bank accounts. To get those out, the country would have to tackle large-scale structural reforms, economists say.

However, Japan's leaders neglected that opportunity. Critics also point out that the country still puts the main focus of its research and innovation to manufacturing and the world markets.

Instead of embarking on a reform course, Japan's government is backpedaling, they say. But Japan's problems are likely to grow. No other country is aging faster and the gap between rich and poor is widening.

At the same time, the margin for action is shrinking, as Japan's state debt has climbed to 180 per cent of its gross domestic product. (dpa)