TOKYO (AP) _ Japan's economy could slow dramatically and lose more than 3.5 million jobs by the end of this decade if it does not adjust to the soaring yen, a research organization says.

The Japan Research Institute Ltd. said unemployment could rise from 2.8 percent to 6.4 percent if new jobs aren't created to replace jobs lost because of the high yen.

The yen has risen about 27 percent against the U.S. dollar since January 1993. As it rises, Japanese products become more expensive and less competitive overseas.

That's forcing manufacturers to shift production - and jobs - overseas to lower costs.

''Jobs are going to be lost as companies move production overseas, and there's no way to avoid that,'' Shinichi Kihara, an economist at the private institute, said today.

As of 1993, 6.4 percent of Japanese manufacturing production was overseas. That proportion is likely to reach nearly 10 percent by 1998, the report said.

The drain could cause economic growth to sag to 1.4 percent by 2000 and unemployment to rise to 6 percent or more, the report said.

It said bureaucratic over-regulation makes it hard to stimulate non-export sectors of the economy to make up for the lost growth.

''The growing gap between domestic and foreign prices, and bureaucratic regulations are like fetters on economic growth,'' Kihara said.

He advised the government to reduce the thousands of regulations it imposes on service industries as diverse as law, tourism and distribution.

Japan recently announced a plan to cut red tape on goods and services such as food, building materials and telecommunications. Trading partners say the restrictions block them from doing business in Japan.

Critics of the deregulation package say it costs jobs in the short term, but others, especially trading partners like the United States, which has a $59 billion annual trade deficit with Japan, say much more needs to be done to open Japan's markets.

The deregulation ''would not only allow more foreigners to participate in markets here, but spur long-term economic growth in areas other than manufacturing and exporting,'' Kihara said.

The report predicted that Japan's economy would grow by only 0.9 percent in the current fiscal year ending March 31, because of the lingering effects of Japan's worst economic downturn since World War II. Growth will rise to 1.7 percent the next year and 2.5 percent the year after that, but could fall back if consumer demand is not stimulated, it said.

Unemployment reached a record high of 2.9 percent in February, and has hovered around 2.8 percent as companies restructure to cope with the high yen and declining profits.

The numbers are lower than in the West in part because Japan calculates unemployment differently.

In Japan, anyone who has worked an hour or more in the last week of a given month is considered fully employed for the month, and military personnel are counted as employed. Some economists say that if Japan used Western calculation methods, its current unemployment would be between 5 percent and 8 percent.