Japan, China, South Korea island disputes threaten global economy

What are the biggest short-term threats to the global economy? The two most obvious answers are the ongoing European debt crisis and the looming austerity of the “fiscal cliff” in the United States. But what if I told you that in the running for honorable mention is the sticky situation in East Asia surrounding territorial disputes over several small islands?

At the heart of these disputes lie the region’s “big three” economies: China, Japan, and South Korea. Beijing and Tokyo are at odds over who has rights to the Senkaku Islands (or in China, the Diaoyu) and, more important, the potential oil deposits in the surrounding waters. Meanwhile, Japan has a similar dispute with South Korea over the Takeshima Islands (or in South Korea, the Dokdo), also with energy deposits.

While these territories have been disputed for decades, tensions have recently heightened in the region as all sides intensify ownership claims and leaders use the disputes for leverage in domestic politics. This raises concerns about strategic – and economic – stability in the region going forward.

Fears about instability in East Asia are not new. In the early 1990s, as the cold war entered the history books, some international relations experts feared that East Asia was poised to become like Europe of the early 20th century – a multipolar region with a threatening rising power (in this case China, rather than Germany) and weak regional institutions.

However, by the end of that decade, hopes for regional stability and cooperation were on the rise. Much of the progress came on the financial front. After the 1997 financial crisis rocked the entire region, a consensus emerged among the big three countries and a group of 10 smaller ones in Southeast Asia that East Asia needed a financial safety net.

In 2000, a system of emergency credit lines between central banks was born and has since developed into a regional foreign exchange pool with $240 billion in resources. Trade between nations in the region increased substantially.

More recently, in the immediate aftermath of the global financial crisis in 2008, China, Japan, and South Korea increased existing central bank credit lines with each other. Just last year, China and Japan agreed to begin conducting trade in their own local currencies in order to increase commerce between their two economies.

The island disputes are threatening to undermine all this. Three recent events highlight how the territorial spats are now spilling over into the economic sphere.

First, nationalist fervor in China has led to a de facto boycott of Japanese goods, causing September sales of Japanese cars in China to plummet. Japan’s major automakers say they will draw down production in China. Overall, Japanese exports to China fell 14 percent in September from a year ago, according to preliminary figures from Japan's finance ministry.

The second eyebrow raising incident occurred earlier this month when Japan and Korea allowed a $57 billion expansion of a currency swap agreement – essentially an emergency line of credit – between their central banks to lapse. Both countries deny that territorial dimensions led to the lapse, but the denials are unconvincing. Risks to global financial stability are increasing, which is precisely the climate where such agreements are valuable in the first place.

Third, China decided not to send any representatives to the annual meetings of the International Monetary Fund (IMF) earlier this month. The reason? Tokyo hosted the event.

Other signs cause concern. September Japanese auto sales are also down in Korea. And Chinese tourists, once planning trips to Japan, are opting to visit other countries.

The timing of all this could not be worse for the global economy. 

In its October report on the World Economic Outlook, the IMF warns that “risks for a serious global slowdown are alarmingly high.” East Asia has been the most important region for global economic growth since 2008. With US and European economic struggles likely to continue next year, East Asia’s economic performance is more important to the world economy than ever.

To date, the US has largely sat on the sidelines as the spat has intensified. That can no longer continue. The next administration – regardless of party – should address the territorial and economic issues head on by publicly and persistently pushing for an international solution to the crises. At a minimum, the next US president should meet with the leaders of China, Japan, and South Korea over the economic and security aspects of the disputes at the next G20 summit in June 2013.

The events of recent weeks, including Chinese military exercises in the East China Sea, clearly show that the next administration cannot treat this as a purely regional issue. While a negotiated settlement on island ownership is not likely any time soon, American engagement should provide an opportunity for the big three to take the necessary steps to cool down – and warm a shivering global economy.

Daniel McDowell is an assistant professor of political science at the Maxwell School of Citizenship and Public Affairs at Syracuse University.