Dispute With China Hits Japan's Economy Hard

In early September, Yoshihiko Noda passed the one-year mark as Japanese prime minister. That's no small accomplishment—the country is on its sixth premier since 2006. Noda has seen his approval rating drop to 34 percent after doubling a sales tax to 10 percent, however, and he has reshuffled his Cabinet three times. If he's going to make it another year, he'll need to defuse a tricky foreign policy crisis: Japan and China's quarrel over ownership of a group of uninhabited islands in a potentially energy-rich section of the East China Sea. The Japanese government's decision last month to nationalize part of the islands (called the Senkaku in Japanese and the Diaoyu in Chinese) triggered protests in dozens of Chinese cities. It is also hurting Japan's economy. In September, Toyota (TM) and Nissan (NSANY) suffered their biggest monthly drop in Chinese car sales since the financial crisis in late 2008. JPMorgan Chase (JPM) is predicting a 0.8 percentage-point hit to Japan's gross domestic product from the China dispute in the fourth quarter. The International Monetary Fund, which held its annual meeting in Tokyo from Oct. 12 to 14, said the tension may crimp growth worldwide. Noda has called for talks with China, and diplomats from both sides have agreed to hold a meeting soon to resolve the crisis. "These are the second- and third-largest economies in the world, and our interdependence is deepening," Noda, 55, said in an Oct. 10 interview in his office in Tokyo. "If our ties cool, particularly economic ones, then it isn't a question of one or the other country suffering. Both countries lose out." The Japanese premier says his government won't compromise on its ownership claim on the islands, situated on a continental shelf which is home to between 1 and 2 trillion cubic feet of natural gas and as many as 100 billion barrels of oil, according to Chinese studies cited by the U.S. Energy Information Administration. Japan imports virtually all of its petroleum. "There is no doubt that the Senkaku islands are Japan's inherent territory in terms of history and international law," Noda said. "There is no problem of sovereignty." Japan argues that it took control of the islands in 1895 and that while it lost authority over them after World War II, the U.S. returned them along with Okinawa in 1972