Global business leaders are voicing increasing concern over heightened political tensions between China and Japan, sparked by a maritime dispute in the East China Sea. They fear an escalation may have a spill-over effect on their regional operations and damage trade ties between the world’s second and third-largest economies.

Company executives, diplomats and analysts told CNBC that supply chains across China and Japan and regional trade flows are at risk if the territorial dispute between the north Asian neighbors – believed to be the worst in decades – deepens.

“This could really be something that causes a huge economic dislocation,” Mike Splinter, chief executive officer at Applied Materials told CNBC. “If import barriers go up, it could affect our business.”

John Rice, president and CEO at GE Global Growth and Operations said he was worried about the potential “repercussions” to the flow of free trade that may arise because of escalating “geo-political” risk in the region. “That’s what we worry about…because we’re free traders to our core.” Rice said he was monitoring developments “very closely.”

While the precise scale of any disruption to manufacturing supply chains is hard to assess, many observers are starting to draw a parallel with the disruption in the wake of the 2011 Fukushima disaster in Japan.

“Everyone is taking their cue from last year’s earthquake and tsunami in Japan…no one expected what the damage would be,” said Stephen Bosworth, dean of The Fletcher School of Law and Diplomacy at Tufts University, and former U.S. Ambassador to South Korea between 1997 and 2001. “All these things have consequences. This is probably the most tightly integrated region in the world in terms of trade and investment.”

Martin Jacques, author of ‘When China Rules the World: the End of the Western World and the Birth of a New Global Order’, added: “There are so many companies tied into the production chain, that this could have wider dislocation effects. We saw this with the earthquake and tsunami in Japan in 2011.”

Politics Trumps Economics

In the immediate term, Japanese companies operating in China have borne the brunt of a backlash after Japan bought the disputed islands, called Senkaku in Japan and Diaoyu in China, earlier this month, sparking anti-Japan protests across China.

Toyota Motor (TM) will cut production of its premium Lexus vehicle by about 20 percent as anti-Japan protests hit sales in China, the Nikkei reported on Tuesday. Toyota’s sales fell about 30 percent after some of its stores in China were damaged during violent demonstrations over Japan government’s acquisition of three islands in the East China Sea, the business daily said.

Japanese capital flight is a growing concern. About 41 percent of Japanese firms see friction with China affecting their business plans, with some considering pulling out of the country and shifting operations elsewhere, a Reuters poll showed on September 20.

Much is at stake for both China and Japan. In 2011, bilateral trade grew 14.3 percent to a record $345 billion.

Still, mutual economic interests may not be enough to keep a lid on the row. “If it gets out of hand, it’s a situation where politics trumps economics,” said author Martin Jacques.

The root of the crisis lies in Japan’s imperial expansion and wartime past, notably its perceived lack of atonement for atrocities committed during the Second World War.

“The Senkakus/Diaoyus are subject to long-running tension that periodically spikes owing to civilian activities, and are currently subject to such friction owing to the rise of China, the desire for energy and fisheries, and renewed nationalism in both countries,” said Christian Le Mière, research fellow for Naval Forces and Maritime Security, at the International Institute for Strategic Studies in London.

But Chinese business may also suffer if the row worsens. “From a China point of view, in the longer run this could have an impact,” Jacques warned. “As they move up the value chain, it could be harder to get the equipment they need from the Japanese if the dispute becomes ‘tit-for-tat’.”

– Sri Jegarajah