By YUKA HAYASHI
August 5, 2012, 10:31 p.m. ET
NIIGATA City, Japan—In a notable role reversal, China is emerging as a major investor in Japan—a diminished status for the island-nation that is inflaming old animosities between two wary neighbors.
Here in this port city, the distrust is taking the form of an ugly battle over construction of a new Chinese consulate. Dignitaries in Niigata lobbied for the consulate for years—traveling to Beijing, offering gifts of local sake—in hopes of bringing tourists and business to their struggling city of 800,000 on the Sea of Japan.
But in their moment of triumph, when the consulate was announced, locals erupted in protest. Some 15,000 people signed petitions against the Chinese. Protesters blocked streets with their trucks. This past March, the city assembly passed a resolution demanding tighter control of land purchases by foreigners. Construction remains stalled as Tokyo and Beijing try to figure out what to do next.
"It is unsettling to have foreigners living in the middle of our city, hidden behind high walls," said Shigenobu Fukaya, a city assembly member who is leading the opposition. He thinks the consulate will bring an "unwanted element" to Niigata—namely, Chinese people—along with more crime.
The scuffle embodies the complex nature of the Japan-China relationship. The two nations share a culture, and a long, war-scarred history. They have repeatedly invaded each other since the 1200s, while also engaging in vigorous trade that brought religion and firearms to Japan, and minerals and lumber to China. In a defining modern incident, Japan in the 1930s colonized China and massacred civilians in Nanjing, a period that casts a long shadow over ties today.
Many Japanese appreciate that China's growing economic clout could help Japan in its struggle to regain economic vigor. But at the same time, animosity is growing.
A case in point: Last month, Japan temporarily recalled its ambassador to China amid a nasty diplomatic clash over some tiny islands that both nations claim. Earlier, in May, it was China's turn to be angry when Japanese nationalists in Tokyo hosted a conference for a group of ethnic Uighur separatists that China considers terrorists.
A recent survey showed 84% of Japanese respondents had a negative impression of China, up six points from a year earlier. Nearly two in three Chinese said the feeling was mutual.
For many Japanese, China's investments are a reminder of their own nation's diminished role on the world stage. After years of torrid growth, China in 2010 replaced Japan as the world's No. 2 economy, after the U.S.—a position Japan had held for more than four decades.
"On the one hand, Japan wants to take advantage of China's rise. But on the other, it can't stop worrying. It hasn't figured out how to deal with the new money and the newcomers," said Jianmin Jin, a Chinese economist who has watched China-Japan relations at the Fujitsu Research Institute in Tokyo since 1998.
It is difficult to calculate precisely how much money China invests in Japan, because some deals get done through third countries to avoid notice. China's net direct investments in Japan rose to a record $338 million in 2010, roughly 20 times the level of five years earlier, according to China's Ministry of Commerce. (In 2011, all foreign direct investment fell off a bit, including China's, after the Fukushima nuclear disaster.)
China lags behind other major investors in Japan, including the U.S. and the U.K., which spent $3.5 billion and $5.2 billion, respectively, in 2010. Still, experts tracking individual deals call the Chinese money an increasingly significant presence.
From April 2003 to March 2012, Chinese companies accounted for 97 of the 970 investment deals in Japan made by foreigners and coordinated by the Japan External Trade Organization, a government investment-promotion body. That put China in second place, after the U.S. with 293 deals.
At the same time, China's government investment fund appears to be buying stakes in Japanese companies. The Nihon Keizai Shimbun daily reported in June, based on an analysis of shareholder lists, that the Chinese fund owned 1% of all shares of companies listed on the Tokyo Stock Exchange.
Japan is chasing Chinese money of all sorts. In recent weeks the government inaugurated a special visa program for wealthy Chinese tourists willing to vacation in areas hardest hit by last year's tsunami.
Chinese investors have aided prominent Japanese companies still suffering from last year's tsunami and nuclear disaster. Taiwan-based Hon Hai Precision Industry Co., which assembles Apple Inc.products in China under the name Foxconn, agreed in March to take a 10% stake in Japanese electronics giant Sharp Corp. Also in March, Panasonic Corp. completed the sale of household-appliances operations to China's Haier Electronics Group Inc.
In some ways, Japan's response to Chinese investments echoes the U.S. reaction to Japanese wealth in the 1980s and the early 1990s. Japanese investments in American landmarks such as New York's Rockefeller Center and California's Pebble Beach Golf Course set off an uproar.
One congresswoman famously smashed a Toshiba cassette recorder at the Capitol, calling Japanese investments an "invasion." A bid by Japan's Fujitsu Ltd. 6702.TO +1.98% for a U.S. semiconductor company (later withdrawn) spawned a 1988 law giving the president authority to block foreign mergers and acquisitions seen as threatening national security.
In Japan today, the backlash is building just as quickly as Chinese funds arrive. Japanese lawmakers speculate that Chinese companies want technology or military intelligence.
"No one was worried when the Americans were buying our land, but China's entry is making a lot of people uneasy. After all, it's a country that we consider a threat," said Sanae Takaichi, an opposition politician who is crafting legislation that would tighten land-purchase rules by foreigners. "We can't afford to keep our guard down any longer," she said. Hers is just one of an array of such laws in the past year.
Later this year, Parliament is expected to pass legislation to protect drinking water that was born out of a 2010 territorial dispute with China. Some Japanese, including Ms. Takaichi, have voiced concerns that Chinese investors might drill up mineral water for export until springs run dry.
The law would give Tokyo new powers to monitor the safety of community water supplies—rivers, lakes, wells—on private property. While it applies equally to foreign and domestic landowners, the proposal was driven by rising foreign investment, particularly from China.
"We now need to put in place systems and plans to deal with problems that could result from increased investments from abroad," Hiroyuki Moriyama, a ruling party lawmaker spearheading the legislation, said in an interview. He said the time has come for Japan to decide whether or not to open its economy to foreigners further, including whether to restrict investments in sensitive industries or to ease immigration rules.
Some Chinese say Japanese racism undermines China's ability to do business here. After years studying Japanese, Sun Rong Qing arrived in Niigata in 2006 to open a branch of a food-trading company from Dalian, a Chinese port city. The 53-year-old businesswoman said she struggled to build relationships. Some people declined to shake her hand at social events, she said. Others called her derogatory names that were common during Japan's colonial rule, such as "chin-koro," an extremely derogatory way of saying "Chinese."
After a batch of made-in-China dumplings sickened a handful of people elsewhere in Japan, Ms. Sun said she suddenly faced trouble selling her soybeans—merely because they, too, came from China. "It is extremely difficult for Chinese companies to build trust here," she said. The branch office recently closed, and today she works at a Japanese-owned food importer.
In Tokyo, an attempt to brand a "Tokyo Chinatown"—a neighborhood bustling with Chinese businesses—to attract tourists and Tokyoites has been thwarted by non-Chinese business owners and officials in the area.
A group of young Chinese business owners cooked up the idea in 2008, but the project faltered as Japanese shop owners complained about their Chinese neighbors. The Chinese didn't sort their garbage properly, or they spread merchandise on the sidewalks, or erected signs that neighbors griped were visually out of character with the neighborhood.
"Together, we should be able to do so much to promote this neighborhood," said Hu Yifei, a 50-year-old Chinese business consultant and former Japanese ad-agency employee who heads the Tokyo Chinatown committee. "But building friendship has been so tough." Mr. Hu said invitations for drinks and parties from Chinese business owners to Japanese neighbors are routinely ignored.
The chairman of the local shop-owners' federation, Mitsuru Miyake—a second-generation hat-shop owner—opposes the idea of creating a Chinatown in his Tokyo neighborhood. "If they come and ask us to do business together, that would be fine for me," he said. "But I cannot accept the idea of turning this whole place into a Chinatown and do business their way." The neighborhood already draws plenty of shoppers, he said.
The port city of Niigata, however, could use some help. Its population is declining, alongside a retreat in heavy industry. The economy is in tatters.
Downtown is scarred by dozens of closed stores, including a once prominent department store at the city's busiest intersection. Niigata Prefecture's economic output shrank in 10 of the 13 years through 2009 (the latest data available), and overall was down 14% from 1996 levels.
Despite the fact that Niigata's controversial new Chinese consulate has yet to be built, the city is already seeing the benefits of having its China connection. In April, the consulate—operating from a temporary home in an old school building—helped to bring in a tourist group of 150 people from the Chinese city of Nanjing. Many were tour agents looking to design new trips for Chinese travelers who have already visited more popular cities like Tokyo and Kyoto. They admired cherry blossoms in bloom and spent a night at a hot spring resort.
"Strengthening our ties with China and the continent is the only way to compete with big cities," said Hiroo Ono, deputy governor of Niigata prefecture.
Executives from more than 100 Chinese companies are expected to visit Niigata in September for a seminar for prospective investors. To commemorate Chinese ties, Niigata has been staging various events including a calligraphy show featuring dozens of Chinese calligraphers.
Still, some residents, including many of Niigata's city assembly members, feel the city has more to lose from a bigger Chinese presence. "It's a consulate with just 17 staffers. I have a hard time understanding why they need 16,000 square meters [roughly four acres] of land for that," said Kaoru Sasaki, another Niigata assembly member. "I am against this plan."
Some speculate that it would be used for espionage activity. On Sunday an activist group affiliated with Mr. Fukaya, the city assemblyman, hosted a seminar titled "Your Life and Foreigners' Crimes—Examining Cases of Chinese Espionage," in a downtown event hall.
The speaker was Tadanobu Bando, a former investigator at the Tokyo Metropolitan Police Agency and author of books on crimes by Chinese residents. Mr. Bando said he examined both the merits and demerits of accepting more Chinese, but "the demerits are much larger than the merits."
In March, the city assembly voted overwhelmingly in favor of a resolution requesting the government restrict land purchases by foreigners. The resolution seeks restraints on purchases that could affect national security, among other measures. Thirty members supported the measure, 23 abstained, and just one voted against.
Niigata assembly members who abstained from the vote were attacked in anonymous blogs. One site posted their names and photos and said: "Let's remember these faces and protest!" One politician was called a "traitor."
"It's becoming more and more difficult for us to speak our minds," said Yoshiaki Kobayashi, the lone assembly member to vote against the resolution. "This reminds me of the years before World War II, when nationalism swept the whole country."
The vote can't stop construction, given that Japanese law can't void a private owner's land sale. But it puts pressure on the central government in Tokyo, which has requested Beijing to "gain understanding of local residents" before going ahead with the project.
Asked in parliament about the Niigata consulate dispute at a recent parliament session, foreign minister Koichiro Gemba said the government has asked Beijing for "detailed explanation" for the purpose of the new consulate. "The issue of land purchases by foreigners…is a theme that we will have to consider broadly over the coming years," Mr. Gemba said.
—Miho Inada contributed to this article.