Tensions in the South China Sea are ratcheting up. China and the Southeast Asian nations with competing territorial claims seem set on a collision course. Though still low, the probability of conflict is rising inexorably.

The current trajectory is lose-lose-lose for all concerned, including China, Southeast Asia and third-party countries in the Pacific Rim, such as the United States, that have a large stake in a peaceful South China Sea. At this point, the focus should not be resolving competing claims. Instead, diplomats must try to lower temperatures and get all sides to implement confidence-building measures to ensure peace and stability in the region. Only when cooler heads prevail can the concerned countries turn their attention to resolving the longer-term questions of the sovereignty and jurisdiction of the islands in the South China Sea.

The forty-year history of disputes in the region has seen a steady escalation in tension punctuated by occasional conflicts that have been quickly contained. Based on the vaguely defined "nine-dash line" (reduced from eleven dashes in 1953), China claims sovereignty over the Paracel and Spratly Islands and their adjacent seas in accordance with the United Nations Convention on the Law of the Sea. The other side is represented by the Association of Southeast Asian Nations (ASEAN) and includes Brunei, Malaysia, Philippines and Vietnam, which have more modest, but nevertheless competing, claims that overlap with each other and with China.

The latest escalation in friction started with a confrontation between China and the Philippines over the Scarborough Shoal. There also were competing international bids by China and Vietnam for oil exploration in areas of the South China Sea contested by the two countries. Efforts by the Philippines and Vietnam to get the support of their ASEAN counterparts at a recent ministerial meeting resulted in ASEAN's inability to issue a communiqué for the first time in the organization's forty-five-year history.

Cambodia, ASEAN's chair for 2012, refused to make reference to disputes in the South China Sea, starkly revealing the not-so-subtle influence of China. But thanks to shuttle diplomacy by Indonesia's energetic foreign minister, Marty Natalegawa, ASEAN emerged with a face-saving "common position" that reiterated six principles adhering to the declaration of a code of conduct and the Law of the Sea. ASEAN's joint communiqué, however, still hasn't been issued.

Following Vietnam's June 2012 approval of a maritime law that declared sovereignty and jurisdiction over the Spratly and Paracel Islands in the South China Sea, China objected strongly and upped the ante by announcing steps to actively administer the disputed islands and the Macclesfield Bank, as well as 772,000 square miles of ocean within its "nine-dashed line." Sansha, a 1.5-kilometer islet in a disputed part of the South China Sea, has been declared a city that will include a local government responsible for overseeing the area. Legislators and a mayor have been elected, and the Chinese authorities announced plans to station a People's Liberation Army garrison there to monitor—and defend, if necessary—China's claims over the area.

These developments merely escalated tensions and served neither China's broader strategic interests nor those of the Southeast Asian claimant nations.

China's recent actions in the South China Sea are likely to severely damage its ability to influence the region and the world on other more important issues. For example, China's economic strength relies in part on its economic integration with Southeast Asia that has helped build globally competitive production networks. That integration, which depends on good bilateral relations with its neighbors, is now jeopardized.

China already has few friends in the region. In a speech last year, Vice Premier Li Keqiang (expected to be China's next prime minister) said that China sought to assure the world that its intentions are to cooperate with other countries to smooth its emergence as a global power. This idea of China's peaceful rise has been a cornerstone of Beijing's foreign-policy strategy. Unfortunately, its Southeast Asian neighbors do not see China's actions matching its rhetoric.

By taking provocative actions in the South China Sea themselves, Vietnam and the Philippines are not altogether blameless in the latest series of events. They don't need reminding, however, that a confrontation with China is not in their interests or those of the rest of Southeast Asia.

The region's impressive economic performance over the last two decades has benefitted enormously from China's growth engine. Major investments have been made in developing production networks, and continued good relations with China hold out promise for more. Worsening relations could put this at risk. More importantly, Southeast Asian countries recognize the dangers of any armed conflict with China, which could increase manifold if the United States were to be drawn into the fight.

Finally, the growing risk of conflict is not in the interest of the global community, especially for countries that rely on peaceful passage through the South China Sea and those on the Pacific Rim. The global economy, already suffering from myriad challenges, cannot afford yet another layer of uncertainty.

Certainly, the potential costs of conflict for the region and the world far outweigh any potential economic benefits contained in the seabed of the South China Sea—much of which is unknown in any case. Rather than the availability of hydrocarbons and fisheries, the South China Sea dispute is now increasingly being driven by domestic public opinion in the countries concerned that is fueled by military lobbies and strong nationalist sentiments.

Stepping back from the brink is in everyone's interests. But this has to be done in a way that builds mutual trust and confidence. The current escalating tit-for-tat dynamic between China and the two ASEAN claimants—Vietnam and the Philippines—must be stopped, difficult as that may be, and perhaps even reversed. It necessarily will involve a series of carefully choreographed actions to gradually unwind present positions in a way that can satisfy their respective domestic constituencies.

Given his recent success at shuttle diplomacy, Indonesia’s Natalegawa could well be the man to thread this needle. Perhaps helped by a small team of internationally recognized statesmen, he could shuttle between the three key claimant countries—China, Philippines and Vietnam—to broker a deal. Natalegawa's recently burnished credentials as a diplomat have earned him the confidence of both sides. Moreover, such an approach could satisfy Beijing's reluctance to enter multilateral negotiations over the South China Sea while still arranging a collective stand-down.

But make no mistake, the real leadership and courage will need to come from the claimant countries themselves. Given the high stakes involved, let's hope that such leadership is forthcoming.

Vikram Nehru is a senior associate and Bakrie Chair in Southeast Asian Studies at the Carnegie Endowment for International Peace.