The most striking feature in this scenario is that the US, which till recently experienced strong growth while most of the other economies in the world system languished, had also begun to lose steam. It is now widely accepted that the principal factor underlying the dramatically different outcomes in the US when compared to the rest of the world, barring exceptions like the UK, was the fact that differential interest rates and confidence in the US dollar, had made American capital markets a haven for the financial investors. Large financial flows into American debt and equity markets strengthened the US dollar even while the deficit on the current account of its balance of payments widened, and triggered a speculative boom in financial markets, especially in new economy stocks.
 
Given the substantial direct and indirect (through pension funds) participation of many American households in the market, the sharp rise in stock market indices implied a substantial increase in the value of their savings. Since this inflated their wealth position, Americans turned confident about the future, and went out to spend, resulting in the fact that personal savings rates turned negative. Further, with private markets flush with funds, even relatively unknown and obviously risky start-ups, especially in the now busted dotcom area, had no difficulty mobilising capital for investments.
 
With consumption and investment demand sustained in this fashion, the fact that the Federal budget was in surplus and that the Fed was consistently raising interest rates to pre-empt inflation, mattered little. Growth remained high and productivity rose in the course of the boom. That boom also led to misplaced confidence. Rather than set aside surpluses for expenditures that can prove crucial when the boom exhausts itself, they were sought to be translated into tax cuts that would sustain the consumption splurge.
 
Once rising current account deficits moderated confidence in the US dollar and the collapse of the dotcom bubble took a toll on tech stocks, the spur provided by the US financial boom to consumption and investment spending, employment and incomes in the rest of the economy diminished. Unfortunately, government spending could not be raised since tax cuts were eating up surpluses and deficits were seen as unacceptable. The only instrument that was at hand to stall the slowdown was a cut in interest rates. However, despite more than half a dozen rate cuts by the Fed in the course of a year, investment failed to respond, resulting in stagnation in output and a rise in unemployment. What is more, with the rest of the world, especially the European Community, unwilling to respond equally to the rate cuts for fear of inflation, the differential in interest rates between the US and the rest of the developed world was shrinking, making capital flows into the US more dependent on confidence in the US currency and economy, which too was waning.
 
There are two implications that flow from this narrative. First, the terrorist attacks in New York and Washington, by disrupting financial markets, by raising costs and increasing the risk of bankruptcies in the airline and insurance businesses, by further dampening consumer confidence, and by reducing confidence in the US currency, are likely to aggravate the slowdown. There is a real danger that the slowdown could transform itself into a recession. It is this immediate likelihood that informed Alan Greenspan’s negative reading of short-term prospects in his testimony to the US Congress.
 
The second implication however has connotations that are positive from a narrow economic point of view. Developments prior to September 11 had made it clear that government spending to pump-prime the system and revive demand was the only real option to stall the slowdown in US growth. But conservative fears that this would contribute to inflation and adversely affect financial confidence, as well as the Bush administration’s commitment to abjure deficit spending even while cutting taxes, had foreclosed that alternative.
 
The September 11 incidents have changed that mindset in two ways. To the extent that there is unanimity in the US on the need to quickly restore normalcy, reconstruct the damaged buildings and compensate those likely to suffer commercial losses on account of the assault, purse strings are likely to be loosened and fears of deficits are likely to disappear. The much needed increase government expenditure is likely to materialise, though for reasons that were best not there. Estimates put the additional expenditure that is being undertaken and planned to exceed $60 billion. Further, with the Bush administration committed to its war in Afghanistan and possibly elsewhere, even when the enemy and the targets are not clearly defined, spending is likely to increase even if at the cost of many innocent lives.
 
Whether the relaxed monetary stance of the Fed and the rise in government expenditure would be adequate to neutralise the many factors that contributed to the slowdown prior to September 11 and the elements of the tragedy on that day that are likely to aggravate that sluggishness, is anybody’s guess. But tragedy has brought with it the macabre medium-term prospect that a recovery in the US may be one of the pieces picked out of the rubble in New York and Washington.
 
The answer to the question as to which possibility would prove to be the reality would also define the implications for the rest of the world, including India. For most countries, while the late 1990s boom in the US did not mean much in terms of faster growth, a downturn in the US does not augur well. It would worsen conditions in Japan, East Asia and even Europe. It would slow world trade, which has become important to all countries in the aftermath of widespread liberalisation. And it would reduce even the limited financial and direct investment flows many of these countries receive. The Institute of International Finance, which represents global banks and asset managers, has predicted that private capital flows to emerging economies will fall sharply in the wake of the terrorist attacks on the US, resulting in the most difficult financial conditions for these countries since the debt crises of the 1980s. It estimates that net private capital flows would drop to $106bn this year from $167bn in 2000, before recovering slightly to $127bn next year. Net inflows from private creditors will turn from $20bn last year to an outflow of $22bn this year.
 
Closer home, Indian business would be affected by any contraction in world trade or curtailment of investment, especially IT expenditure, in the developed world, by the already visible contraction in portfolio inflows into emerging markets and by any reticence on the part of international investors to grow their capacities in developing countries. Given the financial bias of the media, the Sensex is the focus of attention today. But much more could change in the days to come.
 
Meanwhile, in the effort to use the occasion to win support for one vis-à-vis the other, India and Pakistan are likely to go out of their way to please the US, within the parameters defined by domestic political compulsions. What this would mean in terms of economic policy and possible increases in external vulnerability only time will tell. But the prognosis cannot but be negative. US growth driven by a domestic tragedy and a war is likely to be less generous in terms of the distribution of the benefits of that growth across the world. And, with world attention diverted to the scale of the human tragedy in New York and Washington and the implications of that tragedy for the way civil society would function and evolve, much can happen on the economic front without it receiving the immediate attention it would have in more normal times. For developing countries generally, the possibility that the global campaign against the inequality and dominance that goes with globalisation may be replaced by a campaign in support of the war against terrorism could prove a setback.