For an already traumatized nation, America seemed to take the Oct. 7 news that the U.S. had begun bombing Afghanistan in stride. Stock prices slid, then recovered in the days that followed. Retailers reported that shoppers were still showing up at malls. CEOs exuded confidence that lower interest rates and fiscal stimuli had set the stage for a strong recovery sometime next year.
That also was the market-soothing message the Group of Seven industrial countries sought to project on Oct. 6, the eve of the U.S. strikes. At an unprecedented joint press conference at a Washington conference center, where reporters first had to pass through metal detectors and be checked by bomb-sniffing dogs, finance ministers and central bankers from the U.S., Europe, and Japan assured investors that the global economy will shake off its malaise and snap back smartly next year.
"NEW KIND OF UNCERTAINTY." It's a brave front. But lest anyone believe the U.S. and the rest of the world can rest easy, Treasury Secretary Paul H. O'Neill threw in a major caveat. "We have a new kind of uncertainty to deal with. It probably was always present, but we never reflected it in our markets because it was such a remote possibility."
Behind closed doors at the Treasury Dept. earlier that day, Federal Reserve Chairman Alan Greenspan was more explicit. He spoke at length with G-7 officials about the economic costs of business anxieties caused by the threat of terrorism. Greenspan noted that the cost of capital is rising as investors demand higher returns to account for bigger risks. The evidence: steep drops in global equities and sharply higher interest rates for bonds issued by emerging markets and all but the most solid corporations.
Even as the war heats up, many corporate bosses, especially in the U.S., warn against excessive gloom. "We have not curtailed things. We have not pulled the sheets over our head," says William R. Johnson, CEO of food giant H.J. Heinz (HNZ). Despite early shipment bottlenecks for parts and supplies, manufacturers such as Ford Motor (F) and Flextronics International (FLEX) insist the hiccups haven't seriously disrupted their businesses. And leading multinationals vow that anxiety about travel and fear of violence won't make them retreat from foreign markets. "This hasn't changed the way I feel about the need to globalize," says new General Electric (GE) Chairman Jeffrey R. Immelt.
SLOWER FLOW. Yet if Greenspan's hunch is correct, the implications are far-reaching. What if the war against terrorism is a protracted affair and terrorists manage to wreak more large-scale havoc in the U.S. and Europe? As companies worry more about the safety of their staff and facilities, the free flow of people and goods could slow, hurting economic efficiency.
Because of the higher cost of capital, investment won't return to boom-era levels. That, in turn, could mean that even when the U.S. emerges from recession, it will be hard-pressed to return to the 4% baseline growth rate it achieved during the go-go years of the 1990s. In short, America's golden age of prosperity -- and the promise it held for global growth -- may have hit its zenith.
The reason is that one of the chief casualties of this new era of insecurity is the very ideal of free-wheeling globalization that emerged in the past decade. Economists, including Allen L. Sinai at consultant Primark Decision Economics in Boston, figure that the freer flow of goods, capital, and people made possible by the dismantling of global trade-and-investment barriers contributed a good three-quarters of a percentage point to annual U.S. growth over the last half of the decade.
Open global markets led to a boom in trade, which swelled to 26% of global economic output in 2000, from 18% in 1990. Globalization helped disseminate investment capital, technology, and entrepreneurial ideas far and wide. It lowered prices for consumer goods, enabled manufacturers to boost productivity with just-in-time supply chains, and opened vast pools of technical talent to Silicon Valley.
NARROWER HORIZONS. Globalization certainly isn't going to disappear -- the world's markets are too vitally integrated to roll back now. But globalization could well become slower and costlier, crimping the high-productivity, low-inflation model of the 1990s.
Companies will likely have to pay more to insure and provide security for overseas staff and property. Heightened border inspections could slow movements of cargo, forcing companies to stock more inventory. Tighter immigration policies could curtail the liberal inflows of skilled and blue-collar laborers that allowed companies to expand while keeping wages in check.
Meanwhile, a greater obsession with political risk has companies greatly narrowing their horizons when making new investments. "What drove the rapid expansion in trade and capital flows was the notion that the world was becoming a seamless, frictionless place," says Morgan Stanley Dean Witter Chief Global Economist Steven S. Roach. "Now, there's sand in the gears of cross-border connectivity. That's a huge tectonic change in the global landscape."
PLUGGING HOLES. Perhaps the best evidence of this cautious new era is the marked shift in U.S. foreign policy. (See BW Online, 10/12, "Fighting a Spreading Anti-U.S. Fire") After the end of the cold war, promoting economic interests became the top goal of American diplomacy as Washington mobilized to export its own model of open markets. But in these times, unfettered openness directly conflicts with Washington's new priority on security.
It's certainly a different world from the 1990s, when "the goals of American diplomacy and business were in sync," recalls Yale School of Management Dean Jeffrey E. Garten, who as a Commerce Dept. official in the first Clinton Administration led the U.S. trade push in emerging markets. "Now, instead of knocking down new barriers, foreign policy will likely be more focused on addressing the many holes and vulnerabilities in the system. This is what will have to happen in this new war."
Greenspan's concerns are just one hint that the carefree nature of globalization has taken a severe jolt. You sense it from an executive with a major U.S. airline who says his carrier's flights to London have been half full since the U.S. bombings began. "International travel will tank if the terrorists retaliate," he says. And United Technologies (UTX) CEO George A. David says: "We took a blow to confidence as a nation. People don't do discretionary things, and they don't go to strange places. Travel is all about strange places."
WIDESPREAD ANXIETY. You can see it on the U.S. border with Mexico, where cargo-laden trucks take up to seven hours to make the crossing, compared with one or two hours a month ago, now that tighter security policies require every single vehicle and container be opened and inspected. "If you go to Laredo, [Tex.], the busiest cargo border crossing, you'd be astounded -- it looks like some of those trucks are trying to cross the Iron Curtain," says Richard N. Sinkin, managing director at San Diego-based manufacturing consultant Inter-American Holdings Co.
You also hear it from foreign-born entrepreneurs such as Vivek Wadhwa, CEO of Cary (N.C.) software company Relativity Technologies. Wadhwa, a native of India, says he was forced to show I.D. to a retail clerk who thought he was an Arab -- and accused him of shoplifting. "You people think you can come to our country and do what you want," said the clerk, threatening to call the cops. Says Wadhwa: "I think America is going to look inward now. It's a different country."
Anxiety is just as palpable abroad. In Britain, fears of attacks have sparked a run on gas masks and made the financial-services industry "distinctively nervous," says PricewaterhouseCoopers partner John Hitchins.
In India, execs fret that a U.S. clampdown on visas for the nation's software engineers, plus a new wariness of outsourcing sensitive work to foreigners, could severely damage the nation's thriving information-technology services industry. And with security specialist Kroll ranking India just below Afghanistan in political risk because of terrorist threats and possible war with neighboring Pakistan, execs fear new foreign investment will grind to a halt. "Economically, the world will be divided again," says a Bombay-based U.S. telecom exec. And in once-stable Indonesia, mounting signs of radical Islamic unrest aimed at U.S. and British interests have expatriates packing their bags.
HIGH RISK, HIGH COSTS. Needless to say, it's not an environment that fosters global commerce, especially since economies were slowing well before September 11. HSBC Holdings forecasts that global trade, after surging 12.6% in 2000, will expand a mere 0.9% this year, and just 2% in 2002. That should translate into weaker growth.
A major reason is that higher risk means higher costs. Just as insurance costs for Central London offices leaped fourfold after the Irish Republican Army bombings in the early 1990s, rates are likely to leap for companies with properties anywhere terrorism is a threat. Liability insurance for staff will rise, too. "These costs will have to be passed on through product prices and will force companies to rethink where they should be doing business," says insurance and risk-management professor Jerry S. Rosenbloom at Wharton Business School. "The impact will be felt throughout the world."
If disruptions at border crossings become a fact of life, companies will have to stockpile more spare parts, which will hike costs further. Hundreds of U.S. companies with manufacturing or assembly operations in Mexico, from major Detroit auto makers to data-processing companies, are rethinking their logistics.
Auto-parts maker Delphi Automotive Systems, which runs 56 plants in Mexico and moves 200 trucks across the border each day, has started shipping parts in smaller lots and is dispatching trucks more frequently. If there's a delay at the border, "we could redirect shipments to a plane, boat, or helicopter," says Mark Lorenz, Delphi's vice-president for logistics. Before September 11, Delphi's worst-case scenario was labor strikes by dock-workers or truckers in Brazil or France. "We never really planned for this kind of event, even during the gulf war," he says.
IMMIGRATION CHILL. Tighter U.S. immigration policies could also develop in the wake of the war. Swelling immigration played a key role in the success of the New Economy. It helped hold down labor costs, allowing the economy to grow faster and for longer without igniting inflation. Legal immigrants, who accounted for two-thirds of the record inflow of 14 million foreign nationals in the 1990s, accounted for 34% of workforce growth over the decade. Some 30% of Silicon Valley startups were founded by ethnic Chinese or Indians.
But a chill is settling over U.S. immigration policy. In the short run, America will tighten border security. The antiterrorist legislation pending in Congress would triple the 334 Border Patrol agents who police the 4,000-mile border with Canada -- and crack down on the thousands of visitors who overstay their visas.
Harsher measures are also cooking on Capitol Hill. Representative Tom Tancredo (R-Colo.) has introduced a bill that would halt all immigration for six months. Senator Dianne Feinstein (D-Calif.) is pushing for a six-month moratorium on all student visas to give the Immigration & Naturalization Service time to put into place a system to track foreign students.
The worry is that curbs on immigration will come back to haunt the U.S. "The economic boom of the late '90s probably never would have happened if not for the immigrant flows," says Mark M. Zandi, chief economist at consulting firm Economy.com. "The next quarter-century will be marked by a lack of qualified labor, especially in tech fields," because of America's aging workforce.
RESHAPING THE MAP. Just as the U.S. is rethinking immigration policy, companies are contemplating a globalization that is less global. Despite what companies say about not changing any plans, curtailment of overall foreign investment is already under way.
Few companies will admit they're giving up on a country, especially if they've already invested serious capital. But Vince Tobkin, Bain & Co.'s top IT consultant, says corporations are flocking to only a handful of nations -- such as China, South Korea, and Mexico -- that are seen as stable and growing.
Any place that smacks of political instability, has a volatile currency, or simply has lackluster growth prospects is off the map of most multinationals. Most of the Arab world is seen as toxic. And parts of Latin America and Southeast Asia, including Indonesia and the Philippines, also are off-limits.
PUSHING FOR PROGRESS. That's why restoring confidence in the safety of the global economy is emerging as a vital challenge for the Bush Administration as it wages war on terror. Treasury and Congress are working with U.S. banks to devise better ways to police money-laundering for global crime syndicates without overly interfering in markets. U.S. Customs is racing to implement new technologies that can electronically monitor cargo shipments without completely clogging borders. And U.S. Trade Representative Robert B. Zoellick is working to make sure the World Trade Organization summit in Qatar, intended to launch a new global trade round, comes off on schedule in early November.
"Because of the terrorist attacks, the major trading nations have shown more determination to push on with the trade agenda," says WTO Director-General Designate Supachai Panitchpakdi.
But with unresolved issues ranging from agriculture to antidumping rules, it's far from clear that a WTO meeting will be successful, if it takes place at all. In this new environment, how many nations have the stomach for measures that could cause disruptions? Openness was the ideal of the 1990s. Now, safety is paramount. The task is to secure both. The future of global prosperity depends on it. By Pete Engardio in New York and Rich Miller in Washington, with Geri Smith in Mexico City, Diane Brady in New York, Manjeet Kripalani in Bombay, Amy Borrus in Washington, Dean Foust in Atlanta, and bureau reports