The war of words between the United States and Pakistan in recent weeks has put in stark relief the two core strategic conundrums Washington has vis-à-vis Islamabad, as well as the integral role India plays in both of them. The first is to encourage a more constructive Pakistani approach in Afghanistan, which Islamabad regards as a theater for its endemic rivalry with New Delhi. The second is to steer a nuclear-armed but deeply dysfunctional Pakistan away from failed state status, a harrowing prospect that many believe is all too plausible unless Islamabad is convinced that its prospering neighbor to the East actually represents an economic opportunity rather than an existential threat.

The Obama administration entered office believing that Pakistani cooperation on Afghanistan was a function of addressing its acute security anxieties regarding India. Two weeks before the November 2008 election, Barack Obama declared that resolving the perennially-inflamed dispute over the Kashmir region was one of the “critical tasks” for U.S. foreign policy and worthy of “serious diplomatic resources.” It was a valid observation but the manner in which Washington pursued it guaranteed a quick failure. Moves to appoint a turbo-charged envoy (in the person of Richard Holbrooke) with the mandate of mediating the Kashmir issue– similar to U.S. efforts to broker the Middle East peace talks – met with Pakistani approval but proved too much for the sovereignty-conscious Indians to accept.

For the past three years, Washington has struggled to find a way to bring the two sides together and focus them on their common interests. Fortunately, the parties may have found one themselves. Despite the obvious displays of mutual suspicion in both capitals, a consensus is growing in the two countries – especially evident in their business communities – that the time has come for a more normalized relationship.

After a three-year hiatus caused by the 2008 terrorist strikes in Mumbai, India and Pakistan have restarted their peace dialogue. In July, Pakistan’s new foreign minister, the 34-year-old Hina Rabbani Khar, held unexpectedly warm talks in New Delhi, where she emphasized that a “mind-set change” was occurring among younger Indians and Pakistanis. Last month, for the first time in 35 years, Pakistan’s commerce minister visited New Delhi, bringing with him a notably large business delegation. The trip was especially productive. The two countries pledged to more than double their two-way trade flows – to the $6 billion annual level – by 2015. They agreed to ease visa rules for business travel and to open a new customs post at the Wagah border crossing that lies midway between Lahore and Amritsar. Islamabad also committed to extending “most favored nation” trade status to New Delhi, reciprocating the status India earlier conferred upon Pakistan. This last development promises to enliven the 2006 South Asia Free Trade Agreement which up until this point has been all but a dead letter. India’s commerce minister, Anand Sharma, captured the spirit of the meeting when he exclaimed that “only shared prosperity can bring lasting peace.”

The annals of India-Pakistan relations are filled with numerous false dawns and the current moves toward greater economic engagement could well founder upon the sharp historical animosities that regularly bedevil bilateral affairs. But things may be different this time. Reports out of Islamabad indicate that the Pakistani government realizes the country is in desperate economic straits and that closer ties with India constitute a much needed lifeline. The military establishment is also said to understand that the eastern border needs to be stabilized so resources can be focused on combating rising internal security threats.

If enhanced trade ties were to develop between South Asia’s largest economies, they would produce significant economic and (eventually) security dividends for both countries. Despite the common civilizational and historical bonds that permeate South Asia, as well as the unified market forged by the British Raj, the region today is remarkably fragmented economically. Trade flows between India and Pakistan, for instance, represent a miniscule fraction of each country’s overall trade portfolio.

Wagah is the only vehicle crossing along the 1,800-mile-long international border. The two-lane road there is only open a mere eight hours a day and the cargo that passes through it must be unloaded and transferred to local trucks. Indeed, the crossing, which some refer to as the “Checkpoint Charlie of South Asia,” is better known for the Kabuki-like displays put on by the border guards than as an efficient transit point.

The pervasive barriers to bilateral economic cooperation have also spurred circuitous and highly inefficient trade patterns. A booming India requires cement for its construction sector yet is forced to import it from Africa instead of Pakistan, where the cement industry has excess capacity. Off-the-books trade – the value of which easily rivals official levels – is also conducted via third countries like Dubai, Singapore and Afghanistan. According to various studies, a more liberalized trade regime would increase bilateral exchange at least 20 times above current figures as well as boost economic prosperity in both countries.

The Obama administration would do well to reinforce the current stirrings by launching a Marshall Plan-like initiative geared toward the expansion of cross-border economic linkages between the two countries. One of the keys to the Marshall Plan’s far-reaching success was the major financial inducement it gave European countries devastated by World War II to frame their economic futures in conjunction with their neighbors. By putting an emphasis on reconstruction projects that crossed national frontiers, it was an important catalyst for the historic reconciliation between France and Germany and paved the way for the deep economic integration embodied in today’s European Union.

A similar vision should inspire a U.S. effort to bolster cross-border economic cooperation between India and Pakistan. This initiative would be aimed at helping the two countries, on a joint basis, upgrade and expand the meager transportation infrastructure presenting connecting them. It would support projects that increase road and rail linkages, as well as the number and capacity of customs posts. It would help provide resources for modernized seaport facilities that enable more two-way trade. And with each country plagued by chronic power shortages, it would help bankroll cross-border energy projects such as joint electrical grids or the proposed natural gas pipeline connecting Central and South Asia via Afghanistan.

This effort would dovetail well with the “New Silk Road” initiative that Secretary of State Hillary Clinton announced in Chennai this past July, to foster the economic integration of Central and South Asia. Indian Prime Minister Manmohan Singh, who was born in what is now Pakistan, has spoken eloquently of the powerful role stronger economic linkages can play in bridging South Asia’s deep political fissures. In early 2007, he spelled out his vision for regional integration:

“I dream of a day when, while retaining our respective identities, one can have breakfast in Amritsar, lunch in Lahore and dinner in Kabul. That was how my forefathers lived. That is how I want our grandchildren to live.”

For his part, Pakistani President Asif Ali Zardari has even expressed the hope that India and Pakistan could one day join together in an economically-unified zone like the EU.

The original Marshall Plan entailed a staggering sum of money – well over $100 billion in today’s terms – and an austerity-minded U.S. Congress would certainly balk at any scheme with a similar price tag. But the initiative outlined here need only entail a modest level of expenditures – say, $50-75 million per year over a five-year period – and could be paid for by redirecting funding already authorized under the 2009 Enhanced Partnership with Pakistan Act. Better known as the Kerry-Lugar-Berman bill, the act provides $1.5 billion annually in non-military assistance to Pakistan through 2013. But due to a variety of factors, much of its economic development funds remain unspent.

To avoid potential concerns in New Delhi and Islamabad that Washington might try to extract diplomatic concessions from specific funding decisions, resources could be routed through the World Bank or the Asian Development Bank, where professional staff would assess the viability and impact of proposals submitted jointly by the two countries and make final judgments on which projects go forward. Additional countries, such as those assembled by Secretary Clinton in New York last month to discuss the New Silk Road plan, also could be invited to contribute resources.

Obviously, this initiative offers no magic bullet for transforming the singular intensity of the India-Pakistan strategic rivalry. But it would be a creative investment in nurturing promising developments already underway in both countries, which if they take root over the long term would help lead to a game-changing situation in South Asia: One in which Islamabad looks upon New Delhi more as a partner than as an outright enemy. If such a development came to pass, U.S. interests in the region would be vastly easier to safeguard than they are today.